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

I think we'll get going. I'm Jeff Meuler, Baird's information solutions analyst. Pleased to introduce Gartner, probably a brand that all of you know, a leading provider of insights and advice across all corporate functions. It has a business model that combines excellent organic growth with really strong capital efficiency. I'm going to hand it over to Craig, who's on stage with me. Craig has been the CFO since 2014. He's been at Gartner since 2002. In the audience with us, we also have David Cohen, the SVP of IR; as well as Mike Orlando, the Group Vice President of Finance. But with that, I'll hand it over to Craig for a brief overview, and then we'll get into Q&A. If you'd like to send in a question for the Q&A, I think it's [email protected]. It's on the placards on the table. So with that, over to you, Craig.

Awesome. Thanks, Jeff. Thanks for having us, and thanks, everyone, for joining us this morning. Before I jump in, obviously, I just want to make sure, we will be making forward-looking statements. So we have that now covered here. So I'll give you a really quick intro to Gartner because I do want to give Jeff the bulk of the time on Q&A. But we are and have been a growth company for the last 15-, 17-plus years. We're closing in on $6 billion in revenues. We're a global business. We've got about 19,000 -- close to 20,000 people around the world. And we're not new to this game. We've actually been doing it for a really long time. When we think about what is the value of Gartner or how do we talk about ourselves in terms of -- with investors, we really think about 3 primary things. So number one is we are committed to being a consistent and sustained double-digit top line grower. There's a lot of reasons for that, I'm sure we'll get into them, most notably huge untapped market opportunity for us. We can grow efficiently and modestly expand margins from our baseline where we are now in the low 20s, deliver double-digit growth and modestly expand margins each and every year. And then lastly, we are a free cash flow generation machine. And Jeff alluded to it a little bit, but significant free cash flow well in excess of net income, think between 140% to 160% of net income on an annual basis. And we get that because -- predominantly because our research business, which is our largest business, essentially, we invoice upfront, collect and then recognize the revenue and deliver the services in arrears of actually collecting the cash. So great model, and this is sort of the mantra for us, double-digit growth, modest margin expansion, huge amounts of free cash flow that we put to use to also increase and enhance shareholder value. We've been doing it for a while. Again, if I took the chart back to 2004, you'd see a similar trend. So great contract value growth, which is the best measure we have of both current and future research growth. And on the bottom, you can see the free cash flow generation really ramped up in 2020, but on a pretty significant growth trajectory there as well. Essentially, the core value proposition of our research is helping executives achieve their goals and accomplish their mission-critical priorities. We do that through a variety of different ways, which you can see here on the slide, which I won't belabor. And then lastly, I'd say we've got a monstrous untapped market opportunity. So we estimate it at around $200 billion spread across the various functional areas that we serve. And you can see that little tiny sliver on the right is our overall contract value today. So a long way to go, long runway to go to go capture that market opportunity. And then lastly, business model is all about -- it's a recurring revenue business, high renewal rates, high contribution margins, low capital intensity and upfront invoicing. And so we generate huge amounts of free cash flow that we put to use through share buybacks and strategic value-enhancing tuck-in M&A.

Awesome overview. I want to pick up off of that. So you joined in 2002. Your current CEO, Gene Hall, joined in 2004. You gave us a lot of the metrics, but I think organic contract values average something like 11% over Gene's tenure. And there's only one down year, minus 1 in the financial crisis, so very resilient. What's the business case study? And like why that happened? Like what were the big changes that you put into place starting around 2004? Because I don't think it was obvious at that point in time or people would have made a heck of a lot of money in your stock, just that you are going to become the one to dominate the syndicated research market for corporate functions.

Yes. I think it's probably 3 primary things. So one is the whole value of the business is based on our research business. And we had lost a little bit of sight of that, and we're worried about getting disintermediated by Google or something like that back in 2001, 2002, 2003. And so Gene came in and put an enormous focus on we are a research or insight business, and we need to make sure that, that is the thing that fuels all of our growth. And then what are the things that we need to make sure that we can consistently deliver that growth? And so one of the primary things we did was we had been shrinking our sales force. And I tell this long-winded story, but I won't -- I'll spare you. Gene basically came in, I remember one of my first meetings with him, I was running financial planning at the time. He was like, Craig, don't you think there's a correlation between shrinking CV and top line and having fewer salespeople? And I'm embarrassed to admit it, I was like, maybe. And so we really embarked on getting a view of the overall market opportunity, which we had a lot. That confidence was very large. And once we did the math on, proved it was really large. And then the way we're going to go get that is by growing the sales force. And we've been consistently growing the sales force, probably compound annual growth rate of 10% or 11% over the last 15 years, and we've slowly but surely been capturing that market opportunity. But as you can see, a long way to go. And so short answer is focus on research, make sure we've got great insights and great products and make sure we've got enough salespeople to go capture the market opportunity.

And then you've structurally increased your margins relative to pre-COVID. I think part of that is reengineering the business in response to COVID. But there were also a lot of big changes in 2019 that were harder to see the effect of because the pandemic onset. So what did you change about the way you operate the business in 2019?

Yes. I mean, I think historic -- just a little historical context there. So in 2017, we did a major -- we actually had 2, but 1 major acquisition when we bought a company called CEB. And it's a $3.5 billion deal. We had -- we were probably a $2.5 billion business at that time. They were a roughly $1 billion business. And there was a lot of complexity associated with the transaction. We ended up divesting large chunks to really focus on the core asset that we acquired. And then we actually invested pretty heavily behind making the CEB research business like the Gartner research business from an insight perspective, from a service perspective and from a sales perspective. And so if you think about, in 2019, we had come through 2.5 years of pretty heavy investment. And we had seen our margins come down quite a bit from, call it, 18% to 19% pre-acquisition to in 2019, we delivered 16% margins. And so about halfway through 2019, we tapped the brakes on investment and said, you know what, we've invested a lot behind the business. Let's make sure we actually now get returns on those investments. And so in July, August of 2019, we slowed sales force headcount, which have been really accelerated over the past 2 years, and we slowed other areas as well. Then the pandemic hit. And we had already tightened our belt in a lot of areas. And so we were actually probably better prepared for the pandemic than a lot of other companies out there. But we learned a lot, to your point, about the -- through the pandemic as well. And so I think if you think about going from 16% prepandemic margins to now we're saying our structural margins are in the low 20s, there's probably 3 or 4 major changes that have impacted that. Number one is what you alluded to, which is more carefully calibrating the investment in headcount growth with overall contract value growth. And so what we said in '19, and we've been -- we'll live by this moving forward, is we're going to grow our sales force headcount about 4 to 5 points lower than our contract value growth. Essentially, the goal there is to keep cost of sale essentially flat or stable moving forward. So that was a big change, number one. And that obviously helps because we were actually degrading cost of sale when we're investing so fast in adding sales headcount. Second big thing is the acquired businesses, which we now call GBS, we put a lot of money behind and hadn't grown in a number of years. And we had a high degree of confidence that we could grow them, but they hadn't grown in a number of years. And so that put a lot of pressure on the margins. And so actually, if you look at where we were prepandemic with the GBS business, call it, $600 million, $650 million of CV, now it's about $1 billion of CV. That scale that we grew there obviously help the economics quite a bit as well. And then the last 2 things, I'd say, are, one, we determined, through the pandemic, that we could travel less or, I should say, travel more effectively and efficiently, spend less on travel. And the fourth thing is we could spend less on facilities as well. So sort of the cocktail is the combination of those 4 things leading us to having much higher structural margins.

And I just want to highlight one point. The low 20s EBITDA margin is while you have a lot of growth investment in the business? So like the long-term margin could be even higher?

Well, that's right. And so again, the commitment we've made from a medium-term objective perspective is to grow the top line at double-digit growth rates, while also modestly expanding margins. So growing EBITDA a little bit faster than the top line. And again, that combination kicks off huge amounts of free cash flow as well.

Let's do the cyclical component on research contract value. As I said, only one down year. It was resilient and grew through COVID, but it has been decelerating lately. How much of that deceleration is in the tech vendor channel? What's going on outside of it? And is the value prop any different in the tech vendor channel or the way the product is sold?

Yes. Yes, sure. So we have a pretty unique market that we serve in that we serve every industry. We serve companies of all sizes, and we serve geographies around the world. The only place where we're overweighted is tech vendor, which is why we've been talking about it. And that market, on average, performs like our average contract value growth. Obviously, in 2021, when the tech market was on fire, we actually saw above-average growth for that segment. In fact, as we talked about last quarter, our year-over-year compare, going back to Q1 of '22, that business was growing high teens and is now mid-single digits. So it's still growing, but obviously, going from high teens to mid-single digits can drag down the overall contract value growth rate. With our enterprise end-user markets, which consist of chief information officers and their teams within GTS and all of the GBS business, we're performing really well. Obviously, the compares are super tough, especially for GBS, which a year ago was ringing up 22%, 24% year-over-year growth. We're still growing in the 16-ish percent range. So really, really strong growth. But those 2 businesses, despite the macro challenges, are continuing to perform really well.

And it still grew overall research contract value, I think, 10.4% organic constant currency. So...

I mean the other thing to note is even on the tech vendor business, with this modest slowdown, if you go do a look back, the compound annual growth rate has been double digits over the period and continues to be.

Yes. The investors got a lot more skittish on macro kind of like in mid-March and maybe people are less concerned today. But did you see any change in trend that was detectable in your business kind of like after mid-March relative to some of the slowing that you had already seen in '22 or early this year?

I mean the things that happened from mid-March on like Silicon Valley Bank and some of the regional banking stuff, it certainly didn't help. But I wouldn't say we saw anything really different. I think our experience with the tech vendors, we started to see a little bit of pressure, call it, Q2, Q3 of last year in the small tech space as venture capital funding really slowed and dried up. And so that put a lot of pressure on the really small tech side of our business. By Q4, we were seeing it, for lack of a better word, in fact, the entire tech business from the smallest companies all the way up to the largest companies. And again, as we made our way through Q1, we were dealing with clients in a market where people were laying off literally tens of thousands of people on a daily or weekly basis, which is obviously not the ideal sales -- selling environment. But again, we continue to make sure we're delivering value to our tech vendor clients. They're still great clients. They still spend a lot of money with us. And again, over the medium term, there's no reason why once they've finished recalibrating that they don't get back to growing in that 12% to 16% range that we expect.

So we really appreciate how many financial metrics you give us. One of them is new business sold. Talk about GTS new business sold. The year-over-year was actually better in Q1 than it was in Q4. That was surprising to me, given that it was not ideal selling environment late in the quarter.

And a tough compare as well, I would argue. And so the color there, and again, that's even with pressure in the tech vendor market. And so the implication, and again, we talked about this on our call, is the tech end-user market, new business was actually up year-over-year against the tough compare. And so again, it's a small quarter, seasonally small in both years and a tough compare, but certainly, a positive trend rolling from Q4 to Q1 that the new business growth stabilized.

Yes. And it's at a high level that's like way above the attrition rate, so very growthful.

Yes.

And then when you've had some slowdowns in the past, like the business doesn't normally slow a lot, it will go from like 14 down to 12 or something like that over a few quarters. But what are the leading indicators that you look to in the business to say, whatever slowing we're seeing, looks like it's getting through the system, and we're kind of approaching the front end of stabilization or reacceleration?

Yes. I mean it's really 2 angles. So it's the retention angle, which is really driven by engagement and client situation and then the new business angle, and I'll touch on both of them. So we are obsessed with engagement, and not just engagement for the sake of engagement, but engagement on high-value stuff that really supports our clients' most important priorities. And so our basic thesis is, as long as we're doing that, as long as we're delivering value on our clients' most important mission-critical priorities, that increases the odds of retention. And again, if you don't retain someone, you can't grow them. And again, as -- and Jeff, you've known our business for a really long time, we generate a significant amount of our growth from existing clients. And so our new business engine is not just find new logos, it's expand in existing accounts and find new logos. And so we're very focused on engagement. We're very focused on making sure that we are lining up proof of our value as we work through the retention cycle. And again, in tougher environments, the bar gets raised a little bit. And so what was good enough 2 years ago in a up environment is no longer good enough in a tougher environment, and we know that and we work through that. We also turn the crank on different elements of value that we know clients find value in, in a tough environment. Cost optimization is probably the best example. And so we help our clients, and again, this is across the entire portfolio, but most notably on the tech side, save a lot of money on renewals and new technology that they're buying, whether it be cloud services, Software as a Service, IT services, whatever it may be. And so when we turn that crank, that usually correlates to retention as well. So very focused on that. And then on the pipeline side, we're making sure that our reps are adding the right number of opportunities to the pipeline, that they are then moving those things through the pipeline. We're watching conversion rates. Obviously, we're watching pipeline velocity, but it starts with the top of the funnel. And we need to make sure that we are putting enough things into the top of the funnel, because we know, historically, things fall out. And in this environment, more stuff falls out. And so we've got to make sure that we've got the right level of pipeline, that we're working it through the pipeline and then converting at the right rate. So we're all over those things to make sure that we can continue to deliver growth. And also in tough environments, and we've seen this in 2009 rolling into 2010, 2020 rolling into 2021, we tend to explode back once the market stabilizes, and some of that is through win back. So just because you reduced your license doesn't mean we go away and stop bothering you. We stay very well connected to even licensed users that are no longer subscribing because they represent the lowest hanging fruit from a win-back perspective. And so we're all over that as well. And priorities change as markets change as well, and we need to make sure that we're well positioned to take advantage of that.

So you have at least guidance methodology that you're basically giving us the low end of the range, but you've also been significantly outperforming your guidance on almost all metrics the last couple of years. The Q2 EBITDA guidance seems to imply a still really good EBITDA margin. That's above what you're calling like your steady state or above what's implied in the full year guidance. What expense normalization is yet to occur? Because it seems hard to go from the first half EBITDA to the implied full year EBITDA margin.

Yes. I mean there is some seasonality and cyclicality within our business, most notably in conferences. And so Q2 is a very big quarter from a conferences perspective, and that helps reduce the margin. Q3 is a very small quarter. And a lot of our OpEx is fixed and rolls across, and so you see degradation there. Consulting is similar.

But Q4 is an even bigger quarter.

It is an even bigger quarter. And obviously, there's a lot of costs that come with that bigger quarter as well, both from a variable cost on conferences, travel, et cetera. So look, I think the way to think about it is if you look at Q1 sort of as, okay, you guys said you're fully staffed. That should be a good baseline run rate to think about. We do our wage or merit increase starting April 1. And that's -- again, the bulk of our costs are people costs. So that rolls through the P&L. We are traveling more, that flows through the P&L. And again, with the contract value, modest degradation, that obviously flows through on the top line as well. It puts a little bit of pressure on Q3 and Q4 operating margins as well. I think the moral of the story is we're delivering margins in the low 20s, which is what we've committed to. And it sets us up for what we want to do in the future over the medium term, which is drive double-digit top line growth, modestly expand our margins and drive huge amounts of free cash flow.

Okay. Let's do Gen AI. I'm going to ask like a couple of different questions related to it. And it's kind of interesting because you mentioned like...

Did you develop these questions. Or...

No, it did. But like I'm going to -- keying off of you said you were worried about like Google disintermediation risk back in 2002. And now there's an element of like is there AI disintermediation risk. But just first, like if we go to like Gartner conference, agendas or Gartner website, like Gen AI is obviously a popular topic. So...

It is, yes.

Does that drive conference attendance? Does it drive research sign-ups? Or do kind of like the shiny object tend to not really do that for your business?

It's hard to draw a direct solid line between any one topic in retention or signing up for a subscription. Again, as you mentioned earlier, and you hopefully weren't being ageist in pointing out my tenure at Gartner, but we wrote through so many different technology waves. And I think the thing to keep in mind is, yes, Gen AI is on every -- the tip of everyone's tongue and sort of frontal lobe for everything -- for everyone rather, but it's not the only thing. And they're still worried about cybersecurity, and they're still worried about data and analytics. And they're still worried about making sure they make the full transition to the cloud, and they're still worried about digital transformation, et cetera, et cetera. And so in my mind, this is another -- just another sort of wave. It happens to be a very large one. And I do think it will have lasting impacts on the world, but it's just another wave. And again, can we drive some demand through that wave? Absolutely. Can we drive some engagement through that wave? Absolutely. To your point, we had Gen AI sessions at our sales conference. We had Gen AI sessions at our marketing conference. We had Gen AI sessions at our finance conference because people want to learn about it and understand it. But it is just another one of those -- the waves keep coming. You don't know what they're going to be called, but the waves keep coming. And quite frankly, that's really good for us.

So they still need Gartner research after completing their SAP or Oracle transition?

Exactly. I'll go back even further, after Y2K, how about that?

How about as an internal productivity tool for research, for interacting with gartner.com, for your salespeople?

Yes. So we're very excited, but cautious, about the opportunities to really drive a better client experience and productivity through the enterprise. We're in the process of running a number of use case tests, both from a client-facing perspective and also from an internal process perspective. Like everyone else, everyone is really excited about it. We are very mindful of the fact that it's not perfect. And there have been lots of examples of hallucinations and other challenges. And look, we're helping our clients with their most important mission-critical priorities. The last thing we want to do is advise them on something that actually is a good advice that impacts their enterprise. So we're being very thoughtful about it, but I do think, to your point, on both the client-facing perspective and from internal operational execution perspective, huge opportunities to leverage tools like this. And again, we're all -- we've been leveraging AI and AI tools for a long time. This is the next generation that we're now looking at how do we actually embed within the way we do our business to drive productivity enhancements.

And maybe like if you can counter the risk factor element, like instead of asking a Gartner analyst or instead of searching gartner.com for content, what if I can use an AI tool and query and curate information that's publicly available? And is that a barrier to somebody signing on as a Gartner client?

Yes. I mean we don't think so at all. And there's a number of reasons why that is. So I think one is we have so much proprietary insight, data information, et cetera, that we have in our ecosystem that is not out there that is hugely valuable and, quite frankly, not replicable. And so if you think about we have 2,000-plus experts creating these insights, we have millions of search strings on gartner.com, we know every document that gets clicked on, every tool that gets used, every conference session that gets attended, that is all information and insight that influences the way we create our insights. That can't be replicated by a tool outside our firewall. And so, yes, we're just -- we continue to be focused on making sure that we are creating insights and data and tools and information and assets that help our clients with their mission-critical priorities and making sure it's significantly differentiated from what you can get through ChatGPT or a tool like that.

So we both highlighted Gartner's capital efficiency and free cash conversion. It is lower this year than normal. It's still good. But why is free cash flow conversion lower? And why did you not raise free cash flow guidance when you increased EBITDA guidance when you reported Q1?

Yes. I mean 2 things. So one is we're still delivering free cash flow well in excess of net income, in order of magnitude, $900 million to $1 billion worth of free cash flow. Two big reasons why it's a little bit lower this year, the conversion rate. One is, last year, we actually earned a lot of money, and so our cash taxes jumped up this year. The second is we actually had a divestiture that we closed on in February, and there's a significant tax burden -- cash tax burden associated with the gain on that divestiture. And so the cash taxes flow through operating cash flow, the proceeds from the divestiture do not. But moving forward, we would expect our free cash flow, absent those 2 anomalies, to be in the range of what we expect from a net income conversion or even EBITDA conversion rate.

So you don't give us contract value guidance, but one of the questions we got from investors, was there an implicit guide down on contract value and the slower contract value growth is an offset to the increased EBITDA guidance? Any change?

Yes. No, I think the primary thing that kept us from -- so absent the divestiture cash burden, we would have taken up our free cash flow guidance in May.

Okay. Let's do capital allocation, we only have a minute. What types of acquisitions would you consider? Is there something else that's even like chunky out there like a CEB? And then just buyback appetite and guidance assumptions.

Sure. So CEB was a pretty unique asset. There really aren't big things of scale out there. And so from an M&A perspective, our radar screen is largely populated with small, medium-sized tuck-in M&A. Again, we don't have to do M&A to support the growth rate. We believe we can achieve our growth objectives organically. And so absent M&A, our bias has been towards returning capital to shareholders through our buyback programs. 2021, 2022, we returned about $2.7 billion. I think our view is, at a minimum, we should be utilizing our free cash flow on an annual basis through our 2 capital allocation priorities, M&A and buybacks. And again, given the environment and given we don't need to do acquisitions biases towards buybacks, we try and be as opportunistic as we can from a pricing perspective. But over the long term, we want to deploy our free cash flow on shareholder value-enhancing initiatives.

And guidance assumes flat share count, not declining.

Correct. That's right.

All right. That's all the time we have for questions in this room. Please join me in thanking Craig for his insights. Craig, David and Mike will be available for a breakout session now in Astor Suite A.