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

All right. Good morning, everyone. Welcome. I'm George Tong. I'm very pleased to be joined by Craig Safian, CFO of Gartner. Craig, thank you for being with me.

My pleasure, George. Great to see you. Good to be here.

Likewise. So let's start at a high level. Gartner is in a very unique position to assess IT spending trends, given its leadership in IT research. Can you give us an overview of what you're seeing with enterprise IT spending, both from the perspective of just broadly at the industry level and then what you're specifically seeing with your customers?

Yes, sure. So Gartner Research, our latest forecast for 2023 is for global IT spending, order of magnitude, $4.7 trillion, up about 4% from last year. And obviously, within that overall global number, there are differing trends. So I think enterprise software is projected to be up double digits; IT services, up high single digits year-over-year; and some of the other segments within the overall global IT spending, a varying growth and declines. But overall, $4.7 trillion, a 4% increase year-over-year. As we look at our business, we are not directly tied to overall IT spending. Our mission is making sure that we are helping our clients accomplish their most important mission-critical priorities. And what we've been seeing in our business is our enterprise function leaders business, so that's IT leaders within GTS and all of the other leaders within GBS, those businesses are up. The contract value is up nicely, double-digit growth rates. We're seeing some areas of more strength and some of a little bit less strength, but overall, as long as we are helping our clients accomplish their mission-critical priorities, we are renewing those clients. And as long as we can articulate how we can help prospects accomplish their most important mission-critical priorities, we're able to convert those prospects as well. So $4.7 trillion, it's a big number, obviously, up 4%. And again, we help our clients optimize their overall IT spend and also we help them along a host of their other really important priorities as well.

Right. Let's unpack that a little bit. As you think about those buckets of spending, where are you seeing the greatest strength and where are you seeing the greatest weakness?

Yes. So I mean, again, in our overall business, as I mentioned, the enterprise functional leader portion of our research business is performing really well and very strong. And again, it's because we're helping our clients with their most important mission-critical priorities. So as I mentioned or as we mentioned on our last earnings update, IT end user, up double digits. GBS is up 15% year-over-year with HR and supply chain, those practices being -- are our fastest growing within the GBS portfolio. The pressure we're seeing is really on the segments of our business where we serve tech vendors. And as we've talked about, as that whole industry is realigning its cost base and figuring things out, that has put a lot of pressure on our both research contract value and non-subscription revenue business where we are exclusively serving the tech vendors. Once that realigns, we have a very high degree of confidence that we'll be able to get that segment of our business back growing at our medium-term objectives of 12% to 16%. We're just working through a pretty significant recalibration within that industry, but again, we're still focused on making sure we're providing great value to our tech vendor clients. We're still driving a huge amount of contract value and revenue from those clients. It's just they're in the throes of all that realignment and recalibration. But once they get through that, we're confident they'll get back to strong growth.

Yes. Generative AI, certainly a big topic these days. How do you see generative AI impacting Gartner's revenue prospects as demand for related research goes up in response?

Yes. No, it's -- I've been with -- as you know, George, with Gartner for almost 21 years now, and we watch wave after wave of technology come through. And any time a new technology wave comes through, I'd argue it's really good for us because our clients need to understand what's happening. They need to understand what to do, how to deploy, what are the best tools, what are the best governance models, how do I get best pricing on things, all those things where we offer significant level of help and support and insight. And so I'd argue any of the tech waves that have happened over the last 20 years and any that happen over the next 20 years are going to be a good thing for us. With the gen AI wave, which feels a little bit bigger and perhaps crested a lot faster than some other waves, I think there's 2 interesting things there. So one is it's actually a technology, but it is -- people care about it across the entire C-suite. And so it's not just germane to our GTS practice. CFOs care about it. CHROs care about it. Heads of sales, CMOs, you name it, they all also want to know what are the best ways to leverage gen AI. Is it a threat? Can I drive productivity out of it? All those things. The one thing I'd say, though, the way we've structured our business is within research, we serve roles. And we serve roles as opposed to serving technology waves because technology waves come and go, and sometimes the wave crests and there's nothing there, and sometimes it is a real thing. Roles are eternal, and so we want to make sure that we are serving roles. And so as a client or subscriber to Gartner, you get access to all of our AI-related research. And so there's not a first derivative benefit, if you will, of selling an incremental license or access to certain insights or anything like that. If you are a Chief Information Officer and suddenly, gen AI becomes one of your mission-critical priorities, we want to make sure that you have access to that because, again, we're intent on making sure that we serve your mission-critical priorities. I think the way to think about it is gen AI, and again, any major tech wave, is a second or third derivative benefit for us in a couple of different ways. So first way is we know that engagement on important stuff drives retention, and gen AI is important stuff, and we're seeing more and more searches and more and more readership and more and more webinar attendance. And that's a good thing for us, right? So the more engagement we have is always going to be a good thing on the retention side. On the new business side, we can start conversations or get our foot in the door leveraging all the great insights we have about gen AI. And again, we've seen significant attendance and uptake on the assets we're creating, the insights we're creating, et cetera. So there's not a direct in-quarter benefit kind of thing, but we definitely see second and third derivative benefits from gen AI wave just like any other tech wave we might see.

Right. And then looking within the company, how is Gartner deploying generative AI internally? What are the use cases? And what are the potential implications for revenue and margin performance?

Yes. So we have been leveraging artificial intelligence and machine learning and language models for a very long time to essentially drive productivity in the way that we run our business. And we are very intent on continuing to find new ways to drive productivity within the business, and gen AI and AI in general and large language models definitely have a lot of potential use cases across the business. So we are piloting a number of different things, but I'll give you a couple of hypotheticals. So a salesperson calling on a new client, we have a team in India that pulls together a pack for them. That's something that could be potentially automated, right? And again, I think as we look at these things, we're not seeing opportunities to cut significant costs. I think it's more in line with just running our business more efficiently as we continue to grow and scale. And so what it might mean is we need to add fewer people in the future, not that we're going to be able to reduce 100 people here or 200 people here. It's more about how we scale for growth. And so we're looking across a number of different use cases. I mentioned one. There are several others that we're looking at. It's funny. Within finance, and I spent a lot of time with our finance experts talking about AI and gen AI, large language models are great, but they don't do math, and finance people really like math. But there are AI tools that we can leverage that can drive efficiency and how quickly we close in variance analysis and things like that. So we're all internally very excited about the prospects of all the different ways we can leverage AI and gen AI so that we can scale more efficiently and productively moving forward.

Right. Now Gartner has long-term targets of 12% to 16% growth for GTS and GBS. What are the factors that should sustain that level of growth? And does generative AI impact that growth longer term?

Yes, I think -- I mean, there's a number of factors that give us a lot of confidence about that 12% to 16% growth rate. I think it starts with what I mentioned earlier, where our mission is to make sure that we are supporting our clients in accomplishment of their mission-critical priorities. And it's sort of -- it starts there, and that's really the biggest thing we need to make sure that we are doing. And if we are consistently doing that, we're very confident that we can drive the growth rate. The second thing I'd say is the addressable market is enormous and largely untapped. And so we estimate there's about a $200 billion market opportunity -- addressable market opportunity for Gartner Research, and we've got $4.5 billion of it. And so we're going to keep deploying salespeople and driving growth within existing accounts and doing all the things we've done over the last 15 years to get to where we are to be able to support 12% to 16% growth. And then the last thing I'd say is we are engineered to drive growth. And we are making sure that we are being more efficient and more profitable around the ways we drive growth, but we have every confidence that we can drive 12% to 16% growth in our research, which then translates into double-digit top line growth, modest margin expansion, which I'm sure we'll talk about a little bit later, and amazing free cash flow generating into the future. So it's sort of those are the ingredients that drive that long-term growth trajectory.

Right. Let's dive into some of the revenue trends you've been seeing recently. So in 2Q, GTS grew 9% year-over-year. A lot of that growth was led by enterprise functional leaders, which you talked about was a strength there. Can you talk about why spending there has been more resilient? Have we seen any changes in behaviors, customer uptake, budget cycles, et cetera? What's the latest view on enterprise functional leaders?

Yes. I think -- I mean, again, because we're helping our clients with important stuff, and we're helping them be successful on important stuff, that, again, is the crux of everything we do. And that's what drives the retention rates and allows us to bring in enough new business to drive the kind of growth rates we're talking about. I do think that the selling environment overall for the last few quarters has been more challenging than the selling environment from 4, 6 or 8 quarters ago. But we are -- to the point you made, we are working through it and still driving really strong double-digit growth. I do think that there's been the specter of a recession sort of as an overhang in every conversation we have. Every conversation I have with bankers, with clients, there is always a concern about what's lurking around the next quarter. I think -- or next corner, I should say. I think with the economy at least seemingly stabilizing and the macro environment stabilizing, we believe that, that is a great indication that we'll be able to get back to normal or "more normal" and be able to drive the great growth rates we talked about.

Right. And we touched on this a little bit earlier, but tech vendor spending is where you saw the most pressure recently, and that manifested itself on the non-transaction side or on the transaction side but also a little bit on the CV side. Can you unpack what you're seeing with respect to how tech vendor spending is impacting both the recurring and nonrecurring revenues of research?

Yes, absolutely. So on the recurring side or the contract value side, we are coming off of incredibly tough compares with our tech vendor business. So 12 months ago, that business was growing mid-teens. Now it's growing low single digits. It's still growing, though, I should note, but it's a big enough hunk of our contract value base that going from mid-teens to low single digits is going to drag down the overall. And as you mentioned, GTS was around 9% overall, and that's a combination of the tech vendor business and the enterprise end user business. I think, obviously, selling into clients who are either in the process of or have just laid off hundreds or thousands of people is going to be a tougher sell than when they're hiring tons of people or are stable. And again, that kind of goes back to the whole realignment, cost realignment I talked about earlier with our tech vendor clients. Again, CV is still growing. We're still delivering great value. They still need us. But clearly, selling into or renewing into an environment where they are scrutinizing every dollar and actually trying to reduce OpEx makes a challenging environment. But again, once they recalibrate, we really feel confident that we'll be able to get back to growth. And so that's the recurring revenue side of the business. On the non-subscription part of the business, the bulk of what we report for that revenue line is business that we sell to tech vendors, and we're essentially selling leads. It's our -- predominantly our small business -- set of businesses that help really small businesses pick the right software. And tech marketing budgets, as they've gone through this recalibration and realignment, have been under significant pressure, and that's where the monies for those businesses generally come from. Again, we're still driving a ton of revenue there, it's just off of really tough compares in a really challenging environment. And again, same future growth prospects apply where, again, once things recalibrate, we're very confident that we'll be able to get those -- that line of business or those lines of businesses back to the 12% to 16% growth rate that we expect for overall research as well.

Right. Now based on the latest trends that you've seen, have you seen a bottom form with respect to CV performance or transaction performances, one stabilizing faster than the other as you exit 2Q?

I think on the non-subscription piece, and we talked about this on our earnings update, the major driver there is pricing pressure. And so if there are fewer companies bidding on lead, that's going to impact pricing. The good news there is we've seen stabilization of pricing and so -- and that's what we've essentially modeled into our guidance for the balance of the year there. And so that, we feel pretty good about. In terms of calling the bottom, I've been doing this for long enough to know that you can't call the bottom until you're past the bottom. But again, I think we're still working through it, but over the medium term, same objective. We can grow that part of the business 12% to -- our recurring revenue part of the tech vendor business 12% to 16% for a long time into the future.

Great. Now let's talk a little bit about GBS. The growth there was stronger than GTS in 2Q, up mid-teens. Can you talk about some of the dynamics you're seeing there, especially as it relates to macro resilience? Would you say given where we are in the cycle, that part of the business has been and should continue to be more resilient than GTS?

I'd say probably equally resilient. I wouldn't say any more or any less resilient. Again, the GBS value proposition is the same as on the GTS side, and so it's just serving CHROs and their teams and CFOs and their teams and heads of sales and their teams and so on. But it's the same selling motion, it's the same engagement motion, it's the same retention motion that we have. And again, it's all about making sure that we are helping those leaders accomplish their most important mission-critical priorities. So I wouldn't say more or less resilient than the enterprise leader business on the GTS side. I'd say equally resilient.

And I guess as you think about the growth for GBS, what would you say are the external growth drivers and some of the company-specific internal growth drivers you see over the near to medium term?

So if you think about the overall opportunity, and we hit on this a little bit earlier, so we've estimated Gartner Research, GTS and GBS, has about a $200 billion market opportunity. The GBS portion of that market opportunity is $145 billion, and we've only got $1 billion of that. And so we are -- I would argue we are really early days on the GTS side, and then we're really, really, really early days on the GBS side. And so we are really just getting this business going. We acquired the bulk of these practices through the CEB acquisition we made in 2017. People didn't believe that they could grow. We've proven that they could grow and really grow in an accelerated way. And so we are really just getting going there. And our view is there's no reason why each of the functions within GBS can't be a $1 billion practice in its own right, right? So right now, we've got several practices that add up to $1 billion, but there's no reason why HR can't be a $1 billion practice and finance can't be a $1 billion practice and supply chain can't be a $1 billion practice. And so we've got a lot of catching up to do on GBS compared to GTS, but we're equally as excited about the growth prospects and the resiliency of both GTS and GBS.

Right. Let's talk a little bit about new business trends. So GTS new business fell a little bit in 2Q, down I think 2%. GBS, up low single digits, about 4%, low to mid-single digits. What's your outlook for new business for GTS and GBS? And what are the implications for contract value performance for research in the second half of the year?

Yes. So on the GTS side, you do have to disaggregate what's going on. And so -- and we called this out on our earnings call as well. So the enterprise end user business within GTS, new business was up high single digits year-over-year, and then the GBS numbers were up modestly on a year-over-year basis. And again, I would argue both of them against pretty tough compares, Q2 of 2022, when both of those businesses were really booming. I think as we think about the algorithm for contract value growth into the future, it is always a combination of retention rates and new business, and it's also a combination of what is the complement of our sales force look like in terms of where they are tenure-wise, where they are productivity-wise, et cetera. And so those are going to be the big drivers for the future. I think as we've talked about, we hired a lot of people in 2022. They are coming up the tenure curve. That may or may not drive a benefit in 2023, but it definitely will drive a benefit for us as we roll into 2024 and beyond as a larger percentage of our sales force is coming up the tenure curve. And we just know as they gain tenure, they sell more stuff, right? They renew better, and they sell more. And that's what we're focused on, on driving into the future.

Got it. On the topic of sales force headcount, as you know, that's a key growth driver of the research business. How's the hiring environment for sales? And what's your expectation for sales force headcount growth exiting this year and heading into next year?

Yes. So the environment has been and remains great. So Gartner has a wonderful advantage in that we have an extraordinarily great, well-known brand, if you will, for sellers around the globe. And so even when the markets were -- the labor markets were incredibly hot, we were still able to attract great people, and we did not have an issue hiring. We fell behind because we didn't have the recruitment capacity to keep up, which we've obviously rebuilt. And so today, what I'd say is we're even better at bringing in people because there's less pressure from externalities in the labor market and our turnover. Because of the massive recalibration that we talked about earlier within tech vendor and tech vendor sales in particular, there's less pressure on the outflow from us from a turnover perspective. So we're in a great place from a hiring perspective. We've got an amazing, world-class talent acquisition team within Gartner. We've got plenty of capacity so that when we want to turn the dials and go faster, we can go faster. We learned a lesson from 2021 to not let recruitment capacity ever wane down because we're going to need it, and so we've got it, and it's ready to go. In terms of headcount growth expectation, we are still operating under the algorithm of we're going to grow sales force headcount, call it, 4 or 5 points slower than the contract value growth so that we don't erode our sales expense as a percent of revenue. And so we're running a variety of different scenarios, and we can tune the dial for where we want to land the plan by the end of the year, and then more importantly, how do we get out of the gate quickly in 2024 with our hiring plans that align with our CV growth expectations for next year as well.

Right. Let's talk briefly about Conferences. That's the part of the business that surprised the upside the most. It caused you to raise the guide for the full year. Strong attendance with exhibitors, with attendees. How many in-person events are you planning for this year? How does that compare to pre-COVID? And do you expect Gartner to get back to pre-COVID in-person events ever?

Yes. So just kind of context, in 2019, we had low 70s in terms of number of destination conferences and about $475 million in revenue. Obviously, when the pandemic happened, that went to 0 and 0, which we quickly pivoted to virtual and actually managed to drive a decent amount of revenue in 2020 and 2021 before we got back to in-person destination conferences. This year, we're running 47 in-person destination conferences. And I think over the long term, our goal, our strategy, is to have an in-person destination conference for every major role we serve in every major region or geography in which we operate. And that means we're going to have a lot more than 47 conferences over the medium term. We can only launch so many new ones each year, and so it will take time for us to rescale that business, so to speak, and actually get towards that strategy of having an in-person destination conference for every major role we serve in every major region in which we operate. And so we'll keep adding conferences judiciously and efficiently. And again, the beauty of our Conferences business is it's a great business, but it supports our research business and is a wonderful vehicle to help drive retention and drive new business and drive our brand and drive awareness, et cetera, and also make a lot of money at the same time. So great business and, to your point, performing exceptionally well and continues to exceed our expectations.

Great. On the Consulting side, that historically has been probably the most sensitive part of Gartner's business. What are you seeing with trends with Consulting? And what's the sensitivity? Is it different this cycle compared to prior cycles?

I think for us, it's -- I think there's 2 things. For us, it's a little different. So our Consulting team has done a really fantastic job strategically making sure that we're driving stickier engagements, more repeat engagements, bigger relationships with clients and also narrowing what we do to really focus on the things that are most critical to our clients. And so by virtue of doing that, we're kind of always in the game with our clients. I think this cycle has been interesting in that we haven't seen necessarily a major pullback in tech projects and tech spending. So clients are still doing things, and they still need help, and Gartner Consulting is in a really wonderful position to help them with those things. And again, the more we're focused on big time strategic things with our Chief Information Officer clients, the more we're going to be in the game to drive that more predictable revenue. On top of that, our contract optimization business, which is a subsegment within Consulting, again, people are still purchasing software and cloud services and things of that nature, and our contract optimization team is still helping our clients save millions and millions and millions of dollars, and those purchases are still happening. So it's been a weird economic environment, and that's a technical term, weird economic environment. But our Conferences and Consulting businesses, which typically have been the canary in the coal mine, if you will, in terms of volatility, have performed really, really, really well through this environment.

Great. Let's shift our attention to margins. On the last earnings call, you noted that expenses this year have normalized from a sales force hiring and from a T&E perspective, suggesting that this year's EBITDA margins of about 23% should be theoretically the low watermark for EBITDA margins. To what extent will 23% be the low watermark for margins, and what are the puts and takes, too?

Yes. So just to be -- to clarify, what we said was the operating expense levels are normalized, if you will. And so if you were looking to roll out your models for the balance of the year, Q2 is a good full OpEx model. From a margin perspective, we continue to maintain that the fundamental margins of our business are in the low 20s and that we can modestly expand our margins from that level each and every year moving forward. And so as we work our way through the balance of this year, we are dealing with a somewhat modestly decelerating contract value line, which is going to put a little bit of pressure on the revenue line because the revenue lags the contract value decline a little bit, and that puts pressure on the overall margins. And again, for 2024 and beyond or 2024 in particular, the endpoint for contract value this year is the biggest factor that drives research revenue, Gartner revenue and Gartner margins for the following year. And so again, as we think about the sort of normalized number, all we were talking about on the Q2 call was the operating expense number, so revenue minus EBITDA. The operating expense number is a good number to extrapolate off of for the balance of the year.

Right. In recent quarters, Gartner has surprised to the upside with EBITDA margins and have raised the guide for the full year. To what extent could the factors that caused the company to beat persist? How persistent are those tailwinds?

Yes. Look, I think the last year -- 2021 and 2022, in particular, we had a constant recurring theme of revenues above our expectations and expenses below. And part of it was the environment, and we just weren't sure what was happening, and we were consistently beating to the upside on revenue and we were falling behind on hiring, and that was causing the bulk of beat on expenses. And a beat on revenue and a beat on expenses means a very big beat on EBITDA. As we've progress through this year, I think we've gotten much tighter in terms of the revenue and the revenue upside. And also, as we talked about on the expense side, we're no longer playing catch-up. We're actually caught up. There's still normal course hiring that we're doing to support our growth into the future, but we're mostly caught up. So I think the recurring revenue part of our business is pretty darn predictable, one of the reasons why we love it. Conferences has continued to outperform our expectations. We continue to raise our expectations. And so I wouldn't expect it to continue to exceed our expectations by as much as it has. But look, I mean, I think we're running the business and managing the business in a way so that we are set up to deliver double-digit top line growth and modest margin expansion going forward. We're going continue to manage the business that way, and we'll continue to kick off huge amounts of free cash flow as a result of that as well. And so we're just making sure that we're not managing quarter-to-quarter. We are managing this for the long term. It is a really long marathon that we're running. We want to make sure that we just continue to get great splits through the whole marathon and keep driving growth.

Right. You mentioned normalized EBITDA margins are currently in the low 20s. What would you need to see for that to improve to the low to mid-20s or the mid-20s?

I think that we are set up to be able to continue to modestly expand margins moving forward. And everyone's definition of modest is a little different, but over time, if we consistently drive double-digit top line growth and modestly expand margins from where we are, if you run that out, even with my definition of modest, which is very modest, you eventually do get to the mid-20s. And again, I think as we learn better ways to scale and better ways to optimize, there are certainly other opportunities for more step function margin improvement. But we're committed to make sure that we drive double-digit top line growth and modest margin expansion going forward.

Right. From a cash flow perspective, Gartner is on track to generate just under $1 billion of free cash flow this year. That translates into about 125% conversion from net income. How sustainable is that conversion? Should it go higher? And what are your capital allocation priorities for free cash flow?

Sure. So I think normal course, we can generate free cash flow of about 140% to 160% of net income. And I'd say towards the lower end if CV growth is decelerating, towards the upper end of that range if CV growth is accelerating. This year is a little bit wonky because we don't normalize anything in our free cash flow number. So our net income has a large gain from divestiture. Our free cash flow does not. We have pay to taxes on that large gain. That's in free cash flow. And so that's why we're only in the 125%, 130% range this year. But going forward, 140% to 160% is what we should be able to deliver. We have delivered that historically. It's sort of built into our business model, and we're very focused on making sure that, that happens. In terms of capital allocation priorities, again, to your point, we'll generate, order of magnitude, about $1 billion of free cash flow per year and growing over time. We want to buy back shares and do strategic value-enhancing tuck-in M&A. Our growth objectives are organic growth objectives, so we don't need to do M&A to support our growth objectives, but we will do it where we see really good deals where we think we can drive really strong shareholder value. But absent that, the bias will be towards buybacks. And again, if you look at 2021, 2022 and halfway through 2023, we've deployed about $3 billion worth of cash on buybacks over that 2.5-year period.

That's great. Well, we're just about out of time. Please join me thanking Craig. Well, it looks like we have a question here. Maybe a quick question here. Let's wait for the mic.

Just one clarifying one. The tech vendor apportion of the business is about 10% of your revenue?

So what we've talked about on the contract value side is it's about 25% of total contract value.

Okay. And then the second question is in your experience in past periods in tech where we see these waves of sea changes, whether it be cloud computing, phones, pick your thing and now it's gen AI, where do you -- what's kind of the cycle of the timing of when you start to see more business come your way when people are trying to parse through how to deploy these architectures? Is it -- maybe it's not in the beginning. I mean, this is a bit of a weird period post-COVID, but maybe it's not in the beginning. Maybe it is years 2 and year 3. Maybe just curious to hear your thoughts on this.

Yes. So we have a research asset called the Hype Cycle, which is a branded Gartner Research asset, which sort of tracks -- it applies to just about every technology wave you can imagine. And so there's a peak and then a trough and then a plateau of productivity. I think the plateau of productivity is where people are really deploying the new technology and driving value out of it. We're not there yet, but I think once it becomes sort of normal course as a part of a business like CRM has or cloud computing has or moving to the cloud has, that's when you really see the benefits of consistent support that we can help our clients with. Thank you.

Thank you, Craig.

You got it, man.