Gartner, Inc. (NYSE:IT) Q4 2022 Earnings Call Transcript

Gartner, Inc. (NYSE:IT) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good morning, everyone. Welcome to Gartner’s Fourth Quarter 2022 Earnings Call. I’m David Cohen, SVP of Investor Relations. At this time, all participants are in a listen-only mode. After comments by Gene Hall Gartner’s Chief Executive Officer and Craig Safian Gartner’s Chief Financial Officer. There will be a question-and-answer session. Please be advised that today’s conference is being recorded. This call will include a discussion of fourth quarter 2022 financial results and Gartner’s outlook for 2023 as disclosed in today’s earnings release and earnings supplement both posted to our website, investor.gartner.com. On the call, unless stated otherwise, all references to EBITDA are for adjusted EBITDA. With the adjustments as described in our earnings release and supplement.

All growth rates in Gene’s comments are FX neutral unless stated otherwise. And its contract value comments exclude Russia from 2021. All references to share counts are for fully diluted weighted average share counts unless stated otherwise. Reconciliations for all non-GAAP numbers we use are available in the Investor Relations section of the gartner.com website. Finally, all contract values and associated growth rates we discuss are based on 2022 foreign exchange rates unless stated otherwise. As set forth in more detail in today’s earnings release, certain statements made on this call may constitute forward-looking statements. Forward-looking statements can vary materially from actual results and are subject to a number of risks and uncertainties, including those contained in the company’s 2021 Annual Report on Form 10-K, quarterly reports on Form 10-Q, as well as in other filings with the SEC.

I encourage all of you to review the risk factors listed in these documents. Now, I will turn the call over to Gartner’s Chief Executive Officer, Gene Hall.

Gene Hall: Good morning, and thanks for joining us today. Gartner drove a strong performance in the fourth quarter with double-digit growth in contract value, revenue, EBITDA and EPS. We generated nearly $1 billion in free cash flow and we returned even more than that to shareholders through our ongoing share repurchase program. Enterprise leaders are dealing with high volatility and uncertainty. Inflation accelerated to the highest level in 40-years. The dollar was the strongest it’s been in 20-years and it remains extremely volatile. There are ongoing supply chain issues, energy prices has been volatile. The labor market has been volatile. Enterprises are assessing the impact of remote versus hybrid versus in-person work. There are widespread concerns of a recession.

All of these factors and more impact enterprises around the world. Leaders need help navigating this turbulent time and they know Gartner is the best source for that help. Our services often make the difference between success and failure for executives and their enterprises. We help clients succeed with their mission critical priorities, whether they’re in growth mode or cutting costs. With all this volatility, our most recent research shows that Chief Financial Officers are more carefully scrutinizing expenses. But at the same time, they’re increasing investment and mission critical priorities. Even in enterprises, they are under extreme financial pressure. Our research business continues to be our largest and most profitable segment. We help leaders across all major enterprise functions in every industry around the world.

Our market opportunity is fast across all sectors, sizes and geographies. And we’re delivering more value than ever. Research revenue grew 13% in the fourth quarter. Total contract value growth was 12%. Contract value growth was broad-based across practices, industry sectors, company sizes and geographic regions. We serve the executives and their teams through two distinct sales channels: global technology sales or GTS is our largest sales force. GTS contract value grew 11%. The large majority of GTS serves IP leaders and their teams and we saw double-digit growth with this client segment despite tough compares. GTS also serves leaders at technology vendors, including CEOs and product managers. In this segment, growth moderated, but still grew at high-single-digits, despite even tougher compares.

Global Business Sales or GBS serves leaders in their teams beyond IT. This includes HR, supply chain, finance, marketing, sales, legal and more. GBS contract value grew 19% in 2022. In the five years since we launched our GXL products within GBS, we’ve seen exceptional compound annual growth rates. Gartner conferences deliver extraordinarily valuable insights and engaged and qualified audience. In the first half of 2022, we delivered most of our conferences virtually. In the second half, we pivoted back to in-person for nearly all our conferences. Feedback has been excellent. Most in-person conferences were sold out in 2022 and we’ve sold significantly more than half of our exhibitor space for 2023. Gartner consulting is an extension of Gartner Research.

Consulting helps clients execute their most strategic initiatives through deeper, extended project-based work. Consulting is an important complement to our IT research business. Consulting revenue grew 24% in the fourth quarter. We exited the year with a strong backlog and pipeline. Our business is fueled by our highly talented associates. During 2022, we grew our team by about 2,900 associates. With this growth, we ended 2022 with the lowest percentage of open positions ever. When we’re fully staffed, we provide our clients better service, which results in better retention. We also sell more in territories that are fully staffed. We have carefully aligned our hiring with recent demand and the long-term opportunity we have for growth. Our 2023 outlook reflects our most recent experiences from Q4.

We’ve also been prudent in considering the potential impact of volatility from the global environment. We expect to deliver at least 21.5% margins across a wide range of economic scenarios. And our guidance has opportunity for upside if the business performs in line with historical trends. Craig will take you through our guidance in more detail. One of the unique things about Gartner is that we provide value to enterprises that are thriving, shortly or anywhere in between. By being exceptionally agile and adapting to the changing world, we have sustained record of success. We’re well prepared as we enter 2023. We’ve carefully aligned staffing levels with demand and we have the lowest percentage of open positions ever. Our content addresses today’s mission critical priorities.

And we know the right things to do to be successful in any environment. In closing, we again saw strong growth across the business. Looking ahead, we are well positioned to drive growth far into the future. Even as we invest for future growth, we expect margins to increase modestly over time and we generate significant free cash flow well in excess of net income or return capital to our shareholders through buybacks, which reduces shares outstanding and increases returns over time. With that, I’ll hand the call over to our Chief Financial Officer, Craig Safian.

Craig Safian: Thank you, Gene, and good morning. Fourth quarter results were strong with double-digit growth in contract value, revenue, EBITDA and adjusted EPS. FX neutral growth was even stronger than our reported results. We also delivered better than planned EBITDA margins. During 2022, we generated almost $1 billion of free cash flow and we returned more than that to shareholders through stock repurchases. Our financial performance for the full-year 2022 included total contract value growth of 12%, total revenue growth of 16%, EBITDA growth of 14%, diluted adjusted EPS of $11.27, and free cash flow of $993 million. We are introducing 2023 guidance, which reflects higher than normal variability in the set of reasonably likely outcomes.

The guidance accounts for the tough compares at the start of the year and the opportunity for upside if near-term demand is stronger than we built into the outlook. With the catch up hiring we did last year; we are very well positioned to add value to enterprise function leaders and their teams across all industries and around the world. Fourth quarter revenue was $1.5 billion, up 15% year-over-year as reported and 20% FX neutral. In addition, total contribution margin was 68%, down 100 basis points versus the prior year. EBITDA was $421 million, up 37% year-over-year and up 44% FX neutral. Adjusted EPS was $3.70, up 24% and free cash flow in the quarter was $166 million. We finished the year with 19,505 associates, up 18% from the end of 2021.

About 40% of the headcount growth was catch up from prior years. Our hiring has been carefully calibrated to revenue growth and future demand and we are well positioned from a talent perspective heading into 2023. Research revenue in the fourth quarter grew 9% year-over-year as reported and 13% on an FX neutral basis driven by our strong contract value growth. Fourth quarter research contribution margin was 74%, consistent with 2021. The contribution margin had a benefit during the quarter from somewhat lower headcount levels and travel expenses still modestly below our post-pandemic expectations. For the full-year 2022, research revenues increased by 12% on a reported basis and 16% FX neutral. The gross contribution margin for the year was 74% in line with 2021.

Contract value or CV represents the annualized revenue under contract at a point in time. In looking at our global contract value across both GTS and GBS, more than 75% of our CV is from enterprise function leaders and their teams with the bulk of the balance coming from leaders at tech vendors. Our enterprise function leader’s business includes IT leaders, who are end users of technology and who we serve through our GTS sales force. And leaders of other business functions who we serve through our GBS sales force. In both cases, we serve leaders around the world and across all industries. We’re helping these enterprise function leaders address their most important mission critical priorities. CV was $4.7 billion at the end of the fourth quarter, up 11.9% versus the prior year and up 12.3% adjusted for the impact of exiting Russia.

CV from enterprise function leaders across GTS and GBS grew at strong double-digit rates. CV from tech vendors grew high-single-digits, compared to a high-teens growth rate in the fourth quarter of €˜21. Quarterly net contract value increase or NCVI was $189 million business of almost $400 million. CV growth was broad-based across practices, industry sectors, company sizes and geographic regions. Across our combined practices, all industry sectors grew at double-digit rates other than technology and media, which grew at high-single-digit rates. The fastest growth was in the transportation, retail and manufacturing sectors. We had double-digit growth across all of our enterprise size categories. We also drove double-digit growth in nine of our top 10 countries, with high-single-digit growth in the 10.

Global technology sales CV was $3.6 billion at the end of the fourth quarter, up 10% versus prior year and up 10.5% adjusted for the exit of Russia. GTS had quarterly NCVI of $138 million, while retention for GTS was 105% for the quarter. GTS new business was down 8.5% versus last year. New business with IT function leaders was up modestly year-over-year against a tough compare. New business with tech vendors facing even tougher compare against Q4 of 2021, which was its strongest quarter ever. GTS quota-bearing headcount was up 18%, compared to December of last year, about 40% of the growth was catch up hiring from 2021. Our continued investments in our sales teams will drive long-term sustained double-digit growth. Our regular full set of GTS metrics can be found in the appendix of our earnings supplement.

Global business sales CV was over $1 billion at the end of fourth quarter, up 19% year-over-year, which is above the high-end of our medium-term outlook of 12% to 16%. All of our GBS practices other than marketing grew at double-digit growth rates led by supply chain and HR, which both continued to grow faster than 20%. GBS CV increased $52 million from the third quarter, while retention for GBS was 112%. GBS new business was up 3% versus last year against a very strong compare. The two-year compound annual growth rate for new business was 9%. GBS quota-bearing headcount increased 22% year-over-year with a little more than 50% of the growth being catch up from 2021. Headcount we hired in 2022 will help to position us for sustained double-digit growth in the future.

As with GTS, our regular full set of GBS metrics can be found in the appendix of our earnings supplement. Conferences revenue for the fourth quarter was $188 million, contribution margin in the quarter was 53%, we held nine in-person conferences in the quarter. It has been very exciting for our business to return to in-person conferences. For the full year 2022, revenue increased 82% on a reported basis and 90% FX neutral. Gross contribution margin was 54%. Fourth quarter consulting revenues increased by 17% year-over-year to $138 million. On an FX neutral basis, revenues were up 24%. Consulting contribution margin was 37% in the fourth quarter. Labor based revenues were $96 million, up 11% versus Q4 of last year and up 19% on an FX neutral basis.

Backlog at December 31 was $140 million, increasing 24% year-over-year on an FX neutral basis with another strong bookings quarter. The inclusion of multi-year contracts in our backlog calculation a change we described earlier last year, contributed about 13 percentage points to the year-over-year growth rate. Our contract optimization business had a very strong quarter increasing 36 % as reported and 39% on an FX neutral basis versus the prior year. As we have detailed in the past, this part of the consulting segment is highly variable. Full-year consulting revenue was up 15% on a reported basis and 22% on an FX neutral basis. Gross contribution margin of 39% was up 140 basis points from 2021. Consolidated cost of services increased 19% year-over-year in the fourth quarter as reported and 24% on an FX neutral basis.

The biggest drivers of the increase were higher headcount to support our continued strong growth and the return to in-person destination conferences. SG&A decreased 3% year-over-year in the fourth quarter as reported and increased 1% on an FX neutral basis. We had lower non-cash non-recurring charges in 2022, compared to 2021. On a comparable basis, SG&A was up due to additional headcount for sales and G&A functions. For the full -year, cost of services increased 17% on a reported basis and 21% on an FX neutral basis. SG&A increased 15% on a reported basis and 19% on an FX neutral basis in 2022. EBITDA for the fourth quarter was $421 million, up 37% year-over-year on a reported basis and up 44% FX neutral. Fourth quarter EBITDA upside to our guidance reflected revenue exceeding our forecasts, most notably in consulting and expenses at the low-end of our expectations.

EBITDA for the full-year was $1.47 billion, 14% increase over 2021 on a reported basis and up 19% FX neutral. Depreciation was $24 million in the fourth quarter, down modestly versus 2021. Net interest expense excluding deferred financing costs in the quarter was $29 million about flat with the prior year. The modest floating rate debt we have is fully hedged through maturity. The Q4 adjusted tax rate, which we use for the calculation of adjusted net income was 16.7% for the quarter. The tax rate for the items used to adjust net income was 23.2% for the quarter. The full-year tax rate was 21.6% on the same basis. Adjusted EPS in Q4 was $3.70, up 19% year-over-year. The average share count for the fourth quarter was 80 million shares. This is a reduction of about 3.7 million shares or about 4% year-over-year.

We exited the fourth quarter with about 80 million shares outstanding on an unweighted basis. For the full-year, adjusted EPS was $11.27, EPS growth for the year was 22%. Operating cash flow for the quarter was $203 million, excluding insurance proceeds in Q4 of 2021, operating cash flow was down about 7%. Q4 cash flow was impacted by Hurricane Ian, which hit our center of excellence in Fort Myers extremely hard in late September. While we were able to sell and service our clients from Fort Myers, we did have some delays in getting invoices out as quickly as we normally would. Elections for some of these delayed invoices slipped into January, but we are now caught up. CapEx for the quarter was $38 million, up about $16 million year-over-year, led by increases in capitalized technology labor costs and catch-up laptop spend.

Free cash flow for the quarter was $166 million. Free cash flow growth continues to be an important part of our business model with modest CapEx needs and upfront client payments. As many of you know, we generate free cash flow well in excess of net income. Our conversion from EBITDA is also very strong. With the differences being cash interest, cash taxes and modest CapEx, partially offset by strong working capital cash inflows. Free cash flow as a percent of revenue or free cash flow margin was 18% on a rolling fourth quarter basis. On the same basis, free cash flow was 68% of EBITDA and 123% of GAAP net income. At the end of the fourth quarter, we had almost $700 million of cash. Our December 31 debt balance was $2.5 billion. Our reported gross debt to trailing-12-month EBITDA was under 2 times.

Our expected free cash flow generation, unused revolver and excess cash remaining on the balance sheet provide ample liquidity to deliver on our capital allocation strategy of share repurchases, and strategic tuck-in M&A. Our balance sheet is very strong with $1.7 billion of liquidity, low levels of leverage and effectively fixed interest rates. We repurchased more than $1 billion of stock throughout 2022. We expect the Board will refresh our share repurchase authorization as needed, which they did earlier this month. We now have about $1 billion authorized for share repurchases. Across the past two years, we have returned $2.7 billion to shareholders by repurchasing more than 11 million shares. Over that timeframe, we have reduced our shares outstanding by 11%.

As we continue to repurchase shares, our capital base will shrink. This is accretive to earnings per share and combined with growing profits also delivers increasing returns on invested capital over time. Before providing the 2023 guidance details, I want to discuss our base level assumptions and planning philosophy for 2023. For research, we continue to innovate and provide a very compelling value proposition for clients and prospects. Executives and their teams face uncertainty and challenges and they recognize how Gartner can help regardless of the economic environment. Our plan allows for a higher-than-normal level of uncertainty in the world as Gene discussed. We’ve got tough compares across the business and particularly with tech vendors for another quarter or two.

We’ve taken a prudent approach based on historical trends, as well as more normal patterns which we reflected in the guidance. If near-term demand is stronger than we’ve built into the outlook and NCVI phasing, retention rates, and non-subscription growth performed closer to the way they have historically, there would be upside to our guidance. In addition, our teams are focused on driving greater growth than what’s embedded in the guidance. Finally, as you think about GBS overall CV and revenue growth for 2023, please keep in mind that we closed on the divestiture of a small non-core asset last week. We sold Talentneuron which we acquired as part of the CEB transaction for $164 million. In the earnings supplement appendix, we’ve provided historical contract value updated for 2023 FX rates, as well as the removal of Talentneuron from prior years.

For conferences, we are basing our guidance on being 100% in-person for the 47 destination conferences we have planned for 2023. We expect to return to more typical seasonality for the business with fourth quarter the largest followed by the second quarter. For consulting revenues, we have more visibility into the first half based on the composition of our backlog and pipeline as usual. Contract optimization is seasonally slower in the first quarter and remains highly variable. We had a very strong year in 2022, especially in contract optimization in the fourth quarter. Our base level assumptions for consolidated expenses reflect significant headcount increases from 2022 annualizing into 2023. Our plan for headcount for 2023 is more in line with our normal model as we caught up on hiring last year.

If demand is stronger than what’s in the initial plan, we will have opportunity to add even more great talent to our teams. We also expect T&E cost to more fully normalize this year. Finally, we continue to invest in our systems and process automation, both client facing and internal applications as part of our innovation and continuous improvement programs. We will continue both to manage expenses prudently to support future growth and deliver strong margins. At current rates, FX will be a modest tailwind to growth for the full-year with the benefit in the second half. Our guidance for 2023 is as follows: we expect research revenue of at least $4.92 billion, which is growth of about 7%. Excluding the effect of the divest adds 1 percentage point to the year-over-year growth rate.

We expect conferences revenue of at least $445 million, which is growth of about 14%. We expect consulting revenue of at least $500 million, which is growth of about 4%. The result is an outlook for consolidated revenue of at least $5.865 billion, which is growth of about 7%. Excluding the divested business from 2022 would add about 80 basis points to the growth rate. As I’ve mentioned, we’ve taken a prudent approach to planning for 2023. This applies to revenue, operating expenses and free cash flow. We expect full-year EBITDA of at least $1.26 billion. We expect to be able to deliver at least 21.5% margins in most economic scenarios. If revenue is stronger than our guidance, we expect upside to EBITDA and margins. Included in the guidance is equity comp of $132 million, up from 2022.

We expect 2023 adjusted EPS of at least $8.80 per share. For 2023, we expect free cash flow of at least $920 million. Our EPS guidance is based on 80 million shares, which only assumes repurchases to offset dilution. Finally, for the first quarter of 2023, we expect to deliver at least $310 million of EBITDA. All the details of our full-year guidance are included on our Investor Relations site. Our strong performance in 2022 continued in the fourth quarter. Contract value grew 12%, adjusted EPS increased 195, fueled in part by the significant reduction of shares in 2021 and 2022. Over the past few years, our hiring has been carefully calibrated to demand and we are well positioned from a top perspective heading into 2023. Our continued investments in our teams will drive long-term sustained double-digit growth.

We repurchased more than $1 billion in stock last year and remain committed to returning excess capital to our shareholders over time. As I mentioned, we expect to generate at least $920 million in free cash flow in 2023. In addition, we have ample liquidity and the net proceeds from last week’s divestiture for capital deployment initiatives. Looking out over the medium-term, our financial model and expectations are unchanged. With 12% to 16% research CV growth, we will deliver double-digit revenue growth. With gross margin expansion, sales costs growing in line with CV growth and G&A leverage, we can modestly expand margins. We can grow free cash flow at least as fast as EBITDA, because of our modest CapEx needs and the benefits of our clients paying us upfront.

And we’ll continue to deploy our capital on share repurchases, which will lower the share count over time and on strategic value enhancing tuck-in M&A. With that, I’ll turn the call back over to the operator and we’ll be happy to take your questions. Operator?

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Q&A Session

Operator: Thank you. At this time, we will conduct the question-and-answer session. And our first question comes from Jeff Meuler from Baird. Your line is open.

Jeff Meuler: Yes, thank you. Maybe if you could talk through what you think for the outlook for the tech vendor channel? Just given the more recent risks and a need to cycle through kind of renewals on annual and multi-year contracts? And related to that, is there an opportunity or a plan to reallocate some of those sales resources into, kind of, the functional leader channels?

Gene Hall: Hey, Jeff. It’s Gene, I’ll get started. So as we think about the tech vendor channel, I’m going to start with tech industry itself, the technology companies. And we think that those as being in two different segments: One, is sort of enterprise IT and the other is consumer and devices, things like that. On the enterprise IT, we’re expecting the technology companies — technology vendors to grow about 7.8% globally during €˜23. And the reason they’re growing pretty robustly is that enterprise IT spending that’s the ones that are not certainly consumers is selling to large complex B2B sales and they tend to be multi-year contracts and annual increases, et cetera. So that’s the technology vendors that are selling to enterprise IT.

They’re also seeing continued demand for cloud, security, digital modernization. And so all those things are growing at a much higher rate than the general tech industry. And when we survey CEOs, that CEO’s this is a end users, their customers, they’re buying the speed of the equipment. Their business is saying things, I believe digital modernization is still really important to meet the economic situation, as well as staffing situations they face, as well as consumer requirements for more technology and services they offer. So on the enterprise IT, just summarizing the enterprise IT, tech vendors, we have to see that growing about 7.8% globally at ’23. On the consumer device side, that’s going to be a lot worse in the sense that we expect demand to be lower there.

And that’s because a lot of demand was pulled forward during the recession and during the pandemic. And so there’s sort of a tale of two cities in the tech industry. So that’s the tech vendors themselves, our business is predominantly on the enterprise IT side. We just proportionally serve those. So looking forward, we expect actually to check vendors that we serve to be doing okay as opposed to the consumer and device manufacturers, which we expect actually to shrink during 2023. And so that translates into our own business we expect — we had a — as Craig results, our vendor, our sales force that sells to technology vendors actually went from very high teens growth. I’m sorry, that’s a high teens growth to low-single-digit growth. So they actually — I’m sorry in high-single-digit growth.

So they actually performed pretty well in the fourth quarter. Going forward again because our major business is selling to the enterprise IT technology vendors, we expect that business to do pretty well on a go forward basis.

Craig Safian: And Jeff, the last part of your question on the territory assignment and where we’re putting our growth, we’ve got a pretty robust territory optimization and analytics team that is always looking at this and we have the ability to very quickly and with a lot of agility flex up or down on where we’re putting those territories. And so obviously as we’re looking at our selling environment and the growth of the business, we’re continuing to allocate those resources accordingly. And then the last thing, I mentioned and you sort of had this buried in your question, but I’ll pull it out, is our business selling to the enterprise functions, both in IT and outside of IT through GBS performed very, very well in Q4 and for the full-year. And it was really the tech vendors that had, as Gene said, a very tough compare going from high-teens growth to high-single-digit growth in the quarter.