Gartner Inc (IT) — Q3 2021 Earnings Call Transcript

Good morning, everyone. We appreciate your joining us today for Gartner's Third Quarter 2021 earnings call and hope you are well. With me on the call today are Gene Hall, Chief Executive Officer, and Craig Safian, Chief Financial Officer. This call will include a discussion of Third Quarter 2021 financial results in Gartner's updated outlook for 2021. As disclosed in today's earnings release and earnings supplement, both posted to our website, investor.gartner.com. Following comments by Gene and Craig, we will open up the call for your questions. We ask that you limit your questions to one and a follow-up. 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. 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 2021 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 2020 annual report on Form 10-K and 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.

Good morning and thanks for joining us. Our growth increased again in the third quarter. We're performing well across the business. We delivered strong performances in contract value, revenue, EBITDA, and free cash flow. Total Company revenues were up 15% in Q3 with continued momentum across all three of our business segments. We also repurchased another $355 million in stock in the quarter, bringing our year-to-date total through October to $1.6 billion, and we're thriving in the current environment. Research continues to be our largest and most profitable segment. Our research segment provides actionable, objective insight to executives and their teams. Reserve leaders across all major enterprise functions in every industry around the world. Our market opportunity is vast across all sectors, sizes, and geographies. And we're delivering more value than ever. Everywhere around the world, our clients are facing more issues than ever before. Challenging issues, things like the future of work, cybersecurity, carbon footprint, digital business, diversity, equity inclusion, Cloud, and more. Our research is closely aligned to our clients' priorities. We recently launched a new sustainability resource center that provides clients and prospects with actual insights on sustainable business strategy. Total research contract value growth increased to 14% with acceleration in both GTS and GBS driven by strong execution in both retention and new business. Global Technology Sales or GTS returned to double-digit growth. GTS contract value growth accelerated to 12%. We expect GTS to deliver long-term, sustained double-digit contract value growth. Global Business Sales or GBS delivered another outstanding quarter with contract value growth of 22%. All practices across GBS drove double-digit contract value growth. Across our entire research business, we're driving consistent execution of proven practices, and we continue to see the results of our efforts. Our conferences business also continues to deliver excellent performance. In 2020, we developed an entirely new conferences business model. This model leverages virtual conferences to deliver extraordinarily valuable insights to our audiences. We delivered a strong performance in conferences. For the third quarter of 2021, conferences revenues were $24 million. Total attendee numbers were up in Q3, as we are increasing our reach through our valuable content. There's a large constituency of our clients and prospects who prefer in-person conferences. We've recently held some in-person events in advance which were very well received. As conditions continue to stabilize, we are operationally prepared to return to in-person conferences where and when we can. We'll continue to leverage our profitable virtual conferences as appropriate. Consulting is an important complement to our IT research business. Consulting revenues grew 6% in Q3. So overall, we're performing really well as a company. We're thriving in our current environments. We're able to serve our clients and sell to prospects very effectively in a virtual environment. Most of our associates appreciate working virtually. They would like some in-person interactions with their colleagues when that's the best way to engage with each other and get work done. We've created an operating model that supports virtual and in-person interactions. And this gives our associates flexibility while promoting activities to drive associate engagement. We're a growth company. We're focused on ensuring our associates have clear and compelling career paths. We're helping our managers and leaders have powerful career development conversations with their teams. We continue to improve on our proven practices and we're innovating processes and technology to streamline operations. In closing, Gartner delivered another strong performance in Q3. We're performing well across all three of our business segments. We delivered strong performances in contract value, revenue, EBITDA, and free cash flow, and we repurchased another $355 million of stock in the quarter. We continue to get better, faster, and stronger as a company. Gartner is a great place to be for our associates. We deliver extraordinary value to our current clients. We provide outstanding returns for our shareholders. And we're thriving in the current environment. With that, I will hand the call over to our Chief Financial Officer, Craig Safian.

Thank you, Gene, and good morning. Third quarter results were again excellent with acceleration in contract value growth and strength in revenue, EBITDA, and free cash flow. We are increasing our 2021 guidance to reflect our strong Q3 performance. Third quarter revenue was $1.2 billion, up 16% year-over-year as reported, and 15% FX-neutral. In addition, total contribution margin was 69%, up more than 200 basis points versus the prior year. EBITDA was $305 million, up 82% year-over-year and up 80% FX-neutral. Adjusted EPS was $2.03 and free cash flow in the quarter was $331 million. Research revenue in the third quarter grew 16% year-over-year as reported and 15% on an FX-neutral basis. We drove both strong retention and new business in the quarter. Third-quarter Research contribution margin was 74%, up over 200 basis points versus 2020. Higher-than-normal contribution margins reflect improved operational effectiveness, continued avoidance of travel expenses, and lower than planned headcount. Total contract value grew 14% FX-neutral year-over-year to $4 billion at September 30. Quarterly Net Contract Value Increase or NCVI was a very strong $146 million. Quarterly NCVI is a helpful way to measure contract value performance in the quarter, even though there is notable seasonality in this metric. Global Technology Sales contract value was $3.2 billion at the end of the third quarter, up almost 12% versus the prior year. GTS CV increased $102 million from the second quarter. CV growth was led by the technology, manufacturing, and retail industries. While retention for GTS was 104% for the quarter, up 490 basis points year-over-year. GTS new business was up 25% versus last year, with strong growth in new logos and expansion with existing client enterprises. GTS quota-bearing headcount increased from the second quarter. We are beginning to see the positive effects of our investments to ramp up recruiting capacity. We continue to be successful in recruiting new salespeople. Turnover among GTS front-line sellers is stable at the modestly elevated range we saw in the second quarter. With increased recruiting capacity and stable turnover, we expect to see continued expansion of the GTS sales team in Q4 and into 2022 and beyond. Our regular full set of metrics can be found in our earnings supplement. Global Business Sales contract value was $814 million at the end of the third quarter, up 22% year-over-year, which is above the high end of our medium-term outlook of 12% to 16%. GBS CV increased $43 million from the second quarter. Broad-based CV growth included particular strength in the healthcare, technology, and services industries. All of our GBS practices achieved double-digit growth rates with the majority growing more than 20% year-over-year. Growth in the third quarter was led by the supply chain, HR, and sales practices. While retention for GBS was 113% for the quarter, up more than 14 points year-over-year. GBS new business was up 38% compared to last year, reflecting strong growth across the full portfolio. GBS quota-bearing headcount increased sequentially and is up 8% year-over-year. Conferences revenue for the third quarter was $24 million with reported growth of 92% and 93% FX-neutral. Contribution margin in the quarter was 47%. We held eight virtual conferences in the quarter. We also held a number of virtual and in-person meetings. We were able to reintroduce in-person events and meetings in the quarter and plan to ramp those up in Q4. Attendance is up significantly year-over-year as we've launched more virtual conferences to cover additional roles. Third quarter consulting revenues increased by 6% year-over-year to $95 million, on an FX-neutral basis, revenues were also up 6%. Consulting contribution margin was 33% in the third quarter, up more than 110 basis points versus the prior-year quarter. Labor-based revenues were $78 million, up 5% versus Q3 of last year, and up 4% on an FX-neutral basis. Labor-based billable headcount of 749 was up 2%, utilization was 62%, up more than 130 basis points year-over-year. Backlog at September 30 was $126 million, increasing 27% year-over-year on an FX-neutral basis after another strong bookings quarter. Our contract optimization business was up 13% on a reported basis versus the prior-year quarter and up 12% FX-neutral. As we've detailed in the past, this part of the consulting segment is highly valuable. Consolidated cost of services increased 9% year-over-year and 8% FX-neutral in the third quarter. SG&A decreased 2% year-over-year and 3% FX during the third quarter. The year-over-year decline is largely related to the timing of certain prior-year expenses. We expect SG&A expenses to increase over time as our hiring across the business continues to ramp. Total operating expenses were lower than planned because conferences continued to be virtual. We are resuming business travel and reopening offices at a very deliberate pace. EBITDA for the third quarter was $305 million, up 82% year-over-year on a reported basis, and up 80% FX-neutral. The third-quarter adjusted tax rate, which we use for the calculation of adjusted net income, was 25.2% for the quarter. Adjusted EPS in Q3 was $2.03. We exited the quarter with $766 million of cash. Our September 30 debt balance was $2.5 billion. Our reported gross debt to trailing 12-month EBITDA was about 2 times. Our expected free cash flow generation and excess cash remaining on the balance sheet provide ample liquidity to deliver on our capital allocation strategy, including share repurchases. We are updating our full-year guidance to reflect Q3 performance and an improved outlook for the remainder of the year. For revenue guidance, we now expect Research revenue of at least $4.07 billion, which is growth of 13%. We now expect Conferences revenue of at least $190 million, which is growth of 58%. We still expect Consulting revenue of at least $400 million, which is growth of 6%. The result is an outlook for consolidated revenue of at least $4.66 billion, which is growth of 14%. Based on current foreign exchange rates and business mix, the consolidated growth includes an FX benefit of about 190 basis points. We plan to exit the year with quota-bearing headcount about flat for GTS. We expect low double-digit growth for GBS by the end of 2021. Additionally, we continue to invest in a number of programs focused on improving sales productivity and cost-effectiveness. We now expect full-year adjusted EBITDA of at least $1.6 billion, which is an increase of about 54% versus 2020 and reflects reported margins of 27%. Consistent with our comments last quarter, we estimate that normalized 2021 margins would be around 19% if this had been a more typical year. About two-thirds of the adjustments are headcount related with most of the rest from travel and real estate. We expect our full-year 2021 adjusted net interest expense to be $113 million. Looking out to 2022 as the balance sheet stands today, we expect interest expense to be around $115 million. We expect an adjusted tax rate of around 22% for 2021. 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 lower the share count over time. With that, I'll turn the call back over to the Operator, and we'll be happy to take your questions.

Thank you. Good morning. I'm pleased to see that sales headcount is growing again, and I appreciate your insights on the investments in recruitment and the returns you're experiencing. My question is, when do you expect the sales headcount growth in GTS to significantly increase, and how much capacity do you still have to maintain this growth? Are we looking at a matter of quarters, or is there a better understanding of how much flexibility you have before needing to accelerate sales headcount?

Hey, Jeff. Gene. So first, we do have a lot of headcounts being one of the levers that we use for growth, but it's not the only lever. We are also very focused on productivity and we believe there's quite a bit of room for productivity improvements going forward. In parallel with that, as I mentioned on the call and Craig did as well, we have initiatives underway to ramp up our recruiting capacity and output. We're quite optimistic about our ability to ramp up hiring as we need to leverage productivity anytime.

Good morning, Jeff. I think there are a couple of ways to look at what's happening under the covers. I think number one, seeing the pickup in world attention is certainly a very positive trend which we anticipated. And as we've looked at the amount of upsell and expansion that we're driving within existing client enterprises, we're back to normal levels. While our retention is strongest, not quite back to historical levels, but we feel really good about the level of expansion we're driving within existing enterprises. Again, some of that is win-back, some of that is organic growth activities within existing enterprises. So we've seen a few quarters of enterprise growth, and as you'd expect, when a new enterprise comes in, it enters at a lower CV level than our overall average. And so the net enterprise adds that we've been doing will suppress a little bit or mute a little bit the CV for Enterprise that you see. What you are seeing actually is both levers working really well for the last several quarters, particularly in the third quarter, with expansion with the existing enterprises showing up in a low retention number and the number of enterprises growing nicely as well.

Hey, good morning, guys. I guess if I go back to GTS headcount, what's really kept you from bringing that back more quickly? I know last quarter you talked about having to ramp up recruiting capacity to deliver on that, but how much is the tight labor market impacting the pace at which you bring people back and what's the risk in the next six months that you continue to have sluggish additions? How do we think about that? And when would that impact revenue growth in the segment if you don't get that up towards high single digits or wherever you're targeting?

Hey, Gary. A couple of things are going on with GTS headcount. First, it is a highly competitive labor market and turnover is up modestly. Within that modestly higher turnover, there are pockets that are harder to retain. We recognize that, and we have a number of programs in place which we think will actually address that. We have a very strong employee value proposition, and we don't have any trouble recruiting people into the Company. And so the combination of continuing to strengthen our employee value proposition will get chatter of this modest, high turnover back to normal levels, and we're rapidly ramping up our recruiting capacity.

Thank you. I actually just wanted to ask a follow-up on the last topic. So on GBS, you mentioned how you're seeing growth driven by supply chain and HR and sales practices. Are these really new client subscriptions or add-ons from existing clients for the most part? And do you view any of that as temporary, so if supply chain issues are doing, for example, would those clients still stay on, or could you see a little bit of higher turnover of those clients?

Good morning, Toni. Across all the GBS practices, each one is experiencing double-digit growth rates year-over-year in the third quarter, with more than half exceeding 20% growth. We highlighted the top three practices performing exceptionally well, but there are others also showing over 20% growth. To emphasize, all of them are achieving double-digit growth. We are seeing significant success in selling new functions within existing enterprises, which has contributed to an impressive retention rate. When a client purchases a supply chain subscription, it doesn't mean they aren't also investing in other areas like finance or HR. Each of these adds to our sales, and we are performing exceptionally well in this area, along with acquiring new enterprises into the GBS franchise.

In GTS and GBS we have a great value proposition. We provide actual insights to our clients on their toughest issues. We've made investments to ensure that we have the right content, sales training, and experts over the last two to three years to deliver that incredibly strong value proposition. And now we're seeing the benefits of that. I'm confident our ability to execute on sales will continue to be very strong as well.

Hi, thanks. Good morning. I wanted to stay on GBS productivity. GBS and CPI, a $176,000 really come significantly above what we're seeing in GBS even before COVID. Were there any unusual tailwinds to put activity or seasonality factors to consider in the quarter? How sustainable are current levels of productivity?

Good morning, George. Productivity is an important measure, and we're trying to even out or account for seasonality from the measure. There are some structural differences that we've discussed previously between GBS and GTS. On GBS, we are in the early innings of going after this enormous market opportunity. We have a better mix of business developers or hunters whose sole job is to find new business, and they're performing incredibly well. This wasn't just a one-quarter phenomenon but has been a multi-quarter, multi-year experience. As we look towards the future, we believe there was some pent-up demand in the market coming out of the pandemic, but we feel like we're in a really good place with GBS achieving strong growth rates.

Hi, good morning, and thank you for taking my questions. I'll start with conferences. I realized that you are only in the early stages of reintroducing in-person conferences and events. But I'm wondering if you have an updated view on the long-term mix of conferences between in-person and virtual particularly as we start to plan for 2022. Would you also have any additional clarity on the profitability of that model and hybrid model longer term relative to pre-pandemic levels?

Hey, Andrew, great question. Conferences are an important part of our business. We developed good virtual conferences during the pandemic that delivered a lot of value to our clients. However, many clients strongly desire to return to in-person conferences. We will plan to hold in-person conferences as conditions allow, and we also plan to continue with virtual conferences for those who cannot or choose not to travel. Our long-term strategy is to have a mix of both in-person and virtual conferences based on the success of both models. As for profitability, the contribution margin for conferences will likely resemble pre-pandemic levels, though it might take time to build back up to previous numbers.

Thank you. You mentioned normalized EBITDA margins are running at 19%, which is a little bit improved from the previous range of 18% to 19%. Can you discuss where in the business you're seeing improved cost profiles?

Yes, George, it's a combination of improved revenue outlook and performance, and some improved cost profiles that are driving the adjustment from 18% to 19%. The normalized margin reflects how our P&L would look in a typical year with sales headcount growing a few points lower than contract value, offices fully opened, normal travel levels, and growth investments to support the business. A modest change is occurring as we've seen revenue perform better than expected and some tightening on the cost side.

Thank you. Gene, you've discussed beefing up recruiting efforts and making changes. What needs to change in the new hybrid world?

Hey, Manav. One of the things we need to focus on in this hybrid world is our employee value proposition. We have to make sure our associates understand and appreciate the value of coming to work at Gartner in an increasingly competitive talent market.

Hi, this is Mario Cortellacci filling in. First question is just around conversion rates. Could you help us think about how we should see conversion rates in the research business from those in-person conferences versus virtual? As you get more back to in-person conferences, should we expect a larger uplift in that conversion and even better growth in research?

Hey, Mario. Conferences are indeed a key piece of our overall portfolio. They help support our research business by engaging prospects and existing clients effectively. When we shifted to virtual, we focused on maintaining engagement levels with existing seat holders to promote retention and driving new business growth. As we transition to a hybrid model, we will leverage both formats to maximize our research implications.

On the consulting side, we are seeing strong performance, particularly in digital transformation, Cloud optimization, security, and strategic sourcing. We're focusing on our largest clients who are tackling these significant issues. Our consulting services are seeing positive trends and growth across those key areas.

As you've heard us say on this call, we once again delivered strong performances in Q3. We performed well across all three of our businesses: research, consulting, and conferences. We delivered strong performances in contract value, revenue, EBITDA, and free cash flow. We repurchased another $355 million of stock in the quarter. We continue to get better, faster, and stronger as a company. Gartner is a great place for associates, providing outstanding returns for our shareholders. Thank you for joining us today and we look forward to updating you again next quarter.