Gartner Inc (IT) — Q1 2022 Earnings Call Transcript

Good morning, everyone. We appreciate you joining us today for Gartner's first quarter 2022 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 first quarter 2022 financial results and Gartner's updated outlook for 2022 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, but the adjustments described in our earnings release and the 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 2021 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. Gartner had a great start to 2022. In the first quarter, performance was strong across the business. We delivered growth in revenue, EBITDA, EPS, and free cash flow. We drove acceleration in contract value and our significant share repurchase program has lowered our share count. With our strong Q1 results, we’re increasing our 2022 guidance. Research continues to be our largest and most profitable segment. Gartner research provides actionable objective insight to executives and their teams across all major enterprise functions in every industry around the world. We continue to have a vast market opportunity across all structures, sizes, and geographies. And we are delivering more value to our clients than ever before. There was a high degree of volatility and uncertainty in the world. Our clients are facing more challenging decisions than ever before. We’ve been incredibly agile in supporting them through these trying times. We’re delivering more relevant and timely content on current pressing issues such as successfully operating in a hybrid work environment, developing strategies to attract and retain talent, and managing supply chain disruptions. Beyond these issues, we continue to provide unparalleled insight and advice on top priorities, including transitioning to digital business, fostering diverse, equitable, and inclusive organizations, managing cybersecurity threats, and much more. Regardless of whether our clients are experiencing good times or bad, and regardless of role, we deliver incredible value to enterprise leaders and their teams and we have strong demand for our services. Research revenue grew 18% in Q1. Total contract value growth was 16% at the top end of our medium-term outlook. Within our research segment, we serve executives and their teams through distinct sales channels. Global technology sales or GTS, serves leaders and their teams within IT. GTS contract value grew 14%. Global business sales or GPS serves leaders and their teams beyond IT, including HR, supply chain, finance, marketing, sales, legal, and more. GBS contract value grew 24%. Turning now to our conferences business, Gartner Conferences deliver extraordinary value to an engaged and highly qualified audience. Q1 is a seasonally small quarter for our conferences business, which performed as expected. We ran five virtual conferences in Q1. We pushed several conferences that traditionally occurred in Q1 to later in the year to facilitate bringing them in-person. We continue to see strong demand for in-person conferences from our clients and prospects. We're taking a deliberate approach as we return to in-person experiences. Next week, we will host our first in-person conference since our pivot to virtual in 2020. The Gartner Data & Analytics Summit will run next week in London. Attendee tickets and exhibitor space has sold out for this summit. Our clients, prospects, analysts, and sales teams are eager to come together. As we return to in-person conferences, we'll continue to leverage our profitable virtual conferences as a complement to our in-person conferences. 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 research business. Consulting revenue grew a very strong 20% in the first quarter. We had a great start to the year. To sustain our success over the long-term, we’ve made target investments in hiring and retaining top talent that are paying off. Across the company, turnover has stabilized. We expanded our recruiting capacity last year and are adding new associates at a strong pace. In Q1, we had our highest number of new hires ever. We grew headcount 4% sequentially, achieving our quarterly hiring target. We’re on pace to achieve our hiring goals for 2022. The world continues to face significant challenges. Beyond the ongoing COVID-19 pandemic, Russia's invasion of Ukraine is a terrible humanitarian crisis. Our thoughts are with all those impacted. Gartner is exiting the Russian market. In addition, we’ve established a free resource center to help leaders address a range of business issues that have emerged as a result of this crisis. In closing, we started 2022 with strong performances. We have great momentum across the business. Regardless of whether our clients are experiencing good times or bad, and regardless of role, we deliver incredible value to enterprise leaders and their teams, and we have strong demand for our services. We have a vast untapped market opportunity. We generate significant free cash flow in excess of net income. Looking ahead, we’re well-positioned to drive strong top-line growth with modest margin expansion. As we invest for future growth, we will continue to return significant levels of excess capital to our shareholders. This reduces our shares outstanding and increases returns on capital over time. With our strong Q1 results, we're increasing our 2022 guidance.

Thank you, Gene, and good morning. First quarter results were strong with acceleration in contract value growth and strength in revenue, EBITDA, and free cash flow. EPS was particularly strong as the benefit of share buybacks reduced our share count. With results above our expectations, we are increasing our 2022 guidance. The improved outlook reflects the better than expected first quarter top line results and increased revenue from conferences we now expect to hold in-person. First quarter revenue was $1.3 billion, up 14% year-over-year as reported and 16% FX neutral. Additionally, total contribution margin was 70%, up 44 basis points versus the prior year. EBITDA was $329 million, up 3% year-over-year and up 5% FX neutral. Adjusted EPS was $2.33, up 17%, and free cash flow in the quarter was $150 million, up 4% year-over-year. Adjusting for insurance proceeds received last year, free cash flow was up 17% on a rolling four-quarter basis. Research revenue in the first quarter grew 16% year-over-year as reported and 18% on an FX neutral basis. Retention was very strong again, and new business continued to increase. First quarter research contribution margin was 75%, up 81 basis points versus 2021. Higher than normal contribution margins reflect improved operational effectiveness, increased scale, and continued temporary avoidance of travel expenses. We've been increasing our headcount, which we expect to continue as we move through the year. Contract Value or CV was $4.2 billion at the end of the first quarter, up 16% versus the prior year. This includes our decision to exit the Russian market, which reduced CV by about $14 million. Quarterly net Contract Value Increase or NCVI was $80 million net of the impact of Russia CV just noted. Quarterly NCVI is a helpful way to measure Contract Value performance in the quarter, even though there is notable seasonality in this metric. We saw broad-based CV growth across all of our practices. Our technology practice grew 14%, and all of our other business practices grew at double-digit growth rates with the majority of them growing more than 20% year-over-year. From an industry perspective, retail, manufacturing, and services led our CV growth. Global Technology Sales Contract Value was $3.3 billion at the end of the first quarter, up 14% versus the prior year. GTS had quarterly NCVI of $46 million in the quarter, net of the impact of exiting Russia, while retention for GTS was 107% for the quarter, up about 900 basis points year-over-year. GTS new business was up 6% versus last year when very strong new business benefited from a post-pandemic bounce, including modestly higher than normal win backs. Our quota-bearing headcount was up slightly year-over-year. In the first quarter, we promoted a higher than normal level of frontline sellers to sales manager roles. This reflected our strong CV performance and sets us up for future growth. March was our best hiring month since the beginning of the pandemic. Our net hiring is in line with our plan, turnover is improving, and we remain on track to achieve double-digit quota-bearing headcount growth this year. Our regular full set of GTS metrics can be found in the appendix of our earnings supplement. Global Business Sales Contract Value was $899 million at the end of the first quarter, up 24% year-over-year, exceeding the high end of our medium-term outlook of 12% to 16%. GBS CV increased $34 million from the fourth quarter, while retention for GBS was 115% for the quarter, up about 11 percentage points year-over-year. GBS new business was up 18%, compared to last year, reflecting robust growth across the full portfolio and against a strong compare. GBS quota-bearing headcount increased sequentially and is up 15% year-over-year. We remain on track to grow GBS headcount at double-digit rates in 2022. As with GTS, our regular full set of GBS metrics can be found in the appendix of our earnings supplement. Conferences revenue for the first quarter was $10 million in line with our expectations. The first quarter is always a seasonally small quarter, and we pushed several conferences to later in the year to increase the likelihood of running them in-person. Contribution margin in the quarter was negative 28%, given the seasonality in revenue and normal quarterly costs. We held five virtual conferences in the quarter. As we look to the rest of the year, we plan to run 24 in-person conferences. We will continue to run a mix of in-person and virtual conferences as part of our go-forward strategy for the business. I will detail our updated annual outlook for conferences shortly. First quarter consulting revenues increased by 17% year-over-year to $116 million. On an FX neutral basis, revenues were up 20%. Consulting contribution margin was 44% in the first quarter, up almost 5 percentage points versus the prior year with better than expected revenue and a mixed benefit from strong growth in contract optimization. Labor-based revenues were $96 million, up 14% versus Q1 of last year and up 18% on an FX neutral basis. Backlog at March 31 was $147 million, increasing 30% year-over-year on an FX neutral basis with another strong bookings quarter. We revised our backlog methodology to include the expected revenue from the out years of multi-year agreements. This change contributed about 7 percentage points to the backlog growth rate in the quarter. Our contract optimization business was up 29% as reported and 30% on an FX neutral basis versus the prior year. Consolidated cost of services increased 13% year-over-year in the first quarter as reported and 14% on an FX neutral basis. The biggest driver of the increase was higher headcount to support our continued strong growth. SG&A increased 27% year-over-year in the first quarter as reported and 29% on an FX neutral basis. SG&A increased in the quarter as a result of a $24 million non-recurring real estate charge, higher commission expense following strong CV growth in 2021, and increased hiring in sales and G&A functions. SG&A without the facilities-related charge would have increased 22% year-over-year and would have been 47% of revenue in the quarter. We expect SG&A expenses to increase over time as our hiring continues. EBITDA for the first quarter was $329 million, up 3% year-over-year on a reported basis and up 5% FX neutral. First quarter EBITDA upside to our guidance primarily reflected revenue exceeding our forecasts. Depreciation in the quarter was $23 million, down modestly versus 2021. Net interest expense, excluding deferred financing costs in the quarter was $30 million, up $5 million versus the first quarter of 2021, due to an increase in total debt balances. The Q1 adjusted tax rate was 20.3% for the quarter. The tax rate for the items used to adjust net income was 24% for the quarter. Adjusted EPS in Q1 was $2.33, a growth of 17% year-over-year. The weighted average fully diluted share count for the first quarter was 83 million. This is a reduction of more than 6 million shares or about 7% year-over-year. We exited the first quarter with about 82 million fully diluted shares. Operating cash flow for the quarter was $168 million, up 7% compared to last year. CapEx for the quarter was $17 million, up 38% year-over-year as a result of an increase in capitalized software. Free cash flow for the quarter was $150 million. Free cash flow growth continues to be an important part of our business model with modest CapEx needs and upfront client payments. Our conversion from EBITDA is very strong, with differences being cash interest, cash taxes, and modest CapEx, partially offset by strong working capital cash inflows. Adjusting for the insurance proceeds we received last year, free cash flow as a percent of revenue or free cash flow margin was 22% on a rolling four-quarter basis. On the same basis, free cash flow was 84% of EBITDA and 159% of GAAP net income. At the end of the first quarter, we had $456 million of cash. Our March 31 debt balance was $2.5 billion. Our reported gross debt to trailing 12-month EBITDA was under 2x. 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. We repurchased around $450 million of stock during the first quarter and about $630 million through the end of April. Last week, the Board increased the repurchase authorization by $500 million, bringing us to a total of about $1 billion available for open market buybacks. We expect the Board to continue to refresh the repurchase authorization as needed going forward. Since the end of 2020 through the end of this April, we’ve reduced our shares outstanding by 8 million shares, a reduction of 9% from the end of 2020. As we continue to repurchase shares, we expect 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. We are increasing our full-year guidance to reflect strong Q1 performance and the return of in-person conferences. We also updated guidance to reflect stronger U.S. dollar impacts. We now expect an FX impact on our revenue growth rates of about 260 basis points for the full year, which is up from 150 basis points based on rates when we guided in February. As we detailed last quarter, 2021 research performance benefited from several factors, including QBH tenure mix, NCVI phasing, record retention rates, and strong non-subscription growth. We continue to assume that those benefits do not persist at the same levels through 2022. The growth comparisons also get harder as we move through the year. We were taking a balanced approach based on historical trends, which we've reflected in the updated guidance. We are updating our guidance for the incremental revenue from 24 planned in-person conferences with significantly more visibility into the second quarter. We will continue to update our outlook as we have more visibility. For our local one-day Avanta events, we expect to run most of them in-person while continuing to run some virtually. We expect about one-third of our full-year conferences revenue in the second quarter this year. Our base level assumptions for consolidated expenses continue to reflect significant headcount increases during the year to support current and future growth. We have modeled higher labor costs and travel and entertainment well above 2021 levels as previously indicated. We will also have higher commissions during 2022 due to the very good selling performance in 2021. Finally, we continue to invest in our technology, both client-facing and internal applications as part of our innovation and continuous improvement programs. Our updated guidance for 2022 is as follows: We expect research revenue of at least $4.575 billion, which is FX neutral growth of about 14%. The FX neutral growth is up about 160 basis points from our prior guidance due to strong NCVI performance in the first quarter. We expect conferences revenue of at least $270 million, which is growth of about 30% FX neutral. We expect consulting revenue of at least $430 million, which is growth of about 7% FX neutral. The result is an outlook for consolidated revenue of at least $5.275 billion, which is FX neutral growth of 14%. The FX neutral growth is up about 330 basis points from our prior guidance due to strong performance in the first quarter and the shift to in-person conferences. Without the strengthening U.S. dollar since February, our revenue guidance would have been about $155 million higher than previous guidance. We now expect full-year EBITDA of at least $1.135 billion, up $100 million from our prior guidance, and an increase in our margin outlook as well. Without the strengthening U.S. dollar since February, our EBITDA guidance would have been about $110 million higher than previous guidance. We now expect 2022 adjusted EPS of at least $7.80. For 2022, we now expect free cash flow of at least $930 million. Our guidance is based on 82 million fully diluted weighted average shares outstanding, which reflects the repurchases made through the end of April. All of the details of our full-year guidance are included on our Investor Relations site. Finally, for the second quarter of 2022, we expect to deliver at least $300 million of EBITDA. We’ve had a strong start to the year with momentum across the business. Contract Value continues to accelerate. EPS grew mid-teens fueled by the significant reduction of shares over the past year. We repurchased roughly $630 million in stock this year through April and remain committed to returning excess capital to our shareholders. Looking out over the medium-term, our financial model and expectations are unchanged. With 12% to 16% research contract value growth, we will deliver double-digit revenue growth. With gross margin expansion, sales costs growing in-line with contract value growth over time, and general and administrative leverage, we can modestly expand margins from the normalized 2021 level. 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 and on strategic value-enhancing tuck-in M&A.

Yes. Thank you, and great quarter. So, you already gave me 15 talking points on this, but I'm going to ask about it anyway. Just a quota-bearing sales headcount being flat, so, just so I understand reconciling what you gave us to that metric, so the turnover is seasonally higher in Q1, but turnover for quota-bearing headcount is actually getting better year-over-year and then Q1 is also seasonally high for promotions and given the planned growth, there's more promotions this year than there were last year, but hiring is performing to plan and is actually the best since before the pandemic, are those the right reconciliation points to explain while quota-bearing headcount is still flat sequentially?

Yeah, it’s Gene. So, everything is going to plan and we're on track for the year to achieve double-digit growth in our quota-bearing headcount. As you have more factors at the beginning of the year, we've done this for a long period of time. So, we will be experiencing turnover early in the year because of the pandemic, but we are now on track for growth.

Yes, Jeff, let me just repeat what Gene said, we're just having a little bit of trouble with his microphone. So, a couple points. We're seeing improving attrition starting in the second half of last year and continuing through this year, which is very positive. We do almost all of our promotions in the beginning of the year, and so because of the very strong growth and bounce back in GTS, we had more promotions than we normally have in the first quarter, and obviously, we fill them generally with our best performing frontline associates. It’s the next step in the promotional ladder that our frontline sellers take. As Gene and I mentioned, there's very strong recruitment and hiring across the organization and in particular in GTS. One other thing I would add is that the exiting of Russia had a small impact on the sequential quota-bearing headcount reported number as well.

Got it. Very helpful. And then on conferences, so I can understand kind of the business performance and the assumptions, for the Q2 conferences that you have better line of sight to, I heard that at least some of them look like record attendance or sold out attendance. Are those conferences, are you monetizing them above the pre-pandemic level at this point and the full-year guidance being below the pre-pandemic level is about the risk-adjusting the conferences assumptions for later in the year?

Yes, Jeff, it's a great question. As we noted, we are transitioning 24 that had previously been planned as virtual to run in-person over the balance of the year. We have more visibility into those that are happening soon than for those at the end of the year. From a monetization perspective, we're planning on having fewer—in some cases, fewer attendees in each of the conferences than we had historically to be mindful of ensuring people can social distance. This means that in some instances, we will have fewer attendees than we had pre-pandemic. In other cases, as the conferences have been filling up, we might have more attendees than we had pre-pandemic. The revenues will not bounce back immediately to pre-pandemic levels because we want to ensure safety and comfort for the attendees by moderating attendance.

Thanks so much. I wanted to ask about pricing; are you able to increase prices more this year compared to prior years just given the inflationary environment, and have customers been generally understanding about it?

Hi Toni. Thanks for the question. We are being a little more aggressive on pricing this year, and the way we're thinking about it is to ensure we at least match the inflation we are experiencing on our people. Generally speaking, our clients have been understanding of the price increases. As we've talked about in the past, the spending with us at most of our clients represents a relatively small ticket item, and modest price increases are generally well received, especially as we have significantly improved our products and insights along the way.

Great. I wanted to also ask about the EBITDA margin guidance you raised to 21.5% for the year from 20%. I think the results in the quarter and the FX impact based on my estimates that drove about half the raise, but maybe you could clarify if there were different forecasts that contributed to the higher margin guidance.

Of course. The way to think about it is primarily two or three things. First, the NCVI performance in the first quarter exceeded our expectations, benefiting Q1 and flowing through into the balance of the year. Second, the pivot to in-person conferences and the revenue generated there brings additional margins. Lastly, there are some SG&A savings predominantly in G&A that we were able to pass through the P&L and account for in the 2022 expense outlook. It's really a combination of those three factors that are driving both revenue and EBITDA higher, contributing to the improved EBITDA margins for the full year.

Hi, thanks. GTS and GBS productivity both increased pretty significantly in the quarter, can you elaborate on the factors driving improvement in productivity and how much further improvement you see in both of the segments?

Hey, it's Gene. I’ll try again. Hopefully my line works this time. We're focused on improving productivity for both GTS and GBS. This has been an ongoing priority for us, and we have many programs aimed at improving productivity, including recruiting programs, training programs, and the tools we provide our salespeople. Additionally, the content we produce is focused on the most important issues for our clients. The combination of these operational changes and our higher average tenure compared to pre-pandemic times have contributed to productivity improvements.

Got it. That's helpful. And then you're guiding to double-digit growth in headcount this year, can you elaborate on how much headcount growth you're expecting in GTS compared to GBS over the remainder of this year?

Yes. We're expecting both to grow at double-digit rates; however, we expect that GBS will exceed GTS by a modest margin due to its faster-growing contracts.

Hi, good morning. This is actually Trevor Romeo in for Andrew. Thanks so much for taking the questions. First, I was kind of just wondering if you could call out any drivers of the consulting strength with 20% FX neutral growth and what look like record backlog; any new service offerings or changes that clients have been particularly receptive to there?

Hey, Trevor. We always make improvements to our processes and we've been making substantial improvements to our consulting processes. Fundamentally, consulting is an extension of our research business. We help clients with the same challenging issues that we tackle in our research. The growth comes from a combination of operational enhancements and strong demand for consulting services.

I would just add that in the quarter, we saw growth in both labor-based and contract optimization. Specifically, our labor-based revenue saw a 14% year-over-year growth, while our contract optimization business experienced a remarkable 29% growth.

Understood. Thank you. And then just a follow-up on the margin outlook, looks like now 2022, the guide implies about 21% to 22% margins, has your thinking around kind of the normalized margin run rate for the business going forward kind of also increased? Is this kind of a good baseline to build on?

Hey, Trevor. Great question. The implied margin of the outlook is about 21.5%. We still view our normalized margins around 20%, as we think about it. We're still experiencing benefits from previously mentioned operational factors, and we also have some catch-up in travel and other expenses. The normalized margins moving forward should be around that 20% mark.

Hi. Good morning. This is Ryan on for Jeff. I have a follow-up question about the conferences. With the switch to in-person conferences this year, how does that impact the financial model in terms of both margin percentage and margin dollar amounts?

So, as you saw, we’reflowing through an incremental $70 million of revenues. It's important to remember that we're transitioning from virtual where there were revenue expectations to in-person where there are higher revenue expectations. So, it's not going from zero to something; it's going from a smaller number from a virtual conference to a larger figure based on an in-person conference. As I mentioned earlier, we’re running the in-person conferences at a lower scale than pre-pandemic, and therefore our expectation of margin flow-through is not as high as it would have been before. But the dollar margin flow-through is obviously more than it would have been, had we been running virtual.

Got it. Thank you. And then just a modeling question. When should we think about normalized travel and entertainment expense levels returning this year?

It's slowly building. Q1, given the environment and the fact that we weren't running too many conferences, was particularly low. We expect the second half of the year to look more like normal. However, we are still rebuilding our conference portfolio, and as we go beyond 2022, there may be more travel associated with that process. But in the second half of the year, we expect to be back at semi-normal rates of travel, but we won’t see true normal levels until our conference portfolio is fully rebuilt.

Hi, thank you. Just a follow-up question on the normalized margin outlook. You still think it's 20%, and I guess, given that you've exceeded plans thus far this year and have raised your guidance, I’m curious, when you think about the 150 basis points of margin improvement in your guide, how much of that is a go-forward, sustainable benefit versus what might shift into next year?

Good morning, Heather. I think it's due to a few factors. Given the strong growth we delivered last year, we are still catching up on our staffing needs to effectively deliver for our clients and drive future growth. We're hiring at a strong pace, but we still have some areas where we're playing catch-up. Travel expenses remain below plan, so we expect to gradually step up. These two factors, along with ensuring we are investing effectively for sustained top-line growth, are crucial in discussing our guidance and normalized margins.

To summarize today's call, we started 2022 with strong performances. We have great momentum across the business. With our clients, whether they are experiencing good times or bad, and regardless of role, we can deliver incredible value to enterprise leaders and their teams. We have strong demand for our services and a vast untapped market opportunity ahead of us. We generate significant free cash flow and excess net income. Looking ahead, we're well positioned to drive strong top-line growth with modest margin expansion. As we invest for future growth, we will continue to return significant capital to our shareholders, reducing shares outstanding and increasing returns on capital over time. With our strong results, we’re increasing our 2022 guidance. Thanks for joining us today, and we look forward to updating you again next quarter.