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

Gartner, Inc. (NYSE:IT) Q4 2023 Earnings Call Transcript February 6, 2024

IT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

David Cohen: Good morning, everyone. Welcome to Gartner’s Fourth Quarter 2023 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 2023 financial results and Gartner’s outlook for 2024 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, our contract values and associated growth rates we discuss are based on 2023 foreign exchange rates and exclude contributions related to the first quarter divestiture and the 2022 Russia exit.

All growth rates in Gene’s comments are FX neutral, unless stated otherwise. 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. 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 drive materially from actual results and are subject to a number of risks and uncertainties, including those contained in the company’s 2022 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.

Gene Hall: Good morning, and thanks for joining us today. Gartner drove another strong performance in the fourth quarter. We delivered high single-digit growth in contract value, revenue, EBITDA, adjusted EPS and free cash flow came in above expectations. Gartner delivers incredible client value in any macroeconomic environment. In 2023, the world experienced multiple disruptions. They impacted enterprises in dramatically different ways. For example, high interest rates affected capital-intensive industries and financial institutions such as regional banks, high inflation rates had an outsized effect on industries such as health care. Geopolitical polarization and conflict drove increases in military and defense spending while affecting supply chains, more shifts in how and where people work affected real estate, live events and entertainment and other industries.

Cybersecurity attacks became even more frequent while getting stronger and more disruptive. And we saw a significant leap in the capabilities of artificial intelligence, or AI, which fueled even more complexity. We serve leaders in every enterprise across every industry and every geography. They know they need help. And they know Gartner is the best source for the help they need. Gartner delivers actionable objective insight that drive smarter decisions and stronger performance on an organization’s mission-critical priorities. We guide the leaders who shape the world. Our insights often make the difference between success and failure, the leaders we work with and the enterprises they serve. As we move into 2024, our ability to execute operational best practices consistently is the strongest it’s ever been.

We have the lowest proportion of open positions ever. Our recruiting capability and capacity are world-class. We have a strong associate value proposition. And our teams have higher tenure than in 2023, which will allow us to drive strong performance well into the future. Research continues to be our largest and most profitable segment. Our market opportunity is vast across all sectors, sizes and geographies. Our business remains resilient in a complex external environment. Through relentless execution of proven practices, we’re able to deliver unparalleled value to our clients. In the fourth quarter, we help clients with a wide range of topics, including cybersecurity, data analytics, artificial intelligence, remote work, cost optimization and more.

Research revenue grew 5% in Q4. Subscription revenue represented more than 75% of our consolidated global revenue in 2023. We delivered subscription revenue growth of 8% on an organic basis in the fourth quarter. Total contract value growth was 8%. Across GTS and GBS, contract value from enterprise function leaders grew at double-digit rates. New business with enterprise function leaders also grew at double-digit rates. Gartner serves executives and their teams to distinct sales channels. Global Technology Sales, or GTS, serves leaders and their teams within IT. GTS also serves leaders at technology vendors, including CEOs, Chief Marketing Officers and senior product leaders. GTS contract value grew 6%, led by growth with ITs and enterprise function leaders.

GTS sales to leaders and technology vendors continue to be affected by technology sector dynamics. Exiting the year, we began to see some improvement. New business with tech vendors grew at high single digits. We expect new business to lead retention and contract value growth. Global Business Sales, or GBS, source leaders and their teams beyond IT. This includes HR, supply chain, finance, marketing, legal, sales and more. GBS contract value grew 13%. GBS new business was up double digits. Gartner Conferences deliver extraordinarily valuable insights to an engaged and qualified audience. 2023 was the first full year of in-person conferences since 2019. We had a great year, and we drove a strong finish in the fourth quarter. In Q4, we held some of our largest destination conferences, including IT Symposium in Orlando and Barcelona and Ravage HR in Orlando.

These conferences were spectacular. Across all our destination conferences, attendance was up year-over-year with many at or near capacity. Looking ahead to 2024, advanced bookings continue to be very strong and feedback continues to be excellent. Gartner Consulting is an extension of Gartner Research. Consulting helps clients execute their most strategic initiatives through a deeper extended project-based work. Consulting is an important complement to our IT research business. Consulting revenue grew 8% for the full year. We saw growth in labor-based consulting and record results in contract optimization for the full year. We are introducing 2024 guidance, which we view as achievable across a wide range of economic and geopolitical scenarios with opportunity for upside.

In closing, Gartner achieved another strong quarter of growth. We deliver incredible client value, whether our clients are struggling, thriving or anywhere in between. We’re exceptionally agile and continuously adapt to the changing world, and we know the right things to do to be successful in any environment. Looking ahead, we’re well positioned to continue our sustained record of success or into the future. Our client value proposition and addressable market opportunity will allow us to drive long-term sustained double-digit revenue growth. We expect margins will expand modestly over time. And we generate significant free cash flow well in excess of net income. As we invest for future growth, we’ll return significant levels of excess capital to our shareholders.

This produces 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 revenue, EBITDA, adjusted EPS and free cash flow were better than expected as we continue to execute very well in a complex environment. Our financial performance for the full year 2023 included global contract value and consolidated revenue growth of 8%, EBITDA of $1.5 billion, diluted adjusted EPS of $11.33 and free cash flow of $1.1 billion. We are introducing 2024 guidance, which we view as achievable across a wide range of economic and geopolitical scenarios with opportunity for upside. Fourth quarter revenue was $1.6 billion, up 5% year-over-year as reported and 4% FX neutral. In addition, total contribution margin was 67%. EBITDA was $386 million, ahead of our guidance primarily as a result of disciplined cost management.

Adjusted EPS was $3.04 and free cash flow was $196 million. We finished the quarter with 20,237 associates, up 5%, excluding the 2023 divestiture and about the same as Q3. We have a great team across Gartner, driven by a very compelling associate value proposition. Moving into 2024, we are in an excellent position from a talent and tenure perspective. Research revenue in the fourth quarter grew 6% year-over-year as reported and 5% FX-neutral. Subscription revenue grew 8% on an organic FX-neutral basis. Non-subscription revenue performance in the quarter reflects a shift to higher-quality traffic. While this action has a short-term effect on revenue, we expect it will drive higher prices and increase revenue over time. Fourth quarter research contribution margin was 74%, consistent with the prior year period as we have caught up on hiring and return to the new expected levels of travel.

For the full year 2023, research revenues increased by 6%, both as reported and FX neutral. The gross contribution margin for the year was 74%. Contract Value, or CV, was $4.8 billion at the end of the fourth quarter, up 8% versus the prior year. CV growth is FX neutral and excludes the first quarter 2023 divestiture. We expect new business to be a leading indicator for retention and, in turn, contract value growth. We had the highest one month of new business dollars ever in December 2023. For the fourth quarter, CV from enterprise function leaders across GTS and GBS grew at double-digit rates. New business with enterprise function leaders increased double digits as well. CV from tech vendors was about flat versus the prior year and up sequentially.

Tech vendor CV continued the quarterly improvement we saw in Q3. Tech vendor new business was up high single digits in Q4, marking the first year-over-year increase in 2023. Quarterly net contract value increase, or NCVI, was $180 million. As we’ve discussed in the past, there is notable seasonality in this metric. CV growth was broad-based across practices, industry sectors, company sizes and geographic regions. Across our combined practices, the majority of the industry sectors grew at double-digit or high single-digit rates led by the energy, manufacturing and public sectors. We had high single-digit growth across almost all of our enterprise size categories. The small category, which has the largest tech vendor mix grew modestly. We also drove double-digit or high single-digit growth in the majority of our top 10 countries.

Global Technology Sales contract value was $3.7 billion at the end of the fourth quarter, up 6% versus the prior year. GTS CV increased $134 million from the third quarter. Wallet retention for GTS was 101% for the quarter, reflecting net growth even before the addition of new clients. In the fourth quarter, IT enterprise function leaders wallet retention was consistent with historical GTS levels. GTS new business increased 12% versus last year. New business with IT enterprise function leaders increased mid-teens compared to 2022. New business with tech vendors increased high single digits in the quarter. GTS quota-bearing head count was about flat year-over-year. With the dynamic territory planning we introduced a few years ago, the catch-up hiring we did last year and our teams moving up 10-year curve, we’re well positioned for growth moving into 2024.

Operationally, we are continuously allocating resources to the best near-term opportunities even as we ensure we are well positioned to capture the large addressable market opportunity over time. Our regular full set of GTS metrics can be found in the earnings supplement. Global Business Sales contract value was $1.1 billion at the end of the fourth quarter, up 13% year-over-year. The majority of our GBS practices grew at double-digit rates. Growth was led by supply chain, legal and HR. GBS CV increased $46 million from the third quarter. Wallet retention for GBS was 107% for the quarter, reflecting strong net growth with our existing clients. GBS new business was up 13% compared to last year. GBS quota-bearing head count was up 8% versus the fourth quarter of 2022.

This excludes headcount associated with the Q1 divestiture. As with GTS, our regular full set of GBS metrics can be found in the earnings supplement. As we do each year at this time, we’ve provided 2 years of quarterly historical contract value data updated to 2024 FX rates in the appendix of the earnings supplement. Conferences revenue for the fourth quarter was $214 million, up 14% year-over-year. Contribution margin in the quarter was 50%, consistent with typical seasonality. We held 11 destination conferences in the quarter, all in person. For the full year 2023, we delivered an all-time high revenue of $505 million, which was an increase of 30% on a reported basis and 29% FX neutral. Gross contribution margin was 50%. Fourth quarter consulting revenues were $128 million compared with $138 million in 2022 when we saw a record performance in the Contract Optimization business.

Consulting contribution margin was 27% in the fourth quarter, affected by revenue mix and growth hiring. Labor-based revenues were $99 million, up 3% versus Q4 of last year as reported and on an FX-neutral basis. Backlog at December 31 was $162 million, increasing 21% year-over-year on an FX-neutral basis with continued booking strength. We delivered $29 million of Contract Optimization revenue in the quarter. This part of our business is highly variable. For the second half of 2023, revenues were $62 million, up from the second half of 2022 when we delivered our largest ever quarter in Q4. Full year Consulting revenue was up 7% on a reported basis and 8% FX-neutral. Gross contribution margin was 35% compared to 39% in 2022. Consolidated cost of services increased 11% year-over-year in the fourth quarter as reported and 10% on an FX-neutral basis.

The biggest driver of the increase was higher headcount to support our future growth. SG&A increased 9% year-over-year in the fourth quarter as reported and 8% on an FX-neutral basis. SG&A increased in the quarter as a result of headcount growth. EBITDA for the fourth quarter was $386 million compared to $421 million last year. Fourth quarter EBITDA upside to our guidance primarily reflected disciplined expense management. EBITDA for the full year was almost $1.5 billion, a 1% increase over 2022 on a reported basis and up 2% FX-neutral. Depreciation in the quarter of $26 million was up modestly compared to 2022. Net interest expense, excluding deferred financing costs in the quarter was $19 million. This was down $9 million versus the fourth quarter of 2022 due to higher interest income on our cash balances.

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 24% for the quarter. The tax rate for the items used to adjust net income was 15% for the quarter. The full year tax rate for the calculation of adjusted net income was 22%. Adjusted EPS in Q4 was $3.04 compared with $3.70 last year. We had 79 million shares outstanding in the fourth quarter. This is a reduction of about 1 million shares or about 1% year-over-year. We exited the fourth quarter with about 79 million shares on an unweighted basis. For the full year, adjusted EPS was $11.33, up modestly from 2022. Operating cash flow for the quarter was $224 million, up 10% compared to last year.

CapEx for the quarter was $28 million, down $4 million as a result of catch-up spend on technology investments in 2022, which normalize this year. Free cash flow for the quarter was $196 million, up 19% compared to last year. Free cash flow for the full year was almost $1.1 billion, a 6% increase versus 2022. Free cash flow on a rolling four quarter basis was 18% of revenue and 71% of EBITDA. Adjusting for the Q1 divestiture, the full year free cash flow conversion from GAAP net income would have been 138%. Our free cash flow conversion is generally higher when CV growth is accelerating. We have a new slide in the earnings supplement, which shows the conversion from both EBITDA and GAAP net income to free cash flow on a rolling four quarter basis.

The past 2 years have had some unusual items affecting the conversion, including insurance proceeds related to pandemic conference cancellations and the 2023 divestiture. We expect about a 4 to 6 point difference between EBITDA margin and free cash flow margins in a typical year. The normal free cash flow conversion from GAAP net income is 140% to 160%. At the end of the fourth quarter, we had about $1.3 billion of cash. Our December 31 debt balance was about $2.5 billion. Our reported gross debt to trailing 12-month EBITDA was under two times. Our expected free cash flow generation, available 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 $2.3 billion of liquidity, low levels of leverage and effectively fixed interest rates. We repurchased $158 million of stock during the fourth quarter and more than $600 million for the full year. At the end of December, we had about $1 billion of authorization for repurchases remaining, and we expect the Board will continue to refresh the repurchase authorization going forward. As we continue to repurchase shares, our capital base will shrink. Over time, this is accretive to earnings per share and combined with growing profits also delivers increasing returns on invested capital. Before providing the 2024 guidance details, I want to discuss our base level assumptions and planning philosophy for 2024. 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. The outlook for 2024 research revenue growth is a function of three primary factors: first, 2023 ending contract value; second, the timing of growth bottoming and the slope of the reacceleration, and third, the performance of nonsubscription revenue. Starting with the research subscription revenue, which was 76% of 2023 consolidated revenue. Our guidance reflects CV bottoming and reaccelerating during 2024. First quarter and first half NCVI are important inputs to calendar 2024 revenue growth. We have taken a prudent view of NCVI phasing because Q1 is a seasonally important quarter for tech vendor renewals.

With the majority of our contracts being multiyear, some haven’t come up for renewal during the tech sector’s recalibration. And research subscription revenue will likely bottom about one quarter after contract value growth bottoms. If new business continues to perform well and retention is better than we’ve incorporated into the plan, there would be upside to our guidance. The nonsubscription revenue was about 6% of consolidated revenue in 2023. In this part of the business, we help small business buyers find the best software for their needs and help sellers find customers. This adds a lot of tangible value for both groups. The outlook built into the 2024 guidance reflects a shift to higher-quality traffic sources. As I mentioned, this affects revenue in the short term, but we expect it to drive higher prices and increased revenue over time.

For conferences, which was about 9% of 2023 revenue, we are basing our guidance on the 51 in-person destination conferences we have planned for 2024. We expect similar seasonality to what we saw in 2023, with Q4 the largest quarter, followed by Q2. We have very good visibility into 2024 revenue with the majority of what we’ve guided already under contract. This is consistent with last year and ahead of historical levels. For consulting, which was also about 9% of 2023 revenue, we have more visibility into the first half based on the composition of our backlog and pipeline as usual. Contract optimization has had several very strong years. It’s also seasonally slower in the first quarter and remains highly variable. We’ve incorporated a prudent outlook for this part of the segment.

We remain focused on aligning expense growth with CV growth. This is the best way for us to balance short-term margins while investing for long-term sustained double-digit growth. Our base level assumptions for consolidated expenses reflect a more typical cadence than we’ve seen in a while. We are investing for future growth even as we have taken a prudent view of the timing of revenue flowing into the P&L. We recommend thinking about expenses sequentially with notable seasonality driven by the conferences calendar and merit increases. Our plan for mid to high single-digit sales headcount growth for 2024 reflects our commitment to invest for future growth while delivering on our margin targets. We have the recruiting capacity to go faster depending on how the year plays out, and we have other levers like increased tenure to support CV growth in 2024.

At current rates, FX will be approximately neutral to growth for the full year. Our guidance for 2024 is as follows, we expect research revenue of at least $5.15 billion, which is FX-neutral growth of about 5%. The research revenue guidance reflects a prudent plan for NCVI performance and the recalibration of nonsubscription part of the business. The guidance reflects subscription revenue growth in the high single digits. We expect conferences revenue of at least $560 million, which is FX-neutral growth of about 10%. We expect consulting revenue of at least $530 million, which is growth of about 3% FX-neutral. The result is an outlook for consolidated revenue of at least $6.24 billion, which is FX-neutral growth of 5%. We expect full year EBITDA of at least $1.435 billion, which results in an EBITDA margin of at least 23%.

We expect 2024 adjusted EPS of at least $10.55 per share. For 2024, we expect free cash flow of at least $1.065 billion. This reflects a conversion from GAAP net income of above 140%. Our guidance is based on 79 million shares, which only assumes repurchases to offset dilution. Finally, for the first quarter of 2024, we expect to deliver EBITDA of at least $335 million. We performed well this year despite continuing global macro uncertainty and a dynamic tech vendor market. Global CV grew high single digits in the quarter with enterprise function leaders CV growing double digits. Revenue, EBITDA and EPS performance exceeded our expectations, and we introduced achievable guidance with opportunity for upside. We repurchased more than $600 million in stock during 2023 and more than $3 billion in the past 3 years.

We remain eager to return excess capital to our shareholders. We will continue to be price sensitive, opportunistic and disciplined. 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 about in line with CV growth and G&A leverage, we will expand EBITDA margins modestly over time. 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 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: Than for. [Operator Instructions] Our first question comes from the line of Jeff Meuler with Baird. Your line is now open.

Jeff Meuler: Yeah, thank you. Just want to dig in first. I know it’s not a huge business, but on the research nonsubscription headwinds and need for recalibration. I know it’s been weak all year, but I was interpreting that previously more is like cyclical headwinds. And now it seems like you’re responding more operationally to drive higher quality traffic. So just I guess, I don’t know if there was like a business review or, I guess, the why now in terms of cyclicality of the business versus where there’s an opportunity for operational improvement?

Craig Safian: Hey. Good morning, Jeff. Thanks for the question. I’ll give it a start, and then Gene will chime in as well. I think starting with the facts, the nonsubscription part of the business was about 6% of 2023 revenue. Obviously, we have had the tech market pressure for the full year. And the way that mostly manifested itself through our results was real pressure on pricing throughout the full year. And we saw that. We adjusted coming out of Q2 earnings. And the good news is pricing has been roughly stable since we made that adjustment. In Q4, though, one of the things we’re always focused on is making sure that we are providing the highest value to both sides of the equation. And with these offerings, we are essentially – small business buyers are coming to our site to learn more about what software to buy, and we actually help them with reviews and ratings and research and things of that nature.

And then we’re matching them to the sellers. And again, so tangible value, as we mentioned, on both sides of the equation. We’re always focused on driving even more value for our clients. And so one of the things we’ve done is really shift our focus and prioritization to higher-quality forms of traffic. And again, short-term impact on revenues. But over the long term, we think this is good for clients on both sides of the equation will drive higher pricing over time, which will drive higher revenue, which is good for everybody. But one thing I would say just about the guidance is we’ve modeled in the real focus on higher quality traffic. We have not modeled in any real uptick in the pricing. Again, over the long term, we expect that to happen.

We did not want to model that in, so we actually see that manifesting itself in reality.

Jeff Meuler: Okay. And then I hear you loud and clear on the better tech vendor, new business sold trends. Maybe talk through more on the retention for tech vendor, just like how you’re thinking about the tail that has not yet renewed in a more difficult environment? Or just what’s the typical lag time from when you’ve seen prior inflections in new business, like how long it kind of takes for the retention trend to similarly improved?

Gene Hall: Hi, Jeff, it’s Gene. So one – the biggest issue we have is in the small tech vendors and a lot of the small tech vendors are in markets that have changed and they have difficulty getting funding now. And for those vendors, if they signed a 2 or 3 or multiyear a year or 2 ago, when that comes up for renewal, they don’t have any funding. In fact, in many cases, they’re out of business. And so what’s happening there is that that’s our biggest drag in the tech sector in terms of retention. The larger companies, as you’ve seen, are still laying off tens of thousands of people. And so they haven’t finished restructuring. As we mentioned, overall new business is up in the tech sector, mid-single digits. And so we’re thinking that’s a leading indicator that retention will follow once we work through – work our way through these – particularly these companies that have gone out of business since they signed the agreement and today.

And by the way, that’s a very still a very robust business. It’s just a different side of companies now that are getting funding, big [ph] AI.

Jeff Meuler: Got it. Thank you.

Operator: Thank you. Our next question comes from the line of Toni Kaplan with Morgan Stanley. Your line is now open.

Toni Kaplan: Thank you. Actually, maybe following on a similar line to the last question. The commentary around new business in the prepared remarks, and this is beyond tech vendors. So just in general, the enterprise new business sounded very good, even the tech vendor improvement in new business sounded good. Just wanted to understand if there was anything that could – that is a risk to that sort of starting to flow through contract value in the next few quarters? And how quickly you could expect to see sort of that shift in contract value? I know you mentioned in the prepared remarks that you’re expecting an inflection this year? Thanks.

Craig Safian: Good morning, Toni. Thanks for the question. Just to lay out the facts. So to your point, GTS, the HT vendor part of the business, new business grew at high single-digit rates. The end user or enterprise function leader part of GTS grew new business mid-teens year-over-year, and GBS was up 13% over prior year on new business. So we actually saw a pretty strong new business results across all of the markets we sell into in the fourth quarter. And as we mentioned, we view new business as a real leading indicator for what’s happening in the market in the moment, so to speak. And so again, we saw a modest improvement in new business from Q2, Q3. That continued from Q3 to Q4 with tech vendor actually growing for the first time in 2023 in the fourth quarter.