Gartner, Inc. (NYSE:IT) Q3 2023 Earnings Call Transcript
Gartner, Inc. (NYSE:IT) Q3 2023 Earnings Call Transcript November 3, 2023
David Cohen : Good morning, everyone. Welcome to Gartner's Third Quarter 2023 Earnings Call. I'm David Cohen, SVP of Investor Relations. [Operator Instructions]. 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 third quarter 2023 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.
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 vary materially from actual results and are subject to 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 Q3. We delivered high signal digit growth in contract value, revenue, EBITDA, and adjusted EPS came in above expectations. Free cash flow in the quarter was excellent. The external environment remains volatile and uncertain. The tech sector is still adjusting to post pandemic demand. The banking industry continues to grapple with rising interest rates. Supply chain challenges are still impacting many industries. There's heightened geopolitical volatility and more. Leaders know they need help and they know Gartner is the best source for that help. Gartner delivers actionable objective insight that smarter decisions and stronger performance on our client's mission critical priorities.
Whether they're thriving, struggling, or anywhere in between. Our insights, tools and advice often mean the difference between success and failure for leaders and the enterprises they serve. We continue to be agile and adapt to the changing environment. Research continues to be our largest and most profitable segment. We guide leaders across all major enterprise functions in every industry around the world. Our market opportunity is vast, across all sectors, sizes and geographies. We estimate our opportunity at around $200 billion. In the third quarter, we continue to help clients with a wide range of topics such as cybersecurity, data analytics, artificial intelligence, remote work, cost optimization, and more. In the third quarter, research revenue grew 5%.
Subscription revenue grew 8% on an organic basis, 20 contract value growth was 8%. Contract value for enterprise function leaders continue to grow at double digit rates. We serve executives and their teams through distinct sales channels, global technology sales, or GTS source leaders and their teams within IT. GTS also source leaders at technology vendors, including CEOs, Chief Marketing Officers, and Senior Product Leaders. GTS contract valued grew 7%. GTS sales to enterprise function leaders performed well in the quarter. GTS sales to leaders at technology vendors were affected by technology sector dynamics and tough year over year comparisons. We expect sales to technology vendors will return to normal growth rates over the next 12 months to 18 months.
Global business sales or GBS serve leaders in their teams beyond IT. This includes HR, supply chain, finance, marketing, sales, legal and more. GBS contract value grew 14%. Through a relentless execution of proven practices, we're able to deliver unparalleled value to our clients. Our business remains resilient despite a persistent, complicated external environment and tough compares for the technology vendor market. Gartner conferences deliver extraordinarily valuable insights to an engaged and qualified audience. This will be the first full year of in-person conferences since 2019. We're having a great year. In-person attendance and advanced bookings are at record levels. The fourth quarter is off to a great start and our outlook for the year remains strong.
IT Symposium Expo is our flagship conference series. I recently attended this conference in Orlando. Attendance was strong. Our sales teams were highly engaged with clients and prospects, and feedback from the conference continues to be excellent. 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 23% in the third quarter with record results and contract optimization. Given the strong performances across our business, we've increased our 2023 guidance for revenue, EBITDA and free cash flow. Greg will take you through the details. We're well positioned to have strong close to the year and get off to a fast start in 2024.
In closing, Gartner achieved another strong quarter of growth. We deliver unparalleled value to enterprise leaders and their teams across every major function, whether they're thriving, struggling, or anywhere in between. We're essentially agile and continuously adapt to the changing world. We know the right things to do to be successful in any environment. Looking ahead, we are well-positioned to continue our strong record of success far into the future. Our client value proposition and addressable market opportunity will allow us to drive long-term, sustained, double-digit revenue growth. We would fit margins will expand modestly over time, and we generate significant free cash flow well in excess of net income. Even as we invest for future growth, we will return significant levels of excess capital to our shareholders.
This reduces shares outstanding and increases returns overtime. With that, I will hand the call over to our Chief Financial Officer, Craig Safian.
Craig Safian: Thank you, Gene, and good morning. Third quarter results were strong with high single-digit growth in contract value. Revenue, EBITDA, adjusted EPS and free cash flow were better-than-expected with outstanding performance in consulting and disciplined cost management. With strong results in the quarter and good visibility into Q4, we are increasing our 2023 guidance. Third quarter revenue was $1.4 billion, up 6% year-over-year as reported and 5% FX neutral. In addition, total contribution margin was 68%, compared to 69% in the prior year, as the 2022 hiring catch-up continue to flow through the P&L as expected. EBITDA was $333 million ahead of our guidance and about inline with last year. Adjusted EPS was $2.56, up 6% from Q3 of last year.
And free cash flow was $302 million. We have finished the quarter with 20,253 associates, up 6% from the prior year and 1% from the end of the second quarter. We remain well-positioned from a talent perspective, as our associates continue to move up the tenure curve. Research revenue in the third quarter grew 6% year-over-year as reported and 5% on an FX neutral basis. Subscription revenue grew 8% on an organic FX neutral basis. Non-subscription revenue performance was similar to Q2. Third quarter research contribution was 73%, compared to 74% in the prior year period, as we have caught up on hiring and returned to the new expected levels of travel. Contract value or CV was $4.7 billion at the end of the third quarter, up 8% versus the prior year.
The third quarter last year was a very strong research quarter with outstanding performance across most key metrics. CV growth is FX neutral and excludes the first quarter 2023 divestiture. 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 grew low single-digits, compared to mid-teens growth in the third quarter of 2022. Quarterly net contract value increase or NCVI was $101 million. As we have 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 rates, led by the transportation, services, and public sectors.
We had high single-digit growth across all of our enterprise size categories other than the small category, which has the largest tech vendor mix, and grew low single-digits. We also drove double-digit or high single-digit growth in the majority of our Top 10 countries. Global Technology sales contract value was $3.6 billion at the end of the third quarter, up 7% versus the prior year. GTS CV increased $65 million from the second quarter. Wallet retention for GTS was 102% for the quarter, which compares to 107% in the prior year, when we saw a near record high for this metric. IT Enterprise function leaders while retention remained above historical GTS levels during the third quarter. GTS new business was up 7% versus last year. New business with IT enterprise function leaders increased mid-teens compared to the prior year.
GTS quota bearing headcount was up 5% 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 the 10-year curve we're well-positioned for growth moving into 2024. Our regular full set of GTS metrics can be found in the appendix of our earning supplement. Global business sales contract value was $1 billion at the end of the third quarter up 14% year-over-year. All of our GBS practices grew a double-digit or high single-digit rates other than sales, which grew mid-single digits. Growth was again led by supply chain and HR. GBS CV increased $36 million from the second quarter, while retention for GBS was 108% for the quarter, which compares to 114% in the prior year when we saw one of the highest ever results for this metric.
GBS new business was up 10% compared to last year. GBS quota bearing headcount was up 10% year-over-year. This excludes headcount associated with the Q1 divestiture. As with GTS, our regular full set of GBS metrics can be found in the appendix of our earning supplement. Conferences revenue for the third quarter was $57 million ahead of our expectations during a seasonally small period, we delivered strong growth for the conferences we held in Q3 compared to the same conferences in 2022. The calendar shifted significantly from 2022 to 2023 with the return to in-person. Contribution margin in the quarter was 36% consistent with typical seasonality and reflecting investments for future growth. We held nine destination conferences in the quarter, all in person.
Third quarter consulting revenues increased by 24% year-over-year to $133 million. On an FX neutral basis, revenues were up 23%. Consulting contribution margin was 37% in the third quarter. Labor-based revenues were $100 million up 10% versus Q3 of last year, as reported and on an FX neutral basis. Backlog at June 30th was $180 million, increasing 15% year-over-year on an FX neutral basis with continued booking straight. Our contract optimization business is highly valuable. We delivered $33 million of revenue in the quarter with some of the revenue pulled forward from the fourth quarter relative to our prior outlook. Consolidated cost of services increased 8% year-over-year in the third quarter as reported and 7% on an FX neutral basis. The biggest driver of the increase was higher head counts to support our future growth.
SG&A increased 8% year-over-year in the third quarters reported and 7% on an FX neutral basis. SG&A increased in the quarter as a result of headcount growth. EBITDA for the third quarter was $333 million, about in line with last year. Third quarter EBITDA upside to our guidance primarily reflected revenue exceeding our expectations in consulting and prudent expense management. Depreciation in the quarter of $25 million was up modestly compared to 2022. Net interest expense excluding deferred financing costs in the quarter was $21 million. This was down $8 million versus the third 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 Q3 adjusted tax rate, which we used for the calculation of adjusted debt income was 22% for the quarter.
The tax rate for the item was used to adjust that income was 35% for the quarter. Adjusted EPS in Q3 was $2.56 up 6% compared with last year. We had 80 million shares outstanding in the third quarter. This is a reduction of close to 1 million shares or about 1% year over year. We exited the third quarter with about 79 million shares on an unweighted basis. Operating cash flow for the quarter was $331 million, up to 5% compared to last year. CapEx for the quarter was $28 million, down 11% year over year as a result of catch up spend on technology investments in 2022, which normalized this year. Free cash flow for the quarter was $302 million. Free cash flow is a percent of revenue on a rolling four quarter basis was 18% of revenue and 67% of EBITDA.
Adjusted for the after-tax impact of the Q1 divestiture free cash flow conversion from gap net income was 122%. Our free cash flow conversion is generally higher when CV growth is accelerating. At the end of the third quarter, we had about $1.2 billion of cash. Our September 30th 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, share repurchases, and strategic tuck-in M&A. Our balance sheet is very strong with $2.2 billion of liquidity, low levels of leverage, and effectively fixed interest rates. We repurchase $209 million of stock during the third quarter and about $100 million in October.
The board increased the authorization by $500 million earlier this week, and we expect they will continue to refresh the repurchase authorization as needed going forward. At the end of October, following the increased authorization, we had about $1 billion available for repurchases. 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. We are raising our full-year guidance to reflect the better than expected Q3 performance and good visibility into the fourth quarter. For research, we continue to innovate and provide a very compelling value proposition for clients and prospects. Subscription research growth will reflect recent trends in contract value.
We continue to expect stronger growth from the subscription business than the non-subscription part of the segment consistent with the third quarter. For conferences, we still expect Q4 to be the largest quarter of the year. For consulting revenues, the labor business continues to perform well. We have very tough contract optimization comparisons in Q4 and pulled some revenue into Q3 relative to our prior expectations. We will continue both to manage expenses prudently to support future growth and deliver strong margins. Our updated 2023 guidance is as follows. We expect research revenue of at least $4.875 billion, which is FX neutral growth of about 6% or 7%, excluding the Q1 divestiture. The update to the research revenue guides reflects better than planned NCVI performance in Q3 with continued stability in the non-subscription part of the business.
There is modest incremental upside relative to the expectations we built into the guidance last quarter. We expect conference revenue of at least $500 million, which is FX neutral growth of about 27%. We have increased our outlook for conferences by $10 million to reflect a good start to the fourth quarter. We expect consulting revenue of at least $550 million, which is growth of about 8% FX neutral, reflecting the very strong performance of Q3 and timing in the contract optimization business. The result is an outlook for consolidated revenue of $5.89 billion, which is FX neutral growth of 8%. We now expect full-year EBITDA of at least $1.440 billion, up $80 million from our prior guidance. With the strong performance in Q3, we have increased confidence in the margin forecast for the fourth quarter.
We expect typical operating expense seasonality from Q3 to Q4. We now expect 2023 adjusted EPS of at least $10.90 per share. For 2023, we now expect free cash flow of at least $1.025 billion, up $50 million from our prior guidance. The higher free cash flow reflects a conversion from GAAP net income of 136%, excluding the after-tax divestiture proceeds. Our guidance is based on 80 million fully diluted, weighted-average shares outstanding, which reflects the repurchases made through the end of October. We are performing well this year, despite continuing global macro uncertainty and the dynamic tech vender market. CV grew high single-digits in the quarter. Revenue and EBITDA performance exceeded our expectations, and we increased our guidance.
Free cash flow was strong in the quarter, and we increased the guidance for the full year. We have repurchased about $550 million in stock year-to-date through October, and remain eager to return excess capital to our shareholders. We will continue to be disciplined, opportunistic, and price-sensitive. 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 about inline with CV growth and G&A leverage, we will expand to 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 pay us up front.
And we will 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 will turn the call back over to the operator, and we will be happy to take your questions. Operator?
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