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Gartner Inc. (NYSE:IT)

Q4 2008 Earnings Call

February 5, 2009 10:00 am ET

Executives

Hank Diamond – Vice President of Investor Relations and Corporate Finance

Gene Hall – Chief Executive Officer

Chris Lafond – Executive Vice President and Chief Financial Officer

Analysts

Jeff King – William Blair

Peter Appert – Piper Jaffrey

Dave Lewis – JPMorgan

Brian Murphy – Sidoti & Company

Operator

Good morning and welcome to Gartner, Incorporated earnings conference call for the fourth quarter and full year 2008. (Operator Instructions). I will now turn the conference call over to Mr. Hank Diamond, Group Vice President of Investor Relations and Corporate Finance for opening remarks and introductions. Please go head, sir.

Hank Diamond

Good morning everyone and thank you all for joining us. On the call with me today are Gartner's CEO, Gene Hall and CFO Chris Lafond. Before we discuss our results I would like to remind everyone of four things. First, the rebroadcast, reproduction and retransmission of this conference call or webcast without the express written consent of Gartner are strictly prohibited. Second, if you did not receive a copy of our press release it is available on our website at www.gartner.com or on the FirstCall system.

Third, the company will be making statements about its future results and other forward-looking statements during this call. Statements about future results made during the call constitute forward-looking statement within the meaning of the Private Securities and Litigation Reform Act of 1995. These statements are based on current expectations and the current economic environment.

Forward-looking statements and projections are inherently subject to significant economic competitive and other uncertainties and contingencies which are beyond the control of management. The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements. Important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements and projections, are specified in the company's filings with the SEC, including in its annual report on Form 10-K for fiscal year 2007.

Finally, during the call the company will be using certain non-GAAP financial measures as defined under SEC rules. Where required we have provided a reconciliation of those measures to the most direct comparable GAAP measures in the tables and the press release.

Before I turn the call over to our CEO, let me briefly review the major points from today's press release. At December 31, 2008, contract value, which is a key leading indicator for Gartner's research business was a record $834 million, up 11% year-over-year as reported and 8% excluding the impact of foreign exchange.

Revenue for fourth quarter 2008 was $347 million, a year-over-year increase of 1% as reported and 6% excluding the impact of foreign exchange. And revenue for the full year 2008 was $1.279 billion, an increase of 9% as reported and 8% excluding the impact of foreign exchange. EPS from continuing operations for fourth quarter 2008 was $0.35 per share versus $0.36 per share in fourth quarter 2007 and EPS from continuing operations for full year 2008 was $0.98, up 51% over 2007.

For the fourth quarter 2008 net income was $34 million and the normalized EBITDA was $66 million. For the full year net income was $104 million, up 41% versus 2007 and the normalized EBITDA was $213 million, up 12% versus 2007.

Turning to cash flow and liquidity, for the full year 2008 Gartner generated $184 million of operating cash flow, up 24% versus 2007 and spent $24 million on capital expenditures. During 2008 the company repurchased 9.7 million shares of its stock for a total of $199 million. On the balance sheet the company had total debt of $416 million and cash of $141 million as of December 31, 2008.

Now, I would like to turn the call over to Gartner's Chief Executive Officer, Gene Hall.

Gene Hall

Thanks, Hank. Good morning everyone and thanks for joining us. During 2008 Gartner grew its total revenue by 9%, including 15% growth in revenue from our research segment. We expanded our profit margins. We generated $184 million of operating cash flow, added new clients and ended the year with record contract value.

We achieved these results despite an already weak economic environment which deteriorated sharply and rapidly during the fourth quarter. Our results demonstrate the tremendous value that our services provide to our clients, our vast market opportunity and the effective management of IT programs and investments is always a critical business function.

Even during the fourth quarter when macroeconomic conditions worsened substantially, we were able to grow our revenue and EPS due to the resiliency of our resulting research and consulting businesses. Although companies became increasingly more cautious on spending in November and December, both our existing and potential clients continue to recognize the importance of using Gartner services. As a result we were able to deliver 11% FX neutral growth in research revenues and 8% FX neutral growth in consulting revenues.

In research we grew contract value to a record of $834 million at December 31st. Up 8% year-over-year excluding the impact of foreign exchange. This growth was broad-based across all industry sectors, including financial services, and was driven by sales to both existing clients and new client enterprises. We added 201 net new enterprises as clients in the fourth quarter, growing our base of client enterprises by 3% versus the third quarter and 5% year-over-year.

We were also successful at renewing business with existing clients as demonstrated by our 82% client retention rate and 98% wallet retention rate. Overall the majority of our contract value growth continued to come from volume versus price. Now these results are a testament to the fact that both existing clients and potential new clients recognize that our research is a critical tool in running a cost effective IT program.

In consulting, fourth quarter results were stronger than expected and this was driven by robust demand for our contract optimization and benchmarking services. These unique services directly help our clients lower costs and their outperformance continued the positive trends from the second and third quarters. Our core consulting revenue also grew in the fourth quarter, although demand for new engagements has slowed and we ended the quarter with lower backlog of $97 million.

Finally, events revenue declined by 7% FX neutral, which was within our expectations. As discussed on our last earnings call that business has been impacted by corporate travel restrictions which have made it more difficult for our clients to attend our events. However, even with these restrictions we still had over 16,000 attendees during the quarter and in addition, exhibitor revenues have been hurt by reductions in marketing spending at technology companies.

Turning to 2009 we've built our operating plan with the assumption that the economic environment neither improves nor worsens this year as compared to the fourth quarter of 2008. In order to maximize profitability in this uncertain environment, we've taken a number of actions. For example, we reduced our cost structure by eliminating approximately 120 jobs, primarily in non-quota bearing and non-client facing functions and suspending a restructuring in a internal programs that are not critical to revenue generation. We expect that these actions, along with others, will generate approximately $50 million in cost savings in 2009.

Second, as we do every year, we carefully evaluate each of our events to determine which to retain and which to discontinue. Based on this analysis, in 2009 we are discontinuing 18 of our least profitable and lest strategically important events and we're launching only two small new events.

Although we've cut costs in certain areas, we're still investing in the long-term growth of our business. We're also continuing to invest in areas such as product development and customer service so that we can continue to enhance the value our services provide to clients, which is a key driver of client retention and growth over the long term.

In addition, we plan to hold our number of sales territories roughly flat in 2009 and focus during this period on increasing productivity so that we are well-positioned for growth once the economic environment [break in audio].

Before turning the call over to Chris, let me briefly comment on our preliminary 2009 guidance, which Chris is going to discuss in more detail. Two thousand nine is a very difficult year to forecast due to the highly uncertain economic environment. While the economy was weak for most of 2008, conditions got substantially worse during the fourth quarter and nobody knows for certain whether we've seen the bottom or when things will start to improve.

As a result, we've set a wide range of expectations based on the trend we saw in our businesses in the fourth quarter and no expectation of change in the macroeconomic environment. We believe this is a prudent approach given the highly uncertain environment.

Beginning with research, we expect revenues to be roughly flat on an FX neutral basis. This is not in our view being driven by weak IT spending. Enterprises are expected to spend about $3.5 trillion on information technology in 2009 and the modest cost of a Gartner research subscription can help them spend these dollars much more efficiently. Thus, as our fourth quarter results demonstrate, clients continue to value our research, whether IT spending is relatively up, down or flat.

So while the demand for our research remains strong what has been impacted are the approval hurdles that clients must overcome to buy our services. Aside from facing layoffs, bankruptcies, and other organizational chaos in the current environment, many of our clients and potential clients must often get CFO approval even for the relatively small amount of spending required for a Gartner research subscription.

As a result we've seen sales cycles linked in substantially, which is impacting our near-term growth. Once macroeconomic conditions improve we remain confident in our ability to grow our research business at 15% to 20% annually over the long term.

In consulting we expect revenue to decline approximately 16% on an FX neutral basis. This is consistent with our backlog levels at year end, and the expectation that we will not repeat some of the big contract optimization deals that we benefitted from in 2008.

Finally in events, we expect revenue to be down approximately 29% on an FX neutral basis. This is due to our decision to hold fewer events this year, coupled with both the expectation that the corporate travel restrictions will continue to impact our clients' ability to attend events and that reduction in marketing spend by technology companies will impact exhibitor revenues.

So based on this outlook we expect to generate normalized EBITDA of $165 to $200 million, EPS of $0.63 to $0.87 and operating cash flow of $100 million to $125 million. So to summarize, during 2008 we generated 9% revenue growth and 51% EPS growth from continuing operations despite a very challenging economic environment.

Even during the fourth quarter when macroeconomic conditions deteriorated significantly, we generated revenue growth including double digit growth in our research business. We were able to achieve these results because our services remain a critical tool to IT professionals regardless of the economy and they provide a high value at a relatively low cost.

With that, I'll turn it over to Chris for additional details on our results and our '09 outlook.

Chris Lafond

Thanks, Gene, and good morning. I'll start today with a review of our full year results and fourth quarter results and finish with a discussion of our full year outlook. Our fourth quarter revenue and earnings results were in line with the guidance we provided in our third quarter earnings release despite an economic environment that as you know deteriorated significantly and rapidly during the quarter. On an FX neutral basis total revenues for the fourth quarter increased 6% over 2007. EBITDA and EPS were also in line with expectations, including the costs related to the elimination of approximately 120 positions, which we announced on January 8th.

We have seen continued demand for our products and services in this environment because organizations have a critical need to reduce costs and effectively manage their IT programs and investments regardless of the economy. Let me now discuss each of our business segments in more detail.

In research, year-over-year FX neutral revenue growth was 11% for the fourth quarter and 14% for the full year. Despite the environment we delivered both sequential and year-over-year growth in contract value. On December 31st contract was a record $834 million, up 11% year-over-year and 3% sequentially. On an FX neutral basis contract value [increased] 8% from December '07.

Our client retention rates increased slightly from Q3 to 82% and remained at the levels experienced throughout 2007 and early 2008. At 98% our wallet retention rate also remained in the range we expected. These retention rates demonstrate that the demand from our existing clients for our research services remain solid. I will point out, however, that our clients' ability to increase their spend at the levels we experienced in 2007 is clearly being impacted by the economic environment.

Growth in contract value also came from gaining new client organizations and enterprises throughout the year and during Q4. While the majority of contract value growth continued to come from new business volume we also increased our effective selling prices in 2008. As previously communicated we announced a 3% price increase on our research products in Q3 and this took effect in Q4.

These results highlight two things. First, our sales expansion efforts enabled us to further penetrate our untapped market opportunity throughout 2008 and in Q4. And second, in a period of uncertainty and increased scrutiny at many companies, the value of our research services and helping clients achieve critical strategic objectives is recognized.

Importantly, the sequential and year-over-year growth in contract value continued to be very broad-based across all client sizes, geographies and industries. From a research product perspective our role-based offerings continued to be an important driver of research growth and an increasing percentage of our total contract value.

As of December 31st Gartner For IT Leaders, our role-based products for the end user market accounted for $203 million of contract value, up 32% year-over-year, and Gartner for business leaders, our role-based products for technology market represented $101 million of contract value, up 82% year-over-year.

Collectively these two products were up 45% year-over-year and accounted for 37% of our total contract value. We expect continued growth in these products from both new clients and migrations of existing clients for the foreseeable future. Our Executive Programs offerings for CIOs also continue this trend of double digit growth in contract value, up 13% to $214 million at December 31st.

The continued growth and inherent operating leverage in the research business led to a full year 2008 gross contribution margin increase in this segment of 2 percentage points to 66%. This increase included severance charges related to the January action. Fourth quarter gross contribution margin was 64% and excluding these expenses would have increased one point year-over-year.

As you can see from these metrics our research business continued to grow in the fourth quarter despite an economic environment that deteriorated more significantly than we expected. On the FX neutral basis 2008 full year growth of 14% approached the low end of our long-term roadmap for the segment of 15 to 20% annual growth.

Our research continues to be highly valued by clients and our performance during the fourth quarter demonstrates that there is a vast untapped market opportunity for our services. While contract value grew sequentially in Q4, the macroenvironment did begin to impact our results. Research growth from both existing clients and prospects is being impacted by lengthening sales cycles as companies deal with layoffs, restructurings and other challenges resulting from the turmoil in the economy.

As a result, both retention rates and new business in Q4 trended down versus last year. I'll discuss this further when we get to the 2009 guidance in a few moments.

Moving on to consulting, our consulting business exceeded our expectations for revenue growth in the fourth quarter and for the full year. During the fourth quarter consulting revenue increased 8% on an FX neutral basis. For the full year 2008 revenue was up 6% on an FX neutral basis which is within our long-term growth objectives for this business of 38%.

As we experienced in the first three quarters of 2008 our contract optimization and benchmarking practices, both of which have clear value propositions and ROIs were stronger than expected. And in fact we had an exceptionally strong quarter in our contract optimization business.

Productivity remained solid with fourth quarter utilization at 70%. For the full year utilization with 72%, up 3 percentage points over 2007 and ahead of our long-term target of 70%. Average billing rate and annual revenue per billable headcount were both up 3% and 7% respectively for the full year. All of these metrics reflect our successful focus on improving the productivity and profitability of this segment.

For the full year gross contribution margin increased 2 percentage points to 41% driven by these productivity improvements and included the impact of severance costs. For the fourth quarter gross contribution margin in the consulting segment was 39% and excluding the impact of severance expense this would have been 41%.

As of December 31st consulting backlog was $97 million, down 20% year-over-year as our fourth quarter bookings slowed with the weak economic environment. As with research we also witnessed lengthening sales cycles for consulting engagements. This level of backlog represents approximately four months of revenue as we enter 2009.

During the fourth quarter we saw year-over-year growth in both our contract optimization and benchmarking practices. While we ended 2008 with 499 billable consultants, the action taken in January reduced this by approximately 30 to match delivery resources with our backlog as we enter 2009.

Turning now to our events segment, this segment, this segment faced a number of challenges during 2008, particularly in the fourth quarter. As discussed in our last earnings call, we have seen a significant increase in travel restrictions and other expense controls implemented at many companies. This clearly impacted the attendance at our conferences. We held 17 events with over 16,000 attendees in the fourth quarter, compared with twelve conferences in Q4 of 2007.

Normalizing for the timing of events held during the fourth quarter, attendance at the twelve events also held in the prior year was down 14% as a result of the severe travel restrictions. For the full year, we held 70 events compared to 62 last year. The 41,000 attendees we attracted are down 6% year over year. Our events are platformed for the delivery of immediately actionable research content and therefore have remained valued by these attendees even in the current economic environment.

On the exhibitor’s side, technology company budgets came under severe pressure in Q4, and in particular marketing budget cuts reduced the number of exhibitors at our events as compared to 2007. As a result of these macroenvironment factors, events revenue for both the fourth quarter and the full year 2008 were down 7% on an FX neutral basis. This was in line with the guidance we provided back in October.

We anticipated the fourth quarter revenue to decline and we were able to take action to reduce costs in the events business. Gross contribution margin for the quarter was 46% but would have been 49%, excluding the impact of severance expenses. For the full year, gross contribution margin was 43%.

We remain confident in the importance of the events to our overall portfolio and the value that our conferences provide as witnessed by the 16,000 people who attended during Q4. As you will see when I discuss guidance in a few moments, we have decided to reduce the number of events to be held in 2009, as we do not expect this year to be an environment where smaller events will be profitable.

Moving down the income statement, the increase in SG&A reflects the continued investment in our sales organization which grew headcount of 15% during the year to 928 sales associates. As we communicated earlier in the year, we decided to add additional sales capacity in 2008 based on our first half performance. During Q4, we decided to hold off additional hiring and expect minimal growth hires in the sales organization in 2009.

Year-over-year SG&A expense comparisons in the fourth quarter were negatively impacted by 2 million due to the severance expenses. We continue to carefully manage SG&A, which remains roughly flat as a percent of revenue for the full year of 2008.

Turning now to cash for the full year of 2008, operating cash flow increased 24% to $184 million, which exceeded our guidance. The growth in cash flow was driven by our strong operational performance coupled with tight management of working capital. In particular, our accounts receivable position improved significantly from last year, with receivables over 60 days on December 31, well below last year and near an all-time low.

Capital expenditures remained at the 2007 level of $24 million and cash tax payments were less than originally expected. As a result, we generated free cash flow per share substantially in excess of our earnings per share and were able to convert a significant percentage of our EBITDA into operating cash flow.

During 2008, we deployed our cash primarily to re-purchase stock. We repurchased 9.7 million shares at a total cost of $199 million. As a result, our fully diluted shares outstanding decreased 9% in 2008 versus 2007. Over the long term, we believe that re-purchasing our stock remains a compelling use of our capital, and we have over 82 million remaining under our existing authorization.

In the near term, we will carefully manage and balance the returns from share-repurchase against the prudence of insuring that we maintain a strong balance sheet in liquidity position in light of the uncertain economic environment and credit markets. At December 31, we had total debt of $416 million and cash of $141 million.

To summarize our 2008 performance, we generated 9% revenue growth, 12% normalized EBITDA growth, and 51% EPS from continuing operations growth despite the rapidly worsening economic environment. We continue to invest to accelerate the long-term growth and profitability of our research business through new product launches, sales capacity and client service improvements. This positions us for growth when client spending returns to normal levels.

We improved all key operating metrics in our consulting business with utilization up three points, driving a contribution margin increase of two points for the year. We face significant challenges in our events business with both attendance and exhibitor participation down from 2007.

We generated $184 million in operating cash flow by effectively managing as aspects of working capital, most notably accounts receivable. And we returned significant cash to our shareholders by re-purchasing close to ten million shares of outstanding stock.

Now we move on to our financial outlook for 2009. Our 2009 guidance has been established in the context of the rapid and severe deterioration of the economy that we witnessed during the fourth quarter. We have prudently and realistically assumed that the same economic environment that we experienced during the fourth quarter persists throughout all of 2009.

All the economic data and evidence that we see daily suggests that so far the environment we face in Q1 will be no better than Q4, and we have taken actions in light of this. As this is an extremely challenging environment to forecast, we have provided a much wider range of potential outcomes with this guidance.

We can and will make our decisions to effectively manage this business for the long term in this environment. For our research business, this means that the contract value growth for both existing clients and prospects will continue to be influenced by the unprecedented challenges facing many companies and our clients today, including lay-offs, business re-structuring and other organizational operational issues. These challenges and the resulting uncertainty will result in lengthened sales cycles.

As we saw during the fourth quarter, this is likely to impact both retention rates and new business. In this environment, we expect research revenue to be roughly flat in 2009. When we have returned to a more normal economic environment, we still expect to grow research revenue at 15 % to 20% per year per our long-term financial roadmap.

For our consulting business, we are entering the year with a back load that is 20% below where it was the same time last year. As I mentioned earlier, we had an exceptionally strong quarter in our contract optimization practice during Q4. And while we expect this practice area to continue to do rather well in 2009, we are not expecting to repeat some of the large deals that benefited 2008. With lengthening sales cycles, we are guiding to a 12 to 21% decrease in consulting revenue in 2009. Over the long term, however, we still expect to grow this business 3-8% per year.

For our events business, severe travel restrictions and marketing budget cuts in technology companies are expected to significantly impact both attendee and exhibitor participation. As in previous years, we have evaluated each of our events in the portfolio in order to determine which to retain and which to discontinue.

This year we decided to discontinue 18 events including our Spring Symposium. This is a larger number than in past years and will reduce annual revenue by $21 million. Unlike the past few years where we have launched around ten new events each year, we plan to launch only two small events during 2009.

We do not believe that 2009 is a year conducive to establishing new events. The events we eliminated are those that we felt would have no interest to our clients in the current environment and would generate minimal or no profit in 2009.

So we expect to hold a total of 54 events this year, down from 70 in 2008. With fewer events and continued cost controls at our clients, our guidance is for the events revenue is to decline 26% to 33% in 2009. Over the long-term, we still expect revenues for this business to grow at a rate consistent with our long-term target of 5% to 10% annually.

With this context, we project total revenues to range from $1.1 to $1.16 billion for the full year. This represents a decline of $9 million to $14 million as reported and 6 to 10%, excluding the impact of foreign exchange. Projected revenues by segment can be found in our press release issued earlier this morning.

With regard to expenses, and as Gene discussed, we have taken numerous actions to reduce and control costs in 2009, including eliminating approximately 120 positions and reducing the number of events we will hold. Importantly, we have also made conscious decisions not to cut costs in certain areas that we fell would weaken our business or hurt our ability to grow when the economy returns to health. For example, we do not plan to reduce the size of our sales force but rather expect to continue to replace open sales positions throughout 2009.

We also expect to continue key product development efforts like enhancing existing and launching new products, and plan to maintain the current levels of analysts to ensure we deliver on our client commitments. To be clear, we could have cut additional costs to improve short-term profitability at the expense of long-term profit growth, but purposely we have decided not to do that.

We expect normalized EBITDA for 2009 to range between $165 million and $200 million based on these assumptions. This range of normalized EBITDA is being driven almost entirely by gross contribution – by lower gross contribution expectations from the consulting and events segment.

Moving down the income statement, we expect total depreciation and amortization to be approximately $26 million in 2009, interest expense to be approximately $17 million and other expense to be approximately $2 million. We are projecting an effective annual tax rate of between 32% and 33%, and average fully diluted shares outstanding of between 97 and 99 million shares for the year. This all results in an expected EPS range of $0.63 to $0.87. We expect these operating expectations to translate into cash flow from operations of $100 to $125 million and we expect $15 to $20 million in capital expenditures.

In 2008, we benefited from a significant improvement in the effectiveness of cash collection. In this environment we do not expect that to continue. In fact, this company’s conserved cash given the current state of the credit markets our accounts receivable position could worsen.

In addition, for the past few years we have benefited from low cash tax payments. As we discussed last year this is expected to change over time. We believe that repurchasing our stock remains a compelling use of our capital and we have over $82 million remaining on our existing authorization. Minimizing the dilution of our equity compensation plans remains a priority for the deployment of cash in 2009.

While our policy is to provide annual but not quarterly earnings guidance, I want to provide some additional information to allow for an understanding of the seasonality and other factors that will impact our revenue and earnings on a quarterly basis. The full year research revenue will be fairly evenly distributed across each quarter of 2009. Consulting revenue will be slightly higher in the second and fourth quarters and approximately 50% of the full year events revenue will be earned in Q4 with the [Plaus] Symposium and other large events held that quarter.

We preliminarily expect EPS in the first three quarters to be roughly 60% of the annual EPS with roughly 20% in each quarter, and Q4 is expected to be 40% of the annual EPS primarily due to the timing of our events calendar.

Finally, I’d like to spend a moment on the impact of the volatility in the foreign exchange markets on our business. As we have communicated to you in the past research contract value is reported on an FX neutral basis within each fiscal year. We do this so that you can understand the true organic growth in our research segment throughout the year.

In January of each year we restate the opening contract value at new FX rates. As a result of the significant strengthening of the U.S. dollar in Q4, contract value on January 1st will be approximately $40 million lower than reported on December 31st.

This change is consistent with the treatment in previous years and is solely due to foreign exchange movements and does not imply lower volumes. Our guidance is based on spot rates in early January. We have made no attempt in our guidance to anticipate any strengthening nor weakening of the U.S. dollar from the actual foreign exchange rates in early January.

Importantly, we still believe that movements in FX rates will have a minimal impact on our earnings given our mix of revenues and expenses around the world. However, with the continued significant volatility in foreign exchange markets we’ll update you on our quarterly earnings calls during 2009.

Although we’re bracing for a challenging year for growth due to weak and uncertain economic environment, looking ahead we’re very optimistic about the long-term business fundamentals and market opportunity. We are prudently managing our business to ensure that once the macro environment improves we’ll return to double-digit revenue growth, double-digit earnings growth and increasing returns to our share holders.

With that we’ll open the call up for your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) You have a question from Jeff King – William Blair.

Jeff King – William Blair

Hey guys. Could you talk about how much your sales cycles have lengthened and also if business was weaker in the enterprise or the middle market?

Gene Hall

Basically we haven’t measure precisely how much the sales cycles have lengthened, but looking we do reviews very frequently of individual deals and it’s our observation that the number of steps it takes to get a deal closed are more than they were a year ago. And as I mentioned in my comments, in many cases, in most cases, if you went back a year ago in past times you wouldn’t have to take any of our, most of our contracts up to being signed off by a CFO of the company.

Now, because the cost controls many companies have put in place, people still want to buy but they have to go through our clients who want to buy it, they have to go through more hurdles internally to get it approved, and that’s lengthening the sales cycle. And so we haven’t measured it precisely but it’s very obvious that that’s what’s going on.

If you look at it in terms of by – if you look at our performance across industries and size of companies we’ve had similar performance across all industries and all sizes of companies in all geographies for that matter with APEC being slightly better, but the performance has been equal across all of those. So we haven’t seen the smaller companies get worse than larger companies or something like that, and same thing by industry.

Jeff King – William Blair

Could you guys also talk about your consulting business? So are projects being canceled or are they just shortening?

Gene Hall

So as you saw in our consulting business we actually exceeded our expectations in Q4. What we’re seeing on a go forward basis is not projects being cancelled but just that our backlog is down more than we would have expected. And so that’s sort of what’s been going on. So it’s not projects being cancelled, it’s more just fewer new projects. One thing Chris mentioned is our contract authorization services are not included in our backlog and so it doesn’t reflect that.

Jeff King – William Blair

But could you just comment on why you think the backlog is down so much?

Gene Hall

Well, I think it’s a combination of two things. First, part of it is the extended selling cycles and that has an impact on consulting just like it does on research. It takes more steps to get consulting projects done. And secondly, I think more companies have kind of blanket limits on new consulting contracts compared to research where that doesn’t apply. So there’s some companies just would say we’re cutting consulting.

Jeff King – William Blair

And then one final question is would you expect your events margin to actually be higher in 2009?

Chris Lafond

No, I wouldn’t say that. I think the way we looked at our expectations in the guidance we’ve given is there’s a couple of things. Number one, we certainly eliminated a number of lower margin events so on the face of it you would think the margin would increase. However, we’ve also expected that our existing ongoing events will have lower attendees and exhibitors than the prior years which will put pressure on the margin, so obviously there is some fixed cost to holding an event and at lower attendees and exhibitors that’s kind of what you would expect. So I would not expect that sort of increase so that’s not the expectation you should have.

Operator

Your next question comes from Peter Appert – Piper Jaffray.

Peter Appert – Piper Jaffray

Gene, the guidance for research in ’09 is relative to at least the strength you saw in the fourth quarter seems pretty cautionary, and I guess appropriately so, but should we interpret from that that you’ve seen some further significant deterioration in the January sales trends?

Gene Hall

No, you should not. Basically it purely reflects, that guidance purely reflects what we saw in Q4 and it basically reflects the down tick in retention that you saw, the slight down tick in retention, and there’s also been a modest down tick in the amount of new business. When we look at that over the course of 2009 that’s what gives us that result. Chris, you want to comment?

Chris Lafond

Peter, I think Gene is exactly right. I think as our contract value continues to increase a couple of point movement in retention has some fairly significant impacts and as Gene mentioned we started to see a modest decline on a year-over-year basis in new business. So the combination of those two things certainly puts pressure on the early part of the year and it’s far too early for us to look all the way out to the end of the year, but those are the things that I think we thought about as we looked at the research guidance.

Peter Appert – Piper Jaffray

In the fourth quarter, I think I heard you correctly, right, you said you had 928 sales people at the end of the year?

Chris Lafond

That’s correct.

Peter Appert – Piper Jaffray

Okay, so you did step up the hiring in the fourth quarter. How do you square that with the more cautionary view that you were seeing as the quarter progressed?

Gene Hall

Because of the extended selling cycles our sales productivity has declined and that’s kind of what’s going on. So while we still see good demand, and I’ll just use it illustratively, if it used to take three steps to get a deal closed and now it takes six, our sales productivity declines off of that, and that’s kind of what’s going on in terms of the capacity.

Chris Lafond

One other thing I'd comment on is if you remember after the second quarter call we started aggressively recruiting, so some of the fourth quarter hiring you saw was actually people we hired in the third quarter. So as I said during my comments when we started to really see the fourth quarter change dramatically we slowed that down but we honored all the commitments to previous hiring because we still think it’s a good idea to have that capacity. So that’s how you should think about. You shouldn’t think that we were still plowing ahead making offers in Q4. In fact we slowed that down as we saw Q4 play out.

The other thing I would comment on just in terms of the research segment and our continued hiring is you should not expect; we’re not expecting any degradation in the research margin. So as I said during my comments our guidance and the impact on guidance is really driven out of the consulting events segments not of any degradation in the overall margin rates in our research business.

Peter Appert – Goldman Sachs

And then, Gene, finally you started your comments with some fairly strong statements with regard to your view as to the criticality of the Gartner product, etc. How do you square that then against the deteriorating sales trends?

Gene Hall

So again, Peter, what's going on is clients want to buy our products. The internal hurdles they have to go through to get things approved are a lot tougher than they were if you went back a year ago. I'll give you kind of an extreme case. Again, as I said, we review deals all of the time.

There was a client we have where the CIO was fired and they put the IT Department reporting into the head of HR. The people who worked for the CIO all signed contracts with us to buy new services, the head of HR basically then said I'm not going to let you buy anything right now until the new CIO comes on board because some of you guys might not even be working here anymore.

And so it wasn't lack of demand it was the internal difficulty that many companies have are slowing down the processes. I've seen many clients like where a new CIO comes on board and they get approved, but it took a lot longer and a lot more sales effort than it did before.

That's different than if we were seeing that people in stable situations were just saying, oh we don't need Gartner anymore. We're not seeing that. We're seeing people, that our demand, fundamental demand is just as strong as ever.

But the steps required to get a contract closed with all of the organizational chaos, the economic dislocations that are going on and the tight cost controls companies have in place just makes the selling cycle a lot longer than it used to be.

Chris Lafond

One other comment I would make as most of Gene's comments were around kind of existing clients and what we're seeing there. But also just to be clear on new clients we talked about it during our comments is we did penetrate new clients during the quarter. We were able to sign growth deals with new clients. So even in challenging environments and even in companies that when you see the kinds of clients we signed are having significant challenges.

We saw some of those companies signing new deals that were not previously clients. So all of those combinations is how we kind of get comfortable that there's still real demand out there.

Peter Appert – Goldman Sachs

Back as recently as '06 the wallet retention was in the low 90s is that sort of a benchmark that you think might be relevant in terms of thinking about the macro-environment currently?

Chris Lafond

It's a great question. We certainly think it's not out of the question that you could see a decline in the wallet retention rate. We started to see a little bit of decline in the fourth quarter from the previous trend line, so certainly we had been running kind of a 100, 101 dip to 98. So our current expectations aren't that it necessarily goes that low but that is I don't think anything that you say is completely out of the question as we think about it.

However I think our guidance assumes more kind of what we saw in the fourth quarter as opposed to it significantly weakening from there.

Operator

(Operator instructions) Your next question comes from Dave Lewis – JPMorgan.

Dave Lewis – JPMorgan

First question is have you seen an impact from your government contracts, any material cancellations in 4Q or thus far in this quarter? And what's the vulnerability there going forward in light of the budget crisis on the state and federal level?

Gene Hall

We've seen no different environment for contract cancellations in Q4 than in previous periods and that applies to all industries including government sector.

Dave Lewis – JPMorgan

Could you just provide a little more detail on pricing? You mentioned the 3%. Is that pretty firm? Are you getting that 3% through 4Q and how is that trending in the first quarter thus far?

Gene Hall

So long term our strategy has been to increase prices 4% to 7% a year which is what we did in '07. Toward the end of '08 when we do our normal price increase given the macroeconomic situation we decided it made sense to have it a little bit lower.

And really it's because we don't want to see, provoke an emotional reaction with clients on that. And through Q4 we didn’t see any – that kind of approach worked in the sense we didn't see a lot of push-back on the 3% price increase.

Meaning that in our average research product for new products revenue was $18,000 per user. And so people don't not buy because there's a 3% price increase on the $18,000 and that's kind of the net of it. So through Q4 we didn't see a lot of push-back on that 3% as opposed to the 5% to 7% that we had done previous years.

Dave Lewis – JPMorgan

I just want to be clear on the commentary with regard to the first quarter. You guys are assuming that you're seeing an environment that's similar to 4Q and your forward-looking guidance, but are the trends thus far through January are they still similar to 4Q? And the reason I'm asking is obviously trends in many other industries are worse and so that's just a concern that things could be getting worse as we speak.

Chris Lafond

Currently, two points, we're not seeing anything different. It's far too early to really tell. January is one of the smallest months of the whole year for us. But in that small volume we've seen we haven't seen anything different than we saw in the fourth quarter at this point. But I wouldn't necessarily read into that trend one way or the other because it's far too early.

Operator

(Operator instructions) Your final question comes from [Brian Murphy] – Sidoti & Company.

[Brian Murphy] – Sidoti & Company

Chris, you mentioned that you stepped up the sales force headcount and sales force productivity is depressed from previous levels. At what point do you start to add to the sales force again? Would you be doing than when we have productivity returning to previous levels or would you do it ahead of that?

Gene Hall

I'll answer that one. Basically we're thinking that – we're looking for a reasonably short payback in productivity on our sales people. So when we saw a situation where we could kind of get a breakeven in their first year, cost versus their kind of incremental profitability, what they sell, that's kind of in the first 12 to 18 months that's what we're looking for.

So what's going on is, as we hire new people and their productivity is lower in their first year than after their first year. And so if we can get kind of a marginal breakeven or better in the first 12 to 18 months that's when we'll hire more people.

[Brian Murphy] – Sidoti & Company

And, Gene, you mentioned that you're sticking with your sort of long-term target of growing research revenue about 15%. Would you expect to get most of that growth sort of as you have in the past by aggressively growing the sales force or would you expect to get more from productivity gains?

Gene Hall

I'd say we expect to get both kind of equally. In other words we think we can get a lot higher productivity than we out before this economic downturn. As you know, over the past three years we improved our sales productivity every year consistently.

We think that will continue after the downturn. So basically once the economy recovers we're going to be back on the track. We're on track now to get sales productivity up even in this environment. We think it will continue to go up from where it was, from the high point after the economy turns around.

Having said that we'll still add headcount as well again based on the kind of economics I was just talking about. So we'll add headcount as fast as we can operationally absorb it and as fast as we can afford it. And we're still going to focus on sales productivity improvements as well, and those have not topped out by any stretch.

Operator

There are no further questions in the queue at this time. I would like to turn the call back over to management for closing remarks. Please proceed.

Gene Hall

Although we expect 2009 to present a challenging environment for growth we remain confident in our ability to generate double digit revenue and earnings growth once the economy returns to more normal levels. We've taken decisive actions to control costs in the current environment but we're still investing in our businesses so that we're well-positioned for long-term growth once the macro-economic environment improves.

The Gartner brand is in a class by itself. Our products, services and people are superior to the competition. We have a great business model and we benefit from a vast untapped market opportunity. With these great capabilities I remain very optimist about the future success of our company.

Thanks for joining us today and I look forward to reviewing our results next quarter.

Operator

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Good day.

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Source: Gartner Inc. Q4 2008 Earnings Call Transcript
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