Gartner Inc. (NYSE:IT)
BarCap Global Technology TMT Conference
May 23, 2012 3:15 p.m. ET
Chris Lafond - EVP & CFO
Brian Shipman - IR
Manav Patnaik - Barclays Capital
Manav Patnaik - Barclays Capital
Hi, good afternoon everybody. My name is Manav Patnaik, I am Barclays information services analyst. I cover Gartner. Given it was a part technology conference, I thought it makes complete sense to have Gartner here as well. I do have a one overweight grading on them. I find the growth opportunity here attractive in the predominant research subscription model which leads to pretty strong free cash flow generation very attractive as well. So that’s sort of my quick pitch. But we have – thank Chris Lafond, CFO to be here as well as Brian Shipman who is the IR in charge there. So without taking any more time, Chris.
Thank you all for spending a little bit of time on Gartner. Let me take you right into the presentation. For those of you that don’t know Gartner, we are the leading provider and the best source of information for our clients in terms of how and where to use both information technology and supply chain management best practices to accomplish your objectives. And I will tell you what that means in terms of our business and the value that we provide to our clients.
What I want to do today is talk about kind of four things that all lead to the fifth thing which is, I will talk a little bit about our value proposition, our market opportunity, the strategy we’ve been executing, the business model we have that takes advantage of those things and finally, if we execute on all of those things well, why we believe we will continue to grow our business at double-digit rates both from a revenue, cash flow, EPS perspective over the long term which -- and I will show you some of the metrics that we have been delivering over the past six or seven years.
So let me start with our value proposition. Our business really has three segments to it. Research which is by far the largest at 70% of the revenues, consulting at 20% and events at 10%. So I want to spend some time on each one of those segments. If we start with the research, our research product is a really highly differentiated product from anybody else in the marketplace. We have the most comprehensive coverage of information technology and supply chain management in the world. We have 810 analysts globally that cover the space broadly and very, very deeply.
Our clients buy access to our analysts, buy access to the content they create, access to talk to our analysts throughout the entire year. Our model is a subscription model. We sell a minimum of one-year subscription. Within any point of time about a third of our contracts are multi-year in length, that being two to three years generally. And we have a role-based focus. What does that mean? It means we have identified who the buyers of our products and services are. We primarily sell to the end users of technology, so the CIO and the CIOs organization, the vendors of technology and investors in technology.
Underneath each of those three segments, we understand the role that somebody plays. So if you are in the CIOs organization, are you the CIO? Are you the head of security? Are you the head of application development? If you are a vendor, are you the head of product development, are you in sales or are you competitive intelligence? We have different products for those different roles. So our products and services are really tied to delivering the value to each of those roles. And we have tremendously broad set of clients we work with. We work with over 12,000 client organizations in 85 countries around the world. And I will talk a little bit more about each of these businesses as we go through.
Our consulting business, which is about 20% of the revenues, the key point here is you should not think of our consulting business as an implementation organization. We do not implement technology solutions. Our consulting organization has three components to it. We have a benchmark organization. So we do benchmarks for IT organizations of how effectively they’re running their IT organization, and we have the largest database of IT benchmarks in the world.
We have a contract optimization business that allows our clients to understand when they are doing a large purchase whether that’s Oracle, IBM et cetera. Are they getting the best price and terms and conditions? And we can help them make sure they are getting that. And then finally our core consulting practice which is about 70% of the consulting business, is really highly strategic engagements for the CIO and the senior IT professionals. We talk about between $250,000, $300,000 average engagement size, six to seven months in length. Things like helping clients decide on their sourcing strategy, helping them look at their enterprise architecture strategy, very strategic high level projects.
And the reason the clients use our consulting practice is we are truly independent, objective. As I said earlier, we do not do implementation. So we don’t make recommendations and then make money on the back end of that by implementing technology solutions. Our clients come to us and we win in situations because of that objectivity and truly independent approach.
And finally, our events business which is about 10% of the business. We are the largest provider of IT events in the world. This year we will hold between 62 and 65 events and attract well over 40,000 attendees. We view events as an extension of research. Half of the people that attend our events are research clients because they get a research ticket in part of their deliverables. The other half are people that we hope we can over time bring into research by exposing them to the value of engaging with Gartner analysts. Our events, the content is all Gartner analysts, it’s all of our content that we bring to the table.
So those are our three segments and how we can think about delivering value. The reason that we are able to be different than any of our competitors is that, as I talked about earlier, over 800 analysts, we talk to decision makers, key decision makers. We have over 5000 – around 5000 CIOs as members of our various programs. That’s by far the largest number of CIOs that anybody in the industry works with and working with over 12,000 organizations. We have over 12,000 briefings from technology companies who help us understand what they are doing in the industry. So we can bring that to our clients. Obviously we talk to investors, we talk to academic institutions. We have a network that nobody else has and we can bring the best insight to our clients at a size and scale that nobody else in the industry or nobody else can do at the price that we deliver.
So let me now move to our market opportunity. From a market opportunity perspective, this is one of the key points that is important about our company. First is that almost every company in the world, every government agency, every non-profit organization could be a potential client of Gartner. And the reason for that is everybody uses technology in a meaningful way today. What we have identified on this chart is you’ll see kind of in the middle 108,000 enterprises. These are enterprises that have at least $10 million of IT spend. So these are big companies, they are all over the world, there are plenty of them, obviously in the U.S. and Europe but they are spread out around the world.
Way over on the right side of the chart, you will see today we have about 8000 clients. So we have a small fraction of those as clients. We have assigned another almost 26,000 to our field sales force. The challenge we have today is the size of our sales force does not allow us to effectively cover all of the opportunities we have for our products and services. So even the 26,000 clients that are assigned are effectively being called on – all of them are not called on today. So while this chart will say we cover 34,000 of the 108,000, I would argue we are not fully covering those. And we still have 74,000 clients that we’re not even, or potential clients we’re not even assigned yet, are not even talking to yet. And so we have a huge market opportunity and you will see in a minute our strategy has been to continue to expand our sales capacity to go after that market opportunity.
What does that translate into? We believe that translates into over $47 billion market opportunity. What I will tell you is you can see the small bar at $1.1 billion. That’s our research business today. So the point of the chart is not to say we think we’re going to become a $47 billion company any time soon. It’s that we continue to grow this business very aggressively. We can grow our sales force to 15% to 20% per year for the foreseeable future and continue to drive double-digit growth in revenue for a long time before we even bump into any opportunity to say we don’t know where to sell, we don’t know how to grow and expand the business for the products and services we have today. So the market opportunity is a huge piece of the strategy we are executing today.
So what is that strategy? Strategy is really quite simple. First, it’s to make sure we have the best research insight. Our research organization has the 810 analysts I talked about. We do not hire people and train would-be-analysts. We hire people that are 10, 15, 20 years experience. We hire people that are viewed as experts. When our clients talk to them, they are talking to somebody who really understands the issues, has been doing it either at a vendor or in another IT organization and is truly viewed as an expert in the field that they are talking about.
We have very high retention of our analysts. We retain 95 plus percent of our analysts every year. So when we bring an analyst on into our organization, we do a really good job of keeping these key people and these key talent in the organization. So with that content, we also need the sales capability. As you saw from the chart, we have an enormous market opportunity. Over the last six or seven years, and I will show you the numbers in a minute, we’ve dramatically increased the size of our sales force. We’ve gone from just under 500 people to over 1300 people today and we expect to continue to grow that sales capacity 15% to 20% per year.
I talked a little bit about our differentiated offerings. We think we have very unique offerings in the marketplace in terms of the role based focus, in terms of how we bring our products to market. And so we think long and hard about the products we bring to the table and making sure that they are very differentiated in terms of what we have, what we offer and how clients get value from that. And finally, from a world-class service perspective making sure that every single person that has access to Gartner, is using that service, is engaging that service and really is getting full value. So we spend a lot of time making sure clients that are paying for services are really receiving all the benefits they should be getting out of working with Gartner.
And underlying all those things is continuous improvement and innovation. We are constantly improving and enhancing our product portfolio, constantly improving how we think about sales capabilities, research and we have a management team that’s been in place for quite some time. Most of the management team has been in place since we started executing the strategy back in 2005 and many of the folks on the executive team have been with Gartner well over 10 years or longer. So a very experienced team that’s been executing everything you will see in delivering the results I will show in a minute.
From a business model perspective, we can take advantage of all those things. We also have a great business model. I talked earlier about the subscription based model that we have. 70% of our revenues are subscription based. We have great visibility and high retention rate. So of that subscription based business and research, we retain over 80% of our clients. In fact, our client retention rate today is 82% and our wallet retention is 99%. And what that means is even though we lose some of our clients, the ones we retain are spending more with us and that’s almost offsetting fully the loss of the smaller clients that we lose. And we fully expect and continue to see improvements in our retention rate and expect to do that over time.
We have a negative working capital business. And why do we have that? We build our research business upfront annually. The vast majority of our clients pay upfront before we have to deliver, before we have to incur any cost. So as we grow the research business, we actually generate significant amount of cash on that upfront billing model. High incremental margin, particularly on the research business. For every dollar of revenue we need about $0.30 to deliver and grow and build our research business. So all of our analysts, all of our customer service teams, all of our product management, product delivery teams, we can do all of that – fun all of that with about $0.30. So from an increment $0.70 on the $1 flows through the gross margin line in research. And I will talk about the other businesses in a moment.
Strong balance sheet and available liquidity today. We have about $240 million of debt as of March 31 and about $140 million of cash, about $100 million of net debt which is well below one times debt to EBITDA. So we have the ability to take on additional debt for the right transactions whether that’s acquisitions or acquiring shares or other things that we think will drive shareholder value. You will see in a minute a high level of conversion from earnings into free cash flow and we have a great and strong and improving on our capital.
So I talked a little bit about our negative working capital model. We continue over time to further take advantage of that and drive additional growth in cash flow. We’ve been very good at year-over-year improving cash flow at a faster pace than revenue and in many cases at a faster pace than earnings, and again it ties back to this bill and collect upfront as we grow that business.
I talked a little bit about our margin expansion. I talked about the incremental margin in research of 70%, in events that same number is 50%. So as we grow the research business, we need $0.50 on the $1 to deliver those events and for consulting given it’s a much more traditional consulting model, we have about 40% incremental margin. All of that as we’ve grown our business over the last few years since 2004, we have increased our EBITDA margin from just under 12% to 19%. We had set a target to get to 20%. We fully expect to continue to grow our EBITDA margin annually between 50 and 150 basis points as we grow the business.
From a cash flow perspective, you will see because of the negative working capital as well as the fact that we are not a capital intensive business, we spend about $30 million to $35 million a year on capital spending, which is not a lot of money. And as a result of that, we are able to get significant conversion from earnings into free cash. So you will see that as we’ve grown our net income from ’04 to 2011, we’ve even grown cash flow significantly faster than that and you will see now taking cash flow to $214 million last year as we’ve continued to grow.
From a growth strategy perspective, financially to execute the strategy I talked about earlier, we had a number of things we were going to do and I want to show you kind of how we’ve executed those. First, we said we would grow the research business and grow it significantly faster than the rest of the portfolio, optimize the events portfolio to make sure we have the right events and driving the right people to those events, improving the profitability of consulting. When we first started executing the strategy in ’05, we felt there was significant opportunity to improve the profitability while growing that business. Leverage G&A, and I will show you how we have done that and then finally, taking advantage of our cash flow to drive shareholder value.
So first in growing the research business, we’ve got a pretty meaningful shift as we focus our business on really taking advantage of the most profitable and the economically attractive part of the business, that being research, you will see back in ’04, it was less than 60% of the business today, we expect it – in last year it was close to 70% of the portfolio, we expect that to continue to become larger and larger over time.
From an events perspective, optimizing the portfolio, what does that mean? As you can see on this chart, we have increased the events slightly from 2004, from 56% to 60% but the number of attendees have gone up dramatically, number of exhibitors have gone up dramatically. So we believe we’ve put the right portfolio in place that attracts the attendees and has a portfolio clearly most attended them. So if you are the CIO, head of security, head of application development, we have events targeted towards those roles and we believe that those roles are viewed as the most important event for people in that particular role to attend year after year, which is why we believe our events portfolio continues to perform well and continues this trend even as we go into 2012.
From a consulting perspective, you can see what we have been able to do since 2004 is grow our revenue from $259 million to $308 million last year, do that while actually reducing head count and as a result of being more profitable by improving utilization, having better productivity of consulting team have driven the contribution margin from 34% to 37%. We expect that number should be and will continue to drive towards 40%. So we expect to continue to find opportunities to improve that margin as we continue to execute our strategy in the consulting business.
From a G&A perspective, we knew that we could support a much larger business. We know the G&A does not have to grow anywhere near the same pace as revenues and so what’s happened over the last few years is we’ve taken G&A as a percent of revenue down 18% to 15% and expect that number to continue to come down as we continue to grow our overall business. So we think we continue to see opportunities to take advantage of our G&A infrastructure, leverage that and drive improvements in the margin.
So what have we done? With the cash we’ve generated, with the profitability that we have, there is a couple of thing. First, we do still have low levels of debt and we have a very attractive credit facility that gives us over $300 million of available credit. We have more than ample opportunities to use that where it’s appropriate. We have done acquisitions. Acquisitions continue to be an important part of our strategy. So if we find acquisitions that make sense at the right valuation, we will absolutely use our cash flow and our balance sheet to do acquisitions. We have done three, and one is in process as we speak. So META, AMR, Burton and we are doing a relatively small acquisition of a company called Ideas International in Australia as we speak.
And barring acquisitions, we have used our cash to buy shares back very aggressively. So you can see that since 2005, we have reduced our share count by over 20%. We continue to spend aggressively on share repurchase. So at a minimum our goal is to avoid any dilution of internal associate equity program as we progress ahead but we have done much better than that over time and continue to drive our share count down through the use of the cash that we generate.
A couple other metrics, just to show you the success of what we executed. So what you can see on this chart on the left is the growth in our sales head count. So as I talked about earlier, we have been aggressively growing the sales force. So we have taken it from under 500 to now, at the end of last year, just under 1300 and we will move that up between 15% and 20% this year. We grew it 21% last year, we expect over the long term to keep driving growth in our sales force of 15% to 20% to capture that market opportunity.
And how do we find that to be successful? A couple of ways. Number one, are we penetrating the client organizations that we had not penetrated? So you can see back in ‘04, we had under 9000, now we have over 12000 organizations that we are working with. So we’ve definitely penetrated deeper into that set of organizations we hadn’t been working with. The average contract value per client, we are now penetrating more deeply. We still think we have a long way to go. Our average seat price and we sell by seat, so our subscription is a name user kind of model, is an average price of somewhere around $25,000. And so what you can see is the average client is only spending enough to buy three or four seats from us. So we’ve not fully penetrated any of our existing clients. We certainly have clients that spend hundreds of thousands or millions of dollars on research with us but on average, clients are buying between one and five seats. So we have a lot of room and we have done a nice job of beginning to penetrate that but a long ways to go.
And finally, all of that combined has allowed us to drive significant growth in contract value from just about $500 million to over $1.1 billion in contract value which is the key leading indicator of how we look at our growth in the research business. So we have been very successfully executing all the parts of the strategy that I talked about earlier.
Over the long term, our expectation has been very consistent since ’05. For each of our three segments, we believe that we can grow the research business over the long term between 15% and 20%. Last year we grew at 14%. We have been at 14% or more now for six consecutive quarters. We think that we will continue with the sales expansion with improving sales productivity to drive that number into the 15% to 20% range over time.
From a consulting business, we expect to drive a growth of 3% to 85 and events 5% to 10%. That will give us overall revenue growth of 11% to 16% over the long term. Just the point I would make here is that this is a very thoughtful approach to the growth. We are very thoughtful about where we are making our incremental investments, where we are putting our incremental dollars and spending in the company. And so while we could grow the other businesses faster, we believe that allocating more of our resources, more of our sales attention in the research is the real driver of our profitability and the long term financial success over time. So we are purposely driving growth into that business by making the right investments and allocating our time and energy there.
As we grow our business, our expectation also is that we will expand our margins. You saw earlier we moved EBITDA margin from under 12% to almost 20%, we think that we can continue to drive 50 to 150 basis points in margin improvement in our overall business and the EBITDA line as we continue to grow and execute the strategy. We have done that very consistently. If you look back since 2005, on average we have delivered about 100 basis points of margin improvement each year and we think we will continue to execute that kind of margin expansion as we continue to grow the business.
And just finally, some of the key metrics overall from a financial perspective. What you can see is from a free cash flow perspective back in 2004 and ’05, not a significant amount of free cash flow, driving that up this year to between $239 million and $257 million. EPS relatively low, obviously back in the beginning of this and now driving that up to $1.63 to $1.79 this year. Normalized EBITDA of around 100, more than tripling that this year and total revenue growth again below $900 million and now we’re going to be approaching $1.6 billion or higher and expect to continue to see double digit growth in all of these metrics as we continue to execute the strategy that I just walked you through.
So hopefully as I went through that presentation, you’ve got a sense of the value proposition that we bring to the table from a Gartner perspective, lot of value in terms of talking of those research analysts and the content they create at a very relatively low price point. Huge market opportunity that we continue to tap into, so we will continue to expand our sales force to go capture that. The strategy that I talked about in terms of outstanding research, growing our sales capabilities, making sure that we have the best products and services, very differentiated offerings and the best customer service that will deliver value to our clients, and finally, the business model that has all the attractive characteristics of a subscription model with very high retention rates, a great upfront billing and cash flow characteristics, great incremental margins and a great balance sheet that can take advantage of opportunities.
So over time we absolutely believe that we will continue to execute the kind of results that I have just showed you in terms of driving top line growth double digit and even faster growth in earnings, EPS and cash flow. So thanks for taking the time to listen to the Gartner story. I think we’ve got a minute here. I don’t know if there is anybody has a question now, we will do a breakout. Just wait for the microphone, I think.
Thanks. Question on the research portion of the pie, it’s growing faster than the other segments, margins are better. It’s a bigger piece of the business today than it was in 2004. Can you give a little granularity – it’s obviously the strategic agenda that you guys have around that business. Can you give a little more granularity around what you are doing to drive that further?
So we do a number of things. So first, I will tell you a few things. We don’t think we need to expand the product portfolio. We think we’ve got a great product portfolio that covers IT organizations from the CIO all the way down to the lowest level of IT. So we think the product portfolio is great. We are constantly enhancing that portfolio, adding value, adding features and functionality, making sure we have the best content. So we are always looking at what are our clients calling about, what are they asking about to make sure we have the right analysts in the right places. So we do a lot around that.
But primarily the focus is really around driving incremental sales capacity to really drive the growth and get into more of the clients who have not bought from Gartner before. And so the biggest part of our strategy in research, we don’t really have to acquire companies to grow that. It’s really our own growth in the sales force to really go after and take the products we have and bring it to more and more people around the world.
So I think we will be doing a breakout. So if anybody wants to join, we will do that now. Thank you.
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