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Gartner Inc. (NYSE:IT)

Q2 2008 Earnings Call

July 30, 2008 10:00 am ET

Executives

Hank Diamond - Group VP of IR and Corporate Finance

Gene Hall - CEO

Chris Lafond - EVP and CFO

Analysts

Peter Appert - Goldman Sachs

Laura Lederman - William Blair

Dave Lewis - JPMorgan

Eric Wiemann - Schwerin Boyle

Bill Sutherland - Boenning & Scattergood

Dave Lewis - JPMorgan

Operator

Good morning, ladies and gentlemen. Welcome to Gartner's, Inc. Earnings Call for the second quarter 2008. A replay of this call will be available through August 30, 2008. The replay can be accessed by dialing 1-888-286-8010 for domestic call and 617-801-6888 for international call and by entering the pass code 51065265. This call is being simultaneously webcast and will be archived on Gartner's website at www.gartner.com for approximately 90 days.

I will now turn the conference over to Mr. Hank Diamond, Group Vice President of Investor Relations and Corporate Finance for opening remarks and introductions. Please go ahead, 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 for the quarter, 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 statements within the meaning of the Private Securities 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 in the press release.

Before I turn the call over to our CEO, let me briefly review the major points from today's press release. First, diluted EPS from continuing operations for the second quarter 2008 was $0.30 a share, an increase of 173% versus the second quarter last year. Research contract value, which is a key leading indicator for our business, increased 16% year-over-year to a record $794 million and total revenue grew 17% to $344 million.

Excluding the impact of foreign exchange, research contract value and the total revenue, each increased 13% year-over-year. Net income increased a 113% year-over-year to $30 million, and the normalized EBITDA increased 37% to $61 million.

Please take note that diluted EPS from continuing operations and normalized EBITDA exclude the results of the company's former Vision Events business, which was sold in February 2008 and is now reported as a discontinued operation.

Turning to the cash flow statement and balance sheet, operating cash flow for the second quarter increased 54% to $68 million and capital expenditures totaled $5 million. During the quarter, the company repurchased 3.9 million shares of its stock for $85 million, and as of June 30, the company had total debt of $470 million and cash of $137 million.

Turning to Gartner's financial outlook for full year 2008, the company increased its projection for total revenue by $10 million at both the low end and high end of the range. This increase was primarily due to higher than originally anticipated foreign exchange benefits. The company also reiterated its previous guidance for normalized EBITDA, EPS and operating cash flow.

Chris will give you more details, but to highlight, we now project full year 2008 revenue growth in the range of 10% to 12% and continue to expect EPS from continuing operations growth in the range of 33% to 48%, EBITDA growth of 10% to 15%, and operating cash flow of between $155 million and $170 million.

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. Second quarter marked another period of strong growth in both revenue and profits for Gartner, as we continue to deliver on our commitment to generate double-digit revenue and earnings growth. During the quarter, our research revenue grew 20% year-over-year and our contract value increased 16%.

For six consecutive quarters, we've grown research contract value in the high teens and generated wallet retention in excess of 100%. We continue to see growth across our research products, client segments and geographies and to generate business both by further penetrating our existing clients, and by attracting new clients. In fact, approximately 70% of our year-over-year contract value growth in the second quarter was from client enterprises that we did not do business with a year before.

Also, while price increases continue to be a contributor to growth, an increasing majority of our growth is coming from new subscription volume, which accounted for about 76% of our year-over-year contract value growth. The fact that our growth from new client enterprises and subscription volume is increasing, demonstrates that our strategy to penetrate the vast market opportunity for IT research is working, as we continue to grow our sales capacity and offer a value added products to our clients.

In particular, our role-based product offerings continue to contribute to strong growth in research contract value. Gartner for IT Leaders and Gartner for Business Leaders together accounted for $259 million of contract value at June 30, which is up 9% sequentially and 92% year-over-year. These role-based products collectively now account for almost one-third of our contract value, up from zero only two years ago. This has helped attract new clients and sell additional subscriptions and upgrades to our existing clients.

So, the research business continues to perform at or above the high end of our expectations. We continue to see strong demand for our products, both in terms of renewals and new business, stability in pricing and good sales force productivity.

As we said on the first quarter conference call, clients are being more thoughtful in spending and purchasing decisions, but we are not seeing any meaningful impact from the economic environment on the growth of our research business.

In consulting, we continue to be successful at both growing revenue and increasing productivity and profitability. During the quarter, utilization reached 75% and we're well-positioned to meet or exceed our target of at least 70% utilization for the full year. All of our other productivity metrics increased as well as we continue to focus on growing our business with our largest, most profitable clients.

Our consulting revenue grew 13% year-over-year during the quarter, which was ahead of our expectations. This was driven by solid growth in our core consulting business, coupled with unusually strong demand for our contract optimization and benchmarking services. While we fully expected solid performance from these businesses, given their strong value proposition, the timing of revenues was skewed more towards the first half of the year than originally expected.

Finally, our events business is performing in line at the low end of our expectations to date. As we would expect in this environment, we're seeing some vendors be more thoughtful in terms of the number of events at which they exhibit and attendees registering closer to the date of the events. But more importantly, there were three operational issues that impacted our performance.

First, we had higher turnover in our exhibitor sales organizations which resulted in more open territories and lower average tenure of our salespeople. Second, we made substantially more coverage changes than usual in our exhibitor sales organization which slowed down sales cycles. Third, we shifted the mix of our attendee marketing to different target segments which resulted in lower close rates.

Now, we have a good understanding of these issues and our recently appointed leader of events, Alwyn Dawkins is making changes to address them. So, for the first half of the year, we've grown total revenues by 14%, normalized EBITDA by 33% and EPS from continuing operations by 132%, and we generated operating cash flow of over $81 million, which is significantly higher than our net income.

We also returned over $150 million of capital to our shareholders by repurchasing our stock at a discount to where it trades today. These results were driven by the successful execution of the same strategy we have followed since 2005 and again reiterated at our annual Investor Day last March.

The four pillars of this strategy are to produce extraordinary research, deliver innovative highly differentiated product offerings, increase our sales capacity and provide world class service to our customers. That strategy is working and our results continue to demonstrate that our services are critical to clients, regardless of the economic environment.

Now, when we first issued our 2008 guidance early in the year, we started with a conservative plan to grow our sales force by only about 10% this year because we wanted to be prudent in the face of an uncertain economic environment. We also told you we could either increase or decrease that growth later in the year, depending on how we saw demand for our research trend.

As you can see from our results demand has stayed strong through the second quarter, despite the challenging economic environment and as a result we now plan to add more net new sales associates than our original target.

In addition, during the third and fourth quarters we expect to make other investments that we deferred in the first half of the year, including in marketing programs, research analysts and service delivery programs, which together will result in higher expenses. These investments are critical to our strategy to penetrate the estimated $21 billion potential market for IT research and achieve our long-term target of growing our research revenue by 15 to 20% per year.

So to summarize, looking ahead, we remain very excited about our products and market opportunity. Our research business is performing at or above the high end of our expectations. Consulting is solidly within expectations and events is currently performing around the lower end of expectations.

As we discussed in our previous earnings call, we remain cautiously optimistic given the current economic environment and our performance into the first half of 2008. Overall, we remain confident in our ability to meet both our 2008 and long-term revenue and earnings growth targets.

So with that, I'll turn it over to Chris for additional details on our results and our 2008 outlook.

Chris Lafond

Thanks, Gene, and good morning everyone. I'll start today with a review of our results for the second quarter and finish with an update on our full year outlook. Our second quarter performance continued the trend of double-digit year-over-year growth in research revenue and contract value.

As we experienced for the past few quarters, this growth continues to be very broad-based across all client industries, sizes and geographies. Demand for our products and services remain strong, despite the current economy, because organizations have a critical need to effectively manage their IT programs and investments in all economic environments.

The research segment continues to perform at the levels we expect in our long-term financial objectives shared at Investor Day and at or above the high end of our previous guidance for 2008. The strong contract value growth we delivered in 2007 and in the first quarter of 2008 along with favorable impacts from foreign exchange converted to 20% year-over-year research revenue growth in the second quarter.

On an FX neutral basis, research revenue grew 15%. The operating leverage inherent in our research business, together with tight cost controls and investment deferrals drove a 2 percentage point increase in growth contribution margin over last year. The results of the research segment for the first half are consistent with this quarter. Revenue increased 15% on an FX neutral basis, and gross contribution margin increased 3 percentage points over 2007.

During the second quarter, contract value, which is our key leading indicator for future research revenue, grew 16% year-over-year to a record level of $794 million as of June 30. On an FX neutral basis, year-over-year growth of 13% remained at the same level we experienced in the first quarter and consistent with the 14% growth we experienced for the full year 2007.

From a role-based product perspective, Gartner for IT Leaders had $180 million of contract value at June 30, up from $114 million last year and Gartner for Business Leaders represented $79 million of contract value, up from only $21 million last year. Collectively, contract value for these two products is up 92% year-to-date and we expect continued strong growth from both new clients and migrations of existing clients.

Our executive programs offerings also continued to deliver consistent year-over-year growth with contract value up 16% to $201 million at June 30.

In addition to the success we're having in attracting new business with new clients, as Gene discussed earlier, we're also driving growth by further penetrating our existing clients with additional research subscriptions and upgrading them to our role-based products. The success of these efforts is reflected in our retention rates.

Wallet retention has remained above 100% for the past six consecutive quarters and client retention is a solid 81%. Our retention metrics reflect the success of our role-based products, improvements to client service and other actions we have taken to ensure that our clients are receiving maximum value from their research subscriptions.

Turning to our consulting segment, for the second quarter of 2008, consulting revenue increased 13% as reported and 8% on an FX neutral basis. This was delivered despite a 2% reduction billable headcount versus last year as a result of our decision to exit consulting operations in the APAC region during the second quarter of 2007. This growth was above our expectations and better than expected first half performance in our contract optimization and benchmark practices, coupled with the expected results in our core consulting practice.

All of our key consulting productivity metrics improved as we continued to focus on larger, more profitable engagements and the investment in more senior level managing partners who have both business development and delivery responsibilities. Utilization was up 2 points to 75% over year-over-year, well above our target of 70% and our average billing rate also increased. Together, these improvements drove an 8% year-over-year increase in our annual revenue per billable headcount which was 489,000 in the second quarter.

The revenue growth and productivity improvements in the consulting segment together drove a contribution margin increase of 2 percentage points year-over-year to 43%. For the first half of the year, consulting revenue was up 8% and as of June 30 backlog ended at $111.3 million, up 2% year-over-year.

This demonstrates the continued demand for our unique consulting services and positions us well to achieve our growth objectives for the full year 2008. All of the results in the Consulting segment demonstrate that our strategy to improve productivity and invest for future profitable growth is working as planned.

Turning now to our Events segment, I will focus on the first half results since quarterly comparisons are highly impacted by timing of the events calendar. For the first half of the year, events revenue increased 3% but was down about 2% on an FX neutral basis due to mix of events and lower exhibitor revenue at our Spring Symposium. Although we held 37 events in the first half of 2008 compared to 32 in the prior year, this included only 29 ongoing events.

We continue to successfully capitalize on opportunities to launch new events and as a result growth in the quarter was driven by the addition of eight new events primarily outside of the US. New launch events are considerably smaller in terms of revenue and attendees than established events, while also delivering lower margins in the first year. As a result, attendance was 19,129 for the first six months of this year, compared to 20,234 in the comparable period last year.

As we discussed at our last earnings call, some exhibitors are being more thoughtful in assessing the events at which they exhibit and attendees are registering closer to the date of events. Even more importantly and as Gene mentioned earlier, there were three primary operational issues that contributed to our performance in this segment.

Moving down the income statement, SG&A increased by $18 million or 15% year-over-year. Approximately $4 million of this increase was due to the impact from foreign exchange. The growth in SG&A reflects the continued investment in our sales and marketing organization. We continue to tightly manage G&A expense and overall SG&A declined slightly as a percent of revenue in the second quarter 2008 versus the second quarter of 2007.

Turning to cash, operating cash flow for the second quarter was $67.6 million, up 54% year-over-year and we spent $5.5 million on capital expenditures. We are well positioned to achieve our full year 2008 operating cash flow projection of between $155 million to $170 million and CapEx target of $25 million to $27 million. This represents operating cash flow per share of between $1.57 and $1.72 for the full year. As you can see, we are generating both operating and free cash flow per share substantially in excess of our earnings per share.

We are deploying our cash primarily to repurchase our stock and during the second quarter we bought back 3.9 million shares at a total cost of $84.7 million. Year-to-date through June 30, we have deployed over $150 million in cash on share repurchases. And over the trailing 12 months, we have spent $290 million and repurchased 14.5 million shares.

As a result of our share repurchases over the past 12 months, our fully diluted shares outstanding in the second quarter were 98.9 million, down 10% from the second quarter of 2007. We continually evaluate our options for deploying our cash and currently believe that share repurchases remain a good use of our capital.

Overall, our year-to-date revenue performance through the second quarter remains roughly in line with the quarterly phasing guidance we shared at Investor Day. The skew of research revenue is tracking as expected. Consulting has delivered a slightly greater percentage of our full year expectation in the first half and events a slightly lower percentage.

EBITDA and EPS were both better than our original expectations, primarily due to the strength in our consulting contract optimization and benchmark practices and the deferred investments and tight expense controls we implemented earlier in the year as a result of the uncertain economic environment.

With respect to our full year 2008 outlook, we have modestly raised our total revenue guidance by $10 million at both the low and high ends of the range and reiterated our guidance for normalized EBITDA and EPS from continuing operations. The increase in total revenue guidance is driven entirely by an increase to our events revenue guidance and the revenue outlook for our consulting and events businesses remain unchanged.

So as stated in the press release we are now projecting full year 2008 total revenue of $1.288 billion to $1.313 billion, an increase of 10% to 12% versus 2007. Details by segment can be found in our press release.

The fundamentals of our research business remain strong. This, coupled with our higher than anticipated benefit from foreign exchange, has allowed us to increase our research revenue guidance for the year. Because FX is the primary driver for the increase in revenue guidance, we anticipate only a minimal impact on earnings. Consulting is tracking towards the middle of our full year guidance and events is trending towards the low end of our full year guidance.

Moving to earnings, we continue to expect that for the full year 2008, normalized EBITDA should range between $209 million and $219 million, an increase of 10% to 15% over 2007. Diluted EPS from continuing operations range between $0.88 and $0.98 per share, an increase of between 33% and 48% over 2007.

Although our first half earnings were higher than the quarterly phasing guidance we've previously provided, we're not increasing our normalized EBITDA and EPS from continuing operations guidance for the following reasons; first, the upside in the first half was primarily due to our decision to postpone certain investments and expenses to later in the year, given the uncertain economic environment. These investments will be made during the third and fourth quarters.

Second, the favorable results in the second quarter were also driven by strength in our consulting optimization and benchmark practices. While we fully anticipated solid performance of these businesses given their strong value proposition, the timing of revenues was skewed slightly more towards the first half than originally expected and so we have not changed our overall full year outlook for the consulting segment. So our earnings guidance for the full year remains unchanged.

In closing, during the second quarter and year-to-date we continued to deliver on our financial objectives. We remain very optimistic about our business fundamentals and market opportunities both in 2008 and over the long-term, but remain vigilant as to any impact on our business from the economic environment. We will continue to prudently manage our business to ensure that we deliver double-digit revenue growth, double-digit earnings growth, and increasing returns to our shareholders in any economic environment.

With that, we'll open the call up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

And your first question comes from the line of Peter Appert with Goldman Sachs. Please proceed.

Peter Appert - Goldman Sachs

Thanks very much. Gene apologies if I missed this in your comments. Did you give specifically the number of salespeople at the end of the quarter and the specific targets in terms of what the additions will be in the second half?

Gene Hall

Hi, Peter, it's Gene. No, we didn't actually say the specific number of salespeople at the end of the quarter or the specific number of additions in the second half. Basically, we haven't finalized that number we're going to be adding during the second half which is why we didn't have that number on it. We've set the total amount of investment we want to make and now we're determining exactly how much of that investment goes to marketing programs versus salespeople and so forth. And Chris can give you the number of sales team we had at the end of the first half.

Chris Lafond

Yes, Peter, at the end of the first half, we had 837 quota-bearing salespeople. And I also just wanted to make two quick corrections from my comments. I made a comment at the end that total revenue guidance increase was entirely due to events. It actually was entirely due to research. So, research changed by $10 million at the low and the high, consulting and events, both revenue guidance remained unchanged.

And then a second correction, when I was talking about the role-based products, Gartner for IT Leaders and Gartner for Business Leaders, I said contract value for these two products was up 92% year-to-date. It's up 92% year-over-year. So, those are the only two corrections I just wanted to make to my comments earlier.

Peter Appert - Goldman Sachs

All right, thanks. Chris, 837, if I have got these numbers right, would imply that you've basically I think added no one or one person maybe in the second quarter. Is that correct?

Chris Lafond

You have the numbers correct. What we had talked about at the end of the last quarter was that we had hired a bunch of people in the fourth quarter and the first quarter and that we were going to basically stay roughly where we were through the first half and then assess at the end of the first half if we wanted to do any further investment into the back half of the year. So, the numbers you have are correct.

Peter Appert - Goldman Sachs

Okay. So, I have done just some back of the envelope calculations here. I think the implication of your earnings guidance would be that you would be looking for essentially flat margins in the second half of the year, which given the understanding the investment you're making, but even so, given the inherent operating leverage, the business model seems somewhat conservative. So could you just address that?

Chris Lafond

Just a couple of things, Peter. I think you've seen pretty significant increases in our segment margins across the board, particularly in research. So, segment margin is up 2 points in the quarter and 3 points year-to-date. We have been deferring lots of expenses including hiring research analysts, including some other fulfillment activities, including some product development activities. So, we've been very cautious with this economy in terms of spending money.

So in the back half of the year, with the leverage we get, you're absolutely right. But we're tending to making some of those investments. We continue to see good demand in the business. As we said in last quarter, once we assess that, we would make some decisions to invest for the future. So, we feel very confident. We can deliver all of our commitments that we made at the beginning of the year, while also making these investments and setting ourselves up nicely for 2009 and beyond, which for us is really important.

Peter Appert - Goldman Sachs

Chris or Gene, I know your guidance is set now in terms of zero to 100 basis point year-to-year margin expansion. You had talked previously about 19% to 22% sort of longer term targets. Have you rethought what you think might be realistic in terms of longer term margin objectives for the company?

Gene Hall

Yeah, we are still driving towards the margin expansion that we've talked about. We still believe that we can improve the overall operating margins of the business, as you saw, even with the investments we continue to make year-over-year in the sales organization and other things. SG&A, as a percent of revenue, continues to come down. So, we still feel confident that getting into that 20% to low 20% range is absolutely achievable and where we're driving to.

I think we've said on a number of times, once we get to that point we can take a step back and see where the right balance is, going forward. I think if you look at Gartner's past history, EBITDA margins have been in the mid-to upper 20s. And what we've said repeatedly is, we want to make sure we don't make the mistake that was made, we think at that point in time, which is not making the right investments in the business. So, ultimately we need to understand where we're going to make that balance. But at this point, we're still driving towards that.

Peter Appert - Goldman Sachs

Okay, fair enough. And then, last thing and I'll let someone else speak. You spoke, Gene, at length about the breadth and depth of the growth and I am wondering if it's possible to get a little more color in terms of end user segments or geographies or just anything that would give us more flavor for where the incremental revenue growth is coming from? Or alternatively, if there are any soft spots in the markets you could talk about.

Chris Lafond

Peter, great question because we watch very carefully to see if there's any sort of softness by geography or by industry or anything like that. In essence, all of our geographies are growing well and if you look across the different client segments, we also see good growth across all the client segments. And so, when we look at our contract value growth, basically we see really very solid performance across all. So, right now, we're not seeing any areas that we would classify as being kind of soft or weak.

Peter Appert - Goldman Sachs

Okay, great. Thanks, Gene, Chris.

Operator

Your next question comes from the line of Laura Lederman with William Blair. Please proceed.

Laura Lederman - William Blair

Thanks for taking my questions, and good quarter. Just a quick follow-up from the last few questions from Peter. If you look at the spend increase for the second half, can you give us a rough feel of how much would be sales and marketing versus research. Just kind of a rough feel, and I realize that you've set an overall budget but just a guesstimate as to where it's going.

Chris Lafond

Hi, Laura, it's Chris. I think as we've said repeatedly, the bulk of our investments are going into the sales organization. And so, you should continue to expect that from a sales and marketing perspective, everything we're doing around our investments is really driving towards improving the productivity of the field sales organization, improving the ways we can increase the amount of NCVI per rep that we deliver, which as you know, has increased really nicely over the last kind of four, five years.

So, we're going to put a lot of effort into things that we think will have a big impact on that. So it's a combination of not only increasing sales capacity but also improving their productivity. So, that would be where the bulk will go.

Certainly, as we continue to grow, our executive programs business continues to grow as we talked about earlier, it's up 16%. That requires additional delivery people. As we put some efforts into our retention programs and ensuring that we're delivering world class service, that requires some additional resources and certainly with the growth in overall contract value organically at 13%.

We do need to find pockets where research analysts need to be added. So that's kind of how the picture lays out and as Gene said, we're in the process of assessing exactly where we need to put those resources to make sure we're setting ourselves up really nicely for a strong 2009 and beyond.

Laura Lederman - William Blair

And following up on that, if you look at the sales head count, are you starting to add salespeople now or is that going to be later in the quarter as you assess where you want to add people or are you adding them now?

Gene Hall

It's a great question, Laura. It's Gene. We're adding them now.

Laura Lederman - William Blair

All right. Okay. Moving a little bit to the issues and events, it seems that there is been problems at events for a while now with the sales to vendor piece of the business and you've changed headcount there and things. So, I guess what I am trying to wonder is why that remains an issue. I mean, is it the people or potentially is it also the environments as well, that people just don't want to buy as much. So, I just want a better granular understanding of what's happening at events? Thanks.

Gene Hall

Great question, Laura. Basically I as said, it's clearly people take longer time to make decisions. If you look at our vendors, they're being very careful with their spend. But we think what we saw this quarter was a continuation of what we've seen for the past, as you said the continuation what we've seen for the last four quarters or so. But we do think that we understand what the issues are and we've got the right team in place to address those.

As I mentioned earlier, we think first, and if we look at it, as I said earlier, we had a lot of unplanned or higher than planned sales force turnover and so you end up with new people who have less productivity and also more open territories, you're going to sell less in that kind of environment. We also made coverage changes which, while well-intentioned, have the other issue that it takes longer after you change coverage to reestablish that client relationship and to sell to those clients, to understand exactly what the issues are.

And so on the whole exhibitor sales side of it, we think we understand what's going on. We've added more capacity. We're increasing our tenure of the sales force. We've got the coverage locked down. We think we have good leadership there as well. And again, it will take time. You don't solve the tenure problem overnight. But we think we're on a good track there.

And then lastly on the attendee side, especially the first half of this year we tried different target mix in terms of our marketing away from what we've done traditionally. That didn't work as well as we had hoped. But the good news is that the marketing to our traditional segments did work well. And so, we're going to shift our marketing back to the segments that both have historically have been successful and actually were successful in the first half as well. On both sides, we feel like we've got the right pieces in place that over time will address the issues in that business.

Laura Lederman - William Blair

Do you think that it will be weak for the next few quarters as well, but they will bounce back next year? Or how much of it is tied to the economy versus your own internal issues in terms of one of the issues are fixed this year let's say internally you still expect relatively low growth because of the economy. We are trying to get a sense of what fixes when.

Gene Hall

We think the majority of the issue is our own internal operational issues which I just mentioned a moment ago. So, it's not just the economy but we think that most of the issues are related to these operational issues and again, we expect to perform within the guidance that Chris gave you, which means we'll be seeing a steady recovery on it.

Laura Lederman - William Blair

Okay. And what caused the churn in the salespeople, do you think?

Gene Hall

I think it was a combination of things. I think we did some bunch of operational changes in terms of how you run the sales force that resulted in that, ranging from the way we pay people to quota setting to leadership approaches things like that.. So, there is no one single thing. There were a number of things that caused that. But, again, I think we're on top of that now and have our turnover locked down.

Laura Lederman - William Blair

Thank you so much. Good quarter.

Gene Hall

Thank you.

Operator

Your next question comes from line of Dave Lewis with JPMorgan. Please proceed.

Dave Lewis - JPMorgan

Hey, guys. First question is, can you talk about the conversion rate from old to new products. Are you seeing an acceleration there?

Chris Lafond

Hey, Dave, it's Chris. Thanks for the question. I wouldn't say there is any dramatic change from the last quarter. I think if you look at our overall mix, Gene talked about 70% of our business coming from new clients. I think last quarter it was about 66% coming from new clients. So very consistent I think trend line in terms of how much is coming from new and existing.

Certainly in the very beginning part of the roll-out of Gartner for IT Leaders and Gartner for Business Leaders we had some low hanging fruit and some easier clients to convert but there is still lots of clients left to convert. We still have probably converted less than 30% of our overall client base to the role-based products, so we still have a significant runway in terms of ability to convert. But from a trend line point of view, I think it's been fairly consistent over the last couple of quarters.

Dave Lewis - JPMorgan

Okay. Thanks. And the second question was just, you guys talked about pricing briefly that it remained firm. Are you still expecting the annual price increase which I think kicks in September or October? Is that still business as usual?

Gene Hall

Yeah, hi, Dave, it's Gene. Yes, absolutely. We are seeing, pricing has not been an issue at all for us. Pricing has been just fine in the marketplace and we're expecting to have an annual increase the usual time this fall.

Dave Lewis - JPMorgan

Great. Thanks, guys.

Operator

Your next question comes from the line of Eric [Wiemann] with Schwerin Boyle. Please proceed.

Eric Wiemann - Schwerin Boyle

Hi. Congratulations on a good first half in a tough economic environment. As far as the new role-based products, where do you think that can go over time, as a percentage of contract value?

Gene Hall

Hi, Eric, it's Gene. Over time, again, we expect that share to keep growing over time and what timeframe you give. But ultimately, we would expect all of our products to convert to role-based products. With one short caveat, which is, we have some products like an industry product, for example, but if you look at our traditional products that are our seed base, we would expect over time they would all convert to role-based products.

Eric Wiemann - Schwerin Boyle

And as far as the pricing on the old products, is that still in the 5% to 7% range, if I remember correctly on that?

Gene Hall

Yeah, what you're referencing is, as we move clients who are on the old legacy products, if they don't move on to the new products what we said over time is that on an annual basis trying to move those people up kind of in the 5% to 7% range. That's roughly what we're still saying seeing and doing. The overall pricing increases that we're doing as a business are between 3% and 7% per year and so I think we're very consistently doing that, both on the new products as well as migrating people up from lower priced legacy products.

Eric Wiemann - Schwerin Boyle

And can you just review the pricing differential between old products and various role-based products?

Gene Hall

It's close to a 2X difference, roughly. So, if you take our new role-based product offering, if you take, what we call the adviser level offering, which gives access to everything we write and access to all of our analysts, you're talking about $25,000 a year per seat and the legacy products, the effective selling price is about 12-ish. So, roughly kind of a 2X delta between the old and the new products.

Eric Wiemann - Schwerin Boyle

All right, and lastly, as you exit '09, say Q4, do you think the EBITDA margin pre-stock options will be in that 19% to 22% range in Q4 '09?

Gene Hall

As we exit '09. So as we exit next year?

Eric Wiemann - Schwerin Boyle

Yeah.

Gene Hall

No, I would not expect we're going to get to 19% to 22% that quickly. I think this year we're probably in the 17-ish percent range so I would doubt we will get 4 or 5 points of EBITDA margin expansion over the one year. I think, as we've said, with the investments we're making, we fully expect to get up to 100 basis points a year moving forward.

So, that's more of a relevant range you should expect at the high end. Certainly, through the first part of this year we've seen much better year-over-year improvement in our segment margins, partly because of the deferral of some of the investments that we absolutely need to make.

Eric Wiemann - Schwerin Boyle

All right, thanks a lot.

Gene Hall

Sure.

Operator

Your next question comes from the line of Bill Sutherland with Boenning & Scattergood. Please proceed.

Bill Sutherland - Boenning & Scattergood

Thanks, good morning. On the consulting side, I was impressed that the core consulting was up in line. What are you seeing as you look out as far as the customer desire to keep up in that space?

Gene Hall

Hi, Bill, it's Gene. Great question. Basically, our services are services that help our clients in good times and bad. And they provide a lot of value across all three of the service lines in consulting and so we expect to see the same kind of thing that we've been seeing there.

Bill Sutherland - Boenning & Scattergood

While I realize core consulting, I guess, is a mix of discretionary and continuing needed projects, but you're simply just focused your efforts in a way that you're getting at those projects that they really need to get done?

Gene Hall

Well, let me give you some examples in core consulting. So, one of our service lines in core consulting is helping people build better procurement organizations. They need to do that now more than ever. They're very focused on doing that. So that's a very popular line.

Another one is doing enterprise architecture. The need to do enterprise architecture has not gone away. In fact, a lot of things help you save costs like virtualization and some of these new technologies they are big cost saving items. The way you get at them is actually doing your enterprise architecture.

And so, these are things that, first, are not happened pause of the economy because people get cost reductions as a part of these things. And secondly, it's not like doing a big software implementation that costs like $50 million or $100 million. Our consulting projects are relatively small projects compared to like a big implementation or something like that.

Bill Sutherland - Boenning & Scattergood

Great. That's good color. And then finally, the unexpected surge in the contract optimization and benchmarking. Did that just happen to be timing and so you're not extrapolating that into the second half? Is that what we should think of it there?

Gene Hall

That's exactly right. We basically had more revenues in that business during the first half, slightly, than we had expected in the first half. So, it was just, a skewing was a little different than what we had expected originally. So, the total amount we are still expecting to be the same, but slightly different skewing.

Bill Sutherland - Boenning & Scattergood

Okay, and then last question. With the growth in role-based, are you all finding that you still need to create new role-based products or is your lineup going to be able to see you through 2009? Thanks.

Gene Hall

We're going to continue to create new products. That's a core part of our strategy. One of the four pillars of our strategy is over time to continue introducing innovative new products. And so I think we've got a great suite out there now but we're not going to stop or slow down. And I think, again, there is plenty of growth left in what we have, but I think as we add more of these products, it just continues to give us a good platform for future growth.

Bill Sutherland - Boenning & Scattergood

Thanks.

Operator

(Operator Instructions). And your next question comes from the line of Dave Lewis with JPMorgan. Please proceed.

Dave Lewis - JPMorgan

Hey, guys, just one quick follow-up. What percentage of the Research Business is booked in the last four months of the year or the last quarter of the year? I know a number of these contracts, I believe about 30% are multi-year but what percentage comes up towards the last quarter of the year?

Chris Lafond

Hi, Dave, it's Chris. If you look at the skew of our contract value, it's fairly even. I think in the fourth quarter there is 29%, 30%-ish of our business comes up for renewal in the fourth quarter. The rest is spread fairly evenly. So, there is a little bit more in the fourth quarter, but in terms of each quarter's results, you're getting a fairly good slice of renewals of our overall business. So, that should give you a flavor of how much is coming in each quarter.

Dave Lewis - JPMorgan

Thanks.

Chris Lafond

Sure.

Operator

At this time, you do not have any more questions in queue. And I would like to turn the presentation back to management for closing remarks.

Gene Hall

Hi, it's Gene. I just want to thank you for joining us today and look forward to talking with you guys again next quarter.

Operator

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

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Source: Gartner Inc. Q2 2008 Earnings Call Transcript
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