Insight Enterprises Inc (NSIT) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and my name is Jonathon and I'll be your coordinator for today.

I'd like to welcome everyone to the Quarter Three 2004 Insight Enterprises, Inc.

Earnings Conference Call. (Caller instructions.) I'd now like to turn this presentation over to your host for today, Mr. Stan Laybourne, Chief Financial Officer.

Sir, you may proceed.

Thank you.

Welcome everyone and thank you for joining the Insight Enterprises Conference Call.

Today we will be discussing the Company's operating results for the quarter ended September 30, 2004.

Joining me, Stanley Laybourne, Chief Financial Officer, is Tim Crown, CEO of Insight Enterprises, Inc.

If you do not have a copy of the earnings release that was posted this afternoon and filed with the SEC on Form 8K, you will find it on our website at insight.com under our Investor Relations section.

Since detailed financial and operating data are contained in the earnings release, we will only be concentrating on highlights of the quarter during the scripted portion of the conference call.

As usual, at the conclusion of the scripted portion, we will answer questions from our conference call participants.

Today's call, including all questions and answers, is being webcast live and can be accessed via the Investor Relations section of our website.

An archived indexed copy of the conference call will be available approximately two hours after completion of the call and will remain on our website for a limited time.

This conference call and the associated webcast contain time-sensitive information that is accurate only as of today, October 21, 2004.

This call is the property of Insight Enterprises, Inc.

Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Insight Enterprises, Inc. is strictly prohibited.

Finally, let me remind you about forward-looking statements that will be made on today's call and non-GAAP measures discussed on the call.

All forward-looking statements that are made in this conference call are subject to risk and uncertainties that could cause the actual results to differ materially.

These risks are discussed in today's earnings release and also in greater detail in our quarterly report on Form 10Q for the quarter ended June 30, 2004.

As required by the SEC rules, we have provided a reconciliation of non-GAAP measures to GAAP in our earnings release and 8K filing.

You can find those documents on the Investor Relations section of our website.

I will now turn the call over to Tim Crown for opening remarks.

Tim?

Thank you, Stan.

Hello everyone, and thank you for joining us.

The third quarter was an exciting quarter as we continued to focus on growing net sales, maximizing gross margin, and controlling expenses.

I am pleased to report that this focus by all of our employees resulted in a consolidated net sales growth of 9 percent year-over year and 4 percent sequentially.

Additionally, non-GAAP diluted earnings per share was 30 cents compared to 28 cents last quarter and 22 cents in the third quarter of last year.

These non-GAAP earnings per share numbers in the 2004 periods exclude the gain and expenses associated with the PlusNet IPO, severance and restructuring expenses, reduction in liabilities assumed in previous acquisitions, and the tax effects of these items and some other tax adjustments.

I will be providing a brief overview of third quarter 2004 performance trends and news for each of our operating segments, and Stan will provide an overview of the financial results for the quarter.

Let's start with Insight North America.

I am very pleased with the momentum that is building in Insight North America.

Q3 was one of our strongest quarters in the past few years and we experienced improvements across several aspects of our business.

Sales were strong.

There were improvements in various gross margin areas, and employees are becoming more proficient on the Maximus system.

We also saw productivity improvements in our sales organization and achieved sales growth while reducing the net number of account executives in North America during the quarter.

So far, we are seeing the overall sales and demand trends in Q3 continue into October and I continue to be optimistic about the overall demand for IT solutions and our ability to effectively compete for opportunities.

Insight U.K. completed its seventh consecutive quarter of operating profitability and posted year-over-year net sales growth of 20 percent and non-GAAP earnings from operations of 160 percent growth.

Insight U.K. posted sequential increase in net sales of 10 percent and non-GAAP earnings from operations of 38 percent.

The non-GAAP earnings from operation exclude the bonus expenses related to the PlusNet IPO, income from reduction liabilities assumed in previous acquisitions, and restructuring expenses.

Sequential sales growth for Insight U.K. came primarily from an increase in shipping days and increased demand from the small to mid-sized business and public sector customers.

This brings me to Direct Alliance.

We saw a 10 percent increase in net sales this quarter compared to last quarter due primarily to an increase in pass-through product sales and fees generated from new clients.

Earnings from operation increased 7 percent from last quarter.

We are pleased to announce that Direct Alliance signed a new client from our technologies sector during the quarter.

A program for this new client is scheduled to start in Q4, and although it will take some time for the program to ramp up, as is the case of all new programs, we are pleased that Direct Alliance has successfully added another client.

To touch briefly on the CEO search, we believe we are on track time-wise with our search.

We have narrowed the candidates to a very short list and it remains our desire to announce a new CEO by the end of the year.

Please respect that we will not disclose any information about the final candidates.

I will now turn the call back over to Stan Laybourne to give you some specific financial results for each of the operating segments.

Stan?

Thanks, Tim.

Since substantial detail and year-over-year comparisons are included in the earnings release, I will focus my discussion on fluctuations from last quarter.

We are very pleased to report net sales growth of 5 percent--sequentially over last quarter for Insight North America.

The number of account executives actually decreased by 123 from last quarter to 1,129 and we believe the number will remain flat for the rest of the year.

Average tenure of our North American account reps is up from 3.1 years last quarter to 3.4 years, with 29 percent of the account executives having less than one year experience, 12 percent with one to two, 10 percent with two to three years, and 49 percent with more than three years experience.

The increase in the average tenure is due primarily to the decrease in hiring of account executives during the quarter.

Gross margin decreased this quarter to 11 percent from 11.4 last quarter.

This decrease was due almost entirely to the expected decrease in referral fees from Microsoft enterprise agreement renewals, which surged last quarter.

We were pleased to see increases in other areas of gross margin we have been focusing on, including supplier reimbursements and service margin.

These increases were offset by a decrease in product margin resulting from the increase in the percentage of sales to large corporate and public sector customers which continue to see increased pricing pressures and are generally at a lower gross margin than SMB customers, as well as an increase in the write-down of inventories.

Selling and administrative expenses as a percentage of net sales decreased sequentially to 8.4 percent from 8.9 percent.

The decrease is due to the increase in net sales, increased productivity and efficiencies, and a focus on cost controls resulting in some elimination of management, sales, and sales support positions.

The head--the headcount reductions resulted in the recording of severance and restructuring expenses of approximately $2 million.

I am very pleased to report that we achieved our stated goal to reduce Insight North America's selling and administrative expenses to 8.5 percent or less by Q4 2004, a quarter early.

Long-term, it still remains our goal to reduce our consolidated selling and administrative expenses to between 7.5 and 8.5 percent.

Of course, to achieve this goal we will need to increase net sales, realize additional operate--operational efficiencies, implement additional cost-cutting initiatives, or achieve some combination of the three.

Net sales this quarter for Insight U.K. increased 10 percent sequentially to $115 million from $105 million in Q2 of 2004 with increases in the British pound sterling exchange rates from last quarter accounting for $863,000 of the increase.

Excluding the effect of fluctuations in exchange rates, net sales increased approximately 9 percent sequentially.

The number of Insight U.K. account executives declined by approximately 20 percent during the quarter to 300 due to some attrition, to competition, and to an increase--and to an effort to focus on productivity of existing account executives.

However, our plan for Q2--Q4 2004 is to add approximately 15 to 25 net account executives.

Average tenure of our United Kingdom account executives increased slightly to 2.2 years from two years at last quarter from--with 50 percent of the account executives having less than one year experience, 19 percent with one to two years, 7 percent with two to three years, and 24 percent with more than three years experience.

The increase in average tenure was due to the decrease in hiring during the quarter.

Gross margin decreased this quarter to 13.1 percent from 14.5 percent in Q2.

This decrease was due primarily to a decrease in product margin and the expected decrease in referral fees from Microsoft enterprise agreement renewals, which surged last quarter.

The decrease in product margin was primarily due to the increase in the percentage of sales to public sector customers and increase in percentage of desktop and notebook sales, all of which are generally at lower product margins.

Selling and administrative expenses as a percentage of sales decreased sequentially to 10.3 percent from 12.3 percent due primarily to the increase in net sales and a reduction in bad debt expense due to a bad debt recovery.

Direct Alliance posted net sales of $19.2 million, up 10 percent from $17.4 million last quarter due primarily to an increase and pass--in pass-through product sales and fees generated from new clients.

For the three months ended September 30, 2004, Direct Alliance's largest outsourcing client accounted for approximately 59 percent of Direct Alliance's net sales and the top three clients represented 87 percent of net sales.

Direct Alliance's gross profit increased slightly to $4.9 million compared to $4.8 million in the second quarter of 2004.

Selling and administrative expenses at Direct Alliance decreased to $1.5 million compared to $1.7 million in the second quarter of 2004 due primarily to a reduction in bad debt expense.

Included in non-operating expense for the quarter ended September 30, 2004 is $318,000 of equity and net income of investees.

This represents our percentage ownership in certain equity method investees including PlusNet.

Now additionally, we had several items that are included in the reconciliation from GAAP diluted earnings per share of 41 cents to non-GAAP diluted earnings per share of 30 cents.

These items include the gain and expenses associated with the PlusNet IPO, income resulting from reductions in liabilities assumed in previous acquisitions, severance and restructuring expenses, the tax effect of certain items, and other tax adjustments.

Because these items are each detailed in the earnings release, I will not discuss them in detail during the conference call.

Cash flow from operations were slightly negative this quarter due primarily to sequential increases in net sales resulting in the requirement to fund working capital.

As net sales increase, we typically increase balances in our inventories and pay our suppliers in order to take advantage of supplier discounts on average terms that are shorter than the average terms granted--granted to our customers.

The outstanding balance under our line of credit and accounts receivable securitization facility decreased to $51 million at September 30, 2004 from $61 million--$65 million at June 30, 2004.

And we had approximately $49 million in cash and cash equivalents at September 30.

I'll now turn the call back to Tim for final comments.

Tim?

Thanks, Stan.

I am pleased with the results of the quarter and the improvements that we have made over the past couple of years to position ourselves for both further sales and earnings growth.

We are moving beyond being a product-only reseller to becoming an IT solutions provider.

We have the ability to combine competitively priced products with technology services to create solutions that streamline customers' IT management and costs and deliver strategic business value to their organizations.

I believe strongly with--in this strategy and that we have the best employees in the industry to capitalize on our competitive advantages.

That concludes our comments.

Stan and I will now be available to answer any questions that you might have.

(Caller instructions.) Your first question will come from the line of David Manthey of Robert W.

Baird.

Hi.

Good afternoon.

My question relates to your goal of growing at least as fast as the market.

You know, there has been some question as to what the overall market has been doing lately.

I think you discussed your feeling of your momentum moving from the third quarter into the fourth quarter.

Could you talk about underlying trends and how that relates to your business, if you are experiencing greater than normal market share gains or if you feel the market is fairly stable?

Well, it's one of those--this is Tim.

This is one of those interesting ones where I feel as if part of it over the last couple of quarters has really been internal and the last one external as we really try to redial our focus externally, dial-in the systems of productivity, and the things associated with it.

I think we're actually doing pretty well right now just overall.

We're--we've got good momentum in all segments of our business right now, specifically our corporate arena.

When we say corporate, larger than 1,000 seats is doing well right now.

Traditionally, Q4 is a seasonally strong quarter for them.

So, you know, in terms of relation to the market, I guess you'd have to tell me what you think the market is going to--do you think, as an example, 9 percent is higher or lower than the market?

But overall, we're just really happy with the growth rates that we're seeing right now.

Great.

Just a couple of quick questions here.

Could you answer the question as to the number of account execs you plan on adding next year?

And then, just sort of accounting questions.

Do you--are there any take or pay contracts potentially in DAC this year?

And what was the amount of the recovered bad debt at--in the U.K.?

Thanks.

Let me do the first half and Stan can do the second half.

Our account executives--in Q4 were planning on being approximately flat in the--in North America.

Next year, I think it's really going to depend on market conditions on which way to go.

At--again, at Q4 on the conference call in January we'll probably give more guidance on the number of sales executives that we're gonna hire in 2005.

But again, for right now, roughly flat in North America in Q4.

Stan?

Dave, first of all, explain what you mean take or pay contracts?

Well, I think last year you had a benefit from a DAC take or pay contract where someone didn't do enough volume and they had to pay you.

Oh, I'm sorry.

So guaranteed.

There are none of that.

We don't have any of those so that will not affect anything in Q4.

In terms of your bad debt, you know, quite honestly, I mean, those--it's nothing material.

It's a--it's a smaller amount and, quite frankly, I don't have the details for, you know, specific bad debt write-offs, but it's nothing material.

Great.

Thank you.

Your next question will come from the line of Brian Alexander of Raymond James.

Thanks.

Nice quarter.

Just talking about the growth that you're seeing in your SMB customer base relative to large corporate, it sounds like large corporate is doing much better, which is also having a negative impact on your gross margins.

Could you just give us a sense for order of magnitude in terms of how much faster you see the large corporate business growing relative to SMB on a sequential basis?

This is one of those hard ones.

When you--when you look at it, because we--it's one of the things as a Company we don't like to do which is break relationships.

So it's hard to get down very, very specific because we do have reps that you would call on the SMB who could call on large corporate or vice versa, corporates call on SMB.

But overall right now, just in a generalization, we're seeing the larger customers come back where over the last couple of years they kind of held their purchases down.

We're just seeing the budgets kind of open up a little bit more.

Again, not a floodgate, but when they open up it's on a long-term basis.

So most of the stuff that we're doing is not a quarter-to-quarter basis, it's a multi-year basis.

So overall, if I just had to say which is stronger, I'd say towards the higher end of the customers, i.e. greater than 1,000 seats would be stronger right now in general.

I don't think it's necessarily changing that much from quarter to quarter.

It's just more of a generalization of which customer segment is stronger.

And Brian, I would add on top of that that, you know, do focus on the fact that we did say that all segments were growing.

I mean, SMB is still growing.

It's just, when you look at it from 30,000 feet, not as strong as the other ones.

And I would echo everything that Tim said, that it's sometimes very blurry on where those lines cross over.

And that's why you can't be too exact, but you can get some sort of trends, and that's what we're trying to give you.

If this continues into the fourth quarter, which it sounds like it will, Stan, would you expect gross margins to be down again or some of these other initiatives, better rebates and higher service margins, are they large enough to offset any mix shift in the fourth quarter?

Yeah, that's a great question.

Let's go back to Q2 when we were talking, and if you remember, we had 11.4 in Insight North America.

And at that time, you know, somebody had asked--it probably was you, Brian, that said, you know, what do you expect for Q3, and I said 11.2.

Again, the mix got in the way and really caused it to go down to 11 percent.

And I think what you are saying there is certainly something that could happen in Q4, however--however, I think that we have some other initiatives that you pointed out there that will put an upward trend on it.

So right now, from a guidance point of view, my gut would be that it will be flat, maybe slightly down, but not much at all.

But it will be flat to slightly down in Insight North America in gross margin percentage in Q4.

That's my gut.

Okay.

Last question, Tim, over the last couple quarters on these calls you've given us an update on how things are progressing through the early part of the quarter.

It sounds, based on your comments, that September was a little bit more backend loaded than you expected, and that things are continuing.

So just trying to get a sense.

If you can give us an update on what you're sort of tracking at in North America at a minimum.

On a year-over-year basis, are you higher than the 9 percent that you just generated in the third quarter?

First--I'm not sure where you're talking about in terms of being backend loaded in September.

Traditionally, we do do more sales in the third month of any quarter than we do in the first month as an example.

Because this particular conference call is only 15 shipping days into the quarter, we don't want to get--go out there and give you an exact number, because we think that may not be enough information for you to extrapolate.

You may be extrapolating too high or too low on that.

In general, what we're seeing is about the same demand, if you want to call it, increase year-over-year that we saw in Q3 of '04 versus Q3 of '03.

So business is still good, still positive.

We also had some interesting ones where, if you look at kind of our deferred inventory, those numbers can come in or come out in terms of ship days.

So we can skew the numbers in terms of any individual short period of time.

But again, overall demand is roughly the same as it was in Q3, which we think is positive.

Is that opaque enough?

Sure.

I think it's positive, too.

Thanks.

Your next question will come from the line of Matt Sheerin of Thomas Weisel Partners.

Thanks.

I'd like to go back to the issue of headcount and the pretty big reduction in the quarter.

I guess I still didn't get a real--or understand in the answers why we saw such a big cut in the quarter.

There was--there was no specific number in mind.

What we're doing--what we're doing right now is we're trying--we're trying to go after--if you want to call it--the focus on the productivity of the sales executives, focus on their performance, put our resources toward people that we think could be with the business long-term, and the shift as we move from just product to solutions.

Overall, again, I think we've kind of hit equilibrium, if you want to call it that.

And again, that's what I'm saying in Q4 will probably be basically flat.

You know, it could be up or down 25 either way, as an example.

Okay.

Thanks.

Matt, this is Stan.

I mean, you know, over the years that people like that have been involved with Insight, they have always pointed out the average, you know, sales per account rep could have improved and stuff.

And I think we're starting to see some of that.

Of course, we, you know, with stronger corporate sales that always helps.

But I really believe that the implementation of the new system has also made it more efficient for the account reps to do their business.

So consequently, although I don't think you're trying to, you know, but if you are trying to say, geez, it's bad that the account reps are down, I'd look at it as a very good thing, because--because I think we're becoming more efficient.

Yeah.

No, that wasn't my conclusion, but it did--you were able to bring expenses down a lot and that really offset the--your greater than anticipated decline in gross margin.

So I guess, you know, as a follow-up question, it would be on the expense side.

You know, what are you looking at in the--in the December quarter?

And, you know, especially, you've talked about adding, you know, advertising and marketing expenses.

You know, are we gonna see more incremental expenses in those areas?

Well, I think in Q4, what you can see in terms of selling and administrative will not be a sharp reduction as a percentage of sales, because I think we'll do exactly what you've just insinuated, is that we'll take some of the opportunity to invest, such as in marketing, that may pay off down the line.

As Tim mentioned earlier, Q4 really is seasonally a very good quarter and this is an opportunity to do that.

Now what we have to do is monitor that with the bottom line, obviously, and make sure that--that it all makes business sense.

But my gut from a selling and administrative expense as a percentage of sales is that that will probably be relatively flat in Q4.

Okay.

And just one quick follow-up.

On the operating margin line you're running around 2.9 to 3 percent.

Looking ahead, do you have--have any goals, you know, to increase that too over the next six to 12 months?

Well, we haven't put a timeframe on it.

What we have always said, Matt, is that, you know, ideally, we think we should get the 3.5 to 4 percent--[griminey][ph], we've been as high as 4.9 percent.

So, you know, those don't seem outrageous targets.

But we have not put a specific time on that.

Again, one of the things is you know, we've got a couple of dynamics going on here.

First, we want to get growth back, which I think you've seen over the last couple of quarters, that we're starting to generate it as we focus out.

Second of all, remember that we've got a new CEO that's gonna be coming in.

And so, I'm not sure that I want to sit here from a credibility point of view and establish targets until all of that is really gone over with that person and we make sure that everybody is in agreement where we're going to.

Yeah, that makes sense.

Okay.

Thank you.

Your next question will come from the line of John Lawrence of Morgan Keegan.

Good afternoon, guys.

Tim, would you just talk a little bit about--the last couple of calls we've talked about the system.

You say it's more productive now.

These gains that we're seeing, how much of that is new accounts, how much of that is just getting this, you know, getting the account, getting the services wrapped around that product sale?

Can you just talk about that strategic change and how that's progressing?

Well, let me talk about it at a couple of different angles.

First, as a system.

What you saw last January, as we--as we first put the system and where it ended up happening is that you put the system in initially--it's kind of a rough cut.

And over a period of months, and even years, you get the low hanging fruit, the mid fruit, and the high fruit over time.

So what you've seen over the last, let's call it ten months, is our slow incremental changes to go out there and figure out how we can increase the operating margin and decrease the SG&A.

So it's one of those interesting ones where there's no smoking gun or magic bullet that you can go out to do that.

Each quarter we are gonna get better and better and better at all of the above.

It's one of those interesting things, also, with services.

As you sit and look at it, our warranty, as an example, increased fairly dramatically.

Our warranty sales.

Smart--SmartNet, etc.

These things, over the last couple of quarters.

It's one of those things where it doesn't happen overnight, but as you put these initiatives in place, little by little you start to see the benefits from them.

Does that make sense, John?

Yeah.

Thanks.

(Caller instructions.) Your next question will come from the line of David Small of Goldman Sachs.

Hey guys.

Pretty good.

A few questions.

First, you know, given the improving--the improvements in your business, have you guys started to think at all about share repurchases?

I mean, you're in a net cash position here.

Have you thought about what you want to do with your balance sheet here now?

Yeah.

This is Stan, Dave.

Yeah, we have and as we've said on the--I think on the last conference call and previous ones, we've always wanted to get our debt paid off.

But as you can see, with some good growth in sales we're starting to, you know, still require some working capital.

Having said that, we have an upcoming board meeting.

Matter of fact, it's next week.

We will be discussing the topic that you're bringing up.

I'm not sure where it will fall out, but we definitely have that on the radar screen, and we'll be addressing it next week.

And should something happen, you along with all the rest of the world will know right away.

Okay.

And then, just--just by--I don't want to harp on this headcount issue, but it seems like if you are seeing good momentum in your business and it's--and it's doing better than it has in the past, why are you not more aggressive on trying--on trying to hire people and try to take more market share?

Well, I guess the question is we are aggressive.

We see the business is good.

We are trying to take market share.

But we're not using the traditional methodology of just hiring sales reps to go out and do that.

We think that if you look at the difference, as an example, between where our productivity is, let's see, as in an example, CW, or Dell, we think we have a lot of room to grow our business for existing reps.

But if you look at what we're doing in marketing on the web through our EDI electronic connections to customers, this is where we go out and we look at this from the point of view and say, if we can go out and focus not just on headcount additions while investing in these other areas in our business, we think that that too will go out there and increase our--our business.

If--we were talking earlier is we disclose what our web sales are, but we don't--we don't tell you exactly what our electronic sales are.

We hook up some tremendous numbers of companies through EDIX and [indiscernible], etc., so what ends up happening is as we push more and more of that, that's helping our productivity overall and helping push our business forward, entangle ourselves more with customers.

So as you look over the next several years it's not just about headcount, it's how we're gonna drive it.

Okay.

And then just, you touched on this a little bit, on the marketing.

On the past calls you've talked about expanding your marketing, increasing your marketing.

Originally, you were not getting your vendors to fund that, I guess.

Where are you now in terms of how much you're spending on marketing per quarter, where you think that's gonna go, and what success do you have with vendors refunding you for that or reimbursing you?

Dave, this is Stan, and going back to, you know, a year ago, we were doing about $2 million a quarter.

In Q3, we did right around $4 million, a little bit over $4 million.

In Q4, right now, budgeted it's a little bit higher than that, but I think that some of that is dependent upon, you know, where sales are, where everything else matches on the bottom line.

But there is every intent to try to brand build a little bit more each quarter as we get more successful.

As we mentioned earlier, in terms of your supply reimbursements, yes, one of the things we pointed out is that we have increased supplier reimbursements.

I do believe that there's some positive momentum.

Is it covering it 100 percent?

Absolutely not.

But I think we're making momentum changes in that from what it was two or three quarters.

And I hope, you know, a couple of quarters from now we'll be able to see even a greater percentage covered.

Hopefully, that helps.

Yeah, it does.

And then just one last question.

You know, the sequential decline in absolute dollars of SG&A.

Was the biggest factor there that you had fewer sales people sequentially?

I'm trying to go through sequential decline and absolute dollars.

I think there's more than that.

I don't doubt that that's probably a part of it, Dave, but offhand, I'm trying to think--you know, it's about a million dollars roughly--somewhere.

I would say that's probably the largest, Dave, offhand.

Okay.

Well, thanks guys.

Sir, I am showing no more questions at this time.

Sir, again, I am showing no--no more questions at this time.

I am pleased with the quarter and I am very, very happy with all of our employees on a worldwide basis for putting in a great quarter.

Thank you very much for dialing in, and thanks to all the employees worldwide.

Goodnight.

Ladies and gentlemen, thank you for participating on this conference.

This call is concluded and you may disconnect now.

Good day.