Insight Enterprises Inc (NSIT) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the second-quarter 2005 Insight Enterprises earnings conference call.

My name is Liz and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will, however, be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to your host for today's presentation, Mr. Stanley Laybourne, Chief Financial Officer.

Please proceed, sir.

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 June 30, 2005.

Joining me, Stanley Laybourne, Chief Financial Officer, is Rich Fennessy, President and Chief Executive Officer of Insight Enterprises.

If you do not have a copy of the earnings release that was posted this afternoon and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our Web site at Insight.com under 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 Web site.

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

This conference call and the associated webcast contain time sensitive information that is accurate only as of today, July 21, 2005.

This call is the property of Insight Enterprises.

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

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

All forward-looking statements that are made in this conference call are subject to risks 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 earnings report on Form 10-Q for the quarter ended March 31, 2005.

Insight Enterprises assumes no obligation to update and does not intend to update any forward-looking statements.

As required by the Securities and Exchange Commission rules, we have provided a reconciliation of non-GAAP measures to GAAP in our earnings release and 8-K filing, and you can find those documents on the Investor Relations section of our Web site.

With that, I will now turn the call over to Rich for opening remarks.

Rich?

Thank you, Stan.

Hello, everyone, and thank you for joining us today.

Insight had a solid second quarter.

We attained year-over-year growth in net sales and continued to work on overall operational improvement.

However, it was not a strong quarter relative to our declared objective to drive profitable market share growth across all of our operating segments.

We believe we fell short of this objective within North America.

Specifically, our consolidated quarterly net sales grew by 6% and our non-GAAP net earnings grew by 9%, year-to-year.

Additionally, non-GAAP diluted earnings per share grew 11% year-to-year to $0.31 from $0.28 in the second quarter of last year.

For Insight North America, net sales grew 5.5% over the prior year, which we believe is at or near market growth rates.

In British pounds, Insight UK grew 9% over the prior year, significantly faster than we believe the UK market is growing.

In a few minutes, Stan will review with you the details of our second-quarter results for each of our operating segments.

On our call in April, I discussed our 2005 goals and objectives.

They are designed to fuel the transformation of our business and the successful execution of our business strategies.

Today, I will review our progress toward these goals.

I will also highlight specific actions we are taking within North America to address our second-quarter performance and to ensure that we gain profitable market share going forward.

Our 2005 goals are, one, developing a lasting competitive advantage by enhancing our relationships with employees, clients and partners.

Regarding this goal, we continued to make progress during the last three months.

First, let me start with enhancing our relationships with employees.

I am pleased to say that our semi annual employee satisfaction survey was completed in May, and the results showed an improvement over the 2004 baseline.

We will continue to implement and execute our detailed employee satisfaction improvement plan.

We expect even higher scores regarding our employees' Insight experience in the year-end survey, which is scheduled for November, 2005.

Improving employee satisfaction is leading to increased retention and motivation and is contributing to an overall increase in productivity across the organization.

In the second quarter, we were able to reduce our trailing 12-month turnover by approximately 10% compared to Q2 last year, excluding non-voluntary termination.

In regards to enhancing client relationships, our newly established monthly client-satisfaction survey process is already driving improvement.

In the second quarter, we launched Insight first SMB customer advisory council.

The council focuses on ensuring that Insight strategies and objectives are targeted to clients' needs and expectations.

The focus of our client initiatives is to transform Insight into an even more client-centric organization.

Finally, as it relates to enhancing partner relationships, we've continued to execute on our partner program and we have had several new partners join the program during the quarter.

Additionally, we're are pleased to have received, for the second year in a row, the prestigious Microsoft 2005 Operational Excellence Award.

Now, let's move onto the progress on our second 2005 goal, improving in the Insight experience through e-enablement of key business processes.

In the second quarter, we announced our decision to upgrade the SAP component of our Maximus system to the mySAP business suite.

This upgrade will provide us with enhanced functionality, such as enhanced client relationship management capability and an automated services business module that is required to grow services as part of our solution strategy.

This system upgrade will also help us to conduct more of our business transactions electronically, which helps to improve productivity.

As an aside, we're not waiting for the system upgrade to drive more electronic transactions.

In the second quarter, the number of orders that were transacted electronically increased 15% over the second quarter of last year.

Our third goal for 2005 is to accelerate sales and service skills to support targeted Insight solutions.

In the first quarter, we identified ways to improve the selling skills of our sales team.

As a result, in the second quarter, we launched a progressive training program called World-Class Insight.

As part of this program, we have restructured our new higher sales training program from a six-week product-based program to a comprehensive twelve-month value-based program.

The first sales class to be trained under World-Class Insight just began in July.

In addition, we rolled out the first module of the new training curriculum called question-based selling to our entire SMB sales team late in the second quarter.

This module provides the skills -- provides the sales team with the skills to identify client needs more effectively.

We believe the World-Class Insight training program will translate into continued sales productivity and reduced employee turnover.

The fourth goal is to increase client acquisition and penetration.

In the first quarter, we launched Insight's first ever national advertising campaign across the United States with print advertising showcasing our five solutions in various national business and IT publications, such as Fortune, Business Week, and CIO magazine.

In the second quarter, we rolled out our local customer roadshow program.

For our premier, we partnered with Cisco and Lenovo in Columbus, Ohio to educate potential and existing clients on our capabilities around ability, security and Voice-over-IP.

Feedback from attendees was extremely positive, and we have several more of these roadshows planned in different cities throughout the rest of 2005.

Finally, our fifth and last goal is driving sales and profitability growth.

Ultimately, each of the previous four goals are designed to increase sales and attain profitability growth, and they have in the second quarter.

As an example, I am very encouraged by the growth of 17% and 33% in non-GAAP earnings from operations, year-to-year, in North America and the UK respectively.

We also continue to drive improvements in sales productivity, as net sales per account executive grew 19% year-to-year North America and 11% in the UK.

With this said, we are clearly experiencing challenges in attaining our historical sales growth rate within our North American SMB business.

As a result, we are implementing a set of targeted actions to improve our SMB business as we move into the second half of 2005.

These actions include, one, increasing the number of SMB sales managers so we can reduce the number of account executives under each sales manager's span of control.

This will enable our sales managers to spend more time coaching and developing their sales team.

Two, we made several leadership changes within our sales organization, including a new SMB sales leader.

Three, we will start to grow our SMB sales team in the second half of the year to more aggressively cover the SMB marketplace.

In the first half, we had slowed our hiring of new account executives, as we revamped our recruiting criteria and created a new higher training program focused on ensuring retention and productivity of new salespeople as they join Insight.

Collectively, I believe these actions will help drive increased growth rates in our SMB business.

To support our efforts in improving our U.S. business results, we hired Mark McGrath in May as President of Insight U.S.

Mark's primary role is to drive our U.S. business results.

Mark comes to Insight Enterprises from IBM with a wealth of sales and operational executive experience.

Additionally, I have personally worked with Mark for many years and know well his strength as an exceptional sales leader, which is exactly what we need within our U.S. business.

I am pleased to have him aboard.

Speaking of new leaders, we also recently announced the promotion of Jim Kebert to President of our Direct Alliance operating segment.

Jim has been the Chief Operating Officer of Direct Alliance, and I am pleased that he will now be leading the organization as we continue to focus on growing our operational performance.

Again, each of Insight's five 2005 goals are specifically aligned with our corporate transformation to becoming more of a complete solutions provider and to the successful execution of our business.

Associated with this transformation, as you already know, we're making investments in several areas of our business.

The primary investment focus areas include people, skills development, systems, and marketing.

During the first half of 2005, we conducted an extensive review of our key business processes.

The focus was on identifying ways to reduce expense by automating key business processes, flattening our organizational design, and increasing the effectiveness of our management team.

The objective is simple -- drive profitable market share growth by increasing the efficiencies of our daily operations, by also investing to fuel our long-term success.

As a result, we've implemented a set of restructuring actions to streamline parts of the organization, particularly in the area of executive management and sales support.

We eliminated a total of 73 positions in Insight North America, of which 16 were in management.

Decisions to eliminate positions are never easy, but they were necessary to ensure the alignment of our cost structure with our profitability goals and our investments for our future.

Now, I will turn the call back to Stan to provide more details on our second-quarter performance across each of our operating segments and the details associated with our restructuring action.

Stan?

Thanks, Rich.

The second quarter saw year-over-year increases in quarterly net sales and earnings per share.

Consolidated net sales grew 6% year-over-year and non-GAAP diluted earnings per share grew 11% to $0.31 compared to $0.28 in the second quarter of last year.

The non-GAAP numbers for Q2, 2005 referred to in the earnings release and in this conference call exclude expenses related to severance and restructuring expenses and the tax effects of these items.

Now, let's turn to the North American operations.

Insight North America had sales growth of 5.5% year-over-year.

The number of account executives in our North American operations was 1,054 at June 30, 2005, down from 1,252 at June 30, 2004 and 1,109 at the end of last quarter.

Net sales per average account executive were $619,000 in the second quarter of 2005, a 19% increase in productivity compared to $519,000 in the second quarter last year and a 7% increase in productivity from $580,000 last quarter.

As Rich discussed earlier, we have many initiatives that we believe will continue to improve account executive productivity but believe it is time to start adding modest numbers of net account executives and sales managers during this last half of 2005.

Accordingly, we plan to add approximately 15 net account executives and 15 SMB sales managers in Insight North America by 12-31-2005.

Of course, market conditions and success of recruiting quality candidates will dictate the exact number.

The average tenure of our North American account executive is up from 3.1 years at Q2 2004 and 3.6 years at Q1 2005 to 3.8 years in Q2 of 2005 with 22% of our account executives having less than 1 year experience, 17% with 1 to two years, 9% with 2 to 3 years, and 52% with more than 3 years' experience.

The increase in average tenure is due primarily to the decrease in the hiring of account executives and a decrease in turnover.

Sales by product category, compared to Q2, 2004, remained fairly stable, although we did see some increases as a percent of net product sales in networking and connectivity and some decreases in printer and monitors and videos.

We were pleased to see our initiatives to increase gross margin continue to pay off and in Q2 2005, our gross margin increased to 11.7% from 11.4% in Q2 2004.

Sequentially, we saw a small decrease from 11.8% last quarter.

The increase from Q2 2004 was due primarily to increases in product margins, services and freight margin, offset partially by increases in sales to large enterprises, which are typically at a lower gross margin, increases in write-downs of inventories, and a decrease in supplier reimbursements as a percentage of net sales.

The increases in product margin are primarily the result of internal initiatives to increase the product margin, including the rollout of a new price-to-market tool to our SMB account executives in late Q1.

While Q2 is seasonally the strongest quarter for Microsoft enterprise software agreements renewals, the renewal fees from Microsoft as a percentage of net sales was pretty consistent with Q2 of 2005 compared to Q2 of 2004.

The decrease in gross margin from 11.8% last quarter resulted primarily from a decrease in product margin, due to aggressive pricing late in the quarter, a decrease in freight margin due partly to a free shipping promotion, and increases in sales to large enterprise clients as a percentage of total net sales.

These decreases were partially offset by a seasonally strong quarter for referral fees from Microsoft for enterprise software agreement renewals, and a decrease in the write-downs of inventories.

Going forward into Q3, we would expect gross margin for Insight North America to be flat to slightly down as we continue to work on initiatives to increase gross margin.

However, Microsoft referral fees will be seasonally down, and Q3 should be a strong quarter for public sector, which is generally at lower gross margins.

Selling and administrative expenses as a percentage of sales were 8.9%, consistent with Q2 2004 and Q1 2005.

Compared to Q1 2005 and Q1 2004, we have benefited from increases in net sales, increases in operational efficiency, and decreases in bad debt expense as a percentage of net sales.

These savings were offset by investments that we are making in the areas of account executives and sales managers, marketing, skills development and Human Resources.

As Rich discussed earlier, we made some restructuring decisions during the quarter that we believe will enable us to reduce operating expenses as a percentage of sales while we continue to invest in areas that we believe are necessary for growth, including continued investments in marketing and skills development and increased investments in IT systems, as well as account executives and sales manager headcount.

We recorded severance and restructuring expenses of $3.7 million in Insight North America, of which $2.4 million related to the departure of the former President of Insight North America.

As Rich discussed, the restructuring activities were designed to gain operational efficiencies and flatten the organization.

As a result of these actions, we are reducing quarterly expenses in Insight North America by approximately 1.3 million per quarter in the second half, although the majority of these savings are being used to fund the investments we just discussed.

Going forward into Q3, we would expect overall operating expenses, including the effect of these offsetting savings and investments, to increase from Q2 for variable expenses, such as commissions, which generally average about 10% of gross profit of dollars, and other expenses that fluctuate with net sales, which generally average 1 to 2% of net sales.

Overall in Q2 2005, Insight North America posted non-GAAP earnings from operations as a percentage of net sales of 2.8%.

This number excludes the severance and restructuring expenses.

Insight UK continues to contribute strong operational profitability with posted increases in net sales and non-GAAP earnings from operations up 12% and 33% respectively, compared to the second quarter last year.

In British pounds sterling, we posted an increase in net sales and non-GAAP earnings from operations of 9 and 30% respectively, compared to the second quarter last year.

We also benefited from having 63 shipping days in Q2 2005, compared to only 61 shipping days in Q2 2004.

Seasonally, Q2 is not a strong as Q1 for Insight UK.

Accordingly, net sales decreased 1% from last quarter and non-GAAP earnings from operations were basically flat.

In British pounds sterling, sales grew sequentially approximately 1% and non-GAAP earnings from operations decreased approximately 2%.

The non-GAAP earnings from operations exclude the severance and restructuring expenses in the second quarter of 2005.

We were very pleased with these results, as we believe our sales performance was better than the market in the UK.

The number of account executives in our UK operations was 301 at June 30, 2005, a decrease from 221 at June 30, 2004 and an increase over 296 last quarter.

We continue to target hiring, on average, between 10 and 20 account executives per quarter during 2005.

Average tenure of our United Kingdom account executives remain consistent at two years, compared with Q2 2004 and last quarter, with 47% of the account executives having less than one year experience, 22% with one to two years, 10% with two to three years, and 21% with more than three years' experience.

Net sales per average account executive were 393,000 in the second quarter of 2005, an 11% increase in productivity compared to 355,000 in the second quarter last year and a slight decrease in productivity from 399 last quarter.

Sales by product category compared to 2004, the second quarter of 2004, show a shift to lower-margin products, as we saw increases as a percentage of net product sales in products such as Notebook desktops and servers, while printers and monitors as a percentage of product net sales decreased compared to the prior year.

Gross margin increased 13.7% from 13.2% in Q1 2005, although it decreased from -- (technical difficulty) -- 5% in Q2 -- (technical difficulty).

Compared to Q2 2004, the decrease in gross margin was due primarily to a decrease in product margin due to a shift in product mix to lower-margin products, a decrease in supplier reimbursements as a percentage of net sales, and an increase in the percentage of sales to large enterprise and public-sector clients, which are typically at lower gross margin.

These decreases were offset partially by increases in referral fees for renewals of Microsoft enterprise agreements and a decrease in write-down of inventories.

Compared to Q1 2005, we saw a decrease in the write-down of inventories and increases in referral fees for renewals of Microsoft enterprise agreements.

These increases were offset primarily by a decrease in product margin, due primarily to product mix shift and an aggressive pricing environment in the UK.

Selling and administrative expenses as a percentage of net sales were 11.1% in Q2 2005, an increase over a 10.6 last quarter and a decrease from 12.3% in Q2 2004.

The decrease from Q2 2004 was due primarily to the increase in net sales, an increase in vendor funds specifically identified against marketing expenses, and a decrease in bad debt expense as a percentage of net sales.

Partially offsetting these decreases were investments in account executives, sales management, and changes in sales compensation plans.

The increase over Q1 2005 was due primarily to the investments in account executives, sales management, and changes in sales compensation plans.

Insight UK also recorded restructuring expenses in Q2 totaling $414,000, which represented the elimination of 16 positions, of which 7 were in management.

Most of the savings anticipated by these restructuring activities are being reinvested back into Insight UK, most notably in account executives, marketing and skills development.

Insight UK is in negotiations to move its London operations to a new facility and currently has plans to move this facility towards the end of December.

As such, Insight UK will be recording rent expense for both facilities for the rest of 2005, increasing expense in Q3 2005 and Q4 2005 by approximately $212,000 and $635,000, respectively.

This additional expense will be partially covered by savings associated with the restructuring activities.

Additionally, Insight UK will be taking an additional restructuring charge in Q4 2005 of between $6.5 million and $7.2 million for the remaining lease in the old facility.

This building will provide Insight UK with a much better layout for our business model with additional room for growth.

Additionally, it is in a much more desirable location, which should help employee retention, recruitment and morale.

Insight UK posted non-GAAP earnings from operations of 2.6%, an improvement over 2.2% in Q2 2004 and consistent with last quarter.

This number excludes the severance and restructuring expenses.

This brings me to Direct Alliance, which saw a 4% increase in net sales and a 17% decrease in earnings from operations this quarter, compared to Q2 2004.

The decrease in earnings from operations compared to Q2 2004 is due primarily to renegotiated fee structures as part of multi-year contract renewals with some of Direct Alliance's largest clients.

These decreases were offset partially by increases in sales and earnings from operations contributed by other clients.

Compared to Q1 2005, net sales were basically flat and Direct Alliance posted earnings from operations of $2.6 million, a 3% increase over Q1 2005.

Compared to last quarter, earnings from operation increased due to increases in performance fees resulting from increased sales under client programs and a focus on controlling administrative expenses.

We were pleased that Direct Alliance showed growth in earnings from operations over Q1 2005, and Q3 Direct Alliance will record approximately $1 million in severance and restructuring expenses related to the departure of the former President of Direct Alliance.

Turning to a couple of balance sheet metrics, Days Sales Outstanding in ending Accounts Receivable were 47 days, consistent with Q2 2004, while annual inventory turns increased from 31 times in Q2 2004 to 32 times in Q2 2005.

During the quarter, we also completed the repurchase of $25 million of common stock, representing approximately 1.402 million shares repurchased since the beginning of March at an average price of $17.83.

In May, the Board of Directors authorized a 25 million increase to the stock repurchase program.

Although no shares have yet been purchased under this increase, we expect to initiate purchases in Q3.

I will now turn the call back to Rich for final comments.

Thanks very much, Stan.

As I stated earlier, we had not strong but solid results in the second quarter.

We are progressing in each of our goals.

We have not stepped down at all from our stated objective of growing net sales faster than the market and attaining consolidated operating margin of 4% by Q4 of 2006.

We're very busy, very focused and truly embracing the multitude of changes within our dynamic international organization.

That concludes my comments.

At this time, Stan and I are happy to answer your questions.

(OPERATOR INSTRUCTIONS).

Brian Alexander from Raymond James.

Can you just go into a little bit more detail on the growth you saw in North America -- 5.5% down from 10% year-over-year in the first quarter?

I know you talked about demand being stable on the last call, and I think, at the analyst day, you still characterized it as stable.

So was most of this deceleration due to some of the attrition we saw in account executive headcount?

Could you just address the attrition you saw there, how much of that was voluntary versus involuntary and then just kind of dig a little bit deeper into the growth you saw in North America, SMB versus large corporate?

I'm just trying to get the sense for whether there's any growth in the SMB side of the business.

Brian, this is Rich.

Yes, first of all, from a demand environment perspective, I mean, it does appear that we have a pretty stable environment inside of North America.

June was our strong month inside of the quarter, so we are very encouraged by June.

But to really answer the heart of your question, which is what's going on within our SMB business, year-over-year, our business is basically flat in the second quarter from an SMB perspective.

As you know, we've had some issues, over the last several quarters, with our SMB business.

Some of those can be tied back to historically the strong growth rates in our enterprise business in 2004, which took some of the focus off of SMB quite honestly, but additionally, turnover amongst our sales executives in the SMB division has historically been very high.

But at the end of the day, in my opinion, it's been about execution, and I believe the actions we highlighted today are -- we're putting those in place to ensure we have the right team in place to ensure execution as we move into the second half of the year.

I mean, clearly, the concept of adding more account executives, which we didn't do that in the first half, so you saw us go down from account executives at about 50 from the beginning of the year to midyear.

We did that, quite honestly, on purpose, because as we try to go scale back our recruiting, we want to make sure we are bringing the right people in.

So we're doing a lot of work to retool our recruiting program, to try and go create a new higher training program so that, as we brought salespeople on, we were more successful in retaining them as well as getting productivity out of them.

So we are in a situation in the first half of not bringing on a lot of new talent.

Now, as we've spent a lot of time again redoing our recruiting criteria, spent a lot of time on our new higher training program, we believe we're ready now, going into the second half of the year, to reverse that and to start to regrow our SMB sales team.

So we put a goal there for ourselves to grow our sales team by 50 between now and the end of the year.

A very -- another important investment that I want to highlight to you is our sales managers.

So we've stated we're going to go try to grow (sic) 15 sales managers inside of our SMB business between now and the end of the year.

Today, we run about an 18-to-1 span of control between managers and salespeople.

We're trying to get that down to 12-to-1, which is a substantial investment, but we believe that's required for our sales managers to have the time that is required to work with their sales team to do the things that they should be doing, which is coaching and developing and helping them be successful as they migrate from a product-based sales orientation to more of a solutions-based orientation.

Then just to follow up, Rich, on the headcount reduction you took in the quarter, what was the timing of that?

Did you realize any savings in Q2?

Then Stan, it sounded like most of that's going to be reinvested in the business.

I'm just wondering.

Is any of that going to flow through to the bottom line, and just give us a sense for where specifically did you target those headcount reductions?

Sure, Brian, it is Rich again.

I'll take it and Stan, please add to it if I miss something.

Clearly, the $1.3 million that Stan referenced was -- the target was really sales support, management layers and quite honestly executive layers, so we did a lot of work in terms of combining executive functions together to have less executives.

We looked at our sales support side, which is everything but sales, and tried to go increase the span of control there.

We are running, in some departments, in a 4 to 5 span of control, where a staff manager may have only 5 people working for him.

We're trying to drive that more to like 7 to ate, so we actually increased span of control in sales support, so we have the dollars now to go decrease the span of control in sales.

So we want to go from 18-to-1 down to 12-to-1.

So the focus, in terms of where we targeted -- and all of those resources really came out at the end of the quarter; right there on the 28th was sales support, management and executive management more specifically, with the concept of we wanted to flatten the organization.

So if you go look at Mark McGrath's organization today, who runs the U.S. for us today, he has not taken out a whole layer between him and the sales leadership team.

He used to have one leader of all sales underneath him; then he had underneath that person somebody run SMB, someone who ran enterprise, someone who ran public sector.

We've taken out that one person in terms of -- now he has three sales executives coming in to him, so he didn't need that extra layer in our opinion, in order to go and really get Mark to have a lot of time focused on driving our sales results.

We wanted the enterprise leader, the public sector leader, the SMB leader coming directly into him.

That's an example of one area where we flattened our organization.

Then Brian, addressing your question on reinvesting, yes, that's when I said that we plan to reinvest that back into the areas of the account executives and sales managers that Rich was talking about, marketing, skills development, all of that stuff.

I guess where we would hope to see the benefits from that would be a reenergizing of the sales effort in that area, which hopefully would produce more sales, consequently more gross profit and then drop to the bottom line.

I mean, in summary, just because I think that restructuring action is an important thing for us all to understand, I mean, the action will help us, in our opinion, position us to meet our second-half profitability objectives while at the same time allow us to invest in the key initiatives that we talked about at our analyst meeting back in May.

We clearly have resquizzled (ph) our expenses to put more investment in customer-facing resources as we move into the second half of the year, which we believe, over time, will assist us in driving higher revenue growth rates.

Great.

Last question -- on the gross margin in the quarter in North America, Stan, I didn't hear you comment on how the initiatives, the several initiatives you have, pricing, supplier reimbursements, etc., how that impacted gross margin on a sequential basis in the second quarter.

I did mention that it did have an impact.

We put that in late in Q1.

It did have a positive impact on the quarter.

Unfortunately, there were some other negative things going the other way, but what you're referring to, Brian, is the market pricing more to a market as opposed to cost-plus.

We believe that it's a very positive influence.

We think that will continue to have some positive influence as our account executives become more comfortable with it, but very definitely, between Q1 and Q2, it had a positive effect on there.

I mean, so clearly, on a year-to-year basis, we were 30 basis points from a gross profit perspective in North America, about flat -- I mean down a little on a quarter-to-quarter basis from a gross profit perspective.

Joel Wagonfeld of First Albany.

I have a question and then a clarification.

The question is can you elaborate on a couple of the factors that you mentioned that were pressuring gross margin?

Specifically, why was there an increase or decrease in inventory write-downs, less supplier reimbursements?

What are you going to do to try and stay ahead of the enterprise mix that's gone up until you kind of reenergize your SMB sales and the impact that that has?

Then the clarification is just 386 -- what we should use for a tax rate going forward.

This is Rich.

I will take the second part of the quarter, in terms of the enterprise business, but first let me have Stan do the first part.

First of all, on the write-downs, yes; within the quarter, we did have some write-downs that occurred.

We do that, you know, analyze our inventory quarterly to make sure everything is at a proper value and stuff.

Unfortunately, this quarter, due to some purchasing that we did, we felt that we had some write-downs which had a negative effect on it.

On supplier reimbursements, compared to last year, they were pretty consistent, but they were down as a percentage of sales, particularly compared to Q1.

Now, this was a strong quarter for Microsoft and those type of things, and that will certainly not be repeated in Q3.

All of our partnering activity, though, that was started in Q1 are designed to drive more in that area.

We hope and would expect that we would become more successful in driving more supplier reimbursements as time goes by.

On your tax rate -- and then I will let Rich answer -- (multiple speakers).

Stan, if I could interrupt just to clarify, because I think it was different in what you said versus the release?

Was there increased inventory write-downs in North America and decreased inventory write-downs in the UK?

Is that correct?

Yes, correct.

Okay, and so the increased inventory write-downs you were talking about was specifically -- (multiple speakers)?

Specifically in Insight North America.

In North America?

I'm sorry, I'm sorry.

Yes, absolutely.

Thanks for clarifying that, because you know, I go after the big part of the animal there when I'm answering the question.

Sorry to interrupt.

The other thing that I might mention in there, Joel, that -- you know, just to give you more comfort on the write-downs, sometimes what we will have in there -- you know, so you don't think that we are just buying product and all of a sudden realizing a large write-down; it could be because, for customer relation purposes or whenever we have out-of-policy returns, okay?

So we will authorize some product to come back, which again our policy is to immediately get that out to a broker so we don't hold it within the inventory.

So some of that write-down can be that as opposed to a specifically identified product.

On the tax rate, overall, our blended rate usually, as you know, historically is between 38 and 40%.

Basically in North America, you can assume a 39.5 for North America, about a 33 for the UK-based income. 33 is higher than the usual 30% over there because we have some interest income being generated in the UK which has an additional 5% tax on it.

So, basically, when you're figuring taxes, depending you model us, you need to look at Insight North America and take about 39.5 and then whatever income you have are estimating in the UK, do that at about 33%.

This is Rich again.

Now, relative to the enterprise question, clearly, our enterprise business was a success for us inside North America in the second quarter.

Quite honestly, I view that as a very positive statement because today, as we talked about in terms of our strategy, which is we want to move from an IT product provider to an IT solutions provider, that migration in terms of the relationship we have with our clients in terms of selling not just product but products and services and really having more of a needs-based relationship with them -- that strategy is alive inside of our enterprise business.

I directly attribute that strategy to why our business is successful in enterprise.

Obviously, as you know, we are trying to migrate our product transactional type orientation in SMB to more of a solutions orientation in SMB to a much more needs-based sales approach in SMB.

We're making progress on that, which is what this new World-Class training initiative is all about.

Our strategy with enterprise is to continue to go drive that business.

The good news is we continue to add new clients, new clients to Insight inside of our enterprise space.

We just signed a new contract towards the end of the second quarter, which will be published here early in the next few weeks, which is just another sign that there's more and more enterprise customers feeling comfortable doing business with Insight, because we are really addressing the needs that they have for a multi-vendor solution.

That's what we provide them.

So I guess the question is, if we assume that that continues to be successful, should we expect that, over time, that's going to have a negative impact on overall gross margin, or will there be other offsets, given that the enterprise business has a lower gross margin?

I think there will be other -- our strategy -- clearly there will be other offsets and clearly, we're looking to go drive improvements in our SMB business so the flat performance that we had in the second quarter is not acceptable, from our perspective, so our strategy is to go increase that and we are putting actions in place to go do it.

We have other actions in place as well obviously, things such as trying to go work on driving stronger partner relationships to get our SR investments at a higher level, as an example of one.

But as we sit here today, the big question is the timing it takes us to go drive improvements in our SMB business.

I mean, clearly, from our perspective, I am confident, under Mark's leadership, that we will gain traction in the second half of the year.

But fortunately, I mean, other parts of our business continue to perform well, which is one of the benefits of having a broad customer set portfolio, as well as international presence.

We plan to leverage that as we work as a collective team to go strengthen our SMB business in the second half and going into next year.

Joel, let me also add a couple of things on the gross margin.

Your point is well taken.

However, just to elaborate a little bit further on what Rich is saying, we are taking a whole bunch of different activities, such as trying to maximize freight margin, such as trying to cross-sell different products or upsell, such as also driving services into the business, which will be at a higher margin.

We are certainly evaluating our stocking strategies, continue to look at that direct-ship versus the warehouse.

As we mentioned earlier, this new pricing tool -- we think that that will drive some upward pressure on gross margins.

So there are counter-things that are working that we hope will improve that gross margin.

Having said that, in Insight North America, as I said earlier, from a modeling point, it's probably going to be flat to slightly down going into Q3.

Thanks a lot.

Matt Sheerin of Thomas Weisel Partners.

Just I have a question regarding the revenue trends.

You summed it up pretty well for what you have seen so far, but as we look ahead -- and I know you don't give revenue guidance, but if you could just talk about seasonality, North American and then also specifically in the UK, given that normally there's a big sequential increase in the UK in September but now, because of the selling days in June, I want to know if there was any change there.

Then also, as enterprise ramps up toward the end of the year, I would imagine that you expect to see some growth there.

Yes, clearly, from an enterprise perspective, the fourth quarter is the big quarter for our enterprise business now and as we plan to leverage that.

I mean, overall, from a demand perspective going into the third quarter, I mean, demand does appear to be pretty stable in North America.

As it relates to the UK, we definitely saw some softening starting June, and we anticipate that continuing in the third quarter, obviously given current tragic events within the UK.

So as we look to the demand environment in the UK, there's obviously a lot going on in that market.

I am very pleased, though, I've got to say, that our UK business grew 9% in local currency in the second quarter.

I think we all know, from reading current market reports, that the market is clearly not growing at that level, so that to me is an example that we have a very strong leadership team there, we've got a set of activities and strategies that they are executing that are working.

Obviously, they will continue to go execute those in the third quarter and even though it's a difficult demand environment, we are hoping that they will continue to have the strong success that they had in the second quarter.

You talked about headcount in SMB, but could you talk about what's happening in the enterprise side and the large corporate side?

Is it relatively stable?

Also turnover among employees versus corporate -- I mean versus SMB?

We actually run a very low turnover in our SMB -- excuse me, our enterprise business.

I mean, in fact, that is one of those businesses that we have very high tenure from a sales force perspective, which I think is obviously one of the drivers of our success there.

A lot of the relationships we've had with some of our largest clients we've had for many years, because of those relationships they have with their account executives.

In terms of turnover, we have not experienced, again, near the turnover that we've had in the SMB business, which again is one of the things we are very focused on within SMB.

The reality is it's a multifaceted plan to go address it.

It's everything from recruiting; it's the training program you bring them into to take the responsibility on the Company versus them to enable them to be successful in their first year working for us; it's linking up sales and marketing together.

For the set of actions that we are taking with Gary Glandon, who is our Chief People Officer, to ensure that our historical issues we've had in terms of high turnover within SMB get addressed.

We are encouraged that, in the second quarter, like I referenced in my comments upfront, we are down 10% year-on-year from a turnover perspective.

That is meaningful, from our perspective, and we're looking for that trend to continue as we move into the third quarter and the fourth quarter.

Okay, great.

Just in terms of the operating margin goals that you've stated for North America, I believe it's 4% at the end of '06.

Is that still on track or are we just looking at -- you know, it looks like things are going to be solid a little bit with the investments you're making on gross margin being stalled a little bit.

Are you still looking at that goal or targeting that goal?

Matt, this is Stan.

Yes, absolutely we are targeting it.

The goal that you mentioned, though, is 4% in Q4 of 2006 for Insight Enterprises, Inc., the overall company.

As Rich mentioned earlier, absolutely we are all focused toward that goal.

Okay, thank you.

David Manthey, Robert W. Baird.

To add onto the last comment that you just made, Stan, as it relates to the P&L here over the next year and a half or so as you approach that 4% in the fourth quarter of '06, should we assume that, through the end of this year and maybe into the beginning part of next year, we are sort of looking at slightly faster growth or maybe accelerating growth, flattish GP and then some SG&A leverage as we go forward?

Then I guess as we go into 2006, historically we used to talk about GP ticking down sort of on a secular basis.

Do you think you can hold the line as you add services and work some of these other things out and get additional leverage on SG&A in order to get to the 4%?

Well, David, first of all, we don't give guidance, as you know, except, you know, the stuff I've said earlier.

But having said that, I think what we will probably see within the operating margin to get to that 4% is that gradual increase from now to that fourth quarter of 2006.

Admittedly, we are putting a lot of changes and investments and everything else into Q3 and Q4 that will take some time to pay benefits from, but that's one of the reasons why we went through this restructuring activity -- is by doing that, we felt that we could still stay on track to increase our operating margin during that period of time.

In terms of overall gross profit margin, I mean, your comment in this industry as long as I've been here (sic), I mean it's always downward pressure on that.

But again, as I mentioned earlier, we are initiating a lot of different action, such as the pricing strategies in the SMB, the stocking strategies.

We're trying to work with our partners more -- as we get bigger, hopefully better pricing, more supplier reimbursements.

We're trying to sell more services into the -- (technical difficulty); we are trying to cross-sell upsell.

All of these things along with maximizing freight margin hopefully we think will counterbalance that.

Again, what we've often said is that if you model this company out to get to the 4%, you're probably going to have gross profit margin of between 11.5 and 12.5% and you're going to have operating expenses of 7.5 to 8.5%.

Quite frankly, I guess, looking at it from my position, I don't care where it is as long as operating margin is at 4%.

So I think that if we do see some decrease in gross profit margin, then we're going to have to take out costs or become more efficient, all the things that we're working with in the operating expense area, so that we come to that 4%.

Okay, thanks a lot for that.

Just -- so, as we move forward through the quarters here and think about how your performance is versus expectations, I'm sure you can appreciate that now there's a heck of a lot of moving parts here making it even more difficult to model in terms of cost reductions versus investments.

Are you saying that the way that you're going to judge if you're making progress is if EBIT margins are gradually moving up?

Is that the benchmark for success?

Again, this is Rich.

Yes, we are looking for those to gradually increase through now through the fourth quarter of 2006.

Clearly, the investments -- the restructuring activity that we just took was basically to free up expense to be redirected to pay for those investments.

So, we believe that what we've done with this restructuring activity is we've been able to go look at our profitability goals that we have for the second half of the year, look at the investments that we want to make that we believe fuel our future growth.

By reapplying those expense reductions to fuel those investments was our strategy and what we were able to execute with this most recent action we did at the end of June.

Dave, to answer your question on the modeling, remember, we've often talked about the thing that, when you look at a variable expense overall for the business, and you add (ph) about 10% of gross profit dollars, so wherever your sales are going to hit into that operating expenses, and then about 1 to 2% of net sales, however you're figuring that out will come in operating expenses for such things as bad debt provision or headcount, generally speaking.

So hopefully, we've given you some numbers to help out with your dilemma.

Right, so what I'm hearing you say is that the cost reductions and the investments will be pretty much 1-to-1 and then the normal leverage should take over in the business?

Yes, particularly for Q3.

Hopefully then what you're going to see -- again, knock on wood -- is that, as these investments that we make start to pay off, it's going to drive sales, which is going to improve gross profit, which is going to drop to the bottom line.

Got it, great.

Thanks a lot.

John Coyle of JMP Securities.

Thank you.

Just a couple of questions -- first, on this flattening of the organization, in terms of headcount reduction, are you now pretty much complete?

Do you expect some more to take place for the rest of the year?

I would tell you I'm feeling very confident about the leadership team I now have in place running the business, and I believe we've made a lot of progress in terms of flattening the organization.

Are we completely done?

There's still some areas in the organization that we will be looking at as we move into the future but fundamentally, I think the big action that we needed to go to make to again make sure we had the expense freed up to go fuel the investments we need to make is what we just completed.

Okay, great. (indiscernible) Direct Alliance with the new leadership in place, could you elaborate a little bit more on the direction you want to take that business going forward?

First of all, I'm very pleased to have Jim in place running that business now.

Jim is a strong operational leader, which I think will be very appropriate for business there right now.

I mean, we continue, from a strategic perspective, to focus on growing that business.

However, more attention will be given to growing the business with our existing clients versus new business development.

One of the things we've seen historically is new business development takes a long period of time from initial engagement to actually getting the business up and running.

So the team, with Jim's leadership ,I think is going to be very much focused on -- we have some very strong relationships today, with some very large companies, of how can we go broaden that relationship with those companies, because we believe that is a faster way to go recognize revenue and profitability growth.

Now, don't misinterpret me.

We will still focus on some new business development opportunities, but viewing that is the only way to go drive growth is not the approach that Jim and the leadership team are taking as he comes into that new position.

What he's going to look at first and foremost is how do I go grow or broaden my relationship with my existing accounts?

We believe there's a good opportunity to go to that.

In addition to that -- secondary to that, he will be looking at new business development and adding new accounts.

Great.

Then finally, you noted that you saw some -- (technical difficulty) -- pricing pressure later -- late in the quarter.

Could you elaborate a little bit more on that?

Did that carry over so far this quarter?

No, I don't think I made any specific comments regarding pricing competitiveness.

I mean, clearly, as we were closing out the quarter, every quarter, the third month is one of the most competitive from a pricing perspective.

The good news is, from a demand perspective, we definitely saw some more strength from a demand perspective in the third quarter and our growth rates internally were higher in the month of June as well -- I think tied into that demand statement.

Okay, great.

I will leave it at that.

Thanks.

John Lawrence from Morgan Keegan.

This is actually Adam for John.

Our questions have been answered though, so I appreciate it.

Thank you.

Rob Aman (ph) of RK (ph) Capital Management.

Just a clarification on the turnover -- when you mentioned it had fallen 10%, is that Insight overall or the SMB segment?

All employees inside of Insight North America, so we look at Insight North America and that's how we track it in terms of all employees and turnover.

By 10%, you're talking about falling from hypothetically a 30 to a 27, not a 30 to a 20, not 10 points, correct?

Correct, correct.

Okay, since that was our last question, I mean, on behalf of Insight Enterprises, thank you to our valued employees, clients, partners and stockholders.

We look forward to our next call.

Thank you very much.

Ladies and gentlemen, this concludes your conference call for today.

We thank you for your participation.

You may now disconnect.

Have of good day.