Insight Enterprises Inc (NSIT) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2010 Insight Enterprises earnings conference call.

I will be your operator for today.

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

Later, we will conduct a question-and-answer session.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms.

Glynis Bryan, CFO.

Please proceed.

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 March 31st, 2010.

I am Glynis Bryan, Chief Financial Officer of Insight Enterprises, joining me is Ken Lamneck, President and Chief Executive Officer.

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 website at insight.com under Investor Relations section.

Today's call, including the question and answer period, is being webcast live and can be accessed by the Investor Relations page of our website at insight.com.

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

This conference call and the associated webcast contains time-sensitive information that is accurate only as of today, May 5, 2010.

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.

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

These risks are discussed in today's press release and in greater detail in our annual report on Form 10-K for the year ended December 31st, 2009.

With that, I will now turn the call over to Ken to walk you through an overview of our first quarter 2010 operating results and priorities for our business for the balance of 2010.

Ken?

Thank you, Glynis.

Hello everyone.

Thank you for joining us today to discuss our first quarter operating results.

We're pleased to report that market demand continued to improve in the first quarter across all of our operating segments.

As we reported earlier today, consolidated net sales for the first quarter were $1.05 billion reflecting an increase of 10% from last year's first quarter net sales and the first quarter since Q3 of 2008 that we saw year to year sales growth in all of our operating segments.

Gross profit was $145 million, up 10% from last year, and gross margin was 13.8%, down 10 basis points from 13.9% in the first quarter of 2009.

Earnings from operations increased to $17.3 million from a loss of $7.9 million reported last year.

Please recall that we recorded certain items in the first quarter of last year that did not reoccur this year, including expense related to the termination of an equity incentive plan of $5.5 million and severance and restructuring expenses of $6.3 million, compared to only $71,000 of severance expense this year.

Additionally, we recorded professional fees associated with the trade credits through mediation of $4.1 million in the first quarter of 2009, but only $497,000 of similar expense this year.

Net earnings and diluted earnings per share were $9.2 million and $0.20 in first quarter of 2010 compared to the non-GAAP net earnings and diluted earnings per share from continuing operations reported in the first quarter of 2009 of $3.8 million and $0.08.

We are pleased with our first quarter financial results, which resulted from better than expected sales and gross margin performance in North America across our leaner cost structure and in line performance in our EMEA and Asia-Pacific segments.

In North America, we experienced stronger than expected demand in our hardware category, which resulted in 23% growth year to year in this category.

We were also able to achieve increased gross margin in those sales compared to the fourth quarter of 2009.

In addition demand for hardware improved across virtually all product categories and all client groups, which is encouraging and an indication that it's not just large enterprise clients which are starting the new year with the new CapEx budgets and refreshed needs.

In EMEA we saw sales grow in constant currency across all product categories.

In particular, our UK business performed very well, showing overall strengthening of demand for hardware and a continued focus on winning public sector business in the region.

We believe that the market in the UK has stabilized.

However, we continue to see weakness across the rest of EMEA, where our business is primarily in the software category and within the large enterprise client group.

In Asia-Pacific, sales increased over 100% in US dollars and 71% in constant currency, primarily due to large transactions in the public sector client group.

A significant percentage of our business in this region is generated in Australia, a more mature market where we have a focus on the public sector space.

Typically public sector clients are not fee based and, therefore, have resulted in more top-line sales, but decreased gross margins over the past several quarters.

As a consequence, we expect gross margins to be in the range of 12% to 14% over the balance of the year.

Before I hand the call back over to Glynis, I wanted to quickly update you on our initiatives to create a single sales and delivery organization in the United States.

Success in this initiative is expected to increase sales for existing clients across the full suite of our products and services and ensure we are more directly in line with our partners.

We have concluded the planning and design phase of this initiative and expect implementation to occur in the third quarter.

I believe that successful execution in this initiative will position our business to grow organically and with continued expense control will provide the foundation we need to improve our long-term operating margin performance.

I will now hand the call back over to Glynis who will discuss the first quarter operating results of our business segments.

Thank you, Ken .

Hello, again everyone.

Starting with North America, net sales were $688 million, up 4% from the first quarter of 2009.

Sales in our hardware category increased 23% year to year reflecting higher demand by all client groups, but particularly corporate clients.

Software sales decreased 22% compared to last year due primarily to a significant public sector software transaction in the first quarter of last year that was not replaced with new volume this year and also the effects of publisher program changes related to software enterprise agreements that were effective beginning in May of last year.

Gross profit increased 6% year over year to over $99 million, while gross margin increased to 14.4% from 14.1% in the prior year.

Increases in product margin, driven primarily by sales in our hardware category were partially offset by declines in margin contributed by the software category on lower volume and lower fees from enterprise agreements resulting from publisher program changes.

Gross profit and margin also benefited approximately $1.9 million from the elimination of certain restatement related trade credits during the quarter through negotiated settlement or other legal release.

Selling and administrative expenses for North America in the first quarter were down $10 million or 11% compared to the first quarter of 2009.

During the quarter, we incurred approximately $497,000 of professional fees associated with the trade credit's remediation and related litigation.

Comparatively, selling and administrative expenses in first quarter of 2009 included $8.2 million of charges related to the North America portion of the termination of an equity based incentive compensation plan and professional fees associated with the trade credit investigation and restatement quantification.

The North America segment did not have any severance and restructuring charges during the first quarter of 2010 compared to $5.9 million in severance and restructuring charges recorded during the first quarter of 2009.

As a result, earnings from operations in North America were $14.1 million in the first quarter of 2010, up from non-GAAP earnings from operations of $6.1 million reported in the first quarter of 2009.

Moving on to EMEA, our EMEA operating segment reported net sales of $317 million, up 17% in US dollars.

In constant currency, net sales increased 10%.

Sales of hardware include 20% in constantly currency terms during the quarter, due to high demand across all client groups, but specifically in the public sector group, where we continue to increase our presence, and benefited from the effects of seasonal client budget releases.

Software sales increased 4% in constantly currency compared to last year, due primarily to higher volume, new client engagements, and new publisher offerings, offset in part by the effects of publisher program changes that were effective beginning in May of last year.

Service sales increased 17% in constant currency compared to last year due primarily to higher volume.

Gross profit in EMEA was up 15% in US dollars and up 8% in constant currency terms, while gross margin decreased to 13% from 13.3% in the prior year.

The declining gross margin includes increased product margin of 28 basis points, which was more than offset by the effects of publisher program changes in the software category.

Selling and administrative expenses in EMEA in the first quarter were up 10% in US dollars, and in constantly currency were up 3% or $1.3 million year over year.

The prior year quarter, selling and administrative expenses included $1.4 million of charges related to the EMEA portion of the termination of an equity based incentive compensation plan.

This increase year to year was largely driven by increased salaries resulting from our investment in sales head count focused on the middle market and public sector client groups and higher variable compensation on increased sales.

In addition, we incurred higher facility expenses due to an office relocation in France.

EMEA also recorded $71,000 in severance expense in the quarter, compared to $417,000 in severance expense recorded during the first quarter of 2009.

As a result, earnings from operations in EMEA were $2.8 million in the first quarter of 2010, up from non-GAAP earnings from operations of $2.4 million reported last year.

APAC operating segment reported net sales of $44 million, up over 100% from the prior year in US dollars and up 71% in constantly currency terms.

This increase is due primarily to increased sales to public sector client including a large contract that was earned in the first quarter of this year that was historically executed in the second quarter.

Gross profit was $4.8 million, an increase of 71% year to year in US dollars and 36% in constant currency, while gross margin was 11%, down from 13.9% in the prior-year quarter driven by the increased mix of public sector business partially offset by the effects of the settlement and release of local sales tax reserves of approximately $480,000.

Selling and administrative expenses in APAC increased 34% year over year in US dollars and 5% in constant currency terms as a result of higher variable compensation on increased sales expense.

As a result, our Asia-Pacific segment reported earnings from operations of about $388,000, which was up from the non-GAAP loss from operations of $459,000 reported last year.

On our tax rate, our effective tax rate for the first quarter resulted in an expense of 36.7%, in line with our expected normalized tax rate.

This compares to a benefit of 33% in the prior year quarter due to the net loss recorded in that period.

Moving on to cash flows, during the first quarter, our operations generated $110 million of cash compared to $101 million for the same period in 2009.

These results reflect payments of approximately $12 million to various state agencies as part of our previously announced program of compliance with their unclaimed property programs during the first quarter and the effects of timing to a large supplier payment that was deferred until April 1st.

During the first quarter we also invested $3 million in capital expenditures primarily for improvements to existing infrastructure and our IT systems development project in EMEA.

As a result we were able to pay down debt by approximately $67 million and ended the quarter with $85 million of cash and $80 million of debt outstanding on our revolving credit facility.

I will now turn the call back to Ken for his closing

Given our stronger than expected financial performance in the first quarter, we now anticipate that diluted earnings per share for the full year of 2010 will be between $1.05 and $1.15.

This outlook reflects the following assumptions - continued strong demand for hardware technology in North America, partially offset by the full year effect of partner program changes that were effective beginning in May of 2009 - a decline in sales of services in 2010 due to the completion of a significant service engagement in 2009 that is not currently expected to be replace fully in 2010 - and an effective tax rate of approximately 36% to 39% for 2010, up from 26% in 2009.

This outlook does not include the impact of any severance and restructuring expenses or expenses associated through instatement of our financial statements or related litigation.

I'm pleased with the Company's financial performance in the first quarter, and believe with the changes we are making in our sales engagement model, and through increased focus on operational efficiency, we'll be well positioned to grow organically on both the top and bottom line in 2010 and beyond.

That concludes my comments.

I will now open the line for your questions.

(Operator Instructions) Our first question comes from the line of Brian Alexander.

Please proceed.

Thanks.

Good evening, everyone.

I think last quarter, when we talked about the full year earnings outlook, we were thinking revenue growth in the mid single digits.

You exceeded at least my expectations on the top line growing 10% year on year.

You have got easy comparisons for at least the next two quarters.

You sound more confident about the demand environment, particularly hardware.

So I guess the first question would be, what would be your full-year revenue growth outlook that's associated with the new earnings guidance of $1.05 to $1.15?

Brian, based on the strength that we've seen in hardware, we anticipate specifically, on the hardware side, that our revenue growth is going to be more in the range of the mid to high single digits, like the 8% to 10% range on hardware.

.

We still have the challenges that we spoke about before with regard to the services segment of our business and the large contract that we had last year that's not going to be repeated, and we still have some issues around -- not issues, but we still have some lower revenue expectations around software related to lower true-ups as well as the impact of the program

So would it be fair to say that software and services are unchanged from your prior outlook, while hardware growth expectations have increased?

Correct.

Okay.

That would be a fair summary.

And given how much growth you saw in hardware this quarter, why expect such a material deceleration to get to only mid to high single digits given that you just grew, I think over 20% in both of your major geographies?

In Q1 for us -- I can't speak to the rest of the market, but we think that Q1 was probably the worst quarter for us with regard to the hardware in North America and specifically this is a comment about North America.

So our expectation of being able to grow 23% in subsequent quarters in North America is not really there.

Likewise, in our EMEA operation, part of what contributed to the 20% growth in our EMEA operation was related to budget releases around the timing of power municipalities, the local government in the UK.

Actually when their budgets refresh, so we had some benefit from that in the fourth quarter in EMEA that we also don't expect to be duplicated going forward.

So hence while we're moderating the 23% growth that we saw in first quarter.

Also we actually saw strengthening in our hardware product line.

So in the first quarter of 2009 -- In the second of 2009, I think we reported that was the first quarter that we saw sequential growth in our hardware product lines in sometime towards two years prior.

We actually saw sequential growth each quarter, second, third and fourth quarter in 2009, going into 2010 and so also while in moderating the 23% to the kind of 8% to 10%.

Okay, just on the earnings guidance I don't know, it looks maybe potentially conservative.

You increased the full year by $0.10, but you beat the Q1 consensus at least by $0.07.

I know you didn't guide the first quarter, but it would appear that you're only increasing the balance of the year by $0.03 given the upside in the first quarter.

Is that the way you're looking at it relative to the forecast that you had, that you just had strong upside in Q1 but you don't expect much upside for the rest of the year.

If that's the case, is that because you're reinvesting more?

I'm just trying to connect the dots here on why we're not seeing more of a flow-through on the strong results in Q1 for the rest of the year.

Okay.

So I don't know what the thought process was behind the three analyst that actually came up with that consensus.

But our expectations for the first quarter performance would have been higher than what consensus implied.

You actually, I think had a $0.18 first quarter number for Insight, and that may have been more reasonable with regard to our own internal expectations about what was going to be happening.

I've got you..

So from our perspective, it's not a $0.07 beat in the first quarter.

And then --

But it's still better than our initial expectation.

Okay.

You might have said this in the prepared remarks, but why did the software decline accelerate in the first quarter in North America, and when do you expect software to grow?

On the software side, Brian, this is Ken, there were program changes, of course, that occurred last year.

That compare, of course, impacted us as well as we did have in Q1 2009, we had a very substantial deal in the public sector space that we didn't fully able to recapture in this Q1 this year.

That certainly had some impact.

Going forward for the rest of the year, Brian, we would expect that we'll see modest growth in the compares for software.

Is that just North America?

That's a worldwide statement.

So beginning in Q2, you'll see growth in software.

Correct.

And final question for me and I'll get back in the queue, the gross margin strength in North America, gross margin is up sequentially quite a bit despite the lower mix of software and services, so that implies that hardware margins -- and you alluded to this in the script, were very strong sequentially.

I also think, Glynis, you also mentioned the $1.9 million reversal of trade credit in this quarter, so that would imply maybe 30 basis points of benefit as far as North American gross margins were concerned.

Is that math right, and then, just overall, what drove that hardware margin up so much sequentially, and is that sustainable going forward?

Yes.

So, your math is correct, Brian in that regard.

So we're very pleased with the ability to grow hardware as substantially as we did as well as to improve the margin.

That was a key focus for us, is to really make sure that we weren't just growing revenue at the expense of margins.

We had a concerted effort to make sure we delivered on that.

That's a heavy proposition to try to continue that.

It's certainly our intent is to stay focused on that area.

And the trade credit reversal, is that about 30 basis points in the quarter?

Yes.

You were correct with your math.

You were correct with that math.

So the $1.9 million is not indicative of what we would anticipate every quarter.

But as you know as well, of course, which made it tougher overall even of course, was last year we had a lot more of the software fees in the margin structure.

So we had to make up for that as well.

So there was a good solid performance, as you indicated on the hardware front.

So are you suggesting, just to follow up, going forward in North America, gross margins probably won't hang out at these levels?

Yes, that's probably a fair assessment.

All right.

Thank you very much.

Our following question comes from the line of John Lawrence.

Please proceed.

Yes.

Good afternoon.

Hey, John.

Ken, could you talk a little bit -- you talked a little bit in your prepared remarks, but can you talk about -- obviously the sales channels improved in the demand environment.

What changes have you sort of instilled in your organization from a sales standpoint in the first quarter and as we get into the second quarter.

Yes, John.

What we've done is we put a little more rigor around the process that we have as far as inspection and accountability at the sales level to really drum that up, and I think that's certainly having, certainly some positive impact, and that will continue going forward.

We are touching on, of course, the sales engagement model that we're going to go effective in July.

Those pieces have been coming into play here over the quarter as well and continuing this quarter.

So it's not going to be just one big bang.

So some of those things are having certainly some positive impact on us as an organization.

Yes.

To go back to Brian's questions just a second.

As you've gone through that process and engaged the sales force a little bit more with Brian's question, some of those other categories, software and services, are you more confident in those areas than we were, say, three months ago.

I would say that I think we are as confident as we were originally.

That's what reflected the change that's primarily driving the revision to the guidance that we gave is primarily around the strength that we're seeing in hardware.

Right.

I understand.

So assumptions around software and services are essentially unchanged.

Those are unchanged.

But to follow that logic, I would assume those processes that you're talking about, Ken would affect all areas of the business?

That is correct.

Okay.

And last question, from the cost structure, is there anything that you've done besides just the software -- just from a sales organization, practices that have been steps cut out, whatever to improve the flow of the product?

Yes.

It's really been focused on the whole process --

Okay.

-- of the business.

We're certainly looking at every aspect of that.

Great, thanks for your help.

Good luck.

Thank you.

Our following question comes from the line of Matt Sheerin.

Please proceed.

Yes.

Thank you.

So on the hardware sales strength in the quarter, Ken and Glynis, you've talked about in the past on enterprise hardware sales being a little bit of a drag on gross margin, and it sounds like you talked about strengthening in hardware coming from the enterprise side, yet margins seem to be better.

So why is that?

It's the right mix of business, Matt, that we had in the quarter, but it did play from all components.

So it wasn't , again driven just by SMB or just enterprise.

It was pretty much across the board, and we have a lot of diligence around ensuring that we could maximize profit, and I think it delivered the right results.

So, I mean, that really was the

And if you look at the [Aslan] business, which I know is a small percentage, but a higher-margin business, how did that perform relative to the core commodity types of products that you sell.

Do you mean Calence on that, Matt?

Calence, I'm sorry.

Yes.

The Calence is, of course we don't break that out separately, but they just focused on the networking aspect of the business, as you well know.

It certainly performed in line with where we were overall.

Okay.

In the software business, particularly in EMEA, I know that part of the changes in -- from the vendor margin changes have to do with the focus, with your focus on enterprise in the sense you get penalized on the rebate side of the margin, I know you've talked in the past, Ken, about reorganizing or refocusing your software sales efforts on the SMB side.

How is that going?

You're talking, Matt specifically about --

Software.

Well, in general, but I know that part of the some of the margins cuts from software has to do with your focus, your end market focus.

Yes, so no question the certainly key publishers have created more of an incentive for us to focus our efforts and attention in the SMB space.

We're certainly doing that and that's where you saw us actually in both Europe as well as in Asia-PAC, to make investments in more people to get to that client set that we need to.

And a lot of what we're doing in the the new sales engagement model takes us there as well in the North America marketplace.

So yes, very much so.

So we're making progress certainly in that space.

Not as fast as I'd like, but we're certainly very focused on that and expect to deliver those kinds of results here.

Okay.

And the gross margin range that you gave for the year, 12% to 14%, you're already at the higher end of that in the March quarter and I would have expect, because of seasonal strength in software in June and December, despite some of the margin cuts you've talked about that sequentially it still would go up in June and December relative to the two other quarters.

Is that thinking right, or is it going to change now because of the mix and because of the margin structure on software?

So Matt, just to clarify, the 12% to 14% we referenced in the script was actually related to our Asia-PAC operation.

So Asia-Pacific reported 11% gross margins in Q1, and what we were highlighting is that we thought in Asia-PAC specifically that the margins would normalize over the year to more of a 12% to 14% range, that 11% was not going to be the new run rate for APAC going forward.

What about a range then for your overall business.

We haven't actually ever given you a guidance around our gross margins.

But what we did say, I think in our conference call the last time around was that given the mix of business that we had, specifically the impact of services, et cetera, that we would anticipate for the total Company that there would be a small reduction in our gross margin percent on a year over year basis in 2010 versus 2009.

So your updated EPS guidance still includes 10, 20, whatever basis point decline in gross margin year over year.

Our updated guidance includes some assumption regarding a small decline in GP for the rest -- in the future.

Okay.

But would you expect a seasonal up tick in gross margin in the June and December quarters because of the software business, or no?

I think based on our normal seasonality, we do anticipate there would be an up tick in Q2 more specifically.

I don't think we saw as big as an up tick in Q4 as we normally have seen, but definitely in Q2 with the higher software percentage in there.

We would anticipate a slightly higher margin in general.

It's somewhat more muted this year, because everything is sun setting with regard to -- we have one more month of the publisher program changes, and then it's kind of is a calendar -- it calendarizes for the 12-month period in Q2.

Okay.

And on the expense side, it looks like you're doing a good job of controlling costs.

Could you talk about investments that you're making?

You talked, Ken, about adding some people in your op end, and I'm sure you're doing some cuts here and there.

So how do you see the expenses shaking out throughout the year.

It won't be that substantial.

We'll also be doing a similar add of sales reps here in Q3 and Q4 in the US market to the tune of 30 people per quarter.

So not a substantial impact to the SG&A line.

Okay.

And is there a base salary associated with those reps?

Correct.

They will be inside reps, Matt.

That typically is from a base salary point of view in the $40,000 range.

Okay.

And then -- and just lastly, on the sales reorganization and/or realignment in North America, which you said will take place in Q3, I know you're planning well in advance to avoid any potential hiccups particularly as you enter the stronger fourth quarter period, but are you internally, at least budgeting for some disruptions and perhaps lower than seasonal sales at all, or are you expecting to get right through that and not see any hiccups?

Yes, Matt.

We don't expect we're going to see any hiccup there.

The reason is we've been really clear and very careful that we're not changing the book of business for the reps and accounts they call on.

We've been really careful about doing that, because once we break that relationship with a rep to a client, we know we'll lose business.

So we've been extremely careful to stay out of the chute, we will not do that.

Now they will, in some cases you report to a different manager.

They may be assigned to a different -- more clarity around what geography they're calling on.

But we're really clear on the fact that our reps will not actually have a different book of business starting in July 1.

We know the mistakes that have been made in the industry in that regard, and we're not going to repeat those.

That's why I'm pretty confident we will not see disruption in the business.

So if the salespeople are keeping their accounts, then exactly what changes are taking place?

Yes.

So a couple of changes.

One is we've done an extensive analysis on the accounts that we're calling on, and we've done an extensive analysis on where the top accounts in the industry are and where the business is that's being driven.

In many cases, we're finding is some of our reps are calling on accounts that are very, very well below that.

Reps, of course, will, in any Company, always try to hoard accounts wherever they can.

So as an example -- in many cases, we have reps who aren't doing any business with these current clients that have them.

We've done the analysis, we know where they stand.

We're actually going to just take those accounts away, and we're actually going to reseed them with accounts that have a much higher potential for them to actually start to penetrate and start to put in models in place for higher accountabilities and higher inspection to make sure we're getting the penetration that they need.

Additionally, we're taking -- from the aspect of, in some cases today, we have got situations where a lot of the support resources are misaligned, and we're bringing those support resources much more in line to make them much more easily accessible to assist our reps in closing deals.

So there's a lot more behind it, but that's some of the gist of what's changing.

Okay.

So, in other words, your salespeople will keep their best accounts and get under-performing accounts with potential, is that kind of --

Correct.

And we'll be doing lots of inspection accountability around that.

Okay.

Thanks, Ken.

I'm showing no further questions at this time.

Okay.

Then thank you very much.

(inaudible) second quarter.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect and have a wonderful day.