Insight Enterprises Inc (NSIT) 2010 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third quarter 2010 Insight Enterprises Incorporated earnings conference call.

Presently, all participants are in a listen-only mode.

Later we will facilitate a Q&A session.

(Operator Instructions) I would now like to turn the conference over to your presenter for today, Ms.

Helen Johnson Senior, Vice President and Treasurer.

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 September 30, 2010.

I'm Helen Johnson, Senior Vice President and Treasurer of Insight, and joining me is Ken Lamneck, President and Chief Executive Officer, and Stuart Fenton, President of EMEA and Asia Pacific.

I am sitting in for Glynis today who is home fighting the flu.

She will be back in the office very soon.

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 8K, you'll find it on our website at Insight.com under our Investor Relations section.

Today's call, including the Q&A period is being webcast live and can be accessed by our 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 call and the associated webcast contain time-sensitive information that is accurate only as of today, November 3, 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 10K for the year ended the December 31, 2009.

With that, I will now turn the call over to Ken to walk you through an overview of our third quarter 2010 operating results.

Ken?

Hello everyone.

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

Today, we reported another quarter of healthy year-to-year growth driven by continued strong demand for IT products, improved execution and nice operating leverage.

Consolidated net sales increased 21% in the third quarter to $1.2 billion, up from $969.9 million last year.

On a constant currency basis, consolidated net sales grew 23%.

Gross profit was $154.6 million, up 16% from last year and gross margin was 13.2% down from 13.8% in the third quarter of 2009.

Earnings from operations increased 109% to $24.8 million or 2.1% of net sales compared to $11.9 million or 1.2% of net sales reported last year.

Net earnings and diluted earnings per share were $14.4 million and $0.31 in the third quarter of 2010 compared to net earnings and diluted earnings per share from continued operations reported in the third quarter of 2009 of $7.3 million and $0.16.

Within these results the North America operating segment reported 34% growth in the hardware category and 25% growth in the software business.

Hardware growth in North America continues to be driven by increased demand for notebooks, desktops and accessories as well as networking and communication products.

Software growth was driven by increased volume across multiple publishers including our largest software partner.

The shift in sales mix from higher hardware and software sales but lower services sales resulted in overall lower gross margin this year compared to last year.

We continue to be pleased with the leverage we are getting on our cost structure that resulted in a significant improvement in earnings from operations year-to-year excluding the severance and unique items recorded in both periods.

In EMEA, we saw double-digit sales growth in constant currency including positive growth across all product categories.

Growth in the third quarter was driven by higher volume of hardware sales particularly notebooks and desktops as well as software sales primarily in the large enterprise and middle market client groups.

Also in EMEA, we continued to make progress on the development of our new IT system for the region but have concluded that we need some more time to get the system right for implementation.

Thus, we have decided to defer the first country launch until mid-next year.

The new system is important to our long-term strategy to deliver hardware in key markets and believe this delay is necessary to ensure a smooth transition.

In Asia-Pacific, sales declined 13% in constant currency but our team there grew gross profit year-to-year through higher fees from enterprise agreements.

The overall market continues to improve and we believe we are making progress on our internal initiatives to improve our operational discipline and sales execution.

In addition we have been working to strategically add to the management team here at Insight and I'm pleased to report that Mike Guggemos joined the Company just this week as our new Chief information Officer.

Mike brings a wealth of IT and business transformation experience to Insight.

Prior to joining our team, Mike held various IT leadership roles over a 15 year period at Motorola, including his most recent position as Corporate Vice President, Information Technology.

In his new role, Mike will oversee the development and integration of our global IT infrastructure including the current project ongoing in EMEA and our longer-term plans to integrate our multiple systems here in North America.

We're still recruiting for the lead sales position in North America and hope to conclude that search by the end of this year.

Before I hand the call over to Helen, I want to take a moment out to update you on our recent partner announcement.

Specifically, we, along with other similar resellers, were recently informed that our largest software partner intends to make changes to certain elements of its channel incentive programs effective in late 2011.

These revisions will pertain to both new and renewal business and will take effect over a multi-year period.

Working closely with this partner to understand the components of the plan, and assess the opportunities and potential risks that the change may bring to our business.

In the meantime, we are working diligently to complete our long-term strategic and operational plans to ensure we grow market share and overall profitability.

In order to crystallize our plans, we are deferring our Investor and Analyst Day to mid-2011 rather than later this year.

I will now on the call over to Helen who will discuss the third quarter operating results of our business segments.

Starting with North America, net sales were $871 million in the third quarter, up 27% from the third quarter of 2009 and up 1% sequentially.

Sales in our hardware category increased 34% year-to-year and 8% sequentially due to generally higher volumes particularly in the large enterprise and corporate client group.

Sales in our software category increased 25% compared to last year due primarily to higher volume with multiple publishers and were down sequentially due to typical seasonality.

Sales of services declined 14% due primarily to a large engagement in 2009 that did not recur this year.

Gross profit in North America increased 18% year-over-year to $111 million while gross margin decreased to 12.7% from 13.6% in the prior year.

This change in margin reflects a 105 basis point decline in contribution from lower services sales offset partially by a modest increase in product margin.

Generally, the growth in sales of lower margins in hardware and software products combined with a decline in sales of services and a lower mix of fee-based enterprise agreements has resulted in a decline in our gross margins in North America throughout 2010.

We expect gross margins in this segment will moderate somewhat further in the fourth quarter due to a continuation of this trend in sales mix.

Selling and administrative expenses for North America in the third quarter were up $9.7 million to $89 million from the $79 million reported in the third quarter of 2009, but as a percentage of sales decreased to 10.2% compared to 11.6%.

Within these results, compensation expense increased $4.1 million on higher sales and overcame it of our operating plan.

The balance of the change year-to-year relates primarily to higher employee benefit costs which includes much higher medical claims experienced in this year's third quarter and to a lesser extent, higher salaries and wages.

Sequentially, selling and administrative expenses for North America were up $2.6 million as lower variable compensation on the seasonal decline in gross profit was offset by higher employee benefits expenses and the effect of the reversal of a bad debt reserve recorded in the second quarter of $2.9 million that did not recur this quarter.

We also recorded just under $200,000 in severance and restructuring expenses segment in the third quarter compared to $4.5 million recorded in the third quarter of 2009.

As a result, earnings from operations in North America were $21.3 million or 2.4% of net sales in the third quarter of 2010, up from $9.5 million recorded last year.

Moving on to EMEA.

Our EMEA operating segment reported net sales of $268 million, up 8% in US dollars.

In constant currency, net sales increased 16%.

Also in constant currency, sales of hardware grew 7%, software sales increased 22%, and sales of services increased 44% compared to last year due primarily to higher volume with existing clients.

Gross profit in EMEA was up 8% in US dollars and up 16% in constant currency terms while gross margin remained relatively steady year-to-year at 14.2%.

Within these results, increases in product margin and margin contributed on higher services sales offset a declining margin from a lower mix of agency fees from software enterprise agreements.

Selling and administrative expenses in EMEA in the third quarter were up 4%, or $1.4 million in US dollars and in constant currency were up 13%.

This increase year-over-year was primarily driven by higher variable compensation and sales incentives on increased sales.

EMEA also recorded $99,000 of severance expense in the third quarter compared to a $463,000 net benefit from a reduction of certain restructuring reserves recorded last year.

As a result, earnings from operations in EMEA were $2.2 million in the third quarter of 2010, up from $1.5 million recorded last year.

Our Asia-Pacific operating segment reported net sales of $33 million, down 6% from the prior year in US dollars and down 13% in constant currency.

Despite by lower sales, gross profit was $6 million, an increase of 25% year-to-year in US dollars and 18% in constant currency.

And gross margin was 18%, up from the 13.4% recorded in the prior year quarter due to increased fees from enterprise agreement.

Selling and administrative expenses in APAC increased 21% year-over-year in US dollars or approximately $800,000 and 13% in constant currency terms as a result of higher variable compensation on increased gross profit.

As a result our Asia-Pacific segment reported earnings from operations of $1.3 million which was up 41% from the $900,000 reported last year.

Moving on to our tax rate.

Our effective tax rate for the third quarter was 36.2% which is in line with our normalized tax rate.

This compares to 21.6% in the prior year quarter in which the rate benefited from the true-up of foreign tax credits resulting from the filing of our 2008 US Federal tax return and the recognition of certain tax benefits resulting from the settlement of audit.

We currently expect that our effective tax rate will be in line with our normalized expected rate of 36% to 39% in the fourth quarter of 2010.

Moving on to working capital metrics and cash flow performance.

Due to expected seasonality in the third quarter, our operations used $92 million of cash compared to $79 million for the same period in 2009.

And we invested $4.3 million in capital expenditures this year compared to $3.4 million last year.

As a result, we ended the quarter with $94 million of cash,of which $86 million was [resident] in our foreign subsidiaries and $164.5 million of debt outstanding under our revolving credit facility.

This compares to $69 million of cash and $155.5 million of debt outstanding under our revolving facility at the end of the third quarter 2009.

Our cash conversion cycle was 25 days in the third quarter of 2010, down one day from last year as the benefits of tighter cash management practices in EMEA offset the effect of an increase in certain aged public sector receivables in North America.

Here in the fourth quarter, we expect to return to positive cash flow and we currently expect to end the year with a debt balance of approximately $100 million to $110 million.

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

Thank you Helen.

For 2010 outlook for the fourth quarter, given continued strong demand for hardware and software products partially offset by decline in service sales, we expect that diluted earnings per share will be between $0.38 and $0.43 in the fourth quarter.

We are pleased the momentum in demand for IT products so far in 2010 and the catalyst has provided our business.

We are executing better and maintaining our general cost disciplines while we invest strategically in our sales force which has serviced well as we close out 2010 and head into 2011.

That concludes my comments.

We will now open the line up for your questions.

(Operator Instructions) Your first question comes from the line of Matt Sheerin from Stifel Nicolaus.

Yes, thanks and good afternoon.

So, Ken, first question regarding your commentary about your largest software supplier changing the margin structure and rebates.

I didn't catch all that.

Could you, as much as you can discuss it, give us a little bit more detail of what's happening and the timeline, and what impact as you know it now would it have on your business?

Yes.

Sure Matt.

So basically our largest software partner has indicated that they will be making changes to their programs they have in place for similar resellers like ourselves globally.

What they have indicated to us at this stage was that it would not go into effect until late next year.

That's when we'll see it start to phase in and then it actually happens over a three-year timetable.

So different certainly than the last time this occurred where there was a few months' notice and it went into effect immediately all at once.

So it's certainly more phased-in.

They have given us some data and here's some modeling that we are doing on our side that they are doing but it has not been finalized so we can't talk to the magnitude of the implications yet.

We hope to get much of that work done as we get more data here from them and we will probably have a further update by our next analyst call but we certainly wanted to give a preview of what the notification was to us and the good thing about it is, again, we have got ample time to react to it.

Also, the partners indicated that they are keeping the total fees and rebates and totaled the same.

It's just a matter of how they are tweaking them in different areas.

So it's not like they are extracting dollars, they are keeping it the same.

So we have to obviously maneuver ourselves to where those upsides are going to be and where they want us to focus our time and attention.

Okay.

Because in the last year you have been maneuvering, so to speak, in your business as you are focusing more on the lower end of enterprise and SMB because the margins are more favorable there, right?

That's correct and that's also generally this partner wants us -- is encouraging people through incentives to continue to focus.

Okay and then you pushed out the timing of your Analyst Day is that because of this?

Because you want to get a better understanding of how this impacts the business?

Certainly that was part of it, Matt, is the fact that, that would be a question would come up.

And until we can get accurate modeling, we think to talk to it and general terms wouldn't really be sufficient.

So we wanted to get a better understanding of that piece to it as well as a few other things just internally that we are working on as well.

We thought it would be more prudent to push it out a few months.

Okay great and then a question on the gross margin in [Europe] and you may have mentioned this, helen, but I missed it.

Why the gross margin was up so much sequentially?

Was that because of a higher percentage of services business?

It's really driven by a mix of business, a little bit less public sector and enterprise as a percent of the total and that is more in the middle market drove up the margins in the quarter.

As we had into Q4, we expect seasonally strong software quarter for us in EMEA and they have much more large enterprise clients in that quarter and so we do expect this to normalize back to the rate we have discussed in prior quarters in the 13% range in Q4.

Got it.

Okay thank you.

(Operator Instructions) Your next question comes from the line of John Lawrence from Morgan Keegan.

Good afternoon.

Hi Ken, could you comment just a little bit -- obviously the trends that we have seen just continued to, I guess your expectation as you go through the quarter from where you give us guidance has continued to exceed expectation.

Can you give us some idea of where the upsides are coming from and exceeded expectation obviously volumes are good or maybe quantify it in some sales productivity or something that we can -- some of the metrics that we can look at please?

I'll take that one John.

So in the third quarter, margins were pretty much in line like we had expected, particularly in North America.

The upside for us in the third quarter really came on the volume side both in hardware and software products.

And we expect that trend to continue as we head into the fourth quarter as well.

Combining that with a little bit lower mix of services and sales, we do expect further moderation of the gross margin rate in North America in the fourth quarter.

And that's contemplated in the guidance that we gave today.

Okay and then secondly any metrics of just or comment a little bit about the integration of the sales force and that process and how that is helping you in the quarter and what we could look at to see that productivity curve I guess?

Yes, thanks.

John, thanks for the question.

As you know, we actually fully implemented that execution in July, so we are four months into that and I would say we are certainly pleased with the metrics we have established in and around that at this stage of the game.

We certainly have lots more to do but the initial execution has gone off very well and we are certainly starting to see signs where we are getting better coverage, we are able to penetrate clients further than we had in the past.

So it's going to be a long process but I would say initially, we are pleased with how that has gone and there has been no hiccups at this stage of the game at all.

So we will continue to drive that and it's certainly what we expected to occur as we have indicated, and we certainly are contemplating the benefits of that here as we continue to go on quarter by quarter to build on that success.

And not to belabor the point but just the idea of better regional coverage, deeper penetration within the account and the order possibly has more line items.

Would those be some of the success factors we are seeing?

Yes that is exactly what that is.

We have eliminated any of these silos that we may have had, how we approach client and have come together to get a lot more synergy and with that, of course, as you indicated, we get better coverage, we get deeper penetration and we get a breadth of coverage.

Of course, part of that, as we indicated to is the continuation of hiring 30 new sales reps per quarter and that continues to be on track.

And we're in our third phase of that of hiring and we will continue that through next year as well which will give us, of course, better coverage on the opportunity that we see as available in the marketplace.

And last question for me.

To follow Matt's question just to dive in a little bit more on the software side.

The last time -- just remind us, the last time this adjustment was made it was just more of a, I guess you could call it a soft dollar arrangement where we went to look at things like training, those types of rebates.

Is that not correct?

No, it was pretty -- it was very much the fee structure you get from these enterprise agreements as well as rebates for both impacted last go around.

And would you assume, I know it's hard to say, but at the end of the day, Ken, is it roughly the same type of thing, or is it just a totally different structure to the fee structure?

I would say that it's similar in type.

John, we don't, again, have the magnitude of the numbers just because we are certainly modeling that.

But again, to reiterate the difference this time is that it's not a couple of months' notice.

It doesn't occur for almost a year where it will go into effect.

And additionally, it is phased in over three years from that vantage point so those would certainly be marked differences.

And again to reiterate, the total fees and rebates that they are going to avail to the channel aren't changing at all.

It is just going to be redirected, really encouraging us to go more after that mid-market space, small client space.

And I guess it's too granular to ask what percentage of business of total revenues, say, roughly for 2010 would be affected by this change?

For 2010, there is no impact of course.

Until the latter part of 2011 so there will be no impact in 2010.

I'm sorry the amount of volume going through this, how much of your business would be affected if you use the 2010 number?

(inaudible) our software business is approximately 40% of our consolidated sales and of that, this partner constitutes a majority.

Thanks, good luck.

Next question comes from the line of Brian Alexander from Raymond James.

This is Brian Peterson stepping in for Brian Alexander.

Just to follow-up on the channel changes with your large software partner.

Are you guys calling that out specifically because there is such a large driver of your revenue or this change or this anticipated change actually greater in magnitude than other changes with other partners.

Because if they are actually throwing the same dollar amounts into the channel it sounds like it would be fairly similar.

So I'm just trying to get a sense of the magnitude of the actual change relative to the entire channel?

Yes, Brian.

This is ken.

You actually sound like Brian as well.

But I would say that we are just obviously being prudent.

It was an announcement certainly that was made to us so we certainly wanted to make sure you are aware of that we don't, again, have the specifics to give you the commentary on the magnitude.

It's just being worked through at this stage of the game and I think it is still another three months to probably four, five months before we even have those specifics.

So we're just, I think, just really being prudent on what specifics are out there.

As indicated, it's our largest software partner, so we just wanted to make sure that we are making that information that we have available.

Okay that's fair.

Just on your hardware growth for North America is definitely better than what we were expecting.

I know you alluded to some strength in large enterprise in a lot of hardware categories and even software.

Could you say maybe what grew a little bit better than average particularly on the hardware side, and as you look into the fourth quarter, what expectations do you have regarding the budget flush and what is really reflected in your guidance?

Brian, I'd say that we certainly saw the notebook, desktop arena do very well this past quarter in our geographies, of course, in North America as well as in the UK.

So that continues to go strong for us.

That was certainly a leader for us, the networking product category we saw continued growth there as well in those geographies, On the software side, we certainly saw the enterprise agreements continue to accelerate as well as areas around virtualization were very strong as well.

So as far as the last question you had on budget flush, hard to say.

Last year, of course, it was pretty significant as you recall.

Hard to say that what that would be this year.

We think there certainly will be some but it's hard for us to put a magnitude of what that will be but we certainly are preparing for it and positioning ourselves to take advantage of that.

But like always that -- we don't really see that towards the latter part of the quarter.

Okay.

And your inventory was up about 29% sequentially.

I know that's actually a small number in dollars but can you explain what drove the increase there?

Inventory is up sequentially due to generally higher volume in the hardware category.

But also two specific client engagements where we acquire inventory on their behalf in contemplation of a roll-out of a project and (inaudible) costs over the quarter there.

Don't have any outlook there for you for the fourth quarter.

We feel really good about the quality of that inventory and the declines that it's geared for .

Okay good and just last -- you mentioned that and I know this has been asked before but the gross margins, you expect some sequential erosion heading into the fourth quarter.

You talked about some lower margins, I know there's some mix and some lower services.

I'm just trying to see if actual pricing or product margins are getting incrementally worse heading into the fourth quarter?

Is it an impact at all?

No, over the last few quarters -- that was in North America statement by the way and in North America, over the last few quarters, product margin has remained relatively steady and it grew just a little bit year-to-year in the third quarter.

So it isn't a pricing issue so much as a mix issue.

Okay that's it for me.

Thanks guys.

Thanks.

(Operator Instructions) At this time, I am showing we have no further questions.

I'd like to hand the call back over to management for closing remarks.

Thanks everybody for joining our call and that is it for us.

Think you very much.

Ladies and gentlemen, thank you very much for your participation in today's conference call.

You may now disconnect, and have a wonderful day.