Insight Enterprises Inc (NSIT) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Insight Enterprises Incorporated first quarter 2013 earnings conference call.

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

Later we'll conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference may be recorded.

It is now my pleasure to turn the call over to Chief Financial Officer Glynis Bryan.

Ma'am, the floor is yours.

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 31, 2013.

I am Glynis Bryan, Chief Financial Officer of Insight, and 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 web guide at insight.com under our 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 uncut copy of the conference call will be available approximately two hours after completion of the call and will remain on our website for a limited time.

This conference call, and the associated webcast, contain time-sensitive information that is accurate only as of today, May 1, 2013.

This call is the property of Insight Enterprises.

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

In today's conference call, certain non-GAAP financial measures will be referenced as we discuss the first quarter 2013 financial results.

You will find a reconciliation of these non-GAAP measures to our actual GAAP results posted on our website on the Investor Relations page.

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 31, 2012.

With that, I will now turn the call over to Ken to give you an overview of our first quarter 2013 operating results.

Ken?

Hello, everyone.

Thank you for joining us today to discuss our first quarter 2013 operating results.

In the first quarter, we saw additional weakness in demand for IT products by large enterprise products in North America, which was partially offset by strong top line growth in our EMEA and Asia-Pacific segments.

And we saw lower-than-expected gross margin performance in the EMEA region due to changes in business and client sales mix in the quarter and partner program changes.

We controlled our sale administrative expenses, however these expense savings did not offset the effect of lower sales volume and gross margins which led to earnings from operations performance below our expectations.

For the first quarter of 2013, our consolidated net sales were down 5% year-to-year to $1.18 billion.

Gross margin decreased 30 basis points to 13.4%, with gross profit dollars decreasing 7% and SG&A decreased 2%.

As a result, earnings from operations declined 36% to $17.1 million, excluding severance expenses in both years.

And in the GAAP basis, earnings from operations decreased 44% to $14.4 million.

In North America, hardware sales declined 12% due to lower sales across all client groups in the region, but in particular the large enterprise space.

By category, we saw decline in sales of server, storage and print solutions, as well as desk tops and notebooks.

Overall, we believe the market was generally soft in these categories and that performance was further impacted by delays in the release of certain clients' 2013 capital budgets and prior year projects that were not repeated or replaced this year.

In the software category in North America, net sales declined 17%, also reflecting lower sales to enterprise clients, particularly for business productivity, creative and data protection products.

Additionally, we saw higher mix of software maintenance sales this year compared to last year, which we recorded net of related costs in our financial statements.

Gross margins and gross profit dollars in this category increased year-to-year due to change in the product mix, as well as generally higher product gross margin, driven partly by our profitability initiatives.

In EMEA, net sales increased 12% in constant currency for the quarter.

Software sales were particularly strong and grew 22% in constant currency, driven by higher sales across the region.

Hardware sales declined year-to-year, reflecting slower demand for print and PC products in the middle market.

This decline in hardware sales to mid-market clients, combined with changes in product mix and the effective partner changes in our software category, drove the gross margin decline year-over-year in EMEA.

Our Asia-Pacific business performed very well during the first quarter.

Net sales increased 24% in constant currency, gross profit grew 12%, and earnings from operation grew over 200%.

In thinking about the balance of the year, we currently expect demand by large enterprise clients in North America to continue to be muted in 2013, particularly the demand for data center products, PCs and print solutions as macroeconomic concerns weigh on discretionary capital spending.

We expect gross margin in EMEA for the full year to be down 100 basis points from levels experienced at 2012 due to the expected business mix including lower sales and mid-market and the effect on gross margin of partner program changes.

We will continue to execute our strategy to grow our sales presence in key markets in North America and EMEA, as we believe this is critical to position our business for long term success.

In the short term, we remain focused on managing controllable costs throughout the business, and expect improved operating leverage in the second half of the year.

I will now hand the call back over to Glynis, who will discuss first quarter of 2013 financial results in more detail.

Starting with North America.

Net sales in North America were $747 million in the first quarter, down 13% year-to-year.

Sales in our hardware category decreased 12%, and software sales decreased 17%, with both categories reflecting lower spending by large enterprise clients.

Services sales declined 1% year-to-year.

Gross profit in North America decreased 10% year-over-year to $103 million, and gross margin increased 40 basis points to 13.7%, due primarily to an increase in fees from software enterprise agreements and a higher mix of services sales.

These increases more than offset the effect on gross margin of lower hardware product sales.

Selling and administrative expenses for North America in the first quarter decreased 3% year-to-year to $89.2 million.

Increases in salaries and wages due to head count investments were more than offset by lower variable compensation and lower gross profits, and reduced spending in other categories.

We also recorded $1.1 million in severance and restructuring expenses in this segment in the first quarter, compared to $489,000 in the same period last year.

Earnings from operations in North America were $12.3 million in the first quarter of 2013, down from $21.2 million in the same quarter last year.

Moving on to EMEA, our operating segment reported net sales of $387 million, up 11% in US dollars.

In constant currency, net sales increased 12%.

Also in constant currency, sales of software increased 22%, reflecting higher volumes with new and existing clients.

Hardware sales declined 3% in constant currency, reflecting a decline in hardware sales in the middle market that was partially offset by one additional month of sales year-to-year from the addition of Inmac.

And services sales in EMEA increased 33% in constant currency.

Gross profit in EMEA decreased 4% in US dollars and 3% in constant currency terms, with gross margins decreasing 190 basis points to 12.6%.

This decrease was driven primarily by lower growth -- product growth margins, which include vendor funding, due to changes in business and client mix, which included a higher mix of sales to large enterprise clients in the quarter and the adverse effect of recent partner program changes.

Selling and administrative expenses in EMEA in the first quarter were up 1% in US dollars and by the same percent in constant currency terms.

This increase year-over-year was primarily driven by higher salaries and benefits from investments in head count and the addition of Inmac to our portfolio in February of 2012, mostly offset by decreased expenses in supporting areas resulting from the post-IT systems integration activities.

We expect selling and administrative expenses in EMEA will decline further year-to-year in the back half of 2013 as we gain additional benefits from the recent restructuring activities.

In the first quarter, we recorded net severance expense of $1.7 million in this segment, up from $885,000 recorded in the same period last year.

Earnings from operations in EMEA were $1.2 million in the first quarter, down from $4.1 million reported last year.

Our Asia-Pacific operating segment reported net sales of $48 million, up 22% year-to-year in US dollars and up 24% in constant currency terms.

Gross profit was $7 million, and gross margin was 14.7%, down from 16.2% due to a higher mix of software sales recorded growth in our financial statements.

Selling and administrative expenses in APAC were basically flat year-to-year.

Our Asia-Pacific segment reported earnings from operations of $964,000 which was up over 200% year-to-year.

With regard to our tax rate, our effective tax rate in the first quarter was 27.8%, below our normalized range of 36% to 38% due primarily to the recognition of tax benefits related to the re-measurement of certain tax positions that were resolved during the quarter.

Moving on to cash flow performance, in the first quarter our operations generated $16 million of cash, compared to a use of cash and operations of $20 million last year, reflecting lower working capital needs during the three months ended March 31, 2013.

Our cash conversion title was 25 days in the first quarter, down one day year-to-year.

We also invested $6 million in capital expenditures in the first quarter, down from $8 million in the same period of 2012, reflecting lower spending on our IT systems projects.

And we also spent almost $7 million in the first quarter of 2013 to repurchase approximately 345,000 shares of our Common Stock.

Subsequent to quarter end, we have repurchased 2.3 million additional shares and have now completed our $50 million authorization.

All of this led to a cash balance of $152 million at the end of the first quarter, of which $144 million was resident and/or foreign subsidiaries, and we had $61 million of debt outstanding under debt facilities.

This compares to $133 million of cash and $139 million of debt outstanding as of March 31, 2012.

I will now turn the call back to Ken.

Just a few other updates before we get to your questions.

Last week we announced that Stuart Fenton, President of our EMEA business, will be retiring from Insight at the end of the year.

Stuart joined Insight in 2002, and over his tenure has guided our EMEA business through some tough macroeconomic conditions and led several strategic acquisitions on organic growth initiatives that have taken our EMEA business from $382 million in sales in 2002 to over $1.4 billion in sales in 2012.

We have just begun a search for a new president, and Stuart has agreed to remain in the Business until the position is filled and his responsibilities are fully transitioned up through March 2014.

I would like to thank Stuart for his leadership over the past ten years here at Insight.

Moving on to our outlook for the balance of the year, we currently expect net sales for the full year of 2013 will decline slightly from 2012 due primarily to lower spending by large enterprise clients in North America.

We currently expect our second quarter financial results will exhibit similar year-to-year trends as in the first quarter, but that we will see improved earnings performance in the back half of 2013 as we begin to realize the benefits of our sales and cost control initiatives.

As a result, we now expect diluted earnings per share for the full year of 2013 to be between $1.70 and $1.90.

This outlook includes the adverse effect and gross profit of privileged announced partner program changes in our software category, which is estimated to be between $8 million and $12 million, and an effective tax rate of 36% to 38% for the balance of 2013.

This outlook excludes severance and restructuring expenses incurred during 2013.

Thank you again for joining us today.

I want to thank our teammates, clients and partners for their dedication to Insight.

That concludes my comments, and we will now open the line up for your questions.

(Operator Instructions)

Brian Alexander, Raymond James.

Okay.

Just to, I guess, touch on your guidance for the second quarter.

When you say similar results, I was just wondering if you could elaborate.

Is that operating income change on a year-over-year basis, EPS, revenue, all of the above?

And then, what gives you confidence that things will get much better on the back half?

It looks like maybe Q3 earnings will be down year-over-year, but you're expecting some pretty healthy growth in the fourth quarter to get to your full-year number.

Just help us understand that.

Sure, Brian, good questions, all of them.

We -- if you think through our guidance, we anticipate that we will do better in the second half of the year, primarily based on what the -- what we're hearing now from clients, or large enterprise clients with regard to the expansion of projects that are going to be rolling out in the second quarter.

We're getting a little bit of a sense for that, starting in the late second half -- second quarter, and then rolling out in Q3 and Q4.

Specifically as it relates to the commentary regarding guidance around Q2, what we're seeing now is similar revenue trends with regard to what we have seen in the first quarter.

This is just one month of the quarter, April.

So far, we're seeing similar trends, however we are hearing from our clients that we're going to be seeing some rollouts towards the ends of the quarter, but primarily into the third and fourth quarters.

When we talked about guidance being similar in terms of expectations, it is around a revenue decline being similar -- not the same, but similar, in terms of magnitude.

And on EPS and EFO margins being slightly improved from 2000 -- from the first quarter, but still down relative year-over-year.

That's helpful.

And then on the North American revenue --

Can I also make just one other comment?

Sure.

We also anticipate in the second half of the year that we will get the benefits of some restructuring initiatives that we're kicking off that should, on an annualized basis here, between $12 million to $15 million.

We don't anticipate seeing that benefit until later in the second half of the year, and then going into 2014.

$12 million to $15 million annual.

And most of that targeted at Europe?

Or how does that split across the (multiple speakers).

It's split probably two-thirds, one-third.

One-thirds in Europe and two-thirds in the US and North America.

Okay.

And then on the revenue weakness in North America.

I realize that you're skewed toward large enterprise, and we don't have a lot of visibility into other companies reporting large enterprise customer segments, but it just strikes me as below market.

But I didn't hear anything in your prepared remarks about any market share shifts or any dynamics there.

So, if you could just elaborate on what you saw in your large customer base, and your confidence level that this wasn't more Insight-specific than market-related.

Yes, I would say -- Brian, this is Ken, that I think some of it is certainly related to a market share loss.

I think there certainly is some execution issues on our side, so we own, certainly, that piece to it.

I wouldn't certainly put it all on the market.

I can say, with certainly our exposure to these large enterprise clients, little bit more so than our competition, what we really saw was that, again, we didn't see the rebound from the cycles where you typically would see the budgets start to occur in Q1.

They started pretty slowly, and we see some more discretionary looks.

So when you typically see upsides towards the end of quarters for hardware as well as software, we didn't necessarily experience that.

And we did have some big things that rolled off last year that didn't repeat themselves as well.

And we normally have those, but we didn't have those type of scenarios where we expected a lot of new upside to come in.

But, certainly, you've seen, certainly, the results, certainly from some of the larger distributors, as well, that maybe gear themselves more towards some of the enterprise clients, and those that are geared more towards the median space.

So I think it does reflect that, certainly the spending at those top sort of Fortune 1,000, if you want to call it that, Fortune 2,000 clients, we see that spending certainly was muted in those categories.

Can you elaborate, Ken, on the execution issues?

What caused them, and what are you doing to fix those?

Yes.

I think, when we look at it across the board, the -- we are still in the process of rolling out our city plans, so we have realigned a couple of the organizations to get more granularity towards that.

We broke out our major accounts from our regional accounts during the quarter to get more specificity around the East, Central and West and take out a lot of these very, very large accounts from that, and that was occurring certainly in Q1.

I don't think that's an excuse, but those are some of the dynamics occurring.

We certainly view that we didn't have a full productivity.

As you know, this was a big quarter for our SAP, where all the systems were live.

We converted our Software business as well as our Canadian operation.

And I don't think it was, as we look at the specifics, that it was material to the overall results, but no question it certainly -- we weren't optimized for productivity as changes in the system just -- people learning new processes, those types of things.

But everything is fully functional, there -- on the system, there aren't any issues around that.

It is really just a learning curve issue, and some process improvement issues that are going to avail themselves as we get more accustomed to everybody operating on one ERP platform for the first time in North America.

So that had certainly something to do with it, but it certainly wasn't something that was material, otherwise we would have called it out.

And then finally for me in Europe, and I will get back into queue.

So the gross margin is down 190 basis points, and you called out, Glynis, a few different things, customer mix and some vendor rebate changes.

I just wanted to understand the magnitude of each of those.

And on the mix side, I wonder how much of that might have been self-inflicted, given that your revenue was actually quite strong at well above market?

So perhaps you went after large deals with low margins.

And on the vendor rebate side, is that something that's incremental to the $8 million to $12 million that you called out at the beginning of the year, or is that part of that?

I'm just trying to understand that a little bit better.

Okay.

So when you look at the EMEA operation, it is a tale of two different cities, right?

So hardware is a different story than software.

So we actually had high growth in software product.

So if you look at our software, we said it grew $22 million or 22% on a year-over-year basis, and actually that generated a lower margin associated with that.

On the hardware side, hardware was actually down on a year-over-year basis also, and it was actually the difference between -- our UK business is primarily -- is by and large a larger Mid-market business than it is a large Enterprise business.

However, in the first quarter, they had some significant large enterprise deals that actually impacted the quarter because they're generally transacted at lower margin than the mid-market and they had a decline in the mid-market operation.

So that was the dynamic that was working in Europe.

We anticipate that they will continue to have some of that large enterprise business going into the second and third quarters, but that we will get some recovery in the mid-market or the corporate space, as they call it, as we go into the third and fourth quarter.

And also overall in EMEA, that they will have the benefit of the SG&A cost savings initiatives that they have implemented at the back end of last year and also in the first quarter.

That will help them with regard to improve the EFO performance in this year.

As it relates to the mix between partner program changes versus operational execution, I'm not sure that I can give you a split there.

But in terms of the vendor funding issues that we have -- that we talked about, those are included in the range of $8 million to $12 million.

I think in the fourth quarter, I saw when we released the fourth quarter results and talked about the $8 million to $12 million, I think we indicated that the effect in Europe was going to be greater in 2013 than the impact to North America.

And Europe is actually seeing that in their results to date as it impacts margin, in particular.

Was the impact from vendor rebates more than you expected?

It doesn't sounds like it was.

No, it's not that it is more than we expected.

However, there is a change that is coming.

There is a change in the vendor rebates that is rolling out through this year that will have a bigger impact in the second half of the year than in the first half of the year.

And that is all included in the guidance that we gave.

And as you know, our Software business is strongest in Q2, when you look at it just in terms of the calendar and the fiscal year end for our largest partner, and that actually has an impact on Q2 operating results in EMEA and Henson and overall for IEI, for the -- Insight.

Maybe I just didn't appreciate how much lower software margins were, because it sounds like the strong growth you saw in software had a pretty major effect on the gross margins in Europe.

That's correct.

And I think that Europe has a slightly different dynamic than the US.

So, we have said historically in the US that the difference is just a pure product margin line.

We don't have a significant difference in the US between hardware and software margins.

In EMEA, they do have a difference between hardware and software margins.

So hardware margins in general in the UK are stronger than software margins.

So that is a driver, as well, because of the increase in software revenue and the associated margin with that in Q1.

Okay.

All right.

I will cede the floor.

(Operator Instructions)

Matt Sheerin, Stifel.

Yes.

Just to follow up on some of Brian's questions.

First, on the North America situation.

It sounds like, Ken, there were some significant distractions in terms of some of the sales reorgs that you're going through, and the IT integration, in addition to some of the enterprise push-outs.

Are you satisfied that the sales reorganization and some of the changes that you're making are going to start to pay off and determine in the form of market share gains and growth in the second half of the year?

Or this is, there is still a lot of work to be done there?

Yes, we would say certainly that we have been engaged now in the city plan concept for the last, certainly, three quarters and hiring additional people.

And that is certainly getting some traction and gaining certainly a lot of attention from us internally.

So I would say that we would definitely expect that to have a positive impact going into the second half of the year.

And then on the IT integration?

Yes, the IT side, again, the system is operating as it is supposed to be.

And it is a matter of, again, changing people that were on legacy systems for quite a long time, bringing them into the fold onto a relatively new platform.

So again, no issues on the system itself.

It's really more just different processes that people have to follow on the system and a learning curve associated with that.

And of course, it has pointed out ample opportunities for us to improve processes and make things easier on the new system that now we're currently able to address going forward that we couldn't in the past, because we were so concentrated on just converting the system and more focussed on how we were going to necessarily improve it.

And that's where the attention now is going, towards that.

So, we are confident that certainly the learning curves will improve.

Certainly they are, as we track the productivity of our employees, in regards to the systems.

So we think the toughest part, certainly, no question is behind us in Q1, and that we should certainly see continued improvements here as we go forward.

Okay.

And turning to Europe, regarding the mix shift that seems to have hurt you pretty significantly.

My understanding was that, in Europe, you have been making a big push toward the middle markets and reorganizing your sales force and incentives to focus on below the enterprise level.

And it sounds like that's not working out, and so is that a demand-related in terms of the market?

Or are there execution issues in Europe as well?

Yes, I would say it is probably a combination of both.

I think, as you know, compared to the US market, of course, the European market tends to be more of a mid-market business as a percent than certainly versus enterprise versus here in the US, where it is very dominated by a very large client and larger enterprise.

So a couple of big deals that Glynis mentioned on large enterprise can really skew it.

These are some pretty large global type of accounts.

Certainly they could skew that and they came in at lower gross profit margin.

But I would say that, overall, we would sense certainly that demand, and I think you're seeing that across the board.

For the mid-markets space certainly was a little bit more challenged in Europe for the market overall, and then we probably certainly owned some of it from an execution point of view, as well.

But that -- so I would say it is probably a combination of both.

And on the executive change, you announced last week, with the departure of Stuart Fenton, I'm not sure it is coincidence or not, but you're coming off of arguably the weakest first quarter in Europe in some time now.

And then your executive, your leader there is leaving the Company with a fairly attractive severance package.

So, trying to understand whether it was a mutual agreement, and you're looking for new leadership there, or just what's happening there?

Yes, so Stuart, again, had been here for ten years and we've had lots of conversations.

Certainly it wasn't something that was a reaction to the quarter by any means.

We've had discussions for quite some time with Stuart in regards to what he wants to do in the future, and we came to agreement.

We didn't want to -- obviously, we didn't want a quick transition here, which is why we were able to work with Stuart to certainly stay on board and continue to help us through this year, as far as a transition.

And we're actively right now recruiting for Stuart's replacement, and he'll be certainly heavily engaged in certainly running the region.

Okay.

And then lastly, given that it looks like you've taken a pretty significant step back in terms of your margin expansion plans, are you still comfortable with getting to those goals of 3.5% plus gross margin, or rather operating margin in a couple of years?

Yes, I would say that we certainly believed the business definitely had the attributes to be at 3.5%, so we don't back off from that.

I think we'll update you as we go forward as to the exact timing of that.

Certainly, Q1 puts us a little bit behind the track there, but certainly we're not taking our eye off that ball, as we think that certainly the business can perform at that level, and we will continue to provide updates to you as we work through the timetable on that.

But no, we haven't taken our eye off the ball there.

Okay.

Thanks a lot.

(Operator Instructions)

Presenters, at this time, I'm showing no additional questioners in the queue.

With that, that does conclude our Q&A session and conclude today's conference.

Thank you, presenters, and thank you ladies and gentlemen for your participation, and have a wonderful day.

You may now all disconnect.