Insight Enterprises Inc (NSIT) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Insight Enterprises, Inc.

second quarter 2013 earnings conference call.

(Operator Instructions)

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

It's now my pleasure to turn the floor over to Glynis Bryan.

Ma'am, please go ahead.

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, 2013.

I'm 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 website 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 via the Investor Relations page of our website at Insight.com.

An archived 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, August 8, 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, we will refer to some non-GAAP financial measures as we discuss the second 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, 2013 (sic - see Press Release).

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

Ken?

Hello, everyone.

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

During the second quarter we continued to see soft top-line performance, but we drove gross margin expansion through higher services sales and a strategic focus on more profitable product sales.

We also maintained strict discipline around the costs in our business.

For the second quarter of 2013, consolidated net sales were down 7% year to year, to $1.42 billion.

Gross profit decreased 5%, while gross margin expanded 30 basis points to 13.5%.

SG&A was relatively flat year to year, and earnings from operations, excluding severance expense, decreased 17%, to $47.8 million.

On a GAAP basis earnings from operations decreased 19%, to $44.6 million.

In North America, hardware sales declined 10% year over year, in line with our expectations coming into the quarter, a category where we saw stronger demand for networking solutions but continued to see weaker performance in service sales.

In the software category, net sales declined 4% year to year due to a higher mix of software maintenance sales, which are recorded net of related costs in our financial statement.

Booking trends improved throughout the second quarter in North America, and we currently expect net sales in this segment will return to growth in the second half of the year.

In EMEA, net sales decreased 9% in constant currency in the second quarter.

Hardware and software sales declined 19% and 6%, respectively, in constant currency, due primarily to lower sales of notebooks, desktops and servers.

In addition to a generally weak demand environment in EMEA, our results were further affected by underperformance in the United Kingdom.

While we are taking steps to improve our sales execution in this market, we currently expect this trend to continue for the balance of the year.

In Asia-Pacific, net sales decreased 2% in constant currency, due to an increase in sales of software products recorded net of costs in our financials.

Gross profit grew 5%, and earnings from operations grew 6%, both in constant currency.

Our APAC team continues to execute very well, and the market remains healthy in the region.

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

Thank you, Ken.

Starting with North America, net sales in North America were $923 million in the second quarter, down 7% year to year.

Sales of hardware decreased 10%, due primarily to lower volume in the public sector and large enterprise space.

Software sales decreased 4% due to a higher mix of sales recorded net of costs, as is required for certain products such as software maintenance, and services sales were flat year to year.

Gross profit in North America decreased 4% year to year, to $125 million.

Gross margin increased 40 basis points, to 13.5%, due primarily to the effect of increases in software sales recorded on a net basis and increased [vendor funding] due to high volume with certain strategic partners.

These increases were partially offset by a decrease in fees from enterprise agreements, due partly to the partner program changes.

Selling and administrative expenses for North America in the second quarter were flat year to year, at $90.3 million.

Increases in salaries and wages due to headcount investments were more than offset by lower variable compensation on lower gross profit and reduced spending in other categories.

In addition, the year-to-year comparisons are affected by a $1.2 million gain on the divestiture of certain non-core services contracts that were recorded in the second quarter of last year.

We also recorded $967 million (sic - see Press Release) in severance and restructuring expenses in North America in the second quarter, compared to $894,000 for the same period last year.

Earnings from operations in North America were $33.4 million in the second quarter of 2013, down from $39.1 million in the same quarter last year.

Moving on to EMA, our EMEA operating segment reported net sales of $421 million, down 8% in US dollars.

In constant currency, net sales decreased 9%.

Also in constant currency, sales of hardware decreased 19% due to lower volume across all client groups, software sales decreased 6%, reflecting lower demands of business productivity and creative products.

Services sales grew 41% in the second quarter, reflecting another strong quarter of growth in this category.

Gross profit in EMEA decreased 8% in US dollars and 9% in constant currency terms, with gross margins flat year to year at 12.9%.

The positive effective of higher services sales were offset by the effect of lower overall product sales volume.

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

This decrease year over year was primarily driven by lower teammate costs resulting from recent restructuring activities and lower variable compensation on lower gross profit recorded in the quarter.

In the second quarter we recorded net severance expense of $2.2 million in this segment, up from $1.5 million recorded in the same period last year.

Earnings from operations in EMEA were $5.7 million in the second quarter, down from $10.8 million reported last year.

In APAC, our Asia-Pacific operating segment reported net sales of $72 million, down 5% year to year in US dollars and 2% in constant currency terms.

Gross profit was $12 million, and gross margin was 16.6%, up from 15.3%.

The decline in sales and increase in gross margins were due to a higher mix of software sales recorded net in our financial statements.

Selling and administrative expenses in APAC were up 4% year to year.

Our APAC segment reporting earnings from operations of $5.5 million, an increase of 2% year to year.

With regard to our tax rate, our effective tax rate in the second quarter was 39.6%, higher than our normalized range of 36% to 38%, due primarily to reserves on certain foreign deferred tax assets recorded in the second quarter as a result of greater than expected operating losses in certain foreign jurisdictions.

We expect our effective tax rate to be (inaudible) 39% for the balance of 2013 due to these same factors.

Moving on to our cash performance, in the first six months of 2013 our operations generated $88 million of cash, up from $11 million last year, reflecting generally lower working capital needs during the first half of 2013.

We also invested $10.5 million in capital expenditures in the first half of this year, down from $15.9 million in the same period of 2012, reflecting lower funding on our IT systems projects.

And we spent $50 million in the first half of 2013 to repurchase approximately 26 million shares of our -- excuse me -- we spent $50 million in the first half of 2013 to repurchase approximately 2.6 million shares of our common stock.

All of this led to a cash balance of $142 million at the end of the second quarter, of which $129 million was resident in our foreign subsidiaries.

And we have [$53] million of debt outstanding under our debt facilities.

This compares to $129 million of cash and $128 million of debt outstanding as of June 30, 2012.

From a cash flow perspective, our cash conversion cycle was 18 days in the second quarter of 2013, an improvement of four days year to year.

This decrease year to year was driven primarily by increases in [DPO] resulting from increased usage of our inventory financing facility for certain trade purchases in North America and from improved lender terms recently negotiated in our EMEA business.

I will now turn the call back to Ken.

Thank you, Glynis.

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

We have recently been notified that our largest software partner intends to make changes to its channel incentive program in October 2013.

As you would expect, we are working diligently with that partner right now to finalize the details and timing of all of the changes and to quantify the impact on our business.

We believe that certain of the changes could become effective as multiyear contracts renew under the new program, and some of the changes could become effective as early as October 1, 2013.

The program is complex, with many dynamic elements under review, and we will determine the impact as the program details are finalized.

But at this time we anticipate that these changes will result in reduced incentives from the partner in future periods.

Over the coming months we will actively work to identify actions available to us to mitigate the impact of these program changes.

Moving on to our outlook for the balance of the year, we currently expect full year 2013 earnings per share to be between $1.70 and $1.85.

This outlook includes the following assumptions -- the remaining 2013 adverse effect on gross profit of previously announced partner program changes in their software category, which is estimated to be between $5 million and $8 million in the second half of 2013; and an effective tax rate of 39% for the balance of the year.

This outlook excludes severance and restructured expenses incurred during 2013.

Thank you for joining us today, and I want to thank our teammates, clients and partners for their dedication to Insight.

That concludes our comments.

We will now open the line up for your questions.

Thank you, sir.

(Operator Instructions)

All right, and it looks like our first question will come from the line of Brian Alexander, with Raymond James.

Please go ahead.

Your line is now open.

Thanks.

And I apologize, Ken.

I dropped off right as you were talking about the changes in your software program, so if you can just talk about what you were explaining there and if that's incremental to what we already knew that was going to occur this year.

I know you talked about $5 million to $8 million in the back half.

I'm just trying to figure out what's incremental versus what we knew before.

Yes, thanks for the question, Brian.

So, yes, we were notified by a software partner that they would be going through another round of program changes.

So everything will be incremental to what was previously discussed for those changes.

The details aren't really solid yet, as we are working through many of the program elements.

That's why it's difficult for us to give you any kind of a range of what that might be.

But we certainly wanted to get the communication out there of the changes.

And they could be effective as early as October 1. But, again, we don't know the full impact yet, and we're working diligently right now with them to understand what the total impact will be to us.

And certainly at that point anything that would be significant we'll certainly communicate.

So, I'm sorry, Brian, to answer your question, I think you're going to ask about the $5 million to $8 million.

Yes.

We previously had said that for the full year we had an impact from previously announced partner program changes of $8 million to $12 million.

We're now telling you that that $8 million to $12 million as it plays out in the back half of the year is a $5 million to $8 million impact.

It's related to --

What have you already realized in the front half of the year, and is this reflected in your updated EPS guidance?

It's -- yes.

All of this is reflected in our updated EPS guidance.

So, yes.

And what was the amount that you actually --

We had about $3.5 million -- we had about $3.5 million in the first half.

Okay.

So $3.5 million of the $8 million to $12 million in the first half.

Okay.

So if there's a -- so it sounds like the $5 million to $8 million is incremental to the $8 million to $12 million that you had outlined before.

No.

No.

The $5 million to $8 million is the second half impact of the $8 million to $12 million.

So it was lighter in the first half of the year, so it was only $3.5 million in the first half of the year, so the second half of the year is going to be $5 million to $8 million, for a total of what would be $8 million to $12 million, around $11 million, actually.

So I guess I'm struggling to understand what's changed, then, if it's consistent with what you had previously outlined.

We were just giving you the second half impact more specifically in terms of what's included in our guidance for the second half, and even the $1.70 to the $1.85, we had previously given you a guidance range of $1.70 to $1.90 and told you that we had an $8 million to $12 million impact from these partner program changes.

For the full year.

For the full year.

For the full year.

We are now at the midpoint of the year.

We know what we've incurred with regard to those partner program changes for the first half of the year.

We're giving you guidance now that says we anticipate we're going to do $1.70 to $1.85, and included in that is the second half impact of those partner program changes, which is estimated to be between $5 million to $8 million.

Okay.

My understanding when you first outlined this is that the changes that you talked about on this call were new, and it sounds like these are all part of what you had previously articulated.

Right.

They are part of what we previously articulated.

There are new changes that are coming down the pike.

That's the part of the -- of what Ken said at the end that you missed.

However, we don't have the quantification of those changes yet.

The partner hasn't given us all the specificity that we need in order to do the modeling on that, Brian.

It's a pretty recent occurrence here over the last month that we've been notified.

So there's a lot of details being worked as we speak.

So, do you think it could be comparable to the $8 million to $12 million that you saw coming for this year?

Or would it not be that significant?

It's hard to state right now until we understand all the elements that help us remediate what the takeaways might be on that, so a little bit difficult to us to guesstimate right now.

Okay.

You talked about seeing better bookings I think in North America, specifically in the second quarter.

Can you just drill down a little bit more on where you saw that by customer segment and what product areas?

And as I heard your comments about returning to revenue growth in North America in the second half, clearly your comparisons are a bit easier, and I'm just wondering does that imply that you're expecting better than seasonal growth in the second half sequentially, or is it basically normal seasonal growth gets us to year-over-year growth?

I would say it's probably the latter, Brian, that you mentioned.

But as far as where the growth is coming from, pretty good across the board in regards to the client set that we're talking about, good growth, certainly in the enterprise clients that we're seeing as far as the bookings trends, as well.

And then categories, the networking segment continues to do well for us certainly overall.

I think everybody's pretty much seeing that consistently, that type of growth.

And other segments I think are pretty much as you've been seeing them.

And then just when do you think, like, when do you think total revenue could return to growth?

Is that something that you think on a consolidated basis can occur in the second half, or is that more 2014?

No, we'd say that in the second half.

Okay.

All right.

I'll get back in the queue.

Thank you.

Thank you, sir.

(Operator Instructions)

And our next question will come from Nikhil Kumar, with Stifel.

Please go ahead.

Your line is now open.

Nik Kumar for Matt Sheerin.

Just want to get a sense of like a lot of your competitor talked about, like, pricing pressure, so what you are seeing when you are, like, talking to the clients?

Are you seeing same kind of pricing pressure, or is it different for you guys?

Yes, Nikhil, thanks for the question.

I would say that we're seeing consistent pricing pressure, certainly in the Velocity products certainly more.

But I think it's been pretty consistent, so I don't think anything really out of the norm in that regard.

And we're trying to be more diligent, as well, in chasing the right elements of the business for us versus trying to play completely in the pricing game.

And are you seeing any, like, impact from, like, push-out from federal sequester concern, or nothing as of now?

Yes, I would say that we certainly saw the public sector space was certainly lighter in the quarter for us as far as the results, so I think there's certainly some impact to that.

A little hard for us to completely quantify that, but when we looked, certainly, at the year-to-year results on the federal space, we definitely saw a negative growth rate there in that part of the market.

Okay, perfect.

And, lastly, just an update on like last quarter you talked about some issue with IT integration and (inaudible), so are you still seeing a hangover from them, those issues, or it's pretty much over now?

Yes, I would say that much less, so, yes, the integration on SAP in North America has gone very smoothly.

We have a very small amount of clients that will actually get migrated here during Q3.

Most of the work has really been done.

So now it's just real focused on optimizing the platform to get the efficiencies that we need.

On the European space, very similar circumstance, so we're completely through the full migration there, as well, and focused on optimizing.

So I think from -- as we look into Q3 and beyond, we see certainly a lot of good stabilization, and now the focus really is on just enhancing and improving the productivity of the systems.

Okay.

Thank you.

Thank you.

Our next question will come from the line of Brian Alexander, with Raymond James.

Please go ahead.

Your line is open.

Okay, I'm back.

Ken, maybe a little bit more on what's going on in Europe, significant decline in hardware this quarter, and I think you alluded to the UK having some issues, and I know you're going through a leadership transition in Europe overall, so I'm just wondering if you can kind of tie those things together.

And it didn't sound like you thought that the UK business was going to get turned around here in the near term.

So just help us understand exactly what's going on there.

Yes, so on the hardware side we did see, as we reported, a certainly significant decline in hardware sales related to a few big enterprise clients that pushed some business out.

As far as the prospects there, as we estimated, we think it will probably take the back half of the year to really get that corrected.

We think the leadership team that's running the UK business is really a solid team.

We've had some people, one specific individual, that was out on maternity leave that runs that business for us is back in the business now running that business for us, so we expect to see certainly improvements there over the next couple of quarters.

In regards to Stuart Fenton, who's the -- who's our President of the EMEA business, he's still running the business.

He's still actively involved day to day in all aspects of the business.

The search for his replacement is going in accordance to plan, and we expect to have that completed by the end of this year.

So all things are pretty much according to plan in that front.

So there's nothing really operationally that's new in that region that caused you to see some sales slippage this quarter?

It sounded like maybe there was just a little bit of, I guess, personnel absenteeism that will get addressed this quarter, you should be back on track, and there shouldn't be anything lingering beyond that?

Yes, I think there were certainly some execution issues, and I think, again, with the leader coming back after being out of the business for a year will certainly have a really, I think a very positive impact and being well received by the team.

So I think it's just going to take a little bit of time to -- for her to get her feet under her a little bit and to get things back in motion and building those pipelines of business.

But, yes, no fundamental bigger shifts than that occurring in the UK business for us.

Okay.

And then just over again the gross margin improvement you saw, Glynis, in North America specifically, up 40 basis points year on year, how much of that was related to mix versus other factors, either vendor incentives or product margin?

I think it was a combination of mix, to some extent, related to certain categories of products and the hitting certain thresholds with key partners that actually have more lucrative incentives, I guess I would say.

So I think the team performed well.

We've been targeting our networking category, and that worked out very well for us in Q2 in North America specifically.

So most of the benefit and the improvement that we saw in North America came from execution against a couple of key categories and increased incentives related to that by virtue of overachieving the volume threshold.

It's been a while since I think you guys have talked about deal registration as a potential catalyst for gross margins.

I know this was something that you had highlighted a few quarters ago as an opportunity, particularly on enterprise deals.

So where are you in that initiative, and how is it going relative to your expectations?

Yes, that continues to be an important part of the elements that we're tracking on a daily basis.

So I get reports daily on regards to how we're doing, number of deal registrations each day.

So that continues to see the attention.

I think we'll continue to gain traction, maybe not as fast as we'd like, but it still is an important element of what we're doing.

Again, very focused on how do we drive more solution selling for our partners, and, of course, they are in turn willing to pay us more for that type of effort with the deal registration.

So that continues to move along nicely, and we'll continue to try to accelerate it.

And then just on the cash flow, it was very strong this quarter, and it was very strong for the first six months of the year, and I just wanted to know how sustainable we should think about this working capital performance, in particular.

The trade cycle looked pretty low.

It looked largely driven by payables, which I know could just be a moment in time.

So as we look at the operating cash flow year to date, how should we think about that for the full year relative to the earnings guidance that you gave?

I think for the full year you should anticipate that we're going to be performing in the normal range on a full-year basis, which is in the $80 million to $110 million category in terms of cash flow from operations.

We did do really well with regard to our [DPO], specifically as it related to the inventory financing facility that we were able to leverage.

And, as I said, our EMEA operation also negotiated some better terms with lenders.

But I think you should anticipate that we're going to be in that -- the higher end of that $80 million to $110 million range that we've typically seen over the years for the full year.

Okay, so obviously very front-end-loaded cash flow.

It would put back half cash flow somewhere around $20 million to $30 million?

Yes, there's some seasonality, front end on that seasonality this year, yes.

And then, I guess, final one, as I look at the earnings guidance for the full year, and if I back out what you achieved in the first half, it would imply the second half is roughly flat, maybe down slightly if I use the midpoint from an EPS standpoint versus the first half.

Would you consider that kind of a typical balance for the year, or -- I'm just trying to get a sense for why the second half wouldn't be a little bit better than the first half, given the challenges that you had, particularly in Q1.

Well, I mean, the second quarter is -- historically has been our biggest quarter with regard to the [Microsoft] effect that occurs in the second quarter.

So I would anticipate that we're not -- 50/50 would be great in terms of first and second half.

This year our second half is also impacted by the underperformance that we're seeing in EMEA.

So our North America operation is going to be doing a little bit better in the second half than they did in the first half.

However, what normalizes for that is the issues that we had specifically in the UK and in EMEA that we talked about with regard to the second half performance.

Okay.

That's it for me.

Thank you, sir.

(Operator Instructions)

Presenters, at this time I'm showing no additional phone line questions at this time.

Ladies and gentlemen, that does conclude our time for questions and will also conclude our conference for today.

Thank you for your participation, and have a wonderful day.

Attendees, you may now disconnect.