Insight Enterprises Inc (NSIT) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insight Enterprises third-quarter 2016 operating results. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, today's program is being recorded.

I would now like to introduce your host for today's program, Glynis Bryan, Chief Financial Officer. 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 September 30, 2016. 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 2 hours after the 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, October 27, 2016. This call is the property of Insight Enterprises. Any distribution, 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 non-GAAP financial measures as we discuss the third quarter and year-to-date 2016 financial results. When referring to non-GAAP measures, we will refer to such measures as adjusted. Adjusted measures discussed today will exclude the gain recorded in the second-quarter 2016 on an asset held for sale, and severance and restructuring expenses recorded in all periods, as well as the tax effect of these items. You will find a reconciliation of these non-GAAP measures to our actual GAAP results included in the press release issued earlier today.

Also, please note that unless highlighted as constant currency, all amounts and gross rates are discussed in US dollar terms. Finally, let me remind you about forward-looking statements that will be made on today's call. Our 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, 2015.

With that, I will now turn the call over to Ken to give you an overview of the third-quarter 2016 operating results. Ken?

Hello, everyone. Thank you for joining us today to discuss our third-quarter 2016 operating results.

I am pleased to report another strong quarter of performance in our business. Each of our operating segments delivered solid top-line growth, and we continued to manage expenses, which show strong earnings growth year over year.

Consolidated net sales were $1.4 billion, up 4% year-over-year and 6% in constant currency. In constant currency, all three operating segments reported top-line organic growth year-over-year while also delivering growth at each of our reported categories of hardware, software, and services.

Gross profit of $182 million in the third quarter was flat year-over-year and up 2% in constant currency. Gross margins declined 50 basis points year-over-year to 13.1%, due primarily to lower product gross margins, including lower mix of vendor funding and changes in business mix transacted in the quarter.

Consolidated selling and administrative expenses were $145 million in the third quarter, down 3% in US dollars and 1% in constant currency. Adjusted earnings from operations increased 9% year-over-year to $37 million. On a GAAP basis, earnings from operations increased 12%. And adjusted diluted earnings per share were $0.62; on a GAAP basis, diluted earnings per share were $0.60.

Our North America business performed very well in the third quarter against a tough comparison to the strong double-digit growth on the top line and bottom line delivered in last year's third quarter. Net sales in North America increased 3% year-over-year to $1.1 billion. Within these results, hardware sales grew 2%, reflecting continued strength in demand for client devices as well as server and storage solutions.

Software sales increased 3% year-over-year, and services sales increased 12% year-over-year, assisted by the BlueMetal acquisition we completed last fall. Gross margins contracted due to higher mix of business with large enterprise clients; but the modest gross profit dollar growth, combined with lower operating expenses, drove adjusted earnings from operations up 10% compared to the third quarter of last year.

In EMEA, net sales of $312 million increased 16% year-over-year in constant currency in the third quarter. By category, hardware sales in EMEA increased 9%; software sales increased 22%; and services sales increased 15% -- all in constant currency.

Gross profit grew slower than sales at 3% in constant currency, due mostly to a higher mix of lower margin business with large clients. In addition, operating expenses increased 4% year-over-year in constant currency, which led to a decline in earnings from operations compared to the third quarter of last year.

In Asia-Pac, net sales increased 11% in constant currency, and gross profit grew twice as fast as sales, which led to strong earnings from operations growth year over year. Also in Asia-Pacific in the third quarter we completed the acquisition of Ignia, a business technology consultant and managed services provider headquartered in Perth, Australia. The addition of Ignia to our business expands our global footprint in the areas of application design, cloud, mobility, and business analytics. Integration activities are underway, and we are excited about the ability to bring Ignia's services to our clients in Australia.

I will now hand the call over to Glynis, who will discuss our year-to-date financial results.

Thank you, Ken. Overall for the nine months of 2016, we are pleased with our results across the business. Low single-digit top-line growth, combined with gross margin expansion and improved operating leverage, have driven double-digit earnings growth year-over-year in the first nine months.

Our top-line results year-to-date have been negatively impacted by a higher mix of sales recorded in net, primarily driven by the adoption of cloud offerings by our clients. Despite the top-line optics, and we are pleased with our execution in helping clients assess, acquire, and implement cloud solutions; and those sales now drive approximately 14% of our gross profit.

In addition, all server operating segments have grown gross profit faster than SG&A for the first nine months of 2016 and delivered double-digit earnings from operations growth for the same period, all in constant currency. Consolidated net sales of $4 billion in the first three quarters are up 1% compared to the same period last year, and in constant currency net sales are up 2%.

In North America net sales increased 3% year-over-year in the first nine months of 2016, with particularly strong growth in client devices and servers and storage. In EMEA, net sales are flat year-over-year in constant currency, and higher sales in software and services offset the effects of lower hardware sales in the UK business. And in Asia-Pacific, net sales are down 2% in constant currency due to a higher mix of software sales recorded net.

Consolidated gross profit for the first nine months of 2016 was $552 million, up 3% in US dollars and up 5% in constant currency. Gross margin expanded 30 basis points to 13.7% in the first nine months of this year, due primarily to the increase in cloud and maintenance sales reported net and the higher mix of services sales, which are generally at higher gross margin than hardware and software product sales.

And on the SG&A front, consolidated selling and administrative expenses were $441 million, up 1% year-to-date and up 2% in constant currency. This increase was driven primarily by the addition of BlueMetal to our business late last year, including purchase price amortization and also notable higher health benefit expenses in North America, partly offset by lower reserves on accounts receivable.

Beginning with the third quarter we are realizing the full quarterly effect of cost reductions we implemented in the second quarter, which aided our performance as expected. And this benefit is expected to continue into the fourth-quarter 2016.

Moving on down the P&L, as a result of restructuring activities completed in the first quarter of 2016, we recorded severance and restructuring expenses of $3.1 million compared to $1.9 million for the same period in 2015. Consolidated adjusted earnings from operations were $111 million in the first three quarters of 2016, up 12% year-over-year and up 14% in constant currency terms.

GAAP earnings from operations increased 13% year-over-year in the first three quarters of 2016. And our effective tax rate year-to-date through September 30 was 36.8%, down from 37.1%.

Finally, our weighted average share count is down over 2 million shares since this time last year, due to shares repurchased and retired as a part of our capital deployment strategy. All of this led to diluted earnings per share on an adjusted basis of $1.79 compared to $1.54 earned in the first nine months of 2015. GAAP diluted earnings per share were $1.74, up from $1.49 in the same period last year.

Moving onto cash flow performance, cash flow used in operations in the first nine months of 2016 was $125 million compared to $25 million generated in the first nine months of 2015. In the third quarter we paid approximately $40 million for certain trade payables in advance of their stated terms to take advantage of early pay discounts offered as a one-time incentive. And we also invested $31 million inventory to support specific client rollouts over the next two quarters.

In addition, we are using more cash for working capital generated this year -- generally this year due to business growth. Also, please recall that in our 2016 cash flow, our 2016 cash flow results are lower than historical levels due to a single significant client receivable that was collected in the fourth quarter of 2015, for which the belated payable of approximately $60 million was paid according to its terms in the first quarter of 2016.

In the first nine months of 2016, we also invested $9.7 million in capital expenditures, down from $10.8 million last year. And we deployed approximately $11 million to acquire Ignia, the acquisition we completed on September 1.

In addition, we spent $50 million in the first nine months of this year to repurchase approximately 1.9 million shares of our common stock compared to $92 million in the same period last year. All of this led to a cash balance of $176 million at the end of the third quarter, of which $154 million was [red vent] in our foreign subsidiaries.

And we had $242.5 million of debt outstanding under revolving credit facilities. This compares to $148 million of cash and $85 million of debt outstanding at the end of last year's third quarter.

And from a cash flow efficiency perspective, our cash conversion cycle was 32 days in the third quarter of 2016, up five days year-over-year. This increase resulted from a four-day increase in our DPO, coupled with a one-day increase in our DSO, primarily due to the early payment of certain trade payables I mentioned a moment ago and to generally higher working capital requirements this year due to business growth. I will now turn the call back to Ken.

Thank you, Glynis. Moving on to our outlook for 2016, we are pleased with our team's execution in the third quarter and believe we are well positioned heading into the fourth quarter to meet our financial and operational objectives for the full year.

Given our year-to-date 2016 financial performance, we are maintaining our outlook that we expect net sales in 2016 to grow in the low single-digit range year-over-year. And we are increasing our adjusted diluted earnings per share outlook for the full year to a range of $2.45 to $2.50.

This outlook reflects an effective tax rate in the fourth quarter of approximately 37% to 38%. It also excludes severance and restructuring expenses and the gain on building sale during the year.

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. I'll now open your line up for questions.

(Operator Instructions). Brian Alexander, Raymond James.

Thanks. Can you guys talk a little bit more about the demand environment in North America heading into the fourth quarter, relative to what you would expect from a seasonal perspective? And any color by customer segment and by product would be helpful. And then related to that, the HP transaction that you guys had -- how much revenue is that adding in the second half?

Okay, I'll start off. Thanks, Brian, for your question. I think the demand environment, as we indicated, is looking certainly very stable. We've seen good growth in a lot of different areas.

Certainly cloud, as you saw with Microsoft, is growing very, very well. And we are certainly participating -- actually our numbers indicate that we are actually doing a little bit better than the channel is from a growth point of view in the cloud, based on their data.

On the hardware side we see pretty good growth. Certainly notebook computers did very well in the quarter in the channel. Desktops, as expected, were down. Service grew pretty nicely, too -- about 6.5%.

We saw that storage was a little bit down as well in that sort of category. And networking spend was a little bit down.

So overall I would say certainly a decent amount of growth in the channel, but in different pockets and different areas. And certainly we have participated in those. Glynis, did you want to touch on the HP transaction?

Sure. What I would say, Brian, is that our expectations are that we -- I think we previously talked about a $75 million benefit from that contract in the second half of 2016. I think we are going to be short of that. We have brought over the [team at] a little bit ramp than we had anticipated. So I would say right now we don't have a revised forecast for what that would add, but it's not going to be in that $75 million range that we had talked about previously.

When you do ramp that up, as we look into 2017, how do you expect that to play out on an annualized basis? Or is this contract permanently lower than you thought it would be?

I wouldn't say the contract is permanently lower than we thought it would be; it's just been a little bit slower to ramp that we had anticipated. I would say that in 2017 -- we haven't given guidance yet; we'll give you some guidance when we give the 2017 guidance, but it will be north of that $75 million expectation that we have for the second half of this year.

Okay. (multiple speakers)

-- still very positive on it. The teammates that we brought over -- you know, very well skilled. Just taking a little bit of time to develop that SMB business. But very solid.

Okay. Just on the gross margin decline in North America, how much of that was mix versus vendor incentives? And was there any element of competitive pricing?

And then just how should we think about gross margin trends in North America going forward? You were flattish in Q1, up quite a bit in Q2, and then down in Q3. Is it best to think about gross margins in North America kind of flattish going forward?

So we had some large contracts in Q3 of 2015 that were highly lucrative last year that drove the results that we had in the third quarter of 2015 last year, some large deals that we had. This year we didn't see a repeat of those. That's why we were a little bit cautious originally in the guidance that we gave related to Q3.

I would say that we performed well, but I think that when we talked in the second quarter -- maybe in the first quarter, when we talked about -- when we released first-quarter results and we talked about expectations for the year, what we said is that we are going to be making these reductions in our SG&A because the margin profile that we are looking at in North America is a little bit more muted than we would like.

So to your question, we do believe that the margin in North America is in this range that we are seeing here. It's different from the second quarter, when we have the very large -- the year-to-date range, not this particular quarter range, to be clear -- it is different in the second quarter, when we had the large Microsoft peak, when we had a lot of cloud activity from Microsoft in that second quarter.

But in general we are anticipating that our margins in North America are going to be more comparable to kind of like the year-to-date margins that we are seeing. And we've taken the reductions in our SG&A as a result of our outlook on those margins, so that we can drive the EFO that we need in that business.

Okay. And then maybe over in Europe, you had a nice revenue surprise, at least on the software side. Gross margins were a little bit lower, so maybe just kind of talk about how things played out over in Europe relative to your expectations, and just the sustainability of the software upside that you saw.

So I would say the software upside that we saw was related to two very specific deals. So I wouldn't say that that upside in software is something that we would see on a go-forward basis.

The performance in Europe to date -- let's just say through second-quarter year-to-date -- has been very, very strong, specifically as it relates to gross margin, because they have a significant amount of cloud business that transacted net. So we haven't seen the growth in revenue in EMEA through the second quarter.

What we saw in the third quarter was growth -- not in the cloud, but growth in kind of software product business, transacted at very low margins for some very large enterprise clients. That happens in every quarter; however, in the third quarter, which is our lowest revenue quarter, it has a bigger impact.

So we typically have software deals that transact at lower margin related to our large enterprise clients. In EMEA on a go-forward basis, you should anticipate that revenue is going to remain a little bit more muted still, only because they also have a significant volume of cloud business that is transacted on a net basis. But typically that has translated into higher gross margin. This quarter will be a little bit of an aberration to that story.

Okay. And then finally from me, cash flow: I think year-to-date, you are running a use -- I know there was a pull-forward last year that might be distorting the cash flow numbers. So maybe just remind us of what your goals would be on an annualized basis for cash flow from operations.

On a normal basis we would say that we would anticipate our cash flow is going to be in the range of $80 million to $120 million. At the end of 2015, we had cash flow from operations of $181 million. Included in that was a [$60 million] receivable for which the payable actually hit us in 2016, in January.

So on a normalized basis, if you add back that $60 million to what our expectation is related to cash flow from operations, we would be at the lower end of that range this year. We're using a little bit more cash to fund the working capital requirements in the business. And in Q3 specifically we also had some decisions that we made, ultimately proactively, with regard to taking advantage of certain one-time discounts in terms of funding about $40 million early as it related to a specific client and a specific vendor.

And then we also have about $46 million associated with some cut plant rollouts that we are going to be transacting over the next couple of quarters. So there were some [constant] decisions that we made in the third quarter of 2016 that was impacted. But normalized for the $60 million, we would anticipate that we're going to get in the lower end of our $80 million to $120 million range.

Got it.

There's nothing structurally different, Brian.

Yes, that's what I was trying to get at. So as we think about 2017, assuming normal demand environment and puts and takes to margins, you would expect to be back within that range?

Yes, yes.

Okay. All right. Thank you.

Good to have you back.

Glad to be back. (laughter) I figured I'd make a guest appearance, like Kyle Schwarber. Ken knows what I mean.

Very productive. Very productive.

Matt Sheerin, Stifel.

Just a couple from me. In your opening comments, Glynis, you talked about cloud-based sales representing a percentage of gross profit. I didn't get that number. What was that number?

14%. 14% of GP -- cloud sales, 14% of GP. Of [pos] GP, 14% of total GP.

Of total GP. And what does that compare on a year-over-year basis?

Last year it was around 9% or 10%.

And is that a higher number --?

And that's a year-to-date number. That was a year-to-date number that I was giving.

Got you. Is that a higher number in Europe?

Yes, it is. I don't have that number off the top of my head, but it is a higher percentage in Europe.

Got it, got it. Sure. And then just in terms of the North America business, I know you have some public sector exposure -- maybe not as much as others, but did you see kind of the normal budget flush on federal and state and local?

We did see growth in our public and in state and local -- the growth in our -- sorry, in our fed. The growth in fed was higher, I think, than the growth our state and local.

Okay.

I'm not sure that it's budget flush, but I guess that third quarter, being the end their calendar year, it probably was related to budget flush.

Yes. And just on the -- you talked about some of the puts and takes of the margins in EMEA, but obviously in June quarter there was some -- it was a very good operating margin there. And then you were basically breakeven again in the September quarter, with seasonal swings in revenue, but also on the margin.

And that's been sort of the story -- these big quarter-to-quarter swings. I think that's -- whereas North America, it's -- you are more stable and moving in the right direction. So the question is: are you trying to figure out how to better manage that quarter to quarter? I know there's been focus on a mix of business, diversifying away from the enterprise customer somewhat there, but how do you think that plays out? And what are you doing to sort of -- to help stabilize that?

I think that when you look at it over the year, the margins in EMEA are generally on an improving trend over the course of a year. As I look at quarter two to quarter three, the majority of our business in EMEA is software-related, which just has a different dynamic.

So in Q2 in particular, that gets exacerbated, because it is the year-end for one of our largest partners. And that actually triggers our largest software quarter.

So when you look at the business in EMEA, it is, like, 60%-something, almost 70% software; versus in the US we have the inverse. In the US our business is around [50% to 60%] hardware. That gives us a little bit more stability in the underlying dynamics of the North America business relative to the EMEA business.

So between Q1 and Q2, you would see a difference related to the software dynamic. Between Q2 and Q3 in EMEA, you're going to see a difference related to software dynamic. But if you go back and you look historically since 2014, 2015, and now in 2016, you will see that EMEA has consistently increased their gross margin on an annual basis.

And that actually is the way that we evaluate them on an annual basis, because with the mix of software that we have and the migration to the cloud, there was going to be that spikiness from one quarter to the other, depending on the preponderance of software in any given quarter.

I think --.

In Q3 we [were] significantly different from our expectations. We wouldn't have thought GP would be down, necessarily, on a -- gross margin would be down necessarily on a year-over-year basis. But they did have those two large software product deals at low margin transact that drove that delta, and not as much of the cloud business as a percentage of the total.

Just to add, you know, Matt, of course, that's their lowest revenue quarter of the year, just to do -- you know, the summer holidays and so forth. What we would say -- when you look at it from an earnings from operations perspective, when you look at 2015, double-digit growth from the year prior, and continuing that trend this year as well. So making progress. We are certainly on it, and one that we certainly are continuing to do.

I'm sorry, Matt -- we also look at EMEA on a constant currency basis.

Got you. And just on the hardware business there, you did have sequential growth, but you basically have been on a year-over-year basis -- well, actually, you had good, I guess, comps there. But that's also been a sort of declining trend there.

And is part of that -- is just the shift -- your customers shifting to cloud? Or are you doing different things with your vendors, or deselecting products that are unprofitable? What's your strategy there?

I think a lot of it has been impacting -- and most of that business, you know, for us and from a hardware perspective occurs in the UK; that's the biggest market for us for hardware. We sell hardware pretty effectively in Germany and the Netherlands. In the other countries they are primarily software.

So the UK is the biggest source of revenue in the hardware front for us. And I think that's been a little bit muted, a lot of it just due to some of the consternations going on with potential changes coming forward there. So we are seeing the hardware side of the business actually be, certainly, a little bit more pressured than the software side.

So the hardware market in the UK is down -- the overall hardware market in the UK is down. We are down consistent with that, and maybe in the third quarter a little bit more. But not significantly different from the market for hardware in the UK.

Okay. Yes. Do you see a bit of a currency headwind in the UK, given the declining currency there in the last couple of months or so, as that headwind -- you're taking your overall EPS number for the year up, but based on our numbers, a little bit lower. So does that have anything to do with currency impact?

By the time you get through to the bottom line at the [ESO] and EPS line, the currency impact is more muted. You can definitely see it in the revenue GP line.

So I wouldn't say that the reason for the top end of our forecast is around currency. But I think that when you think about the dynamics about what's happening in EMEA, specifically as it relates to Brexit, everybody -- well, general consensus is that the market performed stronger than they had anticipated immediately following Brexit. They're starting to see a little bit of sniffles coming through in this fourth quarter as it relates to slowing down a little bit. And they would anticipate a greater slowdown going into 2017 as it relates to the UK specifically, with potentially some upside in the rest of Europe.

So a little bit of that is reflected in what we have here, as well as at the end of the year we tend to have higher health care costs. So we have reflected some of that in the numbers that we are putting forward. That's the reason why we took up the bottom end of the range significantly, from $2.37 to $2.45. And then we took the top end of the range up to $2.50.

Okay. All right, thanks a lot.

(Operator Instructions) This does conclude the question-and-answer session as well as today's program. We thank you for your participation. Everyone have a great day.