Insight Enterprises Inc (NSIT) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insight Enterprises Third Quarter 2017 Operating Results Conference Call. (Operator Instructions) As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Ms. Glynis Bryan, CFO. You may begin.

Thank you. Before we officially start the call, I just wanted to highlight that we had some technical issues with our provider on the posting of our earnings release this afternoon. So if you haven't seen it across the wire, you can find it on our website, and it has also been filed with an 8-K with the SEC. So with that, I will actually begin the call.

Welcome, everyone, and thank you for joining the Insight Enterprises earnings conference call. Today, we will be discussing the company's operating results for the quarter ended September 30, 2017. 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 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 completion of the call and will remain on our website for a limited time.

This conference call and the associated webcast contains time-sensitive information that is accurate only as of today, November 7, 2017. 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 certain non-GAAP measures -- non-GAAP financial measures as we discuss the third quarter and year-to-date 2017 financial results. When referring to non-GAAP measures, we will refer to such measures as adjusted. Adjusted measures discussed today will exclude severance and restructuring expenses and acquisition-related expenses recorded in all periods. Adjusted measures will also exclude the loss reported in the third quarter of this year on the sale of business in Russia and the gain on the sale of real estate asset recorded in the second quarter of 2016 as well as the tax effects of these items. You will find a reconciliation of these adjusted 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 growth rates are discussed in U.S. dollar terms. Additionally, any references to our core business or the organic change year-to-year in our performance will exclude Datalink's results subsequent to the acquisition.

Finally, let me remind you about forward-looking statements that will be made on today's call. All forward-looking statements made during 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, 2016, and also on other reports we file with the SEC.

With that, I will now turn the call over to Ken. Ken?

Thank you, Glynis. Hello, everyone. Thank you for joining us today to discuss our third quarter 2017 operating results. For the third quarter of 2017, consolidated net sales were $1.76 billion, up 26% year-over-year, reflecting growth of 17% in our core business and the addition of Datalink, which we acquired on January 6. Net sales in constant currency were up 25%.

Gross profit was $226 million in the third quarter, up 24% year-over-year in both U.S. dollars and in constant currency. Gross margins were 12.9%, down approximately 20 basis points year-over-year, reflecting lower gross margin in our core business driven by lower services sales and lower product margin in sales to large enterprise clients in North America, partly offset by the positive contribution of Datalink.

Consolidated selling, general and administrative expenses were $180 million in the third quarter, up 25% year-over-year, including growth of 7% in our core business and the addition of Datalink.

Strong organic sales growth and good gross profit growth in our core business combined with the positive contribution from the Datalink business led to an increase in adjusted earnings from operations of 20% compared to the third quarter of last year. On a GAAP basis, earnings from operations increased 14% to $41 million and adjusted diluted earnings per share was $0.73; while on a GAAP basis, diluted earnings per share was $0.62.

Within these results, the North America business reported 34% top line growth year-over-year, including double-digit organic growth as well as the addition of Datalink to the business. In our core business, we continued to see strong growth in the hardware category, fueled by demand for client devices and data center solutions. We saw high single-digit growth with SMB clients, while the large enterprise clients grew significantly faster year-over-year, as we continued to see the benefit from new client wins, ongoing refresh cycles and certain large multi-quarter data center projects. The Datalink business added approximately $134 million in sales to our results for the quarter.

Gross profit in North America in the third quarter was 29% year-over-year, while gross margins decreased 50 basis points to 12.5%. Gross margin decline was driven by strong growth with large clients and lower services gross profit year-over-year in the core business.

Adjusted earnings from operations, however, increased 17% year-over-year to $43 million, reflecting the sixth consecutive quarter of double-digit adjusted earnings growth in North America.

Moving on to the third quarter results in EMEA. Net sales in EMEA decreased 2% year-over-year in constant currency, but a higher mix of services sales helped drive gross profit up 6% and gross margin up approximately 100 basis points year-to-year, which, when combined with good cost control, led to adjusted earnings from operations growth of more than 300% in the third quarter.

We also completed 2 strategic transactions in EMEA in the third quarter. First, as we discussed on our last call, we completed the sale of our business in Russia after concluding that this market did not fit our long-term plans. Second, in pursuit of our strategy to expand our cloud and services capabilities in EMEA, we completed the acquisition of Caase in late September.

Located in the Netherlands, Caase provides consulting, deployment and managed services around the Microsoft stack including Office 365 and Azure. Sales over the last 12 months were approximately $5 million. We're excited about accelerating our expertise in the areas of hybrid cloud and workforce productivity in the EMEA region and welcome the Caase team to Insight.

In Asia Pacific, our team also executed very well in the third quarter, delivering double-digit top line growth and strong bottom line growth in constant currency. Demand has been stable in the APAC region so far this year, and in the third quarter, we saw good growth in Australia and China and a bit slower growth in New Zealand. And as Ignia completed its first year as part of Insight in Australia, we continue to be pleased with the talent and capabilities added to our portfolio throughout this combination.

As we head into 2018, we are looking at additional opportunities to scale global offerings around application development and business analytics, leveraging the skills gained from our BlueMetal and Ignia businesses across other parts of our footprint.

We are pleased with our execution globally in the first 9 months of 2017. Our strategy and related solutions areas focusing on helping clients efficiently manage their IT assets today and transform their business for tomorrow. Amid a stable demand environment, we believe our extensive supply chain, cloud, data center and software capabilities, combined with disciplined execution, will serve us well as we close out a record year in 2017.

I'll now hand the call over to Glynis, who will discuss additional highlights of our year-to-date financials. Glynis?

Thank you, Ken. For the first 9 months of 2017, our core business delivered double-digit top line growth -- organic top line growth and high single-digit gross profit growth year-over-year, which, when combined with great cost control, has driven adjusted earnings from operations up 27% year-over-year in the core business. In addition, the Datalink business is performing well in line with our expectations so far this year and on track to meet its earnings target for the full year.

Let me break down our year-to-date financial results in a bit more detail. Consolidated net sales of $4.9 billion in the first 9 months of 2017 are up 22% compared to the same period last year. In North America, net sales were up 30% year-over-year including organic growth of 17% due to significant new large enterprise client wins and expansion within existing clients and also approximately $387 million in sales from Datalink.

In EMEA, net sales year-to-date are up 6% in constant currency, reflecting particularly strong sales growth in hardware and services. And in Asia Pacific, net sales are down 1% in constant currency due to a higher mix of netted software maintenance sales and cloud sales.

As we have discussed before, we are actively engaged in helping our clients migrate to the cloud. And year-to-date, gross profit earned from cloud sales represented 13% of our consolidated gross profit. Because most cloud sales are reported net, we believe our gross profit comparisons year-to-year are the best metric for assessing our business performance.

Consolidated gross profit in the first 9 months of 2017 was $686 million, up 24% in U.S. dollars and up 26% in constant currency. Gross margin expanded 20 basis points to 13.9% in the first 9 months of this year. This increase is driven by the addition of Datalink to our business and the positive effects of a higher mix of netted software sales, partially offset by a lower mix of [fees] earned on enterprise agreements, which are 100% margin, and also a higher mix of product sales to large enterprise clients.

Also, on the SG&A front, consolidated selling and administrative expenses were $539 million, up 22% year-to-date. This increase was driven primarily by the addition of Datalink to our business, including purchase price amortization and low single-digit growth in expenses in our core business.

We also recorded severance and restructuring expense of $6.2 million in the first 9 months of this year compared to $3.1 million for the same period in 2016. And we incurred expenses related to the acquisitions of Datalink and Caase of $3.3 million in the first 9 months of 2017 compared to $741,000 spent on the Datalink and Ignia acquisitions in the third quarter of 2016.

In addition, as Ken mentioned, we sold our business in Russia in the third quarter and incurred a loss on sale of $3.6 million. About $2.9 million of this was related to foreign currency translation adjustments that had previously accumulated in the equity section of our balance sheet.

All of this led to adjusted earnings from operations of $147 million in the first 9 months of 2017, up 32% year-over-year and up 32% in constant currency terms. GAAP earnings from operations increased 24% for the first 3 quarters of 2017.

In addition, our effective tax rate year-to-date through September 30 was 35.6%, down from 36.8% last year, due primarily to approximately $2.3 million of tax benefits this year from the settlement of share-based awards in accordance with the new accounting standard, which was adopted effective January 1, 2017.

All of this led to diluting -- diluted earnings per share on an adjusted basis of $2.43 this year compared to $1.81 earned in the first 3 quarters of 2016. GAAP diluted earnings per share were $2.11, up from $1.74 last year.

Moving on to cash flow performance. In the first 9 months of 2017, our operations used $324 million of cash compared to a use of $125 million in the first 9 months of 2016. As discussed in our last call, our Q1 2017 cash flow results were adversely impacted by the effects of a timing difference in the collection of a single large receivable in Q4 of 2016 of approximately $160 million, for which the payment to the supplier was due and paid in January of 2017. We had the exact same scenario, but for a lesser amount of approximately $60 million in Q1 of 2016.

The balance of the increase year-over-year in cash used in operations was driven primarily by the higher working capital gains on significantly higher sales. We expect strong cash flow generation in the fourth quarter will partially offset the use of cash reported year-to-date through Q3 and expect that, for the full year, we will report a use of cash of between $50 million to $70 million. And we expect to return to normalized cash flow generation of $80 million to $120 million in 2018.

Also, in the first 3 quarters of 2017, we invested $16 million in capital expenditures, up significantly year-over-year due to planned investments in IT infrastructure upgrades, our global website and our digital marketing platform. And we anticipate CapEx for the full year to be between $20 million to $22 million. In addition, we spent $187 million to acquire Datalink and Caase this year.

We did not buy back any stock in the first 9 months of 2017, but for comparison purposes, we used $50 million to acquire shares over the same period last year.

All of this led to a cash balance of $236 million at the end of the third quarter, of which $193 million was (inaudible) and we had $544 million of debt outstanding on the revolving and term debt facilities. This compares to $176 million of cash and $243 million of debt outstanding at the end of Q3 2016.

From a cash flow efficiency perspective, our cash conversion cycle was 37 days for the third quarter of 2017, up 5 days year-to-year. This increase resulted from the net effect of a 1-day increase in DSOs and a 3-day decrease in DPOs due to the relative timing of client receipt and supplier payments during the respective quarters and also a 1-day increase in inventory outstanding due to investments in inventory for specific client engagements.

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

Thank you, Glynis. With respect to our 2017 outlook, for the full year 2017, we now expect our business to deliver sales growth of 20% to 22% compared to 2016. We're maintaining our adjusted diluted earnings per share outlook for the full year of 2017 of $3.15 to $3.25. This outlook assumes an effective tax rate of approximately 38% for the fourth quarter -- for the third -- for the fourth quarter of 2017. This outlook excludes severance and restructuring and acquisition-related expenses incurred during the first 9 months of 2017 and those that may be incurred during the balance of 2017 as well as the loss on the sale of our Russia business that Glynis discussed earlier.

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'll now open the line up for your questions.

(Operator Instructions) And our first question comes from Adam Tindle with Raymond James.

Okay, I just wanted to touch maybe first on guidance. I think, on revenue, you're implying down sequentially in Q4, if I'm reading this correctly. But the core business is typically up, and Datalink, from my understanding, is more seasonal to Q4. So I just wanted to understand maybe touching on the revenue guidance for Q4.

So Adam, that is correct. We are expecting that, seasonally, that Q3 -- Q4 unusually will be a little bit down from where we are in Q3, not significantly. Q3 was actually a very large quarter for us. I think our growth in Q3 in actual dollars was $341 million. That was a significant growth in the quarter, as well as a $134 million contribution from Datalink, and we're not seeing that same rollout in terms of growth in the core going into the fourth quarter. So there was some projects that concluded this quarter. We anticipate growth in the core, but not at the magnitude of the 17% that we saw in Q3.

Understood. Maybe we'll look at kind of a second half stack when we look at it. So...

Right, yes. I think that's how we should look at it because the guidance was based on the second half view, ultimately.

Yes, that makes sense. I did want to ask about gross margins in the quarter. Obviously, they're below previous years despite the addition of Datalink, which should be pretty accretive. I think if I try to back in the North America gross margin ex Datalink, it would've been below 12%. If I hold Datalink around historical levels, which if I look at the core is well below previous years, maybe an all-time low. So I'm hoping that maybe you can give a little bit of additional detail. You touched on some of the reasons for this, including lower hardware margin. What is that attributable to? Was it vendor changes? Competitive pressures? Just any additional detail would be helpful.

So your analysis is correct. It is sub-12% ultimately in the core business, excluding Datalink. This is a North America comment, not -- excluding EMEA and APAC. And I would say that it's a combination of the mix of business that we're actually selling and the clients that we're selling that business to. So they're very large enterprise clients, and I wouldn't say it's increased competitive pressure. We always have very large enterprise clients. And in Q3 in particular, we had particularly strong success with some very large enterprise plants where the -- clients where the margin on that business that we sold, the front-end margin was not as great as we would have liked ultimately. But in terms of the relationships that we have and the (inaudible) that we're establishing with these clients, we thought it was a good thing for us to take the business as we move forward. I don't think that you should anticipate that the -- there's going to be a continuing deterioration or degradation in margins as we move into 2018. One, I think that 17% growth in the core in -- is not going to be something that we should anticipate seeing as we move into 2018. I think we expect [North] growth to normalize to a couple of hundred basis points above market ultimately. And just by definition with that as well as growth in our services business, we should expect margins to more normalize in [Q4]. But Datalink actually is meeting all of our expectations and is performing very well.

The other piece, Adam, you touched on is we didn't attribute any of that (inaudible) to supplier programs at all. So...

Right. Yes, I think, maybe the thing that I'm just a little bit confused by is that it seems like growth is very good for the market in general, and clearly for Datalink -- sorry, for Insight, which should argue for less margin pressure, not more. So I'm just trying to understand how this plays out when growth is less robust.

So I think that it's the weighting of the mix of business ultimately that has the -- that is driving what happened in this quarter. So we had significantly high growth with very, very large clients in lower-margin products ultimately. In a standard year, if such a thing exists when we would have kind of a more normalized growth rate, we would anticipate having a more normalized mix of business ultimately, and not have the preponderance around the lower-margin end of the product spectrum that we saw this year -- this quarter rather. This quarter. I think that, ultimately, it's the type of client and the strong growth in the client as well as the specific products in that segment.

And our next question comes from Matt Sheerin with Stifel.

Yes, just following up on Adam's questions regarding the mix of the business. It sounds like, Ken, that you continue to see strong demand for client devices in notebooks, PCs and also servers, where -- as opposed to -- real value-add solution selling where margins are better. And are you just getting a sense of that's where your enterprise customers' budgets are focused on right now as we continue to see refresh cycle on PCs? And obviously, as we get into FY '18, it looks like we're going to be up against some tough comps there. And are you expecting that to more normalize where you might see a shift in client dollars or budget dollars, where they may shift back toward more solution type of opportunities for you?

Yes. So a couple of points there, Matt. So on the device side, desktops and notebooks, no question that the market was pretty healthy this quarter as we look at the NPD data across the channel for everybody. We were fortunate to actually exceed that growth. And our growth in the units was actually 17%, but the revenue growth was significantly higher than that. A couple of reasons for that. One is the mix of products selling, higher-performing devices, helped us there. But also the component price increases that have occurred now are fully sort of into the new sort of ASPs of these devices. And we attribute that to be about 7% increase in the total ASP of the units, just due to the component price pressures that were in the market. And we expect that, that'll probably continue through to the first half of 2018. So I think there's a 7% uplift just in device revenue because of that. And then of course, there's significant unit growth, as I mentioned, [17%] unit growth, across desktops and notebooks for us as well. So certainly stronger than what the market's seeing. So that's on the device side. On the data center areas, specifically as we look at the NPD data, growth but not robust growth. We certainly had a few large clients that Glynis referenced that might normally take some of this business direct, and that's what made it such a competitive margin. As you force -- but we recognize we've got strategic relationship with this client that it made sense for us to continue to help support them in that business. So those become pretty cyclical because those are pretty big projects, so we don't expect that, that -- those kind of big projects aren't going to continue, and that would certainly more normalize, and as Glynis is attributing that -- as that normalizes out of the business, of course our gross margins will return back to normal sort of areas.

And on the -- in terms of the corporate PC refresh, are you seeing the upgrade to Windows 10 as a driver of that?

Not -- some of it, a little bit, Matt, but not as much as I think it -- you would normally see in this kind of uptick. So I think there's certainly some of that. There's certainly mandates in the government sectors talking about that, but we think that's going to be a little bit slower growth. But that'll certainly be a nice tailwind for us over the next couple of years, because the government tends to move a little bit slower there. And we're pretty well positioned with a lot of the big sort of fed contracts we have in regards to the Windows platform. So we feel like we're in pretty good shape there. And the commercial clients, I think, are certainly moving that way, but we don't see it moving in a big sea change. But we think, again, that's going to be a nice tailwind because that will, in many cases of course, drive definitely an increase of new unit sales. Because you're going to need, obviously, touch and so forth on the devices that people might not have. So we think that will probably be a nice situation over the next couple of years as that really starts to take root in the business.

Okay. And then in EMEA, I noticed that the software revenue was down year-over-year, but gross profit dollars were up overall in EMEA. And is that just a function of the netted down of the revenue of software? Or is there a trend there?

It's not a trend. I guess I would say there was a significantly large deal last quarter that was lower margin. I think we may have talked about it on the call in the Q3 of '16. There's a little bit of netting in there, but it's not the netting impact. It's really the impact of the large deal in the prior year quarter (inaudible) the improvement in gross profit year-over-year.

Okay. But in terms of the revenue decline, that was just up against tough comps from last year?

That was just up against tough comps. The large -- very large deal impacted revenue on a year-over-year basis negatively but gross profit positively.

(inaudible).

Okay, great. And then it sounds like Datalink is on track as expected. But in terms of the cross-selling opportunities on both sides of the business, are you starting to see traction yet? Or is it still sort of building that foundation where that's potentially upside in next year's revenue and in margins?

Yes, good question, Matt. So as we mentioned, the first 6 months certainly was really all about integrating the business well. And then we started -- in Q3 really started to open that up to start really focusing on the cross-selling amongst both entities, Insight to Datalink and vice versa. And that's starting, and we're starting to see some nice pipeline develop there. So we expect that certainly we'll see some of that in Q4, but certainly in 2018, we definitely expect to see a synergistic selling there. So, so far, the outlook looks positive.

(Operator Instructions) And our next question comes from Kara Anderson with B. Riley FBR.

This is Marc Wiesenberger calling in for Kara. Can you speak to the impact, if at all, from any of the hurricanes, Harvey and Irma? And if there was an impact, were the sales lost or just simply delays that you expect to recoup?

Yes, Marc. We had heard that brought up a couple of times. We didn't really see any impact from that. There were certainly -- there's one significant partner of ours that has locations in Houston, and we worked very closely with them to make sure that we prioritized shipments and didn't really see any negative impacts there on our business. So no, we can't really say that we saw anything significant on that. And the ones that we did see where there's any kind of slight impact, of course, that revenue will come in Q4. So that's not lost revenue, just revenue that's pushed. But again, for us, we didn't see anything substantial due to the hurricanes. I think the vendor partners really managed through that very, very well, from our perspective.

Great, and just one other question. Were you seeing any additional traction in taking share from smaller VARs during the quarter and maybe some supplier consolidation?

Yes. I mean, the only data we can have, is we track certainly the data NPD very carefully, so we understand what the growth of -- is occurring in the market. And then of course, we can look at the growth numbers of the public competitive VARs. And there's some pretty good growth numbers. And then when we look at the comparison, the only other real public comparisons we have are the distributors, who again we buy a lot of products from as well. About 50% of our products are bought from people like Ingram and Tech Data and Synnex. Their growth numbers aren't quite as high, so you would have to say that their makeup is our business and small VARs. So if the major sort of players like ourselves, CDW and Connection and Mall and so forth are growing faster, you'd have to say that it's coming somewhat at the expense of the smaller VARs business-wise. That's the only thing we could sort of surmise on that. So we think that's -- that consolidation, I think the scale certainly is playing to our favor.

Thank you. That's all the time we have for questions. I would like to thank everyone for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.