Insight Enterprises, Inc. (NSIT) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Insight Enterprises’ Fourth Quarter 2014 Operating Results Conference Call. 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 and full year ended December 31, 2014. 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 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, February 11, 2015. 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 non-GAAP financial measures as we discuss the fourth quarter and full year 2014 financial results. You will find a reconciliation of these non-GAAP measures to our actual GAAP results, included in the press release issued earlier today and 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. With that, I will now turn the call over to Ken to give you an overview of our fourth quarter 2014 operating results. Ken?

Hello, everyone. Thank you for joining us today to discuss our fourth quarter and full year 2014 operating results. For the fourth quarter of 2014, consolidated net sales grew 4% year-over-year to $1.45 billion. Excluding the effects of currency changes in the quarter, net sales grew 6% with good top line growth in each of our geographic operating segments. Gross profit was $182 million in the fourth quarter, up 1% in U.S. dollars and up 3% in constant currency. Gross profit declined 40 basis points year-over-year to 12.6%. This decrease was driven primarily by lower fees in the sales of enterprise agreements resulting from partner program changes in the software category. Consolidated selling and administrative expenses increased 2% in U.S. dollars and 4% in constant currency, reflecting investments in sales, technical and services headcount in North America and EMEA businesses. Earnings from operations, excluding severance and restructuring expenses, decreased 4% to $38.6 million. On a GAAP basis, earnings from operations decreased 2% to $35.2 million and diluted earnings per share excluding severance and restructuring expenses decreased 4% year-over-year to $0.55 in line with our expectations for the quarter. On a GAAP basis, diluted earnings per share were flat at $0.48. Within these results, the North America business delivered 6% top line growth, another quarter of solid growth across hardware, software and services. In the hardware category, we reported double-digit growth in sales in notebooks and desktops, a category that’s driven nicely for us all year. We also drove double-digit growth in server sales in the fourth quarter as we are helping clients address outdated server technology related to the end-of-life Microsoft Windows Server 2003. In the software category, we continue to see strong demand from business productivity and virtualization solutions by large enterprise and public sector clients. And the momentum in our service category continued with 18% year-over-year sales growth in the quarter driven by increased consulting and technical service engagements. We are pleased with the improvements in top line growth shown in North America business throughout 2014. Hardware sales grew sequentially in each of Q2 through Q4 of 2014. Software sales followed typical seasonal trends during the year and overall grew 4% for the full year. And our services categories demonstrated a positive growth trajectory heading into 2015 at higher gross margin than we have seen in prior years. While top line performance improved throughout the year, the bottom line results in North America were impacted by significantly lower income due to previously announced program changes in the software category and the effect of planned SG&A investments in our sales organization. In that front we added critical sales resources to the business in 2014 more than 160 teammates focused on services, software, key vertical markets and field sales in core geographic markets that are important to the long-term success of our business. Working diligently with these teammates to increase their productivity and currently expect to see this business return to year-over-year earnings growth in the back half of 2015. In EMEA net sales increased 6% year-over-year in constant currency in the fourth quarter including 31% increase in services sales, strong hardware sales growth with mid-market and public sectors clients and higher software sales to large enterprise clients. And the team controlled expenses in the quarter which helped to drive 50% improvement in earnings from operations year-over-year. Our EMEA business is heading into 2015 on a stronger foundation built in 2014. For the full year top line and earnings performance exceeded our expectations in EMEA particularly in the UK, Netherlands and Italy. And by client group we saw accelerated growth in the mid-market and public sector during the year. Productivity per teammate improved in each quarter throughout 2014 as our teammates matured in the new IT system and our sales execution became more rigorous. And we executed very well in EMEA to offset the effect of partner program changes in the software category to increase focus on program execution and deal profitability. In Asia-Pacific, fourth quarter net sales increased 4% year-over-year in constant currency. During the quarter we saw increased demand with mid-sized clients in New Zealand and Hong Kong that more than offset softness with large clients in Australia. With the effect of partner program changes and lower volume with larger clients resulted in a decrease in earnings year-over-year in the quarter. Full year highlights for Asia-Pacific business include the migration of our APAC business on to the IT system that’s in places in North America which was completed in the second quarter. This transition has gone very well and we are pleased to have concluded this last big step in our IT global integration initiatives. Our APAC business which is mostly comprised of software sales was also impacted by our partner program changes in 2014. But our team optimized the program in key areas, driving higher sales of cloud offerings and increasing sales to the public sector which allowed us to substantially mitigate the changes imposed during the year. Moving on 2015 operating plans, across the markets where we do business industry analysts expect low single-digit growth in hardware sales in 2015 and mid single-digit growth in software and services sales. Our plans for 2015 are focused on driving growth in excess of market across our market – our operating segments. However, given recent weakness in major global currencies against the U.S. dollar, we expect that our reported growth in U.S. dollars will be in the low single-digits. As we head into 2015 I am optimistic about the opportunities available to us to bring value to our clients, partners, teammates and shareholders. The IT industry is healthy and we believe that our global scale, deep datacenter penetration software and services capabilities position us well to compete in a marketplace in 2015. In North America in 2014 we increased our investments in our sales and services organization. This year we will continue to invest in field sales as well as software services and cloud specialty sales position in the business. These investments are critical to driving our short and long-term strategic plans. In the corporate space our strategy in 2015 is to earn new clients and more business with existing clients through our core competencies around software and e-commerce and to bring additional value to our unique technical and consulting services capabilities. We will also focus on gaining market share in key verticals including healthcare and service provider as well as the public sector particularly in the Federal and K-12 space. And we will continue to execute our profit improvement plans at the account and partner level which we believe will continue to enhance our profitability. In EMEA we will continue to expand on the momentum we built in 2014. We remain focused on driving sales excellence in our core business and expanding our client portfolio with cloud offerings to consulting services. Strategic partnerships with vendors and service delivery partners will allow us to provide additional license optimization services, cloud assessment and deployment services and a lot of remote collaboration solutions to our clients in 2015. This is the first phase of a multi-year initiative to bring value-added services offerings to clients in the region. Finally, in Asia-Pacific, our plans are focused on penetration in the mid-market and the public sector and the development of more specialized software services capabilities particularly in the area of software asset management and the cloud. Also in 2015, we expect to implement a new and integrated customer relationship management and marketing automation tool to better enable our sales management efforts in the region. I will now hand the call back over to Glynis who will discuss our full year 2014 financial results in more detail.

Thank you, Ken. For the full year 2014, consolidated net sales were $5.3 billion, an increase of 3% year-to-year in U.S. dollars and also 3% in constant currency. North American net sales increased 3% to $3.6 billion with growth reported in all three categories, hardware, software and services. In EMEA, net sales increased 5% year-to-year to $1.5 billion and increased 3% in constant currency. Hardware and services sales in EMEA grew a healthy 9% and 5% respectively, while software sales were flat year-over-year in constant currency. In Asia-Pacific, net sales of $214 million increased 4% in U.S. dollars and 10% in constant currency. Full year 2014 consolidated gross profit was approximately $712 million, up 2% and gross margin of 13.4% decreased 20 basis points year-over-year. This decrease was driven primarily by partner program changes, which resulted in approximately $14 million in lower gross profit in our software category, primarily in North America. Selling and administrative expenses for the full year of 2014 were $577 million, an increase of 2% year-to-year. In North America, SG&A increased $10.6 million year-over-year. This increase included the $5.2 million non-cash charge related to our Illinois real estate recorded in the second quarter. We also invested in additional sales and technical resources in North America and experienced essentially higher medical benefits expenses during the year. In EMEA, SG&A expenses were flat year-to-year in U.S. dollars and down $3.2 million in constant currency in 2014. The decrease in constant currency was due to restructuring actions taken during 2013 partly offset by increased variable compensation on improved financial results in 2014 and also investments to support services and cloud growth in the future. In Asia-Pacific, expenses increased to $2 million year-to-year in constant currency due to headcount investments and planned expenses related to our IT systems project that was completed in the second quarter. As a result of additional restructuring activities in EMEA and the continued review of resource needs in North America, we recorded severance and restructuring expense of $4.4 million in 2014 compared to $12.7 million in 2013. Earnings from operations were $131 million in 2014, an increase of 8% from 2013. Excluding severance expenses and the non-cash real estate charge, earnings from operations were $141 million, up 5% year-to-year. Our effective tax rate in 2014 was 39.1% compared to 38% in 2013. The increase was primarily due to an increase in valuation allowances on foreign tax assets in 2014 and the recognition of certain tax benefits in 2013 partially offset by an increase in foreign income tax at the end of federal rates in 2014. And finally, diluted earnings per share came in at $1.83 on a GAAP basis and excluding severance expenses and the real estate charge, diluted earnings per share were $2, up 7% from $1.87 reported in 2013. Moving on to our cash flow performance, for the year ended December 31, 2014, our operations generated a $110 million of cash, up approximately 45% year-over-year due to working capital timing differences year-over-year. We invested $10 million in capital expenditures in 2014, down from $19 million in 2013 reflecting lower IT spending as we have not completed our global IT systems integration projects. And we spent $50 million in 2014 to repurchase approximately 2 million shares of our common stock. As of December 31, 2014, we have $17 million remaining under current authorization. All of this led to a cash balance of $165 million at the end of 2014, of which $148 million was resident in our foreign subsidiaries and we have $61 million of debt outstanding under our debt facility. This compares to $127 million of cash and $67 million of debt outstanding at the end of 2013. And from the cash flow efficiency perspective, our cash conversion cycle was 24 days in the fourth quarter of 2014, a decrease of 3 days year-over-year as a result of higher payables outstanding in North America driven by the timing of payments due to suppliers in the quarter. One more item before I turn the call back over to Ken. This week our Board of Directors approved an authorization to repurchase an additional $75 million of our common stock. These additional share repurchases will be made on the open market through block trades or through 10b5-1 plans. Subject to market conditions we plan to commence this program this quarter. Over past two years we have repurchased over 5 million shares of our common stock, deploying $108 million of cash on to this initiative. Our capital structure remains healthy with sufficient capacity to support our internal investment plans and also this new repurchase program in 2015. I will now turn the call back to Ken for his final comments.

Thank you, Glynis. Moving on to our outlook for 2015, for the full year 2015 we expect our business to deliver top line growth in the low single-digits in U.S. dollar terms. We also expect diluted earnings per share for the full year 2015 to be between $2.10 and $2.20. This outlook reflects an average U.S. dollar to euro currency exchange rate of $1.05 and an average U.S. dollar to British pound currency exchange rate of $1.45. The adverse effect on gross profit of previously announced partner program changes in the software category which the company expects to be between $5 million and $10 million, an effective tax rate of 37% to 39%, the completion of our current share repurchase program of up to $92 million leading to an average share count of approximately 38 million shares for the year and capital expenditures of $10 million to $15 million. This outlook excludes severance and restructuring expenses. Thank you again for joining us today. I want to thank our teammates, clients and partners for the dedication to Insight. This concludes my comments and we will now open the line up for your questions.

[Operator Instructions] Our first question comes from the line of Brian Alexander from Raymond James, your question please.

If I just do the math Ken on your share count, it looks like most of the EPS growth in 2015 is coming from lower share count, I just did the math real quickly as you were talking. So I guess my question is as you guys think about the $2.10 to $2.20 in earnings, how do you expect that overall earnings growth, I think EPS should be up 7.5% at the midpoint, how does that breakdown in terms of revenue, margin expansion and share reduction?

I will take that one. So as you think about the guidance, you are correct. We expect that on actual dollar basis that our EFO will be flat on the year-over-year basis. However, in constant currencies, we will see an increase of about – in the low single-digits from an EFO perspective. Our plan currently calls for low single-digit revenue growth in actual dollars, in constant currency we anticipate that our revenue growth will be around the mid single-digit range in constant currency. As Ken point out in the guidance we have some headwinds from Europe primarily and a little bit also from Australian dollar. So we anticipate that with the continued investments that we are going to be making, we will have some growth in revenue, some growth in the GP line we will actually be growing our SG&A faster than our GP in actual U.S. dollars such that – on that basis our EFO will be flat. This share repurchase actually will then get us back to the range that we indicated of the $2.10 to $2.20.

That’s great, Glynis very helpful. In terms of the revenue growth in constant currency being in the mid single-digits, is that something you would expect to be occurring in all the regions or do you think the North American growth will be faster than the rest of the world just trying to get a sense for what are you guys – what are you expecting to be growth by region, but that also underneath that what are some of the key product areas that you expect to really contribute to 2015 growth?

Yes. Thanks Brian. This is Ken. Yes, so I think we would expect that mid single-digit growth as we have talked about overall in constant currency and we would expect that North America will be a little faster than that. The key areas of growth that we would expect certainly would be in the services side of the business overall. We think also the software side. And in the hardware side, I think we are all going to see more normalized rates in desktops, notebooks with the XP refresh certainly being in its tail end and then of course I think we are all starting to see Windows Server 2003 end-of-life end-of-service actually starting up and we expect that to be significant growth for 2015.

And then the final one for me is just on the gross margin decline in North America, how much of that was related to the software program change and when are you guys expecting to see gross margin expansion again in North America given the commentary around software services mix improving going forward? Thank you.

So, I think, Brian, most of that decline in North America would be related to the partner program changes. We had – in North America, we had $11 million of the $14 million that we talked about earlier occurred in North America for the year in terms of the reduction in gross profit associated with the partner program changes.

And going forward, Brian, as we talked about we expect that to be sort of $5 million to $10 million impact globally for us and we think that we would hopefully be able to mitigate much of that.

And most of that $11 million as you remember is a 100% margin business, 100% margin.

So, what’s just kind of the outlook for North American profitability? I think you might have said in your prepared remarks probably no growth in operating income in the first half, but growth in the second half. Did I hear that right?

Yes, that is what we said – that’s what Ken said.

Got it. Okay, thank you very much.

Thank you. [Operator Instructions] Our next question comes from the line of Nikhil Kumar from Stifel. Your question please.

This is Nik Kumar for Matt Sheerin. Just quick question on kind of internal investment you guys are making, so can you talk about like what’s your plan hiring sales and technical resources this year and how should we think about SG&A for ‘15?

We have a plan in terms of increasing our hiring in North America, primarily also a little bit in APAC and very, very small amount in EMEA. So, right now, our plan is that our SG&A is going to grow slightly faster than our gross profit in actual dollars. There is a little bit of the currency impact as it relates to EMEA. So, on a constant currency basis, EMEA SG&A will be growing as well although it will be at a slower rate than what’s happening in North America. The primary source of our investments this year, are around sales and sales-related and technical resource in North America.

Okay. And are you expecting any like savings since your global IT rollout is complete, so that should help out something or it’s like maybe more in ‘16?

I think that we feel the benefits from the IT initiatives I think are reflected in our numbers namely in 2014. We will see possibly a little bit of benefit in APAC in 2015, but our plan is to reinvest those dollars in terms of building out and upgrading the talent in APAC to support more of the services and cloud activity.

Okay, perfect. And lastly on, I mean, last earnings call you guys talked about like lower vendor rebates and I think this quarter also you saw some impact right. So, I mean, going forward, should we think as a new norm or you think maybe the volumes pickup so that should revert back to the normal?

Well, I think that the program changes that we talked about in the software category, I will take that one first they are actually a lower number this year than they were last year. So in the programs we rolled out, it’s a 3-year program, it impacts over a 3-year period. As it started up last year at this time when we were giving guidance, we said it is going to be roughly $15 million to $20 million impact from that software program change. It turned out to be slightly less than that than we have updated guidance during the year. This year we think it’s a $5 million to $10 million impact associated with that same program change. And if you wanted to go into 2016, it would be less than that.

Okay, thank you.

So, there are other program changes that are occurring. Each partner has the program – potential program changes, HP, Cisco, any one of our other partners out there have potential program changes, but nothing of the same magnitude that we had with the software partner.

Okay, perfect. Thank you.