Insight Enterprises, Inc. (NSIT) Q3 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Insight Enterprises Third Quarter 2015 Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to turn the call over to Ms. Glynis Bryan, Chief Financial Officer. You may begin.

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, 2015. 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 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 28, 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 third quarter and year-to-date 2015 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. 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, 2014. With that, I will now turn the call over to Ken to give you an overview of the third quarter 2015 operating results. Ken.

Hello everyone. Thank you for joining us today to discuss our third quarter 2015 operating results. In the third quarter our team delivered double digit sales and gross profit growth in constant currency and we controlled discretionary expenses, which resulted in strong earnings growth year-over-year in the quarter. Consolidated net sales of $1.34 billion increased 8% year-over-year in U.S. dollars. Excluding the effects of current changes net sales grew 13%. Gross profit was $182 million in the third quarter, up 6% in U.S. dollars and up 11% in constant currency and gross margin in these sales declined 30 basis points year-over-year to 13.6%, due primary to the low margin in the hardware category in North America and EMEA. Consolidated selling and administrative expenses were $149 million in the third quarter, an increase of 4% year-over-year in U.S. dollars, and excluding the effects of currency changes SG&A expenses increased 9% year-over-year reflecting planed investments in sales, technical and services headcount across the business. Consolidated earnings from operations increased 19% year-over-year to $34.3 million, excluding severance expenses in both periods and the real-estate charge in this year’s third quarter. On a GAAP basis earnings from operations increased 15% to $32.6 million. Below the line EFO, we recorded $600,000 in non-operating expenses, including interest expenses and foreign currency gains, which was down from $2 million last year and our tax rate for the quarter was 35%. All of this led to diluted earnings per share of $0.59 on a non-GAAP basis and $0.56 on a GAAP basis. North America net sales increased 15% year-over-year with double digit growth reported in each of the hardware, software and services categories. For the second time in the company’s history North America quarterly net sales exceeded $1 billion. Q3 is a seasonally strong quarter for our public sector business in North America and this year was no exception as we saw strong fiscal year and spending in the federal space, as well as strong growth with state and local government encasing to all clients. In addition we continue to see elevated spending by our large enterprise clients. Our strong top line results in North America so far this year have been fueled by significantly higher spending on notebook and device refresh, server upgrade and network infrastructure projects by large enterprise and public sector clients. In the hardware and services category we have benefited from growth in these existing accounts, as well as large accounts recently added to our portfolio, and in the software category a federal team has experienced significant growth with new client wins and cross selling into existing clients. As we head into the fourth quarter we are seeing sales trends moderate in North America due to completion of certain multi-quarter projects and to a more challenging year-over-year comparison following nice growth in last year’s Q4. In EMEA net sales increased 6% year-over-year in the third quarter with hardware increasing 5%, software increasing 8% and services sales up 12% compared to the third quarter of last year, all in constant currency. The increase in hardware sales was due to higher volume with corporate clients, most notably in the client devices storage and networking category. The increases in software and services sales were driven by higher volume of virtualization software and professional services to new and existing clients across the region. In Asia Pacific third quarter net sales decreased 7% year-over-year in constant currency due to lower volume with existing clients, primarily in Hong Kong and China. The market continues to be relatively soft and our execution has been mixed across the region, which has led to lower than expected financial results in our Asia Pacific business this year. We continue to hold our top line share positions with key publishers in our largest markets and we are working to expand our cloud and professional service capabilities, as well as select hardware relationships in the region. We believe these actions will help diversify our revenue sources in the market in 2016 and beyond. One more update before in hand the call over to Glynis. I’m pleased to announce that effective October 1 we acquired BlueMetal, an interactive design and technology architecture firm based in the Boston area with offices also in Chicago and New York. BlueMetal delivers strategic design, application development and business inelegance solutions with expertise serving financial services, healthcare, public sector and retail clients in the U.S. We believe this acquisition strengthens our services capabilities in the areas of application design, mobility and big data and are excited to introduction our BlueMetal capacities to our existing strong client base. Over the last 12 months BlueMetal generated approximately $25 million in net sales. We expect the transaction to be largely neutral for our Q4 2015 and full year 2016 earnings performance. I will now hand the call over to Glynis, who will discuss our year-to-date third quarter financial results in more detail. Glynis.

Thank you, Ken. For the first nine months of 2015 we are pleased with our sales execution across the business. Consolidated net sales of approximately $4 billion are up 3% year-over-year in U.S. dollars and up 9% in constant currency terms. In North America net sales have increased 10% year-over-year in the first nine months of 2015 with particularly strong growth in large enterprise and public sector accounts, due to new client wins and penetration of existing accounts. In EMEA net sales year-to-date are up 4% year-over-year in constant currency with solid top line performance in the UK, Netherlands, Germany and the Nordics. And in Asia Pacific net sales are down 5% in constant currency due to lower volume with existing clients in Australia and China, as well as a higher mix of software maintenance sales, which are recorded net in our financial statements. Consolidated gross profit for the first nine months of 2015 was $535 million, up 1% in U.S. dollars and up 6% in constant currency. Gross margin was 13.4%, a decrease of 30 basis points compared to the same period last year. This decrease is primarily due to decreases in hardware margins in North America and EMEA due to client and product mix transactive this year, partially offset by the effect of 20%-plus increase in services sales in the first nine months of this year. On the SG&A front consolidated selling and administrative expenses were $438 million, up 1% year-to-date in U.S. dollars and up 6% in constant currency. This increase is driven by headcount investments, primarily in sales and services in North America and EMEA and higher available compensation on higher sales and gross profit this year. As a percent of net revenue however SG&A expense excluding the impartment charges are down 10 basis points to 11%. Moving down to P&L, as a result of our continuous review of our organizational structure in North America and in EMEA we recorded severance and restructuring expenses of $1.9 million in the nine-months ended September 30, 2015 compared to $1 million for the same period in 2014. Consolidated non-GAAP earnings from operations were $99 million in the first three quarters of 2015, down 3% year-over-year in U.S. dollars, up 1% in constant currency terms, excluding the non-cash impairment charges and severance expenses in both periods. And new to this year our pronounced exchange change volatility, this 4% swing is having a notable adverse effect on our U.S. dollar EFO comparison year-over-year. Our effective tax rate year-to-date through September 30 was 37.1%, down from 37.4% last year. Moving on to cash flow performance, our operations generated $25 million of cash in the first nine months of 2015 compared to $48 million in the same period last year due to increased working capital utilization to support higher growth. We invested $11 million in capital expenditures in the first nine of months of 2015, up from $8 million last year and we spent $92 million to repurchase approximately 3.3 million shares of our common stock. This is compared to $30 million of share repurchases in the first nine months of 2015. All of this led to a cash balance of $148 million at the end of the quarter, up to $121 million as resident in our foreign subsidiaries and $85 million of debt outstanding under our debt facility. This compares to $127 million of cash and $52 million of debt outstanding at the end of last year’s third quarter. As from a cash flow efficiency perspective, our cash conversion cycle was 27 days in the third quarter of 2015, a decrease of 3 days year-over-year due to expanded use of our inventory financing facility. I’ll now turn the call back to Ken.

Thank you, Glynis. Moving on to our outlook for 2015, for the full year 2015 we continue to expect top line growth in the low single digits in U.S. dollars terms and in the fourth quarter we expect diluted earnings per share to be between $0.56 to $0.61 and for the full year diluted earnings per share is expected to be between $2.10 and $2.15. This outlook includes the adverse effect in gross profit of previously announced partner program changes in the software category, which the company expects to be approximately $8 million for the full year 2015 and an effective tax rate of 38% for the fourth quarter, and average common shares outstanding of approximately 38.3 million for the full year 2015. This outlook excludes severance and restructuring expenses incurred during the year and the non-cash real-estate impairment charge recorded in the third quarter. 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.

Thank you [Operator Instructions]. And our first question comes from the line of Matt Sheerin with Stifel. Your line is now open.

Yes, thanks. Good afternoon. Just a couple of questions from me Ken. Just regarding your guidance for the fourth quarter, I know you talked about tough comps year-over-year. It looks like on a sequential basis based on what you’ve done in the past, it looks like it’s going to be lower than normal and I’m just wondering if that’s just a function of beating expectations for September or are you seeing anything on the demand front where customers are a little bit more cautious about spending, whether you might see some push outs. I’m just trying to figure out the guidance there.

Matt I’ll take that one. I think ultimately when we look at the results we had a better than expected Q3, specifically as it relates to the public sector and one of the business that we won around the public sector business in Q3 and also as it relates to our large enterprise clients, we have some initiatives that we’ve been driving through the years related to both product and services that are kind of wrapping up with some large clients at the end of the third quarter. And then starting in probably September, we saw a little bit of a slowdown in terms of our bookings associated with hardware in particular going forward. So the guidance that we are giving here for the fourth quarter is reflective of the mix that we’re seeing in the shift, that we’re seeing between primarily the large enterprise clients in terms of our expectations of what’s going to happen to them in the fourth quarter, and probably – I’m not sure if your factoring in the North America statement, I’m not sure if your factoring in the currency effect on a year-over-year basis, that also would impact Q4 with EMEA particularly.

Okay, so that slowdown that you saw, that was North America and...

That was North America.

Okay, and I guess the trends in Europe have not been great to begin with.

I’m sorry; the trends in Europe on a constant currency basis are okay. I mean I think they are in the low single digits, 1% [ph] or so but not on an actual dollar base.

Okay. I know with the gross margin there was moving parts there. Is your guidance reflecting gross margin to be down year-over-year again?

Yes.

Yes, okay. And then on the cost side it looks like you’ve done a good job of managing costs and at the same time making investments. So what should we be thinking about SG&A. Are there any tweaks in terms of costs coming out, all set by investments. What should we be thinking about there?

I think that as you think of it from a sequential basis, I think you should anticipate that SG&A is going to be relatively flat Q3 to Q4 most likely. We are controlling SG&A growth in other areas of the business to support the technical and sales investment in SG&A that we are making going forward, but I think in general you should anticipate between Q3 and Q4 that there’s going to be a little bit of a flat – SG&A is going to be relatively flat between the two quarters and we are not making any commentary about 2016 yet.

Got you. And just with regarding to the public sector, because you called it out as a bright spot. I mean I know that hasn’t been really a significant percentage of your revenue. It sounds like your starting to grow that business. Could you give us an idea? I think it was around about 5% or 8% of your revenue. Is it still in that ball park or is it higher?

It’s higher, I’d say double digits.

You’re saying double digits and that’s mostly of your North America business then, right.

We have a pretty strong presence in APAC in public sectors as well. This growth that we’re talking is more specific to North America, but we have a strong APAC public sector presence and we have a strong UK public sector brand as well and it is …

And Matt, in that so much of it just the investments that we made years ago and making sure we got on these contracts like NetCents and SEWP [ph] going back. The process was five years ago, literally getting – putting the plans in place to get on these contracts and those have come to fruition and we put a lot of the headcount that we invested in and that we discussed and we’ve added into those specific areas. So we’re seeing the benefits there. But it was also, it wasn’t just fed, it was K312 [ph] grew very nicely as well as state and local. So, some good spending by the – in the public sector space in all those areas.

Okay, and Ken what do you make of the EMC-Dell merger and any impact on your business and then just consolidation, the HD spin-out, other things within the vendor community and how that might impact Insight.

Yes, on the HP front, that’s gone very smoothly as you know. They pretty much trialed, the quarter that we’re in and they go live of course next week. But they’ve operated that way for years with us. So for us we really saw a very minimal impact in the people that we deal with and all the programs and so forth. So I’d say so far so good. We’re really seeing no disruption. We had virtually no issues at all from an IT point of view and they flipped the switch a few months back. So I don’t think we’re going to see really any changes. The leadership alignment that we have with them is again very, very consistent, that we’ve had in the past. So that looks to really be virtually no impact to us at this stage of the game. We continue the same levels of dialog with those different sides of the house as we had before. On the Dell-EMC front, I think lots of discussions there. We have a strong relationship with both companies. We were, you might know, just announced as actually Dell’s partner of the year this year, this past week, so we are doing some good things there. We have a strong partnership and all indications that we’ve had from Dell is Business As Usual. Of course this can take probably nine months before a lot of this comes together, but all the indications are that we should see things pretty much operating the same way as we had in the past. We think that there will probably be a little bit tighter alignment for us, especially with the storage footprint, because we are stronger with Dell than we were with EMC. We think bringing them together will actually probably help our business overall when they start bringing that together. So we remain to be optimistic in regards to how that will play out for us.

Okay, that’s it from me. Thanks for your time.

Thank you [Operator Instructions]. Our next question comes from the line of Brian Alexander with Raymond James. Your line is now open.

All right. Good evening guys. I just want to follow up on Matt’s questions. So the fourth quarter guidance I guess is confusing to me. You are not really looking for much growth on a year-over-year basis in revenue and your guiding EPS basically flat sequentially. It’s normally up strong double digits. So I know Q3 was better due to public sector. It sounds like you had some upside surprise there and that this won’t spill over into the fourth quarter. But it looks like the Q4 forecast is actually coming down from what you would have thought three months ago on an absolute basis. So in other words, all the upside you saw in Q3 is coming at the expense of Q4, given that your full year guide is basically unchanged for earnings, that’s the part that I’m struggling with. The slowdown in bookings that you saw in September, it sounds pretty dramatic for you to actually be reducing your fourth quarter forecast from what you would have thought three months ago.

So Brian, I think you made a couple of different statements there and I would say in general you are trending correctly. So we have the second half of 2015 is playing out as we had anticipated and we gave the guidance back in July. There’s been a flip between Q3 and Q4. So I’m going to separate out the kind of below the line $0.05 or so that is currency gains and tax rate benefit. We actually outperformed our expectations in Q3 and what we saw towards the back end of Q3 were a couple of things. One is the slowdown that we talked about with regard to one, some of the unique growth projects that are wrapping up that we were coming to the conclusion on in Q3, very little of it rolling into Q4. We have new projects ramping up, but not at the same pace of the projects that were in Q3, Q2 and Q3 actually. We have a bit little weaker performance in APAC than we had anticipated. So APAC did not perform as we had anticipated at the end of Q3. So we we’ve adjusted the forecast going into Q4. We’ve got our expectations from APCA and albeit small it does have an impact on our overall number. I think we also have a little bit of [indiscernible] as well that relates to our EMEA operations, specifically around hardware margins. We had anticipated that we would start seeing an improvement in hardware margins in EMEA in the second half of the year and that is actually not playing out as we had anticipated. We didn’t see that in Q3. We are seeing some growth definitely, but we are not seeing the margin impact that we had expected, partly because of the mix of business. We are not getting as much of the mid-market or corporate as they call that business as we anticipated. It’s more of a large enterprise related. It’s a combination of those things that have moderated our Q4, but we would say that the second half is performing and hitting the exceptions that we had laid out in July.

Are you actually seeing demand weakens in large enterprise in North America or are you just seeing the conclusion of some multi-quarter projects that you knew were coming to a close, maybe they are closing sooner than you thought? I’m just trying to differentiate between that and whether you are seeing a broader demand deterioration.

I think it’s a little bit of a combination of both, but I would say it’s more of the former. So we always anticipate that when a project is coming to an end that there’s going to be another piece of the project that we are doing and attach on a go forward basis. So some of the projects are coming to an end and clients are taking a pause before they go forward. There is some noise in the economy about the strength of the economy and what’s happening there. So I think that that is the key pieces that are ultimately – and then we have a strength in our Q4 of last year. We actually started to see the sunshine on North America in Q4 of last year. So it’s probably a strongest fourth quarter last year. So a little bit of that is impacting us now and yes, we did know that when we were giving you the forecast at the beginning of year, back in July as it related to the second half, but it’s really a shift between the two quarters.

Any comments on the SMB space; are you seeing the pause there as well or is this mostly in enterprise?

It’s probably mostly in enterprise Brian. The SMB space was relatively flat. We didn’t see near the growth that we did in the larger and enterprise clients that’s certainly holding its own, but relatively flat.

And then just on the clients pausing in enterprise, is there any specific product areas where you’d say that’s happening more than others. Is it more on the client side where you saw some pretty strong notebook refreshes winding down or is it more on the data center side?

We did see a nice uptick, which is pretty countercyclical to what most people are seeing and in regards to seeing that notebook refresh still occur. But I’d say that we are certainly in the very late innings of that, so we don’t expect that, we don’t – any visibility that that’s continuing into Q4. So it’s probably more of that normalizing towards I think the rest of the channels I think.

And then just kind of on margins. I know it’s been a challenging year for operating margins for lots of reasons, investments and the issue with your vendor funding impacting gross margin. Your Q3 margins were up, of course that was on a very strong revenue quarter. Q4 looks like it’s tracking to be down 20 basis points or so on a year-over-year basis. So my question is, when do you think we’ll start to see a more consistent margin improvement on a year-over-year basis and from a growth standpoint as you think about next year, any early thoughts on what you think is in store for the overall market and whether you think you can do better than that.

I think that we will – as we continue to enter the space we’ll see some pressure on our gross margins going into 2014, not to the extent that we think we are going to see a continued decline – sorry ’16, 2016. Not to the extent that we think we would anticipate a further decline and that is how though kind of year-to-date Q3. I think that we would anticipate they would flatten out some. We are growing our services business at a pretty good rate in North America and in EMEA particularly and Microsoft program changes are kind of triggering out at this stage and ultimately we anticipate that we will start to see some improvement in gross margin, albeit small going into 2016. We would anticipate improvement in the leverage on the fall through of the business, because we are not going to be making the same level of SG&A investments in 2016 that we made in the past two years. And from an operating income perspective we would expect to see improvement in operating income relative to this year.

And just thoughts on overall revenue growth for next year.

I’ll tell you that in February. We’ll continue to believe that we will go higher, faster than the market, but we’ll give you a little bit more specific detail about how much faster than the market in February.

So last one would be, you guys were able to achieve a 2.9% operating margin back in 2012 when you were generating $5.3 billion in sales and I know that seems like a lifetime ago. My question is, what level of revenue do you think you need to see to get back to that kind of operating margin or if you want to think about it more as a 3% counter official target, I mean what’s kind of the revenue level you think we need to achieve to get back to that kind of level.

That’s one of the easiest questions to answer. So part of the reason for the margin degradation is because of the Microsoft program changes or the changes with regard to how it is we – the fee income that we get from our software vendor that we have ultimately. So that has actually had an impact on our business. I think we said that we were $10 million to $15 million in 2014. We just said we were anticipating about $8 million this year. I can’t remember off the top of my head what we said for 2013. That actually has had an impact on the gross margin, much more significantly on the gross revenue. So to the extent that we can grow our services business, its smaller today, but to the extent that we can grow our services business, that as we said before 25% plus margin business, we had some good growth in that this year and to the extent that we can maintain our hardware margins and increase the mix of SMB clients in the overall growth portfolio, all those pieces would drive to higher gross margins and higher EFO margin. The other big pieces that we’ve specifically had are our strategy around investing in sales and technical resources, both in 2014 and in 2015. It’s not that we are not investing in those resources going into 2016, but not at the same pace and that actually will have a impact also on driving the operating income margins, it’s not just a revenue today. Long answer to your question, but it’s got a couple of different pieces impacting it.

And finally, just any change to your cash flow outlook. I think you’ve historically said somewhere between $80 million to $120 million of operating cash flow. So to get to the mid-point of that you’d have to generate somewhere around $75 million in the fourth quarter, which relative to the last year seems like its pretty optimistic, but perhaps there’s some timing in working capital that can help you in the fourth quarter relative to the third quarter?

Actually we were at that. For the full year we ended up at $68 million in Q4. So I think that we continue to say that his business, I think we would have said $80 million to $110 million, not to about $120 million, but we historical said $80 million to $110 million. We still feel the business is in that range on a full year or 12 month basis.

Okay. Thank you.

Thank you. End of Q&A