Insight Enterprises, Inc. (NSIT) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Insight Enterprises Fourth Quarter and Full Year 2015 Operating Results Conference Call. At this time, all participants are in a listen-only mode to reduce background noise, but later we will be conducting a question-and-answer session. Instructions will follow at that time. [Operator Instructions] I would now like to introduce your first speaker for today Ms. Glynis Bryan, Chief Financial Officer. You have the floor ma'am.

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, 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 Web site 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 Web site 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 Web site for a limited time. This conference call and the associated webcast contain time-sensitive information that is accurate only as of today, February 10, 2016. 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 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. Ken?

Thank you, Glynis. Hello everyone, thank you for joining us today to discuss our fourth quarter and full year of 2015 operating results. For the fourth quarter of 2015, consolidated net sales were 1.4 billion down 4% year-over-year in U.S. dollars and down 1% in constant currency. By operating segment year-over-year we saw growth trends soften in North America, while the EMEA and Asia Pacific businesses reported low single-digit declines in sales all in constant currency. Gross profit was 181 million in the fourth quarter, down 1% in U.S. dollars but up 3% in constant currency reflecting gross margin expansion in all three of our operating segments. Gross margin increased 40 basis points year-over-year to 13.0%, this increase was primarily due to a higher mix of services sales which were transacted at gross margins notably higher than our corporate average and an increase of performance-based partner funding across core products offerings. Consolidated selling and administrative expenses were 147 million in the fourth quarter up 3% in U.S. dollars and 6% in constant currency, reflected investments in sales, technical and services headcount across the business. Earnings from operation excluding the severance and restructuring expenses decreased 13% to 33.5 million. On a GAAP basis earnings from operations decreased 13% to 30.5 million and diluted earnings per share excluding severance and restructuring expenses increased 4% year-over-year to $0.57, on a GAAP basis diluted earnings per share were $0.50 also up 4% year-over-year. Within these results the North America business reported 1% top-line growth in constant currency. In the hardware category we continue to see solid growth in client devices and displays, this growth was partially offset by lower service sales resulting from the end of life Microsoft Window Server 2003 and the completion of certain multi coded network deployments. In the Software category, public sector clients increased their spending for business productivity solutions, but reported software sales declined year-over-year due to higher mix of maintenance sales which were recorded net in our financials. And in the service category we added BlueMetal, an interactive design and technology firm to our portfolio of service offerings on October 1st, which led to a 4% improvement in sales in that category in the quarter. Gross profit in North America in the fourth quarter grew slightly faster than sales due to effective SG&A investments made over the past three quarters led to a decline in earnings from operations year-over-year. As we look back at the North America business in 2015 there are quite a few areas that we are excited about. Hardware sales grew 7% for the year ahead of our internal expectations and outperformed the market according to third-party data. Our software business in North America performed well in 2015 growing 5% overall, including a particularly strong performance in the public sector space where we grew more than 30% by adding new clients and continuing to cross-sell and grow within our existing portfolio. And our services sales grew 20% in 2015 reflecting the benefits of expanding our solutions capabilities and investing in the right talent over the last few years. And as part of our continuing efforts we delivered clients relevant technology solutions, we completed the acquisition of BlueMetal in the fourth quarter of 2015. Integration activities are underway and we are excited about the ability to bring BlueMetal’s application design, mobility and big data solutions to our clients. From a profitability perspective gross margins in North America in 2015 were pinched by higher mix of device sales of a larger enterprise and public sector clients and the effective lower fees earned on software enterprise agreements. But our team executed well to optimize partner funding under core partner programs and increase the mix of higher margin services gross profit in the portfolio, which helped mitigate some of the margin compressions. And as committed we invested in sales and technical resources in 2015 adding more than 100 selling resources to the business that we believe will position us well to continue to grow in 2016. In EMEA net sales decreased 4% year-over-year in constant currency in the fourth quarter, reflecting lower software sales to large enterprise clients that were partly offset by a 29% increase in services sales. The gross margins expanded by over 100 basis points and the team controlled expenses which drove non-GAAP earnings from operations up 7% year-over-year in the quarter. Our EMEA business is stronger today than in recent years, our management team has matured, our sales execution has improved, and the strategy to transform to a solutions and services selling model were showing progress. For the full year of 2015 our EMEA business grew top-line by 2% in constant currency terms and gross profit by 2 times that weight due partly to over 20% growth in cloud and other services sales. We delivered improved financial performance in France and Germany, where we have struggled in recent years and continue to execute well on our strongest businesses in the UK, Italy, Nordics and Netherlands. Currency exchange rates dampened our reported results all year. We are pleased with the performance of our EMEA business overall, where 2015 non-GAAP earnings from operations grew high single-digits in constant currency terms. In Asia Pacific, fourth quarter net sales decreased 4% year-over-year in constant currency. During the quarter, we saw increased demand in Australia and New Zealand and softness in China and Singapore. In addition, the top-line results were affected by a higher mix of netted software sales year-over-year. Gross profit dollars increased in the fourth quarter of 2015 which drove earnings from operations up in constant currency terms. Q4 represented a solid close to a tough year for Asia-Pacific business. For the full year of 2015 the softer economy drove our top-line down by 5% constant currency compared to 2014 and our APAC business which is mostly comprised of software sales received $4 million less in incentives due to partner program changes in this category. Our team continued to execute our strategy to grow cloud and professional services capabilities and expand hardware sales in the portfolio, but could not offset the effects of the economic downturn in the region and the program changes. I will now hand the call over to Glynis, who will discuss our full year 2015 financial results in more detail, Glynis?

Thank you, Ken. For the full year of 2015, consolidated net sales were $5.4 billion, an increase of 1% year-to-year in U.S. dollars and 6% in constant currency. North America net sales increased to 7% to 3.8 billion with growth reported from all three categories of hardware, software and services. In EMEA, net sales decreased 11% year-to-year to $1.4 billion in U.S. dollars, but in constant currency net sales increased 2%. Hardware and software sales in EMEA grew 2% and 1% respectively, while services sales grew nicely at 24% all in constant currency. In Asia-Pacific, net sales of $178 million decreased 16% in U.S. dollars and 5% in constant currency. Full year of 2015 consolidated gross profit was approximately $716 million, up 1% in U.S. dollars and up 5% in constant currency. Gross margin in 2015 was 13.3%, down 10 basis points year-over-year. This decrease was primarily driven by partner program changes in the software category which resulted in approximately $8 million in lower gross profit in our software category about half in each of EMEA and APAC. Selling and administrative expenses for the full year of 2015 were 585 million, an increase of 1% year-to-year in U.S. dollars and 6% in constant currency. In North America, SG&A increased $24 million year-over-year. The prior year results include $5.2 million non-cash charge related to our Illinois real estate asset reported in the second quarter of 2014 compared to $800,000 recorded in the third quarter of 2015. We also invested significantly in sales and related headcount in North America and preferred a higher variable compensation on higher gross profit. In EMEA, SG&A expenses were down year-to-year in U.S. dollars but up 5% in constant currency in 2015. The increase in constant currency was due to increased investments to support services and cloud growth across the region. And in Asia-Pacific expenses increased 2% also in constant currency due to an increase teammate related expenses. And as a result of additional restructuring activities in EMEA and the continued review of resource needs in North America, we reported severance and restructuring expenses of $4.9 million in 2015 compared to $4.4 million in 2014. Earnings from operations were $127 million in 2015, a decrease of 3% from 2014. Excluding severance expenses and the non-cash real estate charges, earnings from operations in 2015 were $132 million down 6% year-to-year. Our effective tax rate in 2015 was 36.4% compared to 39.1% in 2014. The decrease was primarily due to reduced operating losses in certain foreign jurisdictions in 2015. And finally diluted earnings came in at $1.98 on a GAAP basis, excluding severance and expenses and real estate charges, diluted earnings per share were $2.11, up 6 % from $2 reported for 2014. Moving on to cash flow performance, for the year at December 31, 2015, our operations generated $81 million of cash, up 64% year-over-year. These results exceeded our historical average annual cash flow generation of 80 million to 120 million due to a single significant receivable received from a client in the fourth quarter, but for which the payment to the supplier as a result of timing only was due and paid in January. In 2016, we expect the payments to the supplier in January will have the opposite effect on our 2016 cash flow results. We invested $13 million in capital expenditure in 2015 up from $10 million in 2014 reflecting technology and facility enhancements made in 2015. And we spent $92 million in 2015 to repurchase 3.3 million shares of our common stock. And as discussed in the last conference call, we also purchased BlueMetal in the fourth quarter for a cash purchase price of $41 million, net of cash acquired and the assumption of $3 million of debt that was repaid at closing. All of this led to a cash balance of $188 million at the end of 2015 of which $169 million was resident in our foreign subsidiaries and we also had $89 million of debt outstanding under our debt facility. This compares to $165 million of cash and $81 million of debt outstanding at the end of 2014. And from a cash flow efficiency perspective, our cash conversion cycle was 20 days in the fourth quarter of 2015, a decrease of 4 days year-to-year as a result of the higher DPOs in North America driven by the single payment I just mentioned. One more item before I turn the call back to Ken. This week our Board of Directors approved an authorization to repurchase $50 million of our common stock. These share repurchases will be made on the open market to through block trades or through 10b5-1 plans. Subject to market conditions we plan to commence this program during this quarter. Over the past few years we have repurchased over 8 million shares of our common stock, deploying $20 million of cash on to this initiative. Our capital structure remains healthy, efficient capacity to support our internal investment plans and to repurchase program in 2016. I’ll now turn the call back to Ken to review our 2016 operating priorities and outlook. Ken?

Thank you, Glynis. Moving on to our 2016 operating plans, across the markets where we do business industry analysts expect flat to low single-digit growth in hardware sales in 2016 and low to mid single-digit growth from software and services sales. Our plans for 2016 are focused on driving growth and excess to the market across our operating segments. However getting continued weakness in major global currencies against the U.S. dollar, we expect that our reported growth in U.S. dollars in a low to mid single-digit range. The IT industry is healthy and constantly changing which provides opportunities for Insight continued to bring value to our clients, partners, teammates and shareholders. We believe that the investments we made over the past few years combined with our global scale, strong datacenter software and services capabilities position us well to compete in the marketplace in 2016. In North America over the past few years we have invested in sales and technical resources in the business particularly in support of large corporate and public sector accounts across the region. As we head into 2016, we are highly focused on helping our new reps improve their productivity and drive the return on our investments. Our strategy in the large corporate space in 2016 is to leverage our expanded salesforce turning new clients and more business with existing clients who are core competences around supply chain, software and cloud and to bring additional value to our technical consulting services capabilities. In the public sector we intend to expand our footprint in k-12 space leveraging our network and expertise in new markets. In the state and local space we will continue to grow our capabilities around public safety, while on federal space and business largely built around software, we will leverage newly won contracting vehicles to garner our share of the hardware spend by federal agencies. In addition to our strategies in large corporate and public sector markets, we have a number of initiatives underway to scale and expand our small to medium business go-to-market capabilities. In 2016 we will look at all faceted SMB sales engagement model including hiring, training, development and compensation as well as sales enablement through digital marketing, Web animation and cloud aggregation and look forward to updating you on this initiative throughout 2016. In EMEA we will continue to expand on our momentum that we gained for 2015 around our two pronged strategy, first we will continue to drive sales excellence in our core business and looks to expand our client portfolio with cloud offerings and consulting services. And second we will continue to grow our services capabilities focused primarily on lighting optimization services, cloud assessment and deployment services and modern workplace collaboration solutions. This strategy is critical to our long-term transformation into our client centric solutions company. Finally in Asia Pacific our plans are focused on penetration of the mid-sized and enterprise markets and the development of more specialized software services capabilities particularly in the areas of software licensing optimization services, cloud assessment, migration and management. Moving now to our outlook for 2016, for the full year 2016 we expect our business to deliver top-line growth from a low to mid single-digit range in U.S. dollars terms. We also expect diluted earnings per share for the full year 2016 to be between $2.25 and $2.35, this outlook reflects the adverse effect on gross profit of previously announced partner program changes and the software category which the company expects to be between 5 million and 10 million. An effective tax rate of approximately 37%, the completion of our recently authorized share repurchase program of up to 15 million, leading to an average share count of approximately 36 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 their dedication to Insight. That concludes my comments and we will now open your line up for questions.

[Operator Instructions] Our first question comes from a line of Matt Sheerin from Stifel. Your line is open.

Just a few questions, Ken on your just the commentary regarding the North America revenue being certainly less than we had expected and you are not the only one talking about some material weakness from U.S. customers. But the hardware number after being very strong in June and September certainly fell off, I am trying to understand the puts and takes of that, I know you went through a server upgrade cycle last year which would certainly help the beginning and middle of the year, and I know that there was some enterprise push outs, but could you just give us more color on what's happening there in terms of what your customers are saying? And as we get into this year your expectation for low to mid single-digit growth given where the starting point is in the seasonally weak quarter it seems like it could even be a little bit ambitious?

Yes thanks Matt for the comment, on the North America side as you saw we have revenue in constant terms was 1% growth. In the hardware category we did actually see good growth on notebook category and tablet category, so we did see continued growth that led to a little bit of margin compression with some of our larger clients where it's a little more competitive, but we did good growth there. And we did see as the networking category was challenged as well as other aspects of the datacenter being the server market. Some pretty tough compares year-over-year as well, but all-in-all that’s where we saw some of the softness in that regard. We are confident in what we're proposing as far as the 2016 outlook and that is sort of mid single-digit growth for the revenue side of the equation that is what we're seeing, so we think it's certainly a function of what we saw in some softness in Q4. Going into Q1, we do think that the revenue numbers are there, we'll see a little bit of still some margin compression for us as we go into Q1, but we do believe that we'll see growth in the hardware categories as we forecast into Q1 and obviously throughout the year.

Okay, like were you talking about gross margin compression on mix or is that [indiscernible] because you also have in the press release talked about your software vendors still weighting on your gross margin this year where they sound like another I think you said $10 million headwind on gross profit because of the software programs, is that right?

Yes, and that's you know we've been sort of experiencing that sort of now for quite a few years the last three years certainly that kind of numbers, so that is sort of now become all built in. We do hope that that will run off this year, but that's what the number of calls for this year in the software category.

Okay, and then just thinking about the guidance for the year, you've got the lower share count certainly helping you and then if you again just looking at sort of let’s say 3% to 4% revenue growth, it looks like based on the EPS growth you said you may see a little bit of a margin expansion but probably in the same range give or take the 5 or 10 basis points, I am trying to figure out whether gross margin can actually grow here given that you're talking about double-digit growth in services which is higher margin and also you do have that Microsoft headwind, but doesn't sound like that that's big, so I am trying to figure out whether you think gross margin can grow or what are the puts and takes for the operating margin number?

I think your analysis is correct when you look at the overall mix of business, we would anticipate the 5% to 10% expansion in overall EFO modules are very sound, we're getting some benefit ultimately from services with regard to higher margin sales and it does have a higher growth rate associated with it. However the base of business is actually the hardware and software business that's significantly larger than our services business, and we're anticipating a little bit of not margin compression but some margin pressure so we are not expecting significant expansion in margin in the hardware and software categories and we have that software effect that is 100% gross margin that impacts the overall margin profile so you are now -- this was spot on.

Thank you. Our next question comes from the line of Adam Tindle from Raymond James. Your line is now open.

Just wanted to ask about the additional gross profit headwind related to the partner program changes in 2016, first of all was all the gross margin headwinds realized in 2015 or is this carryover and is this just Microsoft or are there additional software publisher changes?

So it was the -- there is a program that went into effect that is a carryover going into 2016 just based on the timing about how the contracts that were impacted as of rolling over ultimately. There is a very minor change in the program that's driving a little bit of that, but in general we anticipate it's going to be between the 5 million to 10 million range and likely closer to the $5 million range at this stage. And it is part mix changes all the time not just one partner ultimately.

Okay and maybe I could circle back to the EPS guidance, I think to put some numbers on it, it looks like you're calling for about 8% growth at the midpoint, revenue growth is 3% to 5%, share count guidance implies about a 6%, share count reduction, understand you have got the partner program change but that's just a 1% headwind to gross profit dollars, and 2015 was a year where you had some investments in headcount and it doesn't look like we're seeing much operating leverage implied in 2016, so maybe just help us understand the margin improvement you're expecting?

So as I was talking to Matt about in his analysis, I think that that 5% basis point improvement at the EFO margin is a realistic number and assumption that you could use going forward. When you look at the investments that we made in 2015 and ’14, some of that was not in ’14 so much going through ’15 those are actually kind of anniversarying at different stages in Q1 to Q3 primarily in 2016, so some of that SG&A is incremental in 2016 as well we assume that we're going to get some incremental profitability out of the overall investments that we've made. One other factor a little bit in the overall revenue growth we are anticipating kind of low to mid single-digit U.S. dollar growth and we're anticipating mid single-digit constant currency growth so there is a little bit of impact in terms of currency related to the euro, the GBP, the Canadian dollar and the Australian dollar primarily.

Okay that’s helpful. I wanted to ask about Europe as well I mean revenue growth has been positive all year in constant currency that declined 4% in this quarter, can you talk about the competitive environment there given the increased focus on the region from competitors that have historically remained domestic?

I think it's pretty normal from what we have seen Adam going back so I didn’t see a real -- a significant change there. The decline in Q4 was a lot of it has to do with sort of the netting effect, as you can see the European business did deliver nice GP dollar growth as well as EFO growth, so in the software business we tend to really look more at the GP dollars being the top-line revenue growth. So I don’t think that was an indication of any real softness overall that we are seeing in the European market. So again as we stated we are pleased with the progress that we are making, the team is very stable and continues to make good progress. So I would say overall that the competitive environment to me seems very much the same I don’t see any significant differences in that environment.

Okay that’s helpful.

And I think also on a year-over-year basis Adam there was a very large deal that we had in Q4 of '14 that we didn’t reoccur in Q4 of '15 and that is part of the driver ultimately in EMEA between the growth on a year-over-year basis.

Last question on the operating cash flow, you obviously mentioned the receivable from the client, wondering if you could maybe help us with the -- quantify that sort of expectations correctly going into 2016?

I would say that if you had excluded -- if we hadn’t received that -- collected that receivable from our client our cash flow would have been in a normal range towards the high-end of our normal range.

Okay perfect that’s helpful.

That’s 80 million to 120 million that we have given you. I would just also say that relative to the first quarter I meant to make this as a commentary on Matt’s question when he first asked, we anticipate that our first quarter is going to be a little bit softer, just coming out of the fourth quarter that we have had and the indications that we are seeing right now. So as we think about our guidance for the year, I would just want to let you know that from our perspective our first quarter is going to be a little bit softer than a normal seasonality would imply.