Insight Enterprises, Inc. (NSIT) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Insight Enterprises Second Quarter 2017 Operating Results. [Operator Instructions] As a reminder today's conference is being recorded. I would now like to introduce your host for today's conference, Ms. Glynis Bryan, Chief Financial Officer. Ma'am, please go ahead.

Thank you. 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 June 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 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 by 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, August 2, 2017. This call is 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 financial measures as we discuss the second quarter 2017 financial results. When referring to non-GAAP measures, we would refer to such measures as adjusted. Adjusted measures discussed today will include severance and restructuring expenses recorded in all periods, again, recorded in the second quarter of 2016, on an asset that held for sale and acquisition-related expenses recorded in the second quarter of 2017 as well as tax effect of these items. You will find a reconciliation of these adjusted measures in our actual GAAP results included in the press release issued earlier today. Also, please note that unless highlighted as constant currency, all amounts and gross rates are discussed in U.S. dollars term. Additionally, any reference to our core business excludes Datalink's results, subsequent to the acquisition. Finally, let me remind you about forward-looking statements that will be made on today's call. Our forward-looking statements that are 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 in a greater detail on our annual report on Form 10-K for the year ended December 31, 2016, and other reports that 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 second quarter 2017 operating results. I'm pleased to report that our team delivered another quarter of strong operating results. Global IT demand continue to be healthy in the second quarter, and we executed very well, creating market share in strategic solution areas, substantially completing the integration of Datalink into our business and delivering on our financial commitments. For the second quarter of 2017, consolidated net sales were $1.68 billion, up 16% year-over-year, reflecting growth of 7% in our core business, in addition of Datalink begin in January 6, net sales of constant currency were up 17%. Gross profit was $251 million in second quarter, up 20% year-over-year and up 22% in constant currency. Gross margins were 14.9%, up approximately 50 basis points year-over-year, reflecting the constant -- positive contribution of Datalink, partly offset by lower gross margins in our core business, driven by a lower mix of fees from software enterprise agreements and service of sales. Consolidated selling and administrative expenses were $181 million in the second quarter, up 20% year-over-year, including both slight growth of 2% in our core business and the addition of Datalink. Solid organic growth in sales and gross profit, with effective cost control in our core business, combined with a positive contribution from Datalink business led to an increase in adjusted earnings from operations of 20% compared to the second quarter of last year, and adjusted EFO margin of 4.2%, which is a new record for us. On a GAAP basis, earnings from operations increased 19% to $69 million, and adjusted diluted earnings per share was $1.14, also another quarterly record for us, and on a GAAP basis diluted earnings per share was $1.11. Within these results, the North America business reported 24% 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 growth in hardware categories, fueled by demand for client devices and data center solutions. We saw high single-digit growth with public sector and SMB clients, while our large enterprise clients grew much faster year-over-year due to the new client wins, on-growing refresh cycles and certain multi-quarter data center projects. In addition, the Datalink business added approximately $124 million of sales to our quarter -- to our results for the quarter. Gross profit in North America in the second quarter outgrew sales at 27% year-over-year with gross margins increasing 50 basis points to 14.3%. We continue to focus on controlling costs in our core business and realize cost savings from the Datalink integrations, generally in line with our expectations, which drove adjusted earnings from operations up 23% year-over-year to $51 million. As discussed in our last call on May 1, we completed the migration of the Datalink business onto our SAP platform. The systems integration effort was a success, and over the balance of the second quarter, we focused our efforts on sales engagement and integrated certain back-office functions. As of today, I'm pleased to report that we have substantially completed the integration plans we had for 2017. As we move forward, we will focus on optimizing the sales engagement and service delivery models in consolidation within our facility's footprint. Moving onto the second quarter results in EMEA. In the second quarter, our EMEA business continued to deliver on its strategy to expand cloud and services sales across the region while driving above-market growth in hardware in the U.K. business. All of which led to another quarter of strong earnings results. Net sales in EMEA increased 1% year-over-year in constant currency, reflecting the double-digit growth in hardware and services sales and a decline in software sales due to a higher mix of cloud maintenance sales that are recorded net. Helping our clients assess and implement cloud solutions is a key component of our strategy. Since cloud sales are recorded net, the shift in sales mix continues to dampen our top line comparisons year-over-year. However, gross profit EMEA grew 8% year-over-year on constant currency, which we believe is a better reflection of the underlying health of the business. In addition, we began to realize the benefits of recent cost-reduction actions of EMEA, which, when combined with our gross profit growth, drove adjusted earnings from operations up 16% and EFO margin of 4.0%, up 70 basis points compared to the same period last year. In Asia Pacific, our team also executed very well, delivering double-digit gross profit and earnings growth in the second quarter. Higher hardware sales, significantly higher software maintenance in cloud sales, combined with the contribution from the Ignia business to service sales since the acquisition in the third quarter of 2016 drove gross profit up 19% and earnings from operations up 10% year-over-year. Demand trends for traditional hardware and software offerings in the second quarter continues to support a stable and growing global IT market. We also continue to see clients explore and adopt cloud solutions to increase efficiency and agility within their environment, which drove gross profit earned from cloud sales to 40% of our gross profit. Further in U.S., market share data for the channel shows that sales and devices continues to be healthy for all players, and we could choose to gain share in the data center category even before considering the market share we gained by bringing Datalink into our portfolio. Our growing cloud data center supply chain capabilities, combined with our best-in-class digital marketing platform are allowing us to build momentum in key markets and clients. Our partners are also taking notice. Recently, Insight received Microsoft's Worldwide Mobile Application Development Partner of the Year Award and Microsoft's U.S. Transformation Partner of the Year Award, 2 awards recognized in Insight's investments in key areas of growth and innovation while continuing to serve as Microsoft's largest channel partner worldwide. The solid market backdrop, combined with our deep portfolio of offerings and strong execution led to record-level sales, EFO and EPS results in the first half of 2017. As we head into the back half, we believe our business is healthy and positioned well to close out the year strong. And now I'll hand the call back over to Glynis, who will discuss additional highlights for our first half financial results. Glynis?

Thank you, Ken. For the first 6 months of 2017, we are very pleased with our results across the business. Our core business delivered double-digit organic top line growth and high single-digit gross profit growth year-over-year in the first half, which when combined with the great costs control drove adjusted earnings from operations in the core business, up more than 30% compared to the first half of last year. On top of these exceptional results, the Datalink business also performed well, contributing EFO in line with our expectations in the first half and thus, business is on track to meet its profitability objectives for the year. Let me break down our first half results in a bit more detail. Consolidated net sales of $3.2 billion in the first half are up 20% compared of the first half of last year. In North America, net sales are up 28% year-over-year in the first half of 2017, including organic growth of 15% due to new client wins and expansion with an existing accounts and approximately $252 million in sales from Datalink. In EMEA, net sales year-to-date are up 9% in constant currency, reflecting particularly strong sales growth in our U.K. business. In Asia Pacific, net sales were down 5% in constant currency, solely due to a higher mix of net in software maintenance and cloud sales. As we have discussed before, as clients consume more of their softwares to the cloud, we will start top line results shift to more sales reported net. As a result, we believe our gross profit comparisons year-to-year are the best metric for assessing our business performance. Consolidated gross profit for the first 6 months of 2017 were $460 million, up 24% in U.S. dollars and up 27% in constant currency. Gross margin expanded 40 basis points to 14.5% in the first half of this year. This increase is driven by the addition of Datalink to our business and the positive effect of a higher mix of netted software sales, partially offset by a lower mix of fees earned on enterprise software agreements, which are 100% margin and a higher mix of product sales to large enterprise clients. And on the SG&A front, consolidated selling and administrative expenses were $358 million, up 21% year-to-date and up 24% in constant currency. This increase was driven primarily by the addition of Datalink to our business, including purchase price amortization and low single-digit organic growth in expenses in the core business. We also recorded severance and restructuring expenses of $5.7 million in the first half of this year compared to $2.3 million for the same period in 2016. And we incurred expenses related to the acquisition of Datalink of $3.2 million in the first half of 2017, while there were no capital expenses in the same period last year. Consolidated adjusted earnings from operations was $101 million in the first half of 2017, up 37% year-on-year and up 39% in constant currency terms. GAAP earnings from operations increased 29% year-over-year in the first half. And our invested tax rate year-to-date through June 30, was 35.1%, down from 37.7% last year due primarily to a $2 million of tax benefits this year from the settlement of share-based rewards in accordance with the new accounting standards, which was adopted effective January 1, 2017. All of this reflects earnings -- diluted earnings per share on an adjusted basis of $1.70 this year compared to $1.17 earned in the first half of 2016. GAAP diluted earnings per share in the first half of 2017 were $1.50, up from $1.30 last year. Moving on to cash flow performance. In the first 6 months of 2017, our operations generated $99 million of cash compared to the use of $5 million -- sorry, I'll start over. In the first 6 months of 2017, our operations used $99 million of cash compared to a use of $5 million in the first half of 2017 -- 2016. As discussed on our last call, Q1 2017 cash flow results were adversely impacted by the effect of the timing difference between a collection of a single-large receivable in the fourth quarter of 2016 of approximately $160 million, which the payment to the supplier was due and paid in January 2017. We had the exact same scenario but for a lesser amount of approximately $60 million in the first quarter of 2016. Also, in the first half, we invested $10 million in capital expenditures, up significantly year-over-year due to planned investments in IT infrastructure upgrade, our global lab site and our digital marketing platforms. We anticipate CapEx for the full year will be between $15 million to $20 million. And we spent $181 million to acquire Datalink in the first quarter of this year. We did not buy back any stock in the first 6 months of 2017, but for comparison, reached $48 million to acquire shares in the first half of last year. All of this led to a cash balance of $195 million at the end of the second quarter of 2017, of which $173 million was residential foreign and subsidiaries. And we had $295 million of debt outstanding under our revolving interim debt facility. This compares to $175 million of cash and $85 million of debt outstanding at the end of the second quarter 2016. And from a cash flow efficiency perspective, our cash conversion cycle of 15 days in the second quarter of 2017 is flat year-over-year. Before I hand the call back to Ken, I'd like to update you on a recent business transaction. On July 19, we continued the sale of our business in Russia to a partner focused on this market. As a result of the disposal of our investments in the Russian entity, we expect to record a noncash charge of approximately $3 million in the third quarter of 2017 upon the release of our cumulated transition of adjustment account balance, which currently sits in the equity section of our balance sheet. This noncash charge will be included in earnings from operations as part of the net loss on the sale of the business in our Q3 results. I'll now turn the call back to Ken for his closing comments.

Thank you, Glynis. With respect to our outlook for 2017, for the full year '17, we now expect our business to deliver sales growth of 17% to 19% compared to 2016. We're also increasing our adjusted diluted earnings per share outlook for the year of 2017 to $3.15 to $3.25. This outlook assumes an effective tax rate of approximately 38% for the balance of 2017. This outlook excludes severance and restructuring and acquisition-related expenses incurred during the first half of 2017 and those that may be incurred during the balance of 2017 as well as a noncash charge on the sale of our Russia business that Glynis just discussed. Thank you again for joining us today. I want to thank our teammates, clients and partners for their dedication to Insight. That concludes my comments. I will now open your line up for questions.

[Operator Instructions] Our first question comes from the line of Adam Tindle with Raymond James.

First, Ken, I just wanted to ask you, you saw the trends within Datalink through the due diligence process obviously. Just curious how the revenue growth and margin profile has changed since Insight has owned the asset versus how it was tracking previously. And maybe any comments on what's driving that?

Yes. It's pretty much -- thanks for the question. It's pretty much in line with what we expected. As you know, we had -- when we did do the acquisition, there were some sales, of course, that they were recording gross that we netted. So that may look like it's a little bit more muted, but we were just netting those. And of course, it had no impact to the gross profit being generated. So very much in line with what we had expected and what we had modeled into our plan for Datalink for this calendar year.

Okay. And how is the acquisition changing the nature of your conversations, first, with your customers, and secondly, with your suppliers?

Yes. I think it's adding quite a bit of course, there's synergy amongst the partner base as you know. They've got a very good technical team with a lot of solution architects, that's really given us certainly more ammunition with our partners as well as with our clients. And now we are up to the point where the first couple of quarters, of course, we were pretty careful to make sure the integration went smoothly. And now we are able to sort of open up those resources on to other aspects and other people participating from the traditional Insight business to again expand the hybrid cloud initiatives that we have in place. So very much according to plan and we are certainly pleased how that's proceeding.

Okay. And maybe just one last quantitative question. If I look at the past few years, Insight has typically generated around 53% or 55% of EPS in the second half, which includes last year where you had a really strong Microsoft 2Q, so a tough comparison for the back half of the year. I think your guidance this year implies more like 47% in the second half of the year in terms of the EPS contribution. And Datalink is more seasonal to 4Q, from my understanding. So I'm just trying to understand what's maybe driving this dynamic or perhaps is there some conservatism built in here?

So in the first half of this year, we had a lower tax rate than normal associated with the -- obviously it's addressing your EPS question -- associated with that accounting, that change in accounting that impacted our EPS. It was $2 million so that drove our EPS in the first quarter to the higher, as a percentage of the full year than normal. In the second half of the year, we're anticipating that -- it's not a Datalink issue. Datalink is going to be performing as expected that was built into our numbers around the guidance. We don't anticipate that there is going to be any change there. I think in our core business, we are anticipating that we will have growth in the mid -- low to mid-single-digit range, somewhat impacted by our cloud business. But I think that's consistent with prior quarters, if you backed up the impacts of the EPS associated with the first quarter. It would be more comparable. I think that we typically expect 50-50 between the first half and second half as opposed to what may like 55-45 or the 53-47 you're talking about.

Okay. That's very helpful, Glynis. I guess one last clarification. When you talk about cloud and the 14% of gross profit dollars, how do you define cloud? Is that -- is there hardware within that as well? Just give us a...

No. There is no hardware. There is no hardware within cloud.

Yes. So it's not calculated private cloud at all. It's really just public cloud offerings that we have, otherwise it'd be too hard to determine. As you know, Adam, what's private cloud and what's traditional data center. So no, that's completely excluded so the 14% of the GP dollar is what you would call really is public cloud. So that's Office 365, that's Azure, that's AWS, a whole host of other SaaS-type of partners that we sell, but again, all public cloud type of offerings.

And they also include software that we sell to service providers. But it's not any hardware at all.

[Operator Instructions] Our next question comes from the line of Matt Sheerin with Stifel.

Just following up on Adam's question regarding guidance for the year. It looks like -- I mean you did clarify the Q1 and the tax benefit that you got. But even backing into that, it looks like you're not expecting much margin expansion beyond the 4.1%, which was obviously a very strong number. You do have some incremental cost coming out, I know, from Datalink. It looks like you should see seasonal trends through the rest of the year. So what should we be thinking about in terms of near-term operating margin targets?

I certainly don't want you to walk away with 4.1%. So Q2 is typically our strongest quarter of the year. So we wouldn't anticipate that for the full year 2017 that we'll see 4.1%. When we had provide -- previously given guidance at the beginning of the year, we said that with the addition of Datalink, with the intangible amortization associated with Datalink that the impact on margins for the full year was not going to be that significant. That is still the case. We've had a very strong Q2. We had a very strong Q1 also. We are trending to be a little bit better than that, but I don't want you to walk away thinking that it's going to be a significant uplift with regards to full year EFO margins in 2017. We do anticipate a bigger increase going into 2018.

Okay. And meaning last year, you were just under 3.1% and that's sort of what you guided to at the beginning of this year?

Well, we said we'd be -- there'd be a little bit of upside, but not 100 basis points. I think we said 10 to 20 basis points. At least I think 10 to 20 basis points but I think, we [ had ] that 10 before.

Fair enough. In terms of the revenue growth, Ken, that you're seeing in North America. You talked about client devices and enterprise and data center. You also talked about new client wins. Could you talk about the number of customers that you may have added? How many active customers you have today versus a year ago? What's driving that? Is that sales opportunities or sales efforts? Are there Datalink cross-selling opportunities that you're seeing already?

Yes. So there is no question, there was definitely good expansion. We don't disclose the exact number of clients. But certainly it's in the tens of thousands, as you can imagine with the size and scale of the business. But it's very focused on the additions of people that we made over the last 3 years from a field perspective as well as continue to grow out our inside organization in Conway and so forth. So that's certainly assisting us adding more clients to portfolio and continuing it. And the backdrop is pretty healthy. I mean, you've seen the results from other of our competitors, and we track the market share pretty well. So overall, I think the market continues to perform pretty well, and we are fortunate to perform probably better than that from the share point of view in the second quarter.

And given the scale and given the multiple skill sets that you have and in some of your very larger peers, do you think that there is a multiyear margin or rather market share expansion opportunity against the smaller bars out there?

We think so. In fact, as we were discussing, you can see the significant increases we're just seeing even on devices. Desktops and notebooks grew very handedly for the market share data we track, which is pretty much most of the large players in our space. And when you look at overall, of course, that's not the case. So it's got to be coming at the expense of the smaller bars out there that might be jettisoning that business or just not able to, at the scale levels, to continue to do that business. So we certainly think that there is potential to do share gains. We talk about our business really now in sort of 2 buckets. We talk about being able to help our clients manage their business and help them transform their business. So on the manage side, it's all about the efficiency, supply chain efficiencies. And our scale and our systems really help our clients be very, very cost efficient with what we can provide them. And then the transform side is everything that we can do and that's -- you've seen a lot of acquisitions we've made really add more skills around like BlueMetal and Datalink and Ignia to really provide those kind of skills that we can really do to help our clients really, as we say, make their business run smarter. So how do we help them transform so they can maximize their benefits of what they're spending on IT. So that's mostly around the solutions and services [ area ]. But you'll hear us talk a lot about manage and transform, and it's resonating well with our clients because they're looking for large-scale partners that can do both. Every client I go to wants to do business with less partners. So they're all looking to try to consolidate that spend, and when you can do both aspects of it, they are very amenable to giving you an opportunity.

Our next question comes from the line of Kara Anderson with B. Riley.

Just to start with acquisitions. What is your appetite at this point, and where might investments be concentrated?

Our appetite at this point is to make sure we continue to integrate Datalink very well. As I'd say, from there -- once we've gotten that under about belts -- on the completed the systems integration. There are other pieces in terms of getting the sales force working together and our aspects of integration that we still feel we need to accomplish. And there's additional $8-ish million that we need to get out of business into 2018. So it's not over, totally with direct integration, but we have had a very successful systems integration. I would say that where we are thinking about for acquisitions would be specific capabilities that we have identified as we think about how to better service certain cloud and initiatives that we internally are pursuing with regards to creating a platform for our clients. Part of that is internal in terms of organic development that we need to do, inorganic development that we need to do. And some of it is looking at specialty players out there in the marketplace that we meaning to acquire. At some point in time, we'll look at another scale acquisition at our Datalink. Ultimately, that would help us generate more scale in terms of bringing technical resources to our clients. So I think that that's where you should envision, but right now the focus in 2017 is really around making sure that the integration of Datalink continues as well as it has and it has to date.

Okay. And then can you update me on what synergies you're expecting for Datalink in terms of numbers this year and next and maybe what you recognized so far to date?

We are anticipating gaining between $10 million to $13 million in synergies from Datalink in 2017. I would originally say $20 million over the 2-year period. So we are on track as we had said previously in that $10 million to $13 million range. I think we had said $10 million to $12 million, but we've expanded that to $13 million. We've actually achieved a chunk of that already in the first half with regards to eliminating -- well, we'll see that pulling through in the second half because we've eliminated many of the back-office functions with the integration that we've done in our systems effective in June. We've gotten rid of the corporate shoplifting, all those corporate resources that we didn't need effective with the acquisition. With certain facilities and other kind of operational integration items that will be flowing through this year, the back half of this year, and going into next year that we still need to accomplish. But we are on track to hit that $20 million goal that we've talked about.

[Operator Instructions] I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. Lamneck for any closing remarks.

We thank everybody for your support and interest.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. And you may now disconnect.