Insight Enterprises, Inc. (NSIT) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Insight Enterprises' Third Quarter 2017 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 follow at that time. [Operator Instructions] As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Ms. Glynis Bryan, CFO. You may begin.

Thank you. Before we officially start the call, I just wanted to highlight that we some technical issues with our provider on the posting of our earnings release this afternoon. So, if you haven't seen it across the wire. You can find it on our website, and it has also been field with an 8-K with the SEC. So, with that, I will actually begin the call. Welcome everyone and thank you for joining the Insight Enterprises' earnings conference call. Today, we will be discussing the Company's operating results for the quarter ended September 30, 2017. I'm Glynis Bryan, Chief Financial Officer of Insight, and joining me is Ken Lamneck, President and Chief Executive Officer. If you do not have a copy of the earnings release that was posted this afternoon and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our website at insight.com, under 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 the 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, November 07, 2017. This call is a property of Insight Enterprises. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed 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 third quarter and year-to-date 2017 financial results. When referring to non-GAAP measures, we will refer to such measures as adjusted. Adjusted measures discussed today will include severance and restructuring expenses and acquisition related expenses recorded in all periods, adjusted measures will also exclude the last recorded in the third quarter of this year on the sale of our business in Russia, and the gain on the sale of real estate asset recorded in the second quarter of 2016, as well as the tax effect on these items. You will find a reconciliation of these adjusted measures to our actual GAAP results included in the press release issued earlier today. Also, please note that, unless highlighted as constant currency, all amounts and growth rates are discussed in U.S. dollar terms. Additionally, any reference to our core business or the organic change year-to-year in our performance will 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. All forward-looking statements made during this conference call are subject to risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in today's press release and in greater detail on our Annual Report on Form 10-K for the year ended December 31, 2016, and also and other reports we file with the SEC. With that, I will now turn the call over to Ken. Ken?

Thank you, Glyn. Hello everyone. Thank you for joining us today to discuss our third quarter 2017 operating results. For the third quarter of 2017, consolidated net sales were $1.76 billion, up 26% year-over-year, reflecting growth of 17% in our core business and the addition of Datalink, which we acquired on January 6. Net sales in constant currency were up 25%. Gross profit was $226 million in the third quarter, up 24% year-over-year in both U.S. dollars and in constant currency. Gross margins were 12.9%, down approximately 20 basis points year-over-year, reflecting lower gross margin in our core business driven by lower services sales and lower product margin in sales to large enterprise clients in North America, partly offset by the positive contribution of Datalink. Consolidated selling, general and administrative expenses were $180 million in the third quarter, up 25% year-over-year including growth of 7% in our core business and the addition of Datalink. Strong organic sales growth and good gross profit growth in our core business combined with a positive contribution from the Datalink business led to an increase in adjusted earnings from operations of 20% compared to third quarter of last year. On a GAAP basis, earnings from operations increased 14% to $41 million and adjusted diluted earnings per share was $0.73; while on a GAAP basis, diluted earnings per share was $0.62. Within these results, the North America business reported 34% topline growth year-over-year, including double-digit organic growth, as well as the addition of Datalink to the business. In our core business, we continued to see strong growth in the hardware category, fueled by demand for client devices and datacenter solutions. We saw high single-digit growth with SME clients, while large enterprise clients grew significantly faster year-over-year as we continue to see the benefit from new client wins, ongoing refresh cycles, and certain large multi-quarter datacenter projects. The Datalink business added approximately $134 million in sales to our results for the quarter. Gross profit in North America in the third quarter was 29% year-over-year, while our gross margins decreased 50 basis points to 12.5%. The gross margin decline was driven by a strong growth with large clients and lower services gross profit year-over-year in the core business. Adjusted earnings from operations however increased 17% year-over-year to $43 million reflecting the sixth consecutive quarter of double-digit adjusted earnings growth in North America. Moving on to the third quarter results in EMEA. Net sales in EMEA decreased 2% year-over-year in constant currency, but a higher mix of services sales helped drive gross profit up 6% and gross margin up approximately 100 basis points year-to-year, which when combined with good cost control, led to adjusted earnings from operations growth of more than 300% in the third quarter. We also completed two strategic transactions in EMEA in the third quarter. First, as we discussed on our last call, we completed the sale of our business in Russia after concluding this market did not exceed our long-term plans. Second, in pursuit of our strategy to expand our cloud and services capabilities in EMEA, we completed the acquisition of Caase in late September. Located in Netherlands, Caase provides consulting, deployment and managed services around the Microsoft stack including Office 365 and Azure. Sales over the last 12 months were approximately $5 million. We are excited about accelerating our expertise in the areas of hybrid cloud and workforce productivity in the EMEA region and welcome the Caase team to Insight. In Asia-Pacific, our team also executed very well in third quarter, delivering double-digit topline growth and strong bottom line growth in constant currency. Demand has been stable in the APAC region so far this year. And in third quarter, we saw good growth in Australia and China, and a bit slower growth in New Zealand. And as Ignia completed its first year as part of Insight in Australia, we continue to be pleased with the talent and capabilities added to our portfolio throughout this combination. As we head into 2018, we are looking at additional opportunities to scale our global offerings around application development and business analytics, leveraging the skills gained from our BlueMetal and Ignia businesses across other parts of our footprint. We are pleased with our execution globally in the first nine months of 2017. Our strategy and related solutions areas focusing on helping clients efficiently manage their IT assets today and transform their business for tomorrow. Amid this stable demand environment, we believe our extension to supply chain, cloud, data center and software capabilities, combined with disciplined execution, will serve us well as we close out a record year in 2017. I will now hand the call over to Glynis who will discuss additional highlights of our year-to-date financials. Glynis?

Thank you, Ken. For the first nine months of 2017, our core business delivered double-digit organic topline growth and high single-digit gross profit growth year-over-year, which when combined with great cost control has driven adjusted earnings from operations up 27% year-over-year in the core business. In addition, the Datalink business is performing well in line with our expectations so far this year and on track to meet its earnings target for the full-year. Let me breakdown our year-to-date financial results in a bit more detail. Consolidated net sales was $4.9 billion in the first nine months of 2017 are up 22% compared to the same period last year. In North America, net sales were up 30% year-over-year including organic growth of 17% due to the significant new large enterprise client wins and expansion within existing clients and also approximately $387 million in sales from Datalink. In EMEA, net sales year-to-date are up 6% in constant currency, reflecting particularly strong sales growth in hardware and services. And in Asia-Pacific, net sales were down 1% in constant currency due to a higher mix of net in software maintenance sales and cloud sales. As we have discussed before, we are actively engaged in helping our clients migrate to the cloud. And year-to-date, gross profit earned from cloud sales represented 13% of our consolidated gross profit. Because most cloud sales are reported net, we believe our gross profit comparisons year-to-year are our best metric for assessing our business performance. Consolidated gross profit in the first nine months of 2017 was $686 million, up 24% in U.S. dollars and up 26% in constant currency. Gross margin expanded 20 basis points to 13.9% in the first nine months of this year. This increase is driven by the addition of Datalink to our business, and the positive effect of a higher mix of net software sales, partially offset by a lower mix of fees earned on enterprise agreements, which are 100% margin, and also a higher mix of product sales to large enterprise clients. Also, on the SG&A front, consolidated selling, general and administrative expenses were $539 million, 22% year-to-date. This increase was driven primarily by the addition of Datalink to our business including purchase price amortization and low single-digit in expenses in the core business. We also recorded severance and restructuring expenses of $6.2 million in the first nine months of this year, compared to $3.1 million for the same period in the 2016. And we incurred expenses related to the acquisition of Datalink and Caase of $3.3 million in the first nine months of 2017, compared to $741,000 went on the Datalink and Ignia acquisition in the third quarter 2016. In addition, as Ken mentioned, we sold our business in Russia in the third quarter and incurred a loss on sale of $3.6 million, about $2.9 million of this was related to foreign currency translation adjustment that had previously accumulated in the equity section of our balance sheet. All of this led to adjusted earnings from operations of $147 million in the first nine months of 2017, up 32% year-over-over and up 32% in constant currency terms. GAAP earnings from operations increased 24% for the first three quarters of 2017. In addition, our effected tax rate year-to-date through September 30, was 35.6% down from 36.8% last year, due primarily to approximately $2.3 million of tax benefit to this year from the settlement of share based awards in accordance with the new accounting standard, which was adopted effective January 1, 2017. All of this led to diluted earnings per share on an adjusted basis of $2.43 this year compared to $1.81 earned in the first two quarters of 2016. GAAP diluted earnings per share were $2.11, up from $1.74 last year. Moving on to cash flow performance, in the first nine months of 2017, our operations used $324 million of cash compared to a use of $125 million for the nine months of 2016. As discussed in our last call, our Q1 2017 cash flow results were adversely impacted by the effects of a timing difference in the collection of a single large receivable in the fourth quarter 2016 of approximately $160 million for which the payment to this supplier was due and paid in January 2017. We had the exact same scenario before for amount of approximately $60 million in the Q1 of 2016. The balance of the increase year-over-year in cash used in operations was driven primarily by the higher working capital gains on significantly higher sales. We expect strong cash flow generation in the fourth quarter will partially offset the use of cash reported year-to-date through Q3 and expect that for the full-year, we will report a use of cash of between $50 million to $70 million. And we expect to return to normalized cash flow generation of $80 million to $120 million in 2018. Also in the first two quarters of 2017, we invested $16 million in capital expenditure, up significantly year-over-year due to planned investments in IT infrastructure upgrade, our website and our digital marketing platform. And we anticipate CapEx for the full-year to be between $20 million to $22 million. In addition, we expect $187 million to acquire Datalink and Caase this year. We did not buy back any stock in the first nine months of 2017, but for comparison purposes, we used $50 million to acquire shares over the same period last year. All of this led to a cash balance of $236 million at the end of the third quarter, which $193 million was less than [indiscernible] and we had $544 million at outstanding on a revolving and term debt facility. This compares to $176 million of cash and $243 million of debt outstanding at the end of the Q3 2016. From a cash flow efficiency perspective, our cash conversion cycle is 37 days in the third quarter of 2017, up 5 days year-to-year. This increase resulted from the net effect of a one-day increase in DSOs and there day decrease in DPOs due to the relative timing of client receipts and supplier payments in the respective quarters and also a one-day increase in inventory outstanding due to investments and inventory specific client engagement. I will now turn the call back to Ken for his closing comments.

Thank you, Glynis. With respect to our 2017 outlook, for the full-year 2017, we now expect our business to deliver sales growth of 20% to 22% compared to 2016. We're maintaining our adjusted diluted earnings per share outlook for the full-year of 2017 $3.15 to $3.25. This outlook assumes an effective tax rate of approximately 38% for the fourth quarter of 2017. This outlook excludes severance and restructuring, and acquisition related expenses incurred during the first nine months of 2017 and those that maybe incurred during the balance of 2017, as well as the loss on the sale of our Russia business that Glynis just discussed earlier. Thank you again for joining us today. I want to thank you our team mates, clients and partners for their dedication to Insight. That concludes my comments, and we'll now open the lineup for questions.

Thank you. [Operator Instructions] And our first question comes from Adam Tindle with Raymond James. Your line is open.

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

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

Understood, maybe we'll look at kind of a second half stack when we look at it.

Right. Yes, I think how we should look at it, because the guidance was based on the second half ultimately.

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

So, your analysis is correct. It is sub-12% ultimately in the core business Datalink this is a North America comments not excluding EMEA and APAC. And I was say that the combination of the mix of business that were actually selling and the client that were selling that business to. So, we are very larger enterprise clients and I wouldn't say increased competitive pressure, we always have very large enterprise trends and in Q3 in particular we had safely strong success with some very large enterprise plans where the where the margin on that business that we sold, the front-end margin was not as great as we would have liked ultimately. But in terms of the relationships that we [indiscernible] that we're establishing with these clients, we thought it was a good thing for us to take the business as we move forward. I don't' think that you should anticipate that there is going to be a continuing deterioration or degradation in March as we move into 2018. One I think 17% growth in the quarter, is not going to be something we should anticipate seeing. As we move into 2018 I thick I think we expect North growth to normalize to a couple of 100 basis point above market. Ultimately and just by definition with that as well as gross in our services business, we should expect margins to normalize in the quarter. The Datalink is actually is meeting all of our expectations and it is perforating very well.

Okay.

The other piece Adam, you touched on it as we didn't attribute that of course to supplier programs at all.

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

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

Got it. Thank you.

Thank you. And our next question comes from Matt Sheerin with Stifel. Your line is open.

Yes, thanks. Hello, everyone. Just following up on Adam's questions regarding the mix of the business, it sounds like Ken that you continue to see strong demand for client devices in notebooks, PCs and also servers as opposed to value add solution selling where margins are better. And you just getting a sense of that's where your enterprise customers budgets are focused on right now as we continue to see refresh cycle on PCs. And obviously as we get into FY 2018, it looks like we're going to be up against some tough comps there. And are you expecting that to more normalize where you might see a shift in client dollars or budget dollars where they may shift back toward more solution type of opportunities for you?

Yes. So, couple points there, Matt, so on the device side desktops and notebooks, no question that the market was pretty healthy this quarter as we look at the MPD data across the channel for everybody. We were fortunate to actually see that growth and our growth in the units was actually 17%, but the revenue growth was significantly higher than that. A couple reasons for that one is the mix of products selling higher performing devices helped us there. But also, the component price increases that have occurred now are fully sort of into the new sort of ASPs of these devices and we attribute that to be about 7% increase in the total ASP of the units just due to the component price pressures that were in the market. And we expect that that will probably continue through the first half of 2018, so I think there is a 7% uplift just in device revenue because of that, and then of course, there is a significant unit growth as I mentioned 70% unit growth across desktops and notebooks for us as well, so certainly stronger than what the market's seeing. So that's on the device side. On the data center areas, specifically as you look at the MPD data, growth but not robust growth. We certainly had a few large climes that Glynis referenced. That might normally take some of this business direct and that's what made it such a competitive margin. As you force - but we recognize we've got strategic relations with this client that it made sense for us to continue to help support them in that business. So those become pretty cyclical, because those are pretty big projects. So, we don't expect those kind of big projects aren't going to continue and that would certainly more normalize, and as Glynis was attributing that has that normalized out of the business, of course, our gross margins will return back to normal sort of areas.

In terms of the corporate PC refresh, are you seeing the upgrade to Windows 10 as a driver of that?

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

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

It's not a trend. I guess I would say there was a significantly large deal last quarter that was lower margin. I think we may have talked about it in the call in the Q3 of 2016. There's a little bit of netting in there, but it's not netting impact. It's really the impact of the large deal in the prior year quarter - that's why the improvement in gross profit year-over-year.

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

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

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

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

Okay, all right. That's it for me. Thanks a lot.

Thank you. [Operator Instructions] And our next question comes from Kara Anderson with B. Riley FBR. Your line is open.

Good afternoon. This is Marc Wiesenberger, calling in for Kara. Can you speak to the impact if it all from any of the Hurricanes, Harvey and Irma? And if there wasn't impact were the sales lost or just simply delayed that you expect to recoup?

Yes Marc, we had heard that about a couple times, and we didn't really see any impact from that. There were certainly - there is one significant part of ours that has locations in Houston, we worked very closely with them to make sure that we priorities our shipments and did really see any negative impacts there in our business. So, we can't really say that we saw anything significant on that. And once that we did see where there is any kind of slight impact of course that revenue will come in Q4. So that's not lost revenue. It's just revenue that pushed, but again for us we didn't see anything substantial due to the hurricanes. I think the vendor partners really managed through that very, very well from our perspective.

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

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

Great. Thank you very much.

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