Ladies and gentlemen, welcome to the Insight Enterprises Third Quarter 2022 Operating Results Conference Call. My name is Felicia, and I will be your operator today. Please note, there will be a Q&A session at the end of the presentation today. [Operator Instructions]. I will now hand over to your host today, James Morgado, Senior Vice President of Finance. Please go ahead.

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, 2022. I'm James Morgado, Senior Vice President of Finance and CFO of Insight North America. Joining me is Joyce Mullen, President and Chief Executive Officer; and Glynis Bryan, Chief Financial Officer. If you do not have a copy of the earnings release or the company slide presentation that was posted this morning and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our website at insight.com under the 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 this 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 contain time-sensitive information that is accurate only as of today, November 3, 2022. 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 be referring to non-GAAP financial measures as we discuss the third quarter 2022 financial results. When discussing non-GAAP measures, we will refer to them as adjusted. You will find a reconciliation of these adjusted measures to our actual GAAP results included in either the press release or the accompanying slide presentation issued earlier today. Also, please note that unless highlighted as constant currency, all amounts and growth rates discussed are in U.S. dollar terms. As a reminder, all 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 and in greater detail in our most recently filed periodic reports and subsequent filings with the SEC. All forward-looking statements are made as of the date of this call, and except as required by law, we undertake no obligation to update any forward-looking statements made on this call, whether as a result of new information, future events or otherwise. With that, I will now turn the call over to Joyce, and if you're following along the slide presentation, we'll begin on Slide 4. Joyce?

Thank you very much, James. Good morning, everyone, and thank you for joining us today. It's my pleasure to report that we delivered another quarter of solid results and despite the economic volatility, the year is shaping up as expected. We had another quarter of double-digit year-over-year gross profit growth driven by 20% -- 27% growth in cloud. Our gross margin expanded 90 basis points over the last year to 15.8% and total gross profit grew 10% year-over-year and 11% on a constant currency basis. Our adjusted earnings term operations of $107 million grew 14% compared to last year and 16% on a constant currency basis. Our adjusted EFO margin expanded by 40 basis points to 4.2%, and we generated operating cash flows of $236 million in the quarter. On October 11, we hosted an Investor Day at NASDAQ and showed and shared our bold and very intentional strategy. We stated our ambition to become the leading solutions integrator, setting the pace and defining a new category in the industry. We do this by bringing together our strength in hardware, software and services to create solutions that drive business outcomes for our clients and increased value for our shareholders. Our execution of the strategy is focused on 4 pillars: captivate clients, sell solutions, deliver differentiation and champion our culture. Let me briefly cover the key points in each pillar. First, captivate clients, continued improvement in NPS, our measure of client satisfaction by delivering exceptional results for them. In addition, our investments in e-commerce and automation will allow our clients to get answers and transact faster via self-service. Second, [Dell] solutions. We are transforming our sales capabilities to improve our team's ability to represent our robust solutions portfolio. We will continue to streamline our account coverage to match skills with client…

Thanks, Joyce. As Joyce mentioned, we are on track to deliver 2022 results as expected. In the third quarter, we had double-digit growth in cloud gross profit and we [Technical Difficulty] in the quarter. As we had discussed last quarter, hardware and particularly devices slowed during the quarter with improved supply chain and more normalized demand, our backlog for devices is flushing as expected. Conversely, the supply chain for networking and infrastructure while improving, still remains extended, and we exited the third quarter with backlog in these areas at an all-time high. Inflation continues to fuel macroeconomic concerns and interest rates are higher than we've seen in decades. In the third quarter, we recognized interest expense that impacted our adjusted diluted earnings per share by approximately $0.05 related to our interest rates on our ABL facility over prior year. Additionally, certain currencies, particularly the euro and the British pound sterling continues to depreciate against the dollar. In the third quarter, primarily in the EMEA region, we recognized currency losses that impacted our adjusted diluted earnings per share by approximately $0.05, mostly related to the British pound sterling. Now moving on to our consolidated results for the third quarter, which can be found in the accompanying earnings presentation, starting on Slide 9. Net sales in the third quarter were $2.5 billion, up 6% in constant currency and up 4% in U.S. dollars compared to a very strong third quarter of 2021. Gross profit of $399 million for the third quarter increased 11% in constant currency and 10% in U.S. dollars compared to the prior year. Our Insight core services gross profit was up 9% from prior year. Core services defined as services we deliver and manage on behalf of our clients. Our cloud gross profit for the 3 months of $82…

Thanks, Glynis. In closing, I would like to thank our teammates for their commitment to our clients, partners and each other, our clients for trusting Insight to help them with their transformational journeys, our partners for their continued collaboration and support in delivering innovative solutions to our clients. We have stated our ambition to become the leading solutions integrator, defining a new category in the industry. We have outlined our strategy and we're on our way. We are committed to achieve this ambition and deliver even more value to our clients as they modernize and transform. This concludes my comments, and we will now open the line for your questions.

[Operator Instructions] The first question comes from Joseph Cardoso from JPMorgan Chase.

First one for me. Can you confirm whether we're back at normalized levels of backlog for devices? And then just relative to infrastructure specifically, or specifically the backlog there, you noted that we're at record levels now. However, how should we think about the peak for that? Have we reached that at this point? And then how should we think about the time line around bringing that backlog down? And then I have a follow-up.

So just to start just to start with, I think, what we would say, the device backlog is basically at sort of 2020 levels, right? So it's pretty close to normalize by now. There are certain products that are still on extended lead times. But by and large, that issue is behind us. And from an infrastructure point of view, we are definitely at the highest level of infrastructure backlog ever, I think, is in our history, for sure. And I don't know whether we've seen it peak or not. It seems like it's flattening. The growth is certainly flattening, but I'm not -- I'd hesitate to call it peak yet, but we'll see in this quarter probably. And then in terms of when it will clear, I think, this is going to take some time. I think it's going to be sort of through the first half, probably into the third quarter.

And then my follow-up, and I think this is more for Glynis. If I'm doing my math right, for the midpoint of the implied guide for third Q, I'm getting something that margins are moderating heading into the December quarter. So first, can you confirm if I'm thinking about that correctly? And then second, what's driving that sequential -- if I am correct, what's driving that sequential margin moderation particularly given if I look historically, Insight typically sees margin step up heading into the fourth quarter?

So I would not get to say it because margins are moderating. I think that we have more expenses below the line than we typically have, primarily related to higher interest expense on the debt, if you're thinking about it from an EPS perspective in terms of EPS guidance. I think that is what is moderating and meeting the total EPS growth is that we have higher interest expense expected for the fourth quarter than we would have had previously.

And then maybe if I could just throw one quick bigger picture...

Does that help?

Yes, that does help. And then maybe if I could just throw one bigger-picture question here. Heading into 2023, and we're still sticking on margins here. How should we think about the puts and takes of the margin trends next year, particularly in the context of mix dealing away from devices and more towards higher-margin infrastructure solutions as well as services? Should we think about that as being a margin tailwind? And then what are the kind of headwinds towards that tailwind heading into next year?

We're not going to give specific guidance around 2023, but I'll tell you that Q3 played out as we had expected. So when we had a second quarter call, we said that we thought device growth was going to be more muted in Q3 that we would have a higher percentage of infrastructure and networking sales in our results. They had higher margins. Therefore, we expected margin expansion in the second half of the year. We still believe that Q3 is an example that we have achieved that as we go forward. Going into 2023, we anticipate devices -- or not devices, infrastructure is going to continue to flow out. We will have backlog related to infrastructure still going into 2023. And I think we would expect that, that would give us some benefit throughout the year. And we would anticipate that there is going to be device growth in 2023 as we go through the year. For us, we think it will be stronger in the second half than in the first half, only because it compares in the first half against 2020 were very strong.

The next question comes from Matt Sheerin from Stifel.

Just following up on the last question. First, just on the operating margin assumptions based on what your guidance for the year, it looks like margins should be up sequentially. And I would imagine gross margin should be up as well given the mix towards infrastructure and services. Does that make sense?

You said sequentially, so from Q3 of '22 to Q3 of '24?

That's right. Correct.

I do think so. Yes. We don't typically give margin guidance like that, but yes.

And then just on the hardware. So Joyce, it sounds like supply constraints are still an issue, but you're growing those businesses. So are you seeing some signs of easing supply? And again, it's sort of on a sequential basis, would you expect -- I mean, because typically, enterprises spend their budgets at the end of the year now, I guess, it's based on when they get the product. But would you be -- would you expect at least in North America, the hardware to be up sequentially?

So I think device supply constraints have been largely normalized. So I think we're in pretty good shape there. Infrastructure supply constraints continue. We don't think we will clear the backlog until sort of into Q3, certainly not before the first half. But we are seeing -- we're now shipping. We're now shipping infrastructure products, not because they've been basically on order for almost a year in some cases. So we're shipping more, so we're seeing infrastructure lift in terms of the amount of the shipping, which is why Glynis is saying, we're going to see continued growth in infrastructure in Q4.

And then just in EMEA, I noticed that the hardware revenue has been down two quarters in a row. I'm wondering how much of that is related to FX headwinds versus maybe a different cycle there, maybe some more macroeconomic softness.

There is some effect from EMEA as it relates to FX, and that's going to continue going into Q4 -- and likely into 2023 -- between the euro and the GDP, the decline there has been somewhere in the range of 18% to 20%. It varies depending on which currency is, but it has been significant over the course of the year. Our European business is roughly 50% hardware, 50% software, and there's some services in there. But the U.K. in particular, which has seen the greatest decline in the sterling is about 50% of the base and hardware is probably about 65% on what they do there. So that would be an impact that's slowing from currency.

But in terms of overall demand trends, then it sort of sounds like then you're growing in constant currency.

Well, we did grow in constant currency and -- we did grow in constant currency in EMEA and also in APAC. I think that demand is a little softer. Some of our clients are pulling back or shortening -- reducing the size of projects that they're contemplating to it in the bite-size chunks. I think that there is a little bit of softening that we're seeing maybe more in EMEA than we're seeing here in North America, but there is a little bit of softening that we are starting to see still growth but not at the same pace that we saw in the first half of the year and certainly in the back half of last year.

The next question comes from Anthony Lebiedzinski from Sidoti & Company.

So in terms of the price increases that you have taken, can you comment on how much that was in the third quarter? And have you seen any notable pushback from clients given the current environment?

So we did see some, I would call it, single-digit growth in our ASPs around devices, but that's a combination of pricing and also configuration. So it hasn't been a huge impact, Anthony. We've been watching that really carefully. We've taken some minor pricing increases on some projects just because of labor costs, but again, not significant in the scheme of things. And I would say that we have not seen significant pushback from clients on these. But we also have been pretty careful about the pricing increases.

And then in terms of your own labor costs, have you seen any stabilization there recently or also if you could comment on labor availability for Insight?

So I mean, certainly, it's flattening for sure. So there's still some skills that are in really, really high demand, and you've got to pay for those, of course. But I would say, in general, the labor market is improving. The labor skill shortage is actually quite helpful to us in terms of our offerings and managed services in particular, and that's -- it is harder for some of our customers to find the labor they need to support their digital transformation, and that's where we come in. So it's a little bit of a double-edged sword. We've been pretty successful in our own recruiting and retention efforts.

And then lastly, Joyce, you talked about the -- in your opening remarks about changing of your compensation plans that you're looking to do. Can you just expand on that as to what you're looking to do as you look to achieve your 2027 goals?

I mean it's really around making sure we have the appropriate focus on services and solutions. Those are harder to sell than just plain vanilla kind of products. So we're encouraging our sales teammates to make sure that they have the skills to sell services and solutions, and we're rewarding them for that through our compensation plan.

[Operator Instructions] The next question comes from Vincent Colicchio from Barrington Research.

Given the economic sensitivities, would you expect services growth to exceed product growth in '23?

So we're not guiding yet for 2023. We'll do that in February. We would expect -- so just as a reminder, we've said this a couple of times before, we do expect to see some of the infrastructure backlog flush in the beginning of 2023. And we also expect services to continue to grow. So I think if you look at kind of what Glynis has talked about in terms of our 2009 performance, we saw actually pretty solid software growth. We saw pretty solid services growth even when we saw some declines in hardware. And we think we're in a much better position than 2009.

And what was the revenue contribution, Glynis, of Hanu in the quarter?

Immaterial, it's a small company.

And I'm not sure if you had mentioned this, but any changes in sales cycles or any other indicators of economic impacts in the quarter?

So I would say we are seeing some more caution on the part of our clients in terms of -- and we see it sort of 2 ways. One is customers are looking for smaller bite-size projects where they can -- we can deliver fast, and they can see the results faster. And I think they're also -- we're also seeing a little bit of an elongated sales cycle for the larger products -- projects just because they have to get more approvals and people are generally clients, I think, are just being more careful.

And you had mentioned just a bit ago, some softness in EMEA versus the U.S. market, the North American market. Overall, are you seeing signs of anything shifting in any verticals or anything like that as an indication that maybe EMEA is going to considerably weaken in the coming quarters?

I don't know that we can answer that question. I don't think that we see any of that, yes. I don't think we've seen that.

Okay, that's it for me.

We're not heavily concentrated in any one vertical in EMEA. So maybe that's why we haven't seen it.

This concludes the Q&A session, and there are no further questions registered. Thank you, everyone, for attending. You may now disconnect your lines.