Insight Enterprises, Inc.
Q1 2017 Earnings Call Transcript

Published: 3 Aug 2017

[Operator:]

Good day, ladies and gentlemen. And welcome to the Insight Enterprises’ Second Quarter 2017 Operating Results. At this time, all participants are in a listen-only mode [Operator Instructions]. Later, we will conduct a question-and-answer session and instructions will follow at that time. 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.

[Glynis Bryan:]

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 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 the Web site 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 Web site for a limited time. This conference call and the associated webcast contain time-sensitive information that is accurate only as of today, August 02, 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 second quarter 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 recorded in all periods, the gain recorded in the second quarter of 2016 on an assets held-for-sale and acquisition related expenses recorded in the second quarter of 2017, as well as the tax effect on 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 growth rates are discussed in U.S. dollar terms. 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. 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 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?

[Ken Lamneck:]

Thank you, Glyn. 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 continued to be healthy in the second quarter, and we executed very well, gaining market share in strategic solution areas, substantially completing the integration 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 and the addition of Datalink beginning January 6, net sales and constant currency, were up 17%. Gross profit was $251 million in the 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 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 services 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 the 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 datacenter solutions. We saw high-single digit growth for public sector and SME clients, while large enterprise clients grew much faster year-over-year due to new client wins, ongoing refresh cycles and certain multi quarter datacenter projects. In addition, the Datalink business added approximately $120 million in 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 continued to focus on controlling cost in our core business and realized cost savings from the Datalink integration, 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 in May 1st, 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 integrating certain backoffice 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 and consolidation within our facilities footprint. Moving on to the second quarter results in EMEA. In the second quarter, our EMEA business continues to deliver on its strategy to expand cloud and services sales across the region, while driving above market growth in hardware in the UK 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 the decline in software sales due to higher mix of cloud maintenance sales that are recorded net. Helping our clients to assess and implement cloud solutions is 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 in 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’ve gained and realized the benefits of recent cost reduction actions in EMEA, which, when combined with our gross profit growth, drove adjusted earnings from operations up 16% and the EFO margin up 0.4%, 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 and cloud sales combined with the contributions from the EMEA business to service sales since the acquisition in third quarter of 2016 drove gross profit up 19% and earnings from operations up 10% year-over-year. Demand transfer to traditional hardware and software offerings in the second quarter continue to support a stable and growing global IT market. We also continued to see clients explore and adapt 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 challenge shows that sales and devices continues to be healthy for all players, and we continue to gain share in the datacenter category even before considering the market share we gained by bringing Datalink into our portfolio. Our growing cloud datacenter and 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, two awards recognizing Insight’s investments in key areas of growth and innovation, while continue 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 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 position well to close out the year strong. I’ll now hand the call back over to Glynis so we’ll discuss additional highlights for our first half financial results. Glynis?

[Glynis Bryan:]

Thank you, Ken. For the first six months of 2017, we’re 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 is the great cost control to adjusted earnings from operations and 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 this business is on track to meet profitability objectives for the year. Let me breakdown our first half results in a bit more detail. Consolidated net sales was $3.2 billion in the first half are up 20% compared to the first half of last year. In North America, net sales were up 28% year-over-year in the first half of 2017, including organic growth of 15% due to new client wins and expansion within 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 UK business. And in Asia-Pacific, net sales was 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 software through the cloud their top line results shift to more sales reported mix. As a result, we believe our gross profit comparisons year-to-year are the best metric for assessing our business performance. Consolidating gross profit for the first six months of 2017 was $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% margins and a higher mix of product sales to larger 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 and expenses in the core business. We also recorded severance and restructuring expense 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 $2.2 million in the first half of 2017, while there were no capital expenses in the same period last year. Consolidated adjusted earnings from operations of $101 million in the first half of 2017 are up 37% year-over-year and up 39% in constant currency terms. GAAP earnings from operations increased 29% year-over-year in the first half. And our effective tax rate year-to-date through June 30th was 35.1%, down from 37.7% last year due primarily to $2 million of tax benefit this year from the settlement of share based rewards in accordance with the new accounting standard, which is adapted effective January 1, 2017. 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 first half of 2017 was $1.50, up from $1.30 a share. Moving on to cash flow performance. In the first six months of 2017, our operations generated $99 million of cash compared to a use of $5 million -- I'll start over. In the first six months of 2017, our operations used $99 million of cash compared to use of $5 million in the first half of 2016. And 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 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 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 upgrades, 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 buyback any stock in the first six months of 2017, but for comparison, we did $48 million to acquire shares in the first half of last year. All this reflects were cash balance of $195 million at the end of second quarter of 2017 of which $172 million was residential in our foreign subsidiaries. And we had $295 million of debt outstanding under our revolving and term debt facility. This compares to $175 million of cash and $85 million of debt outstanding at the end of the second quarter of 2016. And from a cash flow efficiency perspective, our cash conversion cycle is 50 days in the second quarter of 2017 year-over-year. Before I hand the call back to Ken, I'd like to update you on our recent business transactions. On July 19th, we completed the sale of our business in Russia to a partner focused on this market and is also the disposal of our investments in the Russian entity, we expect to record a non-cash charge of approximately $3 million in the third quarter of 2017 upon the release of our cumulative translation adjustment account balance, which currently sits in the equity section of our balance sheet. This non-cash 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.

[Ken Lamneck:]

Thank you, Glynis. With respect to our outlook for 2017, for the full year 2017, 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 maybe incurred during the balance of 2017, as well as the non-cash charge on the sale of our Russia business that Glynis just discussed. 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 your line up for questions.

[Operator:]

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

[Adam Tindle:]

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

[Ken Lamneck:]

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

[Adam Tindle:]

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

[Ken Lamneck:]

I think its adding quite a bit of course through 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’re 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’re able to open up those resources 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’re certainly pleased to have that proceeding.

[Adam Tindle:]

And maybe just one last quantitative question. If I look at the past two 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 with tough comparison for the backhalf for 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? Thanks.

[Glynis Bryan:]

So in the first half of this year, we had a lower tax rate than normal associated with the, this is I'm addressing your EPS question, associated with that accounting -- that change in accounting that impacted our EPS. So it was $2 million so that drove our EPS in the first quarter to be 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're anticipating that we will have growth in mid single digit range somewhat impacted by our cloud business. But I think that consistent with prior quarters if you backed out the impact 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 55-45 or 52-47 that you’re talking about.

[Adam Tindle:]

I guess one last clarification. When you talk about cloud and the 14% gross profit dollars, how do you define cloud, is there hardware within that as well? Just give us…

[Glynis Bryan:]

No, there is no hardware within cloud.

[Ken Lamneck:]

So it's not calculated in 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 datacenter so no, that's completely exclude. So the 14% of the GP Dollars is what you would call really public cloud. So that's Office 365, that's Azure, AWS, a whole host of other SaaS type of partners that we sale. But again, all public cloud type of offerings.

[Glynis Bryan:]

And it also includes software that sale to service provider. But it's not any hardware at all.

[Operator:]

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

[Matt Sheerin:]

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 you've been 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. I mean 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?

[Glynis Bryan:]

I certainly don’t 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 of 2017 that we will see 4.1%. When we 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 have 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’re 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 significant uplift with regard to full year EFO margins in 2017. We do anticipate a bigger increase going into 2018.

[Matt Sheerin:]

And meaning last year, you were just under 3% and that’s what you guided to at the beginning of this year?

[Glynis Bryan:]

Well, we said we’d be a little bit of upside but not a 100 basis point. I think we said 10 to 20 basis points, but I think I said 10 before.

[Matt Sheerin:]

In terms of the revenue growth, Ken, that you’re seeing in North America you talked about client devices and enterprise and datacenter. But you also talked about new client wins. Could you talk about the number of customers that you may have added and how many active customers you have today versus a year ago, what’s driving that? Is that the sales opportunities or sales efforts? Are there Datalink cross selling opportunities that you’re seeing already?

[Ken Lamneck:]

So, there’s no question, it was definitely good expansion. We didn’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 few years from a field perspective as well as continuing to grow out our Insight organization in Conway and so forth. So that’s certainly assisting us adding more clients in 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 markets here pretty well. So overall I think the market continues to perform pretty well and we’re fortunate to perform probably better than that from a share point of view in the second quarter.

[Matt Sheerin:]

And given the scale and given the multiple skill sets that you have, and some of your very larger peers. Do you think that there is a multi-year margin or rather than market share expansion opportunity against the smaller out there?

[Ken Lamneck:]

We think so. And in fact, as we were discussing, you can see the significant increases were just seeing on devices, desktops and notebooks grew vey heavily for the market share data we track, which is pretty much most of the large players in those 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 seeing 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. And we talked about our business really now and two buckets we talk about been 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 -- and you’ve seen a lot of acquisition we’ve made to really add more scales 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 make their business and run smarter. So how do we help them transform so they can maximize their benefits of what they’re spending in IT. So that’s mostly around the solutions and services area. Still here is talk a lot about managing transform and its 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 we can do both aspects of it, they’re very amenable to getting an opportunity.

[Operator:]

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

[Kara Anderson:]

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

[Glynis Bryan:]

Well, our appetite at this point is to make sure that we continue to integrate the Datalink very well. And so I’d say from there, once we’ve gotten that under our belt. So we’ve done the -- completed the systems integration and there are other key positions of getting sales force working together and our aspects of integration that we still see leading to accomplish. And there is additional $8-ish million that we need to get out of the business in 2018. So it's not over total product integration that we've had very successful systems integration. I would say that where we're thinking about for acquisitions would be specific capabilities that we've identified as we think about how to better service certain cloud initiatives that we internally are pursuing with regard to cleanup 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 need to acquire. At some point in time, we'll look at another scale acquisition and the Datalink ultimately that would help us generate more scale in terms of bringing technical resources to our clients. So I think that that's what 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 to-date.

[Kara Anderson:]

And then can you update on what synergies you’re expecting for Datalink in terms of numbers this year and next and maybe what you recognize so far to-date?

[Glynis Bryan:]

We're anticipating getting between $10 million to $13 million in synergies from Datalink in 2017, as we’ve originally said $20 million over the two year period. So we're on track as we had said previously in that $10 million to $13 million range. I think we have said $10 million to $12 million and we’ve extended 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 point during the second half, because we’ve eliminated many of the back office functions with the integration that we've done on our system effective in June. We’ve gotten rid of the corporate shoplifting, all those on our corporate resources that we need effective with the acquisition. We have certain facilities and other 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're on track to hit that $20 million goal that we talked about.

[Operator:]

[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.

[Ken Lamneck:]

We thank everybody for your support and interest.

[Glynis Bryan:]

Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.