Insight Enterprises' CEO Discusses Q1 2013 Results - Earnings Call Transcript

May. 1.13 | About: Insight Enterprises, (NSIT)

Insight Enterprises, Inc. (NASDAQ:NSIT)

Q1 2013 Earnings Call

May 1, 2013, 5:00 p.m. ET


Glynis Bryan – Chief Financial Officer

Kenneth Lamneck – President and Chief Executive Officer


Brian Alexander – Raymond James & Associates

Matt Sheerin – Stifel Nicolaus


Good day ladies and gentlemen and thank you for standing by. And welcome to the Insight Enterprises Incorporated first quarter 2013 earnings conference call. (Operator Instructions).

Now my pleasure to turn the call over to Chief Financial Officer, Glynis Bryan. Ma'am, the floor is yours.

Glynis Bryan

Thank you. Welcome everyone and thank you for joining the Insight Enterprises' conference call. Today we will be discussing the company's operating results of for the quarter ended March 31st, 2013. I am Glynnis 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 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 A 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, May 1st, 2013. 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, certain non-GAAP financial measures will be referenced as we discuss the first quarter, 2013's financial results. You will find a reconciliation of these non-GAAP measures to our actual GAAP results posted on our website on the investor relations page.

Finally, let me remind you about forward-looking statements that will be made on today's call. All forward-looking statements that are made in this conference call are subject to risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in today's press release and in greater detail in our annual report on form 10-K for the year ended December 31st, 2012.

With that, I will now turn the call over to Ken to give you an overview of our first quarter 2013 operating results.

Kenneth Lamneck

Thanks, Glynis. Hello everyone. Thank you for joining us today to discuss our first quarter 2013 operating results.

In the first quarter, we saw additional weakness in demand for IT products by large enterprise clients in North America, which is partially offset by strong top line growth in our EMEA and Asia Pacific segments. And we saw lower than expected gross margin performance in the EMEA region due to changes in business and client sales mix in the quarter and partner program changes.

We controlled our sale administrative expenses. However these savings did not offset the effect of lower sales volume in gross margins, which led to earnings from operations performance below our expectations.

For the first quarter of 2013, our consolidated net sales were down 5% year-to-year to $1.18 billion. Gross margin decreased 30 basis points to 13.4% with gross profit dollars decreasing 7% and SG&A decreased 2%. As a result, earnings from operations declined 36% to $17.1 million excluding severance expenses in both years. And on a GAAP basis, earnings from operations decreased 44% to $14.4 million.

In North America, (Harlow Slope) sales declined 12% due to lower sales across all client groups in the region, but in particular, the large enterprise base. By category, we saw a decline in sales of server, surge, and print solutions as well as desktops and notebooks. Overall, we believe that the market was generally soft in these categories. And performance is further impacted by delays in the release of certain client's 2013 capital budgets and prior year projects that were not repeated or replaced this year.

In the software category, North America, net sales declined 17% also reflecting lower sale's enterprise clients particularly for business productivity, creative, and data protection products. Additionally, we saw a higher mix of software maintenance sales this year compared to last year, which recorded net of related costs in our financial statements. Gross margins and gross profit dollars in this category increased year-to-year due to change in the product mix as well as generally higher product gross margin driven partly by our profitability initiatives.

In EMEA, net sales increased 12% in constant currency for the quarter. Software sales were particularly strong and grew 22% in constant currency driven by higher sales across the region. Hardware sales declined year-to-year reflecting slower demand for print and PC products in the middle market. This decline in hardware sales to mid-market clients combined with changes in product mix and effective partner program changes in our software category drove the gross margin decline year-over-year in EMEA.

Our Asia Pacific business performed very well during the first quarter. Net sales increased 24% in constant currency. Gross profit grew 12%. And earnings from operations grew over 200%.

In thinking about the balance of the year, we currently expect demand by large enterprise clients in North America to continue to be muted in 2013, particularly demand for data center products, PCs, and print solutions as macroeconomic concerns weigh in discretionary capital spending.

We also expect gross margin in EMEA for the full year to be down approximately 100 basis points from levels experienced in 2012 due to the expected business mix including lower sales in mid-market and the effect on gross margins of partner program changes.

We will continue to execute our strategy to grow our sales presence in key markets in North America and EMEA as we believe this is critical to position our business for long-term success. In the short term, we remain focused on managing controllable costs throughout the business and expect improved operating leverage in the second half of the year.

I will now hand the call back over to Glynis who will discuss the first quarter of 2013 financial results in more detail.

Glynis Bryan

Thank you, Ken.

Starting with North America, net sales in North America were $747 million in the first quarter, down 13% year-to-year. Sales in our hardware category decreased 12%. And software sales decreased 17% with both categories reflecting lower spending by large enterprise clients.

Service to sales declined 1% year-to-year. Gross profit in North America decreased 10% year-over-year to $103 million. And gross margin increased 40 basis points to 13.7% due primarily to an increase in fees from software enterprise agreements and a higher mix of service to sales. These increases more than offset the effect on gross margin of lower hardware product sales.

Selling and administrative expenses for North America in the first quarter decreased 3% year-to-year to $89.2 million. Increases in salaries and wages due to headcount investments were more than offset by lower variable compensation on lower gross profits and reduced spending in other categories.

We also recorded $1.1 million in severance and restructuring expenses in this segment in the first quarter compared to $489,000 in the same period last year.

Earnings from operations in North America were $12.3 million in the first quarter of 2013, down from $21.2 million in the same quarter last year.

Moving onto to EMEA, our operating segment reported net sales of $387 million, up 11% in U.S. dollars. In constant currency, net sales increased 12%. Also in constant currency, sales of software increased 22% reflecting higher volume with new and existing clients. Hardware sales declined 3% in constant currency reflecting a decline in hardware sales in the middle market that was partially offset by one additional month of sales year-to-year from the addition of InMax. And services sales in EMEA increased 33% in constant currency.

Gross profit in EMEA decreased 4% in U.S. dollars and 3% in constant currency terms. With gross margins decreasing 190 basis points to 12.6%. This decrease was driven primarily by lower growth, product gross margins, which include vendor funding due to changes in business and client mix, which included a higher mix of sales to large enterprise clients in the quarter and the adverse effect of recent partner program changes.

The administrative expenses in EMEA in the first quarter were up 1% in U.S. dollars and by the same percent in constant currency terms. This increase year-over-year was primarily driven by higher salaries and benefits from investments and headcount and the addition of InMax portfolio in February of 2012. Most of the offset by decreased expenses in supporting areas resulting from the post-IT systems integration activities. We expect selling and administrative expenses in EMEA will decline further year-to-year in the back half of 2013 as we gain additional benefits from the recent restructuring activities.

In the first quarter, we recorded net severance expense of $1.7 million in the segment, up from

$885,000 recorded in the same period last year.

Earnings from operations in EMEA were $1.2 million in the first quarter, down from $4.1 million reported last year.

Our Asia Pacific operating segment reported net sales of $48 million, up 22% year-to-year in U.S. dollars and up 24% in constant currency terms.

Gross profit was $7 million. And gross margin was 14.7%, down from 16.2% due to a higher mix of software sales recorded gross in our financial statements.

Selling and administrative expenses in APAC were basically flat year-to-year. Our Asia Pacific segment reported earnings from operations of $964,000, which was up over 200% year-to-year.

With regard to our tax rate, our effective tax rate in the first quarter was 27.8%, below our normalized range of 36% to 38% due primarily to the recognition of tax benefits related to the re-measurement of certain tax positions that were resolved during the quarter.

Moving onto cash flow performance, in the first quarter, our operations generated $16 million of cash compared to a use of cash in operations of $20 million last year reflecting lower working capital needs during the three months ended March 31st, 2013.

Our cash conversion cycle was 25 days in the first quarter, down one day year-to-year.

We also invested $6 million in capital expenses in the first quarter, down from $8 million in the same period of 2012 reflecting lower spending on our IT systems projects.

And we also spent almost $7 million in the first quarter of 2013 to repurchase approximately 345,000 shares of our common stock. Subsequent to quarter end, we have repurchased 2.3 million additional shares and have now completed our $50 million authorization.

All of this led to a cash balance of $152 million at the end of the first quarter, of which $144 million was resident in our foreign subsidiaries. And we had $61 million of debt outstanding under that facility. This compares to $133 million of cash and $139 million of debt outstanding as of March 31st, 2012.

I will now turn the call back to Ken.

Kenneth Lamneck

Thanks, Glynis.

Just a few other updates before I get to your questions. Last week, we announced that Stuart Fenton, President of our EMEA business will be retiring from Insight at the end of the year. Stuart joined Insight in 2002. And over his tenure has guided our EMEA business through some tough macroeconomic conditions and led several strategic acquisitions in organic growth initiatives that have taken our EMEA business from $382 million in sales in 2002 to over $1.4 billion in sales in 2012. We have just begun a search for a new president. And Stuart has agreed to remain in the business until the position is filled and his responsibilities are fully transitioned up through March, 2014. I'd like to thank Stuart for his leadership over the past ten years here at Insight.

Moving onto our outlook for the balance of the year, we're currently expecting net sales for the full year of 2013 will decline slightly from 2012 due primarily to lower spending by large enterprise clients in North America. We currently expect our second quarter financial results will exhibit similar year-to-year trends as in the first quarter. But that we will see improved earnings performance in the back half of 2013 as we begin to realize the benefits of our sales and cost control initiatives.

As a result, we now expect diluted earnings per share for the full year of 2013 to be between $1.70 and $1.90. This outlook includes the adverse effect on gross profit of previously announced partner program changes in our software category, which is estimated to be between $8 and $12 million and an effective tax rate or 36% to 38% for the balance of 2013. This outlook excludes severance and restructuring expenses incurred during 2013.

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. We will now open the line up for your questions.

Question-and-Answer Session


(Operator instructions). Our first question will come from the line of Brian Alexander with Raymond James. Please go ahead, your line is now open.

Brian Alexander – Raymond James & Associates

Okay, thanks. Good evening, everyone. Just to, I guess, touch on your guidance for the second quarter, when you say similar results, I was just wondering if you could elaborate, is that operating income change on a year-over-year basis, EPS, revenue, all the above? And then you know what gives you confidence that things will get much better in the back half? It’s looks like maybe Q3 earnings will be down year over year, but you’re expecting some pretty healthy growth in the fourth quarter to get to your full year number? Just help us understand that.

Glynis Bryan

Sure, Brian. Good question, all of them. We – I guess if you think through our guidance, we anticipate that we will do better in the second half of the year, primarily based on what the – what we’re hearing now from clients, so large enterprise clients with regard to the expansion of projects that are going to be rolling out in the second quarter. We’re getting a little bit of a sense for that starting in the late second half, second quarter and then rolling out in Q3 and Q4.

Specifically as it relates to the commentary regarding guidance around Q2, what we’re seeing now is similar revenue trends with regards to what we have seen in the first quarter. This is just one month of the quarter, April, so far we’re seeing similar trends. However, we are hearing from our clients that we’re going to be seeing some rollouts towards the end of the quarter but primarily into the third and fourth quarters. So we talked about guidance being similar in terms of expectations, it’s around a revenue decline being similar, not the same, but similar, you know, in terms of magnitude, EPS and EFO margins being slightly improved from the first quarter, but still down relative, year over year.

Brian Alexander – Raymond James & Associates

That’s helpful. And then on the North American revenues…

Glynis Bryan

I’ll just make one other comment. We also anticipate in the second half of the year that we will get the benefits of some restructuring initiatives that we’re kicking off that should – would annualize [inaudible] between 12 to $15 million. We don’t anticipate seeing that benefit until later in the second half of the year and then going into 2014.

Brian Alexander – Raymond James & Associates

12 to 15 million annual, most of that targeted at Europe or how does that split across the …

Glynis Bryan

Split probably 2/3s, 1/3, 1/3 in Europe and 2/3s in the U.S., in North America.

Brian Alexander – Raymond James & Associates

Okay. And then on the revenue weakness in North America, I realize that you’re skewed towards large enterprise and we don’t have a lot of visibility into other companies reporting large enterprise customer segments, but it just strikes me as below market, but I didn’t hear anything in your prepared remarks about any market share shifts or any dynamics there. So if you could just elaborate on what you saw in your large customer base and your confidence level that this wasn’t more Insight specific than market related.

Kenneth Lamneck

Yeah, I would say, Brian, this is Ken, that I think some of it is certainly related to a market share loss. I think there’s certainly some execution issues on our side, so we own certainly that piece of it. I wouldn’t certainly put it all on the market. I can say, you know, with certainly our exposure to these large enterprise clients, a little bit more so than our competition. What we really saw was that, again, we didn’t see the rebound from the cycles where you typically see the budget start to occur in Q1. They started pretty slowly and we see some more [inaudible] looks. So we typically see sort of upsides towards the end of quarters for hardware as well as software. We didn’t necessarily experience that, and we did have some big things that rolled off last year that didn’t repeat themselves as well and we normally have those, but we didn’t have those types of scenarios where we expected a lot of new upsides to come in.

But certainly, you know, you’ve seen, you know, certainly the results from some of the larger distributors as well that maybe gear themselves more towards some of the enterprise clients and those that are geared more towards the medium space. So I think it does reflect that certainly the spending as sort of those top sort of Fortune 1000 if you want to call it, that Fortune 2000 clients. We see the spending, certainly, was muted in those categories.

Brian Alexander – Raymond James & Associates

Can you elaborate, Ken, on the execution issues, you know, what caused them and what are you doing to fix those?

Kenneth Lamneck

Yeah, I mean, I think when we look at it across the board, the – we are still in the process of rolling out our city plans. So we have realigned a couple of the organizations to get more granularity towards that. We broke out our major accounts from our regional accounts during the quarter to get more specificity around the East, Central and West and take out a lot of these very, very large accounts from that and that was occurring certainly in Q1. I don’t think that’s an excuse, but those are some of the dynamics occurring.

We certainly knew that we didn’t have a full productivity, as you know, this is the big quarter for our SAP, were all the systems were live. We converted our software business as well as our Canadian operation and I don’t think it’s was – as we look at the specifics, that it was material to the overall results, but no question, it certainly – we weren’t optimized for productivity as, you know, changes in the system just – you know, people learning new processes, those types of things. But you know, everything’s fully functional, on the system there aren’t any issues around that, it’s really just a learning curve issue and some process improvement issues that are going to unveil themselves as we get more accustomed to everybody operating on one ERP platform for the first time in North America. So and that’s certainly something to do with it but it’s certainly wasn’t something that was materialized would have called it out.

Brian Alexander – Raymond James & Associates

And then finally for me, in Europe, and I’ll get back in the queue, so the gross margin is down 190 basis points and you called out, Glynis, a few different things, customer mix and some vendor rebate changes. I just wanted to understand the magnitude of each of those and on the mix side, I wonder how much that might have been self-inflicted given that your revenue was actually quite strong and well above market. So perhaps you went after large deals with low margins.

And on the vendor rebate side, is that something that’s incremental to the 8 to 12 million that you called out at the beginning of the year or is that part of that? I’m just trying to understand that a little bit better. Thanks.

Glynis Bryan

Okay, so when you look at the EMEA operation, it’s a total of two different cities, right. So hardware is a different story than software. So we actually had high growth in software product. So if you look at our software, we said it grew $22 million or 22% on a year-over-year basis. And actually, that generated a lower margin associated with that.

On the hardware side, hardware was actually down on a year-over-year basis also and it was actually the difference between our U.K. business is primarily – is by and large our larger mid-market business than it is a large enterprise business. However, in the first quarter, they had some significant large – large enterprise deals that actually impacted the quarter because they’re generally transacted at lower margins on the mid-market and they had a decline in the mid-market operation. So that was the dynamic that was working in Europe.

We anticipate that they will continue to have some of that large enterprise business going into the second or third quarter, but that we will get some recovery in the mid-market or the corporate space as they call it as we go into the third and fourth quarters. And also, overall in EMEA that they will have the benefit of the SG&A cost savings initiative that they have implemented at the backend of last year and also in this first quarter that will help them with regards to improving performance in this year.

As it relates to the mix between partner program changes versus operational execution, I’m not sure that I can give you a split there, but in terms of the vendor funding issues that we have, that we talked about, those are included in the range of 8 to $12 million. I think in the fourth quarter, when we released the fourth quarter results and we talked about the 8 to $12 million, I think we indicated that the effect in Europe was going to be greater in 2013 than the impact in North America and Europe is actually seeing that in their results today [inaudible].

Brian Alexander – Raymond James & Associates

So was the impact from vendor rebates more than you had expected? It doesn’t sound like it was.

Glynis Bryan

No, it’s not that it’s more than we expected; however, there’s a change that’s coming, there’s a change in the vendor rebates just rolling out this year that will have a bigger impact in the second half of the year. I know the first half of the year, that’s all included in the guidance that we gave and as you know, our software business is strongest in Q2 when you look at it just in terms of the calendar, the fiscal year end for our largest partner and that actually has an impact on the Q2 operating results in EMEA and hence, overall for Insight.

Brian Alexander – Raymond James & Associates

Maybe I just didn’t appreciate how much lower software margins were because it’s sounds like the strong growth you saw in software had a pretty major effect on the gross margins in Europe.

Glynis Bryan

That’s correct, and I think that, you know, Europe has a slightly different dynamic than the U.S., so [inaudible] in the U.S. that the difference is pure product margin line. We don’t have a significant difference in the U.S. between hardware and software margins. In EMEA, they do have a difference between hardware and software margins, so hardware margins, in general in the U.K. are stronger than software margins. So that is a driver as well because of the increase in the software revenue and the associated margin back in Q1.

Brian Alexander – Raymond James & Associates

Okay, all right. I will cede the floor. Thank you.


Thank you, Mr. Alexander. (Operator Instructions). Our next question will come from the line of Matt Sheerin with Stifel. Please go ahead, your line is now open.

Matt Sheerin – Stifel Nicolaus

Yes, thank you. Just a follow up on some of Brian’s questions. First, on the North America situation, it sounds like, Ken, there were some significant distractions in terms of some of the sales that you’re going through and the IT integration I addition to some of the enterprise push outs. Are you satisfied that the sales, the sales reorganization and some of the changes that you’re making are going to start to pay off in the form of market share gains and growth in the second half of the year or is there still a lot of work to be done there?

Kenneth Lamneck

Yeah, thanks, Matt, for your questions. We would say, certainly, that we’ve been engaged now in the city plan concept for the last certainly three quarters in hiring additional people and that is certainly getting some traction and gaining a lot of attention from us internally. So I would say that we would definitely expect that to have a positive impact going into the second half of the year.

Matt Sheerin – Stifel Nicolaus

And then on the IT integration?

Kenneth Lamneck

Yes. The IT side, again, you know, the system is operating as it’s supposed to be. And it’s a matter of, again, changing, you know, people that run legacy systems for quite a long time. You know, bringing them into the fold onto a relatively new platform. So again, no issues on the system itself, it’s really more just different processes that people have to follow on the system and a learning curve associated with that. And of course, it’s pointed out ample opportunities for us to improve processes and make things easier on the new system that we’re – now we’re currently able to address going forward that we couldn’t in the past because we were so concentrated on just converting the system and weren’t focused on how we were necessarily going to improve it and that’s where the attention now is going towards that. So we are confident that certainly the learning curves will improve, you know, certainly they are as we track the productivity of our employees in regards to the systems.

So we think the toughest part, certainly no question is behind us in Q1 and that we should certainly see continued improvements here as we go forward.

Matt Sheerin – Stifel Nicolaus

Okay, and turning to Europe regarding the mix shift that seems to have hurt you pretty significantly, my understanding was that in Europe you’ve been making a big push toward the middle markets and reorganizing your sales force and incentives to focus on below the enterprise level and it sounds like that’s not working out. So is that a demand related in terms of the market or is there execution issues in Europe as well?

Kenneth Lamneck

I would say it’s, Matt, it’s probably a combination of both. I think, as you know, in compared to the U.S. market, of course the European market tends to be more of a mid-market business as a percent and certainly versus enterprise versus here in the U.S. where it’s very dominated by our very large clients and larger enterprise. So a couple of big deals that Glynis mentioned on large enterprise can really skew it. These are some pretty large global type of accounts, certainly they could skew that and they came in at a lower gross profit margin. But I’d say that overall, we would sense, certainly that demand, and I think you’re seeing that across the board for the mid-market space certainly was a little bit more challenged in Europe for the market overall and then we probably certainly own some of it from an execution point of view as well, but so I’d say it’s probably a combination of both.

Matt Sheerin – Stifel Nicolaus

And on the executive change you announced last week with the departure of Stuart Fenton, I’m not sure it’s a coincidence or not, but you’re coming off of arguably the weakest first quarter in Europe in some time now and then your executive, your leader there is leaving the company with a fairly attractive severance package. So trying to understand whether it was sort of a mutual agreement and you’re looking for new leadership there or you know, just what’s happening there.

Kenneth Lamneck

Yes, Stuart, you know, again, had been here for ten years and you know, we’ve had lots of conversations, certainly it wasn’t something that was a reaction to the quarter by any means. We’ve had discussions for quite some time with Stuart in regards to what he wants to do in the future and you know, we sort of come to an agreement, we didn’t want to obviously, we didn’t want a quick transition here, which is why we’re able to work with Stuart to certainly stay on board and continue to help us through this year as far as the transition and we’re actively, right now recruiting for Stuart’s replacement and he’ll be certainly heavily engaged in running the region.


Thank you, sir. (Operator Instructions). At this time I’m showing no additional question in the queue. With that, that does conclude our Q&A session and concludes today’s conference.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!