May 2, 2012
Operator
Welcome to the first quarter 2012 Insight Enterprises Incorporate earnings conference call. At this time all participants are in a listen only mode.
We will facilitate a question and answer session towards the end of the presentation. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the presentation over to your host for today’s call Ms. Glynis Bryan, Chief Financial Officer.
Glynis Bryan
Thank you for joining the Insight Enterprises conference call. Today we will be discussing the company’s operating results for the quarter ended March 31, 2012.
I’m Glynis Bryan, Chief Financial Officer for Insight and joining me is Ken Lamneck, President and Chief Executive Officer.
Glynis Bryan
If you do not have a copy of the earnings release which was posted this afternoon and filed with the Securities & Exchange Commission on form 8K, you will find it on our website at www.Insight.com under the 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 www.Insight.com.
An archived copy of the conference call will be available approximately 2 hours after the completion of the call and will remain on our website for a limited time.
Glynis Bryan
This conference call and the associated webcast contain time sensitive information that is accurate only as of today, May 2, 2012. 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.
Glynis Bryan
In today’s conference call we will be referencing the company’s return on invested capital or RIC for the period ended March 31, 2011 and 2012. A computation of which can be found on our website at www.Insight.com under the investor relations’ section.
Finally, let me remind you about forward-looking statements that will be made on today’s call. 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 on our annual report on Form 10K for the year ended December 31, 2011.
Glynis Bryan
With that, I will now turn the call over to Ken to give you an overview of our first quarter 2012 operating results.
Kenneth Lamneck
Thank you for joining us today to discuss our first quarter 2012 operating results. During the first quarter we focused on integrating recent acquisitions and improving the profitability of our business through gross margin expansion and continued cost control which led to double digit growth in earnings from operations ahead of our expectations for the quarter.
Consolidated net sales increased 2% to $1.24 billion up from $1.22 billion in the first quarter of last year. On a constant currency basis, consolidated net sales grew 3%.
Kenneth Lamneck
Gross profit was $170.4 million up 5% year-over-year and gross margin was 13.7% up approximately 40 basis points from the first quarter of 2011. Earnings from operations increased 12% to $25.6 million or 2.1% of net sales compared to $22.9 million or 1.9% of net sales reported in the first quarter of 2011 and excluding severance expense in both periods, earnings from operations margin in the first quarter of 2012 was 2.2% up 25 basis points from a year ago.
Kenneth Lamneck
Net earnings and diluted earnings per share were $17.4 million or $0.39 in the first quarter of 2012 compared to $13.1 million and $0.28 in the first quarter of 2011. The Q1 2012 net earnings and EPS results include approximately $2 million, $1.7 million net of tax, from a non-operating gain recorded on the recent acquisition which Glynis will cover in more detail later in the call.
And, we achieved return on invested capital of 11.3% in the first quarter up from 10.7% at the end of the first quarter of last year.
Kenneth Lamneck
Within our consolidated results for the first quarter, our North America segment reported sales growth of 1% year-over-year as strong performance in our software category offset declines in hardware and services sales. Software growth was driven by increased demand for office productivity applications in our large enterprise client group partially offset by lower software spending by certain public sector clients.
Kenneth Lamneck
Hardware and service sales comparisons year-to-year reflect large client deployments that concluded in the back half of 2011 that were not completely replaced in the first quarter of 2012 by new sales. However, gross margin improved 35 basis points year-over-year in the first quarter due to a mix of more profitable service sales and modest improvements in gross product margins.
Kenneth Lamneck
We have been more disciplined in setting profitability targets for our various service offerings and at Sunset certain lower margin offerings and engagements in recent months. So despite lower sales year-to-year we are pleased with the improved profitability of this category and we continue to control our expenses in North America in the first quarter which drove just over 50 basis points of growth and earnings from operations margin year-over-year.
Kenneth Lamneck
Moving on to EMEA, we saw sales growth of 7% in constant currency in EMEA for the first quarter. Strong growth of 25% in hardware sales was driven by the acquisition of Inmac in February 2012 and organic growth of approximately 7% year-over-year, each in constant currency.
Software sales declined in the first quarter in EMEA driven primarily by lower volume with existing clients and certain transactions moving between quarters.
Kenneth Lamneck
We expect to see normal seasonal increases in software sales in EMEA in the second quarter and we’re continuing our IT system roll out in the region. In April we went live in France and we expect to go live in the UK and complete the IT integration of Inmac later this year.
Kenneth Lamneck
In Asia Pacific, sales increased 5% in constant currency in the first quarter. Gross profit and SG&A also grew 5% in constant currency which resulted in relatively flat earnings from operations year-to-year.
This market remains healthy in the region and we’re investing in key services capabilities in order to maximize our share of our clients’ software spending and deepen our relationships with our key partners.
Kenneth Lamneck
I will now hand the call over to Glynis who will discuss the first quarter operating results of our business segments.
Glynis Bryan
Starting with North America, net sales were $856 million in the first quarter up 1% from the first quarter 2011. Sales in our hardware category decreased 1% due to the completion of certain large multi-quarter deployments in 2011.
Sales in our software category increased 9% compared to last year due primarily to higher sales of business productivity software to large enterprise clients. Sales of services decreased 10% year-over-year reflecting the completion of a timed engagement early in the fourth quarter 2011 that was not replaced in Q1 of 2012.
Glynis Bryan
Gross profit in North America for the first quarter increased 4% year-over-year to $114 million and gross margin increased 35 basis points to 13.2% compared to the prior year. This change in margin reflects 31 basis points due to a higher mix of higher margin services sales year-to-year despite lower services volume in the first quarter.
Selling and administrative expenses for North America in the first quarter decreased approximately 1% to $92 million and as a percentage of sales decreased 20 basis points to 10.7%.
Glynis Bryan
Excluding a non-cash charge of approximately $1.4 million to write off certain capitalized software costs recorded in the first quarter 2011, selling and administrative costs increased approximately $800,000 year-over-year. This increase is due to investments in headcount and higher medical and other benefit expenses which were partially offset by decreases in other areas.
Glynis Bryan
We also recorded $489,000 in severance and restructuring expenses in this segment in the first quarter compared to $321,000 in the same period last year. As a result, earnings from operations in North America were $21.2 million or 2.5% of net sales in the first quarter of 2012, up 28% from the $16.6 million or 2% of net sales reported in the first quarter 2011.
Glynis Bryan
Moving on to EMEA, our EMEA operating segment reported net sales of $349 million up 4% in US dollars. In constant currency, net sales increased 7%.
Also in constant currency, sales of hardware grew 25% due to both organic growth as well as the effects of our recent acquisition. Software sales decreased 4% and sales of services increased 22% compared to the first quarter of last year, both in constant currency terms.
Glynis Bryan
Gross profit in EMEA was up 7% in US dollars and up 10% in constant currency terms while gross margins increased 45 basis points to 14.5% primarily driven by increased gross product margin which includes vendor funding and freight partially offset by lower volume of fees from enterprise agreements.
Glynis Bryan
Selling and administrative expenses in EMEA in the first quarter were up 11% in US dollars and in constant currency were up 14%. This increase year-over-year was driven primarily by investments in headcount and the addition of our Inmac acquisition into our portfolio.
Glynis Bryan
As we mentioned in our last conference call, in February 2012 we completed the acquisition of Inmac, a hardware reseller located in Frankfurt and Amsterdam. This acquisition is strategically important for us as we look to expand our hardware capabilities into other countries in our EMEA footprint.
The Inmac business performed in accordance with our expectations in the first quarter delivering net sales of approximately $20 million and a modest profit.
Glynis Bryan
We recorded approximately $260,000 in transaction related expenses in the quarter. Also, we have completed our purchase accounting for this acquisition and have recorded a non-operating gain of $2 million, $1.7 million net of tax in the first quarter 2012 as the fair value of the net assets acquired exceeded the purchase price.
EMEA also recorded $885,000 in severance expense in the first quarter 2012 compared to $203,000 in the same period last year. Earnings from operations in EMEA were $4.1 million in this first quarter, down from $6 million reported last year.
Glynis Bryan
Our Asia Pacific operating segment reported net sales of $39 million up 9% from prior year in US dollars and up 5% in constant currency terms. Gross profit was $6.2 million and gross margin was 16.2% consistent with last year.
Selling and administration expenses in APAC increased 10% in US dollars and 5% in constant currency.
Glynis Bryan
As a result, our Asia Pacific segment recorded earnings from operations of approximately $300,000 which was flat year-over-year. Our expected tax rate for the first quarter was 35.6%, slightly below our expected range of 36% to 38%.
This was due to the tax on the non-operating gain discussed earlier related to the Inmac acquisition in EMEA which was recorded at a tax rate less than our cash US federal tax rate.
Glynis Bryan
Moving on to working capital metrics and cash flow performance, in the first quarter cash flow used in operations was $20 million compared to cash generation of $84 million for the same period 2011. In the first quarter 2011 our cash flows benefitted from the timing of a large supplier payment that according to its scheduled payment term was paid in April.
Glynis Bryan
In addition, our cash inflows in the first quarter 2011 included the early collection of a single significant client receivable. It was primarily these items that drove the increase in our cash conversion cycle year-to-year to 26 days.
This is higher than our targeted cycle in the low 20s in terms of day due primarily to a decrease in [DTO] in North America in EMEA due to business mix.
Glynis Bryan
We also invested $7.8 million in capital expenditures this quarter compared to $5 million in last year’s first quarter and $3.8 million on the Inmac acquisition. As a result, we ended the quarter with $133 million of cash of which $116 million was in foreign subsidiaries and $188.5 million of debt outstanding on our revolver.
This compares to $141 million of cash, and $70 million of debt outstanding on our revolving credit facility at the end of the first quarter 2012.
Glynis Bryan
One last update, just last week we completed the refinancing of our senior revolving credit facility and inventory financing facility extending the maturity of both until April 2017. We also renewed our ABS facility for a new 3 year term through April 2016.
Between these new facilities we will now have access to $750 million of borrowing capacity to support the working capital requirements of our business and to fund internal projects and potential future acquisitions.
Glynis Bryan
We’re very pleased to have the tremendous support of our group of lenders and access to low cost capital as we grow our business. I will now turn the call back to Ken for his closing comments.
Kenneth Lamneck
Our first quarter earnings results reflect a solid start to the year with stronger gross margins and tight cost control more than offsetting the effects of softer sales growth. As we look at the full year of 2012, we expect our business to grow in the mid-single digit range and we continue to expect diluted earnings per share for the full year of 2012 to be between $2.20 and $2.30.
This outlook reflects an effective tax rate of 36% to 38% for the balance of 2012 and excludes severance and restructuring expenses occurred during the year and a non-operating gain on the acquisition recorded in the first quarter.
Kenneth Lamneck
Thank you again for joining us today. That concludes my comments and we will now open up the line for your questions.
Operator
[Operator Instructions] Your first question comes from Matt Sheerin - Stifel Nicolaus.
Matthew Sheerin
The first question Ken, just trying to figure the subtle difference in the guidance for the year on the revenue front versus last quarter when you said that you expected to grow above market which you expected to be mid-single digits and now you’re expecting the company in mid-single digits so I know a subtle difference there, any specific reason for that? Is it a mix issue or are you just seeing a little bit slower demand than you thought a couple of months ago?
Kenneth Lamneck
What we’re seeing there is as we commented a little bit there is a few of the large enterprise deals that we had last year just aren’t necessarily repeating in the first half of the year and that we think they’re starting to come forward, from the visibility that we have, towards the second half of the year. So again, it’s a slight tweak to the language but certainly expect that we’ll be in line with how the market grows for the year as well as, of course, making sure we hit and achieve our earnings per share target issued last quarter as well.
Matthew Sheerin
So you expected some deals earlier that haven’t played out yet, is that it?
Kenneth Lamneck
That’s correct.
Matthew Sheerin
Then on the implication of keeping the guidance for EPS implies that margins could track a little bit better and I noticed that the gross margin in EMEA was still quite strong. I know that one of the reasons is because the mix because public sector had been weak in EMEA.
I know public sector, particularly in the UK tends to be lower, is that still part of the reason, public sector is weaker? And also, are you seeing higher percentage of services?
Kenneth Lamneck
Yes, we did have good growth in the services business in EMEA as well which certainly contributed to it but you’re correct in that the public sector market is still a little bit weaker which detracts a little bit from the margin. However, it also should be noted the largest market of course being North America for us where we had a substantial increase in the gross margin as well, up 35 basis points so that certainly has contributed nicely overall and much of that’s attributed to the services businesses which we did not have growth on the revenue side but had actually good double digit growth from a GP dollar perspective in our services businesses.
So again, that’s all about us, as we talked about prior, making sure that we’re in the most profitable pieces of the services business and we did some tweaking of that strategy last year to make sure that we could double down in the areas on the service side that we thought were most profitable and most productive for us going forward and to eliminate pieces of those other parts of our services offering that didn’t really contribute and that we didn’t have the necessary scale in our mind. So those are the primary reasons and we did also see in North America some improvements in the gross profit from our product side of the business as well.
Matthew Sheerin
Could you guys give us examples of the higher margin services that you’re involved in and focusing on, versus the lower margin businesses that you’re deemphasizing?
Kenneth Lamneck
For us, certainly you know our network operation center is a really good business that has good annuity rates, comes in at good significant gross margins, very scalable as well. The professional services business that we have and certainly Ensynch contributed nicely to that when we acquired them last year so that produces some significant gross margin for us as well.
Then our multisite deployment business is a good business as well where we can provide significant services there. Some of the lower gross margin business for us have typically been in the area of telecommic expense management has been lower.
Some of the other - those kinds of pieces, service desk, those are the areas that we’re again deemphasizing where we can so we can put more and more efforts towards the more productive areas for us.
Operator
Your next question comes from Brian Alexander - Raymond James & Associates.
Brian Alexander
One last follow up on the revenue guidance guys, I’m a little confused, if the deals just slipped from the first half to the second half, if I heard you correctly, why does that affect your annual revenue outlook per Matt’s question about growing faster than the market before and now growing more in line with the market? And how much revenue are we talking about there because it looks like your annual guidance implies that revenue will accelerate, growth will accelerate from low single digits in the first half to roughly 10% in the second half?
Kenneth Lamneck
As we talked about as far as the growth, obviously some these large deals aren’t just one quarter deals so if they happen in the back half of the year, of course, we’re not going to have the full extent of them for the year so that certainly has an impact. And again, it’s really more in the enterprise side, we calculate sort of that S&B side of the business is actually growing nicely.
We had nice significant double digit growth in that business in Q1. The enterprise of course is such a big portion of it that that certainly skewed some of the growth rates.
But I think it’s really just a matter of some very large deals. As you remember last year, as an example, in North America we grew for the quarter at 23% year-over-year so it certainly was a more difficult compare as we were going into this year as well so that certainly had some play in regards to why you saw the growth rate being a little bit less.
Brian Alexander
How much visibility do you have into these larger deals that you think will occur a little bit later than you initially expected?
Kenneth Lamneck
Typically the outlook we get on some of these larger enterprise scale deals is we’ll get a couple of quarter outlook on those and then of course, we’re literally working on them a year in advance. But as far as having more firmness to those, it’s typically 2 quarters.
Brian Alexander
Then just back on the services business as you rebalance that portfolio and shift to higher margin services offerings, and it sounds like it’s helping the gross profit dollars even though the revenue was down, I think, 14% or so in North America, what was the year-over-year change in services gross profits? I don’t know if you have that handy?
Kenneth Lamneck
We haven’t disclosed that historically.
Brian Alexander
But did you see growth?
Kenneth Lamneck
Yes.
Brian Alexander
Then just on the expenses it looks like they grew faster than revenue overall primarily in Europe. I think the other regions you actually saw some operating leverage.
How much of that negative expense leverage in Europe was due to the acquisition of Inmac and how much savings are you looking at from some of these restructuring actions you took in the quarter?
Glynis Bryan
The Inmac component on SG&A is about $2.4 million for the 2 months that we had them in the first quarter, $2.4 million in SG&A. Then we had $260,000 of transaction related expenses associated with that.
I don’t know if you’re looking at it with or without the severance charges or if you’re looking at the severance in a separate line, but they had $885,000 of severance expenses associated primarily with just some of the restructuring and consolidation around Inmac.
Brian Alexander
So we should think about that as roughly $1 million of savings going forward per year?
Glynis Bryan
Relative to the first quarter, yes. So between $885,000 and the $260,000.
But, on an ongoing basis I guess the SG&A will be higher in absolute dollars because Inmac is going to be reflected in each quarter going forward relative to last year.
Brian Alexander
I’m just talking about the actions that you took in the quarter that resulted in the charge, how much of that actually translates to in headcount savings on an annual basis, those actions that you took in the quarter?
Glynis Bryan
I’m not quite sure how to answer that because the actions that we took in the quarter were related to Inmac, so you’re going to see the increased SG&A related to Inmac but Inmac’s SG&A is going to lower leverage with the charges that we took but it will still be a higher SG&A number in each quarter going forward as we add them into the portfolio and remember, this is a business that’s different it’s hardware and a hardware expansion strategy so there were some minor back office consolidation impacts but we anticipate that they will add incremental SG&A from a sales perspective, etc., going forward to our business in EMEA.
Brian Alexander
Then just finally, how should we think about cash flow for the balance of the year?
Glynis Bryan
We anticipate that we’re going to end up in our typical range which is $80 to $110 million of cash flow from operations. We anticipate that we’re going to have capital expenditures in the $20 to $25 million range as we continue the rollout the implementation of both the iCare 2 system which is the ARP system in the EMEA as well as our Project system here in North America.
Operator
We have no further questions at this time.
Kenneth Lamneck
We appreciate everybody’s time and attention. Thank you very much.
Operator
Ladies and gentlemen that concludes today’s conference. Thank you so much for your participation.
You may now disconnect. Have a great day.