Aug 1, 2012
Operator
Good afternoon. My name is Roshunda and I will be your conference operator today.
At this time I would like to welcome everyone to the Insight Enterprise Second Quarter 2012 Earnings Call. [Operator Instructions]
Operator
Thank you, I would now like to turn the call over to your host, Ms. Glynis Bryan.
Ma’am, you may begin your conference.
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 for the quarter ended June 30th, 2012. I am Glynis Bryan, Chief Financial Officer of Insight, and joining me is Ken Lamneck, President and Chief Executive Officer.
If you do not have a copy of the earnings release that was posted this afternoon and filed with the Securities and Exchange Commission on form 8-K, you will find it on our website at insight.com under our investor relations section.
Glynis Bryan
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 online 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.
Glynis Bryan
This conference call, and the associated webcast, contain time-sensitive information that is accurate only as of today, August 1st, 2012. This call is the property of Insight Enterprises.
Any redistribution, retransmission or re-broadcast of this call, in any form, without the expressed written consent of Insight Enterprises, is strictly prohibited.
Glynis Bryan
In today’s conference call, we will reference the company’s return on invested capital, or ROIC, for the periods ended June 30th, 2011 and 2012, a computation of which can be found on our website at insight.com under the investor relations section.
Glynis Bryan
Finally, let me remind you about forward-looking statements that will be made on today’s call. All forward-looking statements that are made on this conference call are subject to risks and uncertainties that could cause 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, 2011. With that, I will now turn the call over to Ken to give you an overview of our second quarter 2012 operating results.
Kenneth Lamneck
Hello everyone. Thank you for joining us today to discuss our second quarter 2012 operating results.
In the second quarter, our team continued to execute well, generated solid sales and earnings growth despite slowing demand and continued macroeconomic uncertainty globally.
Kenneth Lamneck
Specifically, consolidated net sales increased 4% to $1.53 billion, up from $1.47 billion in the second quarter of 2011, and on a constant currency basis, consolidated net sales grew 7%. Gross profit was $201.3 million, down 1% year-over-year, and gross margin was 13.2%, down from 13.9% in the second quarter of 2011.
Kenneth Lamneck
Earnings from operations increased 2% to $55.3 million, or 3.6% of net sales, compared to 54.4 million, or 3.7% of net sales reported in the second quarter of 2011. Excluding the effect of currency movements in the quarter, earnings from operations were up 4%.
Kenneth Lamneck
Net earnings were flat year-to-year, at 35.3 million, while diluted earnings per share increased to $.79 in the second quarter of 2012, compared to $.75 in the second quarter of 2011. And we achieved return on invested capital of 11%.
Kenneth Lamneck
Within our consolidated results for the second quarter, our North America segment reported a flat sales performance year-to-year, as strong performance in our software category offset declines in hardware and services sales. The software sales growth was driven by increased demand for office productivity applications across the large and mid-market and public sector client groups.
Hardware and services sales declined year-to-year, due to the effect of large engagements concluded in Q4 of 2011, that have not been fully replaced in 2012, though hardware sales grew 10% sequentially, and by product category, sales of server and storage, networking and notebooks and desktops strengthened quarter-to-quarter.
Kenneth Lamneck
In EMEA, we saw sales growth of 24% in constant currency in the second quarter. Also in constant currency, software sales increased 20% and services sales increased 22% due to higher volume with existing, and new client engagements.
And we reported 35% growth in constant currency in our hardware category, due to the acquisition of Inmac in February 2012, and organic growth of approximately 11% year-over-year. The Inmac acquisition is performing to our expectations, and we expect increased contribution from this business in future quarters as we complete our integration plan.
Kenneth Lamneck
In Asia Pacific, sales increased 5% in constant currency in the second quarter. Low gross margin year-to-year was offset by strong expense management, which led to 5% earnings from operations growth in the quarter, also in constant currency.
Kenneth Lamneck
I will now hand the call over to Glynis, who will discuss the second quarter operating results of our business segments.
Glynis Bryan
Thank you, Ken. Starting with North America.
Net sales were $993 million in the second quarter, a flat year-to-year and up 16% sequentially. Sales in our hardware category decreased 4% year-to-year, due to the completion of certain large, multi-quarter deployments in 2011, but they increased sequentially by 10%.
Glynis Bryan
Sales in our software category increased 11% compared to last year, due primarily to higher sales in business productivity software to large enterprise clients. Sales and services decreased 13% year-over-year, reflecting the completion of a client engagement in early Q4 2011 that was not fully replaced in 2012.
But, we continue to see improved profitability in this category. We have refined our focus on core services offerings and improved our delivery disciplines.
Glynis Bryan
Gross profit in North America for the second quarter increased 1% year-to-year to $130 million, and gross margin decreased 30 basis points to 13.1% compared to the prior year. This decline is largely due to lower vendor funding on lower hardware sales.
Accounting and administrative expenses for North America in the second quarter decreased 5% to $90 million, and as a percentage of sales decreased 50 basis points to 9.1%.
Glynis Bryan
Within these results, [inaudible] compensation decreased $1.5 million on lower gross profit performance, and other [inaudible] and general operating expenses went down $1.9 million as we continue to tightly manage our discretionary spending.
Glynis Bryan
In addition, we recorded a $1.2 million gain on a divestiture of certain non-core services contracts in the second quarter. The sale of these contracts is consistent with our strategy to continue to focus on services offerings so we can add the most value for our clients.
We also recorded $894,000 in severance and restructuring expenses in this segment in the second quarter, compared to $1.1 million in the same period last year.
Glynis Bryan
Relating to operations in North America were $39.1 million, or 3.9% of net sales in the second quarter 2012, up 9% from $36 million or 3.6% of net sales reported in the second quarter of 2011.
Glynis Bryan
Moving on to EMEA, this operating segment reported net sales of $460 million, up 14% in U.S. dollars.
In constant currency, net sales increased 24%. Also in constant currency, sales of hardware grew 35%, due to the effect of a recent acquisition as well as organic growth.
Software sales increased 20% and sales of services increased 22%, compared to the second quarter of last year, both in constant currency. Gross profit in EMEA was down 1% in U.S.
dollars, and up 7% in constant currency terms, with gross margin declining to 12.9%, from 14.9%. This decline was due primarily to a higher mix of sales to large enterprise clients, which tend to transact at lower gross margins, and a lower mix of fees from enterprise improvements and decreased product gross margins, driven primarily by partner program changes.
Glynis Bryan
Accounting and administrative expenses in EMEA in the second quarter were up 5% in U.S. dollars, and in constant currency were up 14%.
This increase year-over-year was driven primarily by investments in headcount to support the rollout of our hardware and sales capability in France and the Netherlands, and also the addition of the Inmac’s portfolio in February.
Glynis Bryan
In order to fund these investments, we are continuing to implement plans to improve the efficiency of our non-sales operations in EMEA. In the second quarter, we recorded a $1.5 million charge for severance expense associated with these initiatives, and expect annualized savings of approximately $3 million beginning in the third quarter.
Glynis Bryan
Earnings from operations in EMEA were $10.8 million in this second quarter, down from $13 million reported last year.
Glynis Bryan
Our Asia Pacific operating segment reported net sales of $76 million, a flat year-to-year in U.S. dollars and up 5% in constant currency terms.
Gross profit was $11.7 million, and gross margin was 15.3%, down from 15.9% last year, due to a higher mix of public sector business in this quarter.
Glynis Bryan
General and administrative expenses in APAC decreased 7% in U.S. dollars, and 3% in constant currency, due to lower available compensation on lower gross profit performance.
Our APAC operating segment reported earnings from operations of $5.4 million, which was flat year-to-year.
Glynis Bryan
Our effective tax rate for the second quarter was 34.9%, below our expected range of 36 to 38%, reflecting benefits from the closure of a foreign tax audit and changes in estimated deferred tax assets.
Glynis Bryan
Moving on to our cash flow performance. For the first 6 months of 2012, our operations generated $11 million of cash, compared to $3 million used in operations last year.
We also invested $16 million in capital expenditures in the first 2 quarters of 2012, compared to $10 million in the same period last year, primarily related to our IT systems integration initiatives in North America. And we spent $3.8 million on the Inmac acquisition in EMEA in the first quarter.
All of this led to a cash balance of $129 million at the end of the second quarter, of which $103 million was [indiscernible]in our formed subsidiaries, and $120 million of debt outstanding under our debt facilities. This compares to $128 million of cash and $115 million of debt outstanding at the end of 2011.
Glynis Bryan
Our cash conversion cycle was 22 days in the second quarter, down from 23 days due primarily to better inventory management in North America. I will now turn the call back to Ken for his closing comments.
Kenneth Lamneck
As you look at the back half of 2012, we expect EMEA to be affected by continued macroeconomic uncertainty. We will continue to make select investments in our IT integration projects, and our sales force in line with our strategic plan.
For the full year 2012, we expect consolidated net sales to grow between 3 and 5%. We expect diluted earnings per share for the full year of 2012 to be between $2.15 and $2.25.
This outlook includes an effective tax rate of 36% to 38%, and a euro-to-U.S.-dollar exchange rate for the balance of 2012 of 1.23:1. It also includes severance and restructuring expenses incurred during the year, and the non-operating gain on an acquisition recorded in the first quarter.
Kenneth Lamneck
Thank you again for joining us today. This concludes my comments and we will now open the lineup for your questions.
Operator
[Operator instructions] And we do have a question from the line of Brian Alexander, Raymond James.
Brian Alexander
So, it looks like you had some upside through revenue in the quarter at least versus the consensus estimates out there, but you’re reducing your full year outlook, so can you just got into the demand picture a little bit more. What did you see during the quarter linearity wise?
Did things get weaker as the quarter progressed, and maybe just more color on why you’re taking the outlook down slightly for the year?
Glynis Bryan
Okay Brian, I’ll start out and then Ken will chime in as I go along. We’re taking the outlook down primarily because of the weakness that saw starting in Q2, and that’s continuing as far as we can see in July to date.
So, we’re actually estimating that the continued weakness in Europe will continue, that America's actually starting - The U.S. is actually starting to soften.
We’ve had clients who’ve actually already notified us that they pushed back certain deployments. So, based on that, that’s one of the reasons that we are actually lowering the guidance.
We anticipate though that our gross margin will be slightly better in the second half of the year than it is in the first half of the year, so net-net for the year, we’re anticipating that our gross margin will be flat.
And one of the other things that’s reflected in this forecast, is originally when we would have last given guidance, we had a euro exchange rate a function in there that was 130
1, and we’re now looking at an exchange rate of 123:1, so it’s a combination of those factors that are driving the change in guidance on a go forward basis.
Kenneth Lamneck
So, again Brian, if you looked at the guidance change, you know, the range changed $.05 as you saw. In a couple of cents of that of course is attributed to the currency as Glynis mentioned, and then just the continued uncertainty and certainly softness that we're seeing.
And primarily in hardware where we had really good growth in the software side across all the regions. And it was interesting of course, that was not just one segment, it was across the board as far as small, medium, and even enterprise clients as well.
So we're seeing softness in the enterprise side and the hardware part of the business, but certainly didn’t experience that on the software side.
Brian Alexander
Okay. And then Glynis can you just go back over the gross margin weakness in Europe.
I think it was down over 100 basis points year-over-year, if I’m looking at that correctly. And then you also had pretty strong growth in Europe, surprisingly strong on the local currency basis even if I exclude the Inmac acquisition, so your point about Europe weakening, I’m just wondering how do we reconcile that comment with the fact that you actually had some pretty good upside in Europe this quarter?
Glynis Bryan
I will answer that question. So when you look at Europe actually weakens at the gross margin line by about 200 basis points.
So when you look at that, about 50% of that number is related to the program changes that we’ve talked about in the past, so what we indicated was that the program changes would have a bigger impact on margin, than it would have actually on dollars, per se. And in the second quarter, July software quarter, our business in Europe is about 50% or so, more than 50% software related, so that's a big impact for them in that particular quarter.
Glynis Bryan
On the other side with regard to - we had some large deals that were transacted at pretty low margin also in the quarter, and that drove the other 50% of the reduction. So on a go forward basis we’re not anticipating Europe that we’re going to have these large deals that drove some of the organic revenue growth, and that occurred across the board - not across the board, it occurred in 3 specific countries related to some very specific deals.
We’re not anticipating that that’s going to be - that that would continue, and I think that we’re going to be subject to the normal seasonality in our business, software are coming down in this third quarter and maybe a little bit of a uptick in the fourth quarter going forward.
Kenneth Lamneck
Yes, we certainly expect Brian that we’ll see growth there, but just not in Europe, not at the accelerated rate. So, when we look at it, we did see that the performance was really across the board in primarily all the countries.
I mean, we saw growth in Spain, saw very good growth in Italy. Places where you might be concerned about, very, very small growth in Russia.
The U.K. grew very, very nicely.
We didn’t perform as well in Germany, but that I think is more on us than it is on the market overall, because you’d expect Germany to be one of the ones that would grow nicely. So it wasn’t on the backs of Germany at all.
So, again we don’t expect it to continue to accelerate like we saw here in Q2, but we certainly do expect that there will be growth in the second half of the year in Europe.
Brian Alexander
And then just a final one for me, can you just give us an update on the IT systems integration what did you accomplish this quarter, and what else remains for the balance of the year and next year.
Kenneth Lamneck
Yes, so we did successfully implement phase I of the IT project in North America in May, so that was a successful integration. And we’re anticipating phase II will go live here in latter part of Q4 into Q1, and that will basically take us pretty much through completion of that project overall for North America.
And the project in our European business continues to go nicely. We did, as you know, convert France, and we’re actually in the midst - this quarter we’ll actually convert the U.K.
business as well. So, we’re making good strides there, and things are on track, on plan in regards to that.
Operator
And your next question comes from the line of Matt Sheerin, Stifel Nicolaus.
Matthew Sheerin
On the expense side you talked about some severance cost on the quarter, can you tell us how that’s going rollout in terms of SG&A savings. You talked about kind of a flattish gross margin, so that would imply SG&A percentage coming down at the back half of the year or so.
What should we think about expenses?
Helen Johnson
On the - I’ll start EMEA. EMEA took a charge in this quarter for $1.2 million dollars - $1.5 million dollars and out of that we anticipate that there’s going to be annualized savings of about $3 million dollars.
We anticipate that in EMEA we’ll probably see about $1.1 million of that in the second half of the year. That may be somewhat disguised, because remember we have then Inmac acquisition that came in, in February of 2011, so that’s going to be adding to the SG&A in EMEA, but net-net we anticipate that the base legacy SG&A will be down - in addition to the normal seasonality associated with the GP around software, it will be down %1.1 million dollars associated with these initiatives.
Matthew Sheerin
Okay, and Ken given the more subdued IT spending environment in North America where you’ve been adding account executives, are you still adding to your sales staff.
Kenneth Lamneck
Yes we are, we’re moving more towards - as you know we’re focused primarily early on about on the inside, so we’ll continue to add it inside but more as to stay in a steady state to replenish any attrition that we might have. And we’re actually working to add more field reps.
And we started working on that last quarter, we’ll continue that through the rest of this year.
Matthew Sheerin
Okay, could you give us the headcount?
Kenneth Lamneck
The headcount number is 5,500.
Glynis Bryan
In total [indiscernible] or the sales number, which one?
Matthew Sheerin
Maybe both.
Kenneth Lamneck
Yes, just let me pull that. It’s right about 5,500 in regards to the total for the company, and about half of that is in sales.
Matthew Sheerin
Okay, and that was up a little bit sequentially or about the same?
Kenneth Lamneck
Yes, if you look year-to-date it’s up 200.
Matthew Sheerin
Okay, all right. And on the gross margin erosion in Europe you explained that pretty well and it sounds like some of those big deals that hurt you somewhat, but on the other side with some of the software agreements with your vendors changing.
And I know that you’re being incentivized to focus more on smaller S&B kind of clients. How is that transition going in terms of trying to build your market share of smaller businesses that would help you improve your margins?
Kenneth Lamneck
Yes, I mean we’re very pleased with the progress that we’ve made, in that regard we’re well on tack in regards to making sure we’re replenishing that business by really targeting that mid-tier client set though. Very pleased with the results so far.
Matthew Sheerin
And then Ken, on your commentary about softer demand and some push out, are you getting the sense that customers, particularly enterprise customers still plan to spend budget this year or is the visibility so limited that it’s really had to tell at this point?
Kenneth Lamneck
I think what you’re seeing, you know, if you look, of course, going back a few years and you looked at the downturn, of course, the pullback primarily was really impacted by hardware. Software's impacted but not to the same extent but it’s a little bit more difficult to see that on the software side.
So we came out of it, of course, there was pent-up demand on the hardware side so we saw these last couple of years significant growth in hardware, but you didn’t necessarily see that significant growth in software and what we’re seeing is now, of course, software didn’t have that big spike up that we saw and we’re starting to see, that’s really more on a continual basis, more of a stable basis of sales. So we think on the software side we’ll continue to perform well on that side.
There is a little bit of, as we said, just a little bit of a cloudy picture on the hardware side and of course, we’ve got a big orientation towards enterprise clients and that’s where we’re seeing a little bit more of that softness where we did see, you know nice growth above-market growth sort of in that mid-tier space for us from a client-set point of view, but it was in the enterprise side on the hardware where we specifically saw that there was some softness that we experience and it’s still uncertain as to how that’s going to play out.
Matthew Sheerin
And have you seen pricing pressure in that business too?
Kenneth Lamneck
You know, not really. I mean, our margin degradation, as we mentioned, in North America was - is primarily from the fact that we didn’t overachieve on some of the supplier - reimbursement targets and that had the most significant impact actually as to why there was a degradation on the gross margin side of the house [ph].
Matthew Sheerin
Okay, and just lastly for me, could you update us, Ken, on the cloud initiatives that you’ve been working on?
Kenneth Lamneck
Yeah. As we know, of course, you know, we certainly foresee that the private cloud is where most of the real revenue will be generated from over the next few years, so a lot of focus on assisting clients in migrating towards private cloud initiatives, so a lot of activity there.
And then, of course, we have our SaaS offering that’s out there. We did announce this past quarter here that we actually surpassed $2 million seats that were managing in the cloud, so that’s good news and that’s really more of a SaaS, software as a service initiative we have going on.
But our portal did come up live, I guess, the quarter before last, so we’re making good strides there. We’re one of the few companies that you can actually do online provisioning for that we have the single billing, a lot of those initiatives and a lot of folks out there with websites show it, but there’s not anybody that we can really see there to date that are actually doing online provisioning which our site actually has the capability to do.
So we’re engaging -- it's still early days and that initiative that we continue to invest and continue to acquire clients and continue to, at this stage to really learn from those clients and how they want to continue to procure more and more in the future.
Operator
And there are no further question in queue at this time.
Kenneth Lamneck
Well, we thank everybody for joining our Q2 earnings call.
Operator
This does conclude today’s conference call. You may disconnect.