Earnings Call Transcript - NSIT Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Insight Enterprises Second Quarter 2020 Operating Results Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Ms. Glynis Bryan, Chief Financial Officer. Please go ahead, ma'am.

Glynis Bryan, Chief Financial Officer

Thank you. Welcome everyone and thank you for joining the Insight Enterprises earnings conference call today. Today, we will be discussing the Company's operating results for the quarter ended June 30, 2020. 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 morning and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our website at insight.com under Investor Relations section. Today's call, including the question-and-answer period is being webcast live and can be accessed via the Investor Relations page of our website at insight.com. An archived copy of 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, August 6, 2020. This call is the property of Insight Enterprises. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Insight Enterprises is strictly prohibited. In today's conference call, we will refer to certain non-GAAP financial measures as we discuss the second quarter 2020 financial results. When referring to non-GAAP measures in today's call, we will refer to adjusted earnings from operations, adjusted diluted earnings per share and return on invested capital. You will find a reconciliation of these non-GAAP measures to actual GAAP results included in the press release and the accompanying slide presentation issued earlier today. Also, please note, that unless highlighted as constant currency all amounts and growth rates are discussed in US dollar terms. 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 in our most recently filed Annual Report on Form 10-K and periodic reports subsequently filed with the SEC. With that, I will now turn the call over to Ken, and if you're following along on slide presentation, we will begin on Slide 4.

Kenneth Lamneck, President and Chief Executive Officer

Hello, everyone, and thank you for joining us today to discuss our second quarter 2020 operating results. I'm pleased to report that through our dedicated team, resilient business model and the PCM acquisition, we delivered double-digit adjusted earnings growth year-over-year in the second quarter. Given the challenging demand environment in the second quarter, our operating priorities for the quarter were clear. First, we tightened the health and safety standards in our warehouse and mobilized most of our teammates to work from home, which allowed us to continue to support our client's most pressing IT needs. Second, we focused on reducing our costs to align with the current demand environment reducing operating expenses by $26 million sequentially. Third, we focused on cash flow generation delivering very strong cash flow from operations in the quarter. And finally, we focused on optimizing our earnings results in this tough climate. Now turning to the second quarter results on Slide 5. Consolidated net sales in the Second quarter were $1.97 billion, up 7% year-over-year due to the acquisition of PCM. We focused on growing our services and solutions business mix, which helped drive gross margins up 150 basis points year-over-year to 16.5% in the second quarter, a new record for our company and adjusted diluted earnings per share was $1.75, up 11% year-over-year on a GAAP basis diluted earnings per was $1.32. Within these results, gross profit generated from cloud solutions increased 90% of our consolidated gross profit over the past 12 months, now a meaningful component of our profitability. Given our strong execution bringing cloud digital solutions to clients, we are proud to announce that Microsoft made Insight their 2020 U.S. Partner of the Year, as well as their Worldwide Customer Experience Partner of the Year. Moving to Slide 6. During the second quarter, we maintained our focus on integrating the PCM business and I'm pleased to report that we have effectively completed the onboarding of all PCM clients to our Insight systems...

Glynis Bryan, Chief Financial Officer

Thank you, Ken. I would also like to thank our global teammates for their dedication and resilience during these last several months. I'm going to start on Slide 10. Last quarter, we identified key initiatives to help protect our profitability during these uncertain economic times. As Ken noted, we decreased our operating expenses by $26 million in the second quarter compared to Q1 of 2020. About half came from lower salaries, the majority of which was due to fewer headcount for planned integration actions and the rightsizing of certain support functions for current demand trends. The balance of the decreased split fairly evenly between lower travel and other discretionary expenses and lower variable compensation on our budget attainment in the first half of the year. As you move on to Slide 11, in addition to the cost savings initiatives and the enhanced credit review procedures, we made debt reduction of hiring fees with available cash. In the second quarter, we generated strong cash flow and reduced debt by $313 million ending the quarter with approximately $435 million of debt outstanding under revolving ABL facility and our convertible note. At the end of the quarter, we had $164 million in cash on hand. We also ended the second quarter with eligible accounts receivable to support access to the maximum availability on our $1.2 billion ABL facility. Exiting the quarter, we are comfortable with our current leverage position of less than 1.5x debt to cash flows or EBITDA. Under our ABL agreement, our primary compliance covenant is a fixed charge coverage ratio, which includes trailing 12-month EBITDA over capital expenditures, taxes, and interest expense. As of June 30, we were at 4x against the minimum requirement of 1x and are very confident that we can support our capital requirements and liquidity. As we highlighted last quarter, our cash cycle is inverted, meaning we pay our partners on terms shorter than we receive from our clients, which allows us to drive more cash flow and sales decline. We saw this dynamic in the second quarter, which helped drive the record cash flow generation of $404 million in the quarter. In this working capital dynamic, we also benefited from more than $200 million in cash flow items related to timing differences between the quarter. For the full-year, we expect cash flow generation will be in the range of $240 million to $280 million comfortably exceeding the top end of our previously announced annual guidance range of $180 million to $200 million.

Kenneth Lamneck, President and Chief Executive Officer

Yes, I think on the gross margin side – I'll let Glynis chime in as well. I think certainly it is a mix issue. Second quarter is our largest quarter, it's Microsoft's year-end. So there is a big acceleration that occurs in there and of course, a lot of that comes in and it's netted, so that certainly has a big impact and always historically has had a bigger impact on our gross margin for the second quarter...

Adam Tindle, Analyst

So I'm going to start with Ken. In the press release, you talked about a pronounced impact in Q2 compared to internal budgets. And when I hear that, I would usually expect to see a disruption in operations and cash flow, but operating margin was up year-over-year and Glynis just covered on cash flow was very strong. So I guess the question would be maybe color on internal budget and the biggest areas of variance and why we didn't see that show up in operating metric issues this quarter.

Glynis Bryan, Chief Financial Officer

So internally, we had a higher growth expectation around the combination of Insight and PCM in our business. That's really the biggest driver in terms of…

Kenneth Lamneck, President and Chief Executive Officer

Yes, we've been very aggressive about managing the operational cost, and then in the quarter, we had some help from PCM on gross margin lines, but it's also the decline in hardware relative to the increase in our services and the mix of the services business with cloud that's driving the gross margin improvement across all jurisdiction.

Matthew Sheerin, Analyst

Yes, thanks. Good morning. I just wanted to ask about the strong gross margin in the quarter and your guide for it to be down roughly 150 basis points sequentially. I imagine that's the mix issue. But you also talk about continued weakness in infrastructure hardware and other hardware products. So you would think that mix would continue to favor you. So could you talk about that dynamic?

Glynis Bryan, Chief Financial Officer

Yes, I think historically, we've seen usually about a 100 basis points decline in gross margin between Q2 to Q3. Q2 is our largest quarter. In this Q2 in particular, our margin was helped by the fact that there was a lower percentage of hardware in our gross margin and a higher percentage of services and specifically professional services that are 100% margin that drove that higher gross profit. We're anticipating that hardware is going to be a bigger component of our overall gross profit in Q3, relative to the 10% decline versus the 20% that we talked about at the beginning of Q2, so that will have a bigger impact on overall gross margin in Q3 relative to what we saw in Q2. Finally, we will continue to focus on controlling our costs to align with the demand environment and currently expect SG&A as a percent of sales will approximate levels reported in the second quarter. There remains significant uncertainty around the ongoing impact of COVID-19 on the economy and potential resurgence of cases in the back half of the year. Based on what we know right now, we would expect the fourth quarter results to follow historical topline trends of low single-digit growth compared to the third quarter. We're pleased to see each of our segments rise to the operating and demand challenges presented by COVID-19 in the first half of 2020.

Kenneth Lamneck, President and Chief Executive Officer

Thank you, Glynis. Slide 16. We remain committed to our long-term priorities discussed at our Analyst Day last fall, which include continuing to innovate in order to capture share in high-growth areas, such as cloud and the intelligent edge. Developing delivery solutions to drive better business outcomes for our clients, expanding the scale in our business and strategic clients and end markets, and lastly, continue to optimize client experience in our execution through relentless focus on operational excellence. Through the remainder of 2020, we believe the overall IT market will be challenging given the COVID crisis, and its adverse impact on the global economy. We have taken the appropriate steps to reduce our discretionary spending and ensure we have access to capital to support our short-term operating plans, and are confident we will weather this tough economic environment and emerge healthy on the other side.

Glynis Bryan, Chief Financial Officer

We're allowing natural employee efficiency to flow through and we're assessing replacement hiring in the context of current demand. We've right-sized our operational and delivery platform to expected volume trends, and we've accelerated our existing PCM integration plan around back office sales and services and that will allow us to meet our revised synergy goals for this year. At the same time, we plan to make strategic investment in sales and technical resources across our solution areas to ensure we optimize our participation as market conditions improve. And finally, we will be judicious about our use of cash, different discretionary capital investments and using available cash to pay down debt as our priority. Our balance sheet is healthy, and we have access to capital to operate in these uncertain economic times. We believe all these steps will help us emerge strong to compete as the economy recovers. Thank you again for joining us today. And thank you for all our teammates across the globe for their support of our company, our partners and our clients. Be safe and we look forward to talking with you again later in the fall. That concludes my comments and we'll now open up the lines for questions.

Operator, Operator

And your first question comes from Adam Tindle with Raymond James.

Adam Tindle, Analyst

Hi, Adam. Before you ask your question, can I just make one correction? When I was talking about cash flow and I talked about the activity that was timing differences in the quarter, I said $2 million, that should have been $200 million. Just to be clear.

Glynis Bryan, Chief Financial Officer

Just to clarify for everybody listening in. But go ahead with your question now. Thank you.

Adam Tindle, Analyst

Glynis Bryan, Chief Financial Officer

So internally, we had a higher growth expectation around the combination of Insight and PCM in our business. That's really the biggest driver in terms of…

Kenneth Lamneck, President and Chief Executive Officer

As you may recall in our last earnings call, we talked about, actually, that – what we received projected wise is actually a 20% sort of bookings decline going into the quarter. So certainly, that is an improvement, we're seeing down 10%. Still down, but certainly, an improvement from what we saw in the – which did play out certainly across the board for the quarter we just announced.

Adam Tindle, Analyst

Okay. But you could – you were able to achieve – yes, but it seems like you were able to manage some costs and the operational aspect to volume negative…

Glynis Bryan, Chief Financial Officer

Yes, we've been very aggressive about managing the operational cost, and then in the quarter, we had some help sided from PCM on gross margin lines, but it's also the decline in hardware relative to the increase in our services and the mix of the services business with cloud that's driving the gross margin improvement across all jurisdiction.

Matthew Sheerin, Analyst

Kenneth Lamneck, President and Chief Executive Officer

Glynis Bryan, Chief Financial Officer

Yes, I think historically, Matt, we've seen usually about a 100 basis points decline in gross margin between Q2 to Q3. Q2 is our largest quarter. In this Q2 in particular, our margin was helped by the fact that there was a lower percentage of hardware in our gross margin and a higher percentage of services and specifically professional services that are 100% margin that drove that higher gross profit. We're anticipating that hardware is going to be a bigger component of our overall gross profit in Q3, relative to the 10% decline versus the 20% that we talked about at the beginning of Q2, so that will have a bigger impact on overall gross margin in Q3 relative to what we saw in Q2. Thank you.