Greetings and welcome to Insight Enterprises' Second Quarter Operating Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host Ms.

Glynis Bryan, Chief Financial Officer. Thank you, you may begin..

Thank you, Donna. Welcome everyone and thank you for joining the Insight Enterprises' earnings conference call. Today we will be discussing the company's operating results for the quarter ended June 30th, 2019. I'm Glynis Bryan, Chief Financial Officer of Insight and joining me is Ken Lamneck, President and Chief Executive Officer.

If you do not have a copy of the earnings release that was posted this 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 6th, 2019. 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-financial -- certain non-GAAP financial measures as we discuss our second quarter 2019 financial results. When referring to non-GAAP measures, we will refer to such measures as adjusted.

Non-GAAP measures to be discussed in today's call include adjusted earnings from operations, adjusted EBITDA, adjusted diluted earnings per share, adjusted return on invested capital, and adjusted free cash flow.

You will find the reconciliation of these adjusted 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 gross rates are discussed on U.S. dollar term.

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 reports subsequently filed with the SEC. With that, I will now turn the call over to Ken. And if you're following along with the slide presentation we will begin on slide 4.

Ken?.

Midsize Agile Software Development Service Providers. The Forrester Wave report is a highly respected and trusted guide for buyers considering agile service providers. Companies are evaluated on 22 criteria across current offerings strategy and market presence.

We're pleased to announce Insight placed as a strong performer, among the 13 distinguished providers in this category. This recognition showcases our expertise in this area for our clients, which we believe provides a distinct advantage over many of our competitors.

Turning to slide 8, before I hand the call back over to Glynis, I want to update you on our acquisition of PCM. Late in the second quarter of 2019, we entered into a definitive agreement to acquire PCM. The acquisition is subject to approval by regulators and PCM shareholders.

Our team could not be more excited about the opportunity to bring these two businesses together.

Insight has agreed to acquire PCM for $35 a share, which implies an enterprise value of $581 million and a transaction purchase price multiple of 4.5 times, calculated as the ratio of enterprise value of PCM's last 12-month, adjusted EBITDA, including the $70 million in synergies.

Strategically through this acquisition, we will expand our reach in the mid-market, particularly in North America and complementary service offerings and more than $224 million annually in services sales to Insight's robust platform; increase our technical and sales coverage globally adding more than 2,700 client-facing teammates, including 1,100 technical architects, engineers and service delivery teammates to our business; and further strengthen our relationship with strategic partners.

Operationally, Insight has a platform that includes scalable IT and e-commerce systems, smart logistics and procurement processes and robust digital marketing capabilities all backed by a culture of continuous process transformation and automation.

When combined with PCM's unique operational delivery model based out of the Philippines, we believe we can integrate the PCM business quickly and allow for cost synergies along the way. Financially, we expect that PCM will add more than $2 billion in our top line and gross margins of more than 15%.

We expect to achieve annualized run rate synergies of $70 million by the end of 2021. And we expect the transaction to add more than $0.70 in adjusted EPS to our consolidated results in 2020, excluding deal-related and integration expenses and intangible amortization expense.

Since the announcement we have launched our detailed integration planning, we'll work towards regulatory clearance and shareholder approval. We currently expect to close this transaction by the end of third quarter and remain committed to realizing the synergies in long-term, returns for our teammates, clients and shareholders.

I'll now turn the call back over to Glynis to provide more detail on our financial performance in Q2..

Thank you, Ken. As Ken noted earlier, we're pleased with our global team's execution in the second quarter. I'll start with North America on slide 10. In North America, net sales were $1.4 billion in the second quarter, up 3% this year compared to 7% growth reported in the second quarter of 2018.

Hardware sales increased 4% year-over-year and were up 25% sequentially. Services sales increased 10% year-over-year in the second quarter, including higher sales of cloud solutions as well as the acquisition of Cardinal; while software sales decreased 6% year-over-year, reflecting continued migration of on-prem licenses to cloud alternatives.

Gross profit in North America was up 4% year-over-year and gross margin improved 30 basis points to 14.2%, reflecting the increase in the cloud and services sales in the business. North America selling and administrative expenses increased year-over-year, primarily due to the Cardinal acquisition.

As a result, adjusted earnings from operations decreased 1% year-over-year to $55 million for the quarter. Moving on to EMEA on slide 11, in EMEA net sales in the second quarter declined 3% in constant currency to $379 million, reflecting lower volume with large enterprise and public sector clients mostly in the hardware category.

The decrease in hardware was partially offset by an increase in services due to higher sales of software maintenance and cloud subscription products as well as higher sales of professional services engagement.

Our team's focus on cloud and services sales drove gross profit growth of 9% in constant currency and expanded gross margins by more than 190 basis points to 17%.

We also control expenses, which drove adjusted earnings from operations up 16% in constant currency compared to the same period last year and adjusted EFO margin to 4.4%, which is up 75 basis points year-over-year and a new record for the region.

Moving on to APAC on slide 12, in APAC net sales in the second quarter declined 12% in constant currency to $51 million. This decrease is due to a shift in business mix that included more cloud and software maintenance sales, which are reported net and in services.

As a result, despite reported top line declines, gross profit grew 7% in constant currency and gross margin expanded significantly. Adjusted earnings from operations in APAC grew 8% year-over-year, also in constant currency. We're pleased with the regional results, particularly our team's focus on improving gross margins.

Our solution areas strategy has refined our focus on services and solutions that deliver value to our clients and improve our earnings potential. As a result, our gross margin expanded year-over-year in the second quarter of 2019 and hit a new record of 15%. Moving on to taxes.

Our effective tax rate for the second quarter of 2019 was 25.9%, which was flat year-over-year, as compared to the prior year quarter. Turning to our cash flow performance on slide 13.

Year-to-date through the second quarter of 2019 our operations generated $183 million of cash compared to $351 million last year and in line with our expectations for the first half.

Our prior year results reflect a higher-than-normal seasonality for cash flow performance, as well as the benefit of our enhanced focus on reducing aged receivable balances. Our year-to-date results for the second quarter of 2019 are more in line with typical seasonality.

And as a reminder, historically, our operations use cash in the third quarter and generate cash in the fourth quarter. For the full year of 2019, we continue to expect cash flow from operations will be in our normalized range -- annual range of between $160 million and $200 million.

In the first half of 2019, we invested approximately $11 million in capital expenditures, which was flat year-over-year. We did not repurchase any stock this year, but we did use $22 million to buy back shares in the first half of last year.

All of this led to a cash balance of $112 million at the end of the second quarter, of which $88 million was resident in our foreign subsidiaries. And we had $74 million outstanding under our revolving credit and capital lease arrangements.

$47 million, I will correct that, $47 million outstanding under our revolving credit and capital lease arrangement. This compares to $248 million of cash and $162 million of debt outstanding at the end of the prior year quarter. Our cash conversion cycle was 26 days in the second quarter of 2019, up six days from the second quarter of 2018.

The result -- this increase resulted from a six-day increase in DSOs, driven primarily by the relative timing of sales during the respective quarter and other sales-related timing differences. DPO and DIOs were flat year-over-year. Moving on to slide 14.

Before I give the call back to Ken, I wanted to provide some color on how to think about the PCM business in connection with our results for 2019. While we do not have a definitive closing date for the transaction, we wanted to provide certain assumptions relevant for your modeling.

Assuming a close date by the end of the third quarter, we believe the business could contribute approximately $530 million to $560 million in net sales and approximately $3 million to $5 million on adjusted earnings from operations in the fourth quarter, including estimated intangible amortization, but excluding deal-related expenses and severance and restructuring costs.

As previously announced, we expect to use cash on hand and borrow approximately $620 million under a new ABL facility to fund the transaction and expect incremental interest expense in the fourth quarter of approximately $11 million.

While our purchase accounting work is pending, we're currently estimating intangible amortization expense of approximately $4 million in Q4, again assuming a close by the end of the third quarter. Because we lack certainty around a close date, we have not included the outlook for PCM in the guidance we published today.

We will update our expectations for guidance on our Q3 conference call, assuming closing occurs beforehand. I will now turn it back to Ken to review our 2019 outlook.

Ken?.

Thank you, Glynis. Before I turn to our outlook for the full year of 2019, I'd like to remind you of our four strategic priorities. First, we are focused on optimizing our opportunity in our four solution areas, leading with services and solutions to drive profitable growth ahead of the market and higher gross margins each year.

Second, we remain disciplined embracing a metric and information-based culture that guides our investments with the goal of driving leverage on our cost structure and we plan to optimize our use of capital by investing in organic growth, pursuing strategic M&A opportunities to expand our offerings and global footprint, and then returning cash to our shareholders.

Moving on to slide 17. Our strategic investments in our solution areas have positioned us well to compete in the markets we serve. Our deep technical knowledge and resources and our differentiated service offerings, strengthened by market-leading partners, allow us to serve clients of all sizes across many verticals and on a global scale. On slide 18.

With respect to our full year 2019 outlook we continue to expect to deliver sales growth in our core business in the low single-digit range compared to 2018. We're increasing our outlook for adjusted diluted earnings per share and now expect adjusted EPS for the full year of 2019 to be between $4.85 and $4.95.

This outlook assumes an effective tax rate of 25% to 26% for the balance of the year, capital expenditures of $20 million to $25 million for the full year and an average share count for the full year of approximately 36.2 million shares.

This outlook does not reflect the results of the PCM acquisition that is expected to close by the end of the third quarter of 2019, the repurchase of any shares that may be made under our current share repurchase program and acquisition-related or severance restructuring expenses incurred in 2019.

Thank you for joining us today and thank you for all our teammates across the globe for their performance in the second quarter. That concludes my comments and we'll now open your line up for your questions..

Thank you. [Operator Instructions] Our first question is coming from Adam Tindle of Raymond James. Please go ahead..

Okay. Thanks and good morning. I just wanted to start Ken it's been just over a month since you announced the intent to acquire PCM. I would imagine you've been able to talk to vendor partners and also customers about this.

So I'm just hoping you can maybe give us a sense of the general response from vendor partners and customers since you announced the intent to acquire PCM?.

Yes. Thanks, Adam. From a partner base point of view very positive. As you know of course, we align very closely to the same partner community. And so all the partners we've discussed feel like there's additional leverage. The combination really takes advantage of what both capabilities we have. So to a partner it's been very positive in all respects.

On the client front, it's a little difficult. Obviously, as you know we're still competitors at this stage. So we're very careful in any communication we have with our clients.

Clients that have brought it up have only brought it up in a positive vein, but certainly we don't really comment on that at this stage due to the nature of this deal being in the quiet period..

Okay. And maybe just kind of digging into the financials that you outlined for Q4, and I don't know if maybe Glynis wants to touch on this as well.

I think if I add back the intangible amortization, the EFO margin in Q4 that is implied here is like mid-1% range and I would think that Q4 is typically when you get pretty good leverage with year end budget flush for PCM.

Is there anything distorting that number that I'm missing? And maybe just touch on why margin is so low for that business and why that asset is attractive..

I don't -- I wouldn't say necessarily that the margin is low for the business in general. Once -- in the Q4 we don't have the reflection of the synergies realistically in terms of it being the first quarter post-closing.

So we've indicated that we anticipate getting about $0.70 in 2020 in terms of EPS -- adjusted EPS coming out of the business when we actually have the synergies under our belt and are ramping up to our two-year run rate of getting to the $70 million.

So I think it's just a timing issue with regard to the timing of close expectations that we have with regard to noise as we go through the close process and talk to the sales organization et cetera. And historically when you look at the PCM results their Q4 gross margins have historically been lower than their margins to-date.

So we've also reflected that in our numbers..

Okay. And then maybe just one last one on near-term trends. It seems like a lot of the vendor partner community has -- in commentary has suggested a slowing environment. You probably saw NetApp pre-announcement, for example.

But the broader of our channel hasn't really seen it and your fiscal year guidance suggests that profit dollar growth is actually going to accelerate on a year-over-year basis in the back half of this year organically. So just maybe hoping that you can touch on the disconnect on what we're seeing.

The vendor some of the vendor partners seeing some slowing yet your back half guidance is still pretty robust. Thank you. .

Yes. It's been a little bit mixed as you basically stated there Adam in regards to some of the -- on the storage front NetApp of course, which is a key partner of ours. And what we've seen really is just maybe a little more slowness in making decisions on that.

We haven't seen the loss of business this example with NetApp just maybe a little bit slower to make decisions. But then when I look at our overall cloud and data center business, it was actually very strong. Network inventory is strong. There was good -- actually very good growth in the data center business for us in the quarter.

So I think it's a little bit mixed dependent upon the situation. So we stand by the fact that we still see pretty good stability from everything we can see in the market. What the tariffs might -- may or may do in the back half is still in question.

To-date we've seen really no impact on that, but that could have some impact as we go forward into the second half..

Okay. That’s helpful. Thank you very much..

Thank you. Our next question is coming from Matt Sheerin of Stifel. Please go ahead. .

Yes. Thanks. Good morning. Just regarding the strong gross margin in the quarter particularly in EMEA which I think was the first time you hit a 17% margin there. I know that it seems like that June quarter seems to be a strong margin quarter historically for Europe.

Is there a particular reason, or is that sort of a one-off? Because if you back into your EPS and revenue guide for the year it looks like your gross margin will not be improving from here.

So could you just give us more color on the mix there Ken both EMEA and North America?.

Should I get?.

I'll have you touch on it Glynis first..

Okay. So in EMEA specifically it is the -- the second quarter is Microsoft event. And in EMEA our business is more heavily weighted towards software or software-related products, the cloud specifically.

You'll notice when we talked about the results in EMEA we said that the top-line decline primarily related to more cloud and software solution sales as opposed to product sales.

So what's happening in EMEA is a conversion of on-prem software to the cloud, as well as more cloud solutions that they're actually selling that's resulting in the higher gross margin that you're seeing there. So, no -- the second quarter is always our highest quarter margin performance.

It's typically not always, but typically our highest gross margin performance and I wouldn't anticipate that the 17% -- I know that the 17% in Europe is not going to be consistent for the rest of the year.

But they had an outstanding quarter all operationally driven and through the focus that they have on Microsoft solutions that are in demand in the European market..

Got it.

And so would you say then that the gross margin improvement in North America is not -- I mean obviously Microsoft plays a part of that, but it seems like particularly with data tech that you are seeing margin expansion because of the solutions business?.

We are seeing margin expansion in North America because of the solutions business. So our Insight-delivered services grew at a faster rate than our overall kind of agency fees, if you want to think about it that way we report services. And we said services grew 10% in North America as an example.

Within that number the services component, the Insight-delivered services component that grew at a faster rate and that is attributable to the success that we're having with our solution -- the sales into our solution areas and a little bit of cross-sell that we are starting to see flow through from the Datalink acquisition.

Do you want to add?.

Yes. And I'd say you're correct in that Matt, t in regards to the Datalink business was strong. The cloud and data center business actually did very well in the quarter as well. So we're seeing good success there. And as you know more design-oriented certainly comes at a higher gross margin..

Got it. And in the North America hardware sales, up very strong sequentially and obviously I would think some of that is coming from this PC refresh cycle.

Could you talk about that and what you're seeing both on the public sector side and the commercial side?.

Yes. On the public sector side, we're -- in the Fed space we're more skewed towards software. So we don't really take full advantage of that like we've seen some of our competitors produce some pretty good quarters. This last quarter in the public sector space with hardware we're more software-oriented, so we didn't have the same benefit there.

But I would say that for the most part there's still a little bit of a backlog issue with some processor issues. We think we'll get through that by this quarter. On the device side with one manufacturer that is certainly muting our performance on the device side a little bit. We think that will resolve itself this quarter.

But again most of our hardware growth was very heavily focused towards the data center. So we're really pleased with that performance and the investments of course that we've made in that area. Again, we see that the device side of the business is continuing to grow nicely.

We think there's still more room to grow there with obviously the Windows 7 of course coming to end of life. We think that will continue supporting the growth that we've seen for so many years now continuing for the device side of the business..

Do you get a sense Ken of what percentage of your customers are not compliance to the newer operating systems and have to be by January?.

It's really hard to get a sense for that. I mean of course there's many clients that won't even migrate to that. They'll continue to stay on Windows 7.

So hard to get a sense for what those percentages are because they're a little bit, so I'd hate to quote a number because I've heard all sorts of varying numbers that we're about halfway through to there's still another 60% to 70% left. So hard to really determine what that real number is..

The other thing I would add Matt is that historically at Insight, we have typically seen our refresh cycles related to a Microsoft change like Win 10 happened later, ultimately because our large enterprise clients have an IT infrastructure such that they can afford to handle their -- any needs that come up without necessarily having to rely on Microsoft.

So if you remember going back to the Windows XP end of life, our transactions in terms of the increase in our devices' sales came about six to nine months later than the standard marketplace just because our clients do their own internal evaluation and take a little bit longer before they pull that trigger.

But we would expect going into the second half of 2020 to see some impacts from that refresh..

Okay. Got it. Thank you..

[Operator Instructions] Thank you. At this time, I would like to thank everyone for their participation. You may disconnect your lines at this time and have a wonderful day..