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Greetings, and welcome to the Insight Enterprises First Quarter 2019 Operating Results Conference Call. [Operator Instructions] Please note, this conference is being recorded.
I will now turn the conference over to your host, Glynis Bryan, Chief Financial Officer. Thank you. You may begin.
Thank you. Welcome, everyone, and thank you for joining the Insight Enterprises Earnings Conference Call today. Today, we'll be discussing the company's operating results for the quarter ended March 31, 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 our 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 2 hours after completion of the call and will remain on our website for a limited time.
This conference call and the associated webcast contains time-sensitive information that is accurate only as of today, May 1, 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 non-GAAP financial measures as we discuss the first 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 diluted earnings per share, adjusted return on invested capital and adjusted free cash flow. You'll find a 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 growth rates discussed are in U.S. 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 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 with the slide presentation, we will begin on the Slide 5. Ken?
Hello, everyone. And thank you joining us today to discuss our first quarter 2019 operating results. I'm pleased to report we have started the new year with a strong earnings performance in the first quarter. Our top line results decreased in the first quarter against a tough comparison last year where we focused on profitable business growing our services sales and helping our clients migrate to the cloud which led to strong gross margin expansion in the quarter. At the same time, we controlled our expenses which allowed us to deliver another quarter of double-digit earnings growth in the first quarter with each of our 4 operating segments contributing to these results. Specifically, for the first quarter of 2019, consolidated net sales were $1.69 billion, down 3% year-over-year in U.S. dollars and down 1% in constant currency. The decline reflects lower hardware sales to large enterprise clients primarily North America. These results compare to 19% year-over-year growth reported in the first quarter of last year.
Consolidated gross profit of $248 million in the first quarter was up 3% year-over-year and up 6% in constant currency. Gross margin expanded 90 basis points year-over-year to 14.7%, a new record for the company.
Consolidated selling and administrative expenses were $191 million, up 2% year-over-year and up 4% in constant currency. This increase is largely due to the acquisition of Cardinal. However, selling and administrative expenses as a percentage of gross profit were down 140 basis points year-over-year, reflecting the benefits of our scalable cost structure with gross profit increases.
Adjusted earnings from operations were up 10% year-over-year to $57 million and adjusted earnings from operations margin expanded 40 basis points to 3.4% of sales. On a GAAP basis, earnings from operations were up 13% compared to the same period last year. And adjusted diluted earnings per share was $1.10, up 16% year-over-year. And on a GAAP basis, diluted earnings per share was $1.09.
Our earnings results in the quarter were in line with our internal expectations coming into the year and we're very pleased to see all of our segments execute well to meet our operational and financial goals for the quarter.
Moving to Slide 6. Our first quarter results reflect our efforts to improve our gross margin profile by leveraging our 4 solution areas to optimize product mix and expand our services offerings globally. Each region grew gross profit dollars mid- to high-single digits year-over-year in constant currency in addition to improving the gross margins year-over-year.
We also continued our strategic efforts to help our clients evaluate and implement cloud technologies. Gross profit earned from cloud solutions was in excess of 18% of our consolidated gross profits for the trailing 12 months as compared to 17% in the prior year trailing 12 months.
Gross margin expansion, combined with continued expense discipline, drove adjusted earnings from operations up 10% compared to the prior year quarter. And adjusted EFO margin was a new quarter -- new first quarter record for us at 3.4% of net sales. In addition, we generated $122 million of cash flow from operations and adjusted return on investment capital increased 200 basis points year-over-year to 17.5%.
Moving to Slide 7. As we look to the remainder of 2019, we believe the IT market is healthy and growing. Our plans for 2019 are focused on driving growth across our operating segments by continuing to empower our clients to manage their IT environments more efficiently for today so they can drive meaningful business outcomes and transform their own businesses for the future. To do this, we will leverage our 4 solution areas to enhance our value proposition to clients around the world, aligning our offerings to our clients' needs, utilizing our strategic partnership relationships and organizing our resources to target key areas of market opportunity.
As a reminder, our 4 solution areas are: First, supply chain optimization which focuses on driving operational excellence to help our clients optimize costs and improve efficiency; second, Connected Workforce which focuses on improving enablement in the workplace to attract and retain talent in addition to improving overall worker productivity; third, cloud and data center transformation which helps clients optimize their data center infrastructure and migrate to a cloud environment to improve speed of business delivery, increase business agility and enhance security; and lastly, digital innovation which leverages the innovative applications to improve clients' business performance and uncover new revenue streams for their businesses.
In recent years, we have made several strategic acquisitions to deepen our technical skills and expand our client reach within our solution areas. In January of 2017, we completed the acquisition of Datalink to strengthen our presence in the cloud and data center transformation space. At that time, we estimated up to $20 million in cost synergies by the end of year 2. I'm pleased to report that we have comfortably exceeded our early estimates and delivered approximately $25 million in cost savings through the end of 2018. As planned, core systems were integrated within 4 months of closing and the back offices fully integrated within the first year, exceeding our financial goals while also successfully retaining key talent across the business.
Headed to 2019, we're now focused on optimizing sales synergies. To that end, we recently made enhancements to our organizational structures and sales compensation schemes, and we're seeing accelerated traction and cross-sell activity which helped drive double-digit growth in data center-related sales in the first quarter.
Similarly, in August 2018, we acquired Cardinal Solutions to accelerate our opportunity in the digital innovation space. Since closing, we have completed the back-office and systems integration, bringing a stronger, more agile and scalable platform to their business and adding strong technical and leadership talent to ours. We've also integrated the Cardinal sales and delivery teams into our existing digital innovation team and have seen early cross-sell success between the teams.
M&A is a strategically important lever for us as we look to expand our capabilities and acquire clients globally. We have a robust due diligence and integration playbook that has proven successful ensuring we realize on the opportunity of the combine businesses. As we move forward, we'll consider tuck-in acquisitions in EMEA and APAC to build out our digital innovation and hybrid cloud practices similar to the Caase acquisition in the Netherlands in 2017 and the Ignia acquisition in Australia in 2016. And in North America, we'll continue to look for opportunities to expand into key markets, add capabilities and new clients to our portfolio.
While each of our solution areas have the opportunity for growth, while connected to each other, they provide a platform for our clients to leverage our breadth and expertise to solve their most relevant business challenges from IT supply chain, workforce modernization, data center transformation and to optimize performance in the digital world.
Moving to Slide 8. Before I hand the call back to Glynis, I want to highlight an example of how we're leveraging our solution areas to help our clients achieve better business outcomes. We recently partnered with the City of Houston to be the first to implement an Internet of Things-enabled platform called ActiveShield that redefines public safety. The IoT safe spaces technology created by our digital innovation team utilizes the power of Microsoft Azure and integrates with the building's safety platforms in order to facilitate critical real-time information sharing during a crisis.
Insight's Safe Spaces solution addresses communication challenges during emergency events while public safety is threatened, running safety mechanisms like sound sensors and color LED lighting through an IoT-enabled response system. The real-time information sharing more clearly conveys the nature of the incident to first responders and people in the vicinity of the impacted area. While our main focus in this endeavor is to provide comprehensive and deeply integrated safety deployments, ActiveShield offers a cost-effective software as a solution service for the broader market. The district recently announced that this application of the smart technology helped the City of Houston win the International Data Corporation’s Smart Buildings Award.
I'll now had the call back over to Glynis to provide more details on our financial performance.
Thank you, Ken. As Ken noted earlier, we're pleased with our global team's execution in the first quarter.
Let me start with North America on Slide 10. In North America, net sales were $1.2 billion in the first quarter, down 3% this year compared to very strong double-digit growth reported in Q1 of 2018. Hardware sales declined 14% year-over-year compared to 23% increase in hardware sales produced by the business in the first quarter of last year. This decline is primarily due to lower spending by a large enterprise client.
Services sales increased 19% year-over-year in the first quarter, including higher sales of cloud solutions, an increase in Insight-delivered services as well as the acquisition of Cardinal. In addition, software sales increased 23% due to strong growth in selected large enterprise clients. Gross profit in North America was up 4% year-over-year and gross margin expanded 100 basis points to 14.7%, reflecting the increased mix of cloud and services sales in the business.
North America's selling and administrative expenses increased year-over-year primarily due to the Cardinal acquisition. However, selling and administrative expenses as a percentage of gross profit dollars increased -- decreased, decreased 60 basis points year-over-year. As a result, adjusted earnings from operations increased 7% year-over-year to $46 million for the quarter.
Moving on to EMEA on Slide 11. In EMEA, net sales in the first quarter grew 2% from constant currency to $390 million. And in that, services sales increased 19% year-over-year primarily driven by higher volume of software maintenance, cloud solutions and professional services engagements. Our team focused on profitability and grew gross profit dollars 9% in constant currency and expanded gross margin by 80 basis points to 14.6%. In addition to improving gross margins, the team reduced expenses as a percentage of gross profit dollars by 340 basis points and this drove adjusted earnings from operations up 27% compared to the same period last year.
Moving on to APAC on Slide 12. Net sales in the quarter grew 1% in constant currency to $53 million. Gross profit grew 9% in constant currency while gross margin expanded from the prior year sales -- prior year quarter due to the higher mix of high-margin cloud and services sales. Expense control was also highlighted in the first quarter in the APAC region as the team reduced selling and administrative expenses as a percent of gross profit dollars by 360 basis points. The improvement in gross margin, combined with the effective cost control, resulted in an adjusted earnings from operations growth of 21% year-over-year.
Our solution areas strategy has refined our focus on innovative services and solutions that best meet our clients' needs. As a result, our services growth was the main driver of our gross margin expansion year-over-year in the first quarter of 2019 to a new record of 14.7%.
As Ken noted, our consolidated results for the quarter were consistent with our expectations for the first quarter. Diluted earnings per share came in slightly above expectations for the quarter due to lower interest expense and taxes. The lower interest expense relates to lower average borrowings under financing facilities partly offset by higher interest rates. Our effective tax rate for the first quarter was 23.5% as compared to 25.9% in the prior year quarter. The lower effective tax rate is primarily due to an increase in tax benefit from a settlement of employee share-based awards and tax benefits related to research and development activities.
Turning to our cash flow performance on Slide 13. In the first quarter of 2019, our operations generated $122 million of cash compared to $151 million of cash last year. Our solid cash flow this year continues to reflect our enhanced focus on reducing aged accounts receivables and minimizing general and client-specific inventory investments. For the full year of 2019, we continue to expect cash flow from operations will be in our normalized annual range of between $160 million and $200 million.
Our cash conversion cycle was 30 days in the first quarter 2019, down 6 days from the prior year quarter. The decrease resulted from the net effect of a 1-day increase in DSO, a 6-day increase in DPO due to the relative timing of client receipts and some payments due in the respective quarters. DIO also decreased 1 day due to the overall focus on minimizing inventory on hand.
Just one more update before I give the call back to Ken. Effective January 1, 2019, we implemented a new accounting standard that requires capitalization of certain committed lease arrangements that historically were off balance sheet. As a result, in the first quarter, we recorded net operating lease right of use assets and lease liabilities of $66 million and $71 million, respectively. The difference between the lease assets and liabilities reflect existing accrued and prepaid rent balances. The adoption of this standard did not affect our consolidated net earnings and had no impact to cash flow in the first quarter.
I'll now turn the call back to Ken to review strategic priorities and our 2019 outlook.
Thank you, Glynis. Moving on to Slide 14. Before I turn to our outlook for the full year 2019, I'd like to remind you of our strategic priorities. First, we're focused on optimizing our opportunity in our 4 solution areas, leading with services to drive profitable growth ahead of the market and higher gross margins each year. Second, we will remain disciplined, embracing the metric- and information-based culture that guides our investments and drives leverage on our cost structure. Finally, we plan to optimize our use of capital by investing in organic growth, pursuing strategic M&A opportunities and to expand our offerings and global footprint and then return cash to our shareholders.
Moving on to Slide 15. 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 services offerings, strengthened by market-leading partners, allow us to serve our clients of all sizes across many verticals and on a global scale.
On Slide 16. With respect to our full year outlook for 2019, we now expect to deliver sales growth in the low single-digit range compared to 2018. We do expect adjusted diluted earnings per share for the full year of 2019 to be between $4.75 and $4.85, 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 purchase of any shares that may be made under our current share repurchase program and assumes no acquisition-related or severance and restructuring expenses occur in 2019.
Thank you again for joining us today, and thank you for all our teammates across the globe for a great start to 2019. That concludes my comments and we'll open your line up for your questions.
[Operator Instructions] Our first question comes from Adam Tindle with Raymond James.
Okay. Ken, I just wanted to start maybe on the revenue growth guidance for 2019 that you just laid out. I think you had previously expected growth in the mid-single-digit range, and I know that you started down in the first quarter on revenue growth off of a tough comparison, but it was better than most of us were thinking. You mentioned in the prepared remarks, the market is healthy and growing, you're optimizing sales synergies and cross-selling should only improve. So if I could just maybe push back on why the downtick to low single-digit growth. Is there slowing in customer purchasing intention over the past 90 days? Looks like one of your main competitors is talking about below-seasonal Q2 right now. So any color on that would be helpful.
Thanks for the question, Adam. Yes, I mean, obviously, as we go through and look for the year and then obviously account for Q1 as a minus 3% for us from a decline point of view as we just do the math, we expect that we'll probably finish in that low single-digit increase for the year when you look at the following 3 quarters. So we definitely see growth. As you can see, we're pretty focused on improving and enhancing our margin profile, for business opportunities to keep that trend going. So I think it's just balancing that, but certainly not a signal to what we're seeing as far as the market being a concern as we do see nice continued growth occurring in the market.
And just to maybe add on to that, Adam. I think that we would anticipate that Q2 is going to be another soft quarter on a revenue -- from a revenue perspective. And that going into Q3, it kind of starts evening out with growth coming in, in the second half in order to get to that low single digit. So we're not envisioning that Q2 is going to be up on a year-over-year basis, given the strong growth that we had in Q2 of 2018. That's how you get to the numbers for the full year.
Right. And then maybe just talking about EFO margin. Typically on a seasonal basis, EFO margin at Q1 is your low quarter and you were near mid-3%. If I back into the guidance for the full year, it implies that you're also going to be in that ballpark. So maybe just touch on the EFO margin line. Is there a gross margin headwind from a vendor change? Are there OpEx investments weighing on this? What would cause leverage to not materialize as the year progresses?
I think we do have some investments that we're making in the business. I wouldn't say it's necessarily related to partner program changes or anything along those lines. There are investments that we're making to the business and we anticipate for the full year that we will come in somewhere in that 3.5% range.
Okay. And maybe just to clarify. You've historically said kind of EPS weighting for first half, second half is like a 50-50 weighting. Can you help us, how we can think about that for 2019?
I would say that it is still going to be somewhat in that range. It's going to be a little bit higher in the first half than in the second half. A little bit higher in the first half versus the second half because of the big Q -- the Q2 is going to be typically our biggest quarter, and we had a bigger-than-expected Q1 from your perspective, not from our perspective.
Got it. Okay.
And we will expect the tax rate to normalize for the remainder of the year. We're not anticipating a 23% tax going forward. It will normalize in that 25% to 26% range.
Our next question comes from Mark (sic) [ Matt ] Sheerin with Stifel.
It's Matt Sheerin from Stifel. Just a couple of follow-ups from Adam. Just regarding the demand environment, just on the hardware refresh cycle that we've been through, Ken. You did talk about obviously tough comps, but it sounds like some enterprise customers were slower. Is that because they've gone through that cycle now? What's your thoughts as we go through the year here, on both servers and PCs?
Yes. On the PC front, I think, Matt, you're calling it correct. And we've discussed, of course, is there really a cycle or is it just sort of a more normalcy? We tend to see that, again, we had some pretty large-scale clients that we did go through a cycle of refresh, they're not going to do it to the same degree every year. But we're seeing consistency in a lot of clients doing it over a 4-year period. And so we have some pretty big upticks as you saw last year in that regard. We're still optimistic. We think that there's still lots of momentum in that space. There's a lot of opportunities still for Win 10 migrations to occur. So we think that will -- I think it'll be more of a normalcy going forward over the next few years. So seeing pretty healthy situations there.
On the data center side, we're continuing to be very focused there as you know with the cloud and data center transformation part that we have been, and we're seeing some really good cross-selling. So there's a lot of opportunities, of course, as we help clients migrate to the public cloud. But there's still a lot of activity, of course, going on in private cloud and private data center activity as well. So overall, I think for the market, a little bit softer in that space. I think we did pick up share in that specific part of the business and we're continuing to be focused on that part of it.
Okay. And in Europe, and the U.K. specifically, where I know you have a lot of exposure, any thoughts on -- we're hearing from some competitors in other parts of the supply chain of some slowdown in the U.K. because of Brexit concerns and uncertainties. Any read there?
Yes. I think -- good question, Matt. There's no question we've been sort of on this for the last couple of years when you really think about it. And it's actually held up, in the scheme of things, much, much better than any of us would have thought. We did start to see, I think, in the first quarter a little bit more of a typical slowdown in the government space. March is typically a very big month as you know in the U.K. on the government side. So a little bit of slowdown, a little consternation there as they try to figure things out. But in the commercial business, we saw continued strength there, so no issues. So we'll continue to forge ahead and execute to our plans in the U.K.
Okay. And in the North America business, your software business grew significantly. I mean I'm trying to -- and I know there's acquisition part of that, but trying to get a handle on seasonality. Were there some sort of one-off kind of engagements or deals or agreements that boosted that number?
I'd say on the acquisition part, it really was more -- that was Cardinal, that was really services related.
Services.
So that wouldn't have shown up on software line. So I think it was continued good execution for us on the -- and very focused on the cross-sell opportunities that we're having with the Datalink acquisition and continue grow that part of the business, that's helping us.
And do you -- okay. And when you talk about revenue down year-over-year, or at least not up, is that -- would that be true for both hardware and software?
I would say it's more of a hardware scenario for us. We expect growth, nice growth in software as well as in services in 2019.
[Operator Instructions] Our next question comes from Marc Wiesenberger with B. Riley FBR.
Can you talk about the effects of the government shutdown and maybe your expectations around the cadence for capturing any potential lost opportunities?
Yes. Good question, Marc. That keeps getting brought up. Certainly, in the early part of the year, we certainly did see a slowdown there, obviously, with the government shutdowns. So Q1, as you're seeing across the board, wasn't very robust from a Federal point of view, and we certainly experienced that as well. I would say, as we're seeing early signs into Q2, we're not seeing that pick up or that acceleration we would have expected from the fact that there was a slowdown in Q1. So obviously, there's still lots of time left in Q2, but the signs aren't pointing to the fact that, that will be a full recovery from what we didn't capture in Q1 at this stage. So certainly, we're focused on that very heavily. But right now, there's a little bit of concern that the government isn't -- the Federal government isn't opening up yet.
Sure. Understood. And then maybe around some commentary around the impact of tariffs and what you're hearing from customers and expectations going forward.
It's almost been business as usual. There has been a lot of discussion on tariffs since really the end of last year -- or second half of last year by any means. So it's sort of normalized. As you know of course with our systems and processes, that's passed on to our clients pretty efficiently. So we haven't heard clients discuss it. We haven't really heard much from our partners discussing that as well at this point either.
Sure. And one final one for me. I think you talked a little bit about maybe some -- I don't see reorganization, but a re-tinkering of incentives for the sales force. Can you talk a little bit more about that? And then how you expect that to enhance sales going forward?
Yes. Marc, it was specifically around our cloud and data center transformation business, we're -- specifically around Datalink as we're trying to use those very valuable resources into the traditional Insight clients and trying to get that cross-sell into those clients, where the first year, we had some success but not the acceleration that we wanted. So we've implemented a program where we've created additional incentives to ensure that compensation is only enhanced for both sides of the equation there to help that. And we are seeing early signs that it's having a good impact on us. And that's certainly much higher-margin business for us, so from a cost point of view, it's a very efficient way for us to try to drive increased revenues.
[Operator Instructions] There appears to be no additional request for questions. This concludes today's conference. All parties may disconnect. Have a great day. Thank you.