Insight Enterprises, Inc.

Good morning and thank you for attending the Insight Enterprises Incorporated third quarter 2023 earnings conference call. My name is Alyssa and I will be your moderator. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. To ask a question, you may press star 1. I would now like to pass the call to our host, James Morgado, SVP of Finance and CFO of North America. James, you may proceed.

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 September 30th, 2023. I'm James Morgado, Senior Vice President of Finance and CFO of Insight North America. Joining me is Joyce Mullen, President and Chief Executive Officer and Glennis Bryan, Chief Financial Officer. If you do not have a copy of the earnings release or the accompanying slide presentation that was posted this morning and filed with the Securities and Exchange Commission on Form 8K, you'll find it on our website at insight.com under the Investor Relations section. Today's call, including the question and answer period, is being webcast live and can also 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, November 2, 2023. 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 call, we will be referring to non-GAAP financial measures as we discuss the third quarter 2023 financial results. When discussing non-GAAP measures, we will refer to them as adjusted. You will find a reconciliation of these adjusted measures to our actual GAAP results included in both the press release and the accompanying slide presentation issued earlier today. Please note, that all growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. Also, unless highlighted as constant currency, all amounts and growth rates discussed are in U.S. dollar terms. As a reminder, 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 periodic reports and subsequent filings with the SEC. All forward-looking statements are made as of the date of this call, and except as required by law, we undertake no obligation to update any forward-looking statement made on this call, whether as a result of new information, future events, or otherwise. With that, I will now turn the call over to Joyce, and if you're following along with the slide presentation, we will begin on slide four. Joyce?

Thank you very much, James. Good morning, everyone, and thank you for joining us today. Q3 met our expectations and delivered record adjusted earnings per share for the quarter. Cloud gross profit grew 17%, and Insight Core Services gross profit grew 20%, demonstrating the progress we are making to becoming the leading solutions integrator. We are also confirming our adjusted diluted earnings per share for the full year of 2023. Here are a few highlights. We achieved gross margin of 18% in Q3, reflecting both an improvement in our revenue mix as well as continued progress on our pricing and profitability initiatives. Q3 adjusted EBITDA margin expanded 130 basis points to 5.7%. We generated $414 million of operating cash flow in the first three quarters of the year, an increase of over 600 million from last year. And consistent with our strategy to focus on cloud and services, We acquired Amdaris, an award-winning software development and digital services company based in the UK. I will provide more details on its acquisition later. These highlights demonstrate we are on the right path with our strategy and making progress towards becoming the leading solutions integrator. We remain focused on the fastest growing areas of the market, cloud, data, AI, edge, and cyber. While we have been leveraging AI to support clients' needs for a long time, we are really excited about the acceleration that generative AI is providing to us and, more importantly, to our clients. We've recently filed GenAI-related patents focused on customer support and sales use cases. These patents integrate large language models with third-party data to enhance support applications, recognize and leverage human sentiment specifically for support applications, reduce hallucinations and query time, which reduces GPU usage, emulate personality types, and improve search capabilities for customer support applications. Combined with our expertise, these capabilities allow us to deliver business outcomes to our clients more efficiently. We are also using GenAI internally to improve efficiencies with our development team and our back office support functions. Our clients need a partner they can trust. to navigate new technologies and the infrastructure and workplace requirements to help them digitally transform. This is at the heart of our strategy. As a reminder, there are four key pillars. Captivate clients, sell solutions, deliver differentiation, and champion our culture. To illustrate this strategy in action, I'd like to talk about one of our clients who is a technology leader in the public safety industry. They were experiencing a significant increase in customer demand and needed help to meet their delivery obligations and fulfill their growing backlog. They required a partner that could design, implement, and execute a large-scale deployment of their technology to tens of thousands of vehicles across multiple locations. Leveraging our edge expertise, we implemented a customized solution combining routers, cameras, and cloud software, along with our services, to deploy and test the solution at the edge. At every stage, we made sure their key requirements around testing and quality assurance were satisfied. We quickly ramped up a successful pilot of several thousand vehicles and have since moved to a multi-year contract. The positive outcomes for our client include faster times to market, improved customer satisfaction, and accelerated revenue growth. The success of this project has led to exploring how we can help them seamlessly deploy more of their products at the edge. This is an excellent example of how we focus on business outcomes, earn the right to do more, and ultimately become the partner our clients can't live without. Our expertise in Edge Solutions is part of our heritage and very important to our clients. As a solutions integrator, by combining hardware, software, and services, we bring even more value to our clients. I'd like to also highlight our application development strength with a recent project we delivered for a large insurance provider. They began an initiative to develop a new custom internal claims processing application to replace their existing outdated and high risk system. They needed help establishing a development environment that could accelerate the time to value. We introduced them to our proven agile development practices and deployed our user experience experts to guide their development efforts. The deployment included user story mapping, planning the project sprints, and performing agility health checks along the way. The effort ultimately concluded with the rollout of a scalable, next-gen claims processing application that helped them realize significant cost savings, improve claims accuracy, and enable digital payments. The two projects I highlighted were delivered by our exceptional technical team of over 6,000 dedicated experts. To augment our exceptional talent and wide-ranging capabilities, M&A remains an important element of our strategy. We are always looking to bolster our capabilities through strategic acquisitions in line with our focus on the fastest growing areas of the market, cloud, data, AI, edge, and cyber. In August, we acquired Amdaras, an award-winning cloud and application modernization company based in the UK with service delivery centers located in several Eastern European countries. Amdaras has been a Microsoft Gold certified partner for more than 10 years. and has a proven track record of delivering transformative digital services. MDARS brings more than 850 teammates, 90% of whom are engineers and developers, making it an ideal addition to our existing application and data practices. Through this acquisition, we also strengthen our solutions capabilities in Europe. I'd like to share an example of how MDARS was able to deliver on a project and earn the right to do more. Their client, a global recruiting firm based in the UK, was dealing with increasing costs while developing their own custom-built CRM system. The Amdaras team stepped in to deliver the project faster with a more scalable and reliable application, all while saving costs. The success of this project has led to additional work with this client, including application development, product design, and data migration support. This illustrates why Amdaras is a perfect complement to our strategy. And our strategy is working. To add to our track record of industry recognitions, I'll highlight a few. We've been included in the Gartner Magic Quadrant for Software Asset Management Managed Services and Public Cloud IT Transformation Services. This highlights our strength in helping clients architect, build, and manage cloud solutions. Additionally, Insight has been named EMEA Innovation Partner at this year's Canales Forum, which recognizes outstanding performance in achieving and driving innovation. In part, this was due to our early development of Insight GPT. And since we believe our culture is a competitive advantage, we are thrilled to be recognized by Forbes as a world's best employer for 2023. In summary, we are making great progress towards becoming the leading solutions integrator, focused on the fastest growing areas of the market and where our clients need the most help. With that, I'll turn the call over to Glynis. to share the key details of our financial and operating performance in Q3 and outlook for 2023. Vanessa?

Thank you, Joyce. Our focus on profitability and growth in high margin cloud and services business has contributed to the expanded margins we've seen in our results this year. And we believe we're well positioned to profitably grow our top line as macroeconomic conditions improve. Moving on to Q3 results, net revenue was $2.3 billion. a decrease of 11% in US dollar terms and also in constant currency. The decline was primarily due to hardware, which was down 17% due to devices, partially offset by cloud growth. Last quarter, we expressed our belief that we had approached the bottom of the device market and that the decline in our devices revenue was low. Sequentially, devices were up slightly in Q3. Despite the 11% decline in net sales, growth profit increased 2%, reflecting the hardware decline offset by higher cloud and Insight Core Services growth, as well as the benefit of profitability and pricing initiatives we implemented last year. Insight Core Services growth profit was $71 million, an increase of 20%. This performance reflects growth in applications, data, digital enablement, as well as networking, partially offset by a decrease and integration and other services related to the client and devices. Cloud growth profit was $96 million, an increase of 17%, reflecting higher growth in SaaS and infrastructure as a service. Growth margin was 18%, an increase of 220 basis points, and reflects the higher mix of cloud, insight core services, and infrastructure products. all of which transact at higher margins relative to devices. In addition, our profitability and pricing initiatives also contributed to higher hardware and services gross margin. Last quarter, we accelerated cost reduction actions to better align our cost structure to the market environment. These actions were completed by mid-quarter, and we have started to see the benefit of the actions in North America, where adjusted operating expenses were down 4%. Our adjusted EBITDA margin expanded 130 basis points to 5.7%. And for the third quarter, adjusted diluted earnings per share was $2.37, up 19% in U.S. dollar terms and also in constant currency, and including the benefit of approximately 4 cents related to the release of certain tax reserves. Our adjusted return on invested capital for the trailing 12 months ended September 30th 2023 was 16.8% compared to 15% a year ago, and this also demonstrates progress towards our long-term goal. Here to date, we generated $414 million of cash flow from operations compared to a usage of $206 million for the corresponding period in 2022. We continue to evaluate our options relative to the convertible notes, as well as the impact of the convertible notes on dilution and our share repurchase strategy. Our 2023 share forecast includes the net impact of share repurchases and the anticipated dilution throughout 2023. You will find the dynamics of the convertible notes illustrated in our investor presentation. We exited Q3 with debt of $324 million outstanding under our ABL compared to $438 million outstanding as of Q3 2022. This reduction in our debt balance is after spending $217 million on share repurchases in the first nine months of 2023, and also includes the acquisition of Andaris in Q3, and is indicative of the strong cash flow in our business. As of the end of Q3, we had approximately $1.5 billion available under our $1.8 billion ABL facility. We have ample capacity to fund our business operations and capital deployment priorities, including M&A. As Joyce mentioned in August, we acquired Andaris, an award-winning software development and digital services company. MDARIS significantly increases our digital and cloud enablement capabilities in EMEA. The impact on adjusted diluted EPS will be negligible in 2023. Our presentation shows our trailing 12-month performance through Q3 2023 relative to the metrics that we laid out at our investor day in October 2022. We believe we're on track to hit these targets by 2027. We are keeping an eye on the broader market and appreciate that demand and spending patterns are volatile. With three quarters under our belt, hardware has started to improve, but not at the level we had anticipated. We expect continued strength in software, cloud, and insight core services, as well as expanded margins from our pricing and profitability initiatives. Additionally, we believe we will benefit from the operating expense actions we took last quarter. Given these factors, we're maintaining our adjusted diluted ETFs guidance of $9.40 to $9.60, and we recognize this is a wider range than is typical for Q4. This guidance includes gross profit growth in the low single-digit range, interest expense between $45 and $47 million, and effective tax rates of 25% to 26% for the full year, capital expenditures of $40 to $45 million, and an average share count for the full year of 34.8 million shares. This outlook excludes acquisition-related intangible amortization expense of approximately $34 million, assumes no acquisition-related or severance and restructuring and transformation expenses, and assumes no meaningful change in our debt instruments or at macroeconomic outlook. I will now turn the call back to Joyce.

Thanks, Gwyneth. The long-term dynamics of the IT industry are very strong. Digital transformation is here to stay, and technologies like generative AI are accelerants. At Insight, we are staying focused on delivering outcomes our clients value most, leveraging our skills in the fastest-growing areas of the market. To summarize our results this quarter, Insight core services gross profit grew 20%. Cloud gross profit grew 17%. Adjusted EBITDA margin increased to 5.7%, adjusted diluted earnings per share grew 19%, adjusted ROIC was 16.8%, and trailing 12 months, free cash flow as a percentage of adjusted net income was 211%. Our portfolio of solutions gives us the resiliency to navigate through economic cycles, and we are prepared to capture growth opportunities when spending patterns improve. We have a healthy balance sheet And our business delivers strong cash flow, giving us the capacity to fund our capital allocation priorities. In particular, acquisitions in the fastest growing segments of the market. In closing, I want to thank our teammates for their commitment to our clients, partners, and each other. Our clients for trusting Insight to help them with their transformational journeys. Our partners for their continued collaboration and support in delivering innovative solutions to our clients. This concludes my comments and we will now open the line for your questions.

We will now begin the question and answer session. If you would like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you would like to remove your question, you may press star 2. As a reminder, if you are using a speakerphone, please pick up your handset before asking your question. Once again, to ask a question, press star one. Our first question comes from the line of Joseph Cardoso with JP Morgan. Your line is now open.

Hey, good morning, everyone, and thanks for the questions. So just starting off here, if I'm looking at the full year guide, you moderated the gross profit outlook modestly to the low end of your prior guide. I was just hoping if you could walk us through the big ticket items that are resulting in the incremental pressures impacting the guide versus, let's say, 90 days ago. And then I have a follow-up.

Sure. Sure. So, Joe, thanks for the question. What I would say is that our device, we're not seeing the improvement in the device segment of the market that we had anticipated. And while that doesn't necessarily drive huge gross margin, it does actually drive some gross profit dollars. We continue to see strength in cloud. We continue to see strength in our services GP, but the hardware side of the business is not recovering as we had anticipated and is specifically around the device side. To offset that, we have some improvements that we're making with regard to SG&A. We took some SG&A actions last quarter, actually this quarter, so we have a little bit of benefit this quarter. We expect to have more benefit in 2023, in the fourth quarter, sorry.

Got it. And then maybe we could just touch on that part on devices. You know, can you just give us a little bit more color on the linearity of customers spending through the quarter, particularly as it relates to the improvement that you are seeing devices? And then maybe just more broadly, not specific to devices, are you seeing any divergence across your various customer verticals, like large enterprise, SMB, and public sector from an overall spending behavior standpoint? Thanks for the questions. Appreciate it.

Hi, Joe. This is Joyce. Thank you very much for asking. So here's the thing. I mean, first of all, I want to make sure it's notable that the reason we set out on this strategy is because we know that devices are going to be inherently cyclical, and we've seen a lot of that this year, and still we've delivered record EPS for the quarter. So just that's kind of the backdrop. But then in terms of devices, we have seen some sequential improvement. We expect to see some continued sequential improvement. But instead of seeing growth as we thought at the beginning of the year in Q4, we expect to see that push out a quarter to probably to the back half of the year. And we know that that's pretty consistent with what we're hearing from our partners and what we're seeing in the market. From a segment point of view, generally we see some improvement first in the commercial space, and it takes longer for that to take hold in the enterprise space. Given the dynamics of the device market, we do believe that Windows 11, Gen AI requirements, hybrid work requirements will drive refresh cycles. But again, those generally, we see that sooner in the commercial segment and later in the enterprise segment. Public sector has been strong for us overall, and that's consistent with kind of the amount of money that's in the public sector at the moment.

And just on the linearity piece, we didn't see any differences really throughout the quarter. in terms of how July versus September transacted short of the third month of the court is always the strongest.

Thank you. The next question comes from the line of Matt Sheeran with Stiefel. Your line is now open.

Yes, thank you and good morning everyone. Just related to the hardware sales, I know client devices are part of it, but so are infrastructure, products, storage, servers, networking. And I know you've commented that you've had good backlog, particularly on the networking side, but that the expectation where that backlog were to get worked down with improving supply. So could you give us some color on what you're seeing with those products and how that plays out in Q4 and into next year?

So, yeah, so the infrastructure backlog has largely normalized now. And we are seeing some softening in infrastructure demand. It's really, again, consistent with what we're hearing from our partners. There's a bit of uncertainty, just, you know, acquisition quotes are taking longer to turn into POs, et cetera, et cetera. However, we still believe the long-term dynamics are very strong. Again, we think GenAI will be an accelerant around infrastructure. And so we're spending a lot of time. It's just the sales cycles are a little longer.

Okay. And you talked about sequential growth in client devices in Q4. Would you expect the infrastructure products to be also up seasonally?

Well, we have a little bit of a different dynamic because we just flushed a bunch of backlog in Q3. So we would not see the same dynamic there. That's largely driven by backlog.

Okay. So... Got it. Okay. That's helpful. And as you noted, the free cash flow has been very strong. I know the inventory has been coming down. I imagine because of the client device flush and also a better supply. Could you talk about expectations for working capital and inventory going forward?

We would say that our inventory has largely normalized as of right now versus the buildup that we had. back in the supply constraint era. And we would expect that it would stay around this level as we move forward. Our working capsule has been great at this stage given that hardware is very soft. It's improving, but it's still very soft. We would anticipate that we'd still be in a positive working capsule environment if hardware were to grow in the kind of low to mid single digits. It becomes more problematic for us when hardware is growing in the 25 to 30, devices in particular. in the 25 to 30% range like it did in 21 and 22. So we'd anticipate that we'd be seeing more capital than we have right now.

Okay, great. And just lastly, your comments about the pricing and profitability projects that you had in terms of customers and increasing pricing. Could you talk about that? Is that across hardware, across services? How successful has that been?

I think it's been very successful as evidenced by the gross margin appreciation that we've seen and the improvement in gross profit on declining revenues. So we have a strategy that is related to hardware, if you want to think about it that way, in terms of the floors that we, pricing that we will accept from large customers and the approval processes that we put in place with regard to level of gross margin, relative size of customer, et cetera. And we've also put some floors and ceilings in place around services that have helped drive that improvement in gross margin, as well as really looking and standardizing our utilization metrics across all of our service practices so that we are measuring it consistently and that we can really pinpoint where we need to be focused in terms of utilization. And to be fair, we've also leveraged some offshore capability to lower our overall charge-out rate that has helped with the gross margin as well in services. So it's been a combination of various factors. I would say they're now systemic. They're not one-offs anymore.

Okay, and there have been no share issues or share loss issues because of that in terms of competitive landscape?

I would say if you look at our results relative to our largest reseller competitor out there, as I'm talking about it from a hardware, from a kind of client segment perspective, we've definitely held our own. We've definitely held our own.

Okay, great. Thank you.

Thank you. The next question comes from the line of Anthony Lebedzinski with Sidoti. Your line is now open.

Hi, good morning. This is Stephan Guillaume on for Anthony Lebedzinski. My first question is, can you talk about the performance during the quarter for your different client groups such as large enterprise, public sector, and SMB?

Yeah. So, you know, I think we've published all this. It's all in the documents, but I'm happy to talk about it. I think the most challenged segment for the quarter is the enterprise business overall. Commercial was also pretty challenged, I would say. Public sector was strong.

And grew.

Yeah, so I think we're happy with that because we think that's pretty consistent with the market.

Yeah. So our public sector grew low single digits, maybe low to mid single digits. And the enterprise and corporate and commercial segments were down in the double digit, maybe teams area.

Yeah, commercial was down the most.

Thank you. And do you think we are at the bottom for the medical devices? Or if not, when do you expect to show positive results for devices?

So we said last quarter we thought we were at the bottom of the device market. We believe that that was true. We saw some sequential growth that we expect to continue, largely because the compares also get a lot easier.

Thank you so much.

Thank you. The next question comes from the line of Jake Norrison with Raymond James. Your line is now open.

Hey, thank you for taking my question. I'm hoping you guys could touch on the performance geographically a little more, maybe touch on what you saw out of EMEA relative to expectations and maybe just the overall macro environment there relative to Americas. Thank you.

Okay. So EMEA business delivered to our expectations. I would say that maybe the mix of business was a little bit different. I think that the outlook for the EMEA region for Q4 as well as going into 2024 is likely is softer than it is anticipated to be for North America. We did do an MDARS, the MDARS acquisition in EMEA. So as we look into 2024, we would see some growth coming through from that. By the time you add interest expense, it's not necessarily a material to total insight results, but you will see kind of improvement in services growth margin associated with that acquisition. And we think that that acquisition will also help with regard to data and cloud-related sales that drive combined with services business outcomes for our clients. So we think that the acquisition should be very beneficial to EMEA as we go into 2024, especially in light of a softer economic environment that's forecast in EMEA for next year.

Perfect. And then on the topic of M&A, can you just please opine on your sort of M&A outlook or what you're thinking about for fiscal 24 just after coming off the Amdaris acquisition? Thank you.

So we've been pretty consistent in talking about focusing on acquisitions that help us improve our capabilities in the fastest growing areas of the market, cloud, data, AI, edge, cyber. So nothing has changed there. We're really pleased by the acquisition in EMEA and we remain very, very focused on looking for other acquisitions that can offer great capabilities to our clients. we're still very, very focused on. We also have the capacity, of course, on the balance sheet, I think, like Glenis talked about. So no change in the strategy there. We do believe that the transactions and the valuations have come down this year, so it's making it a bit more possible to do things like MDARs.

Thank you. The next question comes from the line of Vincent Colicchio with Barrington Research. Your line is now open.

Yeah, Joyce, it was mentioned that offshore was levered to boost margins. Will that become an increasing focus for the company going forward?

Yes, for specific services, Glynis mentioned the work that we're doing to improve the structural profitability of our services business. We're pretty pleased with the work we've done so far there. And as you might remember, we bought HANU about a year ago, a year and a half ago, and we have been working to figure out how to leverage those global capabilities in all three regions. So for specific offers and specific capabilities, we expect to continue to leverage India, and we expect – we have been doing that for quite some time, by the way, for our own internal back office, primarily in Manila, and now we're doing that both in Manila and in India.

And I came on the call a little late, you may have mentioned, but the use of AI to improve productivity and programming, is that – how far off is that in the future? Is there a line of sight to that?

The future is now, Vince. happening now so we are we've been really really excited about the work that we've done we launched insight GPT about I want to say about six weeks after Microsoft did the open AI announcement in February we've been using internal use cases to help educate our clients on what the opportunities and capabilities are in their environments and that's driven a lot of interest and a lot of client meetings and a lot of assessments and That's also driven some very significant opportunities to improve quality of data and data estates for our clients so they can leverage these analytics capabilities and also certainly some use case development and application development. So this is absolutely an accelerant, we think, over the long term or medium term, and we're seeing it start now.

Yeah, I'm curious about its ability to improve programming productivity. Any thoughts on that?

Yeah, well, we have, so the leader of Amdaris gave me a number that is very exciting in terms of software developer productivity improvement, but I mean, and we're hearing this over and over again from our partners as well, but somewhere in the 100 to 100 plus X improvement in terms of productivity is something that we're aiming for. I wouldn't say we're there yet, but we have seen already significant improvement in productivity in the 20, 30, 40% range, primarily around quality checks, quality auditing, and just development time.

Thank you.

Thank you. There are no additional questions registered at this time. So as a reminder, if you would like to queue for a question, press star one. We will pause here for any additional questions to register. There are no further questions at this time. We will now conclude the call if the team has any further remarks. That concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.