Greetings, and welcome to the Insight Enterprises Fourth Quarter and Full Year 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Glynis Bryan, CFO. Thank you, Ms. Bryan. You may begin.

Thank you very much. Welcome, everyone, and thank you again for joining the Insight Enterprises earnings conference call. Today, we will be discussing the company's operating results for the quarter and full year ended December 31, 2018. 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 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, February 14, 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 fourth quarter and full year 2018 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 will find a reconciliation of these adjusted measures to our actual GAAP results included in the press release and the accompanying slide information issued earlier today. Also, please note that unless highlighted as constant currency, all amounts and growth rates discussed are in U.S. dollar terms. Additionally, any references to our core business or organic change year-over-year in our performance will exclude Cardinal Solutions -- will exclude results of Cardinal Solutions subsequent to the acquisition in August 2018. Lastly, we adopted ASC 606 effective January 1, 2018, on a modified retrospective basis. As discussed on previous calls, this means that we have not represented the 2017 results shown in our earnings release or presentation materials issued earlier today. 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 periodic report and subsequent filings with the SEC. With that, I will now turn the call over to Ken. And if you are following along with the slide presentation, we will begin on Slide 4. Ken?

Hello, everyone, and thank you for joining us today to discuss our fourth quarter and full year 2018 operating results. I'm pleased to report we delivered another quarter of strong earnings performance in the fourth quarter. Against a difficult comparison to our strong fourth quarter results last year, our team executed very well to expand gross margins and grow our bottom line results by double digits. Specifically for the fourth quarter of 2018, consolidated net sales were $1.7 billion, down just under 2% year-over-year, including the effect of the adoption of ASC 606, which has resulted in more sales reported on a net basis for us in 2018 and compared to the tough comparison of 22% year-over-year growth reported in the fourth quarter of last year. Consolidated gross profit of $254 million in the fourth quarter was up 9% year-over-year and up 10% in constant currency. Gross margin expanded 140 basis points year-over-year to 14.5% reflecting a higher mix of sales of cloud-based and netted software offerings in the core business and higher professional services sales with the acquisition of Cardinal Solutions, completed in August 1. Consolidated selling and general administrative expenses were $195 million, up 6% year-over-year and 7% in constant currency, largely due to the acquisition of Cardinal. However, selling and administrative expenses as a percent of gross profit were down 260 basis points year-over-year. Adjusted earnings from operations were up 23% year-over-year to $59 million, and adjusted earnings from operations margin expanded 70 basis points to 3.4% of sales. On a GAAP basis, earnings from operations were up 29% compared to the same period last year, and adjusted diluted earnings per share was $1.32, up 63% year-over-year on a GAAP basis. Diluted earnings per share was $1.31. Moving on to Slide 5. Our fourth quarter results reflect…

Thank you, Ken. As Ken noted earlier, we are pleased with the progress we made in 2018 delivering strong top and bottom line results, improving our cash flow generation and making strategic investments in our business that will help position us to compete in the future. I'll take a few minutes to summarize the fourth quarter and full year results of our geographic operating segments and will then cover taxes and cash flow performance. Moving on to Slide 9, in North America in the fourth quarter, hardware sales increased 1% year-over-year; that is compared to a 34% increase in hardware sales in the fourth quarter of last year. Services sales increased 35%, including higher sales of cloud subscription and warranty offerings and the acquisition of Cardinal. Software sales decreased due to a higher mix of software sales now reported net and now included in our services category. Gross profit in North America was up 7% year-over-year and gross margin improved 120 basis points, reflecting the increased mix of services sales in the business. In addition, we focused on controlling costs, which allowed us to grow adjusted earnings from operations 15% year-over-year to $45 million. Moving on to Slide 10. For the full year, net sales in North America grew 3% year-over-year. Hardware and services sales grew 8% and 23%, respectively, which more than offset the decline in software sales. As I've said previously, more software sales are recorded in net in 2018 as a result of ASC 606 and the continued migration of software licenses to cloud subscriptions. In addition, both of those are now reported in services sales. From a profitability perspective, gross margin in North America in 2018 increased 40 basis points year-over-year, and when compared with tight expense control across the business, adjusted earnings from operations in…

Thank you, Glynis. Moving on to Slide 16. We are pleased with our execution in 2018 and believe our business is healthy across each of the markets in which we compete. With respect to our full year 2019 outlook, we expect to deliver sales growth in the mid-single-digit range compared to 2018. We also expect 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 full year 2019. Capital expenditures of $20 million to $25 million for the full year and average share count for the full year of approximately 36.2 million shares. This outlook does not reflect the repurchase of any shares that may be made under our current share repurchase program and assumes no acquisition-related or severance and restructuring expenses. Thank you again for joining us today. I want to once again thank our teammates across the world for everything they do for Insight. I'm honored to be part of such a great team. That concludes my comments. We'll now open your line up for your questions.

[Operator Instructions]. First question is from Mr. Adam Tindle, Raymond James Financial.

Ken, I just wanted to start on the 2019 outlook. I know there's a lot of confusion out there in the investment community. There seems to be a view that tough comparisons, year-over-year, from tax reform benefit in 2018, a potential slowing hardware cycle, a number of different things that are going to make growth more difficult. But it seems like at the distributor and the reseller level we're seeing pretty healthy continuation of solid spending into year-end and outlooks beyond that. So I know you mentioned the industry analysts' expectations for growth in your prepared remarks, but I'm just hoping that you can maybe talk about this dynamic and then also what you're hearing from both the customer and partner level on expectations for 2019.

Thanks, Adam, for that. Yes, I would say, overall, from what we see and, of course, we have visibility, real visibility probably a few quarters out for our business as far as pipeline and bookings. And I would say that things definitely look healthy across the 4 solution areas that we represent. So good activity going on, of course, in the area of desktops, notebooks, sort of the device area. So we continue to see that. Again, as we said, is this a cycle or is this a continuation? We think it will be a little bit lumpy because of just big sort of refreshes that we do with large enterprise clients. But, overall, everything we're seeing and hearing is actually -- continues to be pretty strong. So no pullback from us in that area. Our cloud and data center transformation business as far as focus on the network server storage activity, we're seeing some really good cross-sell activity between Insight and traditional sort of Datalink and really starting to take advantage of that. So we continue to see that grow strong. And of course, cloud sales continue to be very, very strong when you look at the things that we're doing with things like Microsoft Azure, Office 365 and so forth. So we continue to see the market to be healthy and to be moving on as more and more of our clients, of course, are looking to, digitally, how do they improve and enhance their business and IT continues to be more of a solution for them. So we remain pretty consistent with what we've seen in the last few quarters.

Adam, can I just maybe translate that in terms of just numerically how that translates into the guidance that we gave. So we would expect that our growth rate is going to be in the low to mid-single-digit range overall, including hardware and software services, given the comments that Ken made. So we anticipate continuing to grow in 2019. We expect that the gross margin is going to be relatively consistent with where we ended 2018, given all of that. We've seen a little bit more conversion to the cloud, but we expect it to be relatively consistent. And when you look at our EPS guidance, it's relatively low on a year-over-year basis, and there are 2 drivers of that. One is interest expense is anticipated to be a little bit higher, given the higher interest environment that we're in, as well as the fact that we had a lower tax rate in 2018, at 22.7% versus the midrange that we're giving you of around 25.5% to 2019, so that mutes the EPS guidance. But we have anticipated our EFO would be -- our operating income would be higher than that on a year-over-year basis. If you do the math, you will get to about 7% growth there.

Yes, that's really helpful, and I want to touch on the EFO guidance because it seems to suggest kind of a maybe a modest increase to margins on the EFO line. But you've got revenue growth, like you said, in kind of mid-single-digit range, you would expect some leverage. Seems like some of the higher-margin areas are growing nicely. But I'm just trying to understand why we wouldn't see more increase on the EFO line. I know Ken mentioned some investments in the prepared remarks, so there's some things that are offsetting. Just talk about the puts and takes of the EFO margin in 2019 and why it's kind of modest to flattish?

It is modestly up. Modestly flattish, I guess, would be a good explanation for that. And part of it is around the investments that we're continuing to make in the business. We actually had a very strong 2018 on top of a very strong 2017. And we want to continue the trend, but there are certain investments that we're making as we pivot more towards our solution areas that cover Connected Workforce, cloud and data center transformation and digital innovation. So those are going to be the drivers of margin expansion for Insight in the future, and we're continuing to make investments to ensure that we will drive that further going forward. I just want to make one other comment. You will remember, Adam, and I think we talked about this, that in Q1 of last year was a very strong Q1 for Insight. It was -- I think we didn't see the normal seasonal dip in Q1 of last year that we typically see. It was about as strong as December in terms of revenue growth. We'd anticipate that revenue growth may be more muted in Q1, but that we'd still be able to generate EFO and gross margin expansion.

You beat me to the punch, I was just going to go there. I just had one final clarification because I know in the previous call you had talked about a large deal in Q1. Can you maybe just update us on that? So I had been thinking that perhaps, with that large deal, we'd see kind of similar trends to last year where we don't see that drop-off in revenue sequentially from Q4. But just give as an update on what happened with the large deal.

The large deal is still going to be coming in. It is netted. So the impact -- I guess, when we talked about it, we didn't really focus on the revenue side of that transaction, but it is a netted deal so the impact on revenue isn't going to be that great. It's not driving higher revenue growth in Q1 of 2019.

So we may have above kind of normal sequential EFO dollar growth as a result and think of kind of maybe as not quite as much of an uplift in Q2 as in prior years? I just want to make sure we've got all the nuances.

You're actually correct.

The next question is from Matt Sheerin, Stifel.

Just a couple of questions from me. One, just on your revenue expectations for the year, software versus hardware. On the software side, are you -- on an apples-to-apples basis, are we sort of looking at fair comps here given the 606 transition and also the continued migration towards services model with customers? So trying to figure out, because last year, obviously, software was down but because some of that transitioned into services. So I'm trying to figure out how we should think about the actual software number this year.

So on the software number, Matt, the 606 impact goes away because now we're apples-to-apples '19 versus '18 as it relates to the 606 impact, primarily around security. The other conversion, that's the migration to cloud, is still going to continue. That's just the normal trend in the marketplace of on-prem solutions migrating more towards cloud-based solutions. Those cloud-based solutions are going to be reported net and as a result, they will be in the services line. So I don't want you to walk away thinking there's no pressure on the software line going into 2019, but I think we reported that it's going to -- it was a $122 million impact on the software line in 2018 versus 2017. That's not the kind of impact you're going to see going forward because most of that was related to 606.

That's what I'm trying to figure out because if it is slower, I mean, it seems to me just modeling it, that the software top line would grow slower. But in theory, you should have higher or at least gross profit dollar growth because of the netted down, which is -- but you're guiding, basically, flat gross margin for the year so I would've thought that you might still get a boost there just on that mix issue.

We could get a little bit of a boost associated with gross margins in different quarters. But in the back half of 2018, I think you remember, in our second quarter call, we said that we anticipated revenue growth was going to be muted in the back half as the mix of our business changed and that we would anticipate that our gross margins would be higher in the back half of the year. So we're coming out of 2018 strong in terms of gross margins in Q4. And going into Q1 through the rest of the year, we would anticipate that we'll see some strength in our gross margins, but we don't really know how the percentage of cloud conversion is going to play out in 2017 -- 2019, so we may be a bit conservative. But we're not going to see the big benefit from -- that we got in 2018 associated with netting because that 606 differential goes away as well as [indiscernible]

Okay. That's helpful. In the services business, you talked, I think, Ken, you talked about numbers -- a percentage of your total gross profit dollars. Could you remind me what that was?

Yes, what we said there, Matt, was the fact that 18% of our gross profit now is coming from cloud-services type of sales, and that's compared to 13% the year before.

Okay. But what about your total services segment?

I think in my comments, Matt, I said about 46% -- 45% of our total GP comes from services. And that would be the combination of professional services, Insight-delivered service as well as the cloud component and other netted pieces.

Could you maybe list in order the components of that services because it's such a big percentage of your gross profit now? So could you remind us?

In order?

Yes.

I'm not going to list it in order. In terms of you're trying to go which is the largest piece going down, I don't have that off the top of my head, but we can certainly put it on the website, I guess, and we'll follow-up with that. But the components that are within our services would be, if you think through, Microsoft EA, anything that's a fee-based revenue inside a netted, it's going to be a part of that services number. So there are pieces that are agency fees that will be categorized that way. That would include software assurance. It would include EACs. It would include cloud transactions. It would include warranty on hardware. Those are the primary fee-based pieces that are included in that services component. And then on the "Insight-delivered piece", it would be the standard pieces we have around our technical services, our professional services, our consulting services. All of our Digital Innovation group, actually, ends up being a services-driven revenue. So those are the major components that flow into our services business and we'll -- we can put a schedule on the website that provides that detail and then you'll see the numbers.

Okay. And, Ken, just...

And our K, it will be in our 10-K.

Okay, great. And, Ken, just sort of a larger sort of bigger picture question. NetApp last night, one of your suppliers, talked about seeing weakness from large enterprise customers in January that were sort of skittish to pull the trigger on big deals just because of macro issues. I know you don't comment into the quarter but have you seen any, I mean, talking to customers in terms of how they're thinking about this year, in terms of optimism or their take on their budgets or IT budgets?

Yes, we haven't seen that sort of negativity specifically that was pointed out. I did see your report on that. And I'd say that we're seeing pretty much consistency for what we saw in the last 3 or 4 quarters. So there might be isolated cases where NetApp may have seen that, but I wouldn't comment on that as a general comment at this stage.

Okay. And just lastly for me, as you look at into the next year or two as, in theory, the hardware refresh cycle for servers and PCs slow and perhaps flat to down at some point. You obviously have a strong software business and a services business. How are you positioning in that kind of environment in terms of your variable cost, reacting to market swings and that sort of thing?

Yes. Good question. I think we certainly are very strongly positioned there. We see a lot of things because we're obviously our cloud and data center transformation business is both private cloud, public cloud -- really the hybrids of the world. And I think one of the things that's been really in my mind underestimated in the whole hardware world is everything that's going to be occurring with IoT at the edge. I do believe that's going to be a really significant driver for hardware solutions at the edge where it's not economical to do everything up in the public cloud; there are latency issues, so on and so forth. And that's really just starting to emerge, and we see that a lot in our Digital Innovation group where we're at the heart of the start of doing these IoT solutions, where in many industries that would have never considered an IT solution, that were very analog-based, are looking to digital solutions with things like Digital Innovation. And it's driving and will be driving a lot of legally significant sort of hardware IoT solutions at the edge. So that's an area, I think, that again the analysts have underestimated. It's building, we see it on the frontlines. And I think that will start to become, in the next couple of years, a pretty significant part of the hardware revenue platform. So if you talk to companies like Dell and Cisco and HPE, they're very, very excited about what that opportunity is. So we believe that there will be more hardware. It's not all going to go away. It may not be the same footprint, a server and storage that we see today at the edge, but there'll still be a significant amount of business flowing through there. But again, we're positioned well because if it goes cloud like we've seen again it go from 13% to 18% in a year for us in sort of these cloud services offerings, we're positioned to take advantage of that as well. And that's good for us, as it becomes more recurring, we like that model quite a bit as we start to build our managed services offering. So we're bullish on that whole trajectory of where that goes, overall.

We have a question from Kara Anderson, B. Riley FBR.

Most of my questions have been asked at this point, but I did just want to touch on whether or not you guys are seeing any impact from the government shutdown or supply shortages that have been, I guess, called out by some of your competitors.

We feel that it certainly had a little bit of impact. I wouldn't say it was material for us on the shutdown because they've come back to work and they're being -- they're obviously going to fulfill that. I think the fed business, overall, was a little bit slow for us and that was mostly mitigated for us by renewals, which we do think are more cyclical and we'll see those we believe start to occur in the back half of this year. So for us, we don't think that it's going to have a material impact.

And on the supply issues?

On the supply issues, I think you're referring, Kara, to the sort of what we've seen with the Intel chipsets and those type of things. I think we're going to see it hasn't been material for us, it's certainly being constraining. But again, I think as you play in the higher end of the enterprise, a lot of these device manufacturers of course are moving more and more of their production towards the higher end where margins are better and so forth versus the lower end of the market. So we're seeing it tight, but I wouldn't say it's a material impact to our business. And the word we have is that it's probably not going to correct itself completely until, call it, the end of the second quarter.

[Operator Instructions]. Ladies and gentlemen, there are no further questions at this time. The conference is concluded. You may disconnect your telephone lines. Thank you.