INSIGHT ENTERPRISES INC quarterly report, Q2 FY2017

Insight Enterprises, Inc. — 2017 Q2 Form 10-Q Summary

Business context and reporting period

Insight is a global provider of IT hardware, software, cloud and services to business, government, healthcare and education clients. Operations are reported across North America, EMEA and APAC. This unaudited filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.

Results include Datalink from its January 6, 2017 acquisition and Ignia from its September 1, 2016 acquisition. The business is seasonal, with generally stronger sales and profitability in the second and fourth quarters.

Financial performance and key metrics

Metric	Three months ended June 30, 2017	Three months ended June 30, 2016	Six months ended June 30, 2017	Six months ended June 30, 2016
Net sales	$1.684 billion	$1.456 billion	$3.162 billion	$2.625 billion
Gross profit	$251.4 million	$209.2 million	$459.6 million	$370.3 million
Gross margin	14.9%	14.4%	14.5%	14.1%
Earnings from operations	$69.3 million	$58.1 million	$92.3 million	$71.8 million
Net earnings	$40.3 million	$35.1 million	$54.1 million	$42.0 million
Diluted EPS	$1.11	$0.96	$1.50	$1.13
Operating cash flow	Not separately provided	Not separately provided	$(99.3) million	$(4.6) million

Second-quarter sales increased 16%, with reported organic growth of 7% and additional contribution from Datalink. Excluding currency effects, sales increased 17%.
Six-month sales increased 20%, or 23% excluding currency effects. North America was the principal growth driver, while EMEA and APAC reported second-quarter sales declines of 4% and 3%, respectively.
Second-quarter gross profit increased 20%; management attributed margin expansion primarily to Datalink, product mix, higher partner funding and services growth. Core-business gross margin was pressured by lower enterprise software agreement fees and lower services sales.
Selling and administrative expense increased 20% in the second quarter and 21% for the first six months, reflecting Datalink, higher variable compensation and other operating costs.
Interest expense increased to $4.3 million in the second quarter and $8.3 million for the first six months, primarily because of higher borrowings used in connection with the Datalink acquisition.
The six-month effective tax rate was 35.1%, compared with 37.7% in 2016, benefiting from $2.2 million of tax benefits related to employee share-based awards under newly adopted accounting guidance. The quarterly effective tax rate was 37.7%.

Financial position, cash flow, debt and liquidity

At June 30, 2017, cash and cash equivalents were $194.8 million, compared with $202.9 million at December 31, 2016. Accounts receivable were $1.822 billion and inventories were $210.5 million.
Total debt was $300.9 million, including $170.6 million outstanding under Term Loan A, $124.0 million under the accounts receivable securitization facility and $7.3 million of capital leases and other financing obligations. The company had no revolving-facility borrowings.
The revolving credit facility has a $350.0 million maximum capacity and matures in June 2021. The accounts receivable securitization facility has $250.0 million of availability and matures in June 2019. The inventory financing facility has $325.0 million of capacity, with $203.9 million outstanding.
Six-month investing cash use was $191.2 million, including $180.9 million for Datalink, net of cash acquired, and $10.3 million of capital expenditures. Financing activities provided $270.7 million, primarily through new debt borrowings.
Operating cash flow was negative $99.3 million, affected by working-capital growth and a roughly $160 million supplier payment made in January 2017 for which the related receivable had been collected in the prior year. Management stated that operating cash flow would have been positive excluding this timing difference.
The cash conversion cycle was 15 days, unchanged from the prior-year quarter. Management expected available cash flow and financing capacity to support operations, working capital and strategic investments for at least the next 12 months.
The company was in compliance with its debt covenants at June 30, 2017. The maximum permitted leverage ratio was 3.50 times trailing twelve-month adjusted earnings; management expected compliance over the next four quarters.

Material changes, outlook and unusual items

Datalink was acquired for a cash purchase price of $257.5 million, including $76.6 million of cash acquired. The transaction added $64.1 million of goodwill and $94.5 million of identifiable intangible assets; the purchase-price allocation remained preliminary.
Datalink contributed $123.6 million of second-quarter sales and $28.9 million of gross profit, and $252.7 million of six-month sales and $59.3 million of gross profit. Management stated that Datalink was on track to meet its profitability objectives for 2017.
Six-month severance and restructuring expense was $5.7 million, primarily related to Datalink-related role realignment in North America and headcount reductions in Germany and France. Six-month acquisition-related expense was $3.2 million.
The company adopted employee share-based payment guidance and inventory measurement guidance in 2017. The share-based payment adoption increased second-quarter diluted EPS by approximately $0.01 and six-month diluted EPS by approximately $0.06.
Management expected 2017 capital expenditures of approximately $15 million to $20 million, primarily for technology and facility upgrades. Excess cash flow was expected to be used for debt reduction, capital expenditures and potentially acquisitions.
On July 19, 2017, the company completed the sale of its Russia operations and expected to record an approximately $3 million non-cash charge in the third quarter related to release of cumulative foreign-currency translation adjustments.
The company has never paid a cash dividend and did not intend to pay dividends in the foreseeable future. No shares were repurchased during the quarter or first six months of 2017, and no repurchase program was authorized.

Risks, contingencies and controls

Key risks include competition, dependence on technology manufacturers and other partners, rapid technology changes, acquisition integration, international operations and foreign-currency exposure, economic conditions, debt and interest-rate risk, cybersecurity and IT disruption, accounts receivable collections, personnel dependence, contract compliance, tax matters and litigation.
Unrecognized tax benefits were approximately $3.9 million at June 30, 2017. Several subsidiaries were under tax audit for 2012–2015; management could not estimate the range of possible outcomes, although it did not expect a significant effect on income tax expense or net earnings.
Performance bonds outstanding were approximately $2.7 million. The company also disclosed indemnification obligations, legal proceedings in the ordinary course and $5.4 million of accrued severance and restructuring obligations, without recording additional material liabilities for contingencies management considered unlikely.
The company disclosed total contractual obligations of approximately $604.8 million, including $294.6 million of long-term debt, $203.9 million of inventory financing obligations, $65.6 million of operating leases and $5.4 million of severance obligations.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Investor verification priorities

Verify the sustainability of North America growth and the profitability contribution and integration progress of Datalink.
Monitor working-capital conversion, accounts receivable growth, inventory levels and the return to positive operating cash flow.
Reconcile debt balances, Term Loan A amortization, accounts receivable facility usage and compliance with the 3.50-times leverage covenant.
Assess whether gross-margin improvement persists despite lower core-business software agreement fees and services pressure.
Confirm the expected $15 million–$20 million 2017 capital-expenditure range and the use of excess cash for debt repayment or acquisitions.
Evaluate the third-quarter non-cash Russia disposal charge, tax-audit developments and the preliminary Datalink purchase-price allocation.