INSIGHT ENTERPRISES INC quarterly report, Q3 FY2018

Insight Enterprises, Inc. 2018 Q3 Form 10-Q Summary

Business Context and Reporting Period

Insight Enterprises is a global provider of IT hardware, software, cloud, digital innovation, connected workforce, data center transformation and related services. Operations are reported through North America, EMEA and APAC segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods.

The company adopted ASC Topic 606, Revenue from Contracts with Customers, on January 1, 2018 using the modified retrospective method. The adoption changed the timing and gross-versus-net presentation of certain revenues, including security software, cloud offerings, renewals, bill-and-hold arrangements and extended-payment-term contracts.

Financial Highlights

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Net sales	$1.748 billion	$1.758 billion	$5.331 billion	$4.920 billion
Gross profit	$234.9 million	$226.1 million	$739.6 million	$685.7 million
Gross margin	13.4%	12.9%	13.9%	13.9%
Earnings from operations	$49.9 million	$41.4 million	$174.8 million	$133.7 million
Net earnings	$32.2 million	$22.4 million	$116.6 million	$76.5 million
Diluted EPS	$0.89	$0.62	$3.24	$2.11

Q3 sales declined less than 1% year over year, while nine-month sales increased 8%, or 6% excluding foreign-exchange effects.
Q3 operating income increased 21%; the operating margin improved to 2.9% from 2.4%. Nine-month operating margin increased to 3.3% from 2.7%.
Q3 net margin was approximately 1.8%, compared with 1.3% in the prior-year quarter. The nine-month net margin was approximately 2.2%, compared with 1.6%.
The effective tax rate declined to 25.6% in Q3 and 25.8% for the nine-month period, compared with 36.8% and 35.6%, respectively, in 2017, primarily reflecting the lower U.S. federal statutory rate following tax reform.

Cash Flow, Liquidity and Debt

Operating activities generated $247.2 million in the first nine months of 2018, compared with cash used of $323.6 million in the prior-year period. Management attributed the improvement primarily to working-capital optimization, lower aged receivables and reduced inventory investment.
Investing cash outflows were $87.5 million, including approximately $79.0 million for the Cardinal acquisition and $13.0 million of capital expenditures.
Financing cash outflows were $152.1 million, including debt repayments, $81.9 million of net repayments under the inventory financing facility and $22.1 million of share repurchases.
Cash, cash equivalents and restricted cash totaled $112.6 million at September 30, 2018, compared with $107.4 million at December 31, 2017. Cash and cash equivalents alone were $111.1 million.
Total debt was $268.7 million, including $155.7 million under Term Loan A, $111.0 million under the accounts receivable securitization facility and $2.0 million of capital leases and other financing obligations. No balance was outstanding under the senior revolving facility.
The inventory financing facility had $237.6 million outstanding against $400.0 million of availability. The ABS facility had $111.0 million outstanding against $250.0 million of availability, with qualified receivables sufficient for the full facility amount.
The company was in compliance with its debt covenants at September 30, 2018 and stated that it expects to remain compliant over the next four quarters. Management expects operating cash flow and available financing to support operating needs and strategic investments for the next 12 months.
Capital expenditures for full-year 2018 were expected to be $18 million to $20 million, primarily for technology upgrades.

Material Changes Versus the Prior Comparable Period

Services sales increased 25% in Q3 and 23% for the first nine months, while product sales declined 3% in Q3 but increased 7% year to date. The shift reflects growth in professional services, software maintenance and cloud offerings, as well as ASC 606 presentation changes.
North America sales declined 3% in Q3 but increased 6% for the first nine months. EMEA sales increased 11% in Q3 and 18% year to date. APAC sales declined 10% in Q3 but increased 18% year to date.
Q3 gross margin expanded approximately 50 basis points, primarily because of a greater mix of higher-margin services, software maintenance and cloud offerings recorded on a net basis. Nine-month gross margin was unchanged.
Selling and administrative expense increased 2% in Q3 and 4% year to date, primarily due to higher headcount, variable compensation and the addition of Cardinal.
Cardinal Solutions Group was acquired on August 1, 2018 for approximately $79.0 million net of cash acquired. The acquisition added digital innovation, mobile application, Internet of Things and cloud-enabled business intelligence capabilities. Preliminary goodwill was approximately $36.5 million.
The company repurchased 641,211 shares for approximately $22.1 million during the first nine months. No shares were repurchased during Q3, and approximately $27.9 million remained available under the authorization at September 30.
The company corrected immaterial presentation errors in its March and June 2018 interim financial statements relating primarily to classification of certain software revenue transactions. The corrections had no material effect on prior-period earnings.
Management identified and remediated a material weakness in controls over the presentation of certain software revenue and costs under ASC 606. Disclosure controls were assessed as effective at September 30, 2018.

Guidance, Outlook, Risks and Unusual Items

Management expects cash generated in the remainder of 2018, after working-capital needs, to support debt repayment, share repurchases and capital expenditures, while retaining the flexibility to pursue acquisitions.
The business is seasonal: sales and profitability are generally stronger in the second and fourth quarters; federal government sales are often stronger in the third quarter.
Management cited risks from competition, dependence on technology partners and partner incentives, rapid technology changes, acquisition integration, international operations, economic conditions, debt and interest rates, cybersecurity, IT disruptions, contract compliance, credit losses, shipping providers, key personnel, tax matters, litigation and intellectual-property claims.
Gross profit remains sensitive to partner funding and purchasing incentives, which can vary materially among periods.
The company expects adoption of the new lease standard on January 1, 2019 to materially increase other assets and other liabilities through recognition of right-of-use assets and operating lease liabilities, but does not expect a material effect on earnings or cash flows.
Approximately $93.8 million of cash and cash equivalents was held by foreign subsidiaries at September 30, 2018. Certain foreign cash may be remitted through intercompany settlements or dividends.
The company had approximately $4.1 million of unrecognized tax benefits and ongoing tax audits for years 2012 through 2015. Management could not estimate a range of outcomes but did not expect a significant effect on tax expense or net earnings.
Performance bonds totaled approximately $2.1 million. Management considered payments under performance bonds and indemnifications unlikely and recorded no related liability.
The company has never paid a cash dividend and did not expect to pay dividends in the foreseeable future.

Important Facts for Investors to Verify

Assess the comparability of sales and margins after ASC 606, including the migration of certain software and cloud revenue from product sales to services and the gross-versus-net presentation.
Monitor North America hardware demand, public-sector sales, software-to-cloud migration and APAC quarterly volatility.
Evaluate Cardinal’s contribution to services growth, integration progress and the final purchase-price allocation.
Review working-capital trends, particularly the 89-day accounts receivable metric, 38-day cash conversion cycle and reliance on inventory financing.
Reconcile total debt, inventory financing obligations, covenant calculations and available liquidity as interest rates and operating results change.
Confirm remediation of the ASC 606 control weakness and monitor whether similar revenue-presentation errors recur.
Track the effect of the January 2019 lease-standard adoption on reported assets, liabilities and leverage metrics.