Insight Enterprises, Inc. 2018 Q2 Form 10-Q Summary
Business Context and Reporting Period
Insight Enterprises is a global provider of IT hardware, software, cloud, digital innovation, data-center, connected-workforce, supply-chain, and related services. Its reportable segments are North America, EMEA, and APAC. This unaudited filing covers the three and six months ended June 30, 2018, compared primarily with 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 cumulative adjustment reduced opening retained earnings by $7.2 million, including tax effects.
Key Financial Metrics
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Net sales | $1.837 billion | $1.684 billion | $3.600 billion | $3.162 billion |
| Gross profit | $264.4 million | $251.4 million | $504.4 million | $459.6 million |
| Gross margin | 14.4% | 14.9% | 14.0% | 14.5% |
| Earnings from operations | $74.4 million | $69.3 million | $124.6 million | $92.3 million |
| Net earnings | $51.5 million | $40.3 million | $84.2 million | $54.1 million |
| Diluted EPS | $1.44 | $1.11 | $2.34 | $1.50 |
| Effective tax rate | 25.9% | 37.7% | 25.9% | 35.1% |
Q2 operating margin was approximately 4.1% versus 4.1% in the prior-year quarter. Six-month net margin was approximately 2.3% versus 1.7% in 2017. Services revenue increased 22% year over year in Q2 to $217.1 million, while product revenue increased to $1.620 billion.
- Six-month operating cash flow was $351.0 million, compared with cash used of $99.3 million in the prior-year period.
- Capital expenditures were $10.6 million in the first half, and management expects full-year 2018 capital expenditures of $15 million to $20 million.
- Cash, cash equivalents, and restricted cash totaled $249.7 million at June 30, 2018, including $248.1 million of cash and cash equivalents.
- Total debt was $161.8 million, including $16.9 million current debt and $144.9 million long-term debt. The company had no borrowings under its revolving credit or accounts receivable securitization facilities.
- The inventory financing facility had $303.7 million outstanding against $400.0 million of availability.
- The company repurchased 641,211 shares for approximately $22.1 million during the first six months, with $27.9 million remaining under the authorized program at June 30.
Material Changes Versus the Prior Comparable Period
- Q2 sales increased 9% reported, or 7% excluding foreign-currency effects. Six-month sales increased 14% reported, or 11% excluding currency effects.
- Q2 sales grew 7% in North America, 17% in EMEA, and 8% in APAC. Six-month growth was 12%, 19%, and 25%, respectively.
- Growth was led by hardware and services, including an ongoing device-refresh cycle, cloud and warranty offerings, professional services, and the addition of Caase.com in EMEA. North American software sales declined as clients migrated applications to cloud solutions.
- Gross margin declined 50 basis points in both the quarter and first half. Management cited a higher mix of large-enterprise and public-sector sales, lower product margins, reduced partner funding in certain areas, and lower-margin enterprise transactions.
- Operating earnings increased 7% in Q2 and 35% for the first six months. Selling and administrative expense increased 5% in both periods, but declined as a percentage of sales.
- Interest expense increased 18% in Q2 and 35% year to date, primarily because of higher interest rates and increased imputed interest on inventory financing.
- Cash generation improved substantially, partly because of working-capital optimization, lower inventory, and the unusual prior-year impact of an approximately $160 million supplier payment.
Guidance, Outlook, Risks, and Unusual Items
- Management expects operating cash flow and available financing facilities to fund operating needs and strategic investments for the next 12 months. It intends to use excess cash for debt reduction, share repurchases, capital expenditures, and potential acquisitions.
- Management expects to remain compliant with leverage requirements over the next four quarters. The maximum permitted leverage ratio was 3.25 times adjusted earnings; the company was in compliance with all debt covenants at June 30, 2018.
- The company’s revolving credit, Term Loan A, and accounts receivable securitization facilities mature or expire in 2021. The ABS facility was renewed for a three-year term in June 2018.
- The company expects to adopt the new lease standard on January 1, 2019. It anticipates a material balance-sheet effect from recording right-of-use assets and lease liabilities, but does not expect a material effect on earnings or cash flow.
- U.S. tax reform accounting remained provisional. Several subsidiaries were under tax audit for 2012–2015, and the company could not estimate the range of potential outcomes, although it did not expect a significant effect on tax expense or net earnings.
- Reported severance and restructuring expense was $2.0 million year to date, compared with $5.7 million in 2017. Q2 acquisition-related expense was $94,000, compared with $276,000 in the prior-year quarter.
- Effective August 1, 2018, the company acquired Cardinal Solutions Group for approximately $79 million, subject to a final working-capital adjustment. Cardinal expands digital, mobile, Internet of Things, and cloud-enabled business-intelligence capabilities.
- Key risks include competition and technology changes, reliance on partners and partner incentives, acquisition integration, international and foreign-currency exposure, cybersecurity and IT disruptions, customer credit and payment terms, contract compliance, litigation, tax matters, and potential reductions in financing availability.
- The company has performance bonds of approximately $2.1 million and various indemnification obligations, none of which management considered probable of payment at June 30, 2018. No pending or threatened legal proceeding was expected to have a material adverse effect.
Investor Verification Points
- Reconcile reported revenue, gross profit, and segment growth under Topic 606 with comparable results, including changes in gross-versus-net revenue presentation.
- Monitor gross-margin pressure from enterprise and public-sector mix, partner funding, software-to-cloud migration, and product pricing.
- Assess working-capital requirements, particularly accounts receivable, the 107-day DSO, and the 20-day cash-conversion cycle.
- Verify debt reduction, inventory-financing usage, interest-rate exposure, and continued compliance with leverage and fixed-charge covenants.
- Evaluate the financial contribution and integration risks of the Cardinal acquisition and the ongoing impact of Caase.com.
- Track the final accounting for U.S. tax reform, tax audits, and the 2019 lease-standard adoption.
- Consider seasonality: management expects stronger sales and profitability generally in the second and fourth quarters.