INSIGHT ENTERPRISES INC quarterly report, Q1 FY2019

Insight Enterprises, Inc. — Form 10-Q Summary

Reporting period: Three months ended March 31, 2019, compared with the three months ended March 31, 2018. The filing was dated May 1, 2019. Insight provides IT hardware, software, cloud, digital innovation, connected workforce, supply chain, and related services across North America, EMEA, and APAC.

Financial Performance and Position

Metric	Q1 2019	Q1 2018	Change
Net sales	$1.685 billion	$1.742 billion	Down 3%
Gross profit	$248.5 million	$240.3 million	Up 3%
Gross margin	14.7%	13.8%	Up approximately 90 bps
Earnings from operations	$57.0 million	$50.4 million	Up 13%
Net earnings	$39.3 million	$33.0 million	Up 19%
Diluted EPS	$1.09	$0.91	Up 20%
Effective tax rate	23.5%	25.9%	Down 240 bps

North America sales declined 3% to $1.242 billion, EMEA declined 4% to $390.2 million, and APAC declined 7% to $52.9 million on a reported-dollar basis. Excluding foreign currency effects, EMEA sales increased 2% and APAC sales increased 1%.
North American hardware sales fell 14%, while software increased 23% and services increased 19%. Consolidated growth in software and services offset part of the hardware decline.
Gross-margin expansion reflected a higher mix of services and cloud solutions, partially offset by lower product margin and partner funding associated with lower hardware sales.
Selling and administrative expenses increased 2% to $191.1 million, primarily due to higher personnel costs, increased headcount, and the Cardinal acquisition. Severance and restructuring expense declined to $0.4 million from $1.6 million.
Cash and cash equivalents were $124.8 million at March 31, 2019, compared with $142.7 million at December 31, 2018. Total cash, cash equivalents, and restricted cash were $126.5 million.
Accounts receivable were $1.724 billion, inventories were $187.1 million, and total assets were $2.756 billion at quarter-end.
Operating cash flow was $121.9 million, compared with $150.7 million in the prior-year quarter. Capital expenditures were $5.4 million, and net cash used in investing activities was $6.1 million.
Cash conversion cycle improved to 30 days from 36 days, reflecting a six-day improvement in days payable outstanding and a one-day reduction in days inventory outstanding, partly offset by a one-day increase in days sales outstanding.

Debt, Liquidity, and Capital Allocation

Total debt, including finance leases and other financing obligations, was $114.4 million at March 31, 2019, down from $196.9 million at December 31, 2018. The balance included $112.0 million under the accounts receivable securitization facility and no borrowings under the senior revolving facility.
The revolving credit facility has maximum capacity of $350.0 million, and the accounts receivable securitization facility has maximum capacity of $250.0 million. Qualified receivables supported access to the full $250.0 million ABS capacity at quarter-end.
The inventory financing facility had $260.2 million outstanding against $400.0 million of capacity.
The facilities require compliance with financial covenants, including a maximum leverage ratio currently set at 3.0 times trailing twelve-month adjusted earnings. The company stated that it was in compliance with all covenants and expected to remain compliant over the next four quarters.
Net repayments under the revolving and ABS facilities reduced long-term debt by $82.0 million during the quarter. Inventory financing repayments totaled $44.0 million.
The company did not repurchase shares during Q1 2019, compared with $7.7 million of repurchases in Q1 2018. It has never paid a cash dividend and does not currently intend to pay one in the foreseeable future.
Management expects operating cash flow and available financing capacity to support anticipated operating and working-capital needs over the next 12 months. Full-year 2019 capital expenditures are expected to be $20 million to $25 million, primarily for technology upgrades.

Material Changes and Unusual Items

Effective January 1, 2019, Insight adopted the new lease accounting standard, recording additional operating lease right-of-use assets of $65.9 million and lease liabilities of $70.5 million. The adoption did not materially affect net earnings or cash flows.
The August 2018 acquisition of Cardinal Solutions Group contributed to services growth and was included in North America results beginning August 1, 2018. A $0.8 million working-capital adjustment was paid in January 2019, and the purchase price was subsequently reduced by $0.4 million following a tax gross-up adjustment.
A significant Q1 software transaction with a large enterprise client had no comparable transaction in Q1 2018, contributing to North American software growth.
The company reported $106.9 million of cash and cash equivalents held by foreign subsidiaries, principally in the Netherlands and Canada.
Unrecognized tax benefits were approximately $7.4 million at March 31, 2019. Several subsidiaries were under tax audit for years 2012 through 2017; management did not expect a significant effect on income tax expense or net earnings.

Management Commentary and Risks

Management emphasized a continuing shift toward higher-margin software, cloud, and services offerings, while noting that large-enterprise hardware demand was weaker. Results are seasonal: software sales are generally stronger in the second quarter, public-sector sales often strengthen in the second or third quarters, and overall sales and profitability are expected to be higher in the second and fourth quarters.

Gross profit remains sensitive to partner incentives, marketing funds, purchasing incentives, product mix, and freight costs.
Key risks include competition, rapid technology changes, reliance on suppliers and partners, acquisition integration, economic conditions, foreign currency exposure, cybersecurity and IT-system disruptions, accounts receivable credit risk, contract compliance, tax matters, litigation, intellectual-property claims, and access to financing.
The company disclosed approximately $3.9 million of performance bonds and various indemnification obligations, but management considered related payments unlikely and recorded no liabilities for them.
The filing states that no pending or threatened legal proceedings were reasonably expected to have a material adverse effect, although litigation outcomes remain inherently uncertain.
Disclosure controls and procedures were deemed effective as of March 31, 2019, with no material change in internal control over financial reporting during the quarter.

Important Facts for Investors to Verify

Whether services, cloud, and software growth can offset continued weakness or volatility in hardware sales.
The sustainability of the 90-basis-point gross-margin improvement and the company’s exposure to partner funding changes.
Operating cash-flow conversion, receivables quality, inventory levels, and the effect of large or unusual transactions on working capital.
Debt repayment progress, availability under the ABS and revolving facilities, and continued compliance with leverage and other covenants.
The effect of seasonality on subsequent-quarter sales and profitability, particularly the expected strength in the second and fourth quarters.
Integration and contribution of Cardinal, including the pace of services growth and related personnel costs.
Future tax-audit resolutions, foreign-cash repatriation, contingent liabilities, indemnifications, and legal proceedings.