INSIGHT ENTERPRISES INC quarterly report, Q2 FY2020

Business Context and Reporting Period

Insight Enterprises, Inc. filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2020. The company provides hardware, software, cloud, digital innovation, data-center transformation, connected-workforce, supply-chain optimization, and related services across North America, EMEA, and APAC. Results include PCM from its August 30, 2019 acquisition and vNext from its February 28, 2020 acquisition.

Key Financial Metrics

Metric	Q2 2020	Q2 2019	Six Months 2020	Six Months 2019
Net sales	$1.969 billion	$1.836 billion	$4.113 billion	$3.521 billion
Gross profit	$324.4 million	$275.4 million	$649.7 million	$523.9 million
Gross margin	16.5%	15.0%	15.8%	14.9%
Earnings from operations	$74.2 million	$72.1 million	$127.1 million	$129.2 million
Net earnings	$46.4 million	$50.0 million	$80.3 million	$89.3 million
Diluted EPS	$1.32	$1.38	$2.27	$2.47

Q2 sales increased 7%, while six-month sales increased 17%, primarily reflecting PCM. Management stated that the core business declined in Q2 because of COVID-19.
Q2 gross profit increased 18% and six-month gross profit increased 24%. Margin expansion reflected a higher mix of services, stronger hardware margins, cloud solutions, and Insight-delivered services.
Q2 operating margin was 3.8%, versus 3.9% in the prior-year quarter. Six-month operating margin was 3.1%, versus 3.7%.
Q2 interest expense increased to $10.2 million from $4.3 million; six-month interest expense increased to $22.0 million from $8.9 million, primarily due to the ABL facility and convertible senior notes.
The effective tax rate was 26.2% for Q2 and 23.8% for the first half, compared with 25.9% and 24.9%, respectively, in the prior-year periods.

Cash Flow, Debt, and Liquidity

Operating cash flow was $497.5 million in the first half of 2020, compared with $182.5 million in the prior-year period. Management cautioned that the increase was driven by several non-recurring timing items and expects operating cash flow to normalize in the second half.
Cash, cash equivalents, and restricted cash totaled $155.8 million at June 30, 2020, compared with $113.7 million at June 30, 2019. Cash and cash equivalents alone were $153.9 million.
Total debt, including finance leases and other financing obligations, was $437.5 million at June 30, 2020, compared with $859.4 million at December 31, 2019. ABL borrowings were $144.0 million, and convertible notes had a $290.6 million net carrying amount.
The ABL facility had maximum capacity of $1.2 billion, with eligible assets sufficient for access to the full amount at quarter-end. The company stated that it was in compliance with all covenants.
Inventory financing facilities had $490.0 million of aggregate capacity and $261.1 million outstanding at June 30, 2020. A new $250.0 million PNC facility replaced the Wells Fargo facility on July 6, 2020.
Investing cash flow was negative $6.7 million, including $14.5 million of capital expenditures, $6.4 million for the vNext acquisition, and $14.2 million of proceeds from a property sale.
Financing cash flow was negative $450.6 million, principally reflecting $426.2 million of net ABL repayments and $25.0 million of share repurchases.
The cash conversion cycle improved to 22 days from 26 days, although days sales outstanding increased to 124 from 113, reflecting unbilled amounts, deteriorating aged receivables, and COVID-19-related timing.

Material Changes Versus the Prior Comparable Period

PCM materially increased reported revenue, expenses, assets, amortization, and personnel costs. PCM represented approximately 16% of total assets at June 30, 2020 and approximately 13% of six-month net sales.
North America sales increased 10% in Q2 and 21% for the first half; EMEA sales increased 3% and 5%, respectively; APAC sales declined 27% and 15%, respectively.
Services revenue increased to $295.8 million in Q2 from $241.7 million, while software revenue declined to $488.9 million from $505.6 million. Management cited continued migration of software to cloud offerings.
Selling and administrative expense increased 22% in Q2 and 31% for the first half, primarily due to PCM-related headcount and costs. Travel and entertainment expense declined as a result of COVID-19 cost controls.
Severance and restructuring expense increased to $7.0 million in Q2 and $9.2 million for the first half, versus $0.7 million and $1.1 million, respectively, in the prior-year periods.
The company repurchased and retired 444,813 shares for approximately $25.0 million during the first half. A further $25.0 million remained available under the February 2020 authorization at June 30, 2020.

Guidance, Outlook, Risks, and Unusual Items

Management expected demand and booking trends to remain below prior-year levels in the third quarter of 2020, citing continued uncertainty regarding COVID-19, client profitability, liquidity, supply chains, and economic conditions.
The company accelerated PCM integration and reduced discretionary spending, including certain benefits, variable compensation, and travel. It planned to prioritize debt repayment and defer discretionary capital investments.
Full-year 2020 capital expenditures were expected to be $20 million to $25 million. The buildout of the new corporate headquarters was deferred until early 2021.
Management expected operating cash flow, together with available financing capacity, to support anticipated cash and working-capital requirements for the next 12 months.
First-half operating cash flow benefited from a public-sector customer payment of approximately $150 million received before the related vendor payment was due and a $96 million partner payment deferred until the third quarter.
Remaining service performance obligations totaled $169.6 million at June 30, 2020, subject to stated exclusions and cancellation limitations.
Risks include the duration and severity of COVID-19, customer credit losses and payment delays, supply-chain and shipping disruptions, partner incentives and product availability, cybersecurity, IT-system disruptions, foreign currency and interest-rate exposure, acquisition integration, substantial indebtedness, convertible-note conversion, litigation, tax audits, and LIBOR discontinuation.
PCM-related litigation and disputes involving the former En Pointe Technologies assets remain unresolved. Management stated that it could not determine the outcome with certainty but did not believe the matters were reasonably expected to have a material adverse effect.
Disclosure controls were assessed as effective, although the June 30 assessment excluded PCM while its controls were being integrated into the company’s control environment.

Important Facts for Investors to Verify

Whether Q3 and subsequent demand declines associated with COVID-19 offset the reported revenue and margin benefits from PCM and cloud/services growth.
The sustainability of the 16.5% Q2 gross margin after partner incentives, product mix, and unusual COVID-19-related timing effects normalize.
The extent to which the $497.5 million first-half operating cash flow reverses when the $150 million customer timing benefit and $96 million deferred partner payment are reflected in later periods.
ABL availability, borrowing-base changes, covenant compliance, and the maturity and conversion terms of the $350 million principal amount of convertible notes due 2025.
Progress and costs of PCM integration, including completion of related internal-control integration during 2020.
Outcomes and potential exposure from PCM-related litigation, tax audits, receivable aging, and other contingencies.