INSIGHT ENTERPRISES INC quarterly report, Q2 FY2019

Insight Enterprises, Inc. — Q2 2019 Form 10-Q Summary

Business context and reporting period

Insight is a global provider of IT hardware, software, cloud, digital innovation, connected workforce, data-center transformation and supply-chain optimization solutions. Operations are reported across North America, EMEA and APAC. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared primarily with the corresponding 2018 periods.

Key financial metrics

Metric	Q2 2019	Q2 2018	First half 2019	First half 2018
Net sales	$1.836 billion	$1.841 billion	$3.521 billion	$3.583 billion
Gross profit	$275.4 million	$264.4 million	$523.9 million	$504.6 million
Gross margin	15.0%	14.4%	14.9%	14.1%
Earnings from operations	$72.1 million	$74.4 million	$129.2 million	$124.9 million
Net earnings	$50.0 million	$51.5 million	$89.3 million	$84.5 million
Diluted EPS	$1.38	$1.44	$2.47	$2.34
Operating cash flow	Not separately provided	Not separately provided	$182.5 million	$351.0 million

Q2 operating margin was approximately 3.9%, versus 4.1% in the prior-year quarter. First-half operating margin was approximately 3.7%, versus 3.5% in the prior-year period. Q2 net margin was approximately 2.7%, versus 2.8%; first-half net margin was approximately 2.5%, versus 2.4%.

Q2 North America sales increased 3% to $1.406 billion; EMEA declined 7% to $379.2 million; APAC declined 18% to $51.3 million.
Q2 product sales decreased 1%, while services sales increased 9%. Services benefited from cloud solutions and the Cardinal acquisition.
Q2 selling and administrative expenses increased 5% to $199.5 million, primarily due to higher headcount, including Cardinal, and increased variable compensation.
Q2 included $3.2 million of acquisition-related expenses associated with the pending PCM transaction and $0.7 million of severance and restructuring expense.
The effective tax rate was 25.9% in Q2 and 24.9% for the first half, compared with 25.9% for both comparable 2018 periods.

Liquidity, cash flow and capital structure

Cash, cash equivalents and restricted cash totaled $113.7 million at June 30, 2019, down from $144.3 million at December 31, 2018. Cash and cash equivalents alone were $112.1 million.
Operating cash flow of $182.5 million was down from $351.0 million, reflecting working-capital investment, including increases in accounts receivable, inventories and other assets.
Investing cash outflows were $13.9 million, including $10.6 million of capital expenditures and $3.4 million for acquisitions.
Financing cash outflows were $199.0 million, including $149.0 million of combined net repayments under the revolving and accounts-receivable securitization facilities and $43.2 million of net repayments under the inventory financing facility.
Total debt was $47.4 million, including $45.0 million outstanding under the accounts-receivable securitization facility and $2.4 million of finance leases and other financing obligations. No balance was outstanding under the senior revolving credit facility.
The revolving facility and accounts-receivable securitization facility had combined maximum capacity of $600.0 million; qualified receivables supported access to the full $250.0 million accounts-receivable facility at quarter-end.
The inventory financing facility had $400.0 million of capacity, with $260.9 million outstanding. The company was in compliance with its financing covenants, including the 3.0-times maximum leverage ratio, and reported no amortization event.
Management expects operating cash flow and available financing facilities to be adequate for anticipated operating and working-capital needs over the next 12 months.
The cash conversion cycle increased to 26 days from 20 days, primarily because days sales outstanding increased to 113 days from 107 days.

Material changes versus the prior comparable period

Revenue was essentially flat in Q2 and decreased 2% for the first half, primarily because lower software sales in certain regions offset North American hardware and services growth.
Gross profit increased 4% in both Q2 and the first half, with gross-margin expansion driven by a greater mix of higher-margin services, cloud solutions and Cardinal-delivered services.
Operating earnings declined 3% in Q2 but increased 3% for the first half. Higher selling and administrative costs and PCM transaction expenses more than offset gross-profit growth in Q2.
Net earnings declined 3% in Q2 but increased 6% for the first half. Diluted EPS declined from $1.44 to $1.38 in Q2 and increased from $2.34 to $2.47 for the first half.
Operating cash flow declined materially, from $351.0 million to $182.5 million, while the company continued to reduce debt.
The company adopted the new lease standard on January 1, 2019, recording additional net 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.
No shares were repurchased during the first half of 2019 or the second quarter, compared with $22.1 million of repurchases in the first half of 2018.

Guidance, outlook, risks and unusual items

Insight entered into an agreement on June 23, 2019 to acquire PCM for $35.00 in cash per PCM share. The transaction was expected to close by the end of the third quarter of 2019, subject to regulatory approvals, PCM shareholder approval and other customary conditions. Insight expected to fund the transaction with cash on hand and borrowings under a new asset-based revolving credit facility. The filing does not provide formal revenue or earnings guidance.

Management expected 2019 capital expenditures of $20 million to $25 million, primarily for technology upgrades.
Management intended to use excess cash flow to help fund PCM, reduce debt, potentially repurchase shares, fund capital expenditures and pursue selective acquisitions.
Key risks include PCM closing, financing and integration risk; failure to achieve expected synergies; customer, employee or supplier disruption; competition; rapid technology changes; reliance on vendor incentives and product availability; foreign exchange and international operations; cybersecurity and IT-system disruptions; credit and accounts-receivable risk; legal and tax matters; and economic conditions.
The business is seasonal: profitability and sales are generally expected to be higher in the second and fourth quarters, while public-sector demand varies by geography and government fiscal cycle.
Remaining performance obligations totaled $124.0 million, primarily services, but management noted that much of its backlog consists of open, cancelable purchase orders that are not predictive of future results.
Approximately $87.7 million of cash and cash equivalents was held by foreign subsidiaries and may be subject to U.S. tax upon repatriation.
Performance bonds outstanding totaled approximately $3.9 million. Management did not consider payments under the bonds, indemnifications or disclosed legal proceedings probable and recorded no related liability.
Several subsidiaries were under tax audit for 2012–2017. The filing states that a reasonably possible range of outcomes could not be estimated, but a significant effect on income tax expense and net earnings was not expected.
On July 10, 2019, after quarter-end, the company entered into an unsecured inventory financing facility with $200.0 million of maximum capacity.

Important facts for investors to verify

Confirm the closing date, financing structure, purchase accounting and integration results for the PCM acquisition.
Monitor whether services and cloud growth continues to offset declining software and regional weakness in EMEA and APAC.
Evaluate the sustainability of gross-margin expansion and the effect of vendor incentives, mix and Cardinal-related services.
Reconcile the sharp decline in operating cash flow with receivables growth, the 26-day cash conversion cycle and ongoing debt repayments.
Track leverage-ratio compliance, borrowing availability and the treatment of the $260.9 million inventory financing balance.
Assess foreign-currency exposure, cybersecurity and IT disruption risks, partner concentration, tax audits and potential legal or indemnification claims.