Insight Enterprises, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and nine months ended September 30, 2019, filed November 6, 2019. Insight provides hardware, software, cloud, digital innovation, connected workforce, data-center transformation, supply-chain, and related services across North America, EMEA, and APAC.
The results include PCM, Inc. from its August 30, 2019 acquisition date and Cardinal Solutions Group from its August 1, 2018 acquisition date. Interim results are subject to seasonality, with generally stronger sales and profitability in the second and fourth quarters.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $1.913 billion | $1.748 billion | $5.434 billion | $5.331 billion |
| Gross profit | $276.2 million | $234.9 million | $800.1 million | $739.6 million |
| Gross margin | 14.4% | 13.4% | 14.7% | 13.9% |
| Earnings from operations | $44.4 million | $49.9 million | $173.6 million | $174.8 million |
| Net earnings | $27.1 million | $32.2 million | $116.5 million | $116.6 million |
| Diluted EPS | $0.76 | $0.89 | $3.23 | $3.24 |
| Operating cash flow | Not separately provided | Not separately provided | $168.6 million | $247.2 million |
Q3 operating margin was 2.3%, compared with 2.9% in the prior-year quarter. The effective tax rate was 27.2% for Q3 and 25.4% for the first nine months, compared with 25.6% and 25.8%, respectively, in the comparable periods.
Liquidity, debt, and capital allocation
- Cash and cash equivalents were $140.5 million at September 30, 2019; cash, cash equivalents, and restricted cash totaled $142.2 million.
- Total debt, including finance leases and other financing obligations, was $836.9 million, compared with $196.9 million at December 31, 2018. Long-term debt was $835.7 million.
- The new ABL revolving facility had $1.2 billion of capacity, with $553.0 million outstanding and full borrowing availability supported by eligible receivables and inventory. The facility matures in August 2024.
- Insight issued $350.0 million of 0.75% convertible senior notes due February 2025. The notes had a $282.0 million carrying value after discount and issuance costs.
- Inventory financing facilities had $450.0 million of aggregate capacity, of which $207.7 million was outstanding.
- Operating cash flow was $168.6 million, investing cash flow was negative $681.2 million, and financing cash flow was positive $514.4 million for the first nine months.
- Acquisition spending was $664.3 million, primarily for PCM. Capital expenditures were $16.9 million, and share repurchases were $27.9 million for the first nine months.
Material changes versus prior comparable periods
- Q3 sales increased 9%, primarily from PCM; sales increased 2% for the first nine months. Excluding foreign exchange, management reported Q3 sales growth of 11%.
- Gross profit increased 18% in Q3 and 8% year to date. Margin expansion reflected increased services, cloud solutions, and other higher-margin sales.
- Operating earnings declined 11% in Q3 and 1% year to date. Selling and administrative expense increased 21% in Q3, driven largely by personnel costs, headcount, PCM, and Cardinal.
- Net earnings declined 16% in Q3 and were essentially flat for the first nine months. Higher interest expense, acquisition-related expenses, and increased operating expenses offset revenue and gross-profit growth.
- Q3 acquisition-related expenses were $5.9 million, compared with $0.2 million in Q3 2018. Severance and restructuring expense was $2.7 million, compared with $0.7 million.
- Cash flow from operations declined $78.6 million year over year, while the cash conversion cycle increased to 42 days from 38 days. Days sales outstanding increased to 111 from 89, partly due to acquired PCM receivables.
Acquisitions, outlook, and unusual items
- PCM was acquired for a cash purchase price of $745.6 million, including $84.6 million of acquired cash and repayment of PCM debt. The preliminary allocation included $192.2 million of goodwill and $251.4 million of identifiable intangible assets. PCM contributed $172.5 million of sales and $27.8 million of gross profit after acquisition.
- Management expects 2019 capital expenditures of $70 million to $75 million, primarily for technology upgrades and the purchase of real estate. Management expects operating cash flow and available financing to support anticipated operating and working-capital needs over the next 12 months.
- Management intends to use excess cash flow to reduce debt, fund capital expenditures, and potentially pursue additional acquisitions.
- On November 1, 2019, the company purchased real estate in Chandler, Arizona, for approximately $48 million for a planned global headquarters and expects to sell its current Tempe properties.
- Management reported compliance with applicable ABL covenants and no events of default under the convertible notes as of September 30, 2019.
- The company adopted the new lease standard on January 1, 2019, recognizing additional operating lease assets of $65.9 million and lease liabilities of $70.5 million. The adoption did not materially affect net earnings or cash flows.
Risks, contingencies, and controls
- PCM integration may involve higher-than-expected costs, customer or employee loss, operational disruption, failure to achieve synergies, and unresolved litigation. PCM-related disputes involving the En Pointe acquisition are pending in multiple courts and arbitration forums; the company cannot determine their outcome.
- The company faces risks from leverage, interest-rate changes, covenant compliance, refinancing needs, and the subordination of the convertible notes to secured debt and most subsidiary liabilities.
- Conversion of the notes could require cash payments, affect liquidity, increase diluted share count, or cause reclassification of debt. The related hedge transactions also expose the company to counterparty risk.
- Other stated risks include technology and cybersecurity incidents, IT-system disruption, foreign exchange, economic conditions, partner incentives, accounts receivable losses, public-sector and commercial contract compliance, tax audits, litigation, intellectual-property claims, and dependence on key personnel.
- Several subsidiaries are under tax audit for years 2012 through 2017. Unrecognized tax benefits were approximately $8.7 million; management does not expect a material effective-tax-rate impact over the next 12 months.
- Performance bonds totaled approximately $3.7 million. Management believes payments under these bonds and disclosed indemnifications are not probable and recorded no related liabilities.
- Management concluded that disclosure controls were effective as of September 30, 2019. PCM was excluded from the control assessment under SEC guidance, and PCM control integration is expected to continue through 2020.
Investor verification points
- Verify PCM integration progress, purchase-price allocation updates, realized synergies, and the impact on margins, working capital, and leverage.
- Monitor debt reduction, ABL availability, covenant compliance, interest expense, and potential cash or equity settlement of the convertible notes.
- Assess whether the higher days sales outstanding and cash conversion cycle normalize, particularly after incorporating PCM.
- Review the status and potential exposure of PCM-related litigation, tax audits, indemnifications, and other contingencies.
- Compare actual 2019 capital expenditures and headquarters spending with management’s $70 million to $75 million capital-expenditure expectation.
- Evaluate the sustainability of gross-margin improvement, services and cloud growth, partner incentives, and the higher operating-cost base.