INSIGHT ENTERPRISES INC quarterly report, Q2 FY2014

Insight Enterprises, Inc. — Form 10-Q Summary

Business Context and Reporting Period

Insight Enterprises is a global provider of IT hardware, software and services to business and public-sector clients. The filing covers the three and six months ended June 30, 2014, with comparisons to the same periods in 2013. Operations are reported through North America, EMEA and APAC segments. Results are seasonal, with sales and profitability generally higher in the second and fourth quarters.

Financial Performance and Position

Metric	Q2 2014	Q2 2013	Six Months 2014	Six Months 2013
Net sales	$1.418 billion	$1.417 billion	$2.632 billion	$2.598 billion
Gross profit	$194.6 million	$190.9 million	$358.3 million	$349.1 million
Gross margin	13.7%	13.5%	13.6%	13.4%
Earnings from operations	$46.5 million	$44.6 million	$67.5 million	$59.0 million
Net earnings	$27.2 million	$26.5 million	$38.8 million	$35.6 million
Diluted EPS	$0.66	$0.62	$0.93	$0.81

Q2 operating margin was approximately 3.3%, versus 3.1% in the prior-year quarter; six-month operating margin was approximately 2.6%, versus 2.3%.
Q2 net margin was approximately 1.9% in both periods; six-month net margin improved to approximately 1.5% from 1.4%.
Six-month operating cash flow was $103.7 million, up from $87.8 million. Capital expenditures were $5.3 million, compared with $10.5 million.
Cash and cash equivalents were $149.9 million at June 30, 2014, compared with $126.8 million at December 31, 2013.
Total debt was $27.6 million, including $25.0 million outstanding under the accounts receivable securitization facility. The company had no borrowings under its $350 million senior revolving facility and reported $350 million of availability.
The accounts receivable securitization facility had $200 million of capacity, with $25 million outstanding and full qualified-receivables availability. The facility maturity was extended to June 30, 2017.
Inventory financing obligations of $108.7 million were included in accounts payable.
Accounts receivable were $1.326 billion and inventories were $170.4 million, including $43.7 million not available for sale, at June 30, 2014.

Material Changes Versus the Prior Comparable Period

Q2 consolidated sales were essentially flat. North America declined 4%, while EMEA increased 6% and APAC increased 13%. For the six months, sales increased 1%, led by EMEA growth of 3% and APAC growth of 6%; North America was flat.
North America experienced lower hardware, software and services sales in Q2, but gross margin improved to 14.1% from 13.5%, primarily from stronger product margin, vendor funding and lower inventory write-downs.
EMEA benefited from strong hardware growth but experienced lower software sales and lower Q2 gross margin, which fell to 12.6% from 12.9%. APAC sales increased strongly, while Q2 gross margin was slightly lower at 16.5% versus 16.6%.
Gross profit increased 2% in Q2 and 3% for the six months, while selling and administrative expenses increased 3% and 2%, respectively.
Severance and restructuring expense declined to $0.3 million in Q2 and $0.6 million for the six months, compared with $3.2 million and $5.9 million in the comparable 2013 periods.
The company recorded a $5.2 million Q2 non-cash charge related to the planned sale of its Bloomingdale, Illinois property, consisting of a $4.6 million impairment loss and $0.6 million of accelerated depreciation.
Six-month net debt repayments under the revolving and accounts receivable facilities totaled $41.5 million. The company repurchased 1.27 million shares for $29.7 million during the six months; approximately $12.6 million remained authorized for repurchases at June 30.
The cash conversion cycle increased to 21 days from 18 days, driven by higher inventory and timing of supplier payments.

Guidance, Outlook, Commentary and Risks

Management expects $10 million to $15 million less in 2014 incentives from its largest software partner than in 2013, with most of the impact expected in the second half of 2014. The company stated that it is executing mitigation plans globally.
Full-year 2014 capital expenditures were expected to be $15 million to $20 million, primarily for IT systems and facility and technology upgrades.
Management intends to use excess cash flow to fund working capital, repay debt, make capital expenditures, potentially pursue small acquisitions and repurchase shares.
Management expected cash from operations and available financing facilities to support operating and strategic requirements for at least the next 12 months. It anticipated compliance with maximum leverage requirements over the following four quarters.
The company held approximately $125 million of cash at foreign subsidiaries considered indefinitely reinvested and did not expect to repatriate foreign undistributed earnings.
Key risks include dependence on technology and software partners, changes to partner incentive programs, volatile sales and gross profit, competition, rapid technology changes, IT-system disruptions, cybersecurity, contract compliance, international operations, acquisitions, tax matters and intellectual-property claims.
A False Claims Act matter relating to the E-Rate program was remanded for further proceedings by the Fifth Circuit in July 2014. The company disputed the claims, intended to defend the matter vigorously and could not estimate any possible loss range. It was pursuing indemnification under the Calence acquisition agreements.
Tax audits covering years 2006 through 2013 could change unrecognized tax benefits and materially affect the effective tax rate, although the company could not estimate the reasonably possible outcome range.
The company had approximately $1.6 million of performance bonds outstanding and had not accrued liabilities for indemnification obligations because management did not consider payments probable.
ASU 2014-09, the new revenue recognition standard, was issued in May 2014. The company had not selected a transition method or determined the effect of adoption.

Important Facts for Investors to Verify

Whether software-partner incentive reductions in the second half of 2014 remain within the disclosed $10 million to $15 million range and how effectively mitigation actions offset them.
North America’s recovery from Q2 sales declines and the sustainability of its improved gross margin.
Working-capital trends, particularly accounts receivable, inventory, accounts payable and the 21-day cash conversion cycle.
Debt-facility availability, leverage-covenant compliance and the company’s ability to continue debt repayment and share repurchases.
The final sale and valuation of the Bloomingdale property and any additional impairment or restructuring charges.
Developments in the E-Rate litigation, related indemnification recovery and potential financial exposure.
Outcomes of tax audits and the effect on unrecognized tax benefits and future tax rates.
The eventual impact and transition approach for ASU 2014-09 revenue recognition.