INSIGHT ENTERPRISES INC annual report, FY2016

Insight Enterprises, Inc. — 2016 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2016. The filing also provides unaudited fourth-quarter information for the quarter ended December 31, 2016.

Business context

Insight is a global provider of IT hardware, software, Cloud and services solutions to commercial, government, healthcare and education clients. Operations are organized into North America, EMEA and APAC. Consolidated 2016 sales mix was approximately 54% hardware, 40% software and 6% services; geographic sales were approximately 73% North America, 24% EMEA and 3% APAC.

Primary strategy: grow the core business, expand services and accelerate Cloud adoption.
Acquired Ignia in Australia effective September 1, 2016 for approximately $10.8 million net of cash acquired.
Acquired Datalink on January 6, 2017 for approximately $257.5 million; therefore, Datalink is not included in 2016 results.

Key financial metrics

Metric	2016	2015	Change
Net sales	$5.486 billion	$5.373 billion	Up 2%
Gross profit	$743.1 million	$716.3 million	Up 4%
Gross margin	13.5%	13.3%	Up approximately 20 bps
Earnings from operations	$148.8 million	$126.5 million	Up 18%
Operating margin	2.7%	2.4%	Up approximately 30 bps
Net earnings	$84.7 million	$75.9 million	Up 12%
Diluted EPS	$2.32	$1.98	Up 17%
Operating cash flow	$95.8 million	$180.5 million	Down 47%
Cash and equivalents at year-end	$202.9 million	$188.0 million	Up $14.9 million
Long-term debt	$40.3 million	$89.0 million	Down $48.7 million

2016 fourth-quarter net sales were $1.468 billion, gross profit was $191.0 million, earnings from operations were $40.7 million and net earnings were $21.1 million, or $0.59 diluted EPS.

Liquidity, debt and cash flow

Working capital was $544.9 million at December 31, 2016, compared with $543.5 million at year-end 2015.
The company had $39.5 million outstanding under its accounts receivable securitization facility and no borrowings under its $350 million revolving facility at year-end.
Available capacity was $350 million under the revolving facility and, subject to eligible receivables, the full $250 million under the ABS facility.
Inventory financing facility obligations were $154.9 million and are presented separately from debt. The company generally expects no interest payments when amounts are paid within vendor terms.
2016 cash uses included $50.0 million of share repurchases, $49.5 million of net repayments under long-term debt facilities, $10.8 million for Ignia and $12.3 million of capital expenditures.
Operating cash flow was affected by year-end working-capital timing, including a receivable collected in the fourth quarter while approximately $160 million owed to a supplier was paid in January 2017. Excluding comparable timing effects, management stated that 2016 operating cash flow would have been nominal.
The cash conversion cycle was 14 days in the fourth quarter of 2016 versus 20 days in the fourth quarter of 2015, but the comparison was significantly affected by supplier payment timing.

Material changes versus the prior comparable period

North America sales increased 4% to $4.0 billion, supported by higher hardware and services sales. Services sales increased 10% in the region, aided by the BlueMetal acquisition and organic technical-services growth.
EMEA sales declined 2% in reported dollars but increased 4% excluding foreign-currency effects. EMEA operating earnings increased 44% year over year.
APAC sales declined 2% in reported dollars and were flat excluding foreign-currency effects. APAC gross margin increased to 18.2% from 16.0%, partly due to mix and higher-margin services.
Selling and administrative expenses were essentially flat at $585.2 million, declining to 10.7% of sales from 10.9%.
Interest expense increased 19% to $8.6 million, primarily because of higher borrowing rates and average debt balances.
The effective tax rate increased to 39.3% from 36.4%, partly due to a December 2016 tax-law change involving foreign-currency translation gains and losses and nondeductible acquisition costs.
The company repurchased approximately 1.9 million shares for $50 million in 2016, compared with approximately 3.3 million shares for $91.8 million in 2015.

Guidance, outlook, commentary and unusual items

Management expected cash flows from operations and available financing capacity to support operating needs and strategic investments for at least the next 12 months.
2017 capital expenditures were expected to be between $15 million and $20 million, primarily for technology upgrades and acquisition integration.
The Datalink acquisition was funded partly with approximately $196 million of new borrowings. Management expected the additional borrowing to increase 2017 interest expense by approximately $6 million versus 2016.
Management expected approximately $11.5 million of Datalink-related intangible amortization expense in 2017 and approximately $9.2 million annually in 2019 through 2026.
Management anticipated compliance with maximum leverage requirements over the next four quarters and stated that all debt covenants were satisfied at December 31, 2016.
Unusual 2016 items included $4.4 million of acquisition-related costs, $4.6 million of severance and restructuring costs, a $338,000 gain on the sale of real estate and a $2.2 million insurance settlement recorded as a reduction of cost of sales.
The company does not intend to pay cash dividends in the foreseeable future; debt facilities also restrict dividend payments.

Principal risks and contingencies

Intense price competition, low gross margins and potential changes in partner incentives or product availability.
Dependence on major technology partners, particularly Microsoft, which represented approximately 27% of aggregate purchases in 2016.
Rapid technology changes and the risk that Cloud or as-a-service models could reduce hardware, software or reseller demand.
Integration, execution and financing risks associated with Ignia and the substantially larger Datalink acquisition.
Variable-rate debt, increased leverage and compliance with maximum leverage, fixed-charge and receivables covenants following the Datalink financing.
Accounts receivable collection risk, foreign-currency exposure, Brexit-related uncertainty and international operating risks.
Cybersecurity incidents, IT-system disruptions, contract compliance issues, tax audits, litigation and intellectual-property claims.
At year-end, the company disclosed approximately $2.2 million of unrecognized tax benefits, $2.2 million of performance bonds and $66.6 million of future operating lease payments. Management stated that no pending or threatened legal proceedings were expected to have a material adverse effect.

Important facts for investors to verify

Assess post-year-end leverage, interest expense, covenant headroom and amortization obligations after the Datalink acquisition.
Reconcile reported operating cash flow with working-capital timing, especially the approximately $160 million supplier payable paid in January 2017.
Review Datalink purchase accounting, acquired intangible assets, goodwill and final integration costs, which were not finalized in the 2016 filing.
Monitor gross-margin sustainability, partner funding and concentration with Microsoft and other major suppliers.
Evaluate whether services and Cloud growth offsets potential pressure on traditional hardware and software sales.
Review the effect of foreign exchange, Brexit, tax audits and the company’s higher 2016 effective tax rate.
Confirm the company’s adoption conclusions and eventual impact of the new revenue-recognition and lease accounting standards.