Insight Enterprises, Inc. — 2014 Q3 Form 10-Q Summary
Business context and reporting period
Insight Enterprises is a technology provider of hardware, software and services to business and government clients in North America, EMEA and APAC. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2014, compared with the corresponding 2013 periods. Interim results are seasonal and are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Three months ended September 30, 2014 | Three months ended September 30, 2013 | Nine months ended September 30, 2014 | Nine months ended September 30, 2013 |
|---|---|---|---|---|
| Net sales | $1,237.7 million | $1,151.0 million | $3,870.1 million | $3,749.2 million |
| Gross profit | $171.8 million | $168.7 million | $530.2 million | $517.7 million |
| Gross margin | 13.9% | 14.7% | 13.7% | 13.8% |
| Earnings from operations | $28.4 million | $26.3 million | $95.8 million | $85.3 million |
| Net earnings | $17.4 million | $15.0 million | $56.2 million | $50.6 million |
| Diluted EPS | $0.42 | $0.35 | $1.36 | $1.16 |
| Operating cash flow | Not separately provided | Not separately provided | $47.8 million | $66.6 million |
All dollar amounts in the financial statements are in thousands unless otherwise indicated. Third-quarter operating margin was approximately 2.3%; nine-month operating margin was approximately 2.5%. Third-quarter net margin was approximately 1.4%; nine-month net margin was approximately 1.5%.
At September 30, 2014, cash and cash equivalents were $127.1 million, accounts receivable were $1,037.2 million and inventories were $168.0 million, including inventories not available for sale. Total assets were $1.656 billion and stockholders’ equity was $736.1 million.
Total debt was $54.5 million, consisting primarily of $17.0 million under the senior revolving credit facility and $35.0 million under the accounts receivable securitization facility. The revolving facility had $333.0 million of availability, and the ABS facility had $200.0 million of availability based on qualified receivables. The company was in compliance with all debt covenants. The inventory financing facility accounted for $125.7 million included in accounts payable.
For the nine months, investing cash outflow was $8.0 million, primarily capital expenditures, and financing cash outflow was $33.4 million. The company repurchased $29.7 million of common stock, retired all repurchased shares and had approximately $12.6 million remaining under its authorization. Cash increased by $0.3 million after a $6.1 million unfavorable foreign-currency translation effect.
Material changes versus the prior comparable period
- Third-quarter sales increased 8%, while nine-month sales increased 3%. Growth occurred in all segments: third-quarter North America increased 4%, EMEA 19% and APAC 11%; nine-month growth was 1%, 7% and 7%, respectively.
- Gross profit increased 2% in both comparable periods, but gross margin declined 80 basis points in the quarter and 10 basis points year to date.
- Management attributed margin pressure primarily to reduced vendor funding and changes to the incentive program of the company’s largest software partner. The company stated that results were consistent with expectations for lower partner incentives in 2014.
- Operating earnings increased 8% in the quarter and 12% year to date. Selling and administrative expenses increased 2% in both periods, but declined as a percentage of sales.
- Severance and restructuring expense declined to $0.3 million in the quarter and $1.0 million year to date, compared with $2.4 million and $8.3 million, respectively, in 2013.
- Operating cash flow declined 28% year to date, primarily reflecting working-capital movements and lower cash generation relative to the prior period. Capital expenditures declined 44% to $8.0 million.
- Debt declined by approximately $12.7 million from December 31, 2013, while cash was essentially unchanged. The company also repurchased fewer shares than in the prior-year period.
- The cash conversion cycle improved to 30 days from 31 days, driven by a two-day improvement in days sales outstanding, partly offset by supplier-payment timing.
Guidance, outlook, management commentary, risks and unusual items
- Management expected 2014 capital expenditures of $10 million to $15 million, primarily for information-technology system upgrades and facility and technology projects.
- Management expected cash from operations and available financing capacity to support working capital, operations and strategic investments for at least the next 12 months. It intended to use excess cash to reduce debt, fund capital expenditures, consider small acquisitions and potentially repurchase shares.
- Management anticipated compliance with maximum leverage requirements over the following four quarters. The maximum permitted leverage ratio was 2.75 times trailing-twelve-month adjusted earnings.
- Approximately $108.0 million of cash was held by foreign subsidiaries whose undistributed earnings management considered indefinitely reinvested. The company did not intend or foresee a need to repatriate those earnings.
- A $5.2 million non-cash charge was recorded year to date for the planned relocation and sale of the Bloomingdale, Illinois property, including a $4.6 million impairment loss and $0.6 million of accelerated depreciation.
- Effective tax rates were 34.1% for the quarter and 37.4% year to date. Tax benefits from releases of uncertain tax reserves reduced the quarterly rate. Several subsidiaries were under tax audit for years 2006 through 2013, but the filing did not provide a reasonably possible loss range.
- Legal proceedings arise in the ordinary course, including intellectual-property, contract, indemnification and preference-payment claims. Management believed adequate provisions existed for probable and estimable losses, but noted that litigation outcomes could adversely affect a particular period. A previously disclosed E-Rate investigation-related case was dismissed in its entirety in August 2014.
- Key risks include dependence on technology and distribution partners, vendor funding and incentives, rapid technology changes, competition, information-technology and network disruptions, cybersecurity, government and commercial contract compliance, international operations, personnel, foreign exchange, tax matters, acquisitions and intellectual-property claims.
- The company adopted new tax-benefit presentation guidance prospectively in 2014, reducing noncurrent deferred tax assets and uncertain-tax-position reserves by approximately $1.1 million. Revenue-recognition guidance issued in 2014 was not yet adopted; its impact and transition method had not been determined.
- The company paid no cash dividend and stated that it did not intend to pay dividends in the foreseeable future. Disclosure controls were evaluated as effective, with no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether lower vendor funding and software-partner incentive changes continue to pressure gross margin and earnings.
- The sustainability and quality of operating cash flow, particularly working-capital requirements and the increase in inventory levels.
- Debt-facility availability, leverage-covenant headroom and the effect of any decline in adjusted earnings on borrowing capacity.
- Progress and final cost of the information-technology upgrades, facility relocation and property sale.
- Outcomes of tax audits and potential changes in unrecognized tax benefits.
- Foreign-currency exposure, including the effect of translation on cash, equity and reported results.
- Future share repurchases, capital allocation and the absence of a planned cash dividend.
- Seasonality, segment profitability and the continued improvement or deterioration of EMEA and APAC operations.