Insight Enterprises, Inc. — Q2 2013 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 across North America, EMEA and APAC. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the comparable 2012 periods.
Key financial metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $1.417 billion | $1.529 billion | $2.598 billion | $2.773 billion |
| Gross profit | $190.9 million | $201.3 million | $349.1 million | $371.7 million |
| Gross margin | 13.5% | 13.2% | 13.4% | 13.4% |
| Earnings from operations | $44.6 million | $55.3 million | $59.0 million | $80.9 million |
| Net earnings | $26.5 million | $35.3 million | $35.6 million | $52.6 million |
| Diluted EPS | $0.62 | $0.79 | $0.81 | $1.18 |
| Operating cash flow | Not separately provided | Not separately provided | $87.8 million | $11.2 million |
Q2 operating margin was approximately 3.1%, versus 3.6% in the prior-year quarter. Q2 net margin was approximately 1.9%, versus 2.3%. The six-month net margin was 1.4%, versus 1.9% in 2012.
At June 30, 2013, cash and cash equivalents were $142.2 million. Total debt was $53.1 million, consisting primarily of $3.0 million under the senior revolving credit facility and $50.0 million under the accounts receivable securitization facility. The company reported $347.0 million available under the senior revolver and full availability of the $200.0 million ABS facility, subject to receivables eligibility. Inventory financing of $117.2 million was included in accounts payable.
Current assets were $1.679 billion against current liabilities of $1.199 billion. The cash conversion cycle improved to 18 days from 22 days, although days sales outstanding increased to 85 from 81.
Material changes versus the prior comparable period
- Q2 sales declined 7%, primarily because of lower hardware and software sales in North America and EMEA. Six-month sales declined 6%.
- North America Q2 sales decreased 7% and six-month sales decreased 10%; EMEA Q2 sales decreased 8%, while six-month sales were essentially flat; APAC Q2 sales decreased 5%, but six-month sales increased 4%.
- Gross margin improved in Q2 by 30 basis points, supported by increased vendor funding, software-maintenance mix and services sales. Six-month gross margin remained 13.4%.
- Operating earnings declined 19% in Q2 and 27% for the first six months. Selling and administrative expense was broadly flat in Q2 and declined 1% year to date, but increased as a percentage of sales because of lower revenue.
- Severance and restructuring expense increased to $3.2 million in Q2 and $5.9 million year to date, associated with position eliminations and role realignment in North America and EMEA.
- Operating cash flow improved substantially because of lower working-capital requirements associated with reduced sales, including a $25.5 million decrease in accounts receivable. Cash flow was also supported by a $52.5 million increase in accounts payable.
- The company repurchased and retired $50.0 million of common stock, or 2.65 million shares, during the first six months of 2013.
- Capital expenditures declined to $10.5 million from $15.9 million, as major IT system upgrade projects neared completion.
- The prior-year six-month results included a $2.0 million bargain-purchase gain from the Inmac acquisition; no comparable gain was recorded in 2013.
Guidance, outlook, risks and unusual items
- Management expects 2013 capital expenditures of approximately $18 million to $22 million, primarily for IT-system upgrades, facilities and technology projects.
- Management expects cash generated in excess of working-capital needs to support debt repayment, capital expenditures and potential acquisitions. It expects operating cash flow and available financing to cover anticipated requirements for the next 12 months.
- The company expects to remain compliant with its maximum leverage covenant over the next four quarters. The permitted maximum leverage ratio is 2.75 times trailing adjusted earnings; covenant-based debt capacity at June 30 was $476.4 million versus $53.0 million outstanding under the revolving and ABS facilities.
- The company was notified that its largest software partner planned changes to its channel incentive program beginning as early as October 1, 2013. Management anticipated reduced future incentives but had not quantified the impact.
- Effective tax rates increased to 39.6% for Q2 and 37.0% for the six-month period, primarily because of valuation allowances for certain foreign losses and credits and state taxes. Tax audits covering 2006–2011 could materially affect future tax expense, although the potential range of outcomes was not estimable.
- The company recorded $8.0 million of adverse foreign-currency effects on cash during the first six months and maintains forward contracts to partially offset currency exposure.
- A qui tam lawsuit related to the E-Rate program remained subject to appeal and was stayed pending appellate review. The company disputed the claims, could not estimate any possible loss, and was pursuing indemnification under the Calence acquisition agreements.
- Seasonality is significant: sales and profitability are generally higher in the second and fourth quarters. The filing states that interim results are not necessarily indicative of full-year performance.
- The company reported effective disclosure controls as of June 30, 2013. IT-system deployments and integrations modified certain processes and controls, but no other material change in internal control over financial reporting was identified.
Most important facts for investors to verify
- Final terms, timing and financial effect of the largest software partner’s channel incentive program changes.
- Whether declining North American and EMEA hardware and software demand stabilizes and whether services growth can offset product weakness.
- Trends in vendor funding, product mix and gross margin, particularly in EMEA.
- Compliance with leverage, fixed-charge and asset-coverage covenants as earnings and debt levels change.
- Cash availability at U.S. versus foreign subsidiaries and the practical ability to repatriate foreign cash.
- Outcomes of tax audits and changes in unrecognized tax benefits.
- Potential exposure from the E-Rate litigation, other legal proceedings, indemnification obligations and performance bonds.
- Completion, costs and operational risks associated with the remaining IT-system upgrades, including the planned APAC deployment.