Business Context and Reporting Period
Insight Enterprises, Inc. is an information technology hardware, software and services provider serving commercial and public-sector clients across North America, EMEA and APAC. This unaudited Form 10-Q covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods.
Key Financial Metrics
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Net sales | $1.529 billion | $1.469 billion | $2.773 billion | $2.689 billion |
| Gross profit | $201.3 million | $204.2 million | $371.7 million | $366.7 million |
| Gross margin | 13.2% | 13.9% | 13.4% | 13.6% |
| Earnings from operations | $55.3 million | $54.4 million | $80.9 million | $77.2 million |
| Net earnings | $35.3 million | $35.3 million | $52.6 million | $48.4 million |
| Diluted EPS | $0.79 | $0.75 | $1.18 | $1.03 |
Six-month operating cash flow was $11.2 million, compared with cash used in operations of $3.4 million in the prior-year period. Capital expenditures were $15.9 million, primarily for information technology systems, and acquisition spending was $3.8 million for Inmac. Cash and cash equivalents were $129.0 million at June 30, 2012, versus $128.3 million at December 31, 2011.
Total debt was $121.1 million at June 30, 2012, including $120.0 million under the accounts receivable securitization facility and $1.1 million of capital lease obligations. No borrowings were outstanding under the senior revolving credit facility. Accounts payable included $100.4 million related to the inventory financing facility.
The amended senior revolving credit facility provides up to $350.0 million and matures in April 2017. The amended accounts receivable securitization facility provides up to $200.0 million and matures in April 2015. The company reported compliance with all debt covenants and stated that available operating cash flow and financing capacity should support anticipated requirements for the next 12 months.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 4%, while six-month sales increased 3%. EMEA drove most of the growth, with sales up 14% in the quarter and 9% year to date; North America and APAC were approximately flat in the quarter.
- Gross margin declined 70 basis points in the quarter and 20 basis points year to date. Management attributed the pressure to a higher mix of lower-margin enterprise and public-sector business, reduced partner funding and changes to a major software partner’s agency-fee program.
- Operating earnings increased despite lower quarterly gross profit, primarily because selling and administrative expenses declined 2% and operating leverage improved, particularly in North America.
- Six-month net earnings increased 9% and diluted EPS increased from $1.03 to $1.18. The quarterly net earnings comparison was essentially flat.
- Accounts receivable increased to $1.355 billion from $1.208 billion at year-end, reflecting seasonal sales growth and timing. The cash conversion cycle improved to 22 days from 23 days in the comparable quarter, although days sales outstanding increased to 81 from 78.
- Capital expenditures increased 53% year over year to $15.9 million, primarily due to IT systems investments.
- The company acquired Inmac, a Western European hardware reseller, effective February 1, 2012, for $3.8 million net of cash acquired. The transaction generated a $2.0 million bargain-purchase gain and expanded hardware capabilities in Germany and the Netherlands.
- Severance and restructuring expense declined to $2.4 million in the second quarter from $3.4 million in the prior-year quarter. Six-month expense was $3.8 million versus $3.9 million.
- No common shares were repurchased during the quarter, compared with prior-year repurchases of approximately $14.1 million during the first six months.
Guidance, Outlook, Risks and Unusual Items
- Management expects full-year 2012 capital expenditures of $20 million to $25 million, primarily for North American and EMEA IT-system integration and upgrades.
- The company intends to use cash exceeding working-capital needs to reduce debt and fund capital expenditures. It does not intend to pay cash dividends in the foreseeable future.
- Management expects to remain within its maximum leverage covenant over the next four quarters. The covenant permits a maximum leverage ratio of 2.75 times trailing adjusted earnings; a significant earnings decline could reduce permitted debt capacity.
- Results are seasonal, with sales and profitability generally higher in the second and fourth quarters. Interim results are not necessarily indicative of full-year performance.
- Key risks include dependence on technology partners for product availability, marketing funds and incentives; IT-system integration and disruption risk; economic and competitive pressures; acquisition integration; international operations and foreign currency exposure; tax audits; contract compliance; cybersecurity; intellectual-property claims; and dependence on key personnel.
- Subsidiaries are under tax audits for 2003 through 2010. The company reported $4.7 million of unrecognized tax benefits and could not estimate the range of possible outcomes.
- A qui tam lawsuit involving Calence and the federal E-Rate program was unsealed in June 2012. The Department of Justice declined to intervene at that time, but the company could not estimate any potential loss and is seeking indemnification under the Calence acquisition agreements.
- Approximately $20.8 million of performance bonds were outstanding at June 30, 2012. Management had not accrued liabilities for indemnification obligations because payments were not considered probable.
- The company stated that disclosure controls were effective. Ongoing North American and EMEA IT-system projects have modified certain processes and controls, creating execution and implementation risks.
Important Facts for Investors to Verify
- Whether gross-margin pressure from enterprise, public-sector and partner-program mix persists or reverses.
- Progress, cost and operational impact of the North American and EMEA IT-system integration projects.
- Working-capital trends, especially accounts receivable growth, days sales outstanding and cash conversion.
- Debt utilization, covenant headroom and the effect of any decline in adjusted earnings on borrowing capacity.
- Integration results and future contribution from Inmac and the previously acquired Ensynch business.
- Potential tax-audit liabilities and the ultimate outcome, indemnification recovery and financial impact of the Calence E-Rate litigation.
- Whether planned capital expenditures remain within the stated $20 million to $25 million range and whether operating cash flow is sufficient to fund them while reducing debt.