Insight Enterprises, Inc. — Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
Insight Enterprises is a global IT solutions provider offering hardware, software and services through North America, EMEA and APAC. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods. Results include Datalink from its January 6, 2017 acquisition and Caase.com from September 26, 2017.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $1,758.0 million | $1,392.7 million | $4,919.5 million | $4,017.9 million |
| Gross profit | $226.1 million | $181.8 million | $685.7 million | $552.1 million |
| Gross margin | 12.9% | 13.1% | 13.9% | 13.7% |
| Earnings from operations | $41.4 million | $36.4 million | $133.7 million | $108.2 million |
| Net earnings | $22.4 million | $21.6 million | $76.5 million | $63.6 million |
| Diluted EPS | $0.62 | $0.60 | $2.11 | $1.74 |
Q3 operating margin was approximately 2.4%, compared with 2.6% in the prior-year quarter. The nine-month operating margin was approximately 2.7% in both periods. Effective tax rates were 36.8% for Q3 and 35.6% for the nine-month period.
North America generated Q3 sales of $1,411.1 million, EMEA $312.2 million and APAC $34.7 million. North America accounted for nearly all consolidated year-over-year sales growth.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $236.4 million at September 30, 2017, compared with $202.9 million at December 31, 2016.
- Operating activities used $323.6 million during the first nine months of 2017, versus $124.9 million used in the prior-year period. The outflow reflected working-capital needs, supplier payments and increased inventory supporting large client engagements.
- Investing activities used $201.3 million, including $186.9 million for the Datalink and Caase.com acquisitions and $15.9 million of capital expenditures.
- Financing activities provided $539.0 million, primarily through borrowings under the revolving credit facility, accounts receivable securitization facility and Term Loan A.
- Total debt was $549.7 million at September 30, 2017, including $216.0 million under the senior revolving facility, approximately $168.4 million under Term Loan A, $160.0 million under the ABS facility and $6.2 million of capital leases and other financing obligations.
- The inventory financing facility had $224.1 million outstanding against a $325.0 million capacity. The revolving facility, Term Loan A and ABS facility had aggregate maximum borrowing capacity of approximately $768.4 million based on the applicable leverage limitation.
- The Company reported compliance with its debt covenants and no ABS amortization event as of September 30, 2017. Management expects available cash flow and financing capacity to support operating and strategic requirements for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 26%, while nine-month sales increased 22%. Management attributed Q3 growth to 17% core-business growth and the addition of Datalink; currency-adjusted consolidated sales growth was 25%.
- Q3 gross profit increased 24%, but gross margin declined 20 basis points to 12.9%, primarily because of lower core-business services and product margins and a higher mix of large-enterprise sales. Nine-month gross margin improved 20 basis points to 13.9%.
- Q3 operating earnings increased 14% despite higher selling and administrative expenses, which rose 25% primarily from Datalink and increased teammate-related costs.
- Interest expense increased 121% in Q3 and 117% for the first nine months, reflecting substantially higher debt balances used to fund the Datalink acquisition and working capital.
- Accounts receivable increased to $1.48 billion and inventory to $235.3 million from $1.44 billion and $148.2 million, respectively, at December 31, 2016. The cash conversion cycle was 37 days, up from 32 days in Q3 2016.
- The Company acquired Datalink for a cash purchase price of $257.5 million and Caase.com for approximately $6.0 million net of cash acquired. Datalink contributed $387.2 million of sales and $89.1 million of gross profit during the first nine months.
Guidance, Outlook, Risks and Unusual Items
- Management stated that Datalink was performing in line with expectations and was on track to meet its profitability objectives for 2017.
- Expected full-year 2017 capital expenditures were $20.0 million to $22.0 million, primarily for technology and facility upgrades.
- Management intends to use excess cash flow to reduce debt, fund capital expenditures and potentially pursue select acquisitions. The Company does not intend to pay cash dividends in the foreseeable future.
- The Company recorded a $3.6 million loss on the July 19, 2017 sale of its Russia operations, including a $2.9 million non-cash charge from releasing cumulative foreign-currency translation adjustments.
- Nine-month severance and restructuring expense was $6.2 million, primarily related to Datalink integration and EMEA headcount reductions. Acquisition-related costs were $3.3 million.
- The Company adopted share-based payment accounting guidance in 2017, recognizing $2.3 million of tax benefits for the first nine months. It expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method; the filing states that the impact is not currently expected to be material, but the analysis was not finalized.
- Reported risks include competitive and technology pressures, dependence on suppliers and partners, acquisition integration, international operations and foreign exchange, cybersecurity and IT disruptions, customer credit risk, higher debt and interest expense, tax audits, litigation, regulatory compliance and economic conditions.
- Tax audits for certain subsidiaries covering 2012 through 2015 remained ongoing. The filing states that the range of possible outcomes could not be estimated, although a material effect on income tax expense and net earnings was not expected.
Important Facts for Investors to Verify
- Whether Datalink integration produces the expected profitability benefits while acquired intangible amortization and related expenses continue.
- Whether working-capital requirements, the 37-day cash conversion cycle and negative operating cash flow normalize as seasonal receivables are collected.
- Debt repayment progress, floating-rate exposure and continued compliance with the 3.50-times maximum leverage covenant.
- The final purchase-price allocations for Datalink and Caase.com, including goodwill, intangible assets and deferred tax matters.
- The final cumulative-effect adjustment and revenue-recognition effects from the January 1, 2018 accounting adoption.
- Exposure to lower product and services margins, large-enterprise sales mix, supplier funding changes and foreign-currency movements.
- Resolution of tax audits, legal proceedings, indemnification obligations and the $3.9 million of unrecognized tax benefits.