Insight Enterprises, Inc. — 2016 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. The filing was signed October 31, 2016. Insight is a global provider of IT hardware, software, Cloud and services to commercial, government, healthcare and education clients across North America, EMEA and APAC.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $1,392.7 million | $1,342.2 million | $4,017.9 million | $3,985.9 million |
| Gross profit | $181.8 million | $182.3 million | $552.1 million | $535.5 million |
| Gross margin | 13.1% | 13.6% | 13.7% | 13.4% |
| Earnings from operations | $36.4 million | $32.6 million | $108.2 million | $96.0 million |
| Net earnings | $21.6 million | $20.8 million | $63.6 million | $57.3 million |
| Diluted EPS | $0.60 | $0.56 | $1.74 | $1.49 |
- Q3 operating margin was approximately 2.6%, compared with 2.4% in the prior-year quarter; nine-month operating margin was approximately 2.7%, compared with 2.4%.
- Q3 net margin was approximately 1.6% in both periods; nine-month net margin improved to approximately 1.6% from 1.4%.
- Q3 sales increased 4%; on a constant-currency basis, management reported a 6% increase. Nine-month sales increased 1%, or 2% excluding currency effects.
- Q3 selling and administrative expense decreased 3% to $144.6 million, reflecting cost-reduction initiatives, particularly in North America. Nine-month expense increased 1% to $440.9 million.
- Effective tax rates were 35.0% for Q3 and 36.8% for the first nine months, compared with 35.0% and 37.1%, respectively, in 2015.
- Operating cash flow was an outflow of $125.1 million for the first nine months, compared with $24.6 million of cash generation in 2015. The 2016 outflow reflected approximately $40 million of early trade-payable payments and an approximately $60 million supplier payment related to a receivable collected in late 2015.
- Capital expenditures were $9.7 million, and investing cash outflow was $18.6 million, including the $10.8 million Ignia acquisition.
- Cash and cash equivalents were $175.7 million at September 30, 2016, down from $188.0 million at December 31, 2015.
- Total debt was $243.9 million, including $28.5 million under the senior revolving facility, $214.0 million under the accounts receivable securitization facility and $1.4 million of capital leases and other obligations. Inventory-financing borrowings classified in accounts payable were $135.8 million.
- Qualified receivables supported the full $250.0 million ABS facility; $214.0 million was outstanding. The revolving and ABS facilities had aggregate borrowing capacity of $600.0 million, reduced to $569.0 million by the leverage covenant at quarter-end, with $242.5 million outstanding.
Material changes versus the prior comparable period
- North America Q3 sales rose 3% to $1.05 billion, EMEA sales rose 6% to $311.7 million, and APAC sales rose 13% to $29.7 million. For the nine months, North America rose 3%, while EMEA and APAC each declined 5%.
- Q3 gross margin declined 50 basis points, primarily from lower North America and EMEA product margins, lower partner funding and transaction mix. APAC margin expanded to 22.5% from 20.3%.
- Nine-month gross margin increased 30 basis points, aided by improved North America, EMEA and APAC results and a $2.2 million insurance settlement recognized as a reduction of cost of sales.
- Operating earnings increased 12% in Q3 and 13% for the first nine months, supported by lower Q3 selling and administrative expenses and cost-reduction initiatives.
- Interest expense increased 22% in Q3 and 15% year to date because of higher borrowing rates and higher average debt balances. Foreign-currency results shifted from a gain in Q3 2015 to a loss in Q3 2016.
- The company repurchased and retired $50.0 million of common stock during the first nine months, compared with $91.8 million in the prior-year period. The $50 million authorization was completed during Q3.
- Insight acquired Ignia, an Australian business technology consulting and managed-services provider, effective September 1, 2016, for approximately $10.8 million net of cash acquired. The transaction added approximately $7.2 million of goodwill and was recorded in APAC.
Guidance, outlook, risks and unusual items
- Management expected full-year 2016 capital expenditures of $10 million to $15 million.
- Management stated that operating cash flow and available financing were expected to support operations, working capital and strategic investments for at least the next 12 months. It expected to use excess cash to fund capital expenditures, reduce debt and potentially pursue acquisitions.
- Management anticipated compliance with maximum leverage requirements over the following four quarters. The company was in compliance with all financing covenants at September 30, 2016, and no ABS amortization event had occurred.
- The company expected seasonal strength in the second and fourth quarters. Cloud subscriptions and software maintenance increasingly recognized on a net basis may reduce reported revenue while affecting gross margin and profitability comparisons.
- Unusual or nonrecurring items included the $2.2 million insurance settlement, a $338,000 gain on the sale of real estate, $3.1 million of year-to-date severance and restructuring expense, and the Ignia acquisition.
- Tax subsidiaries were under audit for tax years 2006 through 2014. The company had approximately $2.6 million of unrecognized tax benefits; management could not estimate the range of possible outcomes, although it did not expect a significant effect on earnings.
- Performance bonds totaled approximately $2.2 million. Management considered payments under performance bonds and indemnifications unlikely and recorded no related liabilities.
- Key disclosed risks include competition, reliance on vendors and partners, rapid technology changes, economic and international-market conditions, cybersecurity and IT-system disruptions, contract compliance, personnel dependence, tax uncertainty and intellectual-property claims. No pending or threatened legal proceeding was expected to have a material adverse effect.
- The company had approximately $154.4 million of cash held by foreign subsidiaries considered indefinitely reinvested and did not intend to repatriate those earnings.
- The company had never paid a cash dividend and did not intend to pay one in the foreseeable future; financing agreements restrict dividends.
Investor verification checklist
- Verify whether the unusually negative year-to-date operating cash flow was primarily timing-related and whether working-capital conversion normalized after September 30.
- Monitor gross-margin trends, particularly EMEA product margins, partner funding, Cloud and maintenance net-revenue presentation, and the sustainability of APAC margin expansion.
- Reconcile total debt, inventory-financing obligations, borrowing capacity and leverage-covenant headroom after the June 2016 facility amendments.
- Assess the contribution and integration costs of Ignia and the continuing effect of the BlueMetal acquisition on services revenue and expenses.
- Evaluate the effect of future foreign-exchange movements, seasonal spending patterns and public-sector demand on reported results.
- Review the outcome of tax audits, legal and indemnification matters, and the planned adoption of lease and share-based-payment accounting standards.