Insight Enterprises, Inc. — Q1 2017 Form 10-Q Summary
Business Context and Reporting Period
Insight is a global provider of IT hardware, software, cloud and services to business, government, healthcare and education clients. The filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Reportable segments are North America, EMEA and APAC. Results include Datalink from its acquisition on January 6, 2017, and Ignia from September 1, 2016.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $1.478 billion | $1.169 billion | Up 26% |
| Gross profit | $208.2 million | $161.1 million | Up 29% |
| Gross margin | 14.1% | 13.8% | Up approximately 30 bps |
| Earnings from operations | $23.0 million | $13.6 million | Up 68% |
| Net earnings | $13.8 million | $6.9 million | Up 101% |
| Diluted EPS | $0.38 | $0.18 | Up $0.20 |
| Effective tax rate | 26.2% | 38.2% | Down 2,000 bps |
| Cash used in operating activities | $(152.1) million | $(46.9) million | Higher use of cash |
| Capital expenditures | $10.1 million | $2.9 million | Up more than three times |
North America sales increased 34% to $1.111 billion, EMEA sales increased 9% to $330.4 million, and APAC sales decreased 6% to $36.2 million. Excluding currency effects, consolidated sales increased 29% and gross profit increased 32%.
Cash and cash equivalents were $183.7 million at March 31, 2017, compared with $202.9 million at December 31, 2016. Total debt was $375.8 million, including $175.0 million under Term Loan A, $196.0 million under the accounts receivable securitization facility and $5.8 million of capital leases and other financing obligations. Inventory financing outstanding was $174.3 million.
The company had no balance outstanding under its $350.0 million senior revolving credit facility and had access to the full $250.0 million ABS facility based on qualified receivables. Debt subject to the revolving facility, Term Loan A and ABS facility was $371.0 million, against permitted capacity of $775.0 million based on the applicable leverage covenant.
Material Changes Versus the Prior Comparable Period
- Datalink contributed $129.1 million of sales and $30.3 million of gross profit during the post-acquisition period. The acquisition had a cash purchase price of $257.5 million, including $76.6 million of cash acquired, and resulted in $65.1 million of goodwill and $94.5 million of identifiable intangible assets.
- Organic sales growth was approximately 15%, while Datalink accounted for a substantial portion of reported growth, particularly in North American hardware, software and services.
- North America gross margin improved to 14.2% from 13.5%, primarily due to higher-margin services and data-center products associated with Datalink. EMEA gross margin declined to 12.9% from 14.3%, mainly due to lower margins on large enterprise and public-sector deals. APAC gross margin increased to 20.4% from 15.3%.
- Selling and administrative expenses increased 22% to $177.6 million, reflecting Datalink, higher variable compensation and other operating costs, but declined as a percentage of sales to 12.0% from 12.5%.
- Severance and restructuring expense increased to $4.7 million from $1.4 million, and the company incurred $2.9 million of Datalink acquisition-related expenses.
- Interest expense increased 113% to $3.9 million because of higher debt balances used in part to finance Datalink.
- Net cash used in operations increased primarily because of a roughly $160 million supplier payment made in January 2017. Management stated that, excluding this timing item and a comparable $60 million payment in Q1 2016, operating cash flow would have been nominal in both periods.
- The company did not repurchase shares in Q1 2017 and had no currently authorized share repurchase program, compared with $13.5 million of repurchases in Q1 2016.
Outlook, Commentary, Risks and Unusual Items
- Management expects operating cash flow and available financing facilities to support operating needs and strategic investments for at least the next 12 months.
- Management intends to use excess 2017 cash flow to reduce debt and fund capital expenditures and may pursue additional acquisitions.
- Full-year 2017 capital expenditures are expected to be $20 million to $25 million, primarily for technology and facility upgrades.
- Management expects to remain in compliance with the maximum 3.50-times leverage covenant over the next four quarters, but a significant decline in adjusted earnings could reduce permitted borrowing capacity.
- The business is seasonal: sales and profitability are generally expected to be higher in the second and fourth quarters, while the first quarter is typically softer for certain enterprise and commercial clients.
- Q1 net earnings benefited by $2.0 million, or approximately $0.06 per diluted share, from the adoption of ASU 2016-09 concerning employee share-based payment accounting. The lower effective tax rate also reflected certain tax reserve releases and foreign tax effects.
- Severance actions included role realignment following the Datalink acquisition in North America and headcount reductions in Germany. Remaining severance obligations were $5.5 million at March 31, 2017.
- Foreign subsidiaries held approximately $154.4 million of cash considered indefinitely reinvested outside the United States. The company does not currently intend to repatriate those earnings.
- Key risks include competition, reliance on technology partners, rapid technology changes, acquisition integration, international operations and foreign exchange, customer credit and receivables, cybersecurity and IT disruptions, contract compliance, personnel retention, economic conditions, increased debt and interest expense, tax audits, litigation and intellectual-property claims.
- Several subsidiaries are under tax audit for 2012 through 2015. The company could not estimate the range of possible outcomes, although it does not expect the ultimate effect on income tax expense and net earnings to be significant.
- The filing reports no pending or threatened legal proceedings expected to have a material adverse effect, no covenant default, and no ABS amortization event as of March 31, 2017.
Important Facts for Investors to Verify
- Assess whether Datalink integration produces sustainable revenue, service growth and margin benefits after the acquisition-related costs subside.
- Monitor leverage, debt amortization, floating interest rates and compliance with the 3.50-times maximum leverage covenant.
- Evaluate the sustainability of operating cash flow after the unusually large January supplier payment and the effect of seasonal working-capital movements.
- Track EMEA margin recovery and APAC revenue performance, including the impact of net revenue recognition for cloud and software-maintenance offerings.
- Separate the $2.0 million tax benefit and other unusual items from recurring earnings power.
- Verify the preliminary Datalink purchase-price allocation, including goodwill, acquired intangible values and deferred-revenue estimates.
- Consider the liquidity implications of $228.2 million of contractual obligations due within one year, including inventory financing, debt, leases and severance obligations.