e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: September 30, 2006
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-25092
INSIGHT ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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86-0766246 |
(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer Identification Number) |
1305 West Auto Drive, Tempe, Arizona 85284
(Address of principal executive offices) (Zip Code)
(480) 902-1001
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
The number of shares outstanding of the issuers common stock as of June 29, 2007 was 49,100,749.
INSIGHT ENTERPRISES, INC.
QUARTERLY REPORT ON FORM 10-Q
Three Months Ended September 30, 2006
TABLE OF CONTENTS
2
INSIGHT ENTERPRISES, INC.
EXPLANATORY NOTE REGARDING RESTATEMENT OF OUR
CONSOLIDATED FINANCIAL STATEMENTS
In this Quarterly Report on Form 10-Q, we have restated our consolidated balance sheet as of
December 31, 2005. The consolidated statements of earnings for the three and nine months ended
September 30, 2006 and 2005 and the consolidated statements of cash flows for the nine months ended
September 30, 2006 and 2005 did not require restatement.
Based on information provided by an independent committee of the Board of Directors (the
Options Subcommittee) resulting from its review of the Companys historical stock option granting
practices, we identified errors in the Companys accounting related to stock option compensation
expenses in prior periods. The Options Subcommittees review encompassed all options on Company
securities granted to directors, officers, or employees from the Companys initial public offering
in January 1995 through November 30, 2005 (the Relevant Period). During this period, the Company
made more than 28,000 individual option grants, involving options on more than 28 million
(split-adjusted) shares, on 957 separate grant dates. Additionally, the Company undertook an
analysis of the results of the Options Subcommittees review as well as all stock option activity
during the Relevant Period. We determined that corrections to our consolidated financial
statements were required to reflect additional material charges for stock-based compensation
expenses and related income tax effects.
Our consolidated retained earnings as of December 31, 2005 incorporates an aggregate of
approximately $30.9 million in incremental stock option-related compensation charges relating to
the period from January 24, 1995 through December 31, 2005. This charge is net of a $16.5 million
tax benefit related to the restatement adjustments. This additional compensation expense results
from our determination, based upon the Options Subcommittees review and the Companys analysis,
that for accounting purposes, the dates initially used to measure compensation expense for many
stock option grants to employees, executive officers and outside non-employee directors during the
period could not be relied upon. In particular, the Options Subcommittee identified various
categories of grants that had been made by the Company during the period under review including:
(a) discretionary grants of various types; (b) anniversary grants; (c) promotion grants; (d) new
hire grants; and (e) program grants. In general, the Options Subcommittee found: (x) a lack of
significant issues with respect to new hire grants; (y) that during a portion of the period under
review, the Company retrospectively selected dates for anniversary grants and promotion grants
based on the lowest price in a particular period; and (z) inadequate documentation surrounding
certain discretionary grants, including grants to officers that required approval by the
Compensation Committee. We determined that the revised measurement dates for accounting purposes
differed from the originally selected measurement dates due primarily to: (i) insufficient or
incomplete approvals; (ii) inadequate or incomplete establishment of the terms of the grants,
including the list of individual recipients; and (iii) the use of hindsight to select exercise
prices.
In those cases in which the Company had previously used a measurement date that we determined
could no longer be relied upon, we undertook to identify the most supportable measurement date from
the available evidence. For the grant dates specifically reviewed by the Options Subcommittee,
management analyzed the documents identified during the review performed by the Options
Subcommittee, the information contained in the Companys stock plan administration database
application (Equity Edge), minute books, personnel files, payroll records, Securities and
Exchange Commissions (SEC) filings, electronic files on the Companys computer network and human
resources systems to determine the appropriate measurement dates. We considered the information
available for each recipient included in each of the grant dates to determine the most supportable
measurement date for each individual grant within the grant date. For the remaining grants
not specifically reviewed by the Options Subcommittee, management reviewed each grant date
and all available support contained in the Stock Plan Administration hard copy files, human
resources system data and Equity Edge information for each recipient included in each of the
individual grant dates to determine the type of grant and most supportable measurement date for
each individual grant within the grant date. The Company used the information contained in Equity
Edge to categorize the grants, if possible, into the various categories discussed above.
Individual grants categorized in Equity Edge as new hire or anniversary grants were separately
accumulated and analyzed. For more information on our restatement, see Managements Discussion
and
3
INSIGHT ENTERPRISES, INC.
Analysis of Financial Condition and Results of Operations in Item 2 and Note 2 of our Notes to the
Consolidated Financial Statements in Item 1 of this Quarterly Report.
In addition to the restatements for stock-based compensation, we recorded a pre-tax adjustment
for $1.0 million to record a legal settlement expense that was recorded in the first quarter of
2006, which should have been recorded in the fourth quarter of 2005. The tax effect of this
adjustment was $0.4 million.
All financial information contained in this Quarterly Report on Form 10-Q gives effect to the
restatements of our consolidated financial statements as described above. We have not amended, and
we do not intend to amend, our previously filed Annual Reports on Form 10-K or Quarterly Reports on
Form 10-Q for each of the fiscal years and fiscal quarters of 1995 through 2005, and for the first
six months of the fiscal year ended December 31, 2006. Financial information included in reports
previously filed or furnished by Insight Enterprises, Inc. for the periods from January 1, 1995
through June 30, 2006 should not be relied upon and are superseded by the information in this
Quarterly Report on Form 10-Q.
Management has determined that we have a material weakness in our internal control over
financial reporting relating to the implementation and administration of our equity compensation
programs and the accounting for awards thereunder as of December 31, 2006. As described in more
detail in Item 4 of this Quarterly Report, although the Company made its last stock option grant on
November 30, 2005, based on the findings of the Options Subcommittee, the problems uncovered during
the review have caused the Company to undertake remedial measures to ensure that similar problems
cannot occur in connection with its grants of restricted stock. We have identified and are
implementing measures designed to remedy this material weakness.
FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-Q, including statements in
Managements Discussion and Analysis of Financial Condition and Results of Operations in Part I,
Item 2 of this report, are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements may include: projections of
matters that affect net sales, gross profit, operating expenses, earnings from continuing
operations, non-operating income and expenses or net earnings; effects of acquisitions; projections
of capital expenditures and growth; hiring plans; plans for future operations; the availability of
financing and our needs or plans relating thereto; plans relating to our products and services; the
effect of new accounting principles or changes in accounting policies; the effect of guaranty and
indemnification obligations; statements of belief; and statements of assumptions underlying any of
the foregoing. Forward-looking statements are identified by such words as believe, anticipate,
expect, estimate, intend, plan, project, will, may and variations of such words and
similar expressions, and are inherently subject to risks and uncertainties, some of which cannot be
predicted or quantified. Future events and actual results could differ materially from those set
forth in, contemplated by, or underlying the forward-looking statements. Some of the important
factors that could cause our actual results to differ materially from those projected in any
forward-looking statements, include but are not limited to:
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changes in the information technology industry and/or the economic environment; |
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our reliance on partners for product availability, marketing funds, purchasing
incentives and competitive products to sell; |
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disruptions in our information technology and voice and data networks, including the
upgrade to mySAP and the migration of Software Spectrum to our information technology and
voice and data networks; |
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the integration and operation of Software Spectrum, including our ability to achieve the
expected benefits of the acquisition; |
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actions of our competitors, including manufacturers/publishers of products we sell; |
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the informal inquiry from the SEC and the fact that we could be subject to stockholder
litigation related to the investigation by the Options Subcommittee of our Board of
Directors into our stock option granting practices and the related restatement of our
consolidated financial statements; |
4
INSIGHT ENTERPRISES, INC.
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the recently enacted changes in securities laws and regulations, including potential
risk resulting from our evaluation of internal controls under the Sarbanes-Oxley Act of
2002; |
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the risks associated with international operations; |
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sales of software licenses are subject to seasonal changes in demand; |
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increased debt and interest expense and lower availability on our financing facilities; |
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increased exposure to currency exchange risks; |
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our dependence on key personnel; |
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risk that purchased goodwill or amortizable intangible assets become impaired; |
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our failure to comply with the terms and conditions of our public sector contracts; |
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risks associated with our very limited experience in outsourcing business functions to India; |
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rapid changes in product standards; and |
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intellectual property infringement claims. |
Additionally, there may be other risks that are otherwise described from time to time in the
reports that we file with the Securities and Exchange Commission (SEC).
In addition, these forward-looking statements include statements regarding the informal
inquiry commenced by the SEC and a stockholders demand to inspect our books and records pursuant
to Section 220 of the Delaware General Corporation Law. There can be no assurances that
forward-looking statements will be achieved, and actual results could differ materially from those
suggested by the forward-looking statements. Important factors that could cause actual results to
differ materially include: adjustments to the consolidated financial statements that may be
required related to the SEC informal inquiry; and risks of litigation and governmental or other
regulatory inquiry or proceedings arising out of or related to the Companys historical stock
option granting practices. Therefore, any forward-looking statements in this release should be
considered in light of various important factors, including the risks and uncertainties listed
above, as well as others.
We assume no obligation to update, and do not intend
to update, any forward-looking statements. We do not endorse any projections regarding future performance that may be made by third parties.
5
PART I- FINANCIAL INFORMATION
Item 1. Financial Statements.
INSIGHT ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
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September 30, |
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December 31, |
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2006 |
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2005 |
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(unaudited) |
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As Restated (1) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
71,071 |
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$ |
35,145 |
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Accounts receivable, net of allowances for doubtful
accounts of $23,424 and $15,892 |
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720,022 |
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480,458 |
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Inventories |
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115,670 |
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121,223 |
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Inventories not available for sale |
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19,402 |
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35,528 |
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Deferred income taxes |
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22,764 |
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22,535 |
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Other current assets |
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36,781 |
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7,089 |
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Total current assets |
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985,710 |
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701,978 |
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Property and equipment, net of accumulated depreciation of $84,592
and $90,395 |
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126,228 |
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133,017 |
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Buildings held for lease, net of accumulated depreciation of $4,358 |
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16,706 |
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Goodwill |
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294,212 |
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87,124 |
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Intangible assets, net of accumulated amortization of $741 |
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88,908 |
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Other assets |
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24,821 |
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221 |
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$ |
1,536,585 |
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$ |
922,340 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
390,335 |
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$ |
183,501 |
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Accrued expenses and other current liabilities |
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120,728 |
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55,956 |
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Current portion of long-term debt |
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15,000 |
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Deferred revenue |
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33,860 |
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24,747 |
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Line of credit |
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22,000 |
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21,309 |
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Inventories financing facility |
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4,281 |
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Short-term financing facility |
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45,000 |
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Total current liabilities |
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581,923 |
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334,794 |
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Long-term debt |
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242,000 |
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Deferred income taxes |
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25,787 |
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15,371 |
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Other long-term liabilities |
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22,089 |
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2,262 |
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Commitments and contingencies (Note 11) |
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Stockholders equity: |
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Preferred stock, $0.01 par value, 3,000 shares authorized; no
shares issued |
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Common stock, $0.01 par value, 100,000 shares authorized; 48,728
shares at September 30, 2006 and 47,736 shares at December 31,
2005 issued and outstanding |
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487 |
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477 |
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Additional paid-in capital |
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359,659 |
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334,404 |
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Retained earnings |
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278,797 |
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220,846 |
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Accumulated other comprehensive income foreign currency
translation adjustment |
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25,843 |
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14,186 |
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Total stockholders equity |
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664,786 |
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569,913 |
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$ |
1,536,585 |
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$ |
922,340 |
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(1) |
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See Note 2 Restatement of Consolidated Financial Statements. |
See accompanying notes to consolidated financial statements .
6
INSIGHT ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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Net sales |
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$ |
918,592 |
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$ |
823,599 |
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$ |
2,544,599 |
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$ |
2,371,633 |
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Costs of goods sold |
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803,041 |
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728,937 |
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2,225,743 |
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2,090,991 |
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Gross profit |
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115,551 |
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94,662 |
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318,856 |
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280,642 |
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Operating expenses: |
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Selling and administrative expenses |
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89,553 |
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71,506 |
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247,816 |
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214,321 |
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Severance and restructuring expenses |
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729 |
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378 |
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729 |
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4,442 |
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Reductions in liabilities assumed in a
previous acquisition |
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(664 |
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Earnings from operations |
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25,269 |
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22,778 |
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70,311 |
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62,543 |
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Non-operating (income) expense: |
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Interest income |
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(1,650 |
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(830 |
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(3,658 |
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(2,560 |
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Interest expense |
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1,264 |
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429 |
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2,333 |
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1,026 |
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Other expense, net |
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208 |
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207 |
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552 |
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674 |
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Earnings from continuing operations
before income taxes |
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25,447 |
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22,972 |
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71,084 |
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63,403 |
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Income tax expense |
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8,207 |
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8,814 |
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24,370 |
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24,447 |
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Net earnings from continuing operations |
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17,240 |
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14,158 |
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46,714 |
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38,956 |
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Earnings from discontinued operation,
net of taxes of $0, $755, $1,258 and
$2,857, respectively |
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1,224 |
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2,093 |
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4,623 |
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Gain on sale of discontinued operation,
net of taxes of $5,978 for nine months
ended September 30, 2006 |
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9,144 |
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Net earnings from discontinued operation |
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1,224 |
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11,237 |
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4,623 |
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Net earnings |
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$ |
17,240 |
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$ |
15,382 |
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$ |
57,951 |
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$ |
43,579 |
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Net earnings per share Basic: |
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Net earnings from continuing operations |
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$ |
0.36 |
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$ |
0.29 |
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$ |
0.97 |
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$ |
0.80 |
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Net earnings from discontinued operation |
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0.03 |
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0.23 |
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0.09 |
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Net earnings per share |
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$ |
0.36 |
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$ |
0.32 |
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$ |
1.20 |
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$ |
0.89 |
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Net earnings per share Diluted: |
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Net earnings from continuing operations |
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$ |
0.35 |
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$ |
0.29 |
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$ |
0.97 |
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$ |
0.79 |
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Net earnings from discontinued operation |
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0.02 |
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0.23 |
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0.09 |
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Net earnings per share |
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$ |
0.35 |
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$ |
0.31 |
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$ |
1.20 |
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$ |
0.88 |
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Shares used in per share calculations: |
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Basic |
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48,411 |
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48,412 |
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48,230 |
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48,862 |
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Diluted |
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48,658 |
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48,936 |
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48,375 |
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49,383 |
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See accompanying notes to consolidated financial statements.
7
INSIGHT ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
As Restated (1) |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
$ |
46,714 |
|
|
$ |
38,956 |
|
Plus: net earnings from discontinued operation |
|
|
11,237 |
|
|
|
4,623 |
|
|
|
|
|
|
|
|
Net earnings |
|
|
57,951 |
|
|
|
43,579 |
|
Adjustments to reconcile net earnings to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
14,819 |
|
|
|
10,954 |
|
Provision for losses on accounts receivable |
|
|
2,101 |
|
|
|
4,410 |
|
Write-downs of inventories |
|
|
6,892 |
|
|
|
5,253 |
|
Non-cash stock-based compensation |
|
|
10,101 |
|
|
|
550 |
|
Gain on sale of discontinued operation |
|
|
(15,122 |
) |
|
|
|
|
Tax benefit from employee gains on stock-based compensation |
|
|
|
|
|
|
1,936 |
|
Excess tax benefit from employee gains on stock-based compensation |
|
|
(1,035 |
) |
|
|
|
|
Deferred income taxes |
|
|
22,035 |
|
|
|
3,590 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
(Increase) decrease in accounts receivable |
|
|
(10,538 |
) |
|
|
4,085 |
|
Decrease in inventories |
|
|
25,399 |
|
|
|
4,526 |
|
(Increase) decrease in other current assets |
|
|
(16,627 |
) |
|
|
4,849 |
|
Increase in other assets |
|
|
(20,953 |
) |
|
|
(346 |
) |
Increase (decrease) in accounts payable |
|
|
20,885 |
|
|
|
(22,822 |
) |
Decrease in inventories financing facility |
|
|
(11,819 |
) |
|
|
(3,035 |
) |
(Decrease) increase in deferred revenue |
|
|
(3,193 |
) |
|
|
9,668 |
|
Increase (decrease) in accrued expenses and other liabilities |
|
|
24,762 |
|
|
|
(7,789 |
) |
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
105,658 |
|
|
|
59,408 |
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Proceeds from sale of discontinued operation |
|
|
46,500 |
|
|
|
|
|
Acquisition of Software Spectrum, net of cash acquired |
|
|
(323,009 |
) |
|
|
|
|
Purchases of property and equipment |
|
|
(26,383 |
) |
|
|
(26,395 |
) |
Cash receipt of underwriter receivable, net |
|
|
|
|
|
|
26,904 |
|
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities |
|
|
(302,892 |
) |
|
|
509 |
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Repayments on short-term financing facility |
|
|
(45,000 |
) |
|
|
(40,000 |
) |
Borrowings on long-term financing facility |
|
|
202,000 |
|
|
|
60,000 |
|
Repayments on long-term financing facility |
|
|
(20,000 |
) |
|
|
|
|
Borrowings on term loan |
|
|
75,000 |
|
|
|
|
|
Net borrowings on line of credit |
|
|
691 |
|
|
|
|
|
Proceeds from sales of common stock under employee stock plans |
|
|
14,140 |
|
|
|
6,589 |
|
Excess tax benefit from employee gains on stock-based compensation |
|
|
1,035 |
|
|
|
|
|
Repurchase of common stock |
|
|
|
|
|
|
(49,077 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
227,866 |
|
|
|
(22,488 |
) |
|
|
|
|
|
|
|
Cash flows from discontinued operation: |
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(8,885 |
) |
|
|
(2,348 |
) |
Net cash provided by (used in) investing activities |
|
|
11,710 |
|
|
|
(2,606 |
) |
Net cash used in financing activities |
|
|
(2,696 |
) |
|
|
(127 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) discontinued operation |
|
|
129 |
|
|
|
(5,081 |
) |
|
|
|
|
|
|
|
Foreign currency exchange effect on cash flow |
|
|
5,165 |
|
|
|
(3,325 |
) |
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
35,926 |
|
|
|
29,023 |
|
Cash and cash equivalents at beginning of period |
|
|
35,145 |
|
|
|
38,443 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
71,071 |
|
|
$ |
67,466 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
See Note 2 Restatement of Consolidated Financial Statements. |
See accompanying notes to consolidated financial statements.
8
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation and Recently Issued Accounting Pronouncements
We are a leading provider of brand-name information technology (IT) hardware, software and
services to large enterprises, small- to medium-sized businesses (SMB) and public sector
institutions in North America, Europe, the Middle East, Africa and Asia-Pacific. Currently, our
offerings in North America and the United Kingdom include brand-name IT hardware, software and
services. Our offerings in the remainder of our EMEA segment and in APAC currently only include
software and select software-related services.
On September 7, 2006, we completed our acquisition of Software Spectrum, Inc. (Software
Spectrum) for a cash purchase price of $287,000,000 plus working capital of $64,380,000, which
included cash acquired of $30,285,000. The purchase price was allocated to the tangible and
identifiable intangible assets acquired and liabilities assumed based on their estimated fair
values. The excess purchase price over fair value of net assets acquired was recorded as goodwill.
See further information in Note 12.
On June 30, 2006, we completed the sale of 100% of the outstanding stock of Direct Alliance
Corporation (Direct Alliance) for a cash purchase price of $46,500,000, subject to earn out and
claw back provisions that have not been resolved as of July 25, 2007. Accordingly, Direct
Alliances results from operations for all periods presented are classified as a discontinued
operation. See further information in Note 13.
The accompanying unaudited consolidated financial statements contain all adjustments necessary
to present fairly our financial position as of September 30, 2006, our results of operations for
the three and nine months ended September 30, 2006 and 2005 and our cash flows for the nine months
ended September 30, 2006 and 2005. The accompanying unaudited consolidated financial statements
and notes have been prepared in accordance with the rules and regulations promulgated by the
Securities and Exchange Commission (the SEC) and consequently do not include all of the
disclosures normally required by United States generally accepted accounting principles (GAAP).
The preparation of consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the consolidated
financial statements. Additionally, these estimates and assumptions affect the reported amounts of
sales and expenses during the reported period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Insight Enterprises, Inc. and
its wholly-owned subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation. References to the Company, we, us, our and other similar
words refer to Insight Enterprises, Inc. and its consolidated subsidiaries, unless the context
suggests otherwise.
Recently Issued Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments
(SFAS No. 155), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS No. 133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities (SFAS No. 140). SFAS No. 155 simplifies the accounting
for certain derivatives embedded in other financial instruments by allowing them to be accounted
for as a whole if the holder elects to account for the whole instrument on a fair value basis.
SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140.
SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a
remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption
is permitted, provided the Company has not yet issued financial statements, including for interim
periods, for that fiscal year. We do not expect the adoption of SFAS No. 155 will have a material
effect on our consolidated financial statements and disclosures.
9
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
In June 2006, the EITF reached a consensus on EITF Issue No. 06-3, How Taxes Collected from
Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement
(That is, Gross versus Net Presentation) (EITF No. 06-3) that, for periods beginning after
December 15, 2006, entities may adopt a policy of presenting taxes in the income statement on
either a gross or net basis. Gross or net presentation may be elected for each different type of
tax, but similar taxes should be presented consistently. Taxes within the scope of EITF No. 06-3
would include taxes that are imposed concurrent with or subsequent to a revenue transaction between
a seller and a customer. EITF No. 06-3 will not affect the method that we employ to present sales
taxes in our consolidated financial statements, as we currently present sales net of taxes, and we
anticipate that we will continue to do so in the future.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxesan interpretation of FASB Statement No. 109 (FIN 48), which clarifies the
accounting for uncertainty in tax positions. FIN 48 applies to all entities subject to income
taxes and covers all tax positions accounted for in accordance with FASB Statement No. 109,
Accounting for Income Taxes. This interpretation will require that we recognize the effect of a
tax position in our consolidated financial statements if there is a greater likelihood than not of
the position being sustained upon audit, based on the technical merits of the position. The
provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the
cumulative effect of the change in accounting principle recorded as an adjustment to opening
retained earnings. We have determined that there will not be a material adjustment to beginning
retained earnings as a result of the implementation of FIN 48 in the first quarter of 2007.
On
May 2, 2007, the FASB issued FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB
Interpretation No. 48, or FSP FIN 48-1, which
amends FIN 48, to provide guidance about how an enterprise
should determine whether a tax position is effectively settled for
the purpose of recognizing previously unrecognized tax benefits.
Under FSP FIN 48-1, a tax position is considered to be
effectively settled if the taxing authority completed its
examination, the company does not plan to appeal, and it is remote
that the taxing authority would reexamine the tax position in the
future.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair
Value Measurements (SFAS No. 157), which provides guidance for using fair value to measure
assets and liabilities. The standard also responds to investors requests for more information
about (1) the extent to which companies measure assets and liabilities at fair value, (2) the
information used to measure fair value, and (3) the effect that fair-value measurements have on
earnings. SFAS No. 157 will apply whenever another standard requires (or permits) assets or
liabilities to be measured at fair value. The standard does not expand the use of fair value to any
new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal years. We are in the
process of determining the effect that the adoption of SFAS No. 157 will have on our consolidated
financial statements and disclosures.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
(SAB No. 108). SAB No. 108 provides guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of a materiality
assessment. SAB No. 108 establishes an approach that requires quantification of financial
statement errors based on the effects of each of a companys balance sheets and statements of
operations and the related financial statement disclosures. SAB No. 108 permits existing public
companies to record the cumulative effect of initially applying this approach in the first year
ending after November 15, 2006 by recording the necessary correcting adjustments to the carrying
values of assets and liabilities as of the beginning of that year with the offsetting adjustment
recorded to the opening balance of retained earnings. Additionally, the use of the cumulative
effect transition method requires detailed disclosure of the nature and amount of each individual
error being corrected through the cumulative adjustment and how and when it arose. The adoption of
SAB No. 108 will not have a material effect on our consolidated financial statements and
disclosures.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB
Statement No. 115 (SFAS No. 159), which becomes effective for fiscal periods beginning after
November 15, 2007. Under SFAS No. 159, companies may elect to measure specified financial
instruments and warranty and insurance contracts at fair value on a contract-by-contract basis,
with changes in fair value recognized in earnings each reporting period. This election, called the
fair value option, will enable some companies to reduce volatility in
10
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
reported earnings caused by measuring related assets and liabilities differently. We do not
expect that the adoption of SFAS No. 159 will have a material effect on our consolidated financial
statements and disclosures.
2. Restatement of Consolidated Financial Statements
Background
We announced on October 19, 2006 that the Companys Board of Directors had appointed an
Options Subcommittee, comprised of independent directors, to conduct a review of the Companys
stock options. Certain present and former directors and executive officers of the Company were
named as defendants in a derivative lawsuit related to stock option practices from 1997 to 2002,
filed in Superior Court, County of Maricopa, Arizona on September 21, 2006. The Company had been
named as a nominal defendant in that action. On December 22, 2006, we filed a motion to dismiss
the complaint based on plaintiffs failure to make a pre-suit demand on the Companys Board of
Directors. Before the opposition to the motion was due, the plaintiff voluntarily asked the Court
to dismiss the lawsuit, and, on January 19, 2007, the Court granted the plaintiffs motion to
voluntarily dismiss the lawsuit without prejudice. In addition, we announced on November 6, 2006
that on October 27, 2006, the Company received an informal inquiry from the Securities and Exchange
Commission (the SEC) requesting certain documents and information relating to the Companys stock
option granting practices from January 1, 1996 to the present.
The Options Subcommittee was assisted by independent legal counsel and independent forensic
accounting consultants. At the conclusion of its review, the Options Subcommittee reported its
findings to the Companys Board of Directors and to KPMG LLP, the Companys independent registered
public accounting firm, on March 9, 2007 and March 13, 2007, respectively. Management, assisted by
its own independent legal counsel and independent forensic consultants, then undertook an analysis
of the results of the Options Subcommittees review, as well as all stock option activity during
the period after the Companys initial public offering on January 24, 1995 through November 30,
2005, the last date on which we granted stock options (the Relevant Period).
Based upon the investigation and determinations made by the Options Subcommittee of the Board
of Directors and managements undertaking of a review of historical stock option activity, the
Company identified errors in its accounting related to stock option compensation expense for each
of the fiscal years ended 1995 through 2005 and for the first quarter of the year ended December
31, 2006. In a Form 8-K filed on April 5, 2007, we reported that based on the findings of the
Options Subcommittee and the conclusions reached to date by management in its analysis, our
previously issued financial statements would require restatement and should no longer be relied
upon.
We determined, based upon the Options Subcommittees review and the Companys analysis, that
for accounting purposes, the dates initially used to measure compensation expense for various stock
option grants to employees, executive officers and outside non-employee directors during the period
could not be relied upon. The revised measurement dates identified for accounting purposes
differed from the originally selected measurement dates due primarily to: (i) insufficient or
incomplete approvals; (ii) inadequate or incomplete establishment of the terms of the grants,
including the list of individual recipients; and (iii) the use of hindsight to select exercise
prices. These restated consolidated financial statements reflect the corrections resulting from
our determination.
Restatement Adjustments
Our restated consolidated financial statements contained in this Form 10-Q incorporate
stock-based compensation expense, including the income tax impacts related to the restatement
adjustments. The restatement adjustments result in a $30.8 million reduction of retained earnings
as of December 31, 2004. The total restatement impact for the years ended December 31, 1995
through December 31, 2004, of $30.8 million, net of related tax benefits of $16.5 million, has been
reflected as a prior period adjustment to beginning retained earnings as of January 1, 2005.
11
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
In addition to the restatements for stock-based compensation, we recorded a pre-tax adjustment
for $1.0 million to record a legal settlement expense that was recorded in the first quarter of
2006, which should have been recorded in the fourth quarter of 2005. The tax effect of this
adjustment was $0.4 million.
The following table summarizes the effect of the restatement adjustments on beginning retained
earnings as of January 1, 2005 (in thousands):
|
|
|
|
|
|
|
Retained Earnings |
|
|
|
January 1, 2005 |
|
As previously reported |
|
$ |
230,879 |
|
|
|
|
|
|
|
|
|
|
Adjustments: |
|
|
|
|
Stock option compensation expense |
|
|
(47,307 |
) |
Income tax benefit |
|
|
16,519 |
|
|
|
|
|
|
|
|
|
|
Total adjustments |
|
|
(30,788 |
) |
|
|
|
|
|
|
|
|
|
As restated |
|
$ |
200,091 |
|
|
|
|
|
The consolidated statements of earnings for the three and nine months ended September 30,
2006 and 2005 and the consolidated statements of cash flows for the nine months ended September 30,
2006 did not require restatement.
12
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The tables below present the decrease (increase) in net earnings resulting from the individual
restatement adjustments for each respective period presented and are explained in further detail
following the table (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
|
|
|
|
Ended |
|
|
Year Ended |
|
|
|
June 30, 2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
|
2000 |
|
Stock option compensation from
continuing operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discretionary Grants |
|
$ |
|
|
|
$ |
42 |
|
|
$ |
196 |
|
|
$ |
3,510 |
|
|
$ |
11,716 |
|
|
$ |
4,190 |
|
|
$ |
5,830 |
|
Anniversary Grants |
|
|
|
|
|
|
|
|
|
|
13 |
|
|
|
127 |
|
|
|
929 |
|
|
|
1,591 |
|
|
|
1,432 |
|
Promotion Grants |
|
|
|
|
|
|
2 |
|
|
|
5 |
|
|
|
24 |
|
|
|
105 |
|
|
|
186 |
|
|
|
111 |
|
New Hire Grants |
|
|
|
|
|
|
7 |
|
|
|
19 |
|
|
|
(15 |
) |
|
|
39 |
|
|
|
14 |
|
|
|
48 |
|
Program Grants |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
8 |
|
|
|
28 |
|
|
|
89 |
|
|
|
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock compensation expense
from continuing operations |
|
|
|
|
|
|
51 |
|
|
|
234 |
|
|
|
3,654 |
|
|
|
12,817 |
|
|
|
6,070 |
|
|
|
7,444 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other miscellaneous accounting
adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to record legal
settlement in appropriate period |
|
|
(1,000 |
) |
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other miscellaneous
accounting adjustments |
|
|
(1,000 |
) |
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations
before income taxes |
|
|
(1,000 |
) |
|
|
1,051 |
|
|
|
234 |
|
|
|
3,654 |
|
|
|
12,817 |
|
|
|
6,070 |
|
|
|
7,444 |
|
Income tax (expense) benefit |
|
|
(390 |
) |
|
|
392 |
|
|
|
196 |
|
|
|
1,579 |
|
|
|
4,331 |
|
|
|
2,009 |
|
|
|
2,620 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations |
|
|
(610 |
) |
|
|
659 |
|
|
|
38 |
|
|
|
2,075 |
|
|
|
8,486 |
|
|
|
4,061 |
|
|
|
4,824 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock option compensation
expense from discontinued
operations |
|
|
|
|
|
|
41 |
|
|
|
56 |
|
|
|
880 |
|
|
|
4,834 |
|
|
|
2,951 |
|
|
|
2,344 |
|
Income tax benefit |
|
|
|
|
|
|
16 |
|
|
|
23 |
|
|
|
326 |
|
|
|
1,652 |
|
|
|
980 |
|
|
|
790 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from discontinued operations,
net of taxes |
|
|
|
|
|
|
25 |
|
|
|
33 |
|
|
|
554 |
|
|
|
3,182 |
|
|
|
1,971 |
|
|
|
1,554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to net earnings
before cumulative effect of
change in accounting principle |
|
|
(610 |
) |
|
|
684 |
|
|
|
71 |
|
|
|
2,629 |
|
|
|
11,668 |
|
|
|
6,032 |
|
|
|
6,378 |
|
Total adjustments to cumulative
effect of change in accounting
principle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total decrease (increase) in net
earnings |
|
$ |
(610 |
) |
|
$ |
684 |
|
|
$ |
71 |
|
|
$ |
2,629 |
|
|
$ |
11,668 |
|
|
$ |
6,032 |
|
|
$ |
6,378 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended |
|
|
|
1999 |
|
|
1998 |
|
|
1997 |
|
|
1996 |
|
|
1995 |
|
|
Total |
|
Stock option compensation from
continuing operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discretionary Grants |
|
$ |
1,341 |
|
|
$ |
1,654 |
|
|
$ |
528 |
|
|
$ |
18 |
|
|
$ |
1 |
|
|
$ |
29,026 |
|
Anniversary Grants |
|
|
243 |
|
|
|
11 |
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
4,347 |
|
Promotion Grants |
|
|
97 |
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
551 |
|
New Hire Grants |
|
|
350 |
|
|
|
108 |
|
|
|
31 |
|
|
|
15 |
|
|
|
1 |
|
|
|
617 |
|
Program Grants |
|
|
71 |
|
|
|
188 |
|
|
|
69 |
|
|
|
|
|
|
|
|
|
|
|
477 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock compensation expense
from continuing operations |
|
|
2,102 |
|
|
|
1,982 |
|
|
|
628 |
|
|
|
34 |
|
|
|
2 |
|
|
|
35,018 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other miscellaneous accounting
adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to record legal
settlement in appropriate period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other miscellaneous
accounting adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations
before income taxes |
|
|
2,102 |
|
|
|
1,982 |
|
|
|
628 |
|
|
|
34 |
|
|
|
2 |
|
|
|
35,018 |
|
Income tax benefit |
|
|
702 |
|
|
|
657 |
|
|
|
210 |
|
|
|
13 |
|
|
|
1 |
|
|
|
12,320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations |
|
|
1,400 |
|
|
|
1,325 |
|
|
|
418 |
|
|
|
21 |
|
|
|
1 |
|
|
|
22,698 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock option compensation
expense from discontinued
operations |
|
|
704 |
|
|
|
433 |
|
|
|
123 |
|
|
|
13 |
|
|
|
2 |
|
|
|
12,381 |
|
Income tax benefit |
|
|
215 |
|
|
|
162 |
|
|
|
47 |
|
|
|
5 |
|
|
|
1 |
|
|
|
4,217 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from discontinued operations,
net of taxes |
|
|
489 |
|
|
|
271 |
|
|
|
76 |
|
|
|
8 |
|
|
|
1 |
|
|
|
8,164 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to net earnings
before cumulative effect of
change in accounting principle |
|
|
1,889 |
|
|
|
1,596 |
|
|
|
494 |
|
|
|
29 |
|
|
|
2 |
|
|
|
30,862 |
|
Total adjustments to cumulative
effect of change in accounting
principle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total decrease (increase) in net
earnings |
|
$ |
1,889 |
|
|
$ |
1,596 |
|
|
$ |
494 |
|
|
$ |
29 |
|
|
$ |
2 |
|
|
$ |
30,862 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Option Compensation These adjustments are from our determination, based upon the
Options Subcommittees review and the Companys analysis, that for accounting purposes, the dates
initially used to measure compensation expense for numerous option grants to employees, executive
officers and outside non-employee directors during the period could not be relied upon for various
categories of option grants including: (i) discretionary grants of various types; (ii) anniversary
grants; (iii) promotion grants; (iv) new hire grants; and (v) program grants. The revised
measurement dates identified for accounting purposes differed from the originally selected
measurement dates due primarily to: (i) insufficient or incomplete approvals; (ii) inadequate or
incomplete establishment of the terms of the grants, including the list of individual recipients;
and (iii) the use of hindsight to select exercise prices.
Specifically, for each of the categories of option grants discussed in more detail under
Accounting Considerations below, we noted the following:
Stock option grants with insufficient or incomplete approvals. The Company determined that
the original recorded grant date could not be relied on because there was correspondence or other
evidence that indicated that
14
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
not all required approvals had been obtained, including for certain
grants, Compensation Committee approval. The Company remeasured these option grants with a revised measurement date supported by the
required level of approval, as described below, and accounted for these grants as fixed awards
under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees.
Inadequate or incomplete establishment of the terms of the grants. The Company determined
that for certain stock option grants, the number of shares and the exercise price were not known
with finality at the original measurement date. The Company determined that the original recorded
grant date could not be relied on because there was correspondence or other evidence that indicated
that the Company had not finalized the number of stock options allocated to each individual
recipient and the related exercise price. Based on available supporting documentation, the Company
determined the date by which the number of stock options to be awarded to each recipient was
finalized and the other terms of the award were established and accounted for these grants as fixed
awards under APB 25.
The use of hindsight to select exercise prices. As noted below, the Company followed an
informal policy of awarding options to individual employees in recognition of the anniversary of
their employment with the Company or in conjunction with employee promotions using hindsight to
select the exercise price. In many instances, little or no documentation to support dates selected
for option grants could be located by the Company. Further, instances of favorable, retrospective
date selection of discretionary grants were identified. Also, as noted below, the investigation
noted instances of inadequate documentation, or retrospective date selection, relating to the award
of grants to the Companys top three executive officers, all of which required Compensation
Committee approval. Based on available supporting documentation, the Company determined a revised
measurement date and accounted for these grants as fixed awards under APB 25.
Income Tax Benefit The Company recorded a net income tax benefit of approximately $16.5 million
in connection with the stock-based compensation related expense during the period from fiscal year
1995 to December 31, 2004, net of estimated limitations under Internal Revenue Code Section 162(m).
This tax benefit resulted in an increase of the Companys deferred tax assets for most U.S.
affected stock options prior to the exercise or forfeiture of the related options. With the
exception of UK employees exercising options after 2002, the Company recorded no tax benefit or
deferred tax asset for affected stock options granted to non-U.S. employees because the Company
determined that it could not receive tax benefits for these options. Further, the Company limited
the deferred tax assets recorded for affected stock options granted to certain highly paid officers
to reflect estimated limitations on tax deductibility under Internal Revenue Code Section 162(m).
Upon exercise or forfeiture of the underlying options, the excess or deficiency in deferred tax
assets are written-off to paid-in capital in the period of exercise or forfeiture.
Accounting Considerations Stock-Based Compensation
We originally accounted for all employee, officer and director stock option grants as fixed
grants under APB 25, using a measurement date of the recorded grant date. We issued all grants with
an exercise price equal to the fair market value of our common stock on the recorded grant date,
and therefore originally recorded no stock-based compensation expense.
As a result of the findings of the Options Subcommittee, and our own further review of our
stock option granting practices, we determined that the measurement dates for certain stock option
grants differed from the recorded grant dates for such grants. Based on the analysis described
below, the Company concluded that it was appropriate to revise the measurement dates for these
grants based upon its findings. The Company calculated stock-based compensation expense under APB
25 based upon the intrinsic value as of the adjusted measurement dates of stock option awards
determined to be fixed under APB 25 and the vesting provisions of the underlying options. The
Company calculated the intrinsic value on the adjusted measurement date as the closing price of its
common stock on such date as reported on the NASDAQ National Market, now the NASDAQ Global Select
Market, less the exercise price per share of common stock as stated in the underlying stock option
agreement, multiplied by the number of shares subject to such stock option award. The Company
recognizes these amounts as
15
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
compensation expense over the vesting period of the underlying options
in accordance with the provisions of FASB Interpretation No. 28, Accounting for Stock Appreciation
Rights and Other Variable Stock Option or
Award Plans. We also determined that variable accounting treatment was appropriate under APB
25 for certain stock option grants for which evidence was obtained that the terms of the options
may have been communicated to those recipients and that those terms were subsequently modified
(stock option grants cancelled and repriced). When variable accounting is applied to stock option
grants, we remeasure, and report in our consolidated statements of earnings, the intrinsic value of
the options at the end of each reporting period until the options are exercised, cancelled or
expire unexercised.
The Company determined the most supportable measurement dates for each of the various
categories of options grants as follows:
Discretionary Grants. Discretionary grants included grants to the Companys outside
directors, the Chief Executive Officer (CEO), President and Chief Financial Officer (the three
highest ranking executives of the Company), other Section 16 Officers, and all other Company
employees.
The Company determined that it had granted stock options to its outside directors pursuant to
the Companys stock plans or Board of Directors minutes in the majority of instances; however, in
a few instances, certain grants to these individuals require alternative measurement dates based on
the approval dates specified in plan documents or signed minutes. The Company recorded a pre-tax
adjustment to compensation expense totaling less than $0.1 million associated with all grants to
outside directors during the Relevant Period.
During the Relevant Period, the Company followed a practice of requiring Compensation
Committee approval of the stock option awards to the three highest ranking executives of the
Company. For some grants, the Compensation Committee minutes do not indicate approval of an award.
In other instances, the Company either did not locate minutes or the evidence was inconclusive
concerning when a specific meeting occurred. The Company determined that certain grants to these
individuals require alternative measurement dates. For example, due to inconclusive evidence
regarding the date of Compensation Committee approval, because the Board had approved the Proxy
Statement in which the award was specifically listed, the Proxy Statement filing date was selected
as the best evidence of a measurement date for the award. The Company recorded a pre-tax
adjustment to compensation expense totaling $13.3 million for all grants to the three highest
ranking executives of the Company during the Relevant Period.
Prior to May 16, 2003, the CEO approved stock option awards to Section 16 Officers. Evidence
of CEO approval typically consisted of an email containing the grant terms. Effective with the May
16, 2003 Compensation Committee meeting, the Compensation Committee was required to approve grants
to the Section 16 Officers. Evidence of Compensation Committee approval included Compensation
Committee minutes or a signed Unanimous Written Consent (UWC). The Company determined that
certain grants to these individuals require alternative measurement dates based on the date of
approval identified in the supporting documentation. The Company recorded a pre-tax adjustment to
compensation expense totaling $9.5 million in connection with discretionary grants to Section 16
Officers, in addition to the $13.3 million pre-tax adjustment for grants to the three highest
ranking executives of the Company, during the Relevant Period.
Throughout most of the Relevant Period, the Companys option plans granted discretion to the
CEO to award option grants to any Company employee, other than the top three executives. The CEO
in turn authorized a defined number of options in connection with certain discretionary grants
during the Relevant Period that were allocated by certain senior executives amongst employees
within particular business units. In certain instances, the review revealed that lists of grantees
within specified business units had not been finalized as of the grant date. Where required, the
Company identified alternative measurement dates for these discretionary grants and recorded the
required pre-tax adjustment to compensation expense totaling $7.9 million during the Relevant
Period.
16
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
During the Relevant Period, the Company also granted annual performance-based options to
employees at the discretion of certain executives and managers within each business unit. Based on
the supporting documentation, the business units finalized the list of awards by person on
different dates. The Company
reconciled each list to the actual awards contained in the Companys stock plan administration
database to determine the date by which each business units list was finalized. The Company
recorded a pre-tax adjustment to compensation expense totaling $6.5 million for six grant dates
during the Relevant Period that primarily related to annual performance reviews.
Anniversary Grants. Throughout the Relevant Period, the Company followed an informal policy
of awarding options to individual employees in recognition of the anniversary of their employment
with the Company or in conjunction with employee promotions. The number of these options was
determined by the employees level within the Company, or, in the case of promotion grants, the
level to which the employee was promoted. The majority of these grants were modest in size,
generally 500 options or less. In the case of senior management, anniversary or promotion grants
could be much larger, at 5,000 or 7,500 options. Occasionally, very senior executives, other than
the top three executives, received larger grants for anniversaries or promotions, but these were
relatively few and were generally done on a case-by-case basis.
The Options Subcommittee review indicated that the Companys anniversary related options were
granted with measurement dates determined by three general methods, depending upon the time period
in the Relevant Period. From the beginning of the Relevant Period through the end of 1998,
anniversary grants were generally granted with a measurement date on an employees actual
anniversary date. For a period of time between 1999 and 2002, the grant dates generally were
selected retrospectively based on either the low price of a month or the low price of the quarter.
In the third quarter of 2002, the Company began a practice of awarding anniversary grants on the
15th day of each month for the balance of 2002, and in January 2003, the Company
essentially ceased making anniversary grants, except for minimal contractual grants to certain
United Kingdom employees which continued into 2005.
The Company used email correspondence or other documentation maintained in the Stock Plan
Administration files and information obtained from the Companys human resources system and payroll
records to determine each employees anniversary date based on the employees hire (and
corresponding anniversary) date. The general granting practice for anniversary awards in place at
the relevant point in time was used to determine the appropriate measurement date for each
employees anniversary award. For a limited number of grants, absent evidence of the employees
hire date, the date the employee record of the stock options was added to the Companys stock plan
administration database application was used as the measurement date for the awards identified as
anniversary grants. For periods where the Company issued anniversary grants using quarterly or
monthly lows, or other low prices, alternate measurement dates were required. The Company recorded
a pre-tax compensation expense adjustment totaling $6.6 million for anniversary grants during the
Relevant Period.
Promotion Grants. Promotion grants were generally handled in the same manner as anniversary
grants. In some instances, promotion grants were awarded on the promotion effective date and other
times at the low price of the month or quarter. The Companys analysis revealed that the Company
had a general practice of granting promotion options on the employees promotion effective dates
from 1998 through 2000. The Company selected either the promotion effective date, if available, or
the date the employee record of the stock options was added to the Companys stock plan
administration database application, if the promotion effective date was not available, as the
measurement date for the promotion grants issued from 1998 through 2000. For subsequent periods
where the Company issued promotion grants using quarterly or monthly lows, or other low prices,
alternate measurement dates were required. The Company recorded a pre-tax compensation expense
adjustment totaling $2.2 million for promotion grants during the Relevant Period.
New Hire Grants. Throughout the Relevant Period, the Company issued an option grant to each
new employee on the employees start date. The Company had a uniform practice of granting a
specific number of options depending on the incoming employees level within the Company. For
example, the lowest level
17
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
employees would receive 50 options on their start date, while certain
managers might receive 2,500 options. Senior executive officers would typically receive much
larger grants upon joining the Company, and those grants were typically negotiated as part of a
total compensation package that were reflected in an employment agreement or offer letter. In
general, the Company found a lack of significant issues with respect to new hire grants.
Compensation expense was required to be recorded for administrative and error corrections and
in a small number of cases where it was determined that an employee received an award with an
effective date earlier than their actual start date, or where the amount of the grant was
negotiated or otherwise selected after the employee began working at the Company. Additionally,
during certain limited periods, due to a limited number of options being available to grant, the
Company issued certain new hire grants at a later date along with the periods anniversary grants
at the low price of the month or quarter, in which case the Company determined that alternate
measurement dates were required. The Company recorded a pre-tax compensation expense adjustment
totaling $0.7 million for new hire grants during the Relevant Period.
Program Grants. The Company had numerous routine grant programs under which options were
awarded to employees who participated on specific teams within the Company, completed certain
training programs or achieved certain goals in their jobs. These options (generally 50 to 250
options) were typically only granted to individual employees below a certain level. Although these
grants were routinely made on an annual or quarterly basis, no official written policies existed
describing the exact criteria or timing for each grant program. Not all of the grants awarded
pursuant to these programs could be identified due to incomplete or inconsistent documentation.
The Company typically determined the most supportable measurement date based on communication of
the list of recipients and the respective number of options to be granted to Stock Plan
Administration. In those instances where the review failed to reveal a specific date when lists
were received in Stock Plan Administration, the Company selected the date the employee record of
the stock options was added to the Companys stock plan administration database application as the
measurement date. The Company recorded a pre-tax adjustment to compensation expense totaling $0.6
million for these program grants during the Relevant Period.
For some grants, the Company identified no supporting documentation to determine the timing of
the approval of the terms of the grant. In these instances, the Company selected the date the
employee record of the stock options was added to the Companys stock plan administration database
application as the measurement date.
18
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Effect of the Restatement Adjustments on our Consolidated Financial Statements
The following table presents the effect of the restatement adjustments on the Companys
previously reported consolidated balance sheet as of December 31, 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005 |
|
|
|
As Reported |
|
|
Adjustments |
|
|
As Restated |
|
ASSETS |
|
|
|
|
|
|
|
|
|
|
|
|
Current Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
35,145 |
|
|
$ |
|
|
|
$ |
35,145 |
|
Accounts receivable, net |
|
|
480,458 |
|
|
|
|
|
|
|
480,458 |
|
Inventories |
|
|
121,223 |
|
|
|
|
|
|
|
121,223 |
|
Inventories not available for sale |
|
|
35,528 |
|
|
|
|
|
|
|
35,528 |
|
Deferred income taxes |
|
|
22,535 |
|
|
|
|
|
|
|
22,535 |
|
Other current assets |
|
|
7,089 |
|
|
|
|
|
|
|
7,089 |
|
|
|
|
|
|
|
|
|
|
|
Total current assets |
|
|
701,978 |
|
|
|
|
|
|
|
701,978 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment |
|
|
133,017 |
|
|
|
|
|
|
|
133,017 |
|
Goodwill |
|
|
87,124 |
|
|
|
|
|
|
|
87,124 |
|
Other assets |
|
|
221 |
|
|
|
|
|
|
|
221 |
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
922,340 |
|
|
$ |
|
|
|
$ |
922,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
|
|
|
|
Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
183,501 |
|
|
$ |
|
|
|
$ |
183,501 |
|
Accrued expenses and other current liabilities |
|
|
54,926 |
|
|
|
1,030 |
(A)(B) |
|
|
55,956 |
|
Deferred revenue |
|
|
24,747 |
|
|
|
|
|
|
|
24,747 |
|
Short-term financing facility |
|
|
45,000 |
|
|
|
|
|
|
|
45,000 |
|
Line of credit |
|
|
21,309 |
|
|
|
|
|
|
|
21,309 |
|
Inventories financing facility |
|
|
4,281 |
|
|
|
|
|
|
|
4,281 |
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
333,764 |
|
|
|
1,030 |
|
|
|
334,794 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term deferred income taxes |
|
|
20,290 |
|
|
|
(4,919 |
) (A) |
|
|
15,371 |
|
Other long-term liabilities |
|
|
2,262 |
|
|
|
|
|
|
|
2,262 |
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
356,316 |
|
|
|
(3,889 |
) |
|
|
352,427 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity: |
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock |
|
|
|
|
|
|
|
|
|
|
|
|
Common stock |
|
|
477 |
|
|
|
|
|
|
|
477 |
|
Additional paid in capital |
|
|
299,043 |
|
|
|
35,361 |
(A) |
|
|
334,404 |
|
Retained earnings |
|
|
252,318 |
|
|
|
(31,472 |
) (A) |
|
|
220,846 |
|
Accumulated other comprehensive income-
foreign currency translation adjustment |
|
|
14,186 |
|
|
|
|
|
|
|
14,186 |
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
566,024 |
|
|
|
3,889 |
|
|
|
569,913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
922,340 |
|
|
$ |
|
|
|
$ |
922,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(A) |
|
Adjustment for stock-based compensation expense pursuant to
APB No. 25 and the
associated income tax benefit. |
|
|
|
(B) |
|
Adjustment for a legal settlement expense that was recorded
in the first quarter of 2006, which should have been recorded in the
fourth quarter of 2005. |
The following table presents the effect of the restatement adjustments on the Companys
previously reported consolidated statement of cash flows for the nine months ended September 30,
2005 (in thousands):
19
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2005 |
|
|
|
|
|
|
|
Discontinued |
|
|
|
|
|
|
|
|
|
As Reported |
|
|
Operations (B) |
|
|
Adjustments |
|
|
As Restated |
|
Cash flows from operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
$ |
43,579 |
|
|
$ |
(4,623 |
) |
|
$ |
|
|
|
$ |
38,956 |
|
Plus: net earnings from discontinued operation |
|
|
|
|
|
|
4,623 |
|
|
|
|
|
|
|
4,623 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
43,579 |
|
|
|
|
|
|
|
|
|
|
|
43,579 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net earnings to net cash
provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
13,651 |
|
|
|
(2,697 |
) |
|
|
|
|
|
|
10,954 |
|
Provisions for losses on accounts receivable |
|
|
4,160 |
|
|
|
250 |
|
|
|
|
|
|
|
4,410 |
|
Write-downs of inventories |
|
|
5,253 |
|
|
|
|
|
|
|
|
|
|
|
5,253 |
|
Non-cash stock-based compensation expense |
|
|
550 |
|
|
|
|
|
|
|
|
|
|
|
550 |
|
Deferred income taxes |
|
|
3,590 |
|
|
|
|
|
|
|
|
|
|
|
3,590 |
|
Tax benefits from employee gains on stock- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
based compensation |
|
|
1,936 |
|
|
|
|
|
|
|
|
|
|
|
1,936 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in assets and liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in accounts receivable |
|
|
995 |
|
|
|
3,090 |
|
|
|
|
|
|
|
4,085 |
|
Decrease in inventories |
|
|
4,533 |
|
|
|
(7 |
) |
|
|
|
|
|
|
4,526 |
|
Decrease in other current assets |
|
|
4,940 |
|
|
|
(91 |
) |
|
|
|
|
|
|
4,849 |
|
Increase in other assets |
|
|
(346 |
) |
|
|
|
|
|
|
|
|
|
|
(346 |
) |
Decrease in accounts payable |
|
|
(26,378 |
) |
|
|
3,556 |
|
|
|
|
|
|
|
(22,822 |
) |
Decrease in inventories financing facility |
|
|
(3,035 |
) |
|
|
|
|
|
|
|
|
|
|
(3,035 |
) |
Increase in deferred revenue |
|
|
10,622 |
|
|
|
(954 |
) |
|
|
|
|
|
|
9,668 |
|
Decrease in accrued expenses and other |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
current liabilities |
|
|
(6,990 |
) |
|
|
(799 |
) |
|
|
|
|
|
|
(7,789 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
57,060 |
|
|
|
2,348 |
|
|
|
|
|
|
|
59,408 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(29,001 |
) |
|
|
2,606 |
|
|
|
|
|
|
|
(26,395 |
) |
Cash receipt of underwriter receivable |
|
|
26,904 |
|
|
|
|
|
|
|
|
|
|
|
26,904 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in (provided by) investing
activities |
|
|
(2,097 |
) |
|
|
2,606 |
|
|
|
|
|
|
|
509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayments on short-term financing facility |
|
|
(40,000 |
) |
|
|
|
|
|
|
|
|
|
|
(40,000 |
) |
Borrowings on short-term financing facility |
|
|
60,000 |
|
|
|
|
|
|
|
|
|
|
|
60,000 |
|
Repurchase of common stock |
|
|
(49,077 |
) |
|
|
|
|
|
|
|
|
|
|
(49,077 |
) |
Borrowings on long term liabilities |
|
|
(127 |
) |
|
|
127 |
|
|
|
|
|
|
|
|
|
Proceeds from sales of common stock under
employee stock plans |
|
|
6,589 |
|
|
|
|
|
|
|
|
|
|
|
6,589 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(22,615 |
) |
|
|
127 |
|
|
|
|
|
|
|
(22,488 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from discontinued operation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
|
|
|
|
(2,348 |
) |
|
|
|
|
|
|
(2,348 |
) |
Net cash used in investing activities |
|
|
|
|
|
|
(2,606 |
) |
|
|
|
|
|
|
(2,606 |
) |
Net cash used in financing activities |
|
|
|
|
|
|
(127 |
) |
|
|
|
|
|
|
(127 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in discontinued operation |
|
|
|
|
|
|
(5,081 |
) |
|
|
|
|
|
|
(5,081 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency exchange effect on cash flow |
|
|
(3,325 |
) |
|
|
|
|
|
|
|
|
|
|
(3,325 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
29,023 |
|
|
|
|
|
|
|
|
|
|
|
29,023 |
|
Cash and cash equivalents at the beginning of the
year |
|
|
38,443 |
|
|
|
|
|
|
|
|
|
|
|
38,443 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at the end of the year |
|
$ |
67,466 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
67,466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(A) |
|
Adjustment for stock-based compensation expense pursuant to
APB No. 25 and the
associated income tax benefit. |
|
(B) |
|
Adjustments to remove cash flows related to Direct Alliance and PlusNet. See
further information in Note 13. |
20
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Related Proceedings
In October 2006, we received a letter of informal inquiry from the SEC requesting certain
documents relating to our stock option grants and practices. We cannot predict the outcome of this investigation.
3. Stock-Based Compensation
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised
2004), Share Based Payment (SFAS No. 123R), which requires stock-based compensation to be
measured based on the fair value of the award on the date of grant and the corresponding expense to
be recognized over the period during which an employee is required to provide service in exchange
for the award. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, Share-Based
Payments (SAB No. 107), relating to SFAS No. 123R. We have applied the provisions of SAB No. 107
in our adoption of SFAS No. 123R. Prior to January 1, 2006, we issued stock options and restricted
stock shares and units. For 2006, we have elected to issue service-based and performance-based
restricted stock units (RSUs) instead of stock options and restricted stock shares.
We adopted SFAS No. 123R using the modified prospective transition method. Under this method,
the provisions of SFAS No. 123R apply to all awards granted or modified after the date on which we
adopted SFAS No. 123R, and compensation expense must be recognized for any unvested stock option
awards outstanding as of such date of adoption. We have not restated prior periods for the
adoption of SFAS No. 123R. We have recorded stock-based compensation expense in prior periods
related to the amortization of the fair value of restricted stock awards over their respective
vesting period. Stock-based compensation expense is classified in the same line item of the
consolidated statements of earnings as other payroll-related expenses for the specific employee.
Reported and pro forma net earnings and earnings per share for the three and nine months ended
September 30, 2005 were as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
Net earnings, as reported |
|
$ |
15,382 |
|
|
$ |
43,579 |
|
Deduct: Stock-based
compensation expense
determined under fair value
method for all awards, net of
tax |
|
|
(2,465 |
) |
|
|
(6,884 |
) |
Add: Stock-based compensation
expense included in net
earnings, net of tax |
|
|
135 |
|
|
|
311 |
|
|
|
|
|
|
|
|
Pro forma net earnings |
|
$ |
13,052 |
|
|
$ |
37,006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.32 |
|
|
$ |
0.89 |
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.27 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.31 |
|
|
$ |
0.88 |
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.27 |
|
|
$ |
0.75 |
|
|
|
|
|
|
|
|
21
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
We recorded the following pre-tax amounts for stock-based compensation, by operating segment,
in our consolidated financial statements (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Insight North America* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards and RSUs |
|
$ |
812 |
|
|
$ |
209 |
|
|
$ |
2,274 |
|
|
$ |
498 |
|
Stock options |
|
|
1,716 |
|
|
|
|
|
|
|
5,940 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,528 |
|
|
$ |
209 |
|
|
$ |
8,214 |
|
|
$ |
498 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight UK* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards and RSUs |
|
$ |
98 |
|
|
$ |
|
|
|
$ |
263 |
|
|
$ |
|
|
Stock options |
|
|
151 |
|
|
|
|
|
|
|
554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
249 |
|
|
$ |
|
|
|
$ |
817 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software Spectrum* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards and RSUs |
|
$ |
53 |
|
|
$ |
|
|
|
$ |
53 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Continuing Operations |
|
$ |
2,830 |
|
|
$ |
209 |
|
|
$ |
9,084 |
|
|
$ |
498 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued Operation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards and RSUs |
|
$ |
|
|
|
$ |
8 |
|
|
$ |
46 |
|
|
$ |
13 |
|
Stock options |
|
|
|
|
|
|
|
|
|
|
141 |
|
|
|
|
|
Acceleration of RSUs |
|
|
|
|
|
|
|
|
|
|
702 |
|
|
|
|
|
Modification of stock options |
|
|
|
|
|
|
|
|
|
|
128 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
8 |
|
|
$ |
1,017 |
|
|
$ |
13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
2,830 |
|
|
$ |
217 |
|
|
$ |
10,101 |
|
|
$ |
511 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Recorded in selling and administrative expenses. |
We have various long-term incentive plans, including equity-based plans in Insight
Enterprises, Inc. The purpose of the plans is to benefit and advance stockholders interests by
rewarding officers, directors and certain teammates (employees are referred to within the Company
and this document as teammates), for their contributions to our success, thereby motivating them
to continue to make such contributions in the future. The plans permit grants of incentive stock
options, nonqualified stock options, restricted stock awards and RSUs. The stock options,
restricted stock awards and RSUs generally vest over a one to five year period from the date of
grant and the stock options expire five to ten years after the date of grant. Unexercised options
generally terminate seven business or ninety calendar days, depending on grant terms, after an
individual ceases to be an employee. Unvested restricted stock shares and units terminate
immediately after an individual ceases to be an employee.
Company Plans
In October 1997, the stockholders approved the establishment of the 1998 Long-Term Incentive
Plan (the 1998 LTIP) for our officers, teammates, directors, consultants and independent
contractors. The 1998 LTIP authorizes grants of incentive stock options, non-qualified stock
options, stock appreciation rights, performance shares, restricted common stock and
performance-based awards. In 2000, the stockholders approved an amendment to the 1998 LTIP
increasing the number of shares eligible for awards to 6,000,000 and allowing our Board of
Directors to reserve (which they have done) additional shares such that the number of shares of
common
22
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
stock available for grant under the 1998 LTIP and any of our other option plans, plus the
number of options to acquire shares of common stock granted but not yet exercised, or in the case of restricted stock,
granted but not yet vested, under the 1998 LTIP and any of our other option plans, shall not exceed
20% of the outstanding shares of our common stock at the time of calculation of the additional
shares. This plan has no set expiration date, but the Nasdaq Marketplace Rules will require us to
obtain new stockholder approval by 2010 if we desire to continue granting awards under this plan
after 2010. As of September 30, 2006, there were 3,553,435 total shares of common stock available
to grant for awards under the 1998 LTIP and 1999 Broad Based Employee Stock Option Plan (the 1999
Broad Based Plan). For further information on the 1999 Broad Based Plan, see below.
In September 1998, we established the 1998 Employee Restricted Stock Plan (the 1998 Employee
RSP) for our teammates. The total number of restricted common stock shares initially available
for grant under the 1998 Employee RSP was 562,500 and as of September 30, 2006, 434,417 shares of
restricted common stock were available for grant. There were no grants of restricted common stock
under this plan during the three months ended September 30, 2006 and 2005.
In December 1998, we established the 1998 Officer Restricted Stock Plan (the 1998 Officer
RSP) for our officers. The total number of restricted common stock shares initially available for
grant under the 1998 Officer RSP was 56,250, and, as of September 30, 2006, 490 shares of
restricted common stock were available for grant. There were no grants of restricted common stock
under this plan during the three months ended September 30, 2006 and 2005.
In September 1999, we established the 1999 Broad Based Plan for our teammates. The total
number of stock options initially available for grant under the 1999 Broad Based Plan was
1,500,000; provided, however, that no more than 20% of the shares of stock available under the 1999
Broad Based Plan may be awarded to the officers of the Company. Stock options available for grant
under the 1999 Broad Based Plan are included in the total shares of common stock available to grant
for awards under the 1998 LTIP and 1999 Broad Based Plan discussed under our description of the
1998 LTIP above.
The 1998 LTIP, 1998 Employee RSP, 1998 Officer RSP and 1999 Broad Based Plan are administered
by the Compensation Committee of the Board of Directors. Except as provided below, the
Compensation Committee has the exclusive authority to administer the plans, including the power to
determine eligibility, the types of awards to be granted, the price and the timing of awards.
Through some combination of a delegation of authority from the Compensation Committee of the Board
of Directors and the express terms of the applicable plan, our Chief Executive Officer (CEO) was
delegated the authority to grant awards to individuals other than individuals who are subject to
the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended (the
Exchange Act).
Accounting for Stock Options Prior to SFAS No. 123R Implementation
Prior to our adoption of SFAS No. 123R, we applied the intrinsic value-based method of
accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB No. 25) and related interpretations, including FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation an interpretation of APB
Opinion No. 25, to account for our fixed-plan stock options. Under this method, compensation
expense was recorded on the date of grant only if the current market price of the underlying stock
exceeded the exercise price. See Note 2, Restatement of Consolidated Financial Statements.
FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123) established
accounting and disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. Pro forma expense was recognized in our disclosures using
the accelerated vesting methodology of FASB Interpretation No. 28 Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans. To determine the pro forma
expense, we valued our stock options using the Black-
23
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Scholes-Merton (Black-Scholes)
option-pricing model. Our determination of fair value of stock options on the
date of grant using an option-pricing model was affected by our stock price, as well as assumptions
regarding a number of subjective variables. These variables include:
|
|
|
Assumptions related to the expected life of the options, which were based on evaluations
of historical and expected future employee exercise behavior; |
|
|
|
|
The risk-free interest rate, which was based on the U.S. Treasury rates at the date of
grant with maturity dates approximately equal to the expected life at the grant date; and |
|
|
|
|
The historical price volatility of our stock, which was used as the basis for the
expected volatility assumption. |
The assumptions used in the Black-Scholes option pricing model to value options granted during
the three months ended September 30, 2005 were: dividend yield 0%; expected volatility 52%;
risk-free interest rate 4.13%; and expected lives 2.7 years. For the periods prior to January
1, 2006, we accounted for forfeitures as they occurred.
Accounting for Stock Options After SFAS No. 123R Implementation
There were no options granted during the nine months ended September 30, 2006 and we do not
currently plan to grant any. The current expense for all outstanding options granted prior to
January 1, 2006, net of estimated forfeitures, has been recognized in our consolidated statements
of earnings for the three and nine months ended September 30, 2006. Forfeitures were estimated and
will be revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates.
For the three and nine months ended September 30, 2006, we recorded in continuing operations
stock-based compensation expense related to stock options, net of forfeitures, of $1,867,000 and
$6,494,000. As of September 30, 2006, total compensation cost related to non-vested stock options
not yet recognized is $6,775,000, which is expected to be recognized over the next 0.9 years on a
weighted-average basis.
We used the criteria in SFAS No. 123R to calculate and establish the beginning balance of the
additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based
compensation and to determine the subsequent effect on the APIC pool and consolidated statements of
cash flows of the tax effects of employee stock-based compensation awards that were outstanding
upon adoption of SFAS No. 123R.
The following table summarizes our stock option activity during the three months ended
September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
|
Aggregate |
|
|
Remaining |
|
|
|
Number |
|
|
Weighted Average |
|
|
Intrinsic Value |
|
|
Contractual |
|
|
|
Outstanding |
|
|
Exercise Price |
|
|
(in-the-money options) |
|
|
Life (in years) |
|
Outstanding at the beginning of period |
|
|
6,269,137 |
|
|
$ |
19.34 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(397,764 |
) |
|
|
16.97 |
|
|
$ |
1,088,360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired |
|
|
(291,961 |
) |
|
|
22.65 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(96,050 |
) |
|
|
19.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at the end of period |
|
|
5,483,362 |
|
|
|
19.34 |
|
|
$ |
10,322,767 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at the end of period |
|
|
3,540,079 |
|
|
|
19.30 |
|
|
$ |
7,710,636 |
|
|
|
2.85 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest |
|
|
5,318,716 |
|
|
|
19.34 |
|
|
$ |
10,068,283 |
|
|
|
0.28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average grant date fair
value for
options granted during the period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The aggregate intrinsic value in the preceding table represents the total pre-tax
intrinsic value, based on our closing stock price of $20.61 as of September 30, 2006, which would
have been received by the option holders had all option holders exercised options and sold the
underlying shares on that date.
The following table summarizes the status of outstanding stock options as of September 30,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Options Exercisable |
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Weighted Average |
|
|
Average |
|
|
|
|
|
|
Average |
|
Range of |
|
Number of |
|
|
Remaining |
|
|
Exercise |
|
|
Number of |
|
|
Exercise |
|
Exercise |
|
Options |
|
|
Contractual |
|
|
Price Per |
|
|
Options |
|
|
Price Per |
|
Prices |
|
Outstanding |
|
|
Life (in years) |
|
|
Share |
|
|
Exercisable |
|
|
Share |
|
$5.09-17.94 |
|
|
1,128,903 |
|
|
|
3.13 |
|
|
$ |
14.54 |
|
|
|
986,594 |
|
|
$ |
14.42 |
|
17.98-18.93 |
|
|
1,147,717 |
|
|
|
3.50 |
|
|
|
18.51 |
|
|
|
511,986 |
|
|
|
18.48 |
|
19.00-19.93 |
|
|
1,114,855 |
|
|
|
3.04 |
|
|
|
19.71 |
|
|
|
519,282 |
|
|
|
19.66 |
|
20.00-21.25 |
|
|
1,263,925 |
|
|
|
2.26 |
|
|
|
21.03 |
|
|
|
703,005 |
|
|
|
21.07 |
|
21.30-41.00 |
|
|
827,962 |
|
|
|
2.88 |
|
|
|
23.92 |
|
|
|
819,212 |
|
|
|
23.94 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,483,362 |
|
|
|
2.95 |
|
|
|
19.34 |
|
|
|
3,540,079 |
|
|
|
19.30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounting for Restricted Stock
We have issued shares of restricted common stock and RSUs as incentives to certain officers
and teammates and plan to do so in the future. We recognize compensation expense associated with
the issuance of such shares and RSUs over the vesting period for each respective share and RSU.
The total compensation expense associated with restricted stock represents the value based upon the
number of shares or RSUs awarded multiplied by the closing price on the date of grant. Recipients
of restricted stock shares are entitled to receive any dividends declared on our common stock and
have voting rights, regardless of whether such shares have vested. Recipients of RSUs do not have
voting or dividend rights until the vesting conditions are satisfied and shares are released.
For 2006, we have elected to issue service-based and performance-based RSUs instead of stock
options or restricted stock shares. The number of RSUs ultimately awarded under the
performance-based RSUs will vary based on whether we achieve certain financial results. We will
record compensation expense each period based on our estimate of the most probable number of RSUs
that will be issued under the grants of performance-based RSUs. Additionally, the compensation
expense will be reduced for our estimate of forfeitures.
For the three months ended September 30, 2006 and 2005, we recorded in continuing operations
stock-based compensation expense, net of forfeitures, related to restricted stock shares and RSUs
of $963,000 and $209,000, respectively. For the nine months ended September 30, 2006 and 2005, we
recorded in continuing operations stock-based compensation expense, net of forfeitures, related to
restricted stock shares and RSUs of $2,590,000 and $498,000, respectively. As of September 30,
2006, total compensation cost related to nonvested restricted stock was $12,537,000, which is
expected to be recognized over the next 1.4 years on a weighted-average basis.
25
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The following table summarizes our restricted stock activity, including restricted stock
shares and RSUs, during the three months ended September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
Number |
|
|
Grant Date Fair Value |
|
|
Fair Value |
|
Nonvested at the beginning of period |
|
|
539,632 |
|
|
$ |
21.12 |
|
|
|
|
|
Granted |
|
|
197,967 |
|
|
$ |
18.70 |
|
|
|
|
|
Vested |
|
|
(30 |
) |
|
$ |
18.67 |
|
|
$ |
495 |
(a) |
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(28,800 |
) |
|
$ |
21.35 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested at the end of period |
|
|
708,769 |
|
|
$ |
20.43 |
|
|
$ |
14,607,729 |
(b) |
|
|
|
|
|
|
|
|
|
|
|
RSUs expected to vest |
|
|
543,621 |
|
|
|
|
|
|
$ |
11,204,029 |
(b) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
The fair value of vested shares and RSUs represents the total pre-tax fair
value, based on the closing stock price on the day of vesting, which would have been received by
holders of restricted stock shares and RSUs had all such holders sold |
|
|
|
their underlying shares on that date. |
|
(b) |
|
The aggregate fair value for the nonvested shares and the RSUs expected to vest
represents the total pre-tax fair value, based on our closing stock price of $20.61 as of September
30, 2006, which would have been received by holders of
restricted stock shares and RSUs had all such holders sold their underlying shares on that
date. |
Direct Alliance Stock Option Plan
In May 2000, we established the Direct Alliance Corporation 2000 Long-Term Incentive Plan (the
Direct Alliance Plan). We did not issue any stock options to acquire shares of common stock of
Direct Alliance after 2000. The options that were issued in 2000 were fully vested on May 5, 2005
and were exercised on May 5, 2006. As described in Note 13, Direct Alliance was sold on June 30,
2006, and $2,696,000 was paid to the holders of the 1,997,500 exercised Direct Alliance stock
options.
4. Earnings Per Share (EPS)
Basic EPS is computed by dividing net earnings from continuing operations available to common
stockholders by the weighted-average number of common shares outstanding during each quarter.
Diluted EPS includes the effect of stock options assumed to be exercised and restricted stock using
the treasury stock method. A reconciliation of the denominators of the basic and diluted EPS
calculations is as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
$ |
17,240 |
|
|
$ |
14,158 |
|
|
$ |
46,714 |
|
|
$ |
38,956 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares used to compute basic EPS |
|
|
48,411 |
|
|
|
48,412 |
|
|
|
48,230 |
|
|
|
48,862 |
|
Dilutive potential common shares due to dilutive
options and restricted stock |
|
|
247 |
|
|
|
524 |
|
|
|
145 |
|
|
|
521 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares used to compute diluted
EPS |
|
|
48,658 |
|
|
|
48,936 |
|
|
|
48,375 |
|
|
|
49,383 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.36 |
|
|
$ |
0.29 |
|
|
$ |
0.97 |
|
|
$ |
0.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
0.35 |
|
|
$ |
0.29 |
|
|
$ |
0.97 |
|
|
$ |
0.79 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following weighted-average outstanding stock options during the three and nine months
ended September 30, 2006 and 2005 were not included in the diluted EPS calculations because the
exercise prices of
26
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
these options were greater than the average market price of our common stock
during the respective periods (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Weighted-average
outstanding stock
options excluded
from the diluted
EPS calculation |
|
|
4,794 |
|
|
|
3,985 |
|
|
|
4,345 |
|
|
|
4,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5. Goodwill
The changes in the carrying amount of goodwill for nine months ended September 30, 2006 are as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
|
EMEA |
|
|
APAC |
|
|
Consolidated |
|
Balance at December 31, 2005 |
|
$ |
87,124 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
87,124 |
|
Software Spectrum acquisition |
|
|
130,541 |
|
|
|
60,684 |
|
|
|
16,196 |
|
|
|
207,421 |
|
Foreign currency translation
adjustments |
|
|
257 |
|
|
|
(199 |
) |
|
|
(391 |
) |
|
|
(333 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2006 |
|
$ |
217,922 |
|
|
$ |
60,485 |
|
|
$ |
15,805 |
|
|
$ |
294,212 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill of $207,421,000 represented the excess of the purchase price over the estimated fair
values assigned to tangible and identifiable intangible assets acquired and liabilities assumed
from the purchase of Software Spectrum on September 7, 2006, as discussed in Note 12. In
accordance with current accounting standards, the goodwill is not amortized and will be tested for
impairment annually in the fourth quarter of our fiscal year.
6. Debt
At September 30, 2006, our long-term debt consists of the following (in thousands):
|
|
|
|
|
|
|
September 30, |
|
|
|
2006 |
|
Term loan |
|
$ |
75,000 |
|
Accounts receivable securitization financing facility |
|
|
182,000 |
|
|
|
|
|
Total |
|
|
257,000 |
|
Less: current portion of term loan |
|
|
(15,000 |
) |
|
|
|
|
Long-term debt |
|
$ |
242,000 |
|
|
|
|
|
On September 7, 2006, we entered into a credit agreement with various financial institutions
that provides new credit facilities of up to $150,000,000 to finance in part the acquisition of
Software Spectrum and for general corporate purposes. The credit facilities are composed of a
five-year revolving credit facility in the amount of $75,000,000 and a five-year term loan facility
in the amount of $75,000,000. Additionally, we amended our accounts receivable securitization
financing facility to increase the maximum funding under the facility from $200,000,000 to
$225,000,000 and extend its maturity through September 7, 2009. On September 7, 2006, in order to
fund the acquisition of Software Spectrum, we borrowed approximately $173,000,000 under our
accounts receivable securitization financing facility and $75,000,000 under our term loan facility.
The $75,000,000 outstanding under the five-year term loan facility is payable in quarterly
installments through September 2011. Amounts outstanding under the term loan bear interest at a
floating rate equal to the London Interbank Offered Rate (LIBOR) plus a spread of 0.625% to
1.375% (6.44% at September 30, 2006). In conjunction with the acquisition, no amounts were
borrowed under the revolving credit facility. Deferred financing fees of $1,552,000 were
capitalized in conjunction with the transaction and are being amortized to interest expense over
the five-year term of the term loan facility using the effective interest method.
27
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
At September 30, 2006, $22,000,000 was outstanding under our $75,000,000 revolving line of
credit. Amounts outstanding under the revolving line of credit bear interest, payable quarterly,
at a floating rate equal to
the prime rate or, at our option, a LIBOR rate plus a pre-determined spread of 0.625% to
1.375% (8.25% and 6.45% per annum, respectively, at September 30, 2006). Because we generally use
this line for short-term borrowing needs, our borrowings are generally at the prime rate and
amounts outstanding are recorded as current liabilities. The credit facility expires on September
7, 2009. At September 30, 2006, $53,000,000 was available under the line of credit. The line of
credit also has a feature which allows us to increase the availability on the line of credit by
$37,500,000, upon request. We do not pay any fees on the increased availability under the line
until we activate the additional credit.
We have an agreement to sell receivables periodically to a special purpose accounts receivable
and financing entity (the SPE), which is exclusively engaged in purchasing receivables from us.
The SPE is a wholly-owned, bankruptcy-remote entity that we have included in our consolidated
financial statements. The SPE funds its purchases by selling undivided interests in up to
$225,000,000 of eligible trade accounts receivable to a multi-seller conduit administered by an
independent financial institution. The sales to the conduit do not qualify for sale treatment
under SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities as we maintain effective control over the receivables that are sold. Accordingly,
the receivables remain recorded on our consolidated balance sheets. At September 30, 2006, the SPE
owned $371,412,000 of receivables recorded at fair value and included in our consolidated balance
sheet, of which $221,546,000 was eligible for funding. The financing facility expires September 7,
2009. Interest is payable monthly, and the interest rate at September 30, 2006 on borrowed funds
was 5.89% per annum, including the 0.35% commitment fee on the total $225,000,000 facility. During
the three months ended September 30, 2006 and 2005, our weighted average interest rate per annum
and weighted average borrowings under the facility were 5.34% and $43,783,000 and 3.56% and
$17,554,000, respectively. During the nine months ended September 30, 2006 and 2005, our weighted
average interest rate per annum and weighted average borrowings under the facility were 4.93% and
$27,538,000 and 3.29% and $13,223,000, respectively. At September 30, 2006, $182,000,000 was
outstanding and $39,546,000 was available under the facility.
Our financing facilities contain various covenants, including the requirement that we comply
with leverage and minimum fixed charge ratio requirements. In addition, our credit facilities
prohibit the payment of cash dividends without the lenders consent and the requirement that we
provide annual and quarterly financial information which is reported on by our independent
registered public accounting firm to the lenders within a certain time period after the annual or
quarterly period ends. If we fail to comply with these covenants, the lenders would be able to
demand payment within a specified period of time. Because we were not current with our reporting
obligations under the Securities Exchange Act of 1934 beginning on September 30, 2006 and ending on
July 25, 2007, we would have been in violation of our financial reporting covenants had we not
obtained agreements with our lenders regarding delivery of substitute financial information to
them. The agreements with our lenders waived our obligation to provide the filed reports and
waived any events of default occurring under the facility as a result of our failure to comply with
the financial reporting covenants. We intend to provide all late reports and current financial
statements to our lenders upon becoming current in our filings.
7. Share Repurchase Program
In January 2006, our Board of Directors authorized the repurchase of up to $50,000,000 of our
common stock. As of September 30, 2006, we have not purchased any shares under this program.
28
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
8. Income Taxes
Our effective tax rates for the three months ended September 30, 2006 and 2005 were 32.3% and
38.4%, respectively. For the three months ended September 30, 2006, our effective tax rate was
less than the United States federal statutory rate of 35.0% due primarily to:
|
|
|
a benefit recognized during the three months ended September 30, 2006 for the reversal
of accrued income taxes of $1.4 million resulting from the determination during the quarter
that a reserve previously recorded for potential tax exposures was no longer necessary; and |
|
|
|
|
lower tax rates on earnings in the United Kingdom and Canada, offset partially by state
income taxes, net of federal tax. |
For the three months ended September 30, 2005, our effective tax rate was higher than the United
States federal statutory rate of 35.0% due primarily to state income taxes, net of federal tax,
offset partially by lower tax rates on earnings in the United Kingdom and Canada.
Our
effective tax rates for the nine months ended September 30, 2006
and 2005 were 34.3% and
38.6%, respectively. For the nine months ended September 30, 2006, our effective tax rate was less
than the United States federal statutory rate of 35.0% due primarily to:
|
|
|
a benefit recognized during the nine months ended September 30, 2006 for the reversal of
accrued income taxes of $1.4 million resulting from the determination that a reserve
previously recorded for potential tax exposures was no longer necessary; |
|
|
|
|
internal initiatives implemented during the three months ended June 30, 2006 that
reduced certain state income taxes both historically and prospectively; and |
|
|
|
|
lower tax rates on earnings in the United Kingdom and Canada, offset partially by state
income taxes, net of federal tax. |
For the nine months ended September 30, 2005, our effective tax rate was higher than the United
States federal statutory rate of 35.0% due primarily to:
|
|
|
state income taxes, net of federal tax, offset partially by lower tax rates on earnings
in the United Kingdom and Canada; and |
|
|
|
|
a write-off of a deferred tax asset in the United Kingdom after final settlement of a
liability assumed in a previous acquisition. |
9. Restructuring and Acquisition Integration Activities
Acquisition-Related Cost Capitalized in 2006 as a Cost of Acquisition of Software Spectrum
We recorded $11,414,000 of employee termination benefits and facility based costs in
connection with the integration of Software Spectrum. These costs were accounted for under EITF
Issue No. 95-3, Recognition of Liabilities in Connection with Purchase Business Combinations, and
were based on the integration plans that have been committed to by management. Accordingly, these
costs were recognized as a liability assumed in the purchase business combination and included in
the allocation of the cost to acquire Software Spectrum.
The employee termination benefits relate to severance payments for Software Spectrum teammates
in North America and EMEA who have been or will be terminated in connection with integration plans.
The facilities based costs relate to future lease payments or lease termination costs associated
with vacating Software Spectrum facilities.
29
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The following table details the changes in these liabilities during the nine months ended
September 30, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
|
EMEA |
|
|
Consolidated |
|
Acquisition related costs |
|
$ |
1,728 |
|
|
$ |
9,686 |
|
|
$ |
11,414 |
|
Foreign currency translation
adjustments |
|
|
|
|
|
|
(30 |
) |
|
|
(30 |
) |
Cash payments |
|
|
(479 |
) |
|
|
|
|
|
|
(479 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2006 |
|
$ |
1,249 |
|
|
$ |
9,656 |
|
|
$ |
10,905 |
|
|
|
|
|
|
|
|
|
|
|
Severance and Restructuring Costs Expensed in 2006
During the three months ended September 30, 2006, Insight North America and Insight UK
recorded severance expense of $508,000 and $221,000, respectively, associated with the elimination
of Insight positions as part of our Software Spectrum integration and expense reduction plans. Of
these amounts, cash payments of $508,000 and $58,000 were made in Insight North America and Insight
UK, respectively, during the quarter, and $163,000 was still accrued at September 30, 2006. This
amount is expected to be paid in 2006 and is therefore included in accrued expenses and other
current liabilities at September 30, 2006.
The following table details the changes in severance and restructuring liabilities during the
three months ended September 30, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North America |
|
|
Insight UK |
|
|
Consolidated |
|
Severance and restructuring expense |
|
$ |
508 |
|
|
$ |
221 |
|
|
$ |
729 |
|
Cash payments |
|
|
(508 |
) |
|
|
(58 |
) |
|
|
(566 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2006 |
|
$ |
|
|
|
$ |
163 |
|
|
$ |
163 |
|
|
|
|
|
|
|
|
|
|
|
Severance and Restructuring Costs Expensed in 2005
During the year ended December 31, 2005, Insight UK moved into a new facility and recorded
restructuring costs of $7,458,000, of which $6,447,000 represented the present value of the
remaining lease obligations on the previous lease and $1,011,000 represented duplicate rent expense
for the new facility for the last half of 2005. Also, during the year ended December 31, 2005,
Insight North America, Insight UK and Direct Alliance recorded employee termination benefits,
related mainly to the reduction in headcount of senior management and support staff, of $5,069,000,
of which $113,000 was outstanding for Insight North America at December 31, 2005. During the nine
months ended September 30, 2006, adjustments of $182,000 and $863,000 were recorded to reflect the
accretion of interest for the present value of the remaining lease obligations and fluctuations in
the British pound sterling exchange rates, respectively, offset by the release of employee
termination benefit accruals of $113,000. Cash payments of $1,745,000 were made during the nine
months ended September 30, 2006, resulting in an accrual balance of $6,427,000 at September 30,
2006. In the accompanying consolidated balance sheet at September 30, 2006, $1,888,000 is expected
to be paid in 2006 and is therefore included in accrued expenses and other current liabilities, and
$4,539,000 is expected to be paid throughout 2007 and 2008 and is therefore included in long-term
liabilities. Management expects these restructuring activities to have a positive effect on future
operating results as employee-related expenses associated with these positions are expected to be
reinvested in operations of the Company primarily in the areas of IT systems, account executives
and sales manager headcount, marketing and skills development.
30
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The following table details the changes in severance and restructuring liabilities during the
nine months ended September 30, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North America |
|
|
Insight UK |
|
|
Consolidated |
|
Balance at December 31, 2005 |
|
$ |
113 |
|
|
$ |
7,127 |
|
|
$ |
7,240 |
|
Foreign currency translation
and other adjustments |
|
|
(113 |
) |
|
|
1,045 |
|
|
|
932 |
|
Cash payments |
|
|
|
|
|
|
(1,745 |
) |
|
|
(1,745 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2006 |
|
$ |
|
|
|
$ |
6,427 |
|
|
$ |
6,427 |
|
|
|
|
|
|
|
|
|
|
|
Acquisition-Related Integration Costs Capitalized in 2001 as a Cost of an Acquisition
During the year ended December 31, 2001, Insight UK recorded costs of $18,440,000 relating to
restructuring the operations of an acquired company to integrate the acquired companys operations
into our own. These costs consisted of employee termination benefits and facilities-based costs of
$3,532,000 and $14,908,000, respectively, of which only $267,000 of facilities-based costs remained
accrued at December 31, 2005. Cash payments of $85,000 were made and $22,000 in adjustments were
made to reflect fluctuations in the British pound sterling exchange rates, resulting in an accrual
balance of $204,000 at September 30, 2006. Although the facilities-based costs represent
contractual payments under long-term leases, we are actively pursuing opportunities to negotiate a
termination of these leases and have recorded the obligations as current accrued liabilities as of
September 30, 2006.
10. Reductions in Liabilities Assumed in Previous Acquisition
During the nine months ended September 30, 2005, Insight UK settled certain liabilities
assumed in a previous acquisition for $664,000 less than the amounts originally recorded. The tax
expense recorded related to this income was $358,000.
11. Commitments and Contingencies
Contractual
We have entered into a sponsorship agreement through 2013 with the Valley of the Sun Bowl
Foundation, d/b/a Insight Bowl, which is the not-for-profit entity that conducts the Insight Bowl
post-season intercollegiate football game. We have committed to pay an aggregate amount of
approximately $9,650,000 over the next seven years for sponsorship arrangements, ticket purchases
and miscellaneous expenses.
We have committed to pay the Arizona Cardinals an aggregate of approximately $9,900,000 over
the next nine years for advertising and marketing events at the University of Phoenix stadium, the
home stadium of the Arizona Cardinals.
We have entered into a transition services agreement with Level 3 Communications, Inc (Level
3) related to our acquisition of Software Spectrum. We have committed to pay an aggregate amount
of approximately $1,000,000 to $2,000,000 during 2007 as part of the physical separation of
Software Spectrums IT environment from Level 3.
In July 2007, we signed a Statement of Work with Wipro Limited to assist us in integrating our
hardware, services and software distribution operations in North America, EMEA and APAC on mySAP.
We have committed to pay Wipro an aggregate amount of approximately $17,350,000 against milestones
in 2007 through 2009 as set forth in the Statement of Work.
31
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Employment Contracts
We have employment contracts with certain officers and management teammates under which
severance payments would become payable and accelerated vesting of stock-based compensation would
occur in the event of specified terminations without cause or terminations under certain
circumstances after a change in control. If such persons were terminated without cause or under
certain circumstances after a change of control, and the severance payments under the current
employment agreements were to become payable, the severance payments would generally be equal to
either one or two times the teammates annual salary and bonus. Additionally, we would record
additional compensation expense for the acceleration of the vesting of any stock-based
compensation.
On May 2, 2007, we announced the retirement of Stanley Laybourne, the Companys chief
financial officer, secretary and treasurer and a member of our Board of Directors. In connection
with his retirement, we have agreed to provide him payments and benefits consistent with those
required for termination without cause under his existing employment agreement, which has been
previously filed with the SEC. Accordingly, we expect to pay him a lump sum severance payment equal
to two times his base salary plus two times his 2006 bonus. The total severance amount related to
this retirement is estimated to be approximately $2,842,000, including $186,000 of non-cash
stock-based compensation expense for a ninety day extension of the post termination exercise period
for stock options, substantially all of which will be recorded in our financial statements in the
second quarter of 2007.
Guaranties
In the ordinary course of business, we may guarantee the indebtedness of our subsidiaries to
vendors and clients. We have not recorded specific liabilities for these guaranties in the
consolidated financial statements because we have recorded the underlying liabilities associated
with the guaranties. In the event we are required to perform under the related contracts, we
believe the cost of such performance would not have a material adverse effect on our consolidated
financial position or results of operations.
Indemnifications
In the ordinary course of business, we enter into contractual arrangements under which we may
agree to indemnify either our client or a third-party service provider in the arrangement from any
losses incurred relating to services performed on our behalf or for losses arising from certain
defined events, which may include litigation or claims relating to past performance. These
arrangements include, but are not limited to, our indemnification of our officers and directors to
the maximum extent under the laws of the State of Delaware, the indemnification of our lessors for
certain claims arising from our use of leased facilities, and the indemnification of the lenders
that provide our credit facilities for certain claims arising from their extension of credit to us.
Such indemnification obligations may not be subject to maximum loss clauses. Management believes
that payments, if any, related to these indemnifications are not probable at July 25, 2007 and, if
incurred, would be immaterial. Accordingly, we have not accrued any liabilities related to such
indemnifications in our consolidated financial statements.
In connection with our sale of Direct Alliance in June 2006, the sale agreement contains
certain indemnification provisions pursuant to which we are required to indemnify the buyer for a
limited period of time for liabilities, losses or expenses arising out of breaches of covenants and
certain breaches of representations and warranties relating to the condition of the business prior
to and at the time of sale. Management believes that payments related to these indemnifications,
if any, are not probable at July 25, 2007 and, if incurred, would be immaterial.
In connection with our sale of PC Wholesale in March 2007, the sale agreement contains certain
indemnification provisions pursuant to which we are required to indemnify the buyer for a limited
period of time
32
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
for liabilities, losses or expenses arising out of breaches of covenants and certain breaches
of representations and warranties relating to the condition of the business prior to and at the
time of sale. Management believes that payments related to these indemnifications, if any, are not
probable at July 25, 2007 and, if incurred, would not have a material adverse effect on our results
of operations.
Legal Proceedings
We are party to various legal proceedings arising in the ordinary course of business,
including asserted preference payment claims in client bankruptcy proceedings, claims of alleged
infringement of patents, trademarks, copyrights and other intellectual property rights and claims
of alleged non-compliance with contract provisions.
In accordance with SFAS No. 5, Accounting for Contingencies (SFAS No. 5), we make a
provision for a liability when it is both probable that a liability has been incurred and the
amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly
and are adjusted to reflect the effects of negotiations, settlements, rulings, advice of legal
counsel and other information and events pertaining to a particular claim. Although litigation is
inherently unpredictable, we believe that we have adequate provisions for any probable and
estimable losses. It is possible, nevertheless, that the results of our operations or cash flows
could be materially and adversely affected in any particular period by the resolution of a legal
proceeding. Legal expenses related to defense, negotiations, settlements, rulings and advice of
outside legal counsel are expensed as incurred.
In June 2006, our subsidiary, Software Spectrum, Inc. was named as a defendant in a civil
lawsuit, Allocco v. Gardner (Superior Court, County of San Diego), regarding certain software
resale transactions with Peregrine Systems, Inc. The subsidiary was named as successor to Corporate
Software & Technology, Inc. (CS&T) and alleges that during October 2000 CS&T participated in or
aided and abetted a fraudulent scheme by Peregrine to inflate Peregrines stock price. Pursuant to
the terms of the agreement by which we acquired Software Spectrum, Inc. from Level 3 (the former
corporate parent of Software Spectrum, Inc.), Level 3 has agreed to indemnify, defend and hold us
harmless for this matter. The discovery process is on-going, and we strongly dispute any
allegations of participation in fraudulent behavior. On our behalf Level 3 is vigorously defending
this matter.
In October 2006, we received a letter of informal inquiry from the SEC requesting certain
documents relating to our stock option grants and practices. We have cooperated with the SEC and
will continue to do so. We cannot predict the outcome of this investigation.
Software Spectrum, as successor to CST, is party to litigation brought in the Belgian courts
regarding a dispute over the terms of a tender awarded by the Belgian Ministry of Defence (MOD)
in November 2000. In February 2001, CST brought a breach of contract suit against MOD in the Court
of First Instance in Brussels and claimed breach of contract damages in the amount of approximately
$150,000. MOD counterclaimed against CST for cost to cover in the amount of approximately
$2,700,000, and, in July 2002, CST added a Belgian subsidiary of Microsoft as a defendant. We
believe that MODs counterclaims are unfounded, and we are vigorously defending the claim.
33
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
Contingencies Related to Third-Party Review
From time to time, we are subject to potential claims and assessments from third parties. We
are also subject to various governmental, client and vendor audits. We continually assess whether
or not such claims have merit and warrant accrual under the probable and estimable criteria of
SFAS No. 5. Where appropriate, we accrue estimates of anticipated liabilities in the consolidated
financial statements. Such estimates are subject to change and may affect our results of
operations and our cash flows.
12. Acquisition
On September 7, 2006, we completed our acquisition of Software Spectrum for a cash purchase
price of $287,000,000 plus working capital of $64,380,000, which included cash acquired of
$30,285,000.
The following table summarizes the purchase price and the estimated fair value of the assets
acquired and liabilities assumed at the date of acquisition (in thousands):
|
|
|
|
|
|
|
|
|
Purchase price paid as: |
|
|
|
|
|
|
|
|
Cash |
|
|
|
|
|
$ |
103,380 |
|
Borrowings on lines of credit |
|
|
|
|
|
|
248,000 |
|
Acquisition costs |
|
|
|
|
|
|
4,100 |
|
|
|
|
|
|
|
|
|
Total purchase price |
|
|
|
|
|
|
355,480 |
|
Fair value of net assets acquired: |
|
|
|
|
|
|
|
|
Current assets |
|
$ |
284,864 |
|
|
|
|
|
Identifiable intangible assets see description below. |
|
|
89,700 |
|
|
|
|
|
Property and equipment |
|
|
8,265 |
|
|
|
|
|
Other assets |
|
|
19,825 |
|
|
|
|
|
Current liabilities |
|
|
(225,086 |
) |
|
|
|
|
Long-term liabilities |
|
|
(29,509 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Total fair value of net assets acquired |
|
|
|
|
|
|
148,059 |
|
|
|
|
|
|
|
|
|
Excess purchase price over fair value of net assets acquired (goodwill) |
|
|
|
|
|
$ |
207,421 |
|
|
|
|
|
|
|
|
|
Under the purchase method of accounting, the purchase price as shown in the table above is
allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based
on their estimated fair values. The excess purchase price over fair value of net assets acquired
was recorded as goodwill. The adjustments are related primarily to the acquisition of Software
Spectrum and represent adjustments to the fair values of assets acquired and liabilities assumed
subsequent to the acquisition date, the integration plans and the effect of foreign currency
translation adjustments.
The estimated values of current assets and liabilities were based upon their historical costs
on the date of acquisition due to their short-term nature. Property and equipment were also
estimated based upon historical costs as they most closely approximated fair value. The estimated
value of deferred revenue was based upon the guidance in EITF 01-03, Accounting in a Business
Combination for Deferred Revenue of an Acquiree, and was calculated as the estimated cost to
fulfill the contractual obligations acquired under various customer contracts plus a fair value
profit margin. Of the total acquired deferred revenue, approximately $327,000 will result in
future cash flows as the majority of these contracts were prepaid when consummated in the
pre-acquisition period.
Identified intangible assets of $89,700,000 consist primarily of customer relationships, the
trade name and non-compete agreements. The identifiable intangibles resulting from the acquisition
are amortized using the straight-line method over the following estimated useful lives:
34
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
|
|
|
Intangible Assets |
|
Estimated Economic Life |
Customer relationships
|
|
10 Years |
Acquired technology related assets
|
|
5 Years |
Non-compete agreements
|
|
1 Year |
Trade name
|
|
7 months |
Amortization expense recognized for the period from the acquisition date through September 30,
2006 was $741,000.
Goodwill of $207,421,000 represents the excess of the purchase price over the estimated fair
value assigned to tangible and identifiable intangible assets acquired and liabilities assumed from
Software Spectrum. In accordance with current accounting standards, the goodwill is not amortized
and will be tested for impairment annually in the fourth quarter of our fiscal year.
We have consolidated the results of operations for Software Spectrum since its acquisition on
September 7, 2006. The following table reports pro forma information as if the acquisition of
Software Spectrum had been completed at the beginning of the earliest period presented (in
thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
September 30, |
|
|
|
|
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Net sales |
|
As reported |
|
$ |
918,592 |
|
|
$ |
823,599 |
|
|
$ |
2,544,599 |
|
|
$ |
2,371,633 |
|
|
|
Pro forma |
|
$ |
1,084,115 |
|
|
$ |
1,120,361 |
|
|
$ |
3,614,118 |
|
|
$ |
3,426,166 |
|
Net earnings from
continuing
operations |
|
As reported |
|
$ |
17,240 |
|
|
$ |
14,158 |
|
|
$ |
46,714 |
|
|
$ |
38,956 |
|
|
|
Pro forma |
|
$ |
3,373 |
|
|
$ |
10,885 |
|
|
$ |
37,901 |
|
|
$ |
33,815 |
|
Net earnings |
|
As reported |
|
$ |
17,240 |
|
|
$ |
15,382 |
|
|
$ |
57,951 |
|
|
$ |
43,579 |
|
|
|
Pro forma |
|
$ |
3,373 |
|
|
$ |
12,070 |
|
|
$ |
49,138 |
|
|
$ |
38,374 |
|
Diluted earnings per share |
|
As reported |
|
$ |
0.35 |
|
|
$ |
0.31 |
|
|
$ |
1.19 |
|
|
$ |
0.88 |
|
|
|
Pro forma |
|
$ |
0.07 |
|
|
$ |
0.25 |
|
|
$ |
1.01 |
|
|
$ |
0.78 |
|
13. Discontinued Operation
On June 30, 2006, we completed the sale of 100% of the outstanding stock of Direct Alliance
for a purchase price of $46,500,000, subject to a working capital adjustment. The purchase price
did not include real estate and intercompany receivables, which had an estimated fair value of
$49,400,000 (book value of $43,237,000) and were distributed to us immediately prior to closing.
In addition to payment of the purchase price, the buyer is obligated to make a one-time bonus
payment to us if Direct Alliance achieves certain gross profit levels for the year ending December
31, 2006 (Earn Out). Additionally, the buyer is entitled to a claw back of the purchase price of
up to $5,000,000 if certain Direct Alliance client contracts are not renewed on terms prescribed in
the sale agreement. As of July 25, 2007, the company is in the process of negotiating the final
resolution of the Earn Out and the claw back. Also, we paid $2,696,000 to the holders of 1,997,500
exercised Direct Alliance stock options. This amount will be further adjusted for the above
described working capital adjustment, Earn Out and claw back. Adjustments for the above described
working capital adjustment, Earn Out, claw back and payments to holders of exercised Direct
Alliance stock options will also adjust the gain recorded on the sale.
35
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, we have accounted for Direct Alliance as a discontinued operation and have reported the
results of operations of Direct Alliance as a discontinued operation in the consolidated
statements of earnings for all periods presented. We did not allocate interest or general corporate
overhead expense to the discontinued operation.
The following amounts for the three and nine months ended September 30, 2006 and 2005,
respectively, represent Direct Alliances results of operations. The following amounts have been
segregated from continuing operations and reflected as a discontinued operation (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net sales |
|
$ |
|
|
|
$ |
20,449 |
|
|
$ |
34,095 |
|
|
$ |
56,666 |
|
Costs of goods sold |
|
|
|
|
|
|
15,721 |
|
|
|
27,138 |
|
|
|
43,896 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
|
|
|
|
4,728 |
|
|
|
6,957 |
|
|
|
12,770 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
|
|
|
|
1,744 |
|
|
|
3,606 |
|
|
|
4,285 |
|
Severance and restructuring expenses |
|
|
|
|
|
|
1,005 |
|
|
|
|
|
|
|
1,005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
|
|
|
|
|
1,979 |
|
|
|
3,351 |
|
|
|
7,480 |
|
Non-operating income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on sale |
|
|
|
|
|
|
|
|
|
|
15,122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations before income
taxes |
|
|
|
|
|
|
1,979 |
|
|
|
18,473 |
|
|
|
7,480 |
|
Income tax expense |
|
|
|
|
|
|
755 |
|
|
|
7,236 |
|
|
|
2,857 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from discontinued operation |
|
$ |
|
|
|
$ |
1,224 |
|
|
$ |
11,237 |
|
|
$ |
4,623 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On June 30, 2006, in connection with the sale of Direct Alliance, we entered into a lease
agreement with Direct Alliance pursuant to which Direct Alliance will lease from us the facilities
it used prior to the sale. The initial lease term is for eighteen months starting July 1, 2006.
Accordingly, we have separately presented the value of the land and buildings as buildings held
for lease on the consolidated balance sheet at September 30, 2006. Lease income related to these
buildings was $435,000 for the three months ended September 30, 2006 and is classified as net
sales. For the three months ended September 30, 2006, depreciation expense related to the
buildings is $123,000 and is classified as cost of goods sold.
14. Segment Information
We are a leading provider of brand-name information technology (IT) hardware, software and
services to large enterprises, small- to medium-sized businesses (SMB) and public sector
institutions in North America, Europe, the Middle East, Africa and Asia-Pacific. Prior to the
acquisition of Software Spectrum, we were organized in two segments: Insight North America; and
Insight UK. Because Software Spectrum results are only included for 23 calendar days this quarter,
we have disclosed those results through earnings from operations separately from the results of
Insight North America and Insight UK. Beginning in the fourth quarter of 2006, we operate in three
geographic operating segments: North America; EMEA; and APAC. Currently, our offerings in North
America and the United Kingdom include brand-name IT hardware, software and services. Our
offerings in the remainder of our EMEA segment and in APAC currently only include software and
select software-related services.
All intercompany transactions are eliminated upon consolidation, and there are no differences
between the accounting policies used to measure profit and loss for our segments and on a
consolidated basis. Net sales are defined as net sales to external clients. None of our clients
exceeded ten percent of consolidated net sales for the three and nine months ended September 30,
2006.
A portion of our operating segments selling and administrative expenses arise from shared
services and infrastructure that we have historically provided to them in order to realize
economies of scale and to efficiently use
36
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
resources. These expenses, collectively identified as corporate charges, include legal, tax,
insurance services, treasury, senior management expenses and other corporate infrastructure
expenses. Charges are allocated to our operating segments, and the allocations have been
determined on a basis that we considered to be a reasonable reflection of the utilization of
services provided to or benefits received by the operating segments. Corporate charges of $173,000
for the three months ended September 30, 2005 and $306,000 and $514,000, respectively, for the nine
months ended September 30, 2006 and 2005, previously allocated to our discontinued operation,
Direct Alliance, have been reallocated to Insight North America in all periods presented.
The tables below present information about our reportable operating segments as of and for the
three months ended September 30, 2006 and 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2006 |
|
|
|
Insight |
|
|
|
|
|
|
Software |
|
|
|
|
|
|
North America |
|
|
Insight UK |
|
|
Spectrum |
|
|
Consolidated |
|
Net sales |
|
$ |
694,390 |
|
|
$ |
126,488 |
|
|
$ |
97,714 |
|
|
$ |
918,592 |
|
Costs of goods sold |
|
|
609,835 |
|
|
|
108,364 |
|
|
|
84,842 |
|
|
|
803,041 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
84,555 |
|
|
|
18,124 |
|
|
|
12,872 |
|
|
|
115,551 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
64,559 |
|
|
|
14,477 |
|
|
|
10,517 |
|
|
|
89,553 |
|
Severance and restructuring expenses |
|
|
508 |
|
|
|
221 |
|
|
|
|
|
|
|
729 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
$ |
19,488 |
|
|
$ |
3,426 |
|
|
$ |
2,355 |
|
|
|
25,269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating income, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(178 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations before
income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25,447 |
|
Income tax expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,207 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,240 |
|
Net earnings from discontinued operation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
17,240 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,478,057 |
|
|
$ |
327,299 |
|
|
$ |
464,269 |
|
|
$ |
1,536,585 |
* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Consolidated total assets include corporate assets and intercompany eliminations for a net
reduction of $733,040. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2005 |
|
|
|
Insight |
|
|
|
|
|
|
|
|
|
North America |
|
|
Insight UK |
|
|
Consolidated |
|
Net sales |
|
$ |
699,294 |
|
|
$ |
124,305 |
|
|
$ |
823,599 |
|
Costs of goods sold |
|
|
621,124 |
|
|
|
107,813 |
|
|
|
728,937 |
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
78,170 |
|
|
|
16,492 |
|
|
|
94,662 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
58,672 |
|
|
|
12,834 |
|
|
|
71,506 |
|
Severance and restructuring expenses |
|
|
|
|
|
|
378 |
|
|
|
378 |
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
$ |
19,498 |
|
|
$ |
3,280 |
|
|
|
22,778 |
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating income, net |
|
|
|
|
|
|
|
|
|
|
(194 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations
before income taxes |
|
|
|
|
|
|
|
|
|
|
22,972 |
|
Income tax expense |
|
|
|
|
|
|
|
|
|
|
8,814 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
|
|
|
|
|
|
|
|
|
14,158 |
|
Net earnings from discontinued operation |
|
|
|
|
|
|
|
|
|
|
1,224 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
|
|
$ |
15,382 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,028,530 |
|
|
$ |
153,783 |
|
|
$ |
876,755 |
* |
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Consolidated total assets include assets of a discontinued operation, corporate assets and
intercompany eliminations for a net reduction of $305,558. |
37
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
The tables below present information about our reportable operating segments as of and
for the nine months ended September 30, 2006 and 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006 |
|
|
|
Insight |
|
|
|
|
|
|
Software |
|
|
|
|
|
|
North America |
|
|
Insight UK |
|
|
Spectrum |
|
|
Consolidated |
|
Net sales |
|
$ |
2,085,129 |
|
|
$ |
361,756 |
|
|
$ |
97,714 |
|
|
$ |
2,544,599 |
|
Costs of goods sold |
|
|
1,832,290 |
|
|
|
308,611 |
|
|
|
84,842 |
|
|
|
2,225,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
252,839 |
|
|
|
53,145 |
|
|
|
12,872 |
|
|
|
318,856 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
194,265 |
|
|
|
43,034 |
|
|
|
10,517 |
|
|
|
247,816 |
|
Severance and restructuring expenses |
|
|
508 |
|
|
|
221 |
|
|
|
|
|
|
|
729 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
$ |
58,066 |
|
|
$ |
9,890 |
|
|
$ |
2,355 |
|
|
|
70,311 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating income, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(773 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations before
income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71,084 |
|
Income tax expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,370 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46,714 |
|
Net earnings from discontinued operation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
57,951 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,478,057 |
|
|
$ |
327,299 |
|
|
$ |
464,269 |
|
|
$ |
1,536,585 |
* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Consolidated total assets include corporate assets and intercompany eliminations for a net
reduction of $733,040. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2005 |
|
|
|
Insight |
|
|
|
|
|
|
|
|
|
North America |
|
|
Insight UK |
|
|
Consolidated |
|
Net sales |
|
$ |
2,011,031 |
|
|
$ |
360,602 |
|
|
$ |
2,371,633 |
|
Costs of goods sold |
|
|
1,778,694 |
|
|
|
312,297 |
|
|
|
2,090,991 |
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
232,337 |
|
|
|
48,305 |
|
|
|
280,642 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
175,790 |
|
|
|
38,531 |
|
|
|
214,321 |
|
Severance and restructuring expenses |
|
|
3,650 |
|
|
|
792 |
|
|
|
4,442 |
|
Reductions in liabilities assumed in a previous acquisition |
|
|
|
|
|
|
(664 |
) |
|
|
(664 |
) |
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
$ |
52,897 |
|
|
$ |
9,646 |
|
|
|
62,543 |
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating income, net |
|
|
|
|
|
|
|
|
|
|
(860 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations before income taxes |
|
|
|
|
|
|
|
|
|
|
63,403 |
|
Income tax expense |
|
|
|
|
|
|
|
|
|
|
24,447 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
|
|
|
|
|
|
|
|
|
38,956 |
|
Net earnings from discontinued operation |
|
|
|
|
|
|
|
|
|
|
4,623 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
|
|
$ |
43,579 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
1,028,530 |
|
|
$ |
153,783 |
|
|
$ |
876,755 |
* |
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Consolidated total assets include assets of a discontinued operation, corporate assets and
intercompany eliminations for a net reduction of $305,558. |
38
INSIGHT ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
15. Subsequent Event
On March 1, 2007, we completed the sale of PC Wholesale, a division of our North America
operating segment that sells to other resellers. The transaction generated proceeds of $28.7
million including net assets sold that are subject to certain post-closing adjustments. We expect
to have resolution of the post-closing adjustments by the end of August 2007. Any post-closing
adjustments will adjust the gain recorded on the sale. The sale of PC Wholesale is consistent with
our strategic plan as we concluded that selling IT products to other resellers is not a core
element of our growth strategy.
39
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the consolidated financial
statements and the related notes that appear elsewhere in this Quarterly Report on Form 10-Q.
Restatement of Consolidated Financial Statements
Background
We announced on October 19, 2006 that the Companys Board of Directors had appointed an
Options Subcommittee, comprised of independent directors, to conduct a review of the Companys
stock options. Certain present and former directors and executive officers of the Company were
named as defendants in a derivative lawsuit related to stock option practices from 1997 to 2002,
filed in Superior Court, County of Maricopa, Arizona on September 21, 2006. The Company had been
named as a nominal defendant in that action. On December 22, 2006, we filed a motion to dismiss
the complaint based on plaintiffs failure to make a pre-suit demand on the Companys Board of
Directors. Before the opposition to the motion was due, the plaintiff voluntarily asked the Court
to dismiss the lawsuit, and, on January 19, 2007, the Court granted the plaintiffs motion to
voluntarily dismiss the lawsuit without prejudice. In addition, we announced on November 6, 2006
that on October 27, 2006, the Company received an informal inquiry from the SEC requesting certain
documents and information relating to the Companys stock option granting practices from January 1,
1996 to the present.
The Options Subcommittee was assisted by independent legal counsel and independent forensic
accounting consultants. At the conclusion of its review, the Options Subcommittee reported its
findings to the Companys Board of Directors and to KPMG LLP, the Companys independent registered
public accounting firm, on March 9, 2007 and March 13, 2007, respectively. Management, assisted by
its own independent legal counsel and independent forensic consultants, then undertook an analysis
of the results of the Options Subcommittees review, as well as all stock option activity during
the period after the Companys initial public offering on January 24, 1995 through November 30,
2005, the last date on which we granted stock options (the Relevant Period).
In a Form 8-K filed on April 5, 2007, we reported that based on the findings of the Options
Subcommittee and the conclusions reached to date by management in its analysis, our previously
issued financial statements would require restatement and should no longer be relied upon.
We determined, based upon the Options Subcommittees review and the Companys analysis, that
for accounting purposes, the dates initially used to measure compensation expense for various stock
option grants to employees, executive officers and outside non-employee directors during the period
could not be relied upon. The revised measurement dates identified for accounting purposes
differed from the originally selected measurement dates due primarily to (i) insufficient or
incomplete approvals, (ii) inadequate or incomplete establishment of the terms of the grants,
including the list of individual recipients, and (iii) the use of hindsight to select exercise
prices. The restated consolidated financial statements included in this Quarterly Report on Form
10-Q for reflect the corrections resulting from our determination.
We have incurred substantial expenses related to the Options Subcommittees review and the
Companys analysis. We have incurred approximately $11.8 million in costs for legal fees, external
audit firm fees and external consulting fees through June 30, 2007 and anticipate approximately $3
million in additional fees will be incurred through August 2007 in the completion of financial
statement restatement and related matters.
In addition to the restatements for stock-based compensation, we recorded a pre-tax adjustment for
$1.0 million to record a legal settlement expense that was recorded in the first quarter of 2006,
which should have been recorded in the fourth quarter of 2005. The tax effect of this adjustment
was $0.4 million.
40
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Restatement Adjustments
Our restated consolidated financial statements contained in this Form 10-Q incorporate
stock-based compensation expense, including the income tax impacts related to the restatement
adjustments. The restatement adjustments result in a $30.8 million reduction of retained earnings
as of December 31, 2004. The total restatement impact for the years ended December 31, 1995 through
December 31, 2004, of $30.8 million, net of related tax benefits of $16.5 million, has been
reflected as a prior period adjustment to beginning retained earnings as of January 1, 2005.
In addition to the restatements for stock-based compensation, we recorded a pre-tax adjustment
for $1.0 million to record a legal settlement expense that was recorded in the first quarter of
2006, which should have been recorded in the fourth quarter of 2005. The tax effect of this
adjustment was $0.4 million.
The tables below present the decrease (increase) in net earnings resulting from the individual
restatement adjustments for each respective period presented and are explained in further detail
following the table (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
|
|
|
|
Ended |
|
|
Year Ended |
|
|
|
June 30, 2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
|
2000 |
|
Stock option compensation from
continuing operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discretionary Grants |
|
$ |
|
|
|
$ |
42 |
|
|
$ |
196 |
|
|
$ |
3,510 |
|
|
$ |
11,716 |
|
|
$ |
4,190 |
|
|
$ |
5,830 |
|
Anniversary Grants |
|
|
|
|
|
|
|
|
|
|
13 |
|
|
|
127 |
|
|
|
929 |
|
|
|
1,591 |
|
|
|
1,432 |
|
Promotion Grants |
|
|
|
|
|
|
2 |
|
|
|
5 |
|
|
|
24 |
|
|
|
105 |
|
|
|
186 |
|
|
|
111 |
|
New Hire Grants |
|
|
|
|
|
|
7 |
|
|
|
19 |
|
|
|
(15 |
) |
|
|
39 |
|
|
|
14 |
|
|
|
48 |
|
Program Grants |
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
8 |
|
|
|
28 |
|
|
|
89 |
|
|
|
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock compensation expense
from continuing operations |
|
|
|
|
|
|
51 |
|
|
|
234 |
|
|
|
3,654 |
|
|
|
12,817 |
|
|
|
6,070 |
|
|
|
7,444 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other miscellaneous accounting
adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to record legal
settlement in appropriate period |
|
|
(1,000 |
) |
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other miscellaneous
accounting adjustments |
|
|
(1,000 |
) |
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations
before income taxes |
|
|
(1,000 |
) |
|
|
1,051 |
|
|
|
234 |
|
|
|
3,654 |
|
|
|
12,817 |
|
|
|
6,070 |
|
|
|
7,444 |
|
Income tax (expense) benefit |
|
|
(390 |
) |
|
|
392 |
|
|
|
196 |
|
|
|
1,579 |
|
|
|
4,331 |
|
|
|
2,009 |
|
|
|
2,620 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations |
|
|
(610 |
) |
|
|
659 |
|
|
|
38 |
|
|
|
2,075 |
|
|
|
8,486 |
|
|
|
4,061 |
|
|
|
4,824 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock option compensation
expense from discontinued
operations |
|
|
|
|
|
|
41 |
|
|
|
56 |
|
|
|
880 |
|
|
|
4,834 |
|
|
|
2,951 |
|
|
|
2,344 |
|
Income tax benefit |
|
|
|
|
|
|
16 |
|
|
|
23 |
|
|
|
326 |
|
|
|
1,652 |
|
|
|
980 |
|
|
|
790 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from discontinued operations,
net of taxes |
|
|
|
|
|
|
25 |
|
|
|
33 |
|
|
|
554 |
|
|
|
3,182 |
|
|
|
1,971 |
|
|
|
1,554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to net earnings
before cumulative effect of
change in accounting principle |
|
|
(610 |
) |
|
|
684 |
|
|
|
71 |
|
|
|
2,629 |
|
|
|
11,668 |
|
|
|
6,032 |
|
|
|
6,378 |
|
Total adjustments to cumulative
effect of change in accounting
principle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total decrease (increase) in net
earnings |
|
$ |
(610 |
) |
|
$ |
684 |
|
|
$ |
71 |
|
|
$ |
2,629 |
|
|
$ |
11,668 |
|
|
$ |
6,032 |
|
|
$ |
6,378 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended |
|
|
|
1999 |
|
|
1998 |
|
|
1997 |
|
|
1996 |
|
|
1995 |
|
|
Total |
|
Stock option compensation from
continuing operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discretionary Grants |
|
$ |
1,341 |
|
|
$ |
1,654 |
|
|
$ |
528 |
|
|
$ |
18 |
|
|
$ |
1 |
|
|
$ |
29,026 |
|
Anniversary Grants |
|
|
243 |
|
|
|
11 |
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
4,347 |
|
Promotion Grants |
|
|
97 |
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
551 |
|
New Hire Grants |
|
|
350 |
|
|
|
108 |
|
|
|
31 |
|
|
|
15 |
|
|
|
1 |
|
|
|
617 |
|
Program Grants |
|
|
71 |
|
|
|
188 |
|
|
|
69 |
|
|
|
|
|
|
|
|
|
|
|
477 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock compensation expense
from continuing operations |
|
|
2,102 |
|
|
|
1,982 |
|
|
|
628 |
|
|
|
34 |
|
|
|
2 |
|
|
|
35,018 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other miscellaneous accounting
adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to record legal
settlement in appropriate period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other miscellaneous
accounting adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations
before income taxes |
|
|
2,102 |
|
|
|
1,982 |
|
|
|
628 |
|
|
|
34 |
|
|
|
2 |
|
|
|
35,018 |
|
Income tax benefit |
|
|
702 |
|
|
|
657 |
|
|
|
210 |
|
|
|
13 |
|
|
|
1 |
|
|
|
12,320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from continuing operations |
|
|
1,400 |
|
|
|
1,325 |
|
|
|
418 |
|
|
|
21 |
|
|
|
1 |
|
|
|
22,698 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock option compensation
expense from discontinued
operations |
|
|
704 |
|
|
|
433 |
|
|
|
123 |
|
|
|
13 |
|
|
|
2 |
|
|
|
12,381 |
|
Income tax benefit |
|
|
215 |
|
|
|
162 |
|
|
|
47 |
|
|
|
5 |
|
|
|
1 |
|
|
|
4,217 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to earnings
from discontinued operations,
net of taxes |
|
|
489 |
|
|
|
271 |
|
|
|
76 |
|
|
|
8 |
|
|
|
1 |
|
|
|
8,164 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total adjustments to net earnings
before cumulative effect of
change in accounting principle |
|
|
1,889 |
|
|
|
1,596 |
|
|
|
494 |
|
|
|
29 |
|
|
|
2 |
|
|
|
30,862 |
|
Total adjustments to cumulative
effect of change in accounting
principle |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total decrease (increase) in net
earnings |
|
$ |
1,889 |
|
|
$ |
1,596 |
|
|
$ |
494 |
|
|
$ |
29 |
|
|
$ |
2 |
|
|
$ |
30,862 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Option Compensation These adjustments are from our determination, based upon the
Options Subcommittees review and the Companys analysis, that, for accounting purposes, the dates
initially used to measure compensation expense for numerous option grants to employees, executive
officers and outside non-employee directors during the period could not be relied upon for various
categories of option grants including: (i) discretionary grants of various types; (ii) anniversary
grants; (iii) promotion grants; (iv) new hire grants; and (v) program grants. The revised
measurement dates identified for accounting purposes differed from the originally selected
measurement dates due primarily to: (i) insufficient or incomplete approvals; (ii) inadequate or
incomplete establishment of the terms of the grants, including the list of individual recipients;
and (iii) the use of hindsight to select exercise prices.
Specifically, for each of the categories of option grants discussed in more detail under
Accounting Considerations below, we noted the following:
Stock option grants with insufficient or incomplete approvals. The Company determined that
the original recorded grant date could not be relied on because there was correspondence or other
evidence that indicated that not all required approvals had been obtained, including for certain
grants, Compensation Committee approval.
42
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
The Company remeasured these option grants with a revised measurement date supported by the required level of
approval, as described below, and accounted for these grants as fixed awards under Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees.
Inadequate or incomplete establishment of the terms of the grants. The Company determined
that for certain stock option grants, the number of shares and the exercise price were not known
with finality at the original measurement date. The Company determined that the original recorded
grant date could not be relied on because there was correspondence or other evidence that indicated
that the Company had not finalized the number of stock options allocated to each individual
recipient and the related exercise price. Based on available supporting documentation, the Company
determined the date by which the number of stock options to be awarded to each recipient was
finalized and the other terms of the award were established and accounted for these grants as fixed
awards under APB 25.
The use of hindsight to select exercise prices. As noted below, the Company followed an
informal policy of awarding options to individual employees in recognition of the anniversary of
their employment with the Company or in conjunction with employee promotions using hindsight to
select the exercise price. In many instances, little or no documentation to support dates selected
for option grants could be located by the Company. Further, instances of favorable, retrospective
date selection of discretionary grants were identified. Also, as noted below, the investigation
noted instances of inadequate documentation, or retrospective date selection, relating to the award
of grants to the Companys top three executive officers, all of which required Compensation
Committee approval. Based on available supporting documentation, the Company determined a revised
measurement date and accounted for these grants as fixed awards under APB 25.
Other Miscellaneous Accounting Adjustments In addition to the restatements for stock-based
compensation, we recorded a pre-tax adjustment for $1.0 million to record a legal settlement
expense that was recorded in the first quarter of 2006, which should have been recorded in the
fourth quarter of 2005. The tax effect of this adjustment was $0.4 million.
Income Tax Benefit We recorded a net income tax benefit of approximately $16.5 million in
connection with the stock option-related compensation charges during the period from fiscal year
1995 to December 31, 2004. This tax benefit has resulted in an increase of our deferred tax assets
for most U.S. affected stock options prior to the exercise or forfeiture of the related options.
With the exception of UK employees exercising options after 2002, the Company recorded no tax
benefit or deferred tax asset for affected stock options granted to non-U.S. employees because we
determined that we could not receive tax benefits for these options. Further, we limited the
deferred tax assets recorded for affected stock options granted to certain highly paid officers to
reflect estimated limitations on tax deductibility under Internal Revenue Code Section 162(m). Upon
exercise or forfeiture of the underlying options, the excess or deficiency in deferred tax assets
is written-off to paid-in capital in the period of exercise or forfeiture.
Payroll taxes, interest and penalties Management is considering possible ways to address the
impact that Section 409A of the Internal Revenue Code may have as a result of the exercise price of
stock options being less than the fair market value of our common stock on the revised measurement
date. Section 409A imposes additional taxes to our employees on stock options granted with an
exercise price lower than the fair market value on the date of grant that vest after December 31,
2004. The Internal Revenue Service has issued transition rules under Section 409A that allows for
a correction, or cure, for options subject to Section 409A. We may offer the holders of
outstanding options the opportunity to affect a cure of all affected stock options. In connection
with this cure, we may make cash bonus payments in an aggregate amount of up to $200,000 in 2008 to
our non-officer employees.
43
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Accounting Considerations Stock-Based Compensation
We originally accounted for all employee, officer and director stock option grants as fixed
grants under APB 25, using a measurement date of the recorded grant date. We issued all grants with
an exercise price equal to the fair market value of our common stock on the recorded grant date, and therefore originally
recorded no stock-based compensation expense.
As a result of the findings of the Options Subcommittee, and our own further review of our
stock option granting practices, we determined that the measurement dates for certain stock option
grants differed from the recorded grant dates for such grants. Based on the analysis described
below, the Company concluded that it was appropriate to revise the measurement dates for these
grants based upon its findings. The Company calculated stock-based compensation expense under APB
25 based upon the intrinsic value as of the adjusted measurement dates of stock option awards
determined to be fixed under APB 25 and the vesting provisions of the underlying options. The
Company calculated the intrinsic value on the adjusted measurement date as the closing price of its
common stock on such date as reported on the NASDAQ National Market, now the NASDAQ Global Select
Market, less the exercise price per share of common stock as stated in the underlying stock option
agreement, multiplied by the number of shares subject to such stock option award. The Company
recognizes these amounts as compensation expense over the vesting period of the underlying options
in accordance with the provisions of FASB Interpretation No. 28, Accounting for Stock Appreciation
Rights and Other Variable Stock Option or Award Plans. We also determined that variable accounting
treatment was appropriate under APB 25 for certain stock option grants for which evidence was
obtained that the terms of the options may have been communicated to those recipients and that
those terms were subsequently modified (stock option grants cancelled and repriced). When variable
accounting is applied to stock option grants, we remeasure, and report in our consolidated
statements of earnings, the intrinsic value of the options at the end of each reporting period
until the options are exercised, cancelled or expire unexercised.
The Company determined the most supportable measurement dates for each of the various
categories of options grants as follows:
Discretionary Grants. Discretionary grants included grants to the Companys outside
directors, the Chief Executive Officer (CEO), President and Chief Financial Officer (the three
highest ranking executives of the Company), other Section 16 Officers, and all other Company
employees.
The Company determined that it had granted stock options to its outside directors pursuant to
the Companys stock plans or Board of Directors minutes in the majority of instances; however, in
a few instances, certain grants to these individuals require alternative measurement dates based on
the approval dates specified in plan documents or signed minutes. The Company recorded a pre-tax
adjustment to compensation expense totaling less than $0.1 million associated with all grants to
outside directors during the Relevant Period.
During the Relevant Period, the Company followed a practice of requiring Compensation
Committee approval of the stock option awards to the three highest ranking executives of the
Company. For some grants, the Compensation Committee minutes do not indicate approval of an award.
In other instances, the Company either did not locate minutes or the evidence was inconclusive
concerning when a specific meeting occurred. The Company determined that certain grants to these
individuals require alternative measurement dates. For example, due to inconclusive evidence
regarding the date of Compensation Committee approval, because the Board had approved the Proxy
Statement in which the award was specifically listed, the Proxy Statement filing date was selected
as the best evidence of a measurement date for the award. The Company recorded a pre-tax
adjustment to compensation expense totaling $13.3 million for all grants to the three highest
ranking executives of the Company during the Relevant Period. Alternatively, for those grants
where the Proxy Statement filing date was selected, had we used the highest or lowest closing price
of our common stock between the grant date and the Proxy Statement filing date as the revised
measurement date (as a measurement date could have occurred on any
44
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
date between those two dates), the pre-tax adjustment to compensation expense would have been $3.2 million higher using the
highest price and $6.9 million lower using the lowest price.
Prior to May 16, 2003, the CEO approved stock option awards to Section 16 Officers. Evidence
of CEO approval typically consisted of an email containing the grant terms. Effective with the May
16, 2003 Compensation Committee meeting, the Compensation Committee was required to approve grants
to the Section 16 Officers. Evidence of Compensation Committee approval included Compensation Committee
minutes or a signed Unanimous Written Consent (UWC). The Company determined that certain grants
to these individuals require alternative measurement dates based on the date of approval identified
in the supporting documentation. The Company recorded a pre-tax adjustment to compensation expense
totaling $9.5 million in connection with discretionary grants to Section 16 Officers, in addition
to the $13.3 million pre-tax adjustment for grants to the three highest ranking executives of the
Company, during the Relevant Period.
Throughout most of the Relevant Period, the Companys option plans granted discretion to the
CEO to award option grants to any Company employee, other than the top three executives. The CEO
in turn authorized a defined number of options in connection with certain discretionary grants
during the Relevant Period that were allocated by certain senior executives amongst employees
within particular business units. In certain instances, the review revealed that lists of grantees
within specified business units had not been finalized as of the grant date. Where required, the
Company identified alternative measurement dates for these discretionary grants and recorded the
required pre-tax adjustment to compensation expense totaling $7.9 million during the Relevant
Period.
During the Relevant Period, the Company also granted annual performance-based options to
employees at the discretion of certain executives and managers within each business unit. Based on
the supporting documentation, the business units finalized the list of awards by person on
different dates. The Company reconciled each list to the actual awards contained in the Companys
stock plan administration database to determine the date by which each business units list was
finalized. The Company recorded a pre-tax adjustment to compensation expense totaling $6.5 million
for six grant dates during the Relevant Period that primarily related to annual performance
reviews.
Anniversary Grants. Throughout the Relevant Period, the Company followed an informal policy
of awarding options to individual employees in recognition of the anniversary of their employment
with the Company or in conjunction with employee promotions. The number of these options was
determined by the employees level within the Company, or, in the case of promotion grants, the
level to which the employee was promoted. The majority of these grants were modest in size,
generally 500 options or less. In the case of senior management, anniversary or promotion grants
could be much larger, at 5,000 or 7,500 options. Occasionally, very senior executives, other than
the top three executives, received larger grants for anniversaries or promotions, but these were
relatively few and were generally done on a case-by-case basis.
The Options Subcommittee review indicated that the Companys anniversary related options were
granted with measurement dates determined by three general methods, depending upon the time period
in the Relevant Period. From the beginning of the Relevant Period through the end of 1998,
anniversary grants were generally granted with a measurement date on an employees actual
anniversary date. For a period of time between 1999 and 2002, the grant dates generally were
selected retrospectively based on either the low price of a month or the low price of the quarter.
In the third quarter of 2002, the Company began a practice of awarding anniversary grants on the
15th day of each month for the balance of 2002, and in January 2003, the Company
essentially ceased making anniversary grants, except for minimal contractual grants to certain
United Kingdom employees which continued into 2005.
The Company used email correspondence or other documentation maintained in the Stock Plan
Administration files and information obtained from the Companys human resources system and payroll
records to determine each employees anniversary date based on the employees hire (and
corresponding anniversary)
45
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
date. The general granting practice for anniversary awards in place at
the relevant point in time was used to determine the appropriate measurement date for each
employees anniversary award. For a limited number of grants, absent evidence of the employees
hire date, the date the employee record of the stock options was added to the Companys stock plan
administration database application was used as the measurement date for the awards identified as
anniversary grants. For periods where the Company issued anniversary grants using quarterly or
monthly lows, or other low prices, alternate measurement dates were required. The Company recorded
a pre-tax compensation expense adjustment totaling $6.6 million for anniversary grants during the
Relevant Period.
Promotion Grants. Promotion grants were generally handled in the same manner as anniversary
grants. In some instances, promotion grants were awarded on the promotion effective date and other
times at the low price of the month or quarter. The Companys analysis revealed that the Company
had a general practice of granting promotion options on the employees promotion effective dates
from 1998 through 2000. The Company selected either the promotion effective date, if available, or
the date the employee record of the stock options was added to the Companys stock plan
administration database application, if the promotion effective date was not available, as the
measurement date for the promotion grants issued from 1998 through 2000. For subsequent periods
where the Company issued promotion grants using quarterly or monthly lows, or other low prices,
alternate measurement dates were required. The Company recorded a pre-tax compensation expense
adjustment totaling $2.2 million for promotion grants during the Relevant Period.
New Hire Grants. Throughout the Relevant Period, the Company issued an option grant to each
new employee on the employees start date. The Company had a uniform practice of granting a
specific number of options depending on the incoming employees level within the Company. For
example, the lowest level employees would receive 50 options on their start date, while certain
managers might receive 2,500 options. Senior executive officers would typically receive much
larger grants upon joining the Company, and those grants were typically negotiated as part of a
total compensation package that were reflected in an employment agreement or offer letter. In
general, the Company found a lack of significant issues with respect to new hire grants.
Compensation expense was required to be recorded for administrative and error corrections and in a
small number of cases where it was determined that an employee received an award with an effective
date earlier than their actual start date, or where the amount of the grant was negotiated or
otherwise selected after the employee began working at the Company. Additionally, during certain
limited periods, due to a limited number of options being available to grant, the Company issued
certain new hire grants at a later date along with the periods anniversary grants at the low price
of the month or quarter, in which case the Company determined that alternate measurement dates were
required. The Company recorded a pre-tax compensation expense adjustment totaling $0.7 million for
new hire grants during the Relevant Period.
Program Grants. The Company had numerous routine grant programs under which options were
awarded to employees who participated on specific teams within the Company, completed certain
training programs or achieved certain goals in their jobs. These options (generally 50 to 250
options) were typically only granted to individual employees below a certain level. Although these
grants were routinely made on an annual or quarterly basis, no official written policies existed
describing the exact criteria or timing for each grant program. Not all of the grants awarded
pursuant to these programs could be identified due to incomplete or inconsistent documentation.
The Company typically determined the most supportable measurement date based on communication of
the list of recipients and the respective number of options to be granted to Stock Plan
Administration. In those instances where the review failed to reveal a specific date when lists
were received in Stock Plan Administration, the Company selected the date the employee record of
the stock options was added to the Companys stock plan administration database application as the
measurement date. The Company recorded a pre-tax adjustment to compensation expense totaling $0.6
million for these program grants during the Relevant Period.
For some grants, the Company identified no supporting documentation to determine the timing of
the approval of the terms of the grant. In these instances, the Company selected the date the employee record of the
46
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
stock options was added to the Companys stock plan administration database
application as the measurement date.
Related Proceedings
In October 2006, we received a letter of informal inquiry from the SEC requesting certain
documents relating to our stock option grants and practices. We have cooperated with the SEC and
will continue to do so. We cannot predict the outcome of this investigation.
Quarterly Overview
On September 7, 2006, we completed our acquisition of Software Spectrum, Inc. (Software
Spectrum) for a cash purchase price of $287.0 million plus working capital of $64.4 million, which
includes cash acquired of $30.3 million. Accordingly, the results of operations from Software
Spectrum are included in our consolidated results of operations since the acquisition date. Prior
to the acquisition of Software Spectrum, we were organized in two operating segments: Insight North
America; and Insight UK. Because Software Spectrum results are only included for 23 calendar days
this quarter, we have disclosed those results through earnings from operations separately from the
results of Insight North America and Insight UK. Beginning with the fourth quarter of 2006, as a
result of the acquisition, we operate in three geographic operating segments: North America; EMEA;
and APAC. Currently, our offerings in North America and the United Kingdom include brand-name IT
hardware, software and services. Our offerings in the remainder of our EMEA segment and in APAC
currently only include software and select software-related services. See Notes 12 and 14 to the
Consolidated Financial Statements in Part I, Item 1 of this report for further discussion.
Founded in 1983 and headquartered in Plano, Texas, Software Spectrum is one of the worlds
leading providers of business-to-business IT solutions and services, with particular expertise in
the selection, purchase and management of software. Software Spectrum delivers value-added
technology solutions across the globe through sales and operations centers in North America,
Europe, Middle East, Africa and Asia-Pacific.
This acquisition represents a solid next step in our evolution to becoming a trusted advisor
to our clients on technology solutions to address business needs. We had identified expansion of
software sales and services capabilities as a necessary augmentation of our value proposition and
we have now begun to leverage our capabilities to drive services and solutions into the small- and
medium-sized business space and to further penetrate the large enterprise sector. Additionally,
with this acquisition we have established a global footprint.
On June 30, 2006, we completed the sale of 100% of the outstanding stock of Direct Alliance
Corporation (Direct Alliance) as business process outsourcing was not a core element of our
growth strategy. Accordingly, the results of operations attributable to Direct Alliance for all
periods presented are classified as a discontinued operation in our Consolidated Financial
Statements in Part I, Item 1. See Note 13 to the Consolidated Financial Statements in Part I, Item
1 of this report for further discussion.
Net sales for the three months ended September 30, 2006 increased 11.5% to $918.6 million from
$823.6 million for the three months ended September 30, 2005. Net earnings for the three months
ended September 30, 2006 increased 12% to $17.2 million from $15.4 million for the three months
ended September 30, 2005. Net earnings
for the three months ended September 30, 2006 include the effect of
the following items:
|
|
|
stock-based compensation expense of $2.8 million or $1.7 million, net of tax; and |
|
|
|
|
severance and restructuring expenses of $729,000 or $454,000, net of tax. |
47
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Net earnings and diluted earnings per share for the three months ended September 30, 2005
include the effect of the following items:
|
|
|
stock-based compensation expense of $217,000 or $135,000, net of tax; and |
|
|
|
|
severance and restructuring expenses of $1.4 million or $881,000, net of tax. |
Net sales for the nine months ended September 30, 2006 increased 7.3% to $2,544.6 million from
$2,371.6 million for the nine months ended September 30, 2005. Net earnings for the nine months
ended September 30, 2006 increased 33% to $58.0 million from $43.6 million for the nine months
ended September 30, 2005. Net earnings for the nine months ended September 30, 2006 include the effect of the
following items:
|
|
|
stock-based compensation expense of $10.1 million or $6.3 million, net of tax; |
|
|
|
|
severance and restructuring expenses of $729,000 or $454,000, net of tax; and |
|
|
|
|
gain on sale of discontinued operation of $15.1 million or $9.1 million, net of tax. |
Net earnings for the nine months ended September 30, 2005
include the effect of the following items:
|
|
|
stock-based compensation expense of $511,000 or $311,000, net of tax; |
|
|
|
|
severance and restructuring expenses of $5.4 million or $3.4 million, net of tax; and |
|
|
|
|
income from reductions in liabilities assumed in a previous acquisition of $664,000 or $306,000, net of tax. |
Although included in our consolidated financial statements, we exclude the items noted above
when internally evaluating gross profit, selling and administrative expenses, earnings from
continuing operations, tax expense, earnings from a discontinued operation, net earnings and
diluted earnings per share for the Company and when evaluating gross profit, selling and
administrative expenses and earnings from operations for our individual operating segments. We exclude these items to evaluate financial performance against budgeted
amounts, to calculate incentive compensation, to assist in forecasting future performance and to
compare our results to competitors financial results.
Overviews of each of our operating segments are discussed below and reconciliations of segment
results of operations to consolidated results of operations can be found in Note 14 to our
Consolidated Financial Statements provided in Part I, Item 1 of this report.
Our discussion and analysis of financial condition and results of operations is intended to
assist in the understanding of our consolidated financial statements, the changes in certain key
items in those consolidated financial statements from year to year, the primary factors that
contributed to those changes, as well as how certain critical accounting estimates affect our
consolidated financial statements.
Insight North Americas net sales for the three months ended September 30, 2006 decreased
slightly to $694.4 million, compared to net sales of $699.3 million for the three months ended
September 30, 2005. We saw slight growth in sales to our small- to medium-sized business (SMB)
clients and strong growth in our sales to public sector segments; however, sales to large
enterprise clients declined during the quarter.
Insight UKs net sales for the three months ended September 30, 2006 increased by 1.8% to
$126.5 million, compared to net sales of $124.3 million for the three months ended September 30,
2005. In British pounds sterling, net sales decreased by 3.2% for the three months ended September
30, 2006 compared to the three months ended September 30, 2005. During the quarter, we continued
to experience challenges in the UK market that have
48
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
prevented top line growth, particularly with our SMB and large enterprise clients.
Similar to Insight North America, sales to our public sector
clients in the UK continue to show strong growth and provide new sales opportunities.
Software Spectrums results of operations are included in our consolidated results of
operations after the close of the acquisition on September 7, 2006. In the last 23 days of
September, Software Spectrum contributed $97.7 million in net sales and $2.4 million in earnings
from operations to our consolidated results.
Critical Accounting Estimates
General
Our consolidated financial statements have been prepared in accordance with United States
generally accepted accounting principles (GAAP). The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the reported amounts of
assets, liabilities, net sales, costs of goods sold and expenses. We base our estimates on
historical experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Members of our senior
management have discussed the development, selection and disclosure of these estimates with the
Audit Committee of our Board of Directors. Actual results, however, may differ from estimates we
have made.
We believe that other than the adoption of Statement of Financial Accounting Standards No. 123
(revised 2004), Share Based Payment (SFAS No. 123R), there have been no significant changes
during the nine months ended September 30, 2006 to the items that we disclosed as our critical
accounting estimates in Managements Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K for the year ended December 31, 2005.
Stock-Based Compensation Expense
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R
using the modified prospective transition method and, therefore, have not restated prior periods
results. Under the fair value recognition provisions of SFAS No. 123R, we recognize stock-based
compensation net of an estimated forfeiture rate and only recognize compensation cost for those
shares expected to vest over the requisite service period of the award. We elected to not make any
modifications to existing stock options outstanding prior to January 1, 2006, such as accelerating
the vesting of previously granted options, as we did not believe it made business sense to do so.
We did, however, take the opportunity to reevaluate our equity compensation plans, and in 2006, we
have elected to issue service-based and performance-based restricted stock units (RSUs) instead
of stock options or restricted shares. The number of RSUs ultimately awarded under the
performance-based RSUs will vary based on whether we achieve certain financial results. We will
record compensation expense each period based on our estimate of the most probable number of RSUs
that will be issued under the grants of performance-based RSUs.
Prior to our adoption of SFAS No. 123R, we applied the intrinsic value-based method of
accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB No. 25). Under this method, compensation expense was recorded on the date of
grant only if the current market price of the underlying stock exceeded the exercise price. In
order to comply with the disclosure requirements of Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (SFAS No. 123), we determined the estimated fair
value of stock options on the date of the grant using the Black-Scholes-Merton (Black-Scholes)
option-pricing model. The Black-Scholes model required us to apply highly subjective assumptions,
including expected stock price volatility, expected life of the option and the risk-free interest
rate. If we decide to issue stock options in the future, we will use an option-pricing model to
determine the fair value of
49
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
stock options as permitted by SFAS No. 123R. A change in one or more of the assumptions used
in the option-pricing model may result in a material change to the estimated fair value of the
stock-based compensation.
See Note 3 to our Consolidated Financial Statements in Part I, Item 1 of this report for
further discussion of stock-based compensation.
RESULTS OF OPERATIONS
The following table sets forth for the periods presented certain financial data as a
percentage of net sales for the three and nine months ended September 30, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Costs of goods sold |
|
|
87.4 |
|
|
|
88.5 |
|
|
|
87.5 |
|
|
|
88.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
12.6 |
|
|
|
11.5 |
|
|
|
12.5 |
|
|
|
11.8 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative expenses |
|
|
9.7 |
|
|
|
8.6 |
|
|
|
9.7 |
|
|
|
9.0 |
|
Severance and restructuring expenses |
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
0.2 |
|
Reductions in liabilities assumed in a
previous
acquisition |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from operations |
|
|
2.8 |
|
|
|
2.8 |
|
|
|
2.8 |
|
|
|
2.6 |
|
Non-operating (income) expense:
Interest income |
|
|
(0.1 |
) |
|
|
(0.1 |
) |
|
|
|
|
|
|
(0.1 |
) |
Interest expense |
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
Other income, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from continuing operations
before
income taxes |
|
|
2.8 |
|
|
|
2.8 |
|
|
|
2.8 |
|
|
|
2.7 |
|
Income tax expense |
|
|
0.9 |
|
|
|
1.1 |
|
|
|
1.0 |
|
|
|
1.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations |
|
|
1.9 |
|
|
|
1.7 |
|
|
|
1.8 |
|
|
|
1.6 |
|
Earnings from discontinued operation,
net
of taxes |
|
|
0.0 |
|
|
|
0.2 |
|
|
|
0.1 |
|
|
|
0.2 |
|
Gain on sale of discontinued operation,
net
of taxes |
|
|
0.0 |
|
|
|
|
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from discontinued operation |
|
|
0.0 |
|
|
|
0.2 |
|
|
|
0.5 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
1.9 |
% |
|
|
1.9 |
% |
|
|
2.3 |
% |
|
|
1.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales. Net sales for the three months ended September 30, 2006 increased 11.5% to $918.6
million from $823.6 million for the three months ended September 30, 2005. Net sales for the nine
months ended September 30, 2006 increased 7.3% to $2,544.6 million from $2,371.6 million for the
nine months ended September 30, 2005. Our net sales by operating segment were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
% |
|
|
September 30, |
|
|
% |
|
|
|
2006 |
|
|
2005 |
|
|
Change |
|
|
2006 |
|
|
2005 |
|
|
Change |
|
Insight North America |
|
$ |
694,390 |
|
|
$ |
699,294 |
|
|
|
(0.7 |
%) |
|
$ |
2,085,129 |
|
|
$ |
2,011,031 |
|
|
|
3.7 |
% |
Insight UK |
|
|
126,488 |
|
|
|
124,305 |
|
|
|
1.8 |
% |
|
|
361,756 |
|
|
|
360,602 |
|
|
|
0.3 |
% |
Software Spectrum |
|
|
97,714 |
|
|
|
|
|
|
|
|
|
|
|
97,714 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated |
|
$ |
918,592 |
|
|
$ |
823,599 |
|
|
|
11.5 |
% |
|
$ |
2,544,599 |
|
|
$ |
2,371,633 |
|
|
|
7.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North Americas net sales for the three months ended September 30, 2006 decreased 0.7%
to $694.4 million from $699.3 million for the three months ended September 30, 2005. Insight North
Americas net
50
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
sales for the nine months ended September 30, 2006 increased 3.7% to $2,085.1 million from
$2,011.0 million for the nine months ended September 30, 2005. We saw slight growth in sales to our
SMB clients and strong growth in our sales to public sector clients; however, sales to large
enterprise clients declined during the quarter. Insight North America had 1,033 account executives
at September 30, 2006, compared to 1,071 at September 30, 2005. Net sales per average number of
account executives in Insight North America decreased 1% from $658,159 for the three months ended
September 30, 2005 to $652,776 for the three months ended September 30, 2006. The average tenure
of our account executives in Insight North America has increased from 3.8 years at September 30,
2005 to 4.3 years at September 30, 2006. The increase is due primarily to a decrease in account
executive turnover.
Insight UKs net sales for the three months ended September 30, 2006 increased by 1.8% to
$126.5 million, compared to net sales of $124.3 million for the three months ended September 30,
2005. In British pounds sterling, net sales decreased by 3.2% for the three months ended September
30, 2006 compared to the three months ended September 30, 2005. Insight UKs net sales for the
nine months ended September 30, 2006 increased by 0.3% to $361.8 million, compared to net sales of
$360.6 million for the nine months ended September 30, 2005. During the quarter, we continue to
experience challenges in the UK market that have prevented top line growth, particularly with our
SMB and large enterprise clients. Similar to Insight North America, sales to our public sector
clients in the UK continue to show strong growth and provide new sales opportunities. Insight UK
had 291 account executives at September 30, 2006, compared to 293 at September 30, 2005. The
decrease is due primarily to aggressive recruiting of our more experienced account executives by
some of our competitors during the last half of 2005 almost entirely offset by recent successful
recruiting. Net sales per average number of account executives in Insight UK increased 12% from
$417,134 for the three months ended September 30, 2005 to $466,742 for the three months ended
September 30, 2006. We believe this increase is attributable to internal initiatives designed to
allow our account executives to work more productively and to the increase in the average tenure of
our account executives. The average tenure of our account executives in Insight UK at September
30, 2006 has remained stable at 2.2 years, despite the loss of some experienced account executives
in 2005.
The percentage of product net sales by category for Insight North America and Insight UK,
excluding Software Spectrum, were as follows for the three and nine months ended September 30, 2006
and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North America |
|
|
Insight UK |
|
|
|
Three Months |
|
|
Nine Months |
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
Ended September 30, |
|
Product Categories |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Computers: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notebooks and PDAs |
|
|
17 |
% |
|
|
18 |
% |
|
|
16 |
% |
|
|
17 |
% |
|
|
19 |
% |
|
|
19 |
% |
|
|
17 |
% |
|
|
19 |
% |
Desktops and servers |
|
|
15 |
% |
|
|
16 |
% |
|
|
16 |
% |
|
|
16 |
% |
|
|
15 |
% |
|
|
16 |
% |
|
|
15 |
% |
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
32 |
% |
|
|
34 |
% |
|
|
32 |
% |
|
|
33 |
% |
|
|
34 |
% |
|
|
35 |
% |
|
|
32 |
% |
|
|
34 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software |
|
|
12 |
% |
|
|
11 |
% |
|
|
11 |
% |
|
|
12 |
% |
|
|
14 |
% |
|
|
14 |
% |
|
|
15 |
% |
|
|
15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Storage devices |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Printers |
|
|
7 |
% |
|
|
7 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
9 |
% |
|
|
9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Network and
connectivity |
|
|
14 |
% |
|
|
13 |
% |
|
|
15 |
% |
|
|
12 |
% |
|
|
9 |
% |
|
|
8 |
% |
|
|
9 |
% |
|
|
8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Monitors and video |
|
|
6 |
% |
|
|
7 |
% |
|
|
6 |
% |
|
|
7 |
% |
|
|
9 |
% |
|
|
11 |
% |
|
|
9 |
% |
|
|
10 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Memory and processors |
|
|
6 |
% |
|
|
5 |
% |
|
|
5 |
% |
|
|
5 |
% |
|
|
4 |
% |
|
|
4 |
% |
|
|
4 |
% |
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplies and
accessories |
|
|
7 |
% |
|
|
7 |
% |
|
|
7 |
% |
|
|
7 |
% |
|
|
8 |
% |
|
|
7 |
% |
|
|
8 |
% |
|
|
7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Miscellaneous |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
8 |
% |
|
|
6 |
% |
|
|
5 |
% |
|
|
6 |
% |
|
|
5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
In general, we continue to experience declines in average selling prices for most of our
product categories, which requires us to sell more units in order to maintain or increase the level
of sales. Additionally, average selling prices for printers, monitors and notebooks have been
declining at a greater rate than the other product categories as demand and competition for these
products have increased. The largest product category continues to be computers, representing 32%
of Insight North America and 34% of Insight UK product net sales for the three months ended
September 30, 2006.
Gross Profit. Gross profit increased 22% to $115.6 million for the three months ended
September 30, 2006 from $94.7 million for the three months ended September 30, 2005. As a
percentage of net sales, gross profit increased from 11.5% for the three months ended September 30,
2005 to 12.6% for the three months ended September 30, 2006. Gross profit increased 14% to $318.9
million for the nine months ended September 30, 2006 from $280.6 million for the nine months ended
September 30, 2005. As a percentage of net sales, gross profit increased from 11.8% for the nine
months ended September 30, 2005 to 12.5% for the nine months ended September 30, 2006. Our gross
profit and gross profit as a percentage of net sales by operating segment for the three and nine
months ended September 30, 2006 and 2005 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
2006 |
|
|
Sales |
|
|
2005 |
|
|
Sales |
|
|
2006 |
|
|
Sales |
|
|
2005 |
|
|
Sales |
|
Insight North
America |
|
$ |
84,555 |
|
|
|
12.2 |
% |
|
$ |
78,170 |
|
|
|
11.2 |
% |
|
$ |
252,839 |
|
|
|
12.1 |
% |
|
$ |
232,337 |
|
|
|
11.6 |
% |
Insight UK |
|
|
18,124 |
|
|
|
14.3 |
% |
|
|
16,492 |
|
|
|
13.3 |
% |
|
|
53,145 |
|
|
|
14.7 |
% |
|
|
48,305 |
|
|
|
13.4 |
% |
Software Spectrum |
|
|
12,872 |
|
|
|
13.2 |
% |
|
|
|
|
|
|
|
|
|
|
12,872 |
|
|
|
13.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated |
|
$ |
115,551 |
|
|
|
12.6 |
% |
|
$ |
94,662 |
|
|
|
11.5 |
% |
|
$ |
318,856 |
|
|
|
12.5 |
% |
|
$ |
280,642 |
|
|
|
11.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North Americas gross profit increased for the three months ended September 30, 2006
by 8% to $84.6 million from $78.2 million for the three months ended September 30, 2005. As a
percentage of net sales, gross profit increased to 12.2% for three months ended September 30, 2006
from 11.2% for the three months ended September 30, 2005 due primarily to:
|
|
|
increases in sales of services; |
|
|
|
|
increases in supplier reimbursements; and |
|
|
|
|
a reduction in the reserve for uncollectible vendor receivables due to an improvement
in the aging of these receivables. |
These increases were offset partially by:
|
|
|
decreases in freight margin; and |
|
|
|
|
increases in the write-downs of inventories. |
Insight North Americas gross profit increased for the nine months ended September 30, 2006 by
9% to $252.8 million from $232.3 million for the nine months ended September 30, 2005. As a
percentage of net sales, gross profit increased to 12.1% for the nine months ended September 30,
2006 from 11.6% for the nine months ended September 30, 2005 due primarily to:
|
|
|
a reduction in the reserve for uncollectible vendor receivables due to an improvement
in the aging of these receivables; |
|
|
|
|
increases in sales of services; |
52
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
|
|
|
increases in supplier reimbursements; and |
|
|
|
|
increases in referral fees for Microsoft enterprise software agreement renewals. |
These increases were offset partially by decreases in freight and product margins.
Insight UKs gross profit increased for the three months ended September 30, 2006 by 10% to
$18.1 million from $16.5 million for the three months ended September 30, 2005. As a percentage of
net sales, gross profit increased to 14.3% for the three months ended September 30, 2006 from 13.3%
for the three months ended September 30, 2005. The increase was due primarily to:
|
|
|
increases in product margins; |
|
|
|
|
increases in referral fees for Microsoft enterprise software agreement renewals; |
|
|
|
|
increases in sales of services; and |
|
|
|
|
decreases in write-downs of inventories. |
These increases were offset partially by decreases in supplier reimbursements.
Insight UKs gross profit increased for the nine months ended September 30, 2006 by 10% to
$53.1 million from $48.3 million for the nine months ended September 30, 2005. As a percentage of
net sales, gross profit increased to 14.7% for the nine months ended September 30, 2006 from 13.4%
for the nine months ended September 30, 2005. The increase was due primarily to:
|
|
|
increases in product margin; |
|
|
|
|
increases in referral fees from Microsoft enterprise software agreement renewals; and |
|
|
|
|
increases in sales of services. |
Operating Expenses.
Selling and administrative expenses. Selling and administrative expenses increased 25% to
$89.6 million for the three months ended September 30, 2006 from $71.5 million for the three months
ended September 30, 2005. As a percentage of net sales, selling and administrative expenses
increased to 9.7% for the three months ended September 30, 2006 from 8.7% for the three months
ended September 30, 2005. Selling and administrative expenses increased 16% to $247.8 million for
the nine months ended September 30, 2006 from $214.3 million for the nine months ended September
30, 2005. As a percentage of net sales, selling and administrative expenses increased to 9.7% for
the nine months ended September 30, 2006 from 9.0% for the nine months ended September 30, 2005.
Selling and administrative expenses as a percent of net sales by operating segment for the three
and nine months ended September 30, 2006 and 2005 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
|
|
|
Net |
|
|
|
2006 |
|
|
Sales |
|
|
2005 |
|
|
Sales |
|
|
2006 |
|
|
Sales |
|
|
2005 |
|
|
Sales |
|
Insight North America |
|
$ |
64,559 |
|
|
|
9.3 |
% |
|
$ |
58,672 |
|
|
|
8.4 |
% |
|
$ |
194,265 |
|
|
|
9.3 |
% |
|
$ |
175,790 |
|
|
|
8.7 |
% |
Insight UK |
|
|
14,477 |
|
|
|
11.4 |
% |
|
|
12,834 |
|
|
|
10.3 |
% |
|
|
43,034 |
|
|
|
11.9 |
% |
|
|
38,531 |
|
|
|
10.7 |
% |
Software Spectrum |
|
|
10,517 |
|
|
|
10.8 |
% |
|
|
|
|
|
|
|
|
|
|
10,517 |
|
|
|
10.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated |
|
$ |
89,553 |
|
|
|
9.7 |
% |
|
$ |
71,506 |
|
|
|
8.7 |
% |
|
$ |
247,816 |
|
|
|
9.7 |
% |
|
$ |
214,321 |
|
|
|
9.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insight North Americas selling and administrative expenses increased for the three months
ended September 30, 2006 by 10% to $64.6 million from $58.7 million for the three months ended
September 30, 2005. As a percentage of net sales, selling and administrative expenses increased to
9.3% for the three months ended September 30, 2006 from 8.4% for the three months ended September
30, 2005. Insight North Americas selling
53
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
and administrative expenses increased for the nine months ended September 30, 2006 by 11% to
$194.3 million from $175.8 million for the nine months ended September 30, 2005. As a percentage
of net sales, selling and administrative expenses increased to 9.3% for the nine months ended
September 30, 2006 from 8.7% for the nine months ended September 30, 2005. Selling and
administrative expenses as a percentage of sales for the three and nine months ended September 30,
2006 has increased over the three and nine months ended September 30, 2005 due to:
|
|
|
increases in stock-based compensation expense under SFAS No. 123R; |
|
|
|
|
increases in bonus expenses due to increased overall financial performance; |
|
|
|
|
increases in sales incentive plans; |
|
|
|
|
accelerated depreciation related to portions of our current operating system that will
not be utilized after
we upgrade to mySAP; |
|
|
|
|
integration expenses; and |
|
|
|
|
other IT expenses related to the mySAP upgrade. |
These increases were offset partially by decreases in marketing expenses.
Stock-based compensation expense of $2.5 million and $209,000 is included in Insight North
Americas selling and administrative expenses for the three months ended September 30, 2006 and
2005, respectively. Stock-based compensation expense of $8.2 million and $498,000 is included in
Insight North Americas selling and administrative expenses for the nine months ended September 30,
2006 and 2005, respectively.
Insight UKs selling and administrative expenses increased 13% to $14.5 million for the three
months ended September 30, 2006 from $12.8 million for the three months ended September 30, 2005.
As a percentage of net sales, selling and administrative expenses increased to 11.4% for the three
months ended September 30, 2006 from 10.3% for the three months ended September 30, 2005. Insight
UKs selling and administrative expenses increased 12% to $43.0 million for the nine months ended
September 30, 2006 from $38.5 million for the nine months ended September 30, 2005. As a
percentage of net sales, selling and administrative expenses increased to 11.9% for the nine months
ended September 30, 2006 from 10.7% for the nine months ended September 30, 2005. The increase in
selling and administrative expenses as a percentage of net sales for the three months ended
September 30, 2006 compared to the three months ended September 30, 2005 was due primarily to:
|
|
|
increases in sales compensation plans; and |
|
|
|
|
increases in facility costs related to our new London office. |
These increases were offset partially by a property tax rebate recorded during the three months
ended September 30, 2006.
Selling and administrative expenses as a percentage of net sales increased for the nine months
ended September 30, 2006 compared to the nine months ended September 30, 2005 due primarily to:
|
|
|
increases in marketing expenses; |
|
|
|
|
increases in sales compensation plans; and |
|
|
|
|
increases in facility costs related to our new London office. |
These increases were offset partially by a property tax rebate recorded during the nine months
ended September 30, 2006.
Stock-based compensation expense of $249,000 and $817,000 is included in Insight UKs selling
and administrative expenses for the three and nine months ended September 30, 2006, respectively.
No stock-based compensation expense was recorded for Insight UK in 2005.
54
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Severance and restructuring expenses. During the three months ended September 30, 2006,
Insight North America and Insight UK recorded severance expense of $508,000 and $221,000,
respectively, associated with the elimination of Insight positions as part of our integration and
expense reduction plans. During the three months ended September 30, 2005, Insight UK recorded
restructuring costs of $378,000 for duplicate rent expense related to the move to a new facility at
the end of 2005.
Reductions in Liabilities Assumed in Previous Acquisition. During the nine months ended
September 30, 2005, Insight UK settled certain liabilities assumed in a previous acquisition for
$664,000 less than the amounts originally recorded. See Note 10 to the Consolidated Financial
Statements in Part I, Item 1 of this report for further discussion.
Interest Income. Interest income of $1.7 million and $830,000 for the three months ended
September 30, 2006 and 2005, respectively, and $3.7 million and $2.6 million for the nine months
ended September 30, 2006 and 2005, respectively, was generated through short-term investments. The
increase in interest income is due to a generally higher level of cash available to be invested in
short-term investments and increases in interest rates earned on those investments during the three
and nine months ended September 30, 2006.
Interest Expense. Interest expense of $1.3 million and $429,000 for the three months ended
September 30, 2006 and 2005, respectively, primarily relates to borrowings under our financing
facilities. Interest expense of $2.3 million and $1.0 million for the nine months ended September
30, 2006 and 2005, respectively, primarily relates to borrowings under our financing facilities.
The increase in interest expense is due to increased borrowings outstanding in the three months
ended September 30, 2006, due to the acquisition of Software Spectrum and increases in interest
rates.
Other Expense, Net. Other expense, net, was $208,000 for the three months ended September 30,
2006 compared to $207,000 for the three months ended September 30, 2005. Other expense, net,
decreased to $552,000 for the nine months ended September 30, 2006 from $674,000 for the nine
months ended September 30, 2005. These amounts consist primarily of bank fees associated with our
financing facilities and cash management and miscellaneous foreign currency translation gains or
losses.
Income Tax Expense. Our effective tax rates for the three months ended September
30, 2006 and 2005 were 32.3% and 38.4%, respectively. For the three months ended September 30,
2006, our effective tax rate was less than the United States federal statutory rate of 35.0% due
primarily to:
|
|
|
a benefit recognized during the three months ended September 30, 2006 for the reversal
of accrued income taxes of $1.4 million resulting from the determination during the quarter
that a reserve previously recorded for potential tax exposures was no longer necessary; and |
|
|
|
|
lower tax rates on earnings in the United Kingdom and Canada, offset partially by state
income taxes, net of federal tax. |
For the three months ended September 30, 2005, our effective tax rate was higher than the
United States federal statutory rate of 35.0% due primarily to state income taxes, net of federal
tax, offset partially by lower tax rates on earnings in the United Kingdom and Canada.
Our effective tax rates for the nine months ended September 30, 2006 and 2005 were 34.3% and
38.6%, respectively. For the nine months ended September 30, 2006, our effective tax rate was less
than the United States federal statutory rate of 35.0% due primarily to:
|
|
|
a benefit recognized during the nine months ended September 30, 2006 for the reversal of
accrued income taxes of $1.4 million resulting from the determination that a reserve
previously recorded for potential tax exposures was no longer necessary; |
55
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
|
|
|
internal initiatives implemented during the three months ended June 30, 2006 that
reduced certain state income taxes both historically and prospectively; and |
|
|
|
|
lower tax rates on earnings in the United Kingdom and Canada, offset partially by state
income taxes, net of federal tax. |
For the nine months ended September 30, 2005, our effective tax rate was higher than the
United States federal statutory rate of 35.0% due primarily to:
|
|
|
state income taxes, net of federal tax, offset partially by lower tax rates on earnings
in the United Kingdom and Canada; and |
|
|
|
|
a write-off of a deferred tax asset in the United Kingdom after final settlement of a
liability assumed in a previous acquisition. |
Discontinued Operation. On June 30, 2006, we completed the sale of 100% of the outstanding
stock of Direct Alliance and the results of operations attributable to Direct Alliance for all
periods presented are classified as a discontinued operation. See Note 13 to the Consolidated
Financial Statements in Part I, Item 1 of this report for further discussion.
Liquidity and Capital Resources
The following table sets forth certain consolidated cash flow information for the nine
months ended September 30, 2006 and 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
As Restated (1) |
|
Net cash provided by operating activities |
|
$ |
105,658 |
|
|
$ |
59,408 |
|
Net cash (used in) provided by investing activities |
|
|
(302,892 |
) |
|
|
509 |
|
Net cash provided by (used in) financing activities |
|
|
227,866 |
|
|
|
(22,488 |
) |
Net cash provided by (used in) discontinued operation |
|
|
129 |
|
|
|
(5,081 |
) |
Foreign currency exchange effect on cash flow |
|
|
5,165 |
|
|
|
(3,325 |
) |
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
35,926 |
|
|
|
29,023 |
|
Cash and cash equivalents at beginning of period |
|
|
35,145 |
|
|
|
38,443 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
71,071 |
|
|
$ |
67,466 |
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
See Note 2 Restatement of Financial Statements. |
Cash and Cash Flow
Net cash provided by operating activities. Cash flows from operations for the nine months
ended September 30, 2006 and 2005 were $105.7 million and $59.4 million, respectively. During the
nine months ended September 30, 2006, we received $46.5 million from the sale of Direct Alliance
and used $323.0 million, net of cash acquired of $30.3 million, to acquire Software Spectrum. The
acquisition was partially financed by new term loan borrowings of $75.0 million under our amended
and restated credit facility and $173.0 million under our amended accounts receivable
securitization financing facility. Cash flows from operations for the nine months ended September
30, 2006 resulted primarily from net earnings from continuing operations before depreciation and
amortization, decreases in inventories and increases in accounts payable. Inventories decreased
due primarily to decreases in inventories not available for sale, which represent inventories
segregated pursuant to binding customer contracts, which will be recorded as net sales when the
criteria for sales recognition are met. Accounts payable increased due to the timing of payments
at period end. Cash flows from operations for the nine months ended September 30, 2005 resulted
primarily from net earnings from continuing operations before depreciation and amortization and
increases in deferred revenue for client payments received in advance of shipment.
56
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Our consolidated cash flow operating metrics for the nine months ended September 30, 2006 and
2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
September 30, |
|
|
2006 |
|
2005 |
Days sales outstanding in ending accounts receivable (DSOs) |
|
|
46 |
|
|
|
46 |
|
Annualized inventory turns, excluding inventories not available for sale |
|
|
28 |
|
|
|
31 |
|
Days purchases outstanding in ending accounts payable (DPOs) |
|
|
24 |
|
|
|
23 |
|
The decrease in inventory turns and increase in inventories is due primarily to an increase in
opportunistic purchases made during the period. Inventories will fluctuate depending on
opportunistic purchases by us and the timing of projects with large enterprise and public sector
clients. DPOs increased due to timing of payments at period end.
If, as contemplated, sales continue to increase in the future, we anticipate that cash flow
from operations will be used, at least partially, to fund working capital as we typically increase
balances in our inventories and pay our suppliers on average terms that are shorter than the
average terms granted to our clients in order to take advantage of supplier discounts.
Net cash (used in) provided by investing activities. Cash flows used in investing activities
for the nine months ended September 30, 2006 was $302.9 million. Cash flows provided by investing
activities for the nine months ended September 30, 2005 was $509,000. On September 7, 2006, we
completed our acquisition of Software Spectrum for $323.0 million, net of cash acquired. On June
30, 2006, we completed the sale of Direct Alliance for a purchase price of $46.5 million, subject
to a working capital adjustment. The purchase price did not include real estate and intercompany
receivables, which had an estimated fair value of $49,400,000 (book value of $43,237,000) and were
distributed to us immediately prior to closing. In addition to payment of the purchase price, the
buyer is obligated to make a one-time bonus payment to us if Direct Alliance achieves certain gross
profit levels for the year ending December 31, 2006 (Earn Out). Additionally, the buyer is
entitled to a claw back of the purchase price of up to $5,000,000 if certain Direct Alliance client
contracts are not renewed on terms prescribed in the sale agreement. As of July 25, 2007, the
company is in the process of negotiating the final resolution of the Earn Out and the claw back.
In January 2005, we received the $26.9 million receivable from an underwriter related to the 2004
sale of our investment in a subsidiary. Capital expenditures of $27.2 million for the nine months
ended September 30, 2006 primarily relate to capitalized costs of computer software acquired or
developed for internal use and hardware upgrades. Capital expenditures for the nine months ended
September 30, 2005 of $26.9 million primarily related to the purchase of an office facility for
$7.8 million and capitalized costs of computer software developed for internal use and computer
equipment.
Net cash provided by (used in) financing activities. Cash flows provided by financing
activities for the nine months ended September 30, 2006 was $227.9 million. Cash flows
used in financing activities for the nine months ended September 30, 2005 was $22.5 million. During
the nine months ended September 30, 2006, cash was primarily used to make repayments on our
financing facilities and line of credit, offset partially by cash received from proceeds of sales
of common stock under employee stock plans and excess tax benefit from employee gains on
stock-based compensation.
We anticipate that cash flow from operations, together with the funds available under our
current and contemplated financing facilities, will be adequate to support our presently
anticipated cash and working capital requirements for operations through 2009. Additionally, we
expect to use any excess cash to reduce outstanding debt incurred in connection with the
acquisition of Software Spectrum.
See Note 6 to our Consolidated Financial Statements in Part I, Item 1 of this report for a
description of our financing facilities, including terms, amounts outstanding, amounts available
and weighted average borrowings and interest rates during the quarter.
57
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Our financing facilities contain various covenants, including the requirement that we comply
with leverage and minimum fixed charge ratio requirements. In addition, our credit facilities
prohibit the payment of cash dividends without the lenders consent and the requirement that we
provide annual and quarterly financial information which is reported on by our independent
registered public accounting firm to the lenders within a certain time period after the annual or
quarterly period ends. If we fail to comply with these covenants, the lenders would be able to
demand payment within a specified period of time. Because we were not current with our reporting
obligations under the Securities Exchange Act of 1934 beginning on September 30, 2006 and ending on
July 25, 2007, we would have been in violation of our financial reporting covenants had we not
obtained agreements with our lenders regarding delivery of substitute financial information to
them. The agreements with our lenders waived our obligation to provide the filed reports and
waived any events of default occurring under the facility as a result of our failure to comply with
the financial reporting covenants. We intend to provide all late reports and current financial
statements to our lenders upon becoming current in our filings.
Contractual Obligations for Continuing Operations
At September 30, 2006, our contractual obligations for continuing operations were as follows
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period |
|
|
|
|
|
|
|
Less than |
|
|
1-3 |
|
|
3-5 |
|
|
More than 5 |
|
|
|
Total |
|
|
1 Year |
|
|
Years |
|
|
Years |
|
|
Years |
|
Long-term debt (a) |
|
$ |
257,000 |
|
|
$ |
15,000 |
|
|
$ |
212,000 |
|
|
$ |
30,000 |
|
|
$ |
|
|
Operating lease obligations |
|
|
65,934 |
|
|
|
13,180 |
|
|
|
22,324 |
|
|
|
15,114 |
|
|
|
15,316 |
|
Severance and restructuring
obligations (b) |
|
|
16,952 |
|
|
|
9,246 |
|
|
|
7,706 |
|
|
|
|
|
|
|
|
|
Other contractual obligations (c) |
|
|
66,186 |
|
|
|
18,323 |
|
|
|
32,318 |
|
|
|
4,900 |
|
|
|
10,645 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
406,072 |
|
|
$ |
55,749 |
|
|
$ |
274,348 |
|
|
$ |
50,014 |
|
|
$ |
25,961 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Includes our accounts receivable securitization facility that expires September
2009 and our term loan facility that is scheduled to be paid off in September 2011. |
|
(b) |
|
As a result of approved restructuring and acquisition integration plans, we expect
future cash expenditures related to employee termination benefits and facilities based
costs. See further discussion in Note 9 to the Consolidated Financial Statements in Part
II, Item 8 of this report. |
|
(c) |
|
Includes: |
|
I. |
|
Estimated interest payments in 2007 of $26.0 million based on the average
projected balances at September 30, 2007, September 30, 2008 and September 30, 2009
under the asset backed securitization facility, revolving credit facility and term
loan using the September 30, 2006 weighted average interest rate of 5.8% per annum. |
|
|
II. |
|
Amounts totaling $17.4 million related to Wipro Limited for their
assistance in integrating our hardware, services and software distribution
operations in US, Canada, EMEA and APAC on mySAP. |
|
|
III. |
|
Amounts totaling $9.7 million over the next 7 years to the Valley of the
Sun Bowl Foundation for sponsorship of the Insight Bowl and $9.9 million over the
next 9 years for advertising and marketing events with the Arizona Cardinals NFL
team at the University of Phoenix stadium. |
|
|
IV. |
|
During the year ended December 31, 2005, we recorded $979,000, $649,000 net
of taxes, for the cumulative effect of a change in accounting principle for the
adoption of FIN No. 47. FIN No. 47 states that companies must recognize a liability
for the fair value of a legal obligation to perform asset-retirement activities that
are conditional on a future event if the amount can be reasonably estimated. This
interpretation applies to certain provisions in our facility lease agreements in the
United States and the United Kingdom. Some of our leases stipulate that any
leasehold improvements performed by the tenant with landlord approval become the
landlords property upon expiration of the lease. However, some landlords further
reserve the right to make the determination as to whether the premises must be
returned to their original condition, normal wear |
58
INSIGHT ENTERPRISES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
and tear excepted, at our expense. Because of these provisions, FIN No. 47 now
requires us to record a liability for the estimated fair value of this legal obligation
to return the premises to the original condition with the offset recorded as an
increase to the cost of the leasehold improvements. We estimate that we will owe $3.2
million in future years in connection with returning our leased facilities to original
condition.
See further discussion in Note 11 to the Consolidated Financial Statements in Part I, Item 1
this report.
Off Balance Sheet Arrangements
We have entered into off-balance sheet arrangements, which include guaranties and
indemnifications, as defined by the SECs Final Rule 67, Disclosure in Managements Discussion and
Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations. The
guaranties and indemnifications are discussed in Note 11 to the Consolidated Financial Statements
in Part I, Item 1 this report. We believe that none of our off-balance sheet arrangements have, or
are reasonably likely to have, a material current or future effect on our financial condition,
results of operations, liquidity, capital expenditures or capital resources.
Recently Issued Accounting Pronouncements
See Note 1 to our Consolidated Financial Statements in Part I, Item 1 of this report for a
description of recent accounting pronouncements, including our expected dates of adoption and the
anticipated effects on our financial statements and disclosures.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Risk
We have interest rate exposure arising from our financing facilities, which have variable
interest rates. These variable interest rates are affected by changes in short-term interest
rates. We manage interest rate exposure by maintaining a conservative debt to equity ratio.
Although the credit agreement we entered into to finance in part the acquisition of Software
Spectrum increased our exposure to market risk from changes in interest rates, we believe that the
effect of reasonably possible near-term changes in interest rates on our financial position,
results of operations and cash flows will not be material. Our financing facilities expose net
earnings to changes in short-term interest rates since interest rates on the underlying obligations
are variable. We had $75.0 million outstanding under our term loan, $22.0 million outstanding
under our revolving line of credit and $182.0 million outstanding under our accounts receivable
securitization financing facility at September 30, 2006. The interest rates attributable to the
term loan, the line of credit and the financing facility were 6.44%, 8.25% and 5.89%, respectively,
per annum at September 30, 2006.
A change in annual net earnings from continuing operations resulting from a hypothetical 10%
increase or decrease in interest rates would approximate $1.0 million.
Foreign Currency Exchange Risk
We have operation centers in the U.S., Canada, the United Kingdom, Germany, France and
Australia, as well as sales offices in Australia, Belgium, Canada, China, Denmark, Finland, France,
Germany, Hong Kong, Italy, the Netherlands, Norway, Singapore, Spain, Sweden, Switzerland, the
United Kingdom and the U.S., and sales presence in Austria, Ireland, New Zealand and Russia. In
each of these countries, the majority of sales, expenses and capital purchasing activities are
transacted in the respective functional currencies. Therefore, we have foreign currency
translation exposure for changes in exchange rates for these currencies. Changes in exchange rates
between foreign currencies and the U.S. dollar may adversely affect our operating margins. For
59
INSIGHT ENTERPRISES, INC.
example, if these foreign currencies appreciate against the U.S. dollar, it will become more
expensive in terms of U.S. dollars to pay expenses with foreign currencies. Because we operate in
numerous functional currencies, we cannot predict the effect of future exchange-rate fluctuations
on business and operating results and significant rate fluctuations could have a material adverse
effect on results of operations and financial condition.
In addition, although our foreign subsidiaries have intercompany accounts that eliminate upon
consolidation, such accounts expose us to foreign currency rate movements. Exchange rate
fluctuations on short-term intercompany accounts are recorded in our consolidated statements of
earnings under Net foreign exchange (gain) loss, while exchange rate fluctuations on long-term
intercompany accounts are recorded in our consolidated balance sheets under accumulated other
comprehensive loss in stockholders equity. We also maintain cash accounts denominated in
currencies other than the local currency which expose us to foreign exchange rate movements.
We monitor our foreign currency exposure and may from time to time enter into hedging
transactions to manage this exposure. There were no hedging transactions during the quarter ended
September 30, 2006, and there were no hedging instruments outstanding at September 30, 2006.
Item 4. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial
Officer, as of the end of the period of this report, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) and
determined that, as a result of the material weakness in internal control over financial reporting
described below, as of September 30, 2006 our disclosure controls and procedures were not effective
to ensure that information required to be disclosed by us in reports that we file or submit under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms.
The Public Company Accounting Oversight Boards Auditing Standard No. 2 defines a material
weakness as a significant deficiency, or a combination of significant deficiencies, that results in
there being a more than remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. The Company identified a material weakness
in its internal control over financial reporting as of December 31, 2006, arising from the combined
effect of the following control deficiencies in Companys accounting for equity based awards:
|
|
|
Inadequate policies and procedures to determine the grant date and
exercise price of equity awards; |
|
|
|
|
Inadequate supervision and training for personnel involved in the stock option
granting process; and |
|
|
|
|
Inadequate documentation and monitoring of the application of accounting
policies and procedures regarding equity awards. |
As a result of financial statement errors attributable to the material weakness described
above, we will file a comprehensive Form 10-K for the fiscal year ended December 31, 2006 in which
we will restate our consolidated statements of earnings, of stockholders equity and comprehensive
income and of cash flows for the years ended December 31, 2005 and 2004, our consolidated balance
sheet as of December 31, 2005 and selected consolidated financial data for the years ended December
31, 2005, 2004, 2003 and 2002, and for each of the quarters in the year ended December 31, 2005 and
the quarters ended March 31, and June 30, 2006.
60
INSIGHT ENTERPRISES, INC.
(b) Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30,
2006 that has materially affected, or is reasonably likely to materially affect, the Companys
internal control over financial reporting.
Subsequent to December 31, 2006, we have begun taking several steps to remediate the material
weakness described in (a) above. We have implemented or are in the process of implementing
internal control improvements in the following areas:
|
|
|
implementing new policies and procedures to ensure compliance with accounting
principles applicable to equity compensation, including restricted stock grants, and
through training and additions to the staff; |
|
|
|
|
developing an equity compensation training program for all teammates involved
in the award of and accounting for equity compensation; |
|
|
|
|
restructuring reporting responsibility for the administration of our equity
compensation programs; and |
|
|
|
|
adopting a written policy governing the award of equity compensation,
including standardizing documentation of approvals of all relevant terms of equity
compensation awards. |
The Compensation Committee of our Board of Directors, which was newly constituted in May 2007,
has already revised some of its policies and will now only approve equity compensation grants at
meetings and not by written consent. The Compensation Committee also has improved the process for
documenting its actions and ensuring the timely reporting of its actions to the Board of Directors.
(c) Inherent Limitations of Disclosure Controls and Internal Control Over Financial Reporting
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Projections of any evaluation of effectiveness to future periods are
subject to risks that controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Part II OTHER INFORMATION
Item 1. Legal Proceedings.
We are party to various legal proceedings arising in the ordinary course of business,
including asserted preference payment claims in client bankruptcy proceedings, claims of alleged
infringement of patents, trademarks, copyrights and other intellectual property rights and claims
of alleged non-compliance with contract provisions.
In accordance with SFAS No. 5, Accounting for Contingencies (SFAS No. 5), we make a
provision for a liability when it is both probable that a liability has been incurred and the
amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly
and are adjusted to reflect the effects of negotiations, settlements, rulings, advice of legal
counsel and other information and events pertaining to a particular claim. Although litigation is
inherently unpredictable, we believe that we have adequate provisions for any probable and
estimable losses. It is possible, nevertheless, that the results of our operations or cash flows
could be materially and adversely affected in any particular period by the resolution of a legal
proceeding. Legal expenses related to defense, negotiations, settlements, rulings and advice of
outside legal counsel are expensed as incurred.
61
INSIGHT ENTERPRISES, INC.
In June 2006, our subsidiary, Software Spectrum, Inc. was named as a defendant in a civil
lawsuit, Allocco v. Gardner (Superior Court, County of San Diego), regarding certain software
resale transactions with Peregrine Systems, Inc. The subsidiary was named as successor to Corporate
Software & Technology, Inc. (CS&T) and alleges that during October 2000 CS&T participated in or
aided and abetted a fraudulent scheme by Peregrine to inflate Peregrines stock price. Pursuant to
the terms of the agreement by which we acquired Software Spectrum, Inc. from Level 3
Communications, Inc. (the former corporate parent of Software Spectrum, Inc.), Level 3
Communications, Inc. has agreed to indemnify, defend and hold us harmless for this matter. The
discovery process is on-going, and we strongly dispute any allegations of participation in
fraudulent behavior. On our behalf Level 3 is vigorously defending this matter.
In October 2006, we received a letter of informal inquiry from the SEC requesting certain
documents relating to our stock option grants and practices. We have cooperated with the SEC and
will continue to do so. We cannot predict the outcome of this investigation.
Software Spectrum, as successor to CST, is party to litigation brought in the Belgian courts
regarding a dispute over the terms of a tender awarded by the Belgian Ministry of Defence (MOD)
in November 2000. In February 2001, CST brought a breach of contract suit against MOD in the Court
of First Instance in Brussels and claimed breach of contract damages in the amount of approximately
$150,000. MOD counterclaimed against CST for cost to cover in the amount of approximately
$2,700,000, and, in July 2002, CST added a Belgian subsidiary of Microsoft as a defendant. We
believe that MODs counterclaims are unfounded, and we are vigorously defending the claim.
Item 1A. Risk Factors.
Changes in the IT industry and/or the economic environment may reduce demand for the IT
hardware, software and services we sell. Our results of operations are influenced by a variety of
factors, including the condition of the IT industry, general economic conditions, shifts in demand
for, or availability of, IT hardware, software, peripherals and services and industry introductions
of new products, upgrades or methods of distribution. Net sales can be dependent on demand for
specific product categories, and any change in demand for or supply of such products could have a
material adverse effect on our net sales, and/or cause us to record write-downs of obsolete
inventory, if we fail to react in a timely manner to such changes. Our operating results are also
highly dependent upon our level of gross profit as a percentage of net sales, which fluctuates due
to numerous factors, including changes in prices from partners, changes in the amount and timing of
supplier reimbursements and marketing funds that are made available, volumes of purchases, changes
in client mix, the relative mix of products sold during the period, general competitive conditions,
the availability of opportunistic purchases and opportunities to increase market share. In
addition, our expense levels, including integration related costs and the costs and salaries
incurred in connection with the hiring of account executives, are based, in part, on anticipated
net sales and the anticipated amount and timing of vendor funding. Therefore, we may not be able
to reduce spending in a timely manner to compensate for any unexpected net sales shortfall and any
such inability could have a material adverse effect on our business, results of operations and
financial condition.
We rely on our partners for product availability, marketing funds, purchasing incentives and
competitive products to sell. We acquire products for resale both directly from
manufacturers/publishers and indirectly through distributors. The loss of a partner could cause a
disruption in the availability of products. Additionally, there is no assurance that as
manufacturers/publishers continue to sell directly to end users and through the distribution
channel, they will not limit or curtail the availability of their product to resellers like us.
From time to time, products we offer may become subject to manufacturer allocation, which limits
the number of units available to us. Our inability to obtain a sufficient quantity of product, or
an allocation of products from a manufacturer in a way that favors one of our competitors relative
to us, could cause us to be unable to fill clients orders in a timely manner, or at all, which
could have a material adverse effect on our business, results of operations and financial
condition. In addition, a reduction in the amount of credit granted to us by our partners
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could increase our cost of working capital and have a material adverse effect on our business,
results of operations and financial condition.
Certain manufacturers/publishers and distributors provide us with substantial incentives in
the form of rebates, supplier reimbursements and marketing funds, early payment discounts, referral
fees and price protections. Vendor funding is used to offset, among other things, inventory, costs
of goods sold, marketing costs and other operating expenses. Certain of these funds are based on
our volume of net sales or purchases, growth rate of net sales or purchases and marketing programs.
If we do not grow our net sales over prior periods or if we are not in compliance with the terms
of these programs, there could be a material negative effect on the amount of incentives offered or
paid to us by manufacturers/publishers. Additionally, partners routinely change the requirements
for, and the amount of, funds available. No assurance can be given that we will continue to
receive such incentives or that we will be able to collect outstanding amounts relating to these
incentives in a timely manner, or at all. A reduction in, the discontinuance of, a significant
delay in receiving or the inability to collect such incentives, particularly related to programs
with our largest vendors, HP and Microsoft, could have a material adverse effect on our business,
results of operations and financial condition.
Although product is generally available from multiple sources via the distribution channel as
well as directly from manufacturers/publishers, we rely on the manufacturers/publishers of products
we offer not only for product availability and vendor funding, but also for development and
marketing of products that compete effectively with products of manufacturers/publishers we do not
currently offer, particularly Dell. We do have the ability to sell, and from time to time do sell,
Dell product if it is specifically requested by our clients and approved by Dell, although we do
not currently proactively advertise or offer Dell products.
Disruptions in our IT systems and voice and data networks, including the upgrade to my SAP and
the migration of Software Spectrum to our IT systems and voice and data networks, could affect our
ability to service our clients and cause us to incur additional expenses. We believe that our
success to date has been, and future results of operations will be, dependent in large part upon
our ability to provide prompt and efficient service to our clients. Our ability to provide that
level of service is largely dependent on the accuracy, quality and utilization of the information
generated by our IT systems, which affect our ability to manage our sales, client service,
distribution, inventories and accounting systems and the reliability of our voice and data
networks. In January 2004, we completed the IT system conversion to SAP, version 4.6, across all
of Insights operations serving U.S. clients. We have been making and will continue to make
enhancements and upgrades to the system, including our current upgrade to mySAP. We currently plan
to deploy our IT system in the U.S., including the upgrade to mySAP, to our legacy Software
Spectrum operations in the U.S. in mid 2008 and to our operations outside of the U.S. over the next
two years. Additionally, certain assumed expense synergies are dependent on migrating Software
Spectrum to our IT systems. There can be no assurances that these enhancements or conversions will
not cause disruptions in our business, and any such disruption could have a material adverse effect
on our results of operations and financial condition. The conversion of EMEA to this software
platform will enable us to sell hardware and services to clients in that region and therefore any
delay would have an effect on future sales growth. Further, any delay in the timing could decrease
and/or delay our expense savings and any such disruption could have a material adverse effect on
our results of operations and financial condition. Additionally, if we complete conversions that
shorten the life of existing technology or render it impaired, we could incur additional
depreciation expense and/or impairment charges. Although we have built redundancy into most of our
IT systems, have documented system outage policies and procedures and have comprehensive data
backup, we do not have a formal disaster recovery or business continuity plan. Substantial
interruption in our IT systems or in our telephone communication systems would have a material
adverse effect on our business, results of operations and financial condition.
The integration and operation of Software Spectrum may disrupt our business and create
additional expenses, and we may not achieve the anticipated benefits of the acquisition.
Integration of an acquisition involves numerous risks, including difficulties in the conversion of
IT systems and assimilation of operations of the acquired company, the diversion of managements
attention from other business concerns, risks of entering markets in which we have had no or only
limited direct experience, assumption of unknown liabilities, the
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potential loss of key teammates and/or clients, difficulties in completing strategic initiatives
already underway in the acquired and acquiring companies, and unfamiliarity with partners of the
acquired company, each of which could have a material adverse effect on our business, results of
operations and financial condition. The success of our integration of Software Spectrum assumes
certain synergies and other benefits. We cannot assure that these risks or other unforeseen
factors will not offset the intended benefits of the acquisition, in whole or in part.
The IT hardware, software and services industry is intensely competitive, and actions of our
competitors, including manufacturers and publishers of products we sell, can negatively affect our
business. Competition has been based primarily on price, product availability, speed of delivery,
credit availability and quality and breadth of product lines and, increasingly, is also based on
the ability to tailor specific solutions to client needs. We compete with
manufacturers/publishers, including manufacturers/publishers of products we sell, as well as a
large number and wide variety of marketers and resellers of IT hardware, software and services.
Product manufacturers/publishers have programs to sell directly to business clients, particularly
larger corporate clients, and are thus a competitive threat to us. In addition, the manner in
which software products are distributed and sold and the manner in which publishers compensate
channel partners like us are continually changing. Software publishers may intensify their efforts
to sell their products directly to end-users, including our current and potential clients, and may
reduce the compensation to resellers or change the requirements for earning these amounts. Other
products and methodologies for distributing software may be introduced by publishers, present
competitors or other third parties. An increase in the volume of products sold through any of these
competitive programs or distributed directly electronically to end-users or a decrease in the
amount of referral fees paid to us, or increased competition for providing services to these
clients, could have a material adverse effect on our business, results of operations and financial
condition.
Additionally, we believe our industry will see further consolidation as product resellers and
direct marketers combine operations or acquire or merge with other resellers, service providers and
direct marketers to increase efficiency, service capabilities and market share. Moreover, current
and potential competitors have established or may establish cooperative relationships among
themselves or with third parties to enhance their product and service offerings. Accordingly, it
is possible that new competitors or alliances among competitors may emerge and acquire significant
market share. Generally, pricing is very aggressive in the industry, and we expect pricing
pressures to continue. There can be no assurance that we will be able to negotiate prices as
favorable as those negotiated by our competitors or that we will be able to offset the effects of
price reductions with an increase in the number of clients, higher net sales, cost reductions,
greater sales of services, which are typically at higher gross margins, or otherwise. Price
reductions by our competitors that we either cannot or choose not to match could result in an
erosion of our market share and/or reduced sales or, to the extent we match such reductions, could
result in reduced operating margins, any of which could have a material adverse effect on our
business, results of operations and financial condition.
Certain of our competitors in each of our operating segments have longer operating histories
and greater financial, technical, marketing and other resources than we do. In addition, some of
these competitors may be able to respond more quickly to new or changing opportunities,
technologies and client requirements. Many current and potential competitors also have greater
name recognition and engage in more extensive promotional activities, offer more attractive terms
to clients and adopt more aggressive pricing policies than we do. Additionally, some of our
competitors have higher margins and/or lower operating cost structures, allowing them to price more
aggressively. There can be no assurance that we will be able to compete effectively with current
or future competitors or that the competitive pressures we face will not have a material adverse
effect on our business, results of operations and financial condition.
We have received an informal inquiry from the SEC and could be subject to stockholder
litigation and other regulatory proceedings related to the Options Subcommittees investigation of
our historical stock option granting practices and the related restatement of our consolidated
financial statements. As described in the Explanatory Note immediately preceding Part I, Item 1 of
this report, Note 2 Restatement of Consolidated Financial Statements to consolidated financial
statements and in Restatement of Consolidated Financial Statements in Managements Discussion
and Analysis of Financial Condition and Results of Operations, in
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Part 1, Item 2 of this report, we identified errors in the Companys accounting related to stock
option compensation expenses in prior periods and determined that corrections to our consolidated
financial statements were required to reflect additional material charges for stock-based
compensation expenses and related income tax effects.
There is a pending informal inquiry from the SEC regarding our historical option granting
practices, and we cannot make any assurances regarding the results of that inquiry. One purported
derivative lawsuit was filed and subsequently dismissed without prejudice at the request of the
plaintiff. The Options Subcommittees investigation, our internal review and related activities
have already required the Company to incur substantial expenses for legal, accounting, tax and
other professional services and any future related investigations or litigation could require
further expenditures and harm our business, financial condition, results of operations and cash
flows. Further, if the Company is subject to adverse findings in litigation, regulatory
proceedings or government enforcement actions, the Company could be required to pay damages or
penalties or have other remedies imposed, which could harm its business, financial condition,
results of operations and cash flows.
While the Company believes it has made appropriate judgments in determining the correct
measurement dates for its stock option grants, the SEC may disagree with the manner in which the
Company has accounted for and reported, or not reported, the financial effect. Accordingly, there
is a risk the Company may have to further restate its prior financial statements, amend prior
filings with the SEC, or take other actions not currently contemplated.
The Company has received three Nasdaq Staff Determination letters stating that, as a result of
the delayed filings, the Company was not in compliance with the filing requirements for continued
listing as set forth in Marketplace Rule 4310(c)(14) and was therefore subject to delisting from
the Nasdaq Global Select Market. To date, the Nasdaq Listing Qualifications Panel and the Nasdaq
Listing Council have granted requests for continued listing, subject to the Company filing
delinquent reports by the dates specified by Nasdaq. With the filing of this report and the filing
of our Annual Report on Form 10-K for the year ended December 31, 2006 and our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2007, the Company believes that it has remedied its
non-compliance with Marketplace Rule 4310(c)(14). However, if the SEC disagrees with the manner in
which the Company has accounted for and reported, or not reported, the financial effect of past
stock option grants, there could be further delays in filing subsequent SEC reports that might
result in delisting of the Companys common stock from the Nasdaq Global Select Market.
Evaluation of internal control over financial reporting under the Sarbanes-Oxley Act of 2002
will continue to effect our results. Complying with the requirements of the Sarbanes-Oxley Act of
2002, and Nasdaqs conditions for continued listing have imposed significant legal and financial
compliance costs, and are expected to continue to impose significant costs and management burden on
us.
Additionally, we cannot be sure that we will be able to successfully remediate the currently
reported material weakness in our system of internal control over financial reporting. Our efforts
to comply with Section 404 of the Sarbanes-Oxley Act and the related regulations regarding our
required assessment of our internal control over financial reporting and our external auditors
audit of the assessment of our internal control over financial reporting continues to require the
commitment of significant financial and managerial resources.
There are risks associated with international operations that are different than those
inherent in the U.S. and our exposure to the risks of a global market could hinder our ability to
maintain and expand international operations. We have operation centers in the U.S., Canada, the
United Kingdom, Germany, France and Australia, as well as sales offices in Australia, Belgium,
Canada, China, Denmark, Finland, France, Germany, Hong Kong, Italy, the Netherlands, Norway,
Singapore, Spain, Sweden, Switzerland, the United Kingdom and the U.S., and sales presence in
Austria, Ireland, Japan, New Zealand and Russia. In the regions in which we do not currently have
a physical presence, such as Africa and India, we serve our clients through strategic
relationships. In implementing our international strategy, we may face barriers to entry and
competition from local companies and other companies that already have established global
businesses, as well as the risks generally associated with
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conducting business internationally.
The success and profitability of international operations are subject to numerous risks and
uncertainties, many of which are outside of our control, such as:
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In addition, until a payment history is established with clients in a new region, the
likelihood of collecting receivables generated by such operations, on a timely basis or at all,
could be less than expected. As a result, there is a greater risk that reserves established with
respect to the collection of such receivables may be inadequate. Furthermore, changes in policies
and/or laws of the U.S. or foreign governments resulting in, among other things, higher taxation,
currency conversion limitations or the expropriation of private enterprises could reduce the
anticipated benefits of their international operations. Any actions by countries in which we
conduct business to reverse policies that encourage foreign trade could have a material adverse
effect on our results of operations and financial condition.
The acquisition of Software Spectrum utilized the majority of our cash balances, increased our
outstanding debt and interest expense and lowered the availability on our financing facilities, all
of which could have a material adverse effect on our results of operations and financial condition.
Our financing facilities include a $225.0 million accounts receivable securitization financing
facility, a $75.0 million revolving line of credit and a $75.0 million five-year term loan. As of
September 30, 2006, we had $279.0 million outstanding under these facilities and approximately
$130.0 million, including $37.5 million of increased availability upon our request, was available.
The availability under the accounts receivable securitization facility is subject to formulas based
on our eligible trade accounts receivable. The accounts receivable securitization financing
facility expires in September 2009, and the revolving credit facility expires in September 2011.
Additionally, most of our financing facilities have variable interest rates, which increases our
exposure to interest rate fluctuations and may result in greater interest expense than we have
forecasted.
International operations expose us to currency exchange risk and we cannot predict the effect
of future exchange rate fluctuations on our business and operating results. International
operations are sensitive to currency exchange risks. We have currency exposure arising from both
sales and purchases denominated in foreign currencies. Changes in exchange rates between foreign
currencies and the U.S. dollar may adversely affect our operating margins. For example, if these
foreign currencies appreciate against the U.S. dollar, it will become more expensive in U.S.
dollars to pay expenses with foreign currencies. In addition, currency devaluation against the
U.S. dollar can result in a loss to us if we hold deposits of that currency. We currently do not
conduct any hedging activities, and, to the extent that we continue not to do so in the future, we
may be vulnerable to the effects of currency exchange-rate fluctuations. In addition, some currencies are
subject to limitations on conversion into other currencies, which can limit the ability to
otherwise react to rapid foreign currency devaluations. We cannot predict the effect of future
exchange-rate fluctuations on business and operating results and significant rate fluctuations
could have a material adverse effect on results of operations and financial condition.
International operations also expose us to currency fluctuations as we translate the financial
statements of our foreign operations to U. S. dollars. Although the effect of currency
fluctuations on our financial statements has not generally been material in the past, there can be
no guarantee that the effect of currency fluctuations will not be material in the future.
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Sales of software licenses are subject to seasonal changes in demand and resulting sales
activities. With the acquisition of Software Spectrum, our product mix changed significantly.
Prior to the acquisition of Software Spectrum, software sales represented approximately 12% of net
sales. After the acquisition of Software Spectrum, software sales represent approximately 35% to
40% of annual net sales. Our software business is subject to seasonal change. In particular,
software sales are seasonally much higher in our second and fourth quarter. As a result, our
quarterly results will be materially affected by lower demand in the first and third quarter. A
majority of our costs are not variable and therefore a substantial reduction in sales during a
quarter could have a negative effect on operating results. In addition, periods of higher sales
activities during certain quarters may require a greater use of working capital to fund the
business. During these periods, these increased working capital requirements could temporarily
increase our leverage and liquidity needs and expose us to greater financial risk during those
periods. Due to these seasonal changes, the operating results for any three-month period will not
necessarily be indicative of the results that may be achieved for any subsequent fiscal quarter or
for a full fiscal year.
We depend on certain key personnel. Our future success will be largely dependent on the
efforts of key management personnel. The loss of one or more of these new leaders could have a
material adverse effect on our business, results of operations and financial condition. We cannot
offer assurance that we will be able to continue to attract or retain highly qualified executive
personnel or that any such executive personnel will be able to increase stockholder value. We also
believe that our future success will be largely dependent on our continued ability to attract and
retain highly qualified management, sales, service and technical personnel. We cannot offer
assurance that we will be able to attract and retain such personnel. Further, we make a
significant investment in the training of our sales account executives. Our inability to retain
such personnel or to train them either rapidly enough to meet our expanding needs or in an
effective manner for quickly changing market conditions could cause a decrease in the overall
quality and efficiency of our sales staff, which could have a material adverse effect on our
business, results of operations and financial condition.
If purchased goodwill or amortizable intangible assets become impaired, we may be required to
record a significant charge to earnings. The purchase price allocation for the acquisition of
Software Spectrum resulted in a material amount allocated to goodwill and amortizable intangible
assets. In accordance with GAAP, we review our amortizable intangible assets for impairment when
events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is
required to be tested for impairment at least annually. Factors that may be considered a change in
circumstances indicating that the carrying value of our goodwill or amortizable intangible assets
may not be recoverable include a decline in stock price and market capitalization, reduced future
cash flow estimates, and slower growth rates in our industry. We may be required to record a
significant non-cash charge to earnings in our consolidated financial statements during the period
in which any impairment of our goodwill or amortizable intangible assets is determined, resulting
in a negative effect on our results of operations.
The failure to comply with the terms and conditions of our public sector contracts could
result in, among other things, fines or other liabilities. Net sales to public sector clients are
derived from sales to federal, state and local governmental departments and agencies, as well as to
educational institutions, through open market sales and various contracts. Government contracting
is a highly regulated area. Noncompliance with government
procurement regulations or contract provisions could result in civil, criminal, and administrative
liability, including substantial monetary fines or damages, termination of government contracts,
and suspension, debarment or ineligibility from doing business with the government. In addition,
substantially all of our contracts in the public sector are terminable at any time for convenience
of the contracting agency or upon default. The effect of any of these possible actions by any
governmental department or agency or the adoption of new or modified procurement regulations or
practices could materially adversely affect our business, financial position and results of
operations.
We have very limited experience in outsourcing business functions to India. Early in 2006,
Software Spectrum entered into a business solutions partner agreement to outsource certain business
processes, such as credit and collections, accounts payable and other administrative and
back-office positions, to a third-party
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provider with operations in India. If we continue or
expand this outsourcing of certain business functions to India, we could be required to change our
existing operations and to adopt new policies and procedures for managing the third-party provider.
We have very limited experience in outsourcing business functions to India, and there is no
assurance that we will be successful in achieving meaningful cost reductions or greater resource
efficiency from utilizing this third-party provider. The outsourcing of business functions to
India may also cause disruption in our business that could have a material adverse effect on our
results of operations and financial condition.
Rapid changes in product standards may result in substantial inventory obsolescence. The IT
industry is characterized by rapid technological change and the frequent introduction of new
products and product enhancements, both of which can decrease demand for current products or render
them obsolete. In addition, in order to satisfy client demand, protect ourselves against product
shortages, obtain greater purchasing discounts and react to changes in original equipment
manufacturers terms and conditions, we may decide to carry relatively high inventory levels of
certain products that may have limited or no return privileges. There can be no assurance that we
will be able to avoid losses related to inventory obsolescence on these products.
We may not be able to protect out intellectual property adequately, and we may be subject to
intellectual property infringement claims. To protect our intellectual property, we rely on
copyright and trademark laws, unpatented proprietary know-how, and trade secrets and patents, as
well as confidentiality, invention assignment, non-competition and non-solicitation agreements.
There can be no assurance that these measures will afford us sufficient protection of our
intellectual property, and it is possible that third parties may copy or otherwise obtain and use
our proprietary information without authorization or otherwise infringe on our intellectual
property rights. The disclosure of our trade secrets could impair our competitive position and
could have a material adverse effect on our business relationships, results of operations,
financial condition and future growth prospects. Likewise, many businesses are actively investing
in, developing and seeking protection for intellectual property in the areas of search, indexing,
e-commerce and other Web-related technologies, as well as a variety of on-line business models and
methods, all of which are in addition to traditional research and development efforts for IT
products and application software. As a result, disputes regarding the ownership of these
technologies are likely to arise in the future, and, from time to time, parties do assert various
infringement claims against us in the form of cease-and-desist letters, lawsuits and other
communications. If there is a determination that we have infringed the proprietary rights of
others, we could incur substantial monetary liability, be forced to stop selling infringing
products or providing infringing services, be required to enter into costly royalty or licensing
agreements, if available, or be prevented from using the rights, which could force us to change our
business practices in the future. As a result, these types of claims could have a material adverse
effect on our business, results of operations and financial condition.
We issue equity-based awards, such as restricted stock units under our long-term incentive
plans, and these issuances dilute the interests of stockholders. We have reserved shares of our
common stock for issuance under our 1998 Ling-Term Incentive Plan (the 1998 LTIP) and our 1999
Broad Based Employee Stock Option Plan. As approved by our stockholders, our 1998 LTIP provides
that additional shares of common stock may be reserved for issuance based on a formula contained in
that plan. The formula provides that the total number of shares of common stock remaining for
grant under the 1998 LTIP and any of our other option plans, plus the
number of shares subject to unexercised options and unvested grants of restricted stock granted
under any plan, shall not exceed 20% of the outstanding shares of our common stock at the time of
calculation of the additional shares. Therefore, we reserve additional shares on an ongoing basis
for issuance under this plan. At September 30, 2006, we had options outstanding to acquire
5,483,362 shares of common stock and there were 78,332 shares of restricted common stock and
630,437 restricted common stock units unreleased. Based on the 1998 LTIP formula, we had 3,553,435
shares of common stock available for grant at September 30, 2006.
When stock options with an exercise price lower than the current market price are exercised,
the risk increases that our stockholders will experience dilution of earnings per share due to the
increased number of shares outstanding. Also, the terms upon which we will be able to obtain
equity capital may be affected, because
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the holders of outstanding options can be expected to
exercise them at a time when we would, in all likelihood, be able to obtain needed capital on terms
more favorable to us than those provided in outstanding options.
Some anti-takeover provisions contained in our certificate of incorporation, bylaws and
stockholders rights agreement, as well as provisions of Delaware law and executive employment
contracts, could impair a takeover attempt. We have provisions in our certificate of incorporation
and bylaws which could have the effect (separately, or in combination) of rendering more difficult
or discouraging an acquisition deemed undesirable by our Board of Directors. These include
provisions:
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authorizing blank check preferred stock, which could be issued with voting, liquidation,
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limiting the ability of our stockholders to call special meetings; |
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requiring advance notice of stockholder proposals for business to be conducted at
meetings of our stockholders and for nominations of candidates for election to our Board of
Directors; |
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controlling the procedures for conduct of Board and stockholder meetings and election
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specifying that stockholders may take action only at a duly called annual or special
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These provisions, alone or together, could deter or delay hostile takeovers, proxy contests
and changes in control or management. As a Delaware corporation, we are also subject to provisions
of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents some
stockholders from engaging in certain business combinations without approval of the holders of
substantially all of our outstanding common stock.
On December 14, 1998, each stockholder of record received one Preferred Share Purchase Right
(Right) for each outstanding share of common stock owned. Each Right entitles stockholders to
buy .00148 of a share of our Series A Preferred Stock at an exercise price of $88.88. The Rights
will be exercisable if a person or group acquires 15% or more of our common stock or announces a
tender offer for 15% or more of the common stock. However, should this occur, the Right will
entitle its holder to purchase, at the Rights exercise price, a number of shares of common stock
having a market value at the time of twice the Rights exercise price. Rights held by the 15%
holder will become void and will not be exercisable to purchase shares at the bargain purchase
price. If we are acquired in a merger or other business combination transaction after a person
acquires 15% or more of the our common stock, each Right will entitle its holder to purchase at the
Rights then current exercise price a number of the acquiring companys common shares having a
market value at the time of twice the Rights exercise price.
Additionally, we have employment agreements with certain officers and management teammates
under which severance payments would become payable in the event of specified terminations without
cause or terminations under certain circumstances after a change in control. If such persons were
terminated without cause or under certain circumstances after a change of control, and the
severance payments under the current
employment agreements were to become payable, the severance payments would generally be equal to
either one or two times the persons annual salary and bonus.
Any provision of our certificate of incorporation, bylaws or employment agreements, or
Delaware law that has the effect of delaying or deterring a change in control could limit the
opportunity for our stockholders to receive a premium for their shares of our common stock and also
could affect the price that some investors are willing to pay for our common stock.
Sales of additional common stock and securities convertible into our common stock may dilute
the voting power of current holders. We may issue equity securities in the future whose terms and
rights are superior to those of our common stock. Our certificate of incorporation authorizes the
issuance of up to 3,000,000 shares of
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of preferred stock. These are blank check preferred shares,
meaning our Board of Directors is authorized, from time to time, to issue the shares and designate
their voting, conversion and other rights, including rights superior, or preferential, to rights of
already outstanding shares, all without stockholder consent. No preferred shares are outstanding,
and we currently do not intend to issue any shares of preferred stock. Any shares of preferred
stock that may be issued in the future could be given voting and conversion rights that could
dilute the voting power and equity of existing holders of shares of common stock and have
preferences over shares of common stock with respect to dividends and liquidation rights.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
There were no unregistered sales of equity securities during the three months ended September
30, 2006.
We have never paid a cash dividend on our common stock, and our financing facilities prohibit
the payment of cash dividends without the lenders consent.
Issuer Purchases of Equity Securities
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(c) |
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(d) |
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(a) |
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Total Number of Shares |
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Approximate Dollar Value |
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Total Number |
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(b) |
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Purchased as Part of |
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of Shares That May Yet be |
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of Shares |
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Average Price |
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Publicly Announced |
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Purchased Under the Plans |
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Period |
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Purchased |
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Paid per Share |
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Plans or Programs |
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or Programs1 |
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July 1, 2006 through
July 31, 2006 |
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$ |
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$ |
50,000,000 |
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August 1, 2006 through
August 31, 2006 |
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50,000,000 |
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September 1, 2006 through
September 30, 2006 |
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50,000,000 |
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Total |
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1 |
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On January 26, 2006, we announced that our Board of Directors had authorized the
repurchase of up to $50,000,000 of our common stock. We made no repurchases under this program during the three
months ended September 30, 2006. |
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
70
INSIGHT ENTERPRISES, INC.
Item 6. Exhibits.
(a) Exhibits. (Unless otherwise noted, exhibits are filed herewith.)
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Exhibit No. |
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Description |
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3.1
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Amended and Restated Certificate of Incorporation of Insight Enterprises, Inc.
(incorporated by reference to Exhibit 3.1 of our Annual Report on Form 10-K for
the year ended December 31, 2005 filed on February 17, 2006, File No. 0-25092). |
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3.2
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Certificate of Amendment to the Amended and Restated Certificate of Incorporation
of Insight Enterprises, Inc. (incorporated by reference to Exhibit 3.2 of our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed on
August 5, 2005, File No. 0-25092). |
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3.3
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Amended and Restated Bylaws of the Insight Enterprises, Inc. (incorporated by
reference to Exhibit 3.2 of our Annual Report on Form 10-K for the year ended
December 31, 1999 filed on March 30, 2000, File No. 0-25092). |
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4.1
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Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 of
our Registration Statement on Form S-1 (No. 33-86142) declared effective January
24, 1995). |
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4.2
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Rights Agreement (incorporated by reference to Exhibit 4.1 of our Current Report
on Form 8-K filed on March 17, 1999, File No. 0-25092). |
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10.1
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Stock Purchase Agreement, dated as of July 20, 2006, by and among Insight
Enterprises, Inc., Level 3 Communications, Inc. and Technology Spectrum Inc.
(incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K
filed on July 21, 2006, File No. 0-25092). |
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10.2
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Amended and Restated Credit Agreement, dated as of September 7, 2006, among
Insight Enterprises, Inc., the European borrowers, the lenders party thereto,
J.P. Morgan Europe Limited, as European agent, and JPMorgan Chase Bank, N.A., as
administrative agent (incorporated by reference to Exhibit 10.1 of our Current
Report on Form 8-K filed on September 8, 2006, File No. 0-25092). |
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10.3
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Amendment No. 7 to Receivables Purchase Agreement, dated as of September 7, 2006,
among Insight Receivables, LLC, Insight Enterprises, Inc., JPMorgan Chase Bank,
N.A. (successor by merger to Bank One, NA (Main Office Chicago)), as a Financial
Institution and as Agent, and Jupiter Securitization Company LLC (formerly
Jupiter Securitization Corporation) (incorporated by reference to Exhibit 10.2 of
our Current Report on Form 8-K filed on September 8, 2006, File No. 0-25092). |
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31.1
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Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. |
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31.2
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Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. |
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32.1
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Section 1350 Certification of Chief Executive Officer and Chief Financial Officer. |
71
INSIGHT ENTERPRISES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Date: July 25, 2007 |
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INSIGHT ENTERPRISES, INC. |
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By:
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/s/ Richard A. Fennessy |
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Richard A. Fennessy |
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President and Chief Executive Officer |
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By:
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/s/ Stanley Laybourne |
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Stanley Laybourne |
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Chief Financial Officer, Secretary |
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and Treasurer |
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(Principal financial officer) |
72