| INSIGHT ENTERPRISES INC Item 1A Risk Factors Changes in the information technology industry and/or economic environment may reduce demand for the products 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, computer products, peripherals and software and IT 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 suppliers, 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 17 _________________________________________________________________ [71]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES and opportunities to increase market share |
| In addition, our expense levels, including marketing, the costs of facilities expansion, acquisitions 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 supplier reimbursements and marketing funds |
| 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 suppliers for product availability, marketing funds, purchasing incentives and competitive products to sell |
| We acquire products for resale both directly from manufacturers and indirectly through distributors |
| The loss of a supplier could cause a disruption in the availability of products |
| Additionally, there is no assurance that as manufacturers 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 |
| Although not as prevalent in recent years, certain of the products offered from time to time by us 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 suppliers could increase our cost of working capital and have a material adverse effect on our business, results of operations and financial condition |
| Certain manufacturers 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 |
| Supplier funds are used to offset, among other things, inventory, cost of goods sold, marketing costs and other operating expenses |
| 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 our manufacturers |
| Additionally, suppliers 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 could have a material adverse effect on our business, results of operations and financial condition |
| Although product is available from multiple sources via the distribution channel as well as directly from manufacturers, we rely on the manufacturers of products we offer not only for product availability and supplier reimbursements, but also for development and marketing of products that compete effectively with products of manufacturers we do not currently offer, particularly Dell |
| We do have the ability to sell, and periodically have sold, Dell product if it is specifically requested by our clients and approved by Dell, although we do not proactively advertise or offer Dell products |
| In May 2005, Lenovo, the leading personal computer brand in China, acquired IBM’s Personal Computing Division to form the world’s third-largest PC business |
| IBM is a significant supplier to Insight and was the largest client of Direct Alliance |
| Direct Alliance has entered into separate contracts with IBM and Lenovo representing pro-rata portions of the contract that Direct Alliance previously had with IBM These contracts were effective upon completion of Lenovo’s purchase of IBM’s Personal Computing Division |
| We do not know specifically how this sale will affect our relationships over the long-term with IBM or Lenovo, and we cannot assure you that changes in these relationships will not have a material adverse effect on our business, results of operations and financial condition |
| The IT products and services industry is intensely competitive and actions of competitors, including manufacturers 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, including manufacturers of products we sell, as well as a large number and wide variety of marketers and resellers of IT products and services |
| Product manufacturers, in particular, have programs to sell directly to the business client, particularly larger corporate clients and thus, are a competitive threat to us |
| In addition, manufacturers are increasing the volume of software products distributed electronically directly to end-users and in the future will likely pay lower referral fees for sales of certain software licensing agreements sold by us |
| 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 and direct marketers to increase efficiency 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 18 _________________________________________________________________ [72]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES 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 |
| Disruptions in our information technology 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 clients |
| Our ability to provide such services 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 across all of Insight’s operations serving United States clients |
| We have been making and will continue to make enhancements and upgrades to the system including a planned upgrade to mySAP during 2006 |
| Over the next few years, we plan to convert Insight’s United Kingdom and Canadian operations to this software platform |
| 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 |
| 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 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 |
| We rely on a limited number of outsourcing clients |
| Through our Direct Alliance operating segment, which represented 2prca and 11prca of our consolidated net sales and earnings from operations, respectively, for the year ended December 31, 2005, we perform business process outsourcing services for a small number of clients in the IT, consumer electronics, software, warranties, service contracts and office automation industries pursuant to various contracted arrangements |
| For the year ended December 31, 2005, one outsourcing client accounted for approximately 28prca of Direct Alliance’s net sales and our three largest outsourcing clients accounted for approximately 76prca of net sales |
| For the year ended December 31, 2004, one outsourcing client accounted for approximately 60prca of Direct Alliance’s net sales and our three largest outsourcing clients accounted for approximately 88prca of net sales |
| The declines from prior year in concentration with Direct Alliance’s largest clients reflects the fact that the historical contract with Direct Alliance’s largest client, IBM, was replaced in May 2005 with separate contracts with IBM and Lenovo which expire at the end of 2006 |
| Although the contracts with these clients are generally multi-year contracts, these clients may cancel their contracts under certain circumstances on relatively short notice, elect to not renew them upon expiration or renew them only on terms that are less favorable to us |
| There is no assurance that we will be able to replace any outsourcing clients that terminate or fail to renew their relationships with us or that we will be able to renew existing contracts on terms that are as favorable to us as the current terms |
| Additionally, we seek to expand our offerings both within and outside of the computer industry |
| The failure to maintain current arrangements or the inability to enter into new ones within or outside the computer industry could have a material adverse effect on our business, results of operations and financial condition |
| The majority of our current outsourcing business is with clients who are manufacturers in the IT industry and are, therefore, subject to similar industry risks that we face, with respect to our Insight North America operations |
| These risks may negatively affect the amount of business our clients outsource to us and the performance fees we receive from clients that are based on the volume of client product we sell or process through our systems |
| 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 19 _________________________________________________________________ [73]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES addition, substantially all of our contracts in the public sector are terminable at any time for convenience 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 |
| There are risks associated with international operations that are different than those inherent in the United States business |
| We currently have operations in the United Kingdom and Canada and may expand operations further globally |
| 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 conducting business internationally |
| These risks include local labor conditions and regulations, the ability to attract and retain suitable local management, exposure to currency fluctuations, limitations on foreign investment, potential tax exposure in repatriating earnings, and the additional expense and risks inherent in operating in geographically and culturally diverse locations |
| Because we may continue to develop our international business through acquisitions, we may also be subject to risks associated with such acquisitions, including those relating to combining different corporate cultures and shared decision-making |
| There can be no assurance that we will succeed in increasing our international business or do so in a profitable manner |
| International operations also expose us to currency fluctuations as we translate the financial statements of our United Kingdom and Canadian operations to US dollars |
| Although the effect of currency fluctuations on our financial results 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 |
| In particular, there has been a trend toward a strengthening US dollar relative to the British pound sterling |
| If this trend continues, it could have a negative effect on our financial condition and results of operations |
| We depend on certain key personnel |
| Our future success will be largely dependent on the efforts of key management personnel |
| and the President of Direct Alliance with new key personnel |
| The loss of one or more of these key teammates could have a material adverse effect on our business, results of operations and financial condition |
| We cannot assure you 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 lead us in directions that will 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 assure you 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 |
| Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain teammates, and changes in accounting for equity compensation will adversely affect earnings |
| We have historically used equity based compensation, primarily in the form of stock options, as a key component of total teammate compensation in order to align teammates’ interests with the interests of our stockholders, encourage teammate retention and provide competitive compensation packages |
| Volatility or lack of positive performance in our stock price may adversely affect our ability to retain key teammates, all of whom have been granted stock based compensation, or attract additional highly qualified personnel |
| To the extent these circumstances continue or recur, our ability to retain present teammates may be adversely affected |
| In addition, changes to GAAP require compensation expense to be recorded for stock option grants and other equity based compensation beginning January 1, 2006 |
| Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to teammates in the future |
| As a result, in addition to recording additional compensation expense, we may incur increased compensation costs, change our stock compensation strategy or find it difficult to use stock based compensation to attract, retain and motivate teammates, any of which could materially adversely affect our business |
| Additionally, some of our competitors modified their outstanding stock options in 2005 and, as a result, will decrease the amount of equity compensation expense related to the modified stock options in their future statements of earnings |
| This could result in our equity compensation expense being greater than our competitors in future periods |
| The integration and operation of future acquired businesses may disrupt our business, create additional expenses and utilize cash or debt availability |
| Over the past few years, we completed acquisitions in the United States, the United Kingdom and Canada |
| These acquired operations have been fully integrated and now comprise a material portion of our business |
| Our strategy includes the possible acquisition of other businesses to expand or complement our operations |
| An acquisition involves numerous risks, including difficulties in the conversion of IT systems and assimilation of operations of the acquired company, the diversion of management’s attention from other business concerns, risks of entering markets in 20 _________________________________________________________________ [74]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES which we have had no or only limited direct experience, assumption of unknown liabilities and the potential loss of key teammates and/or clients of the acquired company, all of which in turn could have a material adverse effect on our business, results of operations and financial condition |
| The magnitude, timing and nature of any future acquisitions will depend on a number of factors, including the availability of suitable acquisition candidates, the negotiation of acceptable terms, our financial capabilities and general economic and business conditions |
| There is no assurance that we will identify acquisition candidates that would result in successful combinations or that any acquisitions will be consummated at all or on acceptable terms |
| Any future acquisitions may result in potentially dilutive issuances of equity securities, the incurrence of additional debt, the utilization of cash, amortization of expenses related to identifiable intangible assets and future impairments of acquired goodwill, all of which could adversely affect our profitability |
| 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 |
| Our principal financing facility expires in December 2006, and if we are unable to renew this facility or replace it on acceptable terms, we may incur higher interest expenses or your equity interests may be diluted |
| Our financing facilities include a dlra200dtta0 million accounts receivable securitization financing facility, a dlra30dtta0 million revolving line of credit and a dlra40dtta0 million inventories financing facility |
| The availability under each of these facilities is subject to formulas based on our eligible trade accounts receivable or inventories |
| As of December 31, 2005, the aggregate outstanding balance under these facilities was dlra70dtta6 million, and we had dlra193dtta2 million available |
| The accounts receivable securitization financing facility expires in December 2006, the line of credit expires on December 31, 2008 and the inventories financing facility expires March 31, 2006 |
| We have no reason to believe the accounts receivable securitization financing facility will not be renewed before the end of 2006 and we are currently evaluating whether to renew our inventories financing facility |
| However, it is possible that we may be unable to renew our existing accounts receivable securitization financing facility or secure alternative financing or, if we are able to renew our existing accounts receivable securitization financing facility or secure alternative financing, it may be on less favorable terms, such as higher interest rates |
| If we were unable to renew our existing accounts receivable securitization financing facility or secure alternative financing, we may be required to seek other financing alternatives such as selling additional equity securities or convertible debt securities that would dilute the equity interests of current stockholders |
| We cannot assure you that we will be able to obtain such financing on terms favorable to us or at all |
| We may be subject to intellectual property infringement claims, which are costly to defend and could limit our ability to provide certain content or use certain technologies in the future |
| Many parties are actively developing search, indexing, e-commerce and other web-related technologies, as well as a variety of online business models and methods, all of which are in addition to traditional research and development efforts for IT products and application software |
| We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection |
| As a result, disputes regarding the ownership of these technologies and rights associated with online business and new hardware and software offerings are likely to arise in the future |
| In addition to existing patents and intellectual property rights, we anticipate that additional third party patents related to our services will be issued in the future |
| From time to time, parties assert patent 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 options and restricted stock shares and 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 Long Term Incentive Plan (the “1998 LTIP”) and our 1999 Broad—Based Incentive 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 20prca 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 December 31, 2005, we had options outstanding to acquire 7cmam122cmam391 shares of common stock and there were 122cmam500 shares of restricted 21 _________________________________________________________________ [75]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES common stock and 7cmam500 restricted common stock units outstanding |
| Based on the 1998 LTIP formula, we had 2cmam294cmam915 shares of common stock available for grant at December 31, 2005 |
| Additionally, we have reserved 15prca of the outstanding shares of common stock of our subsidiary, Direct Alliance, under the Direct Alliance 2000 Long-Term Incentive Plan |
| At December 31, 2005, we had options outstanding to acquire 2cmam042cmam500 shares of common stock of Direct Alliance, representing 6dtta8prca of the outstanding common stock of Direct Alliance, at a weighted average exercise price of dlra1dtta42 |
| These stock options vested on May 5, 2005 and expire on May 5, 2006 |
| If option holders exercise these options, they will become minority stockholders of Direct Alliance, and the percentage of Direct Alliance’s net earnings attributable to minority stockholders will not be included in our consolidated statement of earnings |
| As of December 31, 2005, none of the 2cmam042cmam500 outstanding options have been exercised |
| 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 |
| 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: • authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; • limiting the liability of, and providing indemnification to, directors and officers; • limiting the ability of our stockholders to call special meetings; • 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; • controlling the procedures for conduct of Board and stockholder meetings and election and removal of directors; and • specifying that stockholders may take action only at a duly called annual or special meeting of stockholders |
| 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 dlra88dtta88 |
| The Rights will be exercisable if a person or group acquires 15prca or more of our common stock or announces a tender offer for 15prca or more of the common stock |
| However, should this occur, the Right will entitle its holder to purchase, at the Right’s exercise price, a number of shares of common stock having a market value at the time of twice the Right’s exercise price |
| Rights held by the 15prca 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 15prca or more of the our common stock, each Right will entitle its holder to purchase at the Right’s then current exercise price a number of the acquiring company’s common shares having a market value at the time of twice the Right’s 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 |
| 22 _________________________________________________________________ [76]Table of Contents INSIGHT ENTERPRISES, INC AND SUBSIDIARIES 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 3cmam000cmam000 shares 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, all without stockholder consent |
| No preferred shares are outstanding, and we currently do not intend to issue any shares of preferred stock in the foreseeable future |
| 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 |