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Operator
Good day, ladies and gentlemen, and welcome to the Insight Enterprises' Third Quarter 2014 Operating Results Call.
At this time, all participants are in a listen-only mode.
Later, we will conduct a question-and-answer session and instructions will follow at that time.
(Operator Instructions) As a reminder, this conference is being recorded.
I would like to introduce your host for today's conference, Chief Financial Officer, Ms. Glynis Bryan.
Ma'am, you may begin.
Glynis Bryan - CFO
Thank you.
Welcome everyone and thank you for joining the Insight Enterprises conference call.
Today, we will be discussing the Company's operating results for the quarter ended September 30, 2014.
I am Glynis Bryan, Chief Financial Officer of Insight and joining me is Ken Lamneck, President and Chief Executive Officer.
If you do not have a copy of the earnings release that was posted this afternoon and filed with the Securities and Exchange Commission on Form 8-K, you will find it on our website at insight.com under our Investor Relations section.
Today's call, including the question-and-answer period, is being webcast live and can be accessed via the Investor Relations page of our website at insight.com.
An archived copy of the conference call will be available approximately two hours after completion of the call and will remain on our website for a limited time.
This conference call and the associated webcast contain time-sensitive information that is accurate only as of today, October 29, 2014.
This call is a property of Insight Enterprises.
Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Insight Enterprises is strictly prohibited.
In today's conference call, we will refer to non-GAAP financial measures as we discuss the third quarter 2014 financial results.
You will find a reconciliation of these non-GAAP measures to our actual GAAP results included in the press release issued earlier today.
Finally, let me remind you about forward-looking statements that will be made on today's call.
All forward-looking statements that are made in this conference call are subject to risks and uncertainties that could cause our actual results to differ materially.
These risks are discussed in today's press release and in greater detail in our Annual Report on Form 10-K for the year ended December 31, 2013.
With that, I will now turn the call over to Ken to give you an overview of our third quarter 2014 operating results.
Ken?
Ken Lamneck - President and CEO
Hello, everyone.
Thank you for joining us today to discuss our third quarter 2014 operating results.
In the third quarter, consolidated net sales were $1.24 billion, up 8% year-over-year in US dollars and up 7% in constant currency.
We are pleased to report that we saw topline growth in all three of our geographic operating segments and each of our major product categories of hardware, software and services.
Gross profit increased 2% year-over-year to $172 million, while gross margin of 13.9% decreased 80 basis points.
This gross margin performance was driven by the previously-announced partner program changes in the software category and lower vendor funding from the data center product sales in the hardware category.
Consolidated selling and administrative expenses increased 2% year-over-year in the third quarter, reflecting investment in sales, technical and services headcount in North America business.
All of this resulted in consolidated earnings from operations, excluding severance and restructuring expenses of $28.7 million, consistent with the same quarter last year.
On a GAAP basis, earnings from operations increased 8% to $28.4 million, and diluted earnings per share, excluding severance and restructuring expenses, increased 10% year-over-year to $0.43.
On a GAAP basis, diluted earnings per share were $0.42 in the third quarter.
Within these results, North America business reported topline sales growth of 4% year-over-year in the third quarter.
We saw sales growth across large enterprise, mid-market and public sector with particular strong performance to the federal government clients at their fiscal year-end.
In the hardware category, notebook and desktop sales continued to show strong growth.
And increased demand for business productivity, virtualization and security software solutions drove a 5% increase in software sales for the quarter.
Finally, services sales increased 6% year-over-year, driven by more consulting service arrangements, multi-site deployments and new projects running through our integration labs.
In EMEA, we continued to see improved sales execution and discipline, which drove topline improvement of 19% year-over-year in US dollars and 15% in constant currency.
Our EMEA team delivered double-digit topline growth across each of the hardware, software and services categories in the third quarter.
Higher sales of notebooks, desktops, tablets and servers as well as increased demand for business productivity products drove the sales performance year-over-year.
By country, we saw nice topline growth in the UK, Germany and France and even stronger growth in smaller markets like Italy and Spain.
In Asia Pacific, net sales increased 11% year-over-year, reflecting higher software sales volume with public sector and mid-market clients.
I'll now hand the call over to Glynis, who will discuss our third quarter financial results in more detail.
Glynis Bryan - CFO
Thank you.
Starting with North America, net sales in North America were $891 million in the third quarter, up 4% year-over-year.
Sales in the hardware category increased 3% year-over-year and 7% sequentially.
Software and services sales increased 5% and 6% respectively year-over-year.
Gross profit in North America decreased 2% year-over-year to $120 million and gross margin decreased 80 basis points to 13.5%.
This decrease in gross margin was primarily driven by lower fees earned on software enterprise agreements and lower vendor funding on the certain hardware programs in the quarter.
Selling and administrative expenses for North America in this third quarter were up $1.3 million year-over-year, and on a non-GAAP basis were up $5 million sequentially to $94.4 million.
This increase is primarily due to the addition of sales and related headcounts in the business.
As Ken noted earlier, we have been investing in headcount in our North America business in 2014.
In addition, we have been experiencing significantly higher health benefit expenses so far this year, a trend we expect to continue going forward.
As a result, we expect our operating expenses in the fourth quarter will increase slightly from levels seen in the third quarter in this segment.
In the third quarter, we recorded net severance expense of $102,000 in this segment, down from $530,000 reported in the same period last year.
Earnings from operations in North America were $25.8 million in the third quarter of 2014, down 13% from $29.9 million in the same quarter last year, excluding severance expenses in both periods.
We also expect to report a decline in earnings from operations year-over-year in the fourth quarter of approximately the same amount seen in the third quarter driven by the increased SG&A investment I mentioned a moment ago.
Moving on to EMEA.
Our EMEA operating segment reported net sales of $314 million, an increase of 19% year-over-year in US dollars.
In constant currency, net sales increased 15%.
Also in constant currency, hardware sales increased 10% year-over-year due to continued strength in our UK business.
Sales of software increased 19% reflecting higher growth with large and public sector clients and services sales increased 14% year-over-year also in constant currency.
Gross profit in EMEA was $45 million, an increase of 14% year-over-year in US dollars, and an increase of 11% in constant currency with gross margin declining 60 basis points to 14.3% year-over-year.
This decrease in gross margin is primarily due to partner program changes resulting in lower vendor funding and fees from enterprise agreements [in the software order].
Selling and administrative expenses in EMEA in the third quarter were up 4% in US dollars and flat year-to-year in constant currency terms.
In the third quarter, we recorded net severance expense of $209,000 in this segment, down from $1.9 million reported in the same period last year.
Excluding severance expenses, earnings from operations in EMEA were $2.2 million in this third quarter, up significantly from the operating loss of $1.9 million reported in the third quarter of last year.
Moving on to Asia Pacific.
Our Asia Pacific operating segment reported net sales of $33 million, up 11% year-over-year in US dollars and up 10% in constant currency.
Gross profit was $6.7 million, increasing 5% in US dollars and 4% in constant currency.
Gross margin in APAC decreased 110 basis points due to the relative mix of software business transaction in the quarter.
And selling and administrative expenses in APAC increased in this year's third quarter due to investments in headcount.
Earnings from operations in Asia Pacific was $646,000 in the third quarter, down from $730,000 in the last year's third quarter.
With respect to our tax rate, our effective tax rate in the third quarter was 34.1%, down from 37.8% in the third quarter of last year due to the release of certain tax reserves in the quarter.
Moving on to the cash flow performance, in the nine months ended September 30, 2014, our operations generated $48 million of cash, down from $67 million in the same period last year.
This decrease is due to investments in inventory to support specific client engagements occurring over the next few months and higher working capital requirements and higher sales this year.
We invested $8 million in capital expenditures in the first nine months of 2014, down from $14 million in the same period last year, reflecting lower IT investment.
We also spent $30 million to repurchase approximately 1.3 million shares of our common stock.
We ended the third quarter with a cash balance of $127 million, of which $108 million was resident in foreign subsidiaries, and we had $25 million of debt outstanding under that facility.
This compares to $135 million of cash and $88 million of debt outstanding at the end of the third quarter 2013.
From a cash efficiency perspective, our cash conversion cycle is 30 days in the third quarter, down one day from last year due to lower days sales outstanding primarily in EMEA.
One last item before I turn the call back over to Ken.
As announced today, our Board of Directors has approved an additional authorization to repurchase up to $25 million of our common stock.
This $25 million authorization is in addition to the $12.6 million remaining under previous authorization.
These share repurchases will be made in the open market through block trades or through 10b5-1 plan.
We intend to commence this buyback program in the fourth quarter of 2014, subject to market conditions.
I will now turn the call back to Ken.
Ken Lamneck - President and CEO
Thank you, Glynis.
Moving on to our outlook for the fourth quarter, we currently expect diluted earnings per share to be between $0.54 and $0.60 in the fourth quarter.
For the full year 2014, earnings per share sure is expected to be between $1.99 and $2.05.
This outlook includes an effective tax rate of 38% for the fourth quarter.
This outlook does not reflect severance and restructuring expenses incurred during the year, where the non-cash charge related to our Illinois real estate recorded in the second quarter.
Thank you again for joining us today.
I want to thank our teammates, clients and partners for their dedication to Insight.
That concludes my comments.
We'll now open up your lines for questions.
Operator
(Operator Instructions) Matt Sheerin, Stifel.
Matt Sheerin - Analyst
Just a question regarding the SG&A expected increase in the December quarter.
How much related to expansion to investments in your resources, and adding folks versus those healthcare costs you talked about and could you give us an idea of how many account managers or sales folks you've added this year and plan to add this quarter?
Glynis Bryan - CFO
So just talking about the split between their increase, I would say it's about 60%/40%, 60%, 65% related to sales, related resources sales and technical resources, and about 30% to 35% associated with healthcare costs.
In terms of the number of sales people that we've added, we've added about 150 or so, in excess of 150 this year, not sure that we're commenting on the number that we're hiring this quarter.
Matt Sheerin - Analyst
Okay, what's the total headcount within your sales organization in North America?
Roughly.
Glynis Bryan - CFO
1,300.
Matt Sheerin - Analyst
1,300, okay.
Glynis Bryan - CFO
That's including sales support, the technical resources, pre-sales, etcetera.
Ken Lamneck - President and CEO
Sort of quota carrying.
Matt Sheerin - Analyst
And you're adding -- you obviously see opportunities, either for share gains, or you see IT spending environment still fairly stable right, Ken, I mean you wouldn't be putting these resources in place if you didn't right?
Ken Lamneck - President and CEO
That's exactly right Matt.
We definitely -- you see that there is certainly we can add more capacity to take advantage of the IT spending.
We want to obviously grow the services business faster as well and then of course there's resources being applied to the opportunities around specific verticals, as well as the cloud.
Matt Sheerin - Analyst
And Ken, what's your take on the corporate PC refresh that we've seen in the first half and a lot of concern about a drop-off there because of the Windows XP support sort of having come and gone, what's your sense of investments from customers in the PC cycle here?
Glynis Bryan - CFO
Yes, there's no question in that.
Of course, this past year was a catalyst with XP.
So we're certainly I don't think going to see that same degree, and now we're in a sort of a normal -- sort of four-year cycle of refresh I think for clients.
Of course there is continued growth in a lot of those numbers you're seeing there around [K to 12], which continues to spend quite a bit of money on notebooks and tablets for students.
So that's been an acceleration as well.
I do see that continuing probably for the next couple of years on the K to 12 side that I expect to get back to more normal levels in regards to commercial PC, desktop, notebook sales that was accelerated because of XP migration.
Matt Sheerin - Analyst
And then as -- just lastly from me, as we look into next year, your operating margins are sort of flattish this year with a little bit of revenue growth, but as you've talked about some headwinds and some investments, so looking into next year, if we see sort of a normal IT spending environment, low-to-mid single-digits, are you expecting to finally start to see leverage in your model kick in?
Glynis Bryan - CFO
I think that we're doing some investments now Matt with regard to driving revenue growth in 2015.
I think that some of that would translate through to the bottom line, but I'm not sure that I would say we're going to see significant margin expansion and we'll be updating you with regard to the guidance and the impact of the share repurchases in our February call, when we wrap up the 2014, and give the guidance for 2015.
Operator
Adam Dindo, Raymond James.
Adam Dindo - Analyst
Just curious, can you bridge us from your old EPS guidance of $2.02 to $2.10 to the new guidance $1.99 to $2.05, just more specifically are you expecting lower results than a quarter ago?
Is it mostly due to increased investments in North Carolina -- North America?
And if so, can you quantify that?
Ken Lamneck - President and CEO
Okay.
So we have seen higher investments and spend in North America related to investments in sales and technical and support resources to drive higher sales.
We've also seen the higher cost in our healthcare cost, about $1.5 million to $2 million sequentially in terms of an increase.
We are also looking to see what happened with our certain hardware categories in the third quarter.
We didn't get the velocity -- sales that we had anticipated with regard to getting and hitting certain partner thresholds.
So we had lower partner income than we had anticipated.
So I think that it is a combination of those pieces that are driving the change in our outlook going forward for the rest of this year.
Operator
At this time, I see no other questions in queue.
Sorry, we have a follow-up from Mr. Sheerin.
Your line is open.
Matt Sheerin - Analyst
Just the commentary about the lower vendor support you got on the data center products.
Was that specific to one vendor and the weakness that you saw there or was it across different vendors?
And was that a demand issue, just trying to figure out what exactly happened there.
Ken Lamneck - President and CEO
It's really just a couple of partners Matt that impacted it.
And the programs of course do change from quarter-to-quarter.
You've got to be pretty nimble and I think we could have executed a little bit better on the course always higher, higher demand would certainly always help mitigate that.
So I think it was not alarming for us, but it certainly was something that that impacted us in the quarter.
Matt Sheerin - Analyst
And again you're resetting your rebate thresholds quarter-to-quarter where you've got reasonable targets to hits this quarter or next quarter so that you should be able to get the margins back up.
Ken Lamneck - President and CEO
Yes, I mean we always spend on a weekly basis.
We actually review that data point.
So we stayed pretty close to that because it's an important part of our business.
So we're constantly tweaking those looking at those and look at where the real incentives are for us to make sure that we contribute to those areas.
Glynis Bryan - CFO
And Matt, the partners [have varied right], some are quarterly programs, some are half year programs.
So it really depends on the partner with regard to if it's a quarterly or a half year program.
Operator
(Operator Instructions) And we have a follow-up from Mr. Dindo as well.
Your line is open sir.
Adam Dindo - Analyst
Just want to follow-up there a little bit more specifically on what drove the acceleration in North America sales as well as Europe.
I know the Windows XP upgrade, it was mentioned that you do think that's behind us going forward.
Can you talk a little bit more, do you see any uptick from the PC refresh cycle this quarter and expect that to continue at all or drop off?
Ken Lamneck - President and CEO
Yes.
In North America and in Europe, it was pretty much across the board as far as hardware, software and services in regards to where we saw the growth.
So it's pretty well balanced.
As far as the specific commentary around the PC refresh cycle, our sense is that we weren't that heavily sort of skewed towards that business.
So as that starts to decline, we don't think that's going to be a significant sort of headwind for us in regards to that refresh cycle starting to diminish going forward, so we think there's -- we'll go back to a little bit more normalcy with that and we don't think that that will have an impact to us.
Operator
Thank you.
Ladies and gentlemen, thank you for your participation in today's conference.
This concludes your program, you may all disconnect.
Everyone have a great day.
Ken Lamneck - President and CEO
Thank you.
Glynis Bryan - CFO
Thank you.