CDW Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless otherwise noted. CDW provides IT products and integrated solutions to business, government, education and healthcare customers in the U.S., U.K. and Canada.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $4,629.9 million | $4,186.1 million | $8,587.8 million | $7,792.5 million |
| Gross profit | $773.8 million | $695.6 million | $1,445.9 million | $1,299.5 million |
| Gross margin | 16.7% | 16.6% | 16.8% | 16.7% |
| Operating income | $300.3 million | $265.5 million | $529.2 million | $469.6 million |
| Operating margin | 6.5% | 6.3% | 6.2% | 6.0% |
| Net income | $196.6 million | $173.0 million | $349.5 million | $300.0 million |
| Diluted EPS | $1.33 | $1.12 | $2.35 | $1.94 |
- Q2 sales increased 10.6%; management reported 11.2% growth on a constant-currency basis. First-half sales rose 10.2%, or 10.9% constant currency; average daily sales grew 11.1%, with one fewer selling day than in 2018.
- Growth was broad across segments and product categories. Q2 Corporate sales rose 8.7%, Small Business 14.5%, Public 12.5%, and Other (U.K. and Canada) 8.4%. First-half segment growth ranged from 9.6% in Other to 10.7% in Public, with Small Business up 11.5% and Corporate up 9.7%.
- Hardware remained the largest category: 80.4% of Q2 sales and 79.9% of first-half sales. Services grew to $223.4 million in Q2 from $166.3 million and to $420.0 million in the first half from $329.3 million.
- Management attributed margin improvement in part to a higher mix of revenues recorded net of costs, including warranties and software-as-a-service. Higher payroll costs partly offset gross-profit growth. Q2 Small Business operating margin fell to 7.0% from 7.4%; Other declined to 3.6% from 4.5%.
- Non-GAAP operating income was $358.4 million in Q2 and $645.7 million for the first half; respective margins were 7.7% and 7.5%, unchanged from the prior-year periods. Non-GAAP net income was $237.7 million and $423.1 million. These measures exclude specified items, including acquisition-related intangible amortization and equity compensation, and are not GAAP results.
Cash flow, debt and liquidity
- First-half operating cash flow was $414.5 million, compared with $332.3 million in 2018. Cash and cash equivalents were $194.5 million at June 30, 2019, versus $205.8 million at year-end 2018.
- First-half investing cash outflow was $118.9 million, including $75.0 million net cash paid for Scalar and $43.9 million of capital expenditures. Financing cash outflow was $305.2 million, including $332.2 million of share repurchases and $86.3 million of dividends. Cash decreased $11.3 million over the half-year.
- Total debt was approximately $3.3 billion; management reported net debt of $3,084.4 million. Debt increased from $3,208.6 million, including current maturities, at December 31, 2018. Interest expense, net, was $40.5 million in Q2 and $78.8 million in the first half.
- At June 30, CDW reported $973 million of additional borrowing availability under its U.S. asset-based revolver and approximately $63 million under its U.K. revolver. It was in compliance with debt covenants and stated it expected adequate liquidity for at least the next year. Inventory financing payables were $465.7 million, up from $429.3 million at year-end.
- The cash conversion cycle was 16 days, compared with 17 days a year earlier. The company cited higher customer-driven and strategic inventory stocking and changes in receivables and vendor payment terms.
Material changes, outlook and risks
- CDW acquired Scalar Decisions Inc., a Canadian technology solutions provider, on February 1 for a final purchase price of $88 million, including $13 million deferred for potential indemnity obligations. Scalar contributed to Canadian sales growth; the preliminary allocation included $61.8 million of goodwill, which is not tax deductible in Canada.
- CDW adopted the new lease accounting standard on January 1, 2019, recording $81 million of right-of-use assets and additional lease liabilities at adoption. At June 30, operating lease liabilities totaled $158.9 million. A further $99 million lease commitment was expected to commence in 2020.
- The filing provides no quantified full-year revenue or earnings guidance. Management described economic conditions, customer technology spending, government and education budgets, vendor product availability, competition and technology trends as factors affecting performance. It cited cloud, hybrid IT, security and “as-a-service” offerings as ongoing customer trends.
- Management noted uncertainty around Brexit, including potential currency volatility, trade restrictions and regulatory complexity; CDW UK had not seen significant customer buying changes to date. Currency translation reduced growth in Other during the reported periods.
- Other cited risks include substantial indebtedness and debt restrictions, supplier and product-flow disruption, customer receivables and inventory exposure, cybersecurity and IT-system risks, contract compliance, foreign exchange, and legal proceedings and audits. CDW said it did not believe a material loss beyond amounts already recognized was reasonably possible at June 30, while noting outcomes remain unpredictable.
- CDW repurchased 3.4 million shares for $332 million during the first half. The board declared a $0.295-per-share quarterly dividend on July 31, payable September 10, 2019; future dividends remain at the board’s discretion.
Important facts for investors to verify
- How much reported growth reflects underlying demand versus Scalar, product mix, foreign exchange and revenue recorded net of costs.
- Whether gross-margin gains persist and whether payroll and other operating costs remain controlled, particularly in Small Business and Other.
- Working-capital trends, including receivables, inventory, vendor payment terms and the conversion of operating cash flow to cash after acquisition spending and capital expenditures.
- Debt levels, interest-rate exposure, revolver availability, covenant headroom and the effect of continued repurchases and dividends on balance-sheet flexibility.
- Scalar integration, acquisition-related costs and the preliminary purchase-price allocation, as well as lease obligations and the 2020 lease commencement.
- Customer spending, vendor supply and funding, Brexit and currency developments, and the legal, cybersecurity and contract risks identified in the filing.