Business context and reporting period
CDW Corporation’s unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the first quarter of 2016. CDW provides IT products and solutions to business, government, education and healthcare customers in the U.S., Canada and the U.K. Effective January 1, 2017, it began reporting Small Business as a separate segment; prior-period segment data was reclassified.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 or comparator |
|---|---|---|
| Net sales | $3,324.7 million | $3,116.7 million; up 6.7% reported, 7.6% constant currency |
| Gross profit / margin | $552.6 million / 16.6% | $524.5 million / 16.8% |
| Operating income / margin | $169.8 million / 5.1% | $161.0 million / 5.2% |
| Net income / diluted EPS | $57.6 million / $0.35 | $77.8 million / $0.46 |
| Non-GAAP net income | $121.3 million | $112.7 million |
| Adjusted EBITDA / margin | $249.2 million / 7.5% | $232.7 million / 7.5% |
| Operating cash flow | $369.9 million | $427.8 million |
| Cash and cash equivalents | $251.7 million at March 31 | $263.7 million at December 31, 2016 |
| Total debt | Approximately $3.28 billion | Approximately $3.23 billion at December 31, 2016 |
Gross margin fell 20 basis points, primarily from lower product margin, partly offset by growth in net service contract revenue. Operating expenses were 11.5% of sales versus 11.7% a year earlier. The reported net income comparison was affected by a $57.4 million debt-extinguishment loss in Q1 2017; the 2017 effective tax rate was 21.7%, including $12 million of excess tax benefits on equity compensation, versus 37.2% in Q1 2016.
Cash used in investing was $19.6 million, primarily capital expenditures. Financing activities used $362.2 million, including $175.4 million for share repurchases and $25.5 million for dividends; cash declined $12.0 million during the quarter. The cash conversion cycle improved to 18 days from 20 days a year earlier. CDW reported $963 million of additional borrowing availability under its U.S. revolving facility and said it had adequate liquidity for at least the next year.
Material changes and management commentary
- Sales growth was led by Public, up 10.0%, including growth in government and education; Corporate rose 4.3%, Small Business 7.7%, and Other 5.1%. Healthcare sales increased 1.0% amid industry consolidation.
- Management described corporate customers as cautious and focused on shorter-term projects, while public customers were spending existing budgets and small-business confidence remained strong. Security, cloud, hybrid IT and software integrated into solutions were cited as continuing technology trends.
- CDW issued $600 million of 5.0% senior notes due 2025 and used the proceeds, cash and revolving borrowings in connection with redeeming its $600 million 6.0% notes due 2022. The redemption was completed April 2, 2017. It also repriced its term loan, reducing interest margins by 25 basis points, and amended and extended its revolving facility to $1.45 billion, maturing in 2022.
- The company repurchased 2.9 million shares for $175.4 million. The board declared a $0.16-per-share quarterly dividend payable June 12, 2017, subject to the stated record date.
Outlook, risks and contingencies
The filing provides no quantified revenue or earnings guidance. Management identified economic conditions and customer technology spending, government budgets, vendor relationships and incentives, competition, cybersecurity, supplier availability, foreign-exchange movements and substantial indebtedness as risks. CDW noted uncertainty around Brexit, although it had not seen significant changes in U.K. customer buying behavior.
The SEC investigation into CDW’s vendor partner program incentives remained ongoing; the company said it was cooperating and did not believe a material loss beyond amounts already recognized was reasonably possible, while noting outcomes are unpredictable. CDW reported compliance with debt covenants and a 2.68:1.00 total net leverage ratio. It expects to adopt the new revenue recognition standard on January 1, 2018, currently planning full retrospective adoption; bill-and-hold accounting may change for certain transactions, and $83 million of bill-and-hold transactions was deferred at March 31, 2017. The company expects lease accounting changes to put assets and liabilities for operating leases on its balance sheet.
Important facts for investors to verify
- How much of reported and constant-currency sales growth translates into sustainable earnings, given the lower gross and operating margins.
- The effect of the $57.4 million debt-extinguishment charge and the unusually low 21.7% effective tax rate on comparisons with future periods.
- Debt levels, refinancing costs, interest-rate exposure, covenant headroom and the availability of revolving credit; the company had $1.4 billion of interest-rate caps in place through 2018.
- Progress and eventual financial effects of adopting the revenue standard, including bill-and-hold and software arrangements.
- Developments in the SEC investigation, other legal or audit matters, and the company’s capital returns relative to its liquidity and leverage.