CDW Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; unaudited. CDW provides IT products and solutions to business, government, education and healthcare customers in the U.S., Canada and U.K.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $4,033.9 million | $3,708.2 million | $11,353.0 million | $10,489.5 million |
| Gross profit | $642.0 million | $614.3 million | $1,835.6 million | $1,749.3 million |
| Operating income | $243.7 million | $237.5 million | $644.6 million | $622.0 million |
| Net income | $129.2 million | $125.9 million | $327.8 million | $321.2 million |
| Diluted EPS | $0.83 | $0.76 | $2.06 | $1.93 |
- Q3 sales rose 8.8% year over year (8.7% constant currency); average daily sales increased 10.5%, despite one fewer selling day. Nine-month sales increased 8.2% reported and 8.7% constant currency.
- Margins narrowed: Q3 gross margin was 15.9% versus 16.6%, operating margin 6.0% versus 6.4%, and net margin 3.2% versus 3.4%. Nine-month gross, operating and net margins were 16.2%, 5.7% and 2.9%, respectively, versus 16.7%, 5.9% and 3.1%.
- Management attributed gross-margin pressure mainly to a higher mix of lower-margin hardware, especially client devices, and continued competition. Sales and administrative expenses were lower as a percentage of sales, partly offsetting the pressure.
- Non-GAAP net income was $168.2 million for Q3 and $452.7 million for nine months; Adjusted EBITDA was $324.3 million and $888.2 million, respectively. These are company-defined non-GAAP measures.
- Operating cash flow for nine months was $439.1 million, down from $499.3 million. Capital expenditures were $58.6 million; operating cash flow less capital expenditures was approximately $380.5 million (derived). Cash declined $165.8 million to $97.9 million.
- At September 30, cash was $97.9 million, total debt carrying value was $3,429.9 million, and net debt was $3,332.0 million. CDW reported $794 million of additional U.S. revolver availability and $51 million under its U.K. facility. Cash conversion cycle increased to 19 days from 18.
Changes and business trends
- Q3 sales grew across Corporate (9.0%), Small Business (10.3%), Public (5.6%) and Other (22.6%); healthcare sales declined 1.4%. Government growth was strong, while healthcare customers deferred purchases amid funding and reimbursement uncertainty.
- Small Business became a separate reportable segment effective January 1, 2017; prior-period segment information was recast.
- Nine-month share repurchases totaled $534 million for 8.9 million shares, and dividends paid totaled $74.7 million. The board authorized an additional $750 million for repurchases in August.
Debt, outlook, risks and unusual items
- CDW issued $600 million of 5.0% notes due 2025 and redeemed its $600 million notes due 2022. It also refinanced/repriced term and revolving facilities; the revolving facility was extended to 2022 and increased to $1.45 billion. Nine-month debt-extinguishment losses were $57.4 million, including a $37 million redemption premium.
- The company was in compliance with debt covenants. Its total net leverage ratio was 2.88:1.00; the filing states restricted-payment capacity of $1.056 billion under the term loan, subject to applicable terms.
- No numerical full-year earnings or sales guidance is provided in the filing. Management said it believed liquidity and funding sources were adequate for at least the next year, while noting dependence on business execution and economic conditions.
- Demand drivers included security, cloud and hybrid IT, hardware refreshes, public-safety technology and education technology projects. Risks discussed include economic and technology-spending weakness, competition, vendor/product availability, substantial debt, cybersecurity and IT-system risks, customer receivables and inventory, foreign exchange, Brexit uncertainty, and government/healthcare funding changes.
- A retroactive Illinois law change caused $4.1 million of Q3 expense for reinstated prior-year unclaimed-property balances. CDW settled its restricted debt unit plan for $31 million in September.
- CDW plans to adopt the new revenue-recognition standard on January 1, 2018 using full retrospective adoption. It expects certain bill-and-hold revenue to be recognized earlier without material effect on sales or net income; certain security-software transactions will be reported net, reducing sales and cost of sales but not gross profit. Management estimated that the latter change would have reduced 2016 full-year sales and cost of sales by $250–$350 million.
- The SEC concluded its investigation into vendor-partner program incentives and did not intend to recommend enforcement action. CDW said it did not believe a material loss was reasonably possible for other disclosed proceedings, but noted outcomes are inherently unpredictable.
- The board declared a subsequent quarterly dividend of $0.21 per share, payable December 11, 2017, subject to the stated record date.
Important facts for investors to verify
- Whether sales growth and customer demand persist, particularly in hardware refreshes, government and education, and whether healthcare spending recovers.
- Whether product mix and competitive pricing continue to pressure gross and operating margins.
- Working-capital and cash-conversion trends, including receivables, inventory and vendor receivables, alongside the decline in operating cash flow.
- Debt, interest-rate exposure, covenant headroom and continued capacity for buybacks and dividends; review the effects of the refinancing and debt-extinguishment costs.
- Implementation and reporting effects of the 2018 revenue-recognition standard, particularly the expected net presentation of specified software transactions.