CDW Corp annual report, FY2015

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CDW Corporation — FY2015 Form 10-K

Reporting period: Year ended December 31, 2015. This annual filing also reports fourth-quarter results; it is not a standalone quarterly filing. CDW provides IT products, services and integrated solutions to business, government, education and healthcare customers in North America and the U.K. On August 1, 2015, CDW acquired the remaining 65% of Kelway, a U.K.-based IT solutions provider, and consolidated five months of its results.

Financial performance and liquidity

  • Revenue: Net sales were $12.989 billion, up 7.6% from $12.075 billion. Organic growth was 4.7%, or 5.3% on a constant-currency basis; the reported increase also included $350.7 million of Kelway sales. Solutions-focused sales grew faster than transactional product sales.
  • Profit and margins: Gross profit was $2.116 billion, up 10.1%; gross margin was 16.3%, versus 15.9%. Operating income was $742.0 million, up 10.3%, with a 5.7% operating margin versus 5.6%. Net income was $403.1 million ($2.35 diluted EPS), versus $244.9 million ($1.42). Net income included a $98.1 million non-cash gain from remeasuring CDW’s previously held Kelway stake. Adjusted EBITDA, a non-GAAP measure, was $1.019 billion, up 12.3%; non-GAAP net income was $503.5 million, up 22.8%.
  • Cash flow and investment: Operating cash flow was $277.5 million, down from $435.0 million, primarily due to a $342.6 million increase in accounts receivable. Investing cash outflow was $354.4 million, including $263.8 million for the Kelway acquisition; capital expenditures were $90.1 million, versus $55.0 million. Financing cash outflow was $226.5 million. Cash declined to $37.6 million from $344.5 million.
  • Liquidity: Working capital was $903.5 million, down from $985.4 million. The cash conversion cycle remained 21 days, although days sales outstanding rose to 48 from 42. CDW reported $843.1 million of additional availability under its asset-based revolver and £50.0 million ($73.7 million) under Kelway’s revolving facility. Management stated it believed liquidity was adequate for at least the next year.
  • Debt: Long-term debt was $3.260 billion at year-end; inventory-financing obligations were a further $439.6 million. Net debt, as defined by CDW, was $3.222 billion. Total net leverage was 3.0x, and CDW reported compliance with debt covenants. In March 2015, it issued $525 million of 5.0% notes due 2023 and redeemed the remaining $503.9 million of 8.5% notes due 2019, recording a $24.3 million extinguishment loss. Variable-rate debt and covenant restrictions remain relevant to liquidity and capital allocation.

Changes versus comparable periods

  • Full-year sales growth of 7.6% was below 2014’s 12.1%; 2015 organic growth was 4.7%. Kelway’s consolidation and foreign-currency translation affected reported comparisons.
  • Gross margin improved 40 basis points and operating margin improved 10 basis points year over year, reflecting better product margin, service mix and vendor funding, partly offset by higher selling and administrative costs.
  • Net income rose 64.6%, but the comparison reflects the $98.1 million Kelway remeasurement gain in 2015 and the larger debt-extinguishment loss in 2014 ($90.7 million versus $24.3 million in 2015). Net interest expense also fell to $159.5 million from $197.3 million.
  • Government sales rose 15.6%, while education sales declined 0.9%. Corporate sales increased 5.3%; Other segment sales rose 45.5%, substantially reflecting Kelway consolidation.
  • Fourth quarter: Net sales were $3.418 billion versus $3.050 billion; operating income was $179.9 million versus $164.3 million; net income was $89.3 million versus $51.8 million. Fourth-quarter diluted EPS was $0.52 versus $0.30.

Outlook, commentary, risks and unusual items

  • Management offered no quantified revenue, earnings or cash-flow guidance in the provided filing text. It described integrated solutions as a growth opportunity and said customer priorities were shifting toward more complex solutions. It also noted mixed global economic signals, potential technology-spending deferrals and pricing pressure.
  • Public-sector spending and contract risks include government budget changes and uncertain timing of approvals and customer implementation of E-Rate funding. Federal and state/local government sales grew at mid-teens rates in 2015; education sales were slightly lower, partly due to declining K-12 device sales.
  • Vendor and product concentration is significant: products from seven named manufacturers represented 56% of 2015 sales; Cisco and the former Hewlett-Packard businesses represented 16% and 18%, respectively. Vendor agreements generally are not long-term and may be changed or terminated.
  • Other identified risks include intense competition and direct sales by manufacturers or cloud providers; cybersecurity and IT-system disruption; receivable collection and inventory obsolescence; foreign-exchange exposure; public-contract compliance; and substantial indebtedness with variable-rate exposure and restrictive covenants.
  • The SEC requested documents on October 29, 2015, as part of an investigation into CDW’s vendor partner program incentives. CDW said it was cooperating and did not believe a material loss beyond amounts already recognized was reasonably possible as of year-end; the outcome was described as unpredictable.
  • CDW expects quarterly dividends of $0.1075 per share to continue, subject to board discretion, debt restrictions and tax considerations. It repurchased 6.3 million shares for $241.3 million in 2015. Deferred cancellation-of-debt income creates cash tax obligations through 2018 and could affect dividend decisions in certain circumstances.
  • Auditors gave an unqualified opinion on the financial statements and internal control over financial reporting. Management and the auditor excluded Kelway from the 2015 internal-control assessment; Kelway represented approximately $897.5 million of year-end assets.

Important facts for investors to verify

  • How much of sales, profit and cash generation is organic after separating Kelway, currency effects and the one-time remeasurement gain?
  • Whether receivable growth and slower government collections reverse, and whether cash flow recovers from the 2015 decline.
  • Debt maturity and refinancing requirements, variable-rate sensitivity, leverage and actual availability under borrowing-base and liquidity conditions.
  • Developments and any financial or compliance consequences from the SEC inquiry into vendor incentives.
  • Whether solutions and services growth, vendor funding and gross margins can be sustained amid competition, vendor concentration and pricing pressure.
  • How Kelway integration, goodwill and intangible-asset amortization affect future results, and the status of controls at the acquired business.