CDW Corporation — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. CDW provides multi-brand IT products and services to business, government, education and healthcare customers in the U.S. and Canada. Unless stated otherwise, amounts are in millions of dollars.
Financial performance and liquidity
- Q3 revenue: $2,581.4, up 8.7% year over year. Gross profit was $420.8, up 14.3%; gross margin increased to 16.3% from 15.5%.
- Q3 operating income: $139.7, up 33.5%; operating margin rose to 5.4% from 4.4%. Net income was $37.1 versus a $0.3 loss. Net interest expense declined to $85.5 from $105.1.
- Nine-month revenue: $7,123.1, up 9.1% (8.5% on an average-daily-sales basis). Gross profit was $1,174.1, with margin of 16.5% versus 15.8%; operating income was $359.6, up 32.4%.
- Nine-month net result: $1.9 net loss versus a $5.1 loss in 2010. The 2011 result included a $118.9 debt-extinguishment loss; net interest expense was $243.3 versus $288.7.
- Adjusted EBITDA (non-GAAP): Q3 $200.1, up 22.3%, or 7.8% of sales versus 6.9%. Nine-month Adjusted EBITDA was $543.1, up 19.1%, or 7.6% of sales versus 7.0%. The nine-month 2011 figure includes $118.9 of debt-extinguishment loss among adjustments.
- Cash flow: Nine-month operating cash flow was $171.5 versus $363.8; capital expenditures were $25.9 versus $18.3. Cash declined $10.7 to $25.9. The cash conversion cycle improved to 25 days from 33, mainly because days payable outstanding increased.
- Balance sheet and liquidity: Total debt and capital leases were $4,071.0, down from $4,290.0 including current maturities at December 31, 2010. Current assets were $1,862.1 and current liabilities $1,172.8. The $900.0 asset-based revolving facility had $5.0 drawn and $702.6 additional borrowing availability at quarter-end. Inventory-financing payables rose to $223.8 from $28.2.
- Debt covenant: CDW reported compliance at September 30. The senior secured leverage ratio was 2.9 against a maximum of 7.5 under the term-loan test.
Material changes versus prior comparable periods
- Q3 sales growth was led by Corporate, up 8.6%, and Other, up 30.6%; Public grew 6.8%. Healthcare sales rose 21.8%, while government sales fell 2.3%. For the first nine months, Corporate grew 11.7%, healthcare 25.5%, and government declined 10.2%.
- Management attributed improved gross margin to product price/mix and a higher mix of net service-contract and commission revenue. Selling and administrative costs rose with payroll, commissions and headcount; nine-month advertising expense increased 19.3%.
- CDW refinanced much of its 2015 notes: it issued $1,175.0 of 8.5% notes due 2019 and tendered $1,078.0 principal of 2015 notes, leaving $129.0 outstanding. The transactions generated $97.0 of tender premiums and contributed to the $114.1 extinguishment loss. A new $900.0 revolving facility replaced the prior $800.0 facility; the term loan was also amended and partially prepaid.
- The 2010 comparative cash-flow presentation was revised to move $33.8 of inventory-financing cash flows from operating to financing activities. The revision did not change total cash flow, net income, shareholders’ deficit, Adjusted EBITDA or debt-covenant calculations.
Outlook, commentary, risks and unusual items
- Management provided no quantified earnings or revenue guidance. It said current funding sources should cover operating cash needs for the next year and that liquidity is adequate for longer-term needs, while noting dependence on execution and economic conditions.
- Management described growth as continuing at a more moderate pace than in 2010. It cited competitive pricing, uncertain macroeconomic conditions and government budget uncertainty as potential pressures on demand and margins. Fourth-quarter Corporate sales are typically higher; Public sales have historically been stronger in the third quarter.
- Key risks include reliance on vendor relationships, product availability and incentives; significant product/vendor concentration; reduced customer IT spending; government budget reductions; supply-chain disruption; and attracting and retaining key personnel. CEO Thomas Richards took office October 1, 2011; outgoing CEO John Edwardson was expected to remain chairman through 2012.
- CDW reported ordinary-course litigation, customer/vendor and government audits, and potential bankruptcy preference claims. It did not believe a material loss beyond amounts recognized was reasonably possible, but said outcomes are unpredictable. The IRS was auditing tax years 2008–2010; management did not expect audit adjustments to materially affect results.
- Other notable items: the company received $53.3 of tax refunds by September 30; it held $2,207.5 of goodwill and $1,672.8 of net intangible assets; and it disclosed that changes in delivery patterns could materially affect period-end revenue recognition. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue and margin growth continues, particularly in Corporate and healthcare, and whether government weakness persists.
- Whether operating cash generation improves; assess the effect of receivables, inventory financing and payable terms on cash flow and the cash conversion cycle.
- Debt service and refinancing economics, including the 8.5% 2019 notes, remaining 2015 notes, revolver availability, covenant headroom and interest-rate exposure.
- How much of Adjusted EBITDA growth reflects operating performance versus adjustments, including the substantial debt-extinguishment add-back.
- Vendor concentration, product availability and incentive terms; government spending exposure; legal, audit and tax contingencies; and the CEO transition.