CDW Corporation — Q3 2012 Form 10-Q
Business and period: CDW provides branded IT hardware, software and services to business, government, education and healthcare customers in the U.S. and Canada. This unaudited filing covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $2,623.3m | $2,581.4m | $7,527.2m | $7,123.1m |
| Gross profit / margin | $432.7m / 16.5% | $420.0m / 16.3% | $1,244.2m / 16.5% | $1,171.2m / 16.4% |
| Operating income / margin | $139.7m / 5.3% | $139.7m / 5.4% | $379.7m / 5.0% | $359.6m / 5.1% |
| Net income (loss) | $38.0m | $37.1m | $85.7m | $(1.9)m |
| Adjusted EBITDA | $204.6m | $200.1m | $571.6m | $543.1m |
Cash flow and liquidity: For the nine months, operating cash flow was $367.1m, versus $171.5m; investing cash use was $25.4m, mainly capital expenditures, and financing cash use was $249.3m. Cash rose to $193.0m from $99.9m at year-end 2011. Working-capital changes were a major contributor to the operating cash flow increase. The cash conversion cycle improved to 21 days from 25 days a year earlier.
Debt: Long-term debt was $3,871.2m at September 30, 2012, compared with $4,066.0m at December 31, 2011; no current debt maturities were reported. The $900m asset-based revolver had no borrowings, with $667.7m of additional borrowing availability. CDW reported compliance with its debt covenants. The senior secured leverage ratio was 2.2 against a maximum of 6.75; total net leverage was 5.2, down from 5.9 at year-end 2011.
Changes versus prior periods
- Q3 sales increased 1.6% (3.2% on an average-daily-sales basis); operating income was flat and net income rose modestly. Q3 gross margin improved 20 basis points, while operating margin declined 10 basis points.
- Nine-month sales increased 5.7% (6.2% on an average-daily-sales basis); operating income rose 5.6%. Net income turned positive from a small loss, largely because the prior-year period included a $118.9m debt-extinguishment loss versus $9.4m in 2012.
- Public segment sales grew 3.6% in Q3 and 8.0% year to date, led by healthcare and government. Corporate sales fell 1.3% in Q3 but rose 3.1% year to date. Education sales declined in both comparisons.
- Q3 advertising expense increased 27.1% to $36.0m, contributing to the lower operating margin. For nine months, selling and administrative costs and advertising grew faster than sales, also weighing on operating margin.
Outlook, risks and unusual items
- Management said customers became more cautious amid macroeconomic uncertainty and expected that trend to continue through at least the end of 2012. No numeric earnings or revenue guidance is provided in the filing.
- Management cited potential economic weakness, reduced IT spending, competitive pricing pressure, and uncertainty around federal budget and tax or regulatory policy. Public-sector results are exposed to government budgets and procurement decisions.
- Q3 gross margin benefited from a higher mix of commissions and net service-contract revenue, partly offset by lower vendor funding. Nine-month margin included a $3.8m favorable vendor-audit accrual reversal.
- In February and March 2012, CDW refinanced and retired the remaining $129.0m of notes due 2015, issuing $130.0m of 2019 notes; the transactions resulted in a $9.4m extinguishment loss.
- Term-loan requirements include mandatory prepayments in specified circumstances and interest-rate hedging. The company maintained interest-rate caps and reported covenant compliance. It warned that an uncured covenant default could accelerate term-loan repayment and restrict revolver access.
- CDW is subject to ordinary-course litigation, audits and potential customer bankruptcy preference claims. Management did not believe a material loss beyond amounts recognized was reasonably possible, while noting outcomes are unpredictable. The IRS was auditing tax years 2008–2010; management did not expect audit adjustments to have a material impact.
Key investor verification points
- Confirm the sustainability of sales and gross-margin growth, particularly given Q3 softness in Corporate and education and reliance on stronger healthcare and government demand.
- Assess how much of the increase in operating cash flow came from working-capital timing, including trade payables, receivables and inventory.
- Review debt maturities, interest costs, leverage definitions and covenant headroom; verify availability under the asset-based revolver after reserves and floorplan financing.
- Evaluate the effect of advertising, compensation and other operating-cost growth on margins, and distinguish GAAP results from management’s adjusted EBITDA measure.
- Monitor macroeconomic and public-budget risks, tax audits and legal contingencies. The filing states that all outstanding common shares were owned by CDW Holdings LLC.