CDW Corporation — Q2 2012 Form 10-Q
Business context and reporting period
CDW provides multi-brand technology products and services to business, government, education and healthcare customers in the U.S. and Canada. This unaudited quarterly report covers the three and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods.
Financial performance and liquidity
- Q2 revenue and earnings: Net sales rose 7.2% to $2,584.7 million. Gross profit increased 6.5% to $426.9 million; operating income increased 6.4% to $136.4 million. Net income was $36.8 million, versus a $34.8 million net loss in Q2 2011.
- Margins: Q2 gross margin was 16.5%, down from 16.6%; operating margin was 5.3%, unchanged. Net margin was 1.4%, versus negative 1.4%.
- First-half results: Sales rose 8.0% to $4,903.9 million; operating income increased 9.1% to $240.0 million. Net income was $47.7 million, compared with a $39.0 million loss in 2011. Gross margin held at 16.5%; operating margin was 4.9% versus 4.8%.
- Cash flow: First-half operating cash flow was $304.7 million, compared with $129.8 million in 2011; investing cash outflow was $15.7 million, primarily capital expenditures, and financing cash outflow was $230.1 million. Cash increased $58.8 million to $158.7 million.
- Liquidity and debt: Current assets were $1,964.3 million and current liabilities $1,297.5 million. Long-term debt was $3,871.4 million, with no current maturities reported. The revolving facility had no borrowings and $651.7 million of additional borrowing availability. The company reported covenant compliance; its senior secured leverage ratio was 2.3 against a maximum of 7.0.
- Other measures: First-half Adjusted EBITDA, a non-GAAP measure, increased 7.0% to $367.0 million; as a share of sales it was 7.5%, versus 7.6%. The cash conversion cycle improved to 20 days from 28 days.
Material changes versus the prior comparable period
- Q2 sales growth was strongest in Public (+9.4%), particularly healthcare (+19.6%); Corporate sales grew 4.2%. First-half Public sales grew 10.9%, led by healthcare (+19.9%) and government (+9.9%).
- Q2 sales benefited from higher demand across networking, notebooks/mobile devices, telephony and software. Healthcare growth was partly attributed to an expanded group-purchasing-organization relationship. Education growth remained modest, with K-12 customers affected by budget constraints.
- Q2 gross margin slipped 10 basis points. Management cited vendor funding as a drag, partly offset by a $3.8 million accrual reversal following a favorable vendor audit. First-half gross margin was flat year over year.
- First-half operating cash flow improved substantially, primarily due to working-capital movements, including accounts receivable and accounts payable. The company cautioned that a change in inventory-financing arrangements also shifted cash-flow classification between operating and financing activities.
- The 2011 comparison included a $118.9 million first-half loss on debt extinguishments, including $115.7 million in Q2. In 2012, CDW retired its remaining $129.0 million of 2015 notes, issuing $130.0 million of 2019 notes and recording a $9.4 million extinguishment loss. First-half interest expense was $155.8 million, down from $157.8 million.
Outlook, commentary and risks
- Management said customers began taking a more cautious approach to spending in Q2 amid increased macroeconomic uncertainty and expected that trend to continue through 2012. The filing provides no quantified revenue or earnings guidance.
- Management said current funding sources should cover operating needs for the next year and longer-term needs, while noting dependence on business execution and economic conditions. Fourth-quarter Corporate sales are typically higher; Public sales have historically been higher in the third quarter.
- Risks include weaker business or government IT spending, competitive pricing pressure, government budget and revenue changes, and fluctuations in vendor incentives, product mix and gross margins. Federal sales were approximately 10% and state/local government sales approximately 4% of 2011 revenue.
- Ordinary-course litigation, audits and possible customer-bankruptcy preference claims remain contingencies. Management did not believe a material loss beyond amounts already recognized was reasonably possible, but noted outcomes are unpredictable.
- The company revised 2011 cash-flow presentation for inventory-financing classification errors: first-half operating cash flow was reduced by $77.6 million, from $207.4 million to $129.8 million, with an equal offset to financing cash flow. Total cash change, net income, equity, Adjusted EBITDA and debt covenants were unaffected; management said the revisions were not material to previously issued statements.
Important facts for investors to verify
- Whether customer caution persisted after Q2 and how it affected sales growth, especially healthcare, government and education demand.
- How sustainable operating cash flow and the 20-day cash conversion cycle are, given the contribution of working-capital timing and payable terms.
- Debt-service capacity and refinancing exposure, including the 12.5% senior subordinated notes and the company’s covenant headroom.
- Whether gross margins can hold amid vendor-funding changes, pricing pressure and product-mix shifts; note the benefit of the $3.8 million vendor-audit accrual reversal.
- The effect of the inventory-financing presentation revision when comparing historical operating and financing cash flows.