CDW Corporation — Q2 2017 Form 10-Q
Business context and reporting period. CDW provides IT products and integrated technology solutions to business, government, education and healthcare customers in the U.S., Canada and the U.K. This unaudited filing covers the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $3,994.4M | $3,664.6M | $7,319.1M | $6,781.3M |
| Gross profit | $641.1M | $610.5M | $1,193.6M | $1,135.0M |
| Income from operations | $231.1M | $223.5M | $400.9M | $384.5M |
| Net income | $141.0M | $117.5M | $198.7M | $195.3M |
| Diluted EPS | $0.89 | $0.70 | $1.23 | $1.16 |
| Operating cash flow | Not separately presented | Not separately presented | $376.2M | $313.1M |
- Q2 sales increased 9.0% year over year (9.8% on a constant-currency basis); six-month sales rose 7.9% (8.8% constant currency). Q2 average daily sales increased to $62.4M from $57.3M.
- Gross margin contracted to 16.1% from 16.7% in Q2 and to 16.3% from 16.7% for the first half. Management attributed the decline mainly to lower product margins from higher hardware sales and competitive pricing, partly offset by vendor funding and service revenue.
- Q2 operating income increased 3.4%, but operating margin declined to 5.8% from 6.1%. First-half operating income rose 4.3%, while margin declined to 5.5% from 5.7%.
- Q2 net income rose 20.0%; the effective tax rate fell to 27.9% from 37.3%, primarily reflecting $19M in excess tax benefits on equity compensation. First-half net income was nearly flat despite operating improvement, in part because of a $57.4M debt-extinguishment loss; the first-half effective tax rate was 26.2%, including $30M of equity-compensation tax benefits.
- First-half investing cash outflow was $36.8M, primarily capital expenditures; operating cash flow less capital expenditures was approximately $339M. Cash declined to $79.0M from $263.7M at year-end, following $526.7M of financing cash outflows, including $359.4M of share repurchases and $50.3M of dividends.
Debt, liquidity and capital allocation
- June 30 total debt was $3,296.3M and net debt was $3,217.3M. Long-term debt, excluding current maturities, was $3,277.8M. The company reported $1,016M of additional borrowing capacity under its U.S. asset-based revolver and a further $65M under the U.K. revolving facility.
- CDW refinanced $600M of 6.0% notes due 2022 with $600M of 5.0% notes due 2025, repriced its term loan and amended, extended and increased its revolving facility to $1.45B, maturing in 2022. Refinancing activity generated the $57.4M first-half extinguishment loss.
- The company was in compliance with debt covenants. Its total net leverage ratio was 2.81:1.00; the filing states restricted payments are permitted under a separate provision if pro forma leverage remains below 3.25:1.00.
- In the first half, CDW repurchased 6.1M shares for $359.4M. After quarter-end, the board authorized a $750M increase to the repurchase program and declared a $0.16 quarterly dividend.
Business changes, outlook and risks
- Small Business became a separate reportable segment in 2017; comparative segment results were reclassified. Q2 sales grew across Corporate, Small Business, Public and Other. Healthcare sales declined 7.3% in Q2 as customers deferred purchasing amid uncertainty over funding and reimbursement; Public segment operating margin also weakened.
- Management described stronger hardware sales, client-device refreshes, and ongoing customer demand for security, networking, cloud and integrated solutions. It provided no specific full-year revenue or earnings guidance in the supplied filing text.
- Management said liquidity and funding sources were adequate for at least the next year, while noting dependence on operating cash generation and economic conditions. Key stated risks include technology-spending levels, vendor/product availability, competition, substantial indebtedness, cybersecurity and systems risks, customer receivables and inventory, foreign currency, legal matters, and uncertainty surrounding Brexit.
- The SEC informed CDW in May 2017 that it had concluded its investigation of the vendor partner incentive program and did not intend to recommend enforcement action. CDW reported no financial impact beyond customary cooperation costs.
- CDW plans to adopt the new revenue recognition standard on January 1, 2018, expecting to use the full retrospective method, subject to system readiness and completion of its analysis. It estimated that net presentation for certain software transactions could have reduced both 2016 sales and cost of sales by $200M–$300M, without affecting gross profit; it expected no material impact on sales or net income from the bill-and-hold change.
- Illinois enacted a higher corporate tax rate and retroactive changes to its unclaimed-property rules. CDW did not expect the rate increase to materially affect annual income tax expense and was evaluating the unclaimed-property impact.
Most important facts for investors to verify
- Whether revenue growth can continue without further gross- and operating-margin pressure from hardware mix and competition.
- Whether healthcare demand stabilizes and whether Public segment profitability recovers.
- How cash conversion, receivables and inventory financing evolve as sales grow; first-half operating cash flow benefited from working-capital movements, including higher trade payables.
- Debt-service capacity and the effect of continued buybacks and dividends on cash and leverage; review the terms and utilization of available revolving credit.
- The final effects and implementation readiness of the 2018 revenue standard, plus the eventual impact of Illinois unclaimed-property changes.