CDW Corporation — Q3 2018 Form 10-Q
Business and period: CDW provides IT products and solutions to business, government, education and healthcare customers in the U.S., U.K. and Canada. This unaudited quarterly report covers the three and nine months ended September 30, 2018. Comparative 2017 figures were adjusted retrospectively for adoption of ASC 606 revenue recognition.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $4,373.2 million | $3,933.2 million | $12,165.7 million | $11,080.8 million |
| Gross profit / margin | $713.6 million / 16.3% | $642.2 million / 16.3% | $2,013.1 million / 16.5% | $1,836.5 million / 16.6% |
| Operating income / margin | $274.8 million / 6.3% | $244.0 million / 6.2% | $744.4 million / 6.1% | $645.6 million / 5.8% |
| Net income | $183.7 million | $129.3 million | $483.7 million | $328.3 million |
| Diluted EPS | $1.20 | $0.83 | $3.14 | $2.06 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $602.3 million | $439.1 million |
Q3 sales rose 11.2% year over year (11.4% at constant currency); nine-month sales rose 9.8% (9.3% at constant currency). Nine-month adjusted EBITDA was $979.2 million, up 10.1%, with an 8.0% margin, unchanged year over year. Q3 adjusted EBITDA was $354.7 million, up 9.3%, with an 8.1% margin versus 8.3%.
Balance sheet and liquidity at September 30: Cash was $255.1 million; total debt was approximately $3.2 billion and net debt $2,964.3 million. Current assets were $3,949.5 million and current liabilities $2,803.9 million. CDW reported $1.1 billion of additional borrowing availability under its U.S. asset-based revolver and $59 million under its U.K. revolver. No U.S. revolver borrowings were outstanding. The company was in compliance with debt covenants; its total net leverage ratio was 2.33:1.00. Nine-month capital expenditures were $53.4 million; operating cash flow less capital expenditures was $548.9 million.
Changes and management commentary
- Q3 growth was broad-based: Corporate sales increased 9.9%, Small Business 11.3%, Public 10.7%, and Other (U.K. and Canada) 18.5%. Management cited client-device refresh, solutions demand and international growth. Education sales rose 14.7% in the quarter.
- For the first nine months, Other sales grew 27.6%, aided by favorable currency translation; Public grew 5.8%. Management also cited the reversal of supply-chain issues experienced at the end of 2017.
- Gross margin was flat in Q3 and down 10 basis points for the nine months. Management cited improved product margins offset by sales growth outpacing partner-funding growth. Nine-month operating margin improved 30 basis points, helped by lower selling and administrative expense, equity compensation and intangible amortization as percentages of sales.
- Operating cash flow increased year over year, while accounts receivable used $334.3 million of cash, largely reflecting higher sales. The cash conversion cycle improved to 18 days from 19 days.
- CDW repurchased 3.0 million shares for $232.5 million and paid $95.5 million in dividends during the first nine months. After quarter-end, it declared a quarterly dividend of $0.295 per share, payable December 10, 2018.
Outlook, risks and unusual items
- The filing provides no quantified full-year revenue, earnings or margin guidance. Management said it believed liquidity and funding sources were adequate for at least the next year, while noting dependence on execution and economic conditions.
- Management identified customer technology spending, government and education budgets, vendor product availability and relationships, competition, supplier disruptions, receivables and inventory exposure, currency movements, cybersecurity and IT-system risks, indebtedness and legal or regulatory matters as risks. It noted typical fourth-quarter strength in Corporate from year-end budget spending and third-quarter seasonality in Public.
- Variable-rate debt exposes CDW to interest-rate risk; $1.4 billion of interest-rate caps were in place. The company amended its term loan in April 2018, reducing interest margins by 25 basis points.
- Net income benefited from a lower U.S. federal statutory tax rate. The nine-month 2018 effective tax rate was 23.7%, versus 31.1% in 2017. A $2 million tax benefit was recorded for adjustments to provisional Tax Cuts and Jobs Act amounts.
- The 2017 nine-month comparison includes a $57.4 million debt-extinguishment loss; no such loss was recorded in 2018. Ordinary-course legal proceedings and audits remain; management did not believe a material loss beyond amounts already recognized was reasonably possible, but acknowledged outcomes are unpredictable.
- ASC 606 adoption reduced reported 2017 sales while having only a small impact on gross profit and net income; comparisons here use adjusted 2017 figures. CDW expected the lease standard, planned for adoption January 1, 2019, to affect the balance sheet, but not the income statement or cash flows.
Important facts for investors to verify
- Whether sales growth and operating-margin improvement persist, particularly given hardware mix and partner-funding trends.
- Receivables growth, collections and working-capital requirements, alongside operating cash flow and the cash conversion cycle.
- Debt service, variable-rate exposure, covenant headroom and continued availability under revolving credit facilities.
- The sustainability of share repurchases and dividend increases relative to cash generation and debt restrictions.
- How foreign exchange, customer spending, supplier availability and seasonal buying patterns affect subsequent results.