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CDW > SEC Filings for CDW > Form 10-Q on 12-Aug-2013All Recent SEC Filings

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Form 10-Q for CDW CORP


12-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Unless otherwise indicated or the context otherwise requires, as used in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," the terms "we," "us," "the Company," "our," "CDW" and similar terms refer to CDW Corporation and its subsidiaries. "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the unaudited interim consolidated financial statements and the related notes included elsewhere in this report and with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. This discussion contains forward-looking statements that are subject to numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statements. See "Forward-Looking Statements" at the end of this discussion. Overview
CDW is a Fortune 500 company and a leading provider of integrated information technology ("IT") solutions in the U.S. and Canada. We help our customer base of more than 250,000 small, medium and large business, government, education and healthcare customers by delivering critical solutions to their increasingly complex IT needs. Our broad array of offerings range from discrete hardware and software products to integrated IT solutions such as mobility, security, data center optimization, cloud computing, virtualization and collaboration. We are technology "agnostic," with a product portfolio that includes more than 100,000 products from more than 1,000 brands. We provide our products and solutions through sales force and service delivery teams consisting of more than 4,300 coworkers, including over 1,700 field sellers, highly-skilled technology specialists and advanced service delivery engineers.
We are a leading U.S. sales channel partner for many original equipment manufacturers ("OEMs") and software publishers (collectively, our "vendor partners"), whose products we sell or include in the solutions we offer. We believe we are an important extension of our vendor partners' sales and marketing capabilities, providing them with a cost-effective way to reach customers and deliver a consistent brand experience through our established end-market coverage and extensive customer access.
We have two reportable segments: Corporate, which is comprised primarily of private sector business customers, and Public, which is comprised of government agencies and education and healthcare institutions. Our Corporate segment is divided into a medium/large business customer channel, primarily serving customers with more than 100 employees, and a small business customer channel, primarily serving customers with up to 100 employees. We also have two other operating segments, CDW Advanced Services and Canada, which do not meet the reportable segment quantitative thresholds and, accordingly, are combined together as "Other." The CDW Advanced Services business consists primarily of customized engineering services delivered by technology specialists and engineers and managed services that include Infrastructure as a Service ("IaaS") offerings. Revenues from the sale of hardware, software, custom configuration and third-party provided services are recorded within our Corporate and Public segments.
We may sell all or only select products that our vendor partners offer. Each vendor partner agreement provides for specific terms and conditions, which may include one or more of the following: product return privileges, price protection policies, purchase discounts and vendor incentive programs, such as purchase or sales rebates and cooperative advertising reimbursements. We also resell software for major software publishers. Our agreements with software publishers allow the end-user customer to acquire software or licensed products and services. In addition to helping our customers determine the best software solutions for their needs, we help them manage their software agreements, including warranties and renewals. A significant portion of our advertising and marketing expenses is reimbursed through cooperative advertising reimbursement programs with our vendor partners. These programs are at the discretion of our vendor partners and are typically tied to sales or purchasing volumes or other commitments to be met by us within a specified period of time. Trends and key factors affecting our financial performance We believe the following trends may have an important impact on our financial performance:
An important factor affecting our ability to generate sales and achieve our targeted operating results is the impact of general economic conditions on our customers' willingness to spend on information technology. In the second quarter of 2012, we began to see customers take a more cautious approach to spending as increased macroeconomic uncertainty impacted decision-making and led to some customers delaying purchases. While we are beginning to see improvements in operating results, we will continue to closely monitor macroeconomic conditions for the remainder of 2013. Uncertainties related to the potential impacts of federal budget negotiations, potential changes in tax and regulatory policy, weakening consumer and business confidence or increased unemployment could result in reduced or deferred spending by our customers on information technology products and services and increased competitive pricing pressures.


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Our Public segment sales are impacted by government spending policies, budget priorities and revenue levels. An adverse change in any of these factors could cause our Public segment customers to reduce their purchases or to terminate or not renew contracts with us, which could adversely affect our business, results of operations or cash flows. Although our sales to the federal government are diversified across multiple agencies and departments, they collectively accounted for approximately 10%, 10% and 11% of our net sales for the years ended December 31, 2012, 2011 and 2010, respectively.

We believe that our customers' transition to more complex technology solutions will continue to be an important growth area for us in the future. However, because the market for technology products and services is highly competitive, our success at capitalizing on this transition will be based on our ability to tailor specific solutions to customer needs, the quality and breadth of our product and service offerings, the knowledge and expertise of our sales force, price, product availability and speed of delivery.

On July 2, 2013, we completed an initial public offering ("IPO") of 23,250,000 shares of common stock. On July 31, 2013, we completed the sale of an additional 3,487,500 shares of common stock to the underwriters of the IPO pursuant to the underwriters' July 26, 2013 exercise in full of the overallotment option granted to them in connection with the IPO. See Note 13 of the accompanying unaudited interim consolidated financial statements for additional discussion of our IPO. In connection with the IPO, we anticipate recording the following significant pre-tax expenses during the third quarter of 2013 in our consolidated statement of operations:
Pre-tax charges of $36.7 million related to the acceleration of the expense recognition for certain equity awards and $4.0 million for the related employer payroll taxes. Such charges will be included in selling and administrative expenses in our consolidated statement of operations. See Note 7 of the accompanying unaudited interim consolidated financial statements for additional discussion of the impact of the IPO on our equity awards.

A pre-tax charge of $24.4 million related to the payment of a termination fee to affiliates of Madison Dearborn Partners, LLC and Providence Equity Partners, L.L.C. in connection with the termination of the management services agreement with such entities, to be included in selling and administrative expenses in our consolidated statement of operations. See Note 13 of the accompanying unaudited interim consolidated financial statements for additional discussion of this transaction.

A pre-tax charge of $16.7 million related to the July 2, 2013 redemption of $175.0 million aggregate principal amount of senior secured notes due 2018. This charge represents $14.0 million in redemption premium and $2.7 million for the write-off of a portion of the remaining deferred financing costs and will be included in loss on extinguishments of long-term debt in our consolidated statement of operations. See Note 13 of the accompanying unaudited interim consolidated financial statements for additional discussion of this redemption.

A pre-tax charge of $24.7 million related to the August 1, 2013 redemption of $324.0 million aggregate principal amount of senior subordinated notes due 2017 using a portion of the net proceeds from the IPO and incremental borrowings under the senior secured term loan facility. This charge represents $20.3 million in redemption premium and $4.4 million for the write-off of a portion of the remaining deferred financing costs and will be included in loss on extinguishments of long-term debt in our consolidated statement of operations. See Note 13 of the accompanying unaudited interim consolidated financial statements for additional discussion of this redemption.

A pre-tax charge of $7.5 million related to compensation expense in connection with the Restricted Debt Unit Plan following the redemption of the $324.0 million aggregate principal amount of senior subordinated notes due 2017 as discussed above. See Note 9 of the accompanying unaudited interim consolidated financial statements for additional discussion of this charge.

Key business metrics
Our management monitors a number of financial and non-financial measures and ratios on a regular basis in order to track the progress of our business and make adjustments as necessary. We believe that the most important of these measures and ratios include average daily sales, gross margin, operating margin, non-GAAP net income, EBITDA and Adjusted EBITDA, cash and cash equivalents, net working capital, cash conversion cycle (defined to be days of sales outstanding in accounts receivable plus days of supply in inventory minus days of purchases outstanding in accounts payable, based on a rolling three-month average), debt levels including available credit and leverage ratios, sales per coworker and coworker turnover. These measures and ratios are compared to standards or objectives set by management, so that actions can be taken, as necessary, in order to achieve the standards and objectives.


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Non-GAAP net income, EBITDA and Adjusted EBITDA are considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. Non-GAAP measures used by the Company may differ from similar measures used by other companies, even when similar terms are used to identify such measures. We believe that non-GAAP net income, EBITDA and Adjusted EBITDA provide helpful information with respect to our operating performance and cash flows including our ability to meet our future debt service, capital expenditures, and working capital requirements. Adjusted EBITDA also provides helpful information as it is the primary measure used in certain financial covenants contained in our credit agreements. See "Results of Operations" for the definition of non-GAAP net income and Adjusted EBITDA and a reconciliation of each to net income.

The results of certain key business metrics are as follows:

(dollars in millions)                                       Three months ended June 30,
                                                              2013               2012
Net sales                                               $       2,779.3     $     2,584.7
Gross profit                                                      451.6             426.9
Income from operations                                            153.6             136.4
Net income                                                         46.7              36.8
Non-GAAP net income                                                79.2              67.2
Adjusted EBITDA                                                   212.6             200.6
Average daily sales                                                43.4              40.4
Net debt (defined as total debt minus cash and cash
equivalents)                                                    3,545.1           3,712.7
Cash conversion cycle (in days)                                      21                21

Results of Operations
Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012
The following table presents our results of operations, in dollars and as a
percentage of net sales, for the three months ended June 30, 2013 and 2012:
                                               Three Months Ended                Three Months Ended
                                                  June 30, 2013                     June 30, 2012
                                          Dollars in      Percentage of     Dollars in      Percentage of
                                           Millions         Net Sales        Millions         Net Sales
Net sales                                $   2,779.3          100.0  %     $   2,584.7          100.0  %
Cost of sales                                2,327.7           83.8            2,157.8           83.5
Gross profit                                   451.6           16.2              426.9           16.5
Selling and administrative expenses            266.4            9.6              259.5           10.0
Advertising expense                             31.6            1.1               31.0            1.2
Income from operations                         153.6            5.5              136.4            5.3
Interest expense, net                          (70.3 )         (2.5 )            (76.9 )         (3.0 )
Net loss on extinguishments of
long-term debt                                 (10.3 )         (0.4 )                -              -
Other income, net                                0.2              -                0.2              -
Income before income taxes                      73.2            2.6               59.7            2.3
Income tax expense                             (26.5 )         (0.9 )            (22.9 )         (0.9 )
Net income                               $      46.7            1.7  %     $      36.8            1.4  %


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Net sales
The following table presents our net sales by segment, in dollars and as a percentage of total net sales, and the year-over-year dollar and percentage change in net sales for the three months ended June 30, 2013 and 2012:

                                         Three Months Ended June 30,
                                     2013                           2012
                                         Percentage                     Percentage
                                          of Total                       of Total        Dollar        Percent
(dollars in millions)     Net Sales       Net Sales      Net Sales       Net Sales       Change       Change (1)
Corporate                $  1,537.4          55.3 %     $  1,394.4          53.9 %     $   143.0          10.3 %
Public                      1,082.6          39.0          1,040.4          40.3            42.2           4.1
Other                         159.3           5.7            149.9           5.8             9.4           6.2
Total net sales          $  2,779.3         100.0 %     $  2,584.7         100.0 %     $   194.6           7.5 %

(1) There were 64 selling days for both the three months ended June 30, 2013 and 2012. The following table presents our net sales by customer channel for our Corporate and Public segments and the year-over-year dollar and percentage change in net sales for the three months ended June 30, 2013 and 2012:

                              Three Months Ended June 30,          Dollar     Percent
(dollars in millions)              2013                 2012       Change      Change
Corporate:
Medium / Large          $       1,271.4              $ 1,124.7    $ 146.7      13.0  %
Small Business                    266.0                  269.7       (3.7 )    (1.4 )
Total Corporate         $       1,537.4              $ 1,394.4    $ 143.0      10.3  %

Public:
Government              $         295.7              $   318.0    $ (22.3 )    (7.0 )%
Education                         420.6                  349.5       71.1      20.4
Healthcare                        366.3                  372.9       (6.6 )    (1.8 )
Total Public            $       1,082.6              $ 1,040.4    $  42.2       4.1  %

Total net sales for the three months ended June 30, 2013 increased $194.6 million, or 7.5%, to $2,779.3 million, compared to $2,584.7 million for the three months ended June 30, 2012. There were 64 selling days for both the three months ended June 30, 2013 and 2012. The increase in total net sales was primarily the result of growth in hardware and software, a more tenured sales force and a continued focus on seller productivity across all areas of the organization. Our total net sales growth for the three months ended June 30, 2013 reflected unit volume growth in notebooks/mobile devices, netcomm products and enterprise storage as well as growth in software. Software gains were driven by growth in security, storage management software, network management software and operating systems, partially offset by a decrease in application suites. Corporate segment net sales for the three months ended June 30, 2013 increased $143.0 million, or 10.3%, compared to the three months ended June 30, 2012, driven by sales growth in the medium/large customer channel. Within our Corporate segment, net sales to medium/large customers increased 13.0% between periods primarily due to certain of these customers increasing their IT spending, a more tenured sales force and a continued focus on seller productivity. This increase was led by unit volume growth in enterprise storage and netcomm products and growth in software and notebooks/mobile devices. Partially offsetting the growth in the medium/large customer channel was a 1.4% decrease in net sales to small business customers, due to certain of these customers continuing to take a more cautious approach to spending as macroeconomic and regulatory uncertainty impacted decision-making. This decrease was led by unit volume declines in notebooks/mobile devices.
Public segment net sales for the three months ended June 30, 2013 increased $42.2 million, or 4.1%, between periods, driven by strong performance in the education customer channel. Net sales to education customers increased $71.1 million, or 20.4%, between periods, led by growth in net sales to K-12 customers, reflecting higher sales of notebooks/mobile devices to support new standardized digital testing requirements that will take effect in 2014. Net sales to government customers decreased $22.3 million, or 7.0%, between periods due to delays in federal government spending following sequestration and the continuing resolution. The government customer channel net sales decline was led by decreases in sales of enterprise storage and servers. Net sales to healthcare customers decreased $6.6 million, or 1.8%, between periods, led by declines in software and point-of-care technology carts, partially offset by an increase in notebooks/mobile devices.


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Gross profit
Gross profit increased $24.7 million, or 5.8%, to $451.6 million for the three months ended June 30, 2013, compared to $426.9 million for the three months ended June 30, 2012. As a percentage of total net sales, gross profit decreased 30 basis points to 16.2% for the three months ended June 30, 2013, down from 16.5% for the three months ended June 30, 2012. Gross profit margin was negatively impacted 40 basis points by unfavorable price/mix changes within product margin and 10 basis points by a $3.8 million accrual reversal in 2012 resulting from a favorable vendor audit outcome that did not repeat. Partially offsetting these decreases was an increase of 10 basis points due to a higher mix of commission revenue and net service contract revenue, and an increase of 10 basis points due to higher net sales and gross profit related to professional and managed services. Commission revenue, including agency fees earned on sales of software licenses and software assurance under enterprise agreements, has a positive impact on our gross profit margin, as we record the fee or commission as a component of net sales when earned and there is no corresponding cost of sales. Net service contract revenue, including items such as third-party services and warranties, also has a positive impact on gross profit margin as our cost paid to the vendor or third-party service provider is recorded as a reduction to net sales, resulting in net sales being equal to the gross profit on the transaction.
The gross profit margin may fluctuate based on various factors, including vendor incentive and inventory price protection programs, cooperative advertising funds classified as a reduction of cost of sales, product mix, net service contract revenue, commission revenue, pricing strategies, market conditions, and other factors, any of which could result in changes in gross profit margins. Selling and administrative expenses
Selling and administrative expenses increased $6.9 million, or 2.7%, to $266.4 million for the three months ended June 30, 2013, compared to $259.5 million for the three months ended June 30, 2012. As a percentage of total net sales, selling and administrative expenses decreased 40 basis points to 9.6% in the second quarter of 2013, down from 10.0% in the second quarter of 2012. Sales payroll, including sales commissions and other variable compensation costs, increased $8.3 million, or 7.2%, between years, consistent with higher sales and gross profit, partially offset by the timing of coworker hiring. Additionally, consulting and advisory fees increased $1.6 million between years. Partially offsetting these increases was a reduction in non-cash compensation costs of $3.7 million between years related to our equity-based compensation plans, driven by the vesting period for certain awards being fully satisfied by the end of 2012. Total coworker count decreased by 99 coworkers from 6,909 at June 30, 2012 to 6,810 at June 30, 2013. Total coworker count was 6,804 at December 31, 2012.
Advertising expense
Advertising expense increased $0.6 million, or 2.2%, to $31.6 million for the three months ended June 30, 2013, compared to $31.0 million for the three months ended June 30, 2012. As a percentage of total net sales, advertising expense decreased 10 basis points to 1.1% in the second quarter of 2013, down from 1.2% in the second quarter of 2012. The increase in advertising expense was due to continued investments in promoting our solutions and services capabilities, investments in sales tools to support our sales organization and the leveraging of corporate communications to reinforce our reputation as a leading IT solutions provider.


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Income from operations
The following table presents income (loss) from operations by segment, in dollars and as a percentage of net sales, and the year-over-year percentage change in income (loss) from operations for the three months ended June 30, 2013 and 2012:

                                     Three Months Ended               Three Months Ended
                                       June 30, 2013                    June 30, 2012
                                                  Operating                        Operating       Percent Change
                                 Dollars in         Margin        Dollars in         Margin       in Income (loss)
                                  Millions        Percentage       Millions        Percentage     from Operations
Segments: (1)
Corporate                      $     103.2            6.7 %     $      92.3            6.6 %              11.7 %
Public                                69.1            6.4              66.1            6.4                 4.6
Other                                  8.9            5.6               5.0            3.3                76.7
Headquarters (2)                     (27.6 )          nm*             (27.0 )          nm*                 2.2
Total income from operations   $     153.6            5.5 %     $     136.4            5.3 %              12.6 %

* Not meaningful
(1) Segment income from operations includes the segment's direct operating income and allocations for Headquarters' costs, allocations for logistics services, certain inventory adjustments, and volume rebates and cooperative advertising from vendors.

(2) Includes certain Headquarters' function costs that are not allocated to the segments.

Income from operations was $153.6 million for the three months ended June 30, 2013, an increase of $17.2 million, or 12.6%, compared to $136.4 million for the three months ended June 30, 2012. The results for the three months ended June 30, 2013 were driven by higher net sales and gross profit, partially offset by higher selling and administrative expenses. Total operating margin percentage increased 20 basis points to 5.5% for the three months ended June 30, 2013, from 5.3% for the three months ended June 30, 2012. Operating margin percentage was positively impacted by the decrease in selling and administrative expenses and advertising expense as a percentage of net sales, partially offset by a decrease in gross profit margin.
Corporate segment income from operations was $103.2 million for the three months ended June 30, 2013, an increase of $10.9 million, or 11.7%, compared to $92.3 million for the three months ended June 30, 2012. This increase was primarily driven by higher net sales and gross profit, partially offset by higher selling and administrative expenses, resulting in a net increase in segment operating income before allocations of $2.0 million for the three months ended June 30, 2013 compared to the same period of 2012. In addition, Corporate segment income from operations benefited from an increase of $7.1 million in income allocations from our logistics operations and a decrease of $1.8 million in Headquarters' expense allocations to the Corporate segment on a year-over-year basis. The improved profitability of our logistics operations was driven by stronger operating leverage given higher purchase volumes while support costs decreased slightly.
Public segment income from operations was $69.1 million for the three months ended June 30, 2013, an increase of $3.0 million, or 4.6%, compared to $66.1 million for the three months ended June 30, 2012. Public segment operating income before allocations was slightly lower as a result of lower gross profit, partially offset by lower selling and administrative expenses. Offsetting the decrease in operating income before allocations, the Public segment income from operations benefited from an increase of $3.3 million in income allocations from our logistics operations and a decrease of $0.7 million in Headquarters' expense . . .

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