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CDW > SEC Filings for CDW > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for CDW CORP


7-Nov-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:
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. The recent federal government shutdown impacted approximately 25% of fourth quarter selling days. While its ultimate impacts are uncertain, the federal government shutdown will likely have a negative impact on fourth quarter Public segment results.


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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 for certain sales channels, we will continue to closely monitor macroeconomic conditions for the remainder of 2013. Uncertainties related to the potential impacts of the federal government shutdown and budget negotiations, potential changes in tax and regulatory policy, weakening consumer and business confidence or increased unemployment could result in reduced or deferred spending on information technology products and services by our customers and result in increased competitive pricing pressures.

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. The consolidated statements of operations for the three and nine months ended September 30, 2013 included pre-tax IPO related expenses of $74.1 million and $74.3 million, respectively. See Note 6 of the accompanying unaudited interim consolidated financial statements for additional discussion of our IPO.

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.

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 (loss).


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The results of certain key business metrics are as follows:

(dollars in millions)                                       Three months ended September 30,
                                                               2013                   2012
Net sales                                               $        2,864.3       $        2,623.3
Gross profit                                                       458.4                  432.7
Income from operations                                              92.9                  139.7
Net (loss) income                                                   (2.2 )                 38.0
Non-GAAP net income                                                 85.2                   68.9
Adjusted EBITDA                                                    216.1                  204.6
Average daily sales                                                 44.8                   41.6
Net debt (defined as total debt minus cash and cash
equivalents)                                                     3,059.9                3,678.2
Cash conversion cycle (in days)                                       21                     22

Results of Operations
Three Months Ended September 30, 2013 Compared to Three Months Ended
September 30, 2012
The following table presents our results of operations, in dollars and as a
percentage of net sales, for the three months ended September 30, 2013 and 2012:
                                               Three Months Ended                Three Months Ended
                                               September 30, 2013                September 30, 2012
                                          Dollars in      Percentage of     Dollars in      Percentage of
                                           Millions         Net Sales        Millions         Net Sales
Net sales                                $   2,864.3          100.0  %     $   2,623.3          100.0  %
Cost of sales                                2,405.9           84.0            2,190.6           83.5
Gross profit                                   458.4           16.0              432.7           16.5
Selling and administrative expenses            332.4           11.6              257.0            9.8
Advertising expense                             33.1            1.2               36.0            1.4
Income from operations                          92.9            3.2              139.7            5.3
Interest expense, net                          (56.2 )         (2.0 )            (76.7 )         (2.9 )
Net loss on extinguishments of
long-term debt                                 (41.3 )         (1.4 )                -              -
Other (expense) income, net                     (0.2 )            -                0.2              -
(Loss) income before income taxes               (4.8 )         (0.2 )             63.2            2.4
Income tax benefit (expense)                     2.6            0.1              (25.2 )         (1.0 )
Net (loss) income                        $      (2.2 )         (0.1 )%     $      38.0            1.4  %

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 September 30, 2013 and 2012:

                                      Three Months Ended September 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                $  1,465.8          51.2 %     $  1,312.8          50.0 %     $   153.0          11.7 %
Public                      1,244.6          43.5          1,163.7          44.4            80.9           6.9
Other                         153.9           5.3            146.8           5.6             7.1           4.8
Total net sales          $  2,864.3         100.0 %     $  2,623.3         100.0 %     $   241.0           9.2 %


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(1) There were 64 selling days for the three months ended September 30, 2013, compared to 63 selling days for the three months ended September 30, 2012. On an average daily basis, total net sales increased 7.5%. 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 September 30, 2013 and 2012:

                               Three Months Ended September 30,           Dollar     Percent
(dollars in millions)                 2013                     2012       Change      Change
Corporate:
Medium / Large          $         1,203.4                   $ 1,055.7    $ 147.7      14.0  %
Small Business                      262.4                       257.1        5.3       2.1
Total Corporate         $         1,465.8                   $ 1,312.8    $ 153.0      11.7  %

Public:
Government              $           375.3                   $   408.6    $ (33.3 )    (8.2 )%
Education                           513.4                       394.7      118.7      30.1
Healthcare                          355.9                       360.4       (4.5 )    (1.2 )
Total Public            $         1,244.6                   $ 1,163.7    $  80.9       6.9  %

Total net sales for the three months ended September 30, 2013 increased $241.0 million, or 9.2%, to $2,864.3 million, compared to $2,623.3 million for the three months ended September 30, 2012. There were 64 selling days for the three months ended September 30, 2013, compared to 63 selling days for the three months ended September 30, 2012. On an average daily basis, total net sales increased 7.5%. The increase in total net sales was primarily the result of growth in hardware, 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 September 30, 2013 was largely driven by growth in notebooks/mobile devices and netcomm products.
Corporate segment net sales for the three months ended September 30, 2013 increased $153.0 million, or 11.7%, compared to the three months ended September 30, 2012, driven by sales growth in the medium/large customer channel. On an average daily sales basis, Corporate segment net sales increased 9.9% between periods. Within our Corporate segment, net sales to medium/large customers increased 14.0% 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 growth in notebooks/mobile devices and netcomm products. Net sales to small business customers increased 2.1% between periods, led by growth in netcomm products and software, partially offset by unit volume declines in notebooks/mobile devices. Growth in net sales to small business customers continued to lag behind growth in net sales to medium/large customers due to certain small business customers continuing to take a more cautious approach to spending as macroeconomic and regulatory uncertainty impacted decision-making.
Public segment net sales for the three months ended September 30, 2013 increased $80.9 million, or 6.9%, between periods, driven by strong performance in the education customer channel. On an average daily sales basis, Public segment net sales increased 5.3% between periods. Net sales to education customers increased $118.7 million, or 30.1%, 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 $33.3 million, or 8.2%, between periods due to delays in federal government spending following sequestration and uncertainty over future budget negotiations. The government customer channel net sales decline was led by decreases in sales of enterprise storage and notebooks/mobile devices. Net sales to healthcare customers decreased $4.5 million, or 1.2%, between periods, led by declines in enterprise storage, partially offset by growth in desktop computers.


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Gross profit
Gross profit increased $25.7 million, or 6.0%, to $458.4 million for the three months ended September 30, 2013, compared to $432.7 million for the three months ended September 30, 2012. As a percentage of total net sales, gross profit decreased 50 basis points to 16.0% for the three months ended September 30, 2013, down from 16.5% for the three months ended September 30, 2012. Gross profit margin was negatively impacted 30 basis points by unfavorable price/mix changes within product margin as we experienced product margin compression in transactional product categories such as notebooks and desktops, 20 basis points by inventory reserve activity, primarily related to accrual reversals in 2012 that did not repeat and 10 basis points by vendor funding. Partially offsetting these decreases was an increase of 10 basis points due to a higher mix of commission revenue and net service contract revenue. 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 $75.4 million, or 29.3%, to $332.4 million for the three months ended September 30, 2013, compared to $257.0 million for the three months ended September 30, 2012. As a percentage of total net sales, selling and administrative expenses increased 180 basis points to 11.6% in the third quarter of 2013, up from 9.8% in the third quarter of 2012. Sales payroll, including sales commissions and other variable compensation costs, increased $7.7 million, or 7.1%, between years, consistent with higher sales and gross profit. Additionally, selling and administrative expenses for the three months ended September 30, 2013 included certain IPO related expenses of $74.1 million, as follows:

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. 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.

A pre-tax charge of $7.5 million related to compensation expense in connection with the Restricted Debt Unit Plan. See Note 9 of the accompanying unaudited interim consolidated financial statements for additional discussion of this charge.

Other IPO related expenses of $1.5 million.

We did not record any IPO related expenses during the three months ended September 30, 2012. Partially offsetting these increases in the three-months ended September 30, 2013, was the favorable resolution of a class action legal proceeding in which we were a claimant, which reduced selling and administrative expenses by $10.4 million in the three months ended September 30, 2013 compared to the same period of 2012. Total coworker count decreased by eight coworkers from 6,922 at September 30, 2012 to 6,914 at September 30, 2013. Total coworker count was 6,804 at December 31, 2012.
Advertising expense
Advertising expense decreased $2.9 million, or 7.9%, to $33.1 million for the three months ended September 30, 2013, compared to $36.0 million for the three months ended September 30, 2012. As a percentage of total net sales, advertising expense decreased 20 basis points to 1.2% in the third quarter of 2013, down from 1.4% in the third quarter of 2012. The decrease in advertising expense was due to a focus on managing expenses as well as the timing of advertising spending.


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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 September 30, 2013 and 2012:

                                     Three Months Ended                Three Months Ended
                                     September 30, 2013                September 30, 2012
                                                   Operating                        Operating       Percent Change
                                 Dollars in         Margin         Dollars in         Margin       in Income (Loss)
                                  Millions        Percentage        Millions        Percentage     from Operations
Segments: (1)
Corporate                      $      63.2             4.3 %     $      79.2            6.0 %            (20.2 )%
Public                                71.1             5.7              81.1            7.0              (12.4 )
Other                                  3.7             2.4               5.6            3.8              (34.6 )
Headquarters (2)                     (45.1 )           nm*             (26.2 )          nm*               72.1
Total income from operations   $      92.9             3.2 %     $     139.7            5.3 %            (33.5 )%

* Not meaningful
(1) Segment income from operations includes the segment's direct operating income and allocations for Headquarters' costs, allocations for income and expenses from 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 $92.9 million for the three months ended September 30, 2013, a decrease of $46.8 million, or 33.5%, compared to $139.7 million for the three months ended September 30, 2012. The decrease in income from operations for the three months ended September 30, 2013 was driven by higher selling and administrative expenses primarily resulting from $74.1 million of IPO related expenses recorded during the third quarter of 2013, partially offset by higher net sales and gross profit. Total operating margin percentage decreased 210 basis points to 3.2% for the three months ended September 30, 2013, from 5.3% for the three months ended September 30, 2012. Operating margin percentage was negatively impacted by the increase in selling and administrative expenses and as a percentage of net sales and by gross profit margin compression, partially offset by a decrease in advertising expense as a percentage of net sales.
Corporate segment income from operations was $63.2 million for the three months ended September 30, 2013, a decrease of $16.0 million, or 20.2%, compared to $79.2 million for the three months ended September 30, 2012. Corporate segment operating margin percentage decreased 170 basis points to 4.3% for the three months ended September 30, 2013, from 6.0% for the three months ended September 30, 2012. Results for the third quarter of 2013 included $26.4 million of IPO related expenses, which reduced Corporate segment operating margin by 180 basis points. Higher sales and gross profit partially offset the effect of IPO related expenses on income from operations for the three months ended September 30, 2013.
Public segment income from operations was $71.1 million for the three months ended September 30, 2013, a decrease of $10.0 million, or 12.4%, compared to $81.1 million for the three months ended September 30, 2012. Public segment operating margin percentage decreased 130 basis points to 5.7% for the three months ended September 30, 2013, from 7.0% for the three months ended September 30, 2012. Results for the third quarter of 2013 included $14.4 million of IPO related expenses, which reduced Public segment operating margin by 120 basis points. Higher sales and gross profit partially offset the effect of IPO related expenses on income from operations for the three months ended September 30, 2013.
Interest expense, net
At September 30, 2013, our outstanding long-term debt totaled $3,410.1 million compared to $3,871.2 million at September 30, 2012. Net interest expense for the three months ended September 30, 2013 was $56.2 million, a decrease of $20.5 million compared to $76.7 million for the three months ended September 30, 2012. This decrease was primarily due to lower effective interest rates and debt balances for the three months ended September 30, 2013 compared to the same period of the prior year as a result of debt repayments and refinancing activities completed during 2012 and 2013. Net loss on extinguishments of long-term debt During the three months ended September 30, 2013, we recorded a net loss on . . .

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