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CDW > SEC Filings for CDW > Form 10-Q on 13-Aug-2014All Recent SEC Filings

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Form 10-Q for CDW CORP


13-Aug-2014

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, 2013. 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 approximately 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 ranges 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 4,500 coworkers, including nearly 1,800 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 7%, 10% and 10% of our net sales for the years ended December 31, 2013, 2012 and 2011, respectively. In 2013 and through the second quarter of 2014, Public segment results were impacted by the combined and residual negative effects of sequestration, the partial shutdown of the federal government and federal government budget uncertainty. However, during the second quarter of 2014, we began to see improvement in net sales activity and had positive sales growth from our federal government customers.


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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. While macroeconomic uncertainty drove a cautious approach to customer spending in the early part of 2013, uncertainty began to dissipate in the back half of 2013 and continued to dissipate through the first half of 2014. We will continue to closely monitor macroeconomic conditions during the remainder of 2014. Uncertainties related to potential reductions in government spending, requirements associated with implementation of the Affordable Care Act, 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.

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, net income, Non-GAAP net income, net income per common share, Non-GAAP net income per diluted share, EBITDA and Adjusted EBITDA, free cash flow, return on invested capital, 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 and Adjusted EBITDA are non-GAAP financial measures. We believe these measures 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 definitions of Non-GAAP net income and Adjusted EBITDA and reconciliations to net income.

The results of certain of our key business metrics are as follows:

(dollars in millions)                                       Three Months Ended June 30,
                                                              2014               2013
Net sales                                               $       3,106.0     $     2,779.3
Gross profit                                                      496.9             451.6
Income from operations                                            188.2             153.6
Net income                                                         86.6              46.7
Non-GAAP net income                                               115.9              79.2
Adjusted EBITDA                                                   247.1             212.6
Average daily sales                                                48.5              43.4
Net debt (defined as total long-term debt minus cash
and cash equivalents)                                           2,898.4           3,545.1
Cash conversion cycle (in days) (1)                                  19                20

(1) Cash conversion cycle is defined as 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. The prior period has been revised to conform to the current definition.


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Results of Operations
Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013
The following table presents our results of operations, in dollars and as a
percentage of net sales, for the three months ended June 30, 2014 and 2013:
                                               Three Months Ended                Three Months Ended
                                                  June 30, 2014                     June 30, 2013
                                          Dollars in      Percentage of     Dollars in      Percentage of
                                           Millions         Net Sales        Millions         Net Sales
Net sales                                $   3,106.0          100.0  %     $   2,779.3          100.0  %
Cost of sales                                2,609.1           84.0            2,327.7           83.8
Gross profit                                   496.9           16.0              451.6           16.2
Selling and administrative expenses            273.9            8.8              266.4            9.6
Advertising expense                             34.8            1.1               31.6            1.1
Income from operations                         188.2            6.1              153.6            5.5
Interest expense, net                          (48.5 )         (1.6 )            (70.3 )         (2.5 )
Net loss on extinguishments of
long-term debt                                  (2.6 )         (0.1 )            (10.3 )         (0.4 )
Other income, net                                0.1              -                0.2              -
Income before income taxes                     137.2            4.4               73.2            2.6
Income tax expense                             (50.6 )         (1.6 )            (26.5 )         (0.9 )
Net income                               $      86.6            2.8  %     $      46.7            1.7  %

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, 2014 and 2013:

                                        Three Months Ended June 30,
                                    2014                           2013
                                        Percentage                     Percentage
                                         of Total                       of Total        Dollar        Percent
(dollars in millions)    Net Sales       Net Sales      Net Sales       Net Sales       Change       Change (1)
Corporate               $  1,656.2         53.3 %      $  1,537.4          55.3 %     $   118.8           7.7 %
Public                     1,271.6         40.9           1,082.6          39.0           189.0          17.5
Other                        178.2          5.8             159.3           5.7            18.9          11.9
Total net sales         $  3,106.0          100 %      $  2,779.3         100.0 %     $   326.7          11.8 %

(1) There were 64 selling days for both the three months ended June 30, 2014 and 2013.


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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, 2014 and 2013. Net sales of $37.1 million for the three months ended June 30, 2013 have been reclassified from the small business customer channel to the medium/large customer channel to conform to the current period presentation.

                              Three Months Ended June 30,          Dollar    Percent
(dollars in millions)              2014                 2013       Change     Change
Corporate:
Medium / Large          $       1,395.4              $ 1,308.5    $  86.9       6.6 %
Small Business                    260.8                  228.9       31.9      14.0
Total Corporate         $       1,656.2              $ 1,537.4    $ 118.8       7.7 %

Public:
Government              $         313.1              $   295.7    $  17.4       5.9 %
Education                         527.0                  420.6      106.4      25.3
Healthcare                        431.5                  366.3       65.2      17.8
Total Public            $       1,271.6              $ 1,082.6    $ 189.0      17.5 %

Total net sales for the three months ended June 30, 2014 increased $326.7 million, or 11.8%, to $3,106.0 million, compared to $2,779.3 million for the three months ended June 30, 2013. There were 64 selling days for both the three months ended June 30, 2014 and 2013. The increase in total net sales was primarily the result of growth in hardware, driven by notebooks/mobile devices and desktop computers, as Corporate customers refreshed their client devices and K-12 customers prepared for digital testing requirements.
Corporate segment net sales for the three months ended June 30, 2014 increased $118.8 million, or 7.7%, compared to the three months ended June 30, 2013, driven by sales growth in both customer channels. Within our Corporate segment, net sales to medium/large customers increased $86.9 million, or 6.6%, between periods due to customers refreshing their client devices, a more tenured sales force, a continued focus on seller productivity and additional customer-facing coworkers. This increase was driven by growth in notebooks/mobile devices and desktop computers. Net sales to small business customers increased by $31.9 million, or 14.0%, between periods, also driven by growth in notebooks/mobile devices and desktop computers.
Public segment net sales for the three months ended June 30, 2014 increased $189.0 million, or 17.5%, between periods, driven by continued strong performance in the education and healthcare customer channels. Net sales to education customers increased $106.4 million, or 25.3%, between periods, led by continued growth in net sales to K-12 customers, reflecting increased sales of notebooks/mobile devices to support standardized digital testing requirements. Net sales to healthcare customers increased $65.2 million, or 17.8%, between periods, driven by growth in desktop computers, notebooks/mobile devices and netcomm products. Net sales to government customers increased $17.4 million, or 5.9%, between periods, driven by growth in sales to state/local government customers and a return to growth in sales to the federal government. The increase in net sales to state/local government customers was led by growth in sales of notebooks/mobile devices, desktop computers and netcomm products. The increase in net sales to the federal government was led by growth in sales of notebook/mobile devices and software, partially offset by a decline in netcomm products.
Gross profit
Gross profit increased $45.3 million, or 10.0%, to $496.9 million for the three months ended June 30, 2014, compared to $451.6 million for the three months ended June 30, 2013. As a percentage of total net sales, gross profit decreased 20 basis points to 16.0% for the three months ended June 30, 2014, down from 16.2% for the three months ended June 30, 2013. Gross profit margin was negatively impacted 25 basis points by unfavorable price/mix changes within product margin, as transactional product categories such as notebooks and desktops experienced a higher rate of net sales growth than our overall net sales growth, accompanied by continuing product margin compression in these product categories. Partially offsetting this decrease was an increase of 5 basis points due to a higher mix of revenue recorded on a net basis, such as 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


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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 $7.5 million, or 2.8%, to $273.9 million for the three months ended June 30, 2014, compared to $266.4 million for the three months ended June 30, 2013. Coworker costs increased $6.3 million quarter-over-quarter primarily due to higher compensation consistent with increased coworker count and attainment-based compensation accruals tied to year-to-date performance. The remaining increase was primarily due to higher equity-based compensation expense of $2.2 million, which was partially offset by the absence of sponsor fee expenses of $1.3 million due to the termination of our management services agreement upon the completion of our initial public offering (the "IPO") in 2013. Total coworker count was 7,151, up 341 from 6,810 at June 30, 2013. Total coworker count was 6,967 at December 31, 2013. As a percentage of total net sales, selling and administrative expenses decreased 80 basis points to 8.8% in the second quarter of 2014, down from 9.6% in the second quarter of 2013. The decrease was largely driven by a decline of 50 basis points in sales payroll, consistent with lower compensation generally associated with transactional products.
Advertising expense
Advertising expense increased $3.2 million, or 9.8%, to $34.8 million for the three months ended June 30, 2014, compared to $31.6 million for the three months ended June 30, 2013. As a percentage of total net sales, advertising expense was 1.1% for both the second quarter of 2014 and 2013. The dollar increase in advertising expense was primarily due to an increase in digital advertising and sponsorships, which reinforces our reputation as a leading IT solutions provider.
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, 2014 and 2013:

                                     Three Months Ended               Three Months Ended
                                       June 30, 2014                    June 30, 2013
                                                  Operating                        Operating       Percent Change
                                 Dollars in         Margin        Dollars in         Margin       in Income (loss)
                                  Millions        Percentage       Millions        Percentage     from Operations
Segments: (1)
Corporate                      $     119.7            7.2 %     $     103.2            6.7 %             16.0  %
Public                                88.8            7.0              69.1            6.4               28.4
Other                                  7.6            4.3               8.9            5.6              (13.4 )
Headquarters (2)                     (27.9 )          nm*             (27.6 )          nm*                1.1
Total income from operations   $     188.2            6.1 %     $     153.6            5.5 %             22.5  %

* Not meaningful
(1) Segment income (loss) from operations includes the segment's direct operating income (loss) 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 $188.2 million for the three months ended June 30, 2014, an increase of $34.6 million, or 22.5%, compared to $153.6 million for the three months ended June 30, 2013. The results for the three months ended June 30, 2014 were driven by higher net sales and gross profit, partially offset by higher selling and administrative and advertising expenses. Total operating margin percentage increased 60 basis points to 6.1% for the three months ended June 30, 2014, from 5.5% for the three months ended June 30, 2013. Operating margin percentage benefited from the decrease in selling and administrative expenses as a percentage of net sales, partially offset by a decrease in gross profit margin.


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Corporate segment income from operations was $119.7 million for the three months ended June 30, 2014, an increase of $16.5 million, or 16.0%, compared to $103.2 million for the three months ended June 30, 2013. This increase was primarily driven by higher net sales and gross profit. Corporate segment operating margin percentage increased 50 basis points to 7.2% for the three months ended June 30, 2014, from 6.7% for the three months ended June 30, 2013. Operating margin percentage benefited from the decrease in selling and administrative expenses as a percentage of net sales, partially offset by a decrease in gross profit margin.
Public segment income from operations was $88.8 million for the three months ended June 30, 2014, an increase of $19.7 million, or 28.4%, compared to $69.1 million for the three months ended June 30, 2013. This increase was primarily driven by higher net sales and gross profit, partially offset by higher selling and administrative expenses. Public segment operating margin percentage increased 60 basis points to 7.0% for the three months ended June 30, 2014, from 6.4% for the three months ended June 30, 2013. Operating margin percentage benefited from the decrease in selling and administrative expenses as a percentage of net sales, partially offset by a decrease in gross profit margin. Interest expense, net
At June 30, 2014, our outstanding long-term debt totaled $3,126.0 million compared to $3,724.4 million at June 30, 2013. Net interest expense for the three months ended June 30, 2014 was $48.5 million, a decrease of $21.8 million compared to $70.3 million for the three months ended June 30, 2013. Net interest expense decreased $19.8 million due to lower debt balances for the three months ended June 30, 2014 compared to the same period of the prior year as a result of debt repayments and refinancing activities completed during 2013 and the first half of 2014. The remaining decrease was primarily attributable to lower effective interest rates and reduced amortization of deferred financing costs for the three months ended June 30, 2014. Net loss on extinguishments of long-term debt During the three months ended June 30, 2014, we recorded a net loss on extinguishment of long-term debt of $2.6 million compared to $10.3 million for the same period in 2013.
In June 2014, we entered into the Revolving Loan, a new five-year $1,250.0 million senior secured asset-based revolving credit facility. The Revolving Loan replaces our previous revolving loan credit facility that was to mature on June 24, 2016. In connection with the termination of the previous facility, we recorded a loss on extinguishment of long-term debt of $0.4 million, representing a write-off of a portion of unamortized deferred financing costs. In May 2014, we redeemed $42.5 million aggregate principal amount of senior subordinated notes. We recorded a loss on extinguishment of long-term debt of $2.2 million, representing the difference between the redemption price and the net carrying amount of the purchased debt, adjusted for a portion of the unamortized deferred financing costs.
In April 2013, we entered into a new seven-year, $1,350.0 million aggregate principal amount senior secured term loan facility. Substantially all of the proceeds were used to repay the $1,299.5 million outstanding aggregate principal amount of the prior senior secured term loan facility. In connection with this refinancing, we recorded a loss on extinguishment of long-term debt of $10.3 million for the three months ended June 30, 2013, representing a write-off of the remaining unamortized deferred financing costs related to the prior senior secured term loan facility.
Income tax expense
Income tax expense was $50.6 million for the three months ended June 30, 2014, compared to $26.5 million for the same period of the prior year. The effective income tax rate, expressed by calculating the income tax expense as a percentage of income before income taxes, was 36.9% and 36.2% for the three months ended June 30, 2014 and 2013, respectively. The increase in the 2014 effective income tax rate is primarily attributable to a lower rate impact of state tax credits due to the increase in income before income taxes. Net income
Net income was $86.6 million for the three months ended June 30, 2014, compared to $46.7 million for the three months ended June 30, 2013. Significant factors and events causing the net changes between the periods are discussed above. Non-GAAP net income
Non-GAAP net income was $115.9 million for the three months ended June 30, 2014, . . .

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