CDW Corporation (CDW) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the CDW First Quarter 2013 Conference Call [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Mr. Tom Richards. You may begin.

Thanks, Tyrone. Good morning, everyone, it's a pleasure to be with you today and report another quarter of record results. Joining me on the call today are Ann Ziegler, our Chief Financial Officer; and Chris Leahy, our General Counsel. I'll begin today's call with a brief overview of our results and discuss our recent strategic progress. Ann will run you through the financial highlights and then we'll go right to your questions. But before we begin, Ann will provide a few important comments regarding what we will share with you today.

Thanks, Tom. Good morning, everyone. If you do not have a copy of the earnings release that was posted this morning and furnished to the SEC on Form 8-K, or the slides we have prepared to go along with this call, you may find them at our website at cdw.com under our Investor Relations section. As you know, CDW filed an initial S-1 registration statement on March 22, 2013 with the SEC and as such, we are in a quiet period. Recognizing this, our prepared remarks will not provide any perspective on future performance nor will we be able to respond to questions, which would require us to comment on future performance. We also will not be able to discuss our proposed initial public offering and we refer you to our S-1 registration statement if you have any questions relating to that. To the extent that any comments made in our presentation this morning are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the Form 8-K we furnished to the SEC today and in the company's other filings with the SEC. CDW assumes no obligation to update the information presented during this webcast. Our presentation also includes certain non-GAAP financial measures. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You will find reconciliation charts in the slides for today's webcast and in the Form 8-K we furnished to the SEC. Finally, all references to growth rates or dollar amount increases in our remarks today are, unless otherwise indicated, versus the comparable period in 2012. Additionally, as Q1 2013 had 1 less selling day than the comparable period in 2012, all references to revenue growth rates versus last year are on an average daily sales basis, unless otherwise indicated. With that, I'll now turn the call back over to Tom to give you an overview of our first quarter operating results.

Okay, thanks, Ann. Our results this quarter once again demonstrated the power of our balanced portfolio and our focus on profitable growth as we delivered sales increases above forecast for the U.S. IT market with excellent profitability. Our first quarter net sales were $2.4 billion, up 4% on a reported basis and 5.6% on an average daily sales basis over last year's first quarter. Gross profit increased 4.5% and our adjusted EBITDA increased 7.3%. We delivered solid top line performance across both our corporate and public segments with corporate up 4.6% and public up 5.2%. These results were powered by our diverse customer base and broad products and solutions portfolio. With 5 customer channels each delivering over $1 billion in annual sales, our broad customer base continues to be a significant contributor to our ability to outperform the overall market. The benefit of this diversity is clear within this quarter's results, both in our corporate and public segments. For our corporate segment, sales increases of 7% in our medium and large business channel more than offset a 4% decline in our small business channel. While we saw solid momentum in sales to medium and large customers, conditions remained soft in the small business market consistent with what we saw at the end of last year as small business customers, which we define as companies with fewer than 100 employees, continued to take a conservative approach to buying. In our Public segment, the benefit from our diverse customer base was also evident. Government was down just over 2% as double-digit sales growth to state and local governments didn't fully offset low double-digit declines to the federal government market. On a federal government front, potential sequestration cuts and the absence of a budget impacted results. State and local government results continued their double-digit growth trend powered by our focus on public safety. Education rose 6% as decreased sales to higher education customers were more than offset by double-digit increases in K through 12. Finally, 3 of our growth engines, health care, Canada and advanced technology services each contributed meaningfully to overall results. Combined, our Canadian Advanced Technology business, which we report as Other, rose 18% in U.S. dollars over last year's first quarter and while up against a strong first quarter last year, health care rose again low double digits. Our suite of over 100,000 products also contributed to our performance. On a net sales basis, hardware grew 3%, software grew 16% and services grew 16%. The increase in software was driven by strong performance in products that support higher growth solutions, including security, virtualization and network management software. Strong services results drove improved field service utilization rates, which added to our margin performance during the quarter. The benefit of our broad product portfolio was particularly evident in hardware performance, which included high teens growth in NetComm, mid-single digit growth in notebooks and mobile devices. These strong results more than offset lower sales in printers, nonenterprise storage and desktops. As you know, there's been a lot of commentary about overall PC performance this quarter. When thinking about the industry of PC data that has been reported, it's important to remember that this data that's being reported includes consumer sales. Our PC business is focused on business customers. For CDW, we saw PCs grow in the quarter consistent with our view that PCs remain an important part of commercial and public organization IT strategies. We delivered excellent top line results with the first quarter's continuing soft North America IT market and we did so without sacrificing profitability, achieving first quarter records for both gross profit and adjusted EBITDA. These results reflect the power of our compensation programs that focus on gross profit growth, our ongoing focus on productivity, as well as the more cautious approach we took to bringing on new coworkers. Taking advantage of the flexibility we have, we decided to slow down our pace of hiring in light of the potential impact of the sequester on the economic recovery. Coworker count was down 25% from year end of 2012 to 6,779. We have made no change to the plan we shared at our year-end call with you to add between 100 and 125 customer-facing coworkers this year. As always, we will continue to monitor the market environment. During the quarter, we continued to make excellent strategic progress, including building our brand as an integrated solutions provider. I hope you had a chance to see our March Madness Winning on the Road campaign featuring Charles Barkley, continuing to help the fictional Gordon & Taylor company win business. This time, Charles, the ultimate road warrior, is part of a team that takes a very funny cross-country road trip to help businesses manage their IT better. March Madness continues to be an excellent investment for us. This year's integrated campaign generated more than 240 million impressions from TV, online, PR and social media. Building our brand underpins the success of all 3 of our strategic priorities. We've been executing against 3 strategic priorities for some time now. First, further penetrate our core markets; second, expand our solutions suite; and third, build our service capabilities. During the quarter, we made progress in all 3. You can see the impact of our first strategy to further penetrate our core markets in the quarter's above market sales results, which were in large part due to the success of our ongoing focus on sales force productivity. During the quarter, we continued to refine our already strong sales tools particularly in the areas of targeting, training and freeing up time for sellers to sell. Our second strategy is to continue to expand our already strong solutions offerings. Today, our solutions suite is broad and includes virtualization, collaboration, security, mobility, data center optimization and of course, cloud computing. During the quarter, solutions success drove results across the business as we continue to leverage our existing portfolio and add new solutions. A great example of how solutions impact results across the company is the mobility solution we delivered to a local community college. The first step was to help the college upgrade its campus network infrastructure to handle BYOD. This required deploying wireless access points in more than 20 buildings and outdoor locations across a more than 200-acre campus. Then, to ensure the college could safely adopt its BYOD policy for students, we implemented a new IT security solution for the college's entire IT system, one that delivered improved visibility and control over all user activity and devices on both their physical network and their wireless infrastructure. Because of the complexity of this particular security solution, only providers like CDW with demonstrated technical knowledge and dedicated engineers are authorized to sell the technology. Each install also requires CDW professional services. Integrated mobility solutions like this one generate hardware, software and services revenue. We continue to see adoption of our cloud solutions also. A great example of this is a hybrid cloud solution we implemented this quarter for a financial services software provider. That company wanted to upgrade its disaster recovery capability. We created a solution that seamlessly integrated private cloud data storage with public cloud virtual disaster recovery. The private cloud is colocated in one of our partner data centers and the public cloud is provided via hosted service. This premise-the-cloud solution uses a flexible data center platform that leverages their existing infrastructure and software. The network and compute stack we installed represents hardware revenue. Colocation and cloud storage delivers an ongoing service revenue stream and the UCS platform we installed required new customer recovery software. We are now working to replicate this solution in other markets for them. We also made progress during the quarter expanding our solutions portfolio. We are particularly excited about one solution we just finished beta testing that fits perfectly in our sweet spot of customers and furthers our goal of enabling small and mid-sized businesses to cost effectively take advantage of emerging technologies. Called CDW Security Threat Check, this new proprietary solution meets a key small and mid-sized business need by making the process of assessing malware infiltration cost effectively and scalable. Security threat check combines an existing software solution with CDW proprietary managed services technology and leverages our configuration and logistics capabilities. With the Security Threat Check, we can deliver and install a malware assessment tool that provides realtime results in as little as a week instead of weeks of engineering effort traditional assignments require. This requires both our cost -- excuse me, this reduces both our cost and the cost for our customers making assessment of security breaches possible that used to be out of the reach for small and mid-sized companies. And early results indicate that once the assessment tool is implemented, we identify security intrusions and malware over 90% of the time. Of course, the goal then is to help our customers mitigate this risk and ultimately convert the assessment into a security sale. Our third strategic priority is continue to build our service capabilities. Service capabilities are an integral component of many high-end solution sales and are one of the key ways solutions add value to our partnerships. We know that expanding our service delivery capabilities deepens relationships with both customers and our vendor partners. Expanded service delivery capabilities also complement our first 2 strategies of further penetrating our core business and expanding our solutions suite. With our 16% services growth in the quarter, which lapped last year's 17% growth, we feel very good about the progress we are making against this strategy in the quarter. Let me conclude by reiterating the confidence we have in our strategy. As you can see, from our results this quarter, we continue to reap benefits from our efforts to build our capabilities and capacity to deliver higher growth technology solutions and our continuous focus on sales productivity and operating efficiency. And with that, let me turn it back over to Ann who will share more detail on our financial performance.

Thank you, Tom. We have posted a few slides to help you follow the numbers. Revenue in Q1 was $2.412 billion, an increase of 4% on a reported basis. Q1, 2013 had 1 less selling day as compared to 2012 so on an average daily sales basis, revenues increased 5.6% as average daily revenues grew to $38.3 million. On a sequential basis, average daily sales in Q1, 2013 declined 7.3% versus Q4, 2012, generally in line with the normal seasonality. Gross profit in Q1 increased 4.5% to $402 million as gross margin increased 10 basis points to 16.7% driven by a higher mix of commission revenue and higher professional services growth profits partially offset by negative price mix and product margins. SG&A, including advertising expense, was $282 million in Q1, an increase of 0.3%. We were able to hold our SG&A expense essentially flat as an increase in sales commissions and other variable compensation consistent with our higher sales and gross profit was offset by a decrease in non-cash equity compensation costs and lower occupancy costs. Adjusted EBITDA for Q1 was $178.6 million, up 7.3% and our Q1 adjusted EBITDA margin was 7.4%. We continued to drive productivity in the business. Q1 annualized sales per coworker was $1.42 million, a 4% increase versus Q1, 2012 and the highest Q1 productivity we have achieved since 2006. Given the macroeconomic uncertainty, we remain very cautious in our hiring and allowed attrition to run a bit ahead of hiring in Q1. As Tom indicated, we ended the quarter with 6,779 coworkers. Also, as Tom mentioned, we do remain committed to the full year hiring plan we articulated on our Q4 call. Moving to the balance sheet. At the end of Q1, our revolver remained undrawn and our cash plus revolver availability was $796.5 million. Our total debt on a GAAP basis at the end of Q1 was $3.681 billion for a net leverage ratio of 4.5x down 0.4 turns since the end of 2012. Debt, as defined by our term loan minus cash, was $3.782 billion, a reduction of $195 million from the end of 2012. Our net leverage ratio, as defined by our term loan at the end of Q1 was 4.9x, representing a deleveraging of 0.3 turns as compared to the company's 5.2x ratio at the end of 2012. Our restricted payment basket at the end of Q1 was approximately $125 million. A few comments on recent refinancing activity. On March 8, we redeemed $50 million in principal amount of our 12.535% senior subordinated notes due 2017. On April 29, we closed the refinancing of our existing $409 million nonextended term loans due 2014 and our $891 million extended term loans due 2017 with a new $1.35 billion, 7-year covenant-like term loan facility. Interest on the new facility is LIBOR plus 250 basis points with a LIBOR floor of 1%, stepping down to LIBOR plus 225 basis points upon our achieving a total net leverage ratio of less than 4x. At closing, the new term loans had an interest rate of 3.5%, which is 40 basis points better than the 3.9% weighted average interest rate of the previous term loan, yielding annualized interest savings of approximately $3.6 million. Additionally, the definition of debt under the new term loans has been closely aligned to GAAP and therefore, on a go forward basis, we will be reporting only GAAP debt and the corresponding net leverage ratio. In terms of working capital metrics, the details by component are provided on the slides posted for the call. All in, our cash conversion cycle is now at 23 days, an improvement of 1 day since the end of last year and in line with the normal seasonality of our business. Cash interest in the quarter was $16.2 million and cash taxes were $1.7 million. That concludes the financial summary. We will now open it up for Q&A. Please remember that CDW is in a quiet period and we are unable to respond to questions which would require us to comment on future performance. Operator, can you please provide the instructions for asking a question and can we please ask each of you to limit your questions to 1 question and 1 follow-up. Operator?

. [Operator Instructions] First question is from David Phipps of Citigroup.

Can you talk about your large segment -- the medium and large corporate segments? You continue to show a strong growth there and we've heard in a lot of other conference calls that some other companies are struggling in that area.

David, it's Tom, sure. I think one thing to keep in mind, though, is kind of where we focus. We're not primarily focused on the very large enterprise marketplace and I think that's where you see some of the pressure in other market segments. We've continued to focus on kind of our sweet spot and in many of the initiatives I talk about, whether it's giving sellers more time to sell, improving our targeting, which kind of relates to giving them more time to sell, but it makes the time they are selling more productive. I think those things have helped kind of the sales productivity issue. And we've seen medium and large business segment kind of for the last couple of quarters begin to show some pretty good performance.

If I could have a quick follow-up. What exactly is in the Other segment that continues to grow at double digit rates? And that's all my questions.

Other is the Canada and Advanced Technology services operation.

[Operator Instructions] Our next question is from Thomas Egan of JPMorgan.

I wonder if you can just clarify a little bit around the thought process with the hiring of the coworkers, because I just wanted to make sure I had that clear. Originally, you said that you had sort of backed off on the hiring because you were worried about sequestration and some of the potential increases that you might not see in the government side, but then you said that you still plan to add the 100 to 125 coworkers, that plan is still in place. So maybe you could just provide us a little bit more color around what you're thinking. Do you -- are you -- do you know you're going to need those folks? What gives you confidence that you're going to need those folks by the end of the year? Why not just say, look, it's in flux and if we need them, we need them, if we don't, we don't?

Well, Tom, if you remember, we were pretty transparent about our sensitivity around the early part of this year and we said that, I think, on the last call, and we built our plan. But we're hopeful and anticipating that the economy will continue to improve and so we can go ahead and continue to execute with our plan. But I always, in my formal comments, Tom, I always have a line in there that said, of course we will monitor market conditions and adjust accordingly. I think what it did though was demonstrate one of the things we're quite proud of which is kind of the rigor and discipline with which we manage the business and the flexibility we have to kind of move the business based on what's going on in the marketplace.

So then just as a follow-up, on the education front, just sort of the same question that David Phipps had on the large business customer front. Many of the companies that I look at that service education are struggling because the budgets are incredibly tight at both the local and the big institution levels. I wondered if maybe you could just comment a little bit on what you're doing differently there that you think that the other guys aren't?

Well, I can't really comment on what the other guys are doing, so I can only tell you a little bit about how we focus. And just like everyone else, higher education is in a unique situation today with just the impact of funding and that clearly spills over into making IT decisions but we have continued to kind of on the other part of which is K through 12, local governments have had the opportunity, I think one of the things that's driving some of the technology decisions in K through 12 is some of the pending requirement to do testing in a digital format. And that, we have taken advantage of that and tried to help our customers get ready for that and to manage that. And I think that's one of the reasons you're seeing a strong performance by our K through 12 group.

There are no further questions at this time. I'd like to turn the call over to Mr. Richards for any closing remarks.

All right. Thanks, everybody again for taking the time to join us today and your interest in CDW. And as always, if we can help you or your company with their IT decisions, we're easy to find. So thanks, again for joining us on today's call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.