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Here’s the entire text of the prepared remarks from CDW Corporation (ticker: CDWC) Q3 2005 conference call. The Q&A, which followed the prepared remarks, is in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: we have paid to have this conference call transcribed, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

John Edwardson, CDW Corporation - Chairman, CEO

As a result of the truly superb efforts of all of our CDW coworkers, we delivered another quarter of record performance in the third quarter of this year. We continue to profitably outpace market growth while setting new records for total revenue, average daily revenue, net income as well as diluted earnings per share.

In addition, we had the best ever revenue week in the history of the company during the last week of September. My belief is that our consistent focus on the customer has been the key to this continuing track record of performance. Our 21-year culture is based upon giving customers a superior customer experience, and we continue to try to perfect this core company philosophy each and every day. Customers come to CDW for a full range of responsive service. This includes the knowledgeable advice of the industry's best-ranked sales group, industry's best products, and best solutions, next-day product delivery, as well as quick resolution to inquiries after the sale.

Please turn to the third slide of the webcast presentation to take a look at our financial results. As you can see, total revenue was 1.67 billion in the third quarter of this year compared to 1.51 billion in the third quarter a year ago, an increase of 159 million or 10.5%. We also had an increased average daily revenue of 10.5%, up to 26.1 million over the period a year ago. Also, annualized revenue per coworker was 1.62 million in the third quarter this year, compared to 1.61 million a year ago.

Gross profit margin was 15.3%, operating profit margin 6.7%, as you can see. Net income was up 12.2% to 73.1 million and diluted earnings per share were up 15.8% to $0.88 a share. For the month of September, we grew average daily revenue 12.5% at 28.2 million. Total revenue in the month was 593 million compared to total revenue in September a year ago, 527 million. Barb will give you many more details on the financial results in a few minutes.

If you turn to overhead No. 4, you can see our return on equity, as well as our return on invested capital. In the third quarter of this year we achieved return on equity of 22.1%, which was 1.7 percentage points above the third quarter a year ago. Likewise, our OIC was up in the third quarter this year to 44.4%, compared to 44.1% in the third quarter a year ago. These numbers, I believe, are outstanding numbers compared to any company in the industry in America.

Consistent with previous quarters overall, IT demand remained relatively stable during the quarter. Activity from different customer channels, and that's different customer segments within CDW, can vary from month to month, but we did achieve growth in every customer channel for the entire quarter, including the federal government channel.

In order to continue to take market share and achieve growth in the future over the long term, we need to make significant new investments to prepare for future growth. So we want to talk about some of those investments at this point.

First, we continue to make significant investments in our sales organization, to develop our customer segmentation model. Last quarter we announced the creation of a dedicated healthcare team, which will be part of our public sector group. This initiative is part of the customer segmentation strategy for specific industry verticals. During the third quarter, we successfully consolidated over 10,000 healthcare accounts from across our entire sales organization and transferred these accounts to the new team in the public sector group. The transition was well executed and we are pleased with the results. We believe that by leveraging our existing expertise in the healthcare industry, we will become increasingly well positioned to serve the unique IT needs of our healthcare customers and take market share in this growing vertical.

As you already know, we are also making significant investments in our infrastructure to position the company for more growth. Our biggest new investment course is the new North Las Vegas distribution center, which is also on track to open by the end of this year. We believe that this new world-class facility will set industry standards in terms of productivity as well as efficiency. While the project was initiated out of necessity, since our Vernon Hills facility is operating at capacity, we believe there are a number of new advantages we will gain as a result of opening this new facility.

First as an ideal location, not because it was just in Las Vegas, but because Las Vegas is 1 day away or less from many of our vendor, distributor, and carrier partner facilities, as well as less than a 1 day trip from the important port in Long Beach where most of our inbound product shipments come into the country. We will also be closer to our largest customer base. Usually our number 1 revenue state is the state of California.

Second, the extra space available in the new distribution center will enhance our purchasing power. We are out of room in this facility, and as a result are not able to take advantage of large product buy-ins when they are available. We've had to restrict our ability to do those, or operate in very tight facilities at Vernon Hills. So this will be a new advantage as well. In addition, our configuration center in Vernon Hills, which all of you know about and which was doubled over the past 18 months, is also at capacity, and we are building an even bigger configuration center in the new Las Vegas facility.

And fourth, we do expect to get shipping efficiencies by leveraging both locations as we are choosing which location to ship from to our customers. So we know that we'll have good enhancements, better customer service as a result of this significant new investment, but it is significant. So investments in our infrastructure and in our organization will add to our expenses in the short-term and Barb will go over those with you in a little more detail in her presentation.

We do need to move forward with these initiatives since they are necessary to provide the room for future growth, but we want you to know that our philosophy of never being satisfied is as strong as ever, and it is just as applicable to earnings per share as it is to customer service, so we will work hard to leverage these additional expenses as quickly as possible.

We believe firmly that our approach to customer segmentation will continue to pay off and we will continue to execute our key strategies for growth, which are enumerated on overhead No. 5 of the webcast presentation. They include improving productivity, growing our customer base, penetrating existing accounts, optimizing our product mix, strengthening our brand, and selectively pursuing strategic transactions.

Finally, I want to give a big thank you to each of our CDW coworkers who delivered another record quarter by doing a great job for our customers. With that, I would like to turn the presentation over to Harry Harczak who is stepping up to the plate to give you his near term outlook, which is White Sox Win the World Series. I will now turn the call over to Harry to discuss baseball, philosophy, sales and product trends for the third quarter.

Harry Harczak, CDW Corporation - EVP, Sales

Thank you, John, and from a baseball perspective what an exciting time it has been in Chicago. Now on to business, both the corporate and public sector segments achieved new quarterly sales records in the third quarter of 2005, and all customer channels grew compared to the same period a year ago. These results reflect a restatement for the consolidation and transfer of all healthcare accounts to the public sector, which is attached as an addendum to our third quarter of 2005 earnings press release.

In the corporate sector, total corporate segment sales were 1.117 billion in the third quarter of 2005, compared to 1.018 billion in the third quarter of 2004, representing a 9.7% growth over the prior year. Average daily sales in the third quarter of 2005 were 17.4 million, compared to 15.9 million in the third quarter of 2004. Both quarters had 64 billing days.

We experienced normal seasonal patterns in the corporate segment during the third quarter. Corporate sector growth, which outpaced the market, resulted from the continued execution of our key growth strategies that John outlined in his section, such as penetration of existing accounts and new customer acquisition. We believe our performance was positively impacted by our continuing investment in our specialist teams and on going training for the entire sales force.

Our public sector segment, CDW-G, generated total sales of $554 million in the third quarter of 2005, compared to 494 million in the third quarter of 2004, representing a 12.2% increase.

Average daily sales were 8.6 million in the third quarter of 2005, compared to 7.7 million in the third quarter of 2004. In our August monthly sales announcements, we indicated that federal sales were flat for the month. Federal sales grew in the third quarter of 2005, compared to the period a year ago, due in large part to our focus on funded opportunities within the federal customer channel. The third quarter has historically represented our strongest quarter due to the federal government's fiscal year end on September 30th. As we examine the potential impact of hurricane Katrina on the third quarter 2005 results, net net we found the impact was minimal for both the corporate and public sectors.

On September 30, 2005, our sales work force numbered 2061, which was 9.6% higher, versus 1,880 on September 30th of 2004. We are on track to add 100 to 125 net new sales force coworkers in 2005, which includes, account managers, specialists and field sales coworkers. We have also continued to increase the number of our advanced technology specialists, which now number approximately 260. Sales force retention continued to improve versus last year. In the third quarter of 2005, the percentage of sales force turnover was in the high teens, while a year ago it was in the high 20's.

On slide 6, average daily sales per average sales force coworker was approximately $13,000 for the third quarter of 2005, which translates to approximately $3.3 million on an annualized run rate basis. On a year-over-year basis, we maintained our productivity levels and on a sequential basis we increased average daily sale per average sales force coworker by 6.6%. This metric is affected by both the timing of new hires and sales cyclicality. As we continue to grow the sales force, we remain focused on improving productivity across the entire sales organization.

I'll now turn to highlights of product trends. Slide 7 shows our product mix for the third quarter of 2005, compared to the third quarter of 2004. Software remained our largest product category comprising 17.3% of sales. Data storage devices was second at 13.9%. Desktop computers and servers were third at 13.7%. Notebooks and accessories was our fourth largest category 12.9% and printers were 5th at 12.2%. Product revenue growth rates are shown on slide 8.

Data storage devices increased 17.8% versus the prior year period, and desktops and servers grew 16.6%. The trend of server consolidation positively impacted both these product categories. In addition, demand for storage was driven by the ever increasing amounts of data to be stored, threats of data loss, and increasing government legislation surrounding maintenance, access, and security of stored data. Growth in servers was positively impacted by increased sales of higher ASP technologies such as blade servers and dual core processors. Strong desktop growth resulted from our PC refresh campaign that focuses on the productivity gains of upgrading old desktops.

Netcom products grew 15.7%, and the category was positively impacted by demand for security products, routers and switches, power and telephony. Software grew 14.8%. Application suites, operating systems, and security software were standout drivers of this category. Printers increased 6%, with solid growth in faster color laser printers, multifunction printers, and printer supplies. The video category had double digit unit volume growth, but total revenue was impacted by declining ASPs, especially for LCD, displays, and projectors. The notebook and accessory category decreased slightly by 0.2%.

Notebook CPU growth of 2.2% was partially offset by lower sales of hand helds and PDA's which are included in the notebook and accessory category. Slide 9 shows the change in revenue, unit volume, average selling prices for notebook CPUs and desktops and server CPUs. Notebook CPU revenue increased 2.2% and unit volume was up 11.8% compared to the third quarter of 2004, with the average selling price declining 8.6% from a year ago. Notebook sales were impacted by product mix. ASPs on some notebook lines were significantly lower but these prices allowed us to be more competitive in the marketplace, driving unit volume. In addition, Apple was focused in taking more business to direct sales channels.

In the fourth quarter of 2005, marketing efforts will be focused on a notebook refresh campaign that promotes the productivity benefits of updating older notebooks. We also expect to expand our notebook category offerings, and will continue to concentrate on further penetrating this category with our existing customer base. Revenue from desktop computers and servers increased 16.6%, and unit volume was up 12% from the third quarter of 2004, with the average selling price increasing 4.2%.

Slide 10 shows that the web generated approximately $455 million in direct online sales for the third quarter, representing 27.3% of sales in the third quarter, an increase of 12.3% over the third quarter of 2004. We want to drive more customer web usage so we'll continue to enhance the functionality of both our website and customer extranets. Barb Klein will now comment on third quarter financial performance.

Barbara Klein, CDW Corporation - CFO, SVP

Thank you Harry, and good morning again. As John mentioned, the third quarter of 2005 was another quarter of record, in which we outpaced market growth and delivered solid financial performance. Gross profit margin in the third quarter of 2005 was 15.3% compared to 15.1% in the third quarter of 2004, and within our stated objective range of 14.75% to 15.5%. The increase was primarily due to stronger product margins.

Additionally, a larger amount of cooperative advertising funds were reclassified as a reduction of cost of sales, due to both an increase in marketing activities and because virtually all cooperative advertising funds were reclassified as a reduction of cost of sales in 2005.

The positive impact from these items was partially offset by reduced customer charges for delivery, insurance and handling, and a lower level of vendor incentives. The company restructured and simplified its charges to customers for delivery and insurance and handling in the first quarter of 2005. We expected these modifications to be offset by changes in product pricing and expedited delivery charges over the course of the year and we have made progress on this objective.

Vendor incentives were lower in the third quarter of 2005 versus 2004 due to changes in vendor program. Advertising expense was $29.8 million in the third quarter of 2005, and $24 million in the third quarter of 2004, an increase of approximately 24%, we continue to execute the integrated branding campaign that was launched earlier in the year.

Slide 11 shows our operating statistics. As CDW's business continues to evolve, we periodically evaluate the relevance of metrics used to measure our performance. As we have discussed before, CDW's business has become less homogeneous over the years. The metrics for invoice size and number of invoices have become less meaningful as the business has changed. For example, an invoice could contain a single item such as a printer, or it could represent a multimillion-dollar billing to a customer. Additionally, a single order could be fulfilled through multiple shipments and invoices. Since invoice size and number of invoices are no longer as relevant as measures of our operations, this is the final quarter we will provide these metrics.

Selling and administrative expenses were 6.8 % of sales in the third quarter of 2005, compared to 6.5% in the third quarter of 2004, an increased 15.1% compared to previous year. The increase was due to increased expense for the additional profit sharing contributions to the 401K plan of $1,000 per coworker announced earlier this year in conjunction with the modification to the company's stock option program. Approximately $1 million of expenses relating to the preparation for start up of the company's new distribution center in North Las Vegas Nevada and increased payroll cost for a larger number of coworkers to support a larger and growing business.

Our operating margin was 6.7% in the third quarter 2005, compared to 7% in the third quarter of 2004, and was within our stated objective of 6.5% to 7%. Inventory turns on an annualized basis were 25 times in the third quarter of 2005, compared to 24 times in the previous year. Our objective remains at 25 inventory turns annually.

Accounts receivable days sales outstanding were 37 days at the end of the third quarter 2005, compared to 33 days at the end of the third quarter of 2004. The increase in day sales outstanding was due to a higher percentage of sales on terms as our commercial customers continue to represent a larger portion of our sales. As a note, over 99% of our customers are commercial customers for the third quarter of 2005. The increase in September 2005 revenue of 12.5% compared to the prior year, and the inclusion of sales taxes collected from our commercial customers in accounts receivable, which permanently added approximately 2 days to days sales outstanding beginning in the second quarter of 2005. Our DSO target is 35 to 37 days.

The effective tax rate for the third quarter of 2005 was 36.9%, compared to 39.6% for the third quarter of 2004. The tax rate of 36.9% for the third quarter of 2005 reflects an adjustment to the overall effective tax rate, to arrive at combined rate of 37.4% for the first nine months of 2005, which is the rate we currently expect for full year 2005.

The primary reason for the year-over-year decrease is the result of collecting state sales taxes, which began in the second quarter 2005. CDW had to register to do business in all states in order to collect sales taxes, which makes the company subject to state income taxes. Income tax rates and apportionment factors vary across state.

The revised effective tax rate is estimated at 37.4% for full year 2005, which is slightly down from the estimate of 37.8% we provided in the second quarter of 2005. The difference is due to an increase in estimated tax-exempt interest income from state and municipal securities that will be earned in 2005. Change in effective tax rate increased earnings per share in the third quarter of 2005 compared to third quarter of 2004 by approximately $0.04 per share.

On a sequential quarter basis, the effective tax rate that we provided in the second quarter for the remainder of full year 2005, compared to the actual tax rate for the third quarter 2005 increased earnings per share in the third quarter by approximately a penny per share.

We repurchased 124,000 shares of our stock in the third quarter at a total cost of $7 million. Year to date we have spent $219 million for share repurchases, at an average price of $56.76. In the second quarter of 2005, share repurchases of approximately 1.5 million shares were more heavily weighted towards the end of the quarter. The full impact of those repurchases was realized in the diluted weighted average number of common shares outstanding in third quarter of 2005. On a sequential quarter basis this positively impacted earnings per share for the quarter by approximately a penny per share. We have approximately 2.9 million shares remaining under the current share repurchase authorization, which expires in April 2007. Slide 12 shows our share repurchase and dividend history. And in total, we have returned over a quarter of a billion dollars to shareholders in 2005.

We ended the third quarter with approximately $590 million in cash, cash equivalents, and marketable securities. Cash flow from operations was approximately $67 million in the third quarter of 2005 and $238 million in the first nine months of 2005. Working capital increased in the third quarter of 2005 as the business continued to grow, which we also saw in last year's third quarter.

As John discussed, we have fully transitioned our healthcare accounts to creating new customer channels within the public sector. Results of operations on a quarterly basis for 2004 and the first two quarters of 2005 have been restated for the corporate and public sector segments to reflect this change. The addendum to the financial information in our press release provides these restatements.

As a result of the transition, corporate sector operating margins did not change significantly, however, the public sector operating margins were generally positively impacted because the margin on sales to health care customers was more similar to an average corporate sector customer than an average public sector customer. In the third quarter 2005, corporate sector sales increased 9.7% and operating income increased 8.9%. Public sector sales increased 12.2% in the third quarter, compared to last year's third quarter, while operating income increased 3%.

Operating income for the public sector increased at a more modest rate due to lower gross margin on certain government customer sales and an increase in selling payroll, primarily for field sales coworkers to support the increase in sales. Headquarters and other expenses increased from $6.7 million in the third quarter of 2004 to $8.6 million in the third quarter of 2005, primarily due to larger number of coworkers to support a larger and growing business and increased depreciation expense related to software investments made in the second half of 2004 and hardware investments made in 2005.

John also talked about our second distribution center in North Las Vegas Nevada, which is scheduled to open by the end of 2005. Since we are at capacity in our existing distribution center in the Chicago area, we are investing in this new facility to prepare for future growth. The Las Vegas distribution center will be approximately 500,000 square feet compared to our current distribution center of 450,000 square feet.

Over the next few years we will leverage the new space and balance shipments and growth between the two facilities. To ensure that everything is working smoothly, the operations in the new distribution center will be ramped in a controlled and deliberate manner. During the initial stages, we will begin to ship to those customers in the western most states, such as California and Nevada. Gradually, we'll begin to serve those customers located west of the Mississippi river out of the new facility.

We estimate capital expenditures of 35 to $40 million for the facility in 2005. By the end of 2006 we anticipate utilizing 30 to 40% of the facility's capacity. As John indicated, the Las Vegas distribution center is an investment to support future growth. As we have stated previously, the project will increase SG&A expenses. In the third quarter of 2005 we incurred approximately $1 million as start-up cost and in the fourth quarter of 2005, we expect approximately 3 to $4 million of start-up costs. The total expected start-up costs for 2005 of approximately 4 to $5 million is down slightly from our previous estimate of 5 to $6 million.

In 2006, there will be added expenses including rent, depreciation, coworker costs, facilities and supplies. Some of these costs like rent and depreciation are straight lined for accounting purposes and are not tied to shipping volume. In addition to the new distribution center, we will be adding leased office space primarily in the Chicago area for sales and support functions. As we continue to grow, we will need more space to accommodate more coworkers. Rent and depreciation are straight lined for accounting purposes, regardless of the fact that the additional costs provide for future growth.

The new distribution center and additional office space represent infrastructure investments that are necessary to support CDW's future growth. However, these investments will impact SG&A expenses and operating margin in both the fourth quarter of 2005 and full year 2006. Total SG&A expense for these investments is estimated at approximately $25 million in 2006, and approximately $17 million incrementally over 2005.

Primarily as a result of these investments, our operating margin objective is modified to a range of 6.1 to 6.6% for these periods. At this time, our goal is to be at the higher end of this range in the fourth quarter of 2005 and the fourth quarter of 2006, but we'll probably be at the lower end of this range in the first quarter of 2006. As we have typically done in the past, we'll continue to provide our operating margin range objective on a quarterly basis during our quarterly earnings conference call. Also as we have done historically we will not update this objective during any quarter.

As John indicated, we will focus on leveraging the additional expenses from these infrastructure investments. Our goal is to work our way back as quickly as possible to our previously stated operating margin range objective of 6.5 to 7% in 2007. We will do this through additional customer segmentation, and the execution of our growth strategies, which, again are, to improve productivity, expand our customer base, penetrate existing accounts, optimize our product mix, strengthen our national brand and selectively pursue strategic transactions.

We've been able to consistently take market share and achieve profitable growth in all economic environments, and these objectives remain firmly in place. Thank you for your attention and we will now open the line for questions.

Continue on to the Q & A.

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Source: CDW Earnings (CDWC Q3 2005 Conf Call) Prepared Remarks
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