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CDW Corporation (CDWC)

Q2 2007 Earnings Call

July 24, 2007 8:30 am ET

Executives

John Edwardson - CEO

Barb Klein - SVP and CFO

Jim Shanks - EVP

Harry Harczak - EVP

Paul Shain - SVP

Cindy Klimstra - VP of Investor Relations

TRANSCRIPT SPONSOR
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Operator

Good morning ladies and gentlemen and welcome to the Second Quarter 2007 Earnings Call. At this time all participants are in a listen-only mode. Please note that this conference is being recorded.

I will now turn this call over to Mr. John Edwardson. Mr. Edwardson you may begin.

John Edwardson

Jenny, thank you and good morning to all of you on the call. And thank you for joining us to discuss CDW's second quarter of 2007 results. With me here in the room today are Jim Shanks, Executive Vice President, Harry Harczak, Executive Vice President; Barb Klein, Senior Vice president and Chief Financial Officer and of course Cindy Klimstra, Vice President of Investor Relations. And as usual, before we begin Barb will present the company's Safe Harbor disclosure statement.

TRANSCRIPT SPONSOR

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Barb Klein

Thank you John and good morning. Any statements made by management in this conference call which are forward-looking, i.e. not historical in nature are made pursuant to the Safe Harbor Provisions of the Private Securities Litigations Reform Act of 1995. Please be cautioned that such forward-looking statements involve risks and uncertainties, and are based on the company's current expectations. Actual results could differ materially from such expectations. Certain risks, uncertainties and other factors affecting the company's business are contained in its filings with the SEC, and are discussed in this conference call.

Also, if you are listening to a playback of this conference call, please be advised that our statements on this conference call are made as of the date of the call, are subject to future events and should not be considered to represent the expectations of management other than as of the date of this call.

Our press release and slides for today's call are posted on the Investor Relations' pages of our website at cdw.com. Supporting materials on the Investor Relations' page are under the heading, entitled "Webcast."

In connection with the merger agreement relating to the proposed acquisition of CDW by an affiliate of Madison Dearborn Partners, LLC and Providence Equity Partners Incorporated, we have filed a definitive proxy statement with the Securities and Exchange commission and the proxy statement had been mailed to shareholders of record of the company as of July 5, 2007.

Before making any voting decision shareholders are urged to carefully read the proxy statement regarding the merger, in its entirety, because it will contain important information about the proposed merger. A copy of this transcript is being filed with the SEC at proxy's listing materials relating to the meeting of shareholders to consider the merger agreement and additional information can be found in the definitive proxy statement filed with the SEC relating to that proposed transaction.

So with that let me turn it back to John.

John Edwardson

Thank you, Barb. As Barb mentioned and as most of you on the call probably know we previously announced the merger agreement that provides for the acquisition of CDW by an affiliate of Madison Dearborn Partners and Providence Equity Partners.

To summarize upon closing of the merger CDW will be controlled by investment funds affiliated with Madison Dearborn Partners, LLC and Providence Equity Partners Inc. We will be holding a special meeting of our shareholders on August 9, 2007 to vote on the merger agreement and we filed our definitive proxy statement with the SEC on July 13, 2007.

Since we are in a proxy solicitation period relating to the pending merger transaction, we will not be holding a Q&A session on our call today. Details of the transaction can be found on the proxy statement. We currently expect to complete the merger on the second half of the third quarter or early on the fourth quarter of 2007.

With that please turn to slide 5 of the webcast presentation that compares our financial results for the second quarter of 2007, to the second quarter of 2006. Thanks to our CDW coworkers' efforts we achieved a record quarterly revenue, gross profit, operating income, net income and diluted earnings per share on the second quarter of 2007.

Total revenue increased 24.4% to $2.03 billion and includes approximately $153 million from Berbee. Excluding Berbee and therefore on a non-GAAP basis, total revenue was $1.88 billion, an increase of 15.1% compared to the prior year period.

Gross profit increased 24.2% to $328 million and gross profit margin was 16.1% of revenue. I'd like to mention that during the second quarter of 2007 we incurred cost related to our pending merger of $8.0 million pre-tax and $4.9 million after tax. Our press release includes a reconciliation of GAAP to non-GAAP measures.

Operating income increased 14.7% to $124 million and operating margin was 6.1% of revenue. Non-GAAP operating income which excludes merger related cost to the $8 million pre-tax and as explained in our press release increased 22.1% to $132 million and non-GAAP operating margin was 6.5% of revenue.

Net income increased 9.5% to $80 million. Net income on a non-GAAP basis which once again excludes the merger related cost of $4.9 million after tax, and as explained in our press release increased 16.3% to $85 million.

Diluted earnings per share were $0.99 compared to $0.91 last year representing an 8.8% increase. Diluted earnings per share on a non-GAAP basis which excludes the merger related cost at $8 million pre-tax and $4.9 million after tax and once again as explained in our press release were $1.05, which represented a 15.4% increase compared to last year.

Our performance this quarter represents the continued execution of our existing strategies. We continue to remain focused on growing our revenue profitability, optimizing margins and keeping SG&A cost under control.

Annualized revenue per coworker declined to $1.41 million in the second quarter of 2007, from $1.49 million in the second quarter of 2006. Annualized gross profit per coworker also declined the $228,000 in the second quarter of 2007 from $240,000 in the second quarter of 2006. The decrease in these metrics is primarily due to the increased number of sales force coworkers over the past three quarters and the fact that Berbee has less revenue per coworker.

Slide 6 shows our return on equity and return on invested capital. In the second quarter of 2007, we achieved return on equity of 20.7% and return on invested capital of 31.4% including Berbee.

Barb will give you more detail on these metrics later in her presentation.

Berbee had solid performance this quarter as demand for unified communications solutions among Berbee customers remained strong. In addition, Berbee experienced continued strength in its server and storage business. Due to its more projects-oriented business model, Berbee's growth rate can be more variable compared to our corporate and public sectors.

Once again, I would like to recognize the outstanding efforts of all of our CDW and Berbee coworkers.

Thank you for remaining focused on providing unmatched service to our customers and helping them identify the right technology to enhance their business performance.

Jim Shanks will now discuss revenue results for the sales force related items, Harry Harczak, will review product trends and Barb Klein will give you more financial information later in her presentation.

Jim Shanks

Thank you, John. In the second quarter of 2007 total corporate sector segment sales were $1.237 billion representing an 11.2% increase over last year. Average daily sales in the second quarter of 2007 were $19.321 million compared to $17.373 million in the second quarter of 2006, which was also an increase of 11.2%. On an average daily sales basis the corporate sector increased 12.3% in April, 10.5% in May and 11.1% in June.

The public sector segment generated total sales of $643.6 million in the second quarter of 2007, which was a 23.4% increase from the second quarter of 2006. Average daily sales were $10.056 million in the second quarter of 2007 compared to $8.150 million in the second quarter of 2006, also representing a 23.4% increase from the prior year. On an average daily sales basis, the public sector grew 19.0% in April, 26.9% in May and 25.1% in June.

In the second quarter of 2007, all customer channels within the public sector had profitable double-digit sales growth, including federal government, state and local government, education and healthcare.

On June 30, 2007 our sales force including Berbee numbered 2722 coworkers. This compares to 2589 sales coworkers on December 31, 2006 including Berbee and 2179 sales coworkers on June 30, 2006.

Nearly 350 advanced technology specialists are included in the sales force for the second quarter of 2007. And we are on track to reach our goal of adding approximately 350 to 400 net new sales force co-workers in 2007.

Turning to slide 7 we show average daily sales, per average sales force coworker which includes Berbee.

For the second quarter of 2007 average daily sales, per average sales force coworker were approximately $11,800, compared to approximately $11,900 for the second quarter of 2006.

Slide 8 shows gross profit dollars on an average daily basis including Berbee. Average daily gross profit dollars per average sales force coworker were approximately $1,900 for the second quarter of 2007 compared to approximately $1920 for the second quarter of 2006.

In the second quarter of 2007 the percentage of sales force turnover based on a trailing 12 months was in the low 20s compared to the mid 20s one year ago.

Slide 9 shows that the web generated approximately $589 million in direct online sales for the second quarter of 2007, representing a 19.3% increase compared to the same period a year ago.

Online sales in the second quarter of 2007 comprised 31.3% of total sales excluding Berbee. Berbee sales are not generated on the web due to the high service component of these sales. Harry will now comment on product trends.

Harry Harczak

Thank you, Jim and good morning. Turning to slide 10, we compare our product mix for the second quarter of 2007 to our product mix for the second quarter of 2006. As a reminder, our second quarter of 2007 product sales include Berbee product sales, which primarily impact the netcomm, server and data storage categories.

In the second quarter of 2007, netcomm slightly exceeded software to become our largest product category comprising 16.1% of sales. Software was second at 15.6%, desktop and servers was third at 13.9%, data storage fourth at 13% and notebooks and accessories was fifth at 12.4%.

Slide 11 shows product category growth rates. Sales growth for netcomm products was 92.1%. Berbee contributed significantly to the netcomm category growth rate due to its focus on Cisco's advanced technologies and Voice over IP security and wireless. CDW sales of netcomm products excluding Berbee also had significant double-digit growth.

Growth was driven by sales of networking switches, security hardware and network routers, which accelerated in the second quarter of 2007 due to the Cisco Gold Authorization we received in the first quarter of 2007 for the corporate sector.

We now have Cisco Gold Authorization for all three operating segments, which allows us to offer a broad array of Cisco products to all CDW customers, including Voice-over-IP and certain high-end routers and switches. From not significant in terms of total sales dollars telephony sales which are included in the netcomm category exhibited strong growth in the second quarter due to the Cisco Gold Authorization as well as leveraging our specialist team.

Sales of the combined category of desktops and servers, which include Berbee server sales increased 27.3% in the second quarter of 2007 compared to the prior year period. While the inclusion of Berbee's server sales added significantly to the category's growth, both CDW server and CDW desktop sales excluding Berbee had double-digit growth.

Sales of data storage devices increased 19.8% and include Berbee sales. Customers continue to store larger amounts of data, protect against threats of data loss comply with increasing government legislation and increase their access in secure stored data.

Greater adoption of disk space storage versus tape has also continued. The combined notebooks and accessories product category increased 15.9%, driven by strong notebook sales which represent most of the category. Software sales which include Berbee increased 13.2% versus the prior year period. Key grows drivers for desktop publishing and graphics, network communication driven by virtualization in securities software. We also had strong sales in Microsoft Enterprise Agreements for which we received a commission but did not include as revenue in the software category.

We did not see significant adoption of Microsoft Vista by our customers in the second quarter 2007. In May of 2007, we released the results of our second Microsoft Windows Vista Tracking Poll. We found the majority of survey respondents are not using or evaluating Windows Vista at this time. However, those who are testing and evaluating Windows Vista, the majority plan to implement Windows Vista within the next 12 months. CDW plans to conduct a third round of the survey later in 2007. In the meantime, we'll continue to promote Vista and educate our customers as they prepare their adoption plans.

Sales of video products increased 8.8%, while we experienced strong double-digit unit growth in the category average selling prices continue to decline significantly. Products experiencing the strongest demand included the medical displays, larger screen desktop displays specifically in the 20" to 29" category, touch screen displays and video accessories, such as video cards.

Demand continues to increase for wide desktop LCD monitors that support Vista's wide monitor format. This trend has also increased sales of video cards and memory upgrades to support the wide video format.

Projectors and related accessories grew at double-digit rate due to strength in the education segment.

Sales of memory products rose 6.9%. Customers continue to add high performance memory products to desktops and notebooks to maximize their systems. The category is also being driven by customers adopting virtualization software and database application in seeking to increase performance on dual and quad-core systems. Memory products play a key role in our efforts to the attach products to anchor product categories.

Sales of input devices grew 6.5%. The category continues to be driven by barcode scanners for point of sale and warehouse applications.

Printer sales increased 1.3%, while ongoing customer migration to multifunction and laser printers drove our unit growth, average selling prices continued to decline. We are seeing steady growth in the thermal printing area, as we target point-of-sale and warehouse solutions for our customers.

We remain focused on our customer penetration program to target existing customers who have not purchased printers from us before and are working closely with our partners as they launch new products and work to accelerate the category.

Slide 12, shows the change in revenue, unit volume and average selling prices for notebook CPUs, and desktop and server CPUs, excluding Berbee sales. Notebook CPU sales increased 17.9% and unit volume was up 20.2%, while the average selling price decreased slightly by 1.9% from the year ago.

Sales were strong for most of our top brands and we continue to experience solid demand based primarily on the replacement of desktops with notebooks. As the price differential between desktops and notebooks has stabilized, we focused on up-selling customers more feature-rich products such as ruggedised notebooks.

Sales of PC tablets also supported the category's results. Our focus on customer penetration continues, which emphasizes selling notebooks to existing customers who have not previously purchased notebooks from us.

Sales from desktop computers and servers excluding Berbee grew 19.5%, while unit volume increased 13.9%. The average selling price increased 5% from the prior period. We had double-digit sales growth in the server category, which reflected customer's continued option for blade servers and multi-core servers.

Customers continue to consolidate and use virtualization technology as a business solution to improve the efficiency and productivity. Desktop sales also produced double-digit results this quarter. The product mix continued to shift towards higher-end work stations with dual core processors, added memory, and upgraded video cards, which helped to offset the continued decline of average selling prices of desktops.

We continue to promote our customer penetration program, which is a primary contributor towards success in the desktop category. Barb Klein will now review our financial results.

Barb Klein

Thank you, Harry. As John stated in the second quarter of 2007, we set new quarterly records for sales, gross profit, operating income, net income and diluted earnings per share. Gross profit margin was 16.1% of sales in the second quarter of 2007 compared to 16.2% of sales in the second quarter of 2006 and within our stated objective range of 15.5% to 16.2%, gross profit margin of 16.2% in the first quarter of 2007.

Slide 13 shows our operating statistics. Selling and administrative expenses as a percentage of sales were 8.5% in the second quarter of 2007, compared to 7.7% in the second quarter of 2006, an increase of $45.9 million. The increase in selling and administrative expenses in the second quarter of 2007 was primarily due to the inclusion of Berbee's operating expenses, increased payroll costs as a result of continued investments in expanding CDW's sales force, and cost related to the previously announced merger agreement.

Selling and administrative expenses in the second quarter of 2007 included approximately $8 million pre-tax of merger related costs. Excluding these merger related costs and therefore on a non-GAAP basis, selling and administrative expenses were 8.1% of sales in the second quarter of 2007. Selling and administrative expenses were 8.3% in the first quarter of 2007.

Advertising expense was $32.2 million or 1.6% of sales in the second quarter 2007 compared to $30 million or 1.8% of sales in the second quarter of 2006. Operating margin was 6.1% in the second quarter of 2007 compared to 6.6% in the second quarter of 2006. Excluding merger related cost of $8 million pre-tax and therefore on a non-GAAP basis operating margin was 6.5% in the second quarter of 2007. Our stated objectives for operating margin is in a range of 6% to 6.4%, therefore excluding the merger related cost, the operating margin was slightly better than the objective range in the second quarter 2007.

We achieved solid revenue and profitability this quarter. Corporate sector revenue growth improved, gross margin was solid and selling, general and administrative expenses were well controlled. While we continue to expect to add a net new 350 to 400 sales force coworkers across the sales organization in 2007 plus additional engineers for Berbee, we will continue to tightly control costs increases in other areas of the business.

The effective tax rate for the second quarter of 2007 was 38.0% compared to 35.4% for the second quarter 2006. The tax rate in the second quarter of 2006 was favorably impacted by a benefit of $2.3 million related to the resolution of an audit of the company's 2003 federal income tax return, which did not repeat in the second quarter of 2007.

Due to our Board's consideration of strategic alternatives as detailed in the proxy statement related to the shareholder meeting to be held with respect to the merger agreement, we did not repurchase any share of the company stock in the second quarter 2007. Berbee was $0.03 per share accretive to the second quarter of 2007 diluted earning per share, net of lower interest income as a result of the purchase.

Turning to the balance sheet, inventory turns on an annualized basis were 26 times in the second quarter of 2007 compared to 23 times in the second quarter of 2006. Berbee positively impacted inventory turnover in the second quarter 2007 by approximately 1.5 days. Berbee has a predominantly drop-ship model due to the types of products it sells. If Berbee's impact to inventory turns consensually have a greater degree of variability from quarter-to-quarter. Therefore our inventory turn up objective remains at 23 to 24 turns on an annualized basis.

Accounts receivables, days sales outstanding were 41 days at the end of the second quarter of 2007 compared to 38 days at the end of the second quarter 2006. Berbee impacted the metrics by approximately one day, because of billing and delivery of projects is spread out over longer period of time compared to CDW's more transactional business. Our DSO target is a range of 40 to 42 days including Berbee.

As of June 30, 2007, our cash, cash equivalents and marketable securities totaled approximately $580 million. In the second quarter of 2007, cash flow from operations was approximately $195 million and capital expenditures were approximately $26 million. We expect capital expenditures to be in the range of $55 million to $60 million in 2007.

John mentioned that in the second quarter of 2007, we achieved return on equity 20.7% and return on invested capital of 31.4% including Berbee, which is shown in slide 6.

Both ROE and ROIC are calculated on a trailing fourth quarters' basis. The addition of Berbee and our purchase of the Western Distribution Center in the fourth quarter of 2006 increased the average total assets while decreasing cash, which resulted in a lower ROIC for the fourth quarter of 2006, first quarter of 2007 and second quarter of 2007 as compared to previous quarters.

Turning to segment results, corporate sector sales increased 11.2% and operating income increased 10% in the second quarter of 2007, compared to the prior year period. Operating income for the corporate sector increased primarily due to revenue growth and an increase in gross margin which was partially offset by investment and selling resources.

Corporate sector operating margin was 7.9% in the second quarter of 2007, compared to 8% in the second quarter of 2006 and 8% in the first quarter of 2006. Public sector sales increased 23.4% and operating income increased to 25% in the second quarter of 2007, compared to the prior year period.

Operating income for the public sector increased primarily due revenue growth. Public sector operating margin was 5.6% in both the second quarter of 2007and the second quarter of 2006 and was 5.1% in the first quarter of 2007.

While we did not own Berbee's prior to October 11th 2006, we are providing Berbee sales growth for comparative purposes, which was 50.1% in the second quarter of 2007 versus the prior year period. Berbee's operating margin was 3.8% in the second quarter of 2006 and 3.6% in the first quarter, sorry 3.8% in the second quarter of 2007 and 3.6% in the third quarter of 2007.

As a reminder Berbee's operating margin is lower than the other segments due to the higher proportion of services in its business. Berbee's operating income also includes the amortization expense related to intangible assets.

Thank you for your attention and I will now turn the call back to John.

John Edwardson

Thank you Barb and in closing a big thank you goes out to all of our coworkers for their very hard work in providing unmatched customer service to each customer of CDW everyday. Nobody does it better than you all coworkers.

As we stated earlier today, there will be no Q&A session and this could be or as this could be our last earnings calls as a public company, I want to thank all of you for your confidence and in your support of CDW over the years and of course for your business, if you are a customer. And if you are not a customer and I'll always close with this, let our coworkers demonstrate their commitment to providing you the best customer service in the business. Call us at 1-800-8004 for CDW or visit us on our website at www.cdw.com. Thank you very much.

That concludes the phone call for all us and Harry Harczak, his 53rd consecutive quarterly phone call to report great earnings to all of you.

Thanks to all of the CDW team for another great quarter.

Operator

Thank you ladies and gentlemen; this concludes today's conference, thank you for participating. You may all disconnect.

TRANSCRIPT SPONSOR

MF logo

Did the analysts get it right?

Wall Street hires some smart cookies. But it’s not always in their best interest to put the hard questions to management. Are YOU even their top priority?

Motley Fool co-founder David Gardner is still bullish on CDWC. It’s up 60% since he recommended it to his Motley Fool Stock Advisor subscribers back in May 2005. Now, discover the companies David and his brother Tom recommend in their free research report “The Motley Fool's 2 Top Picks - Plus Wall Street's Dirtiest Secret.”

Read the complete report courtesy of Seeking Alpha FREE.

* Returns as of 6/12/2007

To sponsor a Seeking Alpha transcript click here.

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