CDW CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2011. 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 We are a leading multi-brand technology solutions provider to business, government, education and healthcare customers in the U.S. and Canada. We provide comprehensive and integrated solutions for our customers' technology needs through our extensive hardware, software and value-added service offerings. Our breadth of offerings allows our customers to streamline their procurement processes by partnering with us as a complete technology solutions provider. Our hardware offerings include products with leading brands across multiple categories such as network communications (netcomm), notebooks/mobile devices (including tablets), data storage, video monitors, printers, desktops and servers, among others. Our software offerings include licensing, licensing management and software solutions and services that help our customers to optimize their software investments. We offer a full-suite of value-added services, which typically are delivered as part of a technology solution, to help our customers meet their specific needs. Our solutions range from configuration services for computer devices to fully-integrated solutions such as virtualization, collaboration, security, mobility, data center optimization and cloud computing. We also offer complementary services including installations, sales of warranties and managed services such as remote network and data center monitoring. We believe both software and service offerings will be important growth areas for us in the future.

We have two reportable segments: Corporate, which is comprised primarily of business customers, and Public, which is comprised of government entities 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 CDW professional engineers and managed services, including hosting and data center services. Revenues from the sale of hardware, software, custom configuration and third-party provided services are recorded within our Corporate and Public segments.

Our business is well-diversified across customers, product and service offerings and vendors from whom we purchase products and software for resale. We have aligned our sales and marketing functions around customer channels to retain and increase our sales to existing customers and to acquire new customers. We have an experienced and dedicated direct selling organization consisting of account managers who provide inside sales coverage, and field account executives who work within an assigned territory and interact with customers in person. Our direct selling organization is supported by a team of technology specialists who design solutions and provide recommendations in the selection and procurement processes. We purchase products for resale from original equipment manufacturers ("OEMs") and distributors. We believe that effective purchasing from a diverse vendor base is a key element of our business strategy. We are authorized by OEMs to sell via direct marketing all or selected products offered by the manufacturer. We also operate as a reseller for major software publishers that allows the end-user customer to acquire packaged software or licensed products and services. Our authorization with each OEM or software publisher may include one or more of the following: product return privileges, price protection policies, purchase discounts and vendor incentive programs, such as volume rebates and cooperative advertising reimbursements.

We market the CDW brand on a national basis through a variety of public and community relations and corporate communications efforts, and through brand advertising that includes the use of print, broadcast, online, social and other media. We also market to current and prospective customers through integrated marketing programs that include print and online media, events and sponsorships.

As a result of our relationships with our vendors, a substantial portion of our advertising and marketing expenses are reimbursed through cooperative advertising reimbursement programs. Such programs are at the discretion of our vendors and are typically tied to sales or purchasing volumes or other commitments to be met by us within a specified period of time.

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 products and services.

Net sales, gross profit and operating income increased 1.6%, 3.0% and 0.0%, and 5.7%, 6.2% and 5.6%, respectively, in the three 29-------------------------------------------------------------------------------- Table of Contents and nine months ended September 30, 2012 compared to the same periods of 2011.

During the second and third quarters of 2012, we began to see customers take a more cautious approach to spending as increased macro-economic uncertainty impacted decision-making and led to some customers delaying purchases. We expect this trend to continue through at least the end of 2012. Uncertainties related to the potential impacts of the Budget Control Act of 2011 (the "Fiscal Cliff"), potential changes in tax and regulatory policy, weakening consumer and business confidence or increased unemployment could result in reduced spending by our customers on information technology products and services and increased competitive pricing pressures. Our Public segment sales are impacted by government spending policies, budget priorities and revenue levels. An adverse change in any of these factors could cause our Public segment customers to reduce their purchases or to terminate or not renew contracts with us, which could adversely affect our business, results of operations or cash flows.

Although our sales to the federal government are diversified across multiple agencies and departments, they collectively accounted for approximately 10% of our net sales in 2011. Further, our sales to state and local governments accounted for approximately 4% of our net sales in 2011. See "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011 for further discussion.

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, EBITDA and Adjusted EBITDA, cash and cash equivalents, net working capital, cash conversion cycle (defined to be days of sales outstanding in accounts receivable plus days of supply in inventory minus days of purchases outstanding in accounts payable), 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. Adjusted EBITDA, a non-GAAP financial measure, also provides helpful information as it is the primary measure used in certain financial covenants contained in our credit agreements. In addition to net sales, gross profit and operating income discussed above, the below are the results of other key measures during the first nine months of 2012 compared to the first nine months of 2011: • Average daily sales increased 6.2% to $39.4 million.

• Adjusted EBITDA increased 5.2% to $571.6 million.

• The cash conversion cycle decreased from 25 days to 21 days.

• The senior secured leverage ratio decreased from 2.9 to 2.2 for the four quarters ended September 30, 2011 and September 30, 2012, respectively.

• The senior secured asset-based revolving credit facility had no outstanding borrowings at September 30, 2012 compared to outstanding borrowings of $5.0 million at September 30, 2011.

Results of Operations Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011 The following table presents our results of operations, in dollars and as a percentage of net sales, for the three months ended September 30, 2012 and 2011: Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 Dollars in Percentage of Dollars in Percentage of Millions Net Sales Millions Net Sales Net sales $ 2,623.3 100.0 % $ 2,581.4 100.0 % Cost of sales 2,190.6 83.5 2,161.4 83.7 Gross profit 432.7 16.5 420.0 16.3 Selling and administrative expenses 257.0 9.8 252.0 9.8 Advertising expense 36.0 1.4 28.3 1.1 Income from operations 139.7 5.3 139.7 5.4 Interest expense, net (76.7 ) (2.9 ) (85.5 ) (3.3 ) Other income, net 0.2 - 0.5 - Income before income taxes 63.2 2.4 54.7 2.1 Income tax expense (25.2 ) (1.0 ) (17.6 ) (0.7 ) Net income $ 38.0 1.4 % $ 37.1 1.4 % 30-------------------------------------------------------------------------------- Table of Contents Net sales The following table presents our net sales by segment, in dollars and as a percentage of total net sales, and the year-over-year dollar and percentage change in net sales for the three months ended September 30, 2012 and 2011: Three Months Ended September 30, 2012 2011 Percentage Percentage of Total of Total Dollar Percent (dollars in millions) Net Sales Net Sales Net Sales Net Sales Change Change (1) Corporate $ 1,312.8 50.0 % $ 1,330.3 51.5 % $ (17.5 ) (1.3 )% Public 1,163.7 44.4 1,123.1 43.5 40.6 3.6 Other 146.8 5.6 128.0 5.0 18.8 14.6 Total net sales $ 2,623.3 100.0 % $ 2,581.4 100.0 % $ 41.9 1.6 % (1) There were 63 selling days for the three months ended September 30, 2012, compared to 64 selling days for the three months ended September 30, 2011. On an average daily basis, total net sales increased 3.2%.

The following table presents our net sales by customer channel for our Corporate and Public segments and the year-over-year dollar and percentage change in net sales for the three months ended September 30, 2012 and 2011: Three Months Ended September 30, Dollar Percent (dollars in millions) 2012 2011 Change Change Corporate: Medium / Large $ 1,055.7 $ 1,070.6 $ (14.9 ) (1.4 )% Small Business 257.1 259.7 (2.6 ) (1.0 ) Total Corporate $ 1,312.8 $ 1,330.3 $ (17.5 ) (1.3 )% Public: Government $ 408.6 $ 388.1 $ 20.5 5.3 % Education 394.7 415.7 (21.0 ) (5.1 ) Healthcare 360.4 319.3 41.1 12.9 Total Public $ 1,163.7 $ 1,123.1 $ 40.6 3.6 % Total net sales for the three months ended September 30, 2012 increased $41.9 million, or 1.6%, to $2,623.3 million, compared to $2,581.4 million for the three months ended September 30, 2011. There were 63 selling days for the three months ended September 30, 2012, compared to 64 selling days for the three months ended September 30, 2011. On an average daily basis, total net sales increased 3.2%. The increase in total net sales was the result of general volume growth, a more tenured sales force, and a continued focus on seller productivity across all areas of the organization. Sales in Other, which includes CDW Advanced Services and Canada, grew 14.6% between periods. Our total net sales growth for the three months ended September 30, 2012 reflected growth in enterprise data storage, software products, netcomm products, and notebooks/mobile devices.

Corporate segment net sales for the three months ended September 30, 2012 decreased $17.5 million, or 1.3%, compared to the three months ended September 30, 2011. On an average daily basis, Corporate segment net sales were essentially flat, increasing 0.2% between periods. Within our Corporate segment, net sales to medium/large customers decreased 1.4% between periods and net sales to small business decreased 1.0%, due to a more challenging market in 2012 reflecting ongoing macroeconomic uncertainty. This decrease was driven by declines in net sales of notebooks/mobile devices and printers, and declines in memory products due to several large orders in the third quarter of 2011 that did not repeat.

Public segment net sales for the three months ended September 30, 2012 increased $40.6 million, or 3.6%, between periods, driven by continued strong performance in the healthcare and government customer channels. Net sales to healthcare customers increased $41.1 million, or 12.9%, between periods, driven by growth in several product categories, including netcomm products, point of care technology carts, enterprise data storage and software products. The healthcare channel growth was partially driven by increased sales from an expanded relationship with a group purchasing organization. Net sales to government customers increased $20.5 million, or 5.3%, between periods, driven by increases in sales of enterprise data storage, notebooks/mobile devices, and software products. Net sales to education customers decreased $21.0 million, or 5.1%, 31-------------------------------------------------------------------------------- Table of Contents between periods, driven by a decline in sales of notebooks/mobile devices, video equipment/monitors, and software products. Education net sales declined for both the K-12 and Higher Education channels, reflecting budget constraints.

Gross profit Gross profit increased $12.7 million, or 3.0%, to $432.7 million for the three months ended September 30, 2012, compared to $420.0 million for the three months ended September 30, 2011. As a percentage of total net sales, gross profit increased 20 basis points to 16.5% for the three months ended September 30, 2012, up from 16.3% for the three months ended September 30, 2011. Gross profit margin was positively impacted 30 basis points by a higher mix of commission and net service contract revenue, partially offset by an unfavorable impact of 10 basis points from vendor funding. Commission revenue, including agency fees earned on sales of software licenses and software assurance under enterprise agreements, has a positive impact on our gross profit margin, as we record the fee or commission as a component of net sales when earned and there is no corresponding cost of sales. Net service contract revenue, including items such as third-party services and warranties, also has a positive impact on gross profit margin as our cost paid to the vendor or third-party service provider is recorded as a reduction to net sales, resulting in net sales being equal to the gross profit on the transaction. Vendor funding includes purchase discounts, volume rebates and cooperative advertising.

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 $5.0 million, or 2.0%, to $257.0 million for the three months ended September 30, 2012, compared to $252.0 million for the three months ended September 30, 2011. As a percentage of total net sales, selling and administrative expenses were 9.8% for both the three months ended September 30, 2012 and 2011. The increase in selling and administrative expenses between periods was driven primarily by an increase in non-cash expenses of $4.9 million and included higher non-cash equity compensation costs of $2.4 million and higher depreciation and amortization expense of $2.3 million related primarily to additional capital expenditures for information technology systems. Incremental expense of $1.6 million related to the modified Class B Common Unit grant agreement with our former chief executive officer drove the increase in non-cash equity compensation costs between periods.

Sales force coworker count increased 13 coworkers from 3,658 coworkers at September 30, 2011 to 3,671 coworkers at September 30, 2012. Total coworker count increased 230 coworkers from 6,692 coworkers at September 30, 2011 to 6,922 coworkers at September 30, 2012 and reflected primarily an increase in service delivery coworkers, the cost of which is reflected in cost of sales.

Higher payroll costs and other coworker costs of $2.8 million included within selling and administrative expenses between periods were largely offset by lower professional fees during the three months ended September 30, 2012.

Advertising expense Advertising expense increased $7.7 million, or 27.1%, to $36.0 million for the three months ended September 30, 2012, compared to $28.3 million for the three months ended September 30, 2011. As a percentage of total net sales, advertising expense increased 30 basis points to 1.4% for the three months ended September 30, 2012, up from 1.1% for the three months ended September 30, 2011.

The increase in advertising expense was due to a focus on continuing to advertise our solutions and products and to build our reputation as a leading IT solutions provider, primarily through targeted digital advertising, partially offset by decreases in advertising expenditures for TV and print.

32-------------------------------------------------------------------------------- Table of Contents Income (loss) from operations The following table presents income (loss) from operations by segment, in dollars and as a percentage of net sales, and the year-over-year percentage change in income (loss) from operations for the three months ended September 30, 2012 and 2011: Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 Operating Operating Percent Change Dollars in Margin Dollars in Margin in Income (Loss) Millions Percentage Millions Percentage from Operations Segments: (1) Corporate $ 79.2 6.0 % $ 80.7 6.1 % (1.9 )% Public 81.1 7.0 79.9 7.1 1.4 Other 5.6 3.8 6.5 5.1 (14.5 ) Headquarters (2) (26.2 ) N/A (27.4 ) N/A 4.8 Total income (loss) from operations $ 139.7 5.3 % $ 139.7 5.4 % - % (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 $139.7 million for the three months ended September 30, 2012 and 2011. The results for the three months ended September 30, 2012 were driven by higher net sales and gross profit, offset by higher selling and administrative expenses and advertising expense. Total operating margin percentage decreased 10 basis points to 5.3% for the three months ended September 30, 2012, from 5.4% for the three months ended September 30, 2011.

Operating margin percentage was negatively impacted by the increase in advertising expense as a percentage of net sales, partially offset by the increase in gross margin percentage discussed above.

Corporate segment income from operations was $79.2 million for the three months ended September 30, 2012, a decrease of $1.5 million, or 1.9%, compared to $80.7 million for the three months ended September 30, 2011. Higher gross profit was offset by higher selling and administrative costs, resulting in a flat segment operating income before allocations for the three months ended September 30, 2012 compared to the same period of 2011. In addition, Corporate segment income from operations was negatively impacted by an increase in Headquarters' expense allocations to the Corporate segment of $1.5 million on a year-over-year basis.

Public segment income from operations was $81.1 million for the three months ended September 30, 2012, an increase of $1.1 million, or 1.4%, compared to $79.9 million for the three months ended September 30, 2011. The increase reflected higher segment operating income before allocations of $0.3 million as a result of increased net sales and gross profit dollars, partially offset by higher selling and administrative costs. In addition, Public segment income from operations benefited from an increase of $1.4 million in income allocations from our logistics operations for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The improved profitability of our logistics operations was driven by stronger operating leverage given higher purchase volumes and support costs that decreased slightly. This increase in income allocations from our logistics operations was partially offset by an increase of $0.6 million in Headquarters' expense allocations to the Public segment on a year-over-year basis.

Interest expense, net At September 30, 2012, our outstanding long-term debt totaled $3,871.2 million.

Net interest expense for the three months ended September 30, 2012 was $76.7 million, a decrease of $8.8 million compared to $85.5 million for the three months ended September 30, 2011. Net interest expense decreased $4.8 million due to lower debt balances and lower effective interest rates for the three months ended September 30, 2012 compared to the same period of the prior year as a result of debt repayment and refinancing activities completed during the first quarter of 2012. In addition, the three months ended September 30, 2011 included $2.1 million of mark-to-market losses on interest rate caps that did not recur in the three months ended September 30, 2012. The remaining decrease was primarily attributable to reduced amortization of deferred financing costs during the three months ended September 30, 2012.

33-------------------------------------------------------------------------------- Table of Contents Income tax expense Income tax expense was $25.2 million for the three months ended September 30, 2012, compared to $17.6 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 (loss) before income taxes, was 39.8% and 32.3% for the three months ended September 30, 2012 and 2011, respectively. The change in the effective income tax rate between years was primarily attributable to the favorable impact to deferred taxes due to updated state apportionment factors for the three months ended September 30, 2011, which did not recur in 2012.

Net income (loss) Net income was $38.0 million for the three months ended September 30, 2012, compared to $37.1 million for the three months ended September 30, 2011.

Adjusted EBITDA Adjusted EBITDA was $204.6 million for the three months ended September 30, 2012, an increase of $4.5 million, or 2.2%, compared to $200.1 million for the three months ended September 30, 2011. As a percentage of net sales, Adjusted EBITDA was 7.8% for both the three months ended September 30, 2012 and 2011.

We have included a reconciliation of EBITDA and Adjusted EBITDA for the three months ended September 30, 2012 and 2011 in the table below. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA, which is a measure defined in our credit agreements, means EBITDA adjusted for certain items which are described in the table below. Both EBITDA and Adjusted EBITDA are considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. We believe that EBITDA and Adjusted EBITDA provide helpful information with respect to our operating performance and cash flows including our ability to meet our future debt service, capital expenditures, and working capital requirements. Adjusted EBITDA also provides helpful information as it is the primary measure used in certain financial covenants contained in our credit agreements.

(in millions) Three Months Ended September 30, 2012 2011 Net income $ 38.0 $ 37.1 Depreciation and amortization 53.4 51.2 Income tax expense 25.2 17.6 Interest expense, net 76.7 85.5 EBITDA 193.3 191.4 Adjustments: Non-cash equity-based compensation 6.5 4.2 Sponsor fee 1.3 1.3 Consulting and debt-related professional fees 0.1 0.6 Other adjustments (1) 3.4 2.6 Total adjustments 11.3 8.7 Adjusted EBITDA $ 204.6 $ 200.1 (1) Other adjustments primarily include certain retention costs.

34-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011 The following table presents our results of operations, in dollars and as a percentage of net sales, for the nine months ended September 30, 2012 and 2011: Nine Months Ended Nine Months Ended September 30, 2012 September 30, 2011 Dollars in Percentage of Dollars in Percentage of Millions Net Sales Millions Net Sales Net sales $ 7,527.2 100.0 % $ 7,123.1 100.0 % Cost of sales 6,283.0 83.5 5,951.9 83.6 Gross profit 1,244.2 16.5 1,171.2 16.4 Selling and administrative expenses 768.1 10.2 724.7 10.1 Advertising expense 96.4 1.3 86.9 1.2 Income from operations 379.7 5.0 359.6 5.1 Interest expense, net (232.5 ) (3.1 ) (243.3 ) (3.4 ) Net loss on extinguishments of long-term debt (9.4 ) (0.1 ) (118.9 ) (1.7 ) Other income, net 0.2 - 1.0 - Income (loss) before income taxes 138.0 1.8 (1.6 ) - Income tax expense (52.3 ) (0.7 ) (0.3 ) - Net income (loss) $ 85.7 1.1 % $ (1.9 ) - % 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 nine months ended September 30, 2012 and 2011: Nine Months Ended September 30, 2012 2011 Percentage Percentage of Total of Total Dollar Percent (dollars in millions) Net Sales Net Sales Net Sales Net Sales Change Change (1) Corporate $ 4,070.0 54.1 % $ 3,948.0 55.4 % $ 122.0 3.1 % Public 3,021.7 40.1 2,798.2 39.3 223.5 8.0 Other 435.5 5.8 376.9 5.3 58.6 15.5Total net sales $ 7,527.2 100.0 % $ 7,123.1 100.0 % $ 404.1 5.7 % (1) There were 191 selling days for the nine months ended September 30, 2012, compared to 192 selling days for the nine months ended September 30, 2011. On an average daily basis, total net sales increased 6.2%.

35-------------------------------------------------------------------------------- Table of Contents 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 nine months ended September 30, 2012 and 2011: Nine Months Ended September 30, Dollar Percent (dollars in millions) 2012 2011 Change Change Corporate: Medium / Large $ 3,270.0 $ 3,168.5 $ 101.5 3.2 % Small Business 800.0 779.5 20.5 2.6 Total Corporate $ 4,070.0 $ 3,948.0 $ 122.0 3.1 % Public: Government $ 989.2 $ 916.1 $ 73.1 8.0 % Education 965.9 973.6 (7.7 ) (0.8 ) Healthcare 1,066.6 908.5 158.1 17.4 Total Public $ 3,021.7 $ 2,798.2 $ 223.5 8.0 % Total net sales for the nine months ended September 30, 2012 increased $404.1 million, or 5.7%, to $7,527.2 million, compared to $7,123.1 million for the nine months ended September 30, 2011. There were 191 selling days for the nine months ended September 30, 2012, compared to 192 selling days for the nine months ended September 30, 2011. On an average daily basis, total net sales increased 6.2%.

Net sales in Other, which includes CDW Advanced Services and Canada, grew 15.5% between periods. The increase in total net sales was the result of general volume growth, a more tenured sales force, and a continued focus on seller productivity across all areas of the organization. Our net sales growth for the nine months ended September 30, 2012 reflected growth in notebooks/mobile devices, netcomm products, and enterprise data storage and software products.

Corporate segment net sales for the nine months ended September 30, 2012 increased $122.0 million, or 3.1%, compared to the nine months ended September 30, 2011. Within our Corporate segment, net sales to medium/large customers customers increased 3.2% between periods, and net sales to small business customers increased 2.6% between periods. These increases were primarily a result of hardware unit volume growth, most notably in notebooks/mobile devices and desktop computers, and growth in netcomm and software products. Partially offsetting the growth was a decline in net sales of memory products due to several large orders in the second and third quarters of 2011 that did not recur.

Public segment net sales for the nine months ended September 30, 2012 increased $223.5 million, or 8.0%, between periods, driven by continued strong performance in the healthcare and government customer channels. Net sales to healthcare customers increased $158.1 million, or 17.4%, between periods, driven by growth in several product categories, including desktop computers, notebooks/mobile devices, netcomm products, point of care technology carts, enterprise storage and software products. The healthcare channel growth was partially driven by increased net sales from an expanded relationship with a group purchasing organization. Net sales to government customers increased $73.1 million, or 8.0%, between periods, driven by unit volume increases in sales of notebooks/mobile devices, enterprise data storage and desktop computers and partially offset by a decline in software products. Net sales to education customers decreased $7.7 million, or 0.8%, between periods, reflecting a decline in sales to K-12 customers, who continue to experience the impact of budget constraints, partially offset by growth in higher education customers that was driven by increased sales of netcomm products.

Gross profit Gross profit increased $73.0 million, or 6.2%, to $1,244.2 million for the nine months ended September 30, 2012, compared to $1,171.2 million for the nine months ended September 30, 2011. As a percentage of total net sales, gross profit increased 10 basis points to 16.5% for the nine months ended September 30, 2012, up from 16.4% for the nine months ended September 30, 2011.

The increase in gross profit margin was primarily due to a 10 basis point increase in net service contract revenue and a $3.8 million (10 basis point) accrual reversal resulting from a favorable vendor audit outcome, partially offset by a 10 basis point decline in vendor funding.

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.

36-------------------------------------------------------------------------------- Table of Contents Selling and administrative expenses Selling and administrative expenses increased $43.3 million, or 6.0%, to $768.1 million for the nine months ended September 30, 2012, compared to $724.7 million for the nine months ended September 30, 2011. As a percentage of total net sales, selling and administrative expenses increased 10 basis points to 10.2% for the nine months ended September 30, 2012, up from 10.1% for the nine months ended September 30, 2011. The increase was primarily due to higher payroll and benefits costs of $34.1 million driven by increased sales commissions and other variable compensation costs consistent with higher sales and gross profit.

Equity-based compensation also increased $5.7 million, primarily due to incremental expense of $4.9 million related to a modified Class B Common Unit grant agreement with our former chief executive officer. Higher depreciation and amortization expense of $5.5 million related to capital expenditures for information technology systems also contributed to the increase in selling and administrative expenses.

Advertising expense Advertising expense increased $9.5 million, or 11.0%, to $96.4 million for the nine months ended September 30, 2012, compared to $86.9 million for the nine months ended September 30, 2011. As a percentage of net sales, advertising expense increased 10 basis points to 1.3% for the nine months ended September 30, 2012, up from 1.2% for the same period of 2011. The increase in advertising expense was due to a focus on continuing to advertise our solutions and products and to build our reputation as a leading IT solutions provider, primarily through targeted digital advertising and higher expenditures for national TV advertising campaigns. These increases were partially offset by decreased spending in print.

Income (loss) 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 nine months ended September 30, 2012 and 2011: Nine Months Ended Nine Months Ended September 30, 2012 September 30, 2011 Operating Operating Percent Change Dollars in Margin Dollars in Margin in Income (Loss) Millions Percentage Millions Percentage from Operations Segments: (1) Corporate $ 256.3 6.3 % $ 246.7 6.3 % 3.9 % Public 189.2 6.3 178.0 6.4 6.3 Other 13.2 3.0 14.5 3.8 (9.7 ) Headquarters (2) (79.0 ) N/A (79.6 ) N/A 0.9 Total income (loss) from operations $ 379.7 5.0 % $ 359.6 5.1 % 5.6 % (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 $379.7 million for the nine months ended September 30, 2012, an increase of $20.1 million, or 5.6%, compared to $359.6 million for the nine months ended September 30, 2011. This increase was driven by higher net sales and gross profit, partially offset by higher selling and administrative expenses and advertising expense. Total operating margin percentage decreased 10 basis points to 5.0% for the nine months ended September 30, 2012, from 5.1% for the nine months ended September 30, 2011.

Operating margin percentage was negatively impacted by the increase in selling and administrative expenses and advertising expense as a percentage of net sales, partially offset by the increase in gross margin percentage discussed above.

Corporate segment income from operations was $256.3 million for the nine months ended September 30, 2012, an increase of $9.6 million, or 3.9%, compared to $246.7 million for the nine months ended September 30, 2011. The increase in Corporate segment income from operations was primarily driven by higher net sales and gross profit margin, partially offset by higher selling and administrative costs, resulting in a net increase in segment operating income before allocations of $10.7 million in the nine months ended September 30, 2012 compared to the same period of 2011. In addition, Corporate segment income from operations benefited from an increase of $4.3 million in income allocations from our logistics operations for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The improved profitability of 37-------------------------------------------------------------------------------- Table of Contents our logistics operations was driven by stronger operating leverage given higher purchase volumes while support costs remained flat. An increase in Headquarters' expense allocations to the Corporate segment of $5.4 million negatively impacted segment income from operations on a year-over-year basis.

Public segment income from operations was $189.2 million for the nine months ended September 30, 2012, an increase of $11.2 million, or 6.3%, compared to $178.0 million for the nine months ended September 30, 2011. The increase reflected higher segment operating income before allocations of $5.6 million as a result of increased net sales and gross profit dollars, partially offset by higher selling and administrative costs. In addition, Public segment income from operations benefited from an increase of $6.6 million in income allocations from our logistics operations for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, partially offset by an increase in Headquarters' expense allocations to the Public segment of $1.0 million on a year-over-year basis.

Interest expense, net At September 30, 2012, our outstanding long-term debt totaled $3,871.2 million.

Net interest expense for the nine months ended September 30, 2012 was $232.5 million, a decrease of $10.8 million compared to $243.3 million for the nine months ended September 30, 2011. Interest expense during the nine months ended September 30, 2011 included a benefit of $19.4 million, due to an adjustment to the long-term accrued interest liability associated with the extinguishment of $1,078.0 million of senior notes due 2015. The long-term accrued interest liability represents the difference between interest expense previously recognized under the effective interest method and actual interest paid. Of the remaining net decrease of $30.2 million, $22.8 million was due to lower debt balances and lower effective interest rates for the nine months ended September 30, 2012 compared to the same period of the prior year as a result of debt repayment and refinancing activities completed during 2011 and 2012. The remaining net decrease was primarily attributable to the impact of interest rate swap terminations during 2011 that did not recur, and higher mark-to-market losses on interest rate caps and higher amortization of deferred financing costs during the nine months ended September 30, 2011 compared to the same period of 2012.

Net loss on extinguishments of long-term debt We recorded a net loss on extinguishments of long-term debt of $9.4 million for the nine months ended September 30, 2012 compared to $118.9 million for the same period of 2011.

In February and March 2012, we purchased or redeemed the remaining $129.0 million of senior notes due 2015, funded with the issuance of an additional $130.0 million of senior notes due 2019. As a result, we recorded a loss on extinguishment of long-term debt of $9.4 million, representing the difference between the purchase or redemption price of the senior notes due 2015 and the net carrying amount of the purchased debt, adjusted for the remaining unamortized deferred financing costs.

In March 2011, we amended our senior secured term loan facility and recorded a loss on extinguishment of long-term debt of $3.2 million, representing a write-off of a portion of the unamortized deferred financing costs on this facility.

In April and May 2011, we purchased $1,078.0 million of senior notes due 2015, funded with the issuance of $1,175.0 million of senior notes due 2019. As a result, we recorded a loss on extinguishment of long-term debt of $114.1 million, representing the difference between the purchase price of the senior notes due 2015 at 109% of par value and the net carrying amount of the purchased debt, adjusted for a portion of the unamortized deferred financing costs.

In June 2011, we entered into a new $900.0 million senior secured asset-based revolving credit facility, replacing the existing $800.0 million facility. As a result, we recorded a loss on extinguishment of long-term debt of $1.6 million, representing a write-off of a portion of the unamortized deferred financing costs related to the previous facility.

Income tax expense Income tax expense was $52.3 million for the nine months ended September 30, 2012, compared to $0.3 million for the same period of the prior year. The effective income tax rate, expressed by calculating income tax expense as a percentage of income (loss) before income taxes, was 37.9% and (18.3)% for the nine months ended September 30, 2012 and 2011, respectively. The effective income tax rate for the nine months ended September 30, 2011 reflected the net unfavorable impact of adjustments to deferred taxes due to changes in state tax laws and the impact of permanent differences in relation to a relatively small pre-tax loss.

Net income (loss) Net income was $85.7 million for the nine months ended September 30, 2012, compared to a net loss of $1.9 million for the nine months ended September 30, 2011. The net loss for the nine months ended September 30, 2011 was primarily due to a $118.9 million net loss from extinguishments of long-term debt during the period.

38-------------------------------------------------------------------------------- Table of Contents Adjusted EBITDA Adjusted EBITDA was $571.6 million for the nine months ended September 30, 2012, an increase of $28.5 million, or 5.2%, compared to $543.1 million for the nine months ended September 30, 2011. As a percentage of net sales, Adjusted EBITDA was 7.6% for the nine months ended September 30, 2012 and 2011, respectively.

We have included a reconciliation of EBITDA and Adjusted EBITDA for the nine months ended September 30, 2012 and 2011 in the table below. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA, which is a measure defined in our credit agreements, means EBITDA adjusted for certain items which are described in the table below. Both EBITDA and Adjusted EBITDA are considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. We believe that EBITDA and Adjusted EBITDA provide helpful information with respect to our operating performance and cash flows including our ability to meet our future debt service, capital expenditures, and working capital requirements. Adjusted EBITDA also provides helpful information as it is the primary measure used in certain financial covenants contained in our credit agreements.

(in millions) Nine Months Ended September 30, 2012 2011 Net income (loss) $ 85.7 $ (1.9 ) Depreciation and amortization 159.1 153.6 Income tax expense 52.3 0.3 Interest expense, net 232.5 243.3 EBITDA 529.6 395.3 Adjustments: Non-cash equity-based compensation 18.0 12.3 Sponsor fee 3.8 3.8 Consulting and debt-related professional fees 0.6 4.7 Net loss on extinguishments of long-term debt 9.4 118.9 Other adjustments (1) 10.2 8.1 Total adjustments 42.0 147.8 Adjusted EBITDA $ 571.6 $ 543.1 (1) Other adjustments primarily include certain retention costs.

The following table sets forth a reconciliation of EBITDA to net cash provided by operating activities for the nine months ended September 30, 2012 and 2011.

Nine Months Ended September 30, (in millions) 2012 2011 EBITDA $ 529.6 $ 395.3 Depreciation and amortization (159.1 ) (153.6 ) Income tax expense (52.3 ) (0.3 ) Interest expense, net (232.5 ) (243.3 ) Net income (loss) 85.7 (1.9 ) Depreciation and amortization 159.1 153.6 Equity-based compensation expense 18.0 12.3 Deferred income taxes (48.1 ) (8.6 ) Allowance for doubtful accounts - 0.9 Amortization of deferred financing costs and debt premium 10.8 12.5 Net loss on extinguishments of long-term debt 9.4 118.9 Other 0.9 6.2 Changes in assets and liabilities 131.3 (122.4 ) Net cash provided by operating activities $ 367.1 $ 171.5 39-------------------------------------------------------------------------------- Table of Contents Seasonality While we have not historically experienced significant seasonality throughout the year, sales in our Corporate segment, which primarily serves business customers, are typically higher in the fourth quarter than in other quarters due to customers spending their remaining technology budget dollars at the end of the year. Additionally, sales in our Public segment have historically been higher in the third quarter than in other quarters primarily due to the buying patterns of the federal government and education customers.

Liquidity and Capital Resources Overview We finance our operations and capital expenditures through a combination of internally generated cash from operations and from borrowings under our senior secured asset-based revolving credit facility. We believe that our current sources of funds will be sufficient to fund our cash operating requirements for the next year. In addition, we believe that, in spite of the uncertainty of future macroeconomic conditions, we have adequate sources of liquidity and funding available to meet our longer-term needs. However, there are a number of factors that may negatively impact our available sources of funds. The amount of cash generated from operations will be dependent upon factors such as the successful execution of our business plan and general economic conditions.

Cash Flows Cash flows from operating, investing and financing activities were as follows:

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