CDW Corporation (CDW) Earnings Call Transcript & Summary

Okay, we're going to go ahead and get started. Thanks, everybody, for joining us today. My name is Adam Tindle. I cover IT supply chain and connected devices here at Raymond James. Very happy to have the team from CDW here. Collin Kebo, CFO, is going to give a presentation, and we'll save a couple of minutes at the end for questions. With that, Collin?

Great. Thanks, Adam. Thank you for inviting us. Great to be here today. I apologize, Chris wasn't able to make it, so you're stuck with me this morning. Before I start, I just want to make a couple of comments. My comments this morning will go back to CDW's Q4 earnings call back on February 6. We do not provide inter-quarter guidance so I expect many of you have questions on the impact of coronavirus on our business. As we shared on the fourth quarter earnings call, it's really too early to tell what the impact is going to be. We are working closely with our OEM vendor partners to understand the impact on our supply chain. Further, our 2020 targets that we shared at that point in time did not include any specific assumptions on the impact of coronavirus. This morning, I'll be referring to non-GAAP metrics, so please see our SEC filings for risks, uncertainties and reconciliations. All right. So CDW is an integrated IT solutions provider. We've been in business for over 35 years. We have roughly 10,000 coworkers. That's what we call our employees. Importantly, roughly 2/3 of those coworkers are in customer-facing roles. We offer a full-range of IT solutions. You're going to hear me talk a fair amount this morning about breadth and balance. We offer over 100,000 products and services from over 1,000 vendor partners or OEMs to over 250,000 customers in the United States, Canada and U.K. Importantly, our sweet spot customer are those customers with fewer than 5,000 employees. We think that's where our value prop plays the strongest. I'll talk some more about that in a little bit. And as you can see from the charts on the right here, we have a track record of delivering consistent above-market growth at attractive profitability margins and returns on invested capital. And what I'd like to do this morning is take some time to explain to you how we've been able to do that and why we think we're going to be able to continue to do it on a go-forward basis. If you start with our -- the marketplace in which we compete. It is a large and growing marketplace. IDC estimates total IT spend in the U.S., U.K. and Canada at approximately $1.1 trillion. Now we further segment that into our, what we call the addressable market, so we would exclude things like consumer. You probably wouldn't come to CDW to do an ERP implementation. So we take out those types of services. And then we'd also exclude things like OEM direct-to-customer. So you're left with an addressable market of around $360 billion. Our $18 billion of sales in 2019 then constitute roughly a 5-share of that addressable market. I think it's also important to understand what the competitive set looks like within this addressable market. It is a highly fragmented marketplace, literally tens of thousands of value-added resellers. There are some larger players. If you took the 3 largest publicly traded solutions provider similar to CDW, coupled with CDW, collectively, we would still be less than a 10% share of this addressable market. We like that. We think that fragmentation provides plenty of headroom for future share gains. The left-hand side of this chart then shows how CDW's net sales have performed against that IT market growth whether it's pre-recession or post-recession. We have consistently outpaced that IT market growth at 290 to 430 basis points over time. What the right-hand side of this chart shows is the percentage of business that goes direct through the channel, through -- from OEMs and the portion that is indirect -- I'm sorry, through the channel, companies like CDW. That's roughly 60%. And that has been steadily growing over time. We estimate that, that has increased roughly 300 basis points since 2007. This next chart begins to explain why that is. We think about our value proposition from 2 different perspectives. One is the value that we bring to our customers and the other is the value that we bring to our OEM vendor partners. From a customer perspective, we bring them a broad selection of products and services from over 1,000 vendor partners. We are agnostic in the advice that we provide to those customers. We give them access to technical resources that they may be challenged in procuring those resources themselves. And we can help them throughout the entire IT life cycle, from the planning, procurement, implementation to ongoing management and ultimately to renewal and asset disposal and things like that. From a vendor-partner perspective, we give them cost-effective access to over 250,000 customers, that would be difficult for them to reach on their own. We -- because of our technical capabilities and our vertical go-to-market segmentation, we provide customers with an experience that our OEM vendor partners would hope is consistent with the experience that they would want with their products. And then finally, given our reach into the SMB space, we can provide feedback to our OEM vendor partners that their technology road maps and help them understand what's being looked for from customers in that segment. So we think of ourselves as sitting in the middle between our vendor partners and our customers. We like to think of this as a virtuous cycle. The more value that we add to our customers, then the more value our -- we are to our vendor partners and vice versa. Another reason we've been able to consistently gain share over time is our balanced portfolio, and this is our balance from a customer end market or customer channels. On the left-hand side of this, you can see we have 5 customer channels in the United States, each greater than $1.5 billion. We also have our international businesses, which are in Other, that are over $2 billion, and that includes our CDW U.K. and our CDW Canada businesses. What this -- the segmentation of the channels allow us to do is really develop vertical solutions for our customers. So even within these channels, we further subsegment. So for example, within our government business, we have a federal and a state and local business. And then within federal, we further segment by DoD and civilian. So what that segmentation allows us to do is develop customized solutions that are important to customers in those specific verticals. So whether it's mobility, endpoint solutions in a hospital setting, public safety solutions at state and local government or in an education setting, digital testing for education customers, we can develop these vertical-specific solutions and replicate those and bring them to customers. What you see on the right-hand side of the page is the benefit we get from having this balance. Some of our end markets behave countercyclically. You can see in the top right here, during the great recession of 2009, our spending was down in our corporate and small business customers. But we were still able to get growth out of our government and education channels. Coming out of the Great Recession, that's work around that and you could see that our corporate and small business provided growth leadership. A second area where we have balance and breadth is across our vendor partners and the offerings that we provide. On the left-hand side of the page, you can see well-established vendor partners. Most of these logos here, you obviously recognize. CDW is typically the #1 or #2 channel partner for these OEMS. If not across the world, certainly in North America or in the United States. We have 6 vendor partners that we do over $1 billion of net sales with. On the right-hand side of the page, here are some examples of emerging vendor partners. We onboard 50 to 75 of these each year. It's a great source of growth and innovation for us. We sometimes see people on the left-hand side of the page, acquiring those on the right-hand side. We are indifferent as long as we have the ability to sell the technology to our end customers. Another reason that CDW has been able to consistently gain share and do so profitably has been our ability to evolve with the marketplace. If you looked at CDW, 15, 20 years ago, we would have been a provider of point products. You would have come to us for a desktop or a notebook or a printer. And what we began to hear from our customers is that increasingly, that they were looking for integrated solutions. So beginning about 10 years ago, we really accelerated our investment into the solutions part of the business because that's important to our customers. And where you can see that is how our workforce has evolved over time. We have roughly 10,000 coworkers across the world. More than 3,000 of those are in technical roles. So when I talk about technical roles here, I'm talking about presales specialist, who assist our sellers and our customers as they're making purchase decisions. Then we also have a service delivery organization that helps implement the solution once the customer has purchased it. As I mentioned earlier, roughly 2/3 of our coworkers are in customer-facing positions. So in addition to the technical organization, we have over 3,000 coworkers in sales positions. And those sales positions have evolved over time. So initially, you can think of CDW as having been more of a call center-type model way back in our history, that would have been inbound. Eventually, migrated or evolved into an outbound call center over time. We began to hear from our customers that having a local process was important to them. So we now have a meaningful field sales organization in market. We have sellers in over 25 major metro market -- markets in the United States. And I think also important to understand about our sales force is that they are paid on gross profit. So our salespeople are incentivized to pursue profitable business. We also have the highly tenured sales force on our -- just after our Q2 earnings call, we shared that roughly half of our sales or our customer spend in the quarter came from customers that have been with us over 20 years and came from sellers who have been with us over 10 years. So long-standing customer relationships. And then finally, you can see the remaining approximately 1/3 of our coworkers are in backbone or support functions. A bit more on our technical organization. You can see here, we're organized into 6 different practices. We have a cloud practice, which I'm going to talk more about here in a second. We also have a software practice, which helps customers manage their software over the entire life cycle. We work with customers in digital workspace. And here, we would include networking, mobility and collaboration solutions. We have a security practice. Several years ago, we shared that our customers were spending over $1 billion with us in security and that has been growing meaningfully double digits since then. We have a large services practice, where we can help customers with both professional services, managed services, warranties and other services. And again, over the entire life cycle of their IT needs. And then finally, we have an infrastructure business that helps customers, whether it's on-prem or if they want to move those workloads to the cloud. I'll just pause here for a second, I got to pull these past few pages together. We recently did some work and asked customers, "What's important to you from an IT solutions provider perspective? What are you looking for?" And we heard 3 things that came back. One is they're looking for a partner who knows their business, who understands their industry as well as understands their IT environment. So when you think about CDW because of our scale and the ability to vertically segment the market, we understand the specific industry challenges that our customers are going through. But also given the long-standing customer relationships we have and that seller and tenure -- that seller and customer tenure, we understand their specific IT environment. The second thing we heard from customers is they want help with technical resources. And just taking you through the significant investment we've made in technical resources from a coworker perspective and how we're organized by practice. And then the third thing they're looking for is unbiased advice. They are looking for guidance, but they don't want to be sold to. So given the strength and diversity of CDW's partner system, we are technology-agnostic. We are brand-agnostic, and we are also consumption model-agnostic, which is a good transition to the cloud page. So from a cloud perspective, we offer our customers over -- offerings from over 75 different public cloud providers. The way a conversation typically works with the customer, it isn't, "I want to go to the cloud." It typically starts with a discussion of workloads. And again, this is where I think CDW's value prop plays well. We can discuss with them the benefits of staying on-prem versus a public cloud solution. We can talk about different hybrid cloud environments, and then once the customer has decided, we can work with them on what's the best solution and then actually help them plan, implement, migrate and manage on an ongoing basis. Our cloud practice has been around since 2011. Every couple of years, we do a strategic plan where we strip the business down and look at ourselves pretty critically in terms of what are our strengths and what are our customers asking for and where could there be some gaps. A few years ago, we began to increasingly hear from our customers, "CDW, we love what you do for us in the U.S. and Canada, but boy, wouldn't it be great if we could work with somebody like you around the world." Managing IT for our multinational customers, is a challenge, and that experience can be very different based on where you are in the world. So we went through a pretty exhaustive study to understand where our customers' IT needs were the greatest. Not surprisingly, a majority of our U.S.-based multinational customers were looking for help in Western Europe. That led us to look for partners in Western Europe, which eventually led to a referral relationship with a company called Kelway, which then led to a minority interest investment and finally, led to an acquisition of Kelway. What Kelway allowed us to do was to serve those multinational customers' needs, not just within the U.K., but it's also a platform that allows us to access other parts of the world. You can see from this chart, we have a physical presence in 10 different countries in the world. In addition to the U.S., U.K. and Canada, we have offices in those countries where you would expect a British-based organization to have offices: Hong Kong, South Africa, Singapore, Dubai, Ireland, et cetera. But the U.K. also provides the ability to export into other countries as well as work with local partners through our third-party network to service customers, and we can service customers in over 150 different countries around the world. At the time we made our investment in U.K., roughly 10% of their business was sales outside of the U.K. Over the past several years, that has now increased to more than 25%. So our thesis that our customers were looking for help internationally has certainly played out. Ads as well as -- has certainly played out, and then we've also seen that the ability that -- capabilities that CDW brings to companies that we acquire, helps them be more effective in terms of bringing our benefits of scale to them and et cetera. I am typically asked, why does a customer choose CDW over a competitor? Why do you win in the marketplace? And the answer is, it depends. It depends on who we're competing against, it depends what type of IT solution we're talking about, it depends where we are from a geography perspective. But the answer is typically rooted in a series of interlocking competitive advantages that you see depicted here. Many of those competitive advantages derived from our scale and scope. Our scale allows us to, again, vertically segment the market. It allows us to make the significant investment that we've made in technical resources. It also allows us to do things like invest in training, on scale. It allows us to invest in our sales force and our technology and the productivity programs that we bring for our sellers that allows them to better serve customers. It also allows us to have distribution centers. So on the bottom left here, you can see robust distribution capabilities. We are a little unique, most solutions providers or value-added resellers do not have distribution capability. We have over 1,000 square feet in North America with 2 locations and another distribution center in the U.K. We found that to be a differentiator when you go through periods of disruption in the supply chain. Many of you may be familiar with some of the challenges have been around Intel chip shortages. Given our scale and the fact that we actually have distribution centers where we can take inventory, that has allowed us over the past several quarters to largely service our customers with minimal disruption and believe that, that is competitively advantaged us against others who don't have those capabilities. We have a highly engaged and performance-driven culture. Earlier, I talked about how our sales force is paid on a percentage of gross profit. Senior management is paid on operating profit. So we are incredibly aligned to pursue profitable business and gain share, again, in a profitable way. I talked about our multinational and global capabilities and our technical capabilities as well and an experienced management team. So when you think about CDW, it isn't just -- you aren't making a bet on a particular specific technology. You're betting that technology is going to be a priority for customers and that CDW has the differentiated capabilities to meet those needs better than our competition. So in terms of how our competitive advantages have played out in the numbers, which you can see in the top left here is, over the past 9 years, our sales have compounded at an 8% growth rate. Most of that is organic growth. So we've roughly doubled the business over this period of time. And the top right, you can see that we've been able to do that quite profitably. So our operating profit on a non-GAAP basis has grown a little bit faster than that at 11%. If you look at the past 3, 4, 5 years, you can see that, that non-GAAP operating margin has been remarkably stable in the mid-7% range. And that's notwithstanding where we are in particular technology cycles. And if you think about that, it's because we pay our sales force on a percentage of gross profit. We have a highly variable cost structure, both in the short term, but also in the intermediate or long term because people are our biggest investments. So again, we have a relatively highly variable cost structure. In the bottom left, you can see that we've been able to convert that operating profit growth into a much more rapid non-GAAP net income growth. There are a couple of reasons for that. We were highly leveraged, formerly as an LBO. And early on in our history, we were paying down debt, and that allowed us to delever by reducing interest expense. But we have also, over the past several years, through our capital allocation program, initiated stock buybacks, and that's contributed to the greater non-GAAP net income growth or EPS growth. And then finally, we were a big beneficiary of tax reform back in 2018. On the bottom right, you can see the deleveraging profile. Our biggest investment in the business from a cash perspective is in working capital. So that has been a focus for us. Here, you can see return on working capital doubling since 2010. And that really has been through a variety of initiatives. Our senior management team from a long-term perspective has performance compensation tied to free cash flow. So that they understand the 2 biggest drivers of free cash flow: our operating profit, and working capital. And as a result, we put in place a series of working capital initiatives that's allowed us to take our cash conversion cycle from the low 40s and knock that out -- knock more than 20 days out of that to the high teens, where we are currently. Our sales leaders receive a working capital charge so that they know that the balance sheet isn't free and are very mindful in terms of how they use that. So as I mentioned, working capital is the biggest use of free cash flow. As we think about free cash flow overall, we target 3.75% to 4.25% of sales as a normal -- normalized free cash flow rule of thumb. And this next slide here then sets out our capital allocation priorities or what we intend to do with that free cash flow once it's generated. First is the dividend. About 5 years ago, we set out a priority to get the dividend to 30% of free cash flow, and we aggressively increased the dividend over those past 5 years. And this past fourth quarter, with a 29% increase. We had the dividend roughly to 30% of free cash flow. On a go-forward basis, we're going to express that as a percentage of non-GAAP net income. So the equivalent of 30% of free cash flow is 25% of non-GAAP net income, and we would expect to grow that in line with earnings on a go-forward basis. Our second priority is to maintain leverage at 2.5 to 3x. We're currently at 2.2x, so slightly below the low end of that. Our third priority then is M&A. In 2019, we did 2 transactions. One was to acquire Scalar in Canada, which brought us certain solution capabilities; and then we bought Aptris, which was a services company focused on services -- ServiceNow, which increasingly, we heard from our customers was a priority for them. And then finally, we'll take the balance of our free cash flow and return it to shareholders through buybacks. We don't have any reason to hoard cash. In 2019, we returned more than 100% of free cash flow to shareholders. And on our most recent earnings call, I shared that, that was our intent to do so in 2020, given that we're at the low end of our target leverage range. Our capital allocation priorities support our 2020 targets. Again, these are as of February 6, when we did our earnings call. We look to outperform U.S. IT market growth of 2.5% to 3%. We look to outperform that by 200 to 300 basis points, and we expect to be just above the high end of that this year. We have the Census offering, which we expect to contribute an incremental 110 basis points of net sales growth to the business in 2020. We continue to look for a non-GAAP operating margin in the mid-7s. And we look for non-GAAP earnings per share growth of approximately 10%. Since we began our capital return program to shareholders in 2014, 2015, we have returned nearly $3 billion of cash. So in summary, we compete in a large, growing, highly fragmented, attractive marketplace. We are the clear share leader in that marketplace, but still have plenty of headroom. We have a proven ability to evolve with IT market trends and meet our customer needs. I talked about the balance and breadth of our portfolio that give us multiple levers for growth. We have an attractive business model, both in terms of return on invested capital, but also then how we use the free cash flow generated from the business. And I think with that, Adam, I'd be happy to open it up and take questions.

I think we maybe have time for 1 or 2 questions before we head to a breakout downstairs [indiscernible] right after. [indiscernible] All right. I'll ask [indiscernible] talk about [indiscernible]

Sure. Yes, we have had a lot of success in client devices growing double digits for 3 years in a row. I think there were multiple contributors to that. Obviously, Win 7 end-of-support, but also new use cases, and we continue to see that as a growth opportunity going forward. It's difficult to go anywhere, whether it's retail, food service, airport where you see tablets and client devices. So yes, we've seen growth from that and expect to see that going forward. And also, we've also had success in terms of different offerings and device-as-a-service, so the Census is a great example of where we've seen that. So on a go-forwarded basis, we do expect to see growth, but we expect it moderating, not to continue at the same levels they've had historically.

Can you go over the decline or the share in the industry [indiscernible] part of over a decade now. I guess, maybe touch on what you think could potentially change that and what that slide might look like a decade from now?

Yes. Thanks, Adam. So it's interesting. Notwithstanding the fact that we've consistently been gaining share, we've been at a $5-share for a long time. So you might ask, "Well, mathematically, how can that be?" And the answer to that is, we've also been expanding our definition of the addressable market. So as we've added solutions and services capabilities, we've redefined the market, and that's why it hasn't grown as rapidly. I would expect us to continue to do that. On a -- I'll call it a same-market definition, I would expect us to continue to outgrow. We are disciplined in the type of growth we get. Could we gain more share? Absolutely, but it might not be with the profit or cash flow return that we'd be looking for. And that I would expect us to continue to expand that market in places that are important to our customers. Specifically in certain solutions and services areas where CDW feels like it has our right to succeed, and we can meet those needs. And that could be inorganically or organically.

All right. Thank you very much, Collin.

Great. Thanks, Adam.