CDW Corporation (CDW) Earnings Call Transcript & Summary

Okay. I think we're going to get started. So welcome, everyone, to Day 1 of Bank of America's Global Technology Conference. My name is Ruplu Bhattacharya, and I'm part of the equity research team at the bank covering IT hardware and technology supply chain companies. This year, we're hosting the conference for the first time virtually, and we've had a great turnout with over 150 corporates and about 800 clients attending the conference. [Operator Instructions] So this morning, we're honored to have Chris Leahy, who is the President and CEO of CDW Corporation. CDW, as all of you know, is one of the largest value-added resellers and system integrators. Chris has been with CDW since 2002. She was at the Boston College, where she attended, she got her J.D. degree. And then she's been with the CDW since she started as Chief Legal Officer. She's held various different positions. She led the development of the company's international strategy as well as the acquisition of Kelway in the U.K. Then she served as Chief Revenue Officer and was responsible for all of the customer-facing units of the company. And in early 2019, she was appointed CEO. And since then, she's been leading the company in its tradition of strong revenue growth and margin performance. So Chris, thank you so much for being part of our call today.

Ruplu, thank you very much for that introduction. I appreciate it.

Great. So I think we'll dive right into the questions. First, for my first question, I'd say that when I think of CDW as a VAR or as a system integrator, certainly, yours is a people business. So how has coworkers having to stay at home impacted their productivity and their revenue generation ability?

Yes. Thanks for that question, Ruplu. And I'm going to -- I get the privilege since I'm on my own here is to just start with reminding folks that my comments today go back to our Q1 earnings call on May 6. So I'll get that out of the way. And then just saying thanks to all of you who are listening in. We appreciate your interest and support. To answer your question, let me start with one of the foundational principles and value drivers of CDW, which is remaining relevant to our customers as a trusted adviser and a provider and focusing on execution. And when you think about the move to work from home, I think those 2 foundational value drivers for CDW were really very clear in our ability to do it quite swiftly and quite productively because our teams really wanted to be able to get on with serving our customers, which they did a wonderful job of. So we implemented the global work from home in mid-March. We tried to stay ahead of the curve here, and that was for our office workers. With regard to our distribution and configuration center, coworkers and our service delivery engineers that were still going on site, we became more focused on keeping them operational in their safety. I've said this before. We try to keep things simple when things are uncertain and complicated and visibility is low. So we've had 3 simple principles that we've operated by: safety and the health and well-being of our coworkers; serving the mission-driven needs of our customers, particularly in this time of urgency; and supporting our communities. So with regard to those engineers on site and our distribution and configuration coworkers, we've included all the things that you are now so familiar with in terms of social distancing and segmented shifts and personal protective equipment, cleanings and temperature screenings and all those things to focus on their health and safety. We were able to implement segment shifts and continue to maintain productivity and stay at highest levels of operations in both facilities. And that is obviously very important to our productivity. The other thing I have a view of is CDW started as an inside sales organization. So our -- we have excellent IT infrastructure and support. So that transition was, as I said, very, very smooth. And once we got home, we're a trusted partner to our customers, and they've been navigating these uncertain times as well. And they've been more reliant on technology than ever, both currently and as they think about their future. And given the value that we deliver to them in terms of our expertise, in terms of our breadth of solutions and offering, in terms of our ability to get the product where they need it, when they need it, get it integrated, and keep them up and running, we've been able to really strengthen those relationships and demonstrate the value of CDW. So you know, look, Ruplu, we're a performance-driven company, and we are continuing to monitor the productivity of our coworkers while also being focused on their health, their mental health, continuing training and development and all the tools to be successful. So we are supporting them and then driving productivity, which means serving their customers' needs. And as we look forward, we'll be very thoughtful about what return to work looks like. We are certainly having our team stay at home through August, and then we'll make decisions going forward.

Yes, Chris, that makes sense. And it's amazing how every company seems to have changed the way they do business and adapt to this work-from-home environment. So talking about work from home, do you think that the demand for work-from-home solutions continues over the longer term? Or do you think this just peters out over the next few months? And the same for the demand for data center and longer-term projects, so can you just give us your thoughts on both work from home as well as for longer-term data center projects?

Yes. Let me start with a quick answer and then give a little color. I think when we think about work from home, and I tend to think remote work because you've got folks who are working now at a different kind of remote environment, like our health care providers, for example, might not be at home, it might be a clinic location, but I do think that the work-from-home solutions is here to stay. And whether it's a hybrid or a blended approach, I do think we're going to see a different environment for work from home. And I think that's consistent with what you'll hear across the industries. And in terms of the infrastructure to support, absolutely, the need for infrastructure will continue. We believe we'll continue to live in this hybrid world and may see some cloud acceleration. We're seeing that now, movement to workloads to the cloud, and we think we'll continue to see that. But if we take a step back and we think about the progression here, in March, the impact of COVID-19 led to quite meaningful increases in the customer demand for devices, for accessories, for collaboration tools, security and all those solutions to keep customers operational. And virtually, across all sectors of economies, our customers look to us to help them orchestrate these solutions to -- for their greater technology capabilities. And they turn to us for the reasons that I mentioned. Our ability to serve their needs, our advantages in the marketplace and our market leadership. And they really have started to turn to those types of solutions that now allow work from home to scale and to scale productively and efficiently. So if you think forward, you think about things like network augmentation and remote performance and security and automation and collaboration at the next level. I call it the enterprise level because what I mean is it's robust, and it drives productivity and effectiveness. Now, look, as we shared in the Q1 earnings call and for Q2 to date at that point, on the demand side, we saw customer activity mixed when we entered April. There was a healthy backlog of remote workforce enablement solutions, which contributed to solid shipment growth in April. But we do expect customers to continue to prioritize mission-critical IT spending going forward, although we have experienced some pushout of infrastructure projects and services engagements. Look, Ruplu, as we move out of this crisis mode, as I said before, we expect our customers are going to emerge and build strategies to not just survive but thrive. And we do expect to see acceleration in digital transformation, which requires the infrastructure to support it. Cloud migration and automation strategies and technology will continue to play even more pivotal role in supporting our customers, both getting through this crisis and then reshaping how they work and live in the future. So we've got a great track record of evolving with our customer needs. We expect these to continue to evolve as we move forward, and we look forward to supporting them.

Yes. That's a great overview. And I'm going to touch on the cloud a little bit. But before I do that, maybe one more higher-level question. I mean when we think about COVID-19, do you think that -- when you think about your industry and the supply chain, do you think that COVID-19 has a lasting impact on this industry and the way people do business in the supply chain? Or do you think that business will be back to normal in a couple of months? So any lasting impact? Any changes to the overall industry going forward?

Yes. Hard to imagine back to normal or what normal look like. So we recognize the duration and depth of this crisis continues to be unknown. And as I said, when customers emerge and CDW emerges, technology, we do believe, will be more essential than ever, and we intend to be more valuable to our customers than ever. But some of the things that I've highlighted in many of the changes happening today such as remote work, such as growth in digital e-commerce channels, such as business continuity, redundancies and supply chain optimization. We believe these will persist and continue to scale and mature. And then as I mentioned, we'll see acceleration in development of online platforms. That will change the way that we create and consume services in most -- every industry. And you can expect us to continue to invest in these next-generation solutions. We've been investing across these solutions for some period of time, in both our solutions capabilities and services. And we'll continue to do that to help our customers adapt to this dynamic environment and meet their evolving end user employee needs. The other thing I would say, Ruplu, is what we're feeling now is an enhanced, I'll call it, speed and complexity. People use the term, shock, shock to our system. And what that is deemed to drive is a speed with which our customers are having to understand, assess, analyze, plan, make decisions on a go-forward basis. It doesn't mean speed to getting there now, this quarter, next quarter, but speed is making decisions and, therefore, turning to CDW in ways that are even more critical to their road mapping. So it makes the role of any IT organization has now got increasing challenges. It's evolution at a greater speed than even we experienced, I think, in the last 2 years. And that challenge plays to CDW's strength as a trusted adviser, who deeply understands the unique need of our customers, and who can help them navigate the increasing evolution and complexity in the world of IT.

Chris, maybe now I'd like to talk about cloud because this question keeps coming up with investors that the cloud is going to be disruptive to all businesses. I mean, how do you see the advent of cloud and the impact to your business? I mean, do you see the move to hybrid cloud as a threat? Or do you see it as an opportunity? And maybe for those investors who don't -- who aren't familiar with this, can you talk about how CDW is involved in the cloud? Which partners do you have? What is it that CDW does for the cloud?

Yes. Yes, I will. And it's an opportunity for CDW. When you use the term, disruptive, you asked the question, I think, for customers, customers are embracing and analyzing cloud as a means to an end. And so if we just take a step back and think about CDW and the role that we play for our customers, cloud adds yet another choice for our customers. And now it's on-premise, on-prem cloud and public cloud. So you've got a multi-cloud environment to analyze. And what CDW believe is that, as I said, a hybrid world, we see cloud as an opportunity for many years to come. Let me give you an example of a simple cloud video call solutions. That creates complexity for our customers' IT staff as they have to enable all coworkers to be able to use the same solution. What I say is it's not just a flip the switch. If it were flip the switch, it would be much easier. It's not a flip the switch. Assessing cloud decisions, requires both a design component. It requires a build component. It requires a migration, an integration component, and it requires a management component. And CDW is building our -- has been building our cloud services capabilities for a number of years. And that's where we play with our customers, which is the assessment, the implementation, the integration and the management. And when you think about why this is so attractive to our customers, we are vendor, technology and consumption-agnostic. We have a portfolio of more than 250 cloud offerings on our line cards. So we are the advisers that customers can turn to help do the entire -- that entire spectrum of services, as I described. When you think about how customers make decisions, Ruplu, there are workloads that customers may need to continue to keep on-prem. Think of latency sensitivity applications or highly customized applications, customer data that they might want to keep on-prem or large sizes of data that they -- that, for a variety of reasons, of cost, optimization, et cetera, they want to keep on-prem. And then there are other workloads that are best in the cloud. And we help them make that assessment, ultimately implement it and manage it in the right -- with the best strategy for them. So I would just say that cloud has consistently been a high-growth area for CDW over the past several years. And customers have turned to us to navigate the options available to them, integrate them into their overall IT portfolio. So again, we see this as an opportunity for years to come. And that certainly has been -- those conversations with our customers have been growing in the last quarter.

And are you partnering with just 1 or 2 of the cloud providers? Or do you have a broad base of vendors that you work with on the cloud?

We have a broad-based event -- the large cloud providers are partners of ours. And then more verticalized and specialized providers are partners as well. We've got a portfolio of over 250 cloud offerings and solution portfolio providers. So think of the largest public cloud and then think of those who are more specialized.

Okay, great. The next question I want to focus on is another question that we keep getting from investors. What percent of your sales comes from the small and medium business market? And how concerned are you about demand in this market?

Yes. No, that's a great -- it's a great question. So let me just -- let me give you some details here. So in 2019, about $1.5 billion of our $18 billion of net sales came from Small Business customers, which we define to be customers with less than 250 employees. So think of that's about 8% of our business. And then you've got the Corporate channel, which is a larger business where we have exposure to mid-sized companies as well. And so our sweet spot of customers is those in the Corporate and Small Business with less than 5,000 employees. Within our Corporate and Small Business channels, we have a diverse customer set, and we are not over-indexed to any one specific industry. So our exposure to what I'll call at-risk industries in these channels is really relatively small as a part of our overall U.S. customer base. So look, we've talked about the importance of balance across our portfolio, which is the real strength of CDW. And that's balanced both in our solutions and services, but also in our customer end markets. And as we've said in our -- as we said in the last earnings call, look, the near-term impact of COVID-19 as some customers we serve could be meaningful, with some end markets impacted more significantly than other, consistent with what we've experienced in the past, where commercial customers react more quickly in a downturn and small businesses act more quickly. So we do expect that demand to be lower for a period of time in Small Businesses and Corporate. But that said, as Colin shared, I think, in Q1, while writings in Corporate and Small Business at the start of the quarter were down, and that weighs on shipments going forward, we did see resiliency in other areas of our business like Public and Healthcare and Education. So look, we're just watching these trends very closely. We are staying close to our customers. We're trying to support our customers. We're working with our partners to support our customers in terms of extended opportunities for payment and things of that sort. But we could not be more focused and more granular in how we're managing and balancing both the health of our own business with the needs of our customers over the long term. Because if there's one thing that we have learned, it is the strength of customer relationships are fortified in times of -- in difficult times and times of struggle. And we saw that in 2008 and 2009. We came out of that very well positioned. And the customer relationships that we developed during that time were just stronger as we came out because of the support that we provided.

Okay. [Operator Instructions] We have one question from the audience. Chris, we have heard about inventory buildup at some OEMs. Can you comment on how that would affect the reseller network and impact your business? Any color on hardware or on the cloud side on this?

Yes, sure. So on the inventory, one of the advantage in CDW, as you know, is our distribution centers and our ability to take inventory in strategic positions with inventory. And so we did do that in the first quarter, anticipating the surge in need for our customers. And look, we will continue to do that over the course of the year as we see fit, ensuring that we have inventory available for our customers as needed. That did position us well in the first quarter as there was quite a hefty demand, particularly on the client side and the supporting accessories.

Okay. Great. Chris, another question that we got after the earnings call was relating to the health care and the education market. I guess, some investors were slightly concerned regarding your comments on the call regarding budget issues in these end markets. So have you started to see a slowdown in these markets? Can you just give us your overall thoughts on health care and higher ed?

Yes. Again, I'm not going to comment beyond what we commented on the earnings call. But look, we're trying to be very clear-eyed and very transparent with our investors in terms of expectations for various segments of the market. And so when we think about what we expect from a demand perspective, we do think health care and education customers have current budget uncertainty. And that could have an impact on a go-forward basis. Now we continue to track very closely stimulus support and, where possible, to help our customers navigate the various programs. That's kind of a muscle that we have in terms of helping our customers understand where the available dollars are, and we are being very proactive in that, but let's just think about the health care industry and what they're facing. In some of the data that you look at now; you've got emergency room visits down. You've got nonessential surgeries down. You've got some losses of jobs in the industry. And you've also got that industry, in particular, that pull forward IT budgets because they had to enable the frontline health care providers and to establish mobile screening centers to expand telehealth capabilities and essentially to prepare for an incredibly challenging point-of-care environment very quickly. So you've got these kind of combined factors that we do think creates a level of budget uncertainty. On the higher education side, it's still uncertain what's going to happen with campuses this fall. I think you're seeing mixed views and decisions about some campuses open. Some are not. You've got students who might be reluctant to commit. And that could impact enrollment. So those also create budget uncertainty. If you think about, again, tying this question to our portfolio generally, we've got exposure to diversified customer end markets. And while we might be expecting budget issues potentially with health care and higher education, we've also said we've seen strength with our government and K-12 areas and resiliency there. And we certainly have the ability to pivot resources to where the growth is. And we're very optimized. We're very focused on optimizing those resources against where the opportunities are. But Ruplu, we're just -- we're trying to be as transparent as possible in terms of what we see based on the factors and the data that's out there in a very, very uncertain time.

No, Chris. That makes sense, and that's perfectly correct to do. Just maybe at this point, I'm going to ask a higher-level question because you talked about the portfolio now. How do you think this downturn is different from the '08, '09 downturn? And can you remind investors, what impact did that downturn have on your revenues and margins? And how do you see impact in this downturn?

Yes, sure. So reminding everyone that no downturns are the same. And this one, in particular, seems to have so many variables to it, including the health care crisis. But if we go back to 2008 and '09, perhaps that can provide some directional indicators of how our business and channels might behave in a negative GDP environment. So in the Great Recession, if you - folks will recall that GDP growth declined year-over-year for 4 consecutive quarters. And that started in Q4 of 2008, I believe. For us, Corporate and Small Business customers did, in fact, react sooner to the macroeconomic environment, and they declined for several quarters. So the investor deck, if you were to look at our investor presentation, Corporate declined 22%, and Small Business declined 18% in 2009. So pretty significantly. They were the steepest of declines in Q1 of '09 and then sequentially improved as we moved through the year. On the other hand, our public sector channels were more resilient. So again, in that presentation, the investor presentation, you would see that our Government channel improved -- increased year-over-year, 11% growth, and our Education channel was up about 3%, and Healthcare was flat. So in 2009, if you put all those segments together, our total net sales declined 11%. But coming out of that recession, Corporate, Small Business and Healthcare were all growth leaders. And I'm going to just tie that back to a comment I made earlier about supporting these customers in a downturn in a struggling environment. I do think that the customer relationships that we solidified and fortified during that period, and also the new customers that we added to our portfolio, you saw the growth coming out of that -- coming out of the Great Recession. Now in terms of differences, look, CDW is in a stronger position today than it was back then. We were, I think, leveraged to our peak with 10x EBITDA in Q4 of '09. And today, we obviously have a balance sheet that is more opportunistic, very healthy. The other thing to think about is technology and the essential role it plays today, particularly in the middle of what we are experiencing with this pandemic and the economic challenges. So technology in our -- in my view has become even more essential to our customer strategies. They have more choices. There's more complexity than there ever was. And that all plays to our value proposition and the capabilities that we've now really built over the years to support our customers. So if you think about our technology, organization, we have over 3,000 technical workers that are pre-sales architects and delivery engineers. The last thing I would just say is on the gross margins, just to hit on that. Our gross margin was impacted as customer demand slowed, and that was primarily due to product margin compression as the competitive environment intensified. Gross product declined to about 16.8%. Adjusted EBITDA declined about 18.4%, resulting in 60 bps of margin compression. Now that reflects our variable cost structure, given that sales commissions are paid on a percentage of gross profit, as well as prudently managing the business during that time, the actions that we took, things like payroll and nonpayroll spending, bonus programs, supplies, P&E, all the cost reductions you would imagine. So long story short, it's well too early to tell, I think, the shape of this downturn, but we do believe technology is more essential to customers across all of the economy. And we feel like we're very, very well positioned to come out of this stronger than ever.

Okay. Thanks for that summary, Chris, and it makes sense. There are a couple of things I want to touch on in the time that we have left. One question we get a lot and investors are focusing on is the balance sheet. You touched on that a little bit. Can you talk to us about your liquidity position? And you've taken on $600 million in senior notes. What is -- what's the plan for that?

Yes. Let me just say, look, I can share that we are -- I'm confident in our liquidity position. And going into this crisis, obviously, liquidity was the #1 thing that we focus on immediately. So if we just very quickly, we added the $600 million for general corporate purposes, including to support our customers, frankly, in some ways, as they're going through some needs for extended payment, for example. That was a high-yield debt offering, which you're all familiar about. If you think about, as of March 31, our cash revolver availability was another $1.2 billion. And we did enhance our liquidity position by suspending share repurchases and implementing various cost savings initiatives in addition to the note offering. And again, Ruplu, that was really going into this crisis with the lack of visibility with the uncertainty. We wanted to ensure our liquidity was as sound as possible. Look, we continue to target the net leverage ratio of 2.5x as we always -- as we have now for a while. And we were a little below that, about 2.2x as of March 31. We don't have debt maturities in '22 and about $57 million due in 2021. So look, our cash interest is manageable with, I believe, the weighted average interest rate now is about 3.9%. Plus, you've got your dividends and our obligations to shareholders and debt holders really feels very manageable. I would say that the quarterly dividend to shareholders continues to be quite important to us and important part of our capital priority. So we're being very thoughtful about the areas of capital deployment.

Got it. No, that makes sense. Another question we keep getting, and you -- I'm sure you get it as well, is the U.S. government census project. Can you talk to us about what Device as a Service means for CDW? And how do you see that evolving over the next few years? And looks like you're supplying a lot of Apple devices. What happens to those devices once the Census collection is done?

Yes, okay. So look, this has been the Census project really showcases our ability to help customers achieve the objective of leveraging our differentiated capabilities. So you think about the solutions from multiple vendors, you think about the professional and configuration services, logistics, distribution and decommissioning capabilities that are delivered as a service. We certainly have built these capabilities that can translate into future opportunities with customers, and I think there is an appetite. And this project has certainly developed our capability for that. What that could look like in the future and how that flows through the financials is an interesting question because to the extent that we continue to do Device as a Service offerings for customers, you could imagine that we would potentially put a third-party intermediary between us and the purchase. So it might look more like a purchase of devices versus the census, where we actually brought the devices on at the front end. So we continue to talk with our OEMs. We continue to explore opportunities to build out a -- an as-a-service motion for our customers, but how that would flow through our financials could look quite different than the Census project.

Got it. Got it. Chris, a higher-level question. What do you think investors are missing about the CDW story? Or what do you think is most misunderstood about CDW?

Well, Ruplu, on that question, I would say, let me just reiterate what, I think, has been an important element of CDW's success and our customers' loyalty over the past 35 years, and that's, number one, our ability to evolve with the market and the needs of our customers. And while I don't know that that's misunderstood, I think it's so central to the value proposition and the value of CDW going forward. So number one, our ability to evolve as the market evolves, and, frankly, with the speed with which the market evolves. The other thing I would say is technology is more essential than ever -- than it ever has been. And the conversations that I have with customers today, there is a continuous mantra of this is going fast. Help us figure it out. We're not sure what to do. We know what we want to accomplish. We know what the outcome needs to be. We need to -- we know we need our customers to grow with us. We know we need business agility. We know we need cost optimization and improved productivity; but there is a lot to digest here and figure out. Help us do that. And I would just say that CDW is very well positioned to help our customers going forward across the full spectrum of IT needs, from work from home, devices and accessories and networking capacity to support that, all the way to the cloud choices that customers are making in a world where they have multiple choices to deliver the business needs that they need and their mission going forward.

Yes. I mean, that's a great summary. So we're just about out of time. So Chris, I really want to thank you for joining our call today. We've had a great turnout. For investors, I do see that we have a lot of questions in the queue that we weren't able to get to. So please feel free to e-mail me your questions, and we'll pass them on to Chris, and we'll try and get them answered for you. So Chris, thank you so much for attending today, and thanks, everyone on the call. And please feel free to reach out with any questions. Thanks, Chris.

Thank you. And you thank you all for joining.