CDW Corporation (CDW) Earnings Call Transcript & Summary

Perfect. Good morning, everyone. My name is Amit Daryanani, the IT hardware and deputy analyst here at Evercore. I'm delighted to kick off our TMT conference today with CDW, and really more thrilled to have with us Collin Kebo, CFO of CDW, to spend the next 35 minutes with us. We'll keep this fireside chat again to 30, 35 minutes. I'll spend the first 20 minutes or so going through some of the questions we have, and happy to take any questions from the audience as well. If you do have any questions, please feel free to either e-mail them to me or actually use a chat function on the webcast and send them our way, and I can kind of get them asked on your behalf as well. So with that, thanks a lot, Collin, for being here. Really appreciate your time, as always. I guess, Collin, before we get into the questions, I always sort of think of CDW as having a very unique vantage point in terms of the enterprise behavior and how those things have changed over time. And really, as I think about t he pandemic, we've seen IT spend patterns swayed a fair bit. Some are transient, some are more durable. I'd love to just understand from the things you have seen through the pandemic, what shifts do you think are structural versus not? And whether you think the use of IT is going to be much more higher in the new normal versus where we used to be pre-pandemic?

Well, good morning, Amit, and thank you for inviting CDW today. It's great to be here. Just a bit of housekeeping to kick off, the standard safe harbor statement. Any forward-looking comments, I'll go back to our earnings call as of May 5, we typically don't provide specific commentary on our vendor partners. And please see our IR website for non-GAAP reconciliations. Yes, Amit, we agree that the pandemic has changed the way that we live and work. And technology is, we believe, more essential than ever. And maybe I could point to a couple trends that we see that we think are durable. The first is accelerated digital transformation, and we really see that across all of our end markets, whether it's commercial markets and how our customers interact with their customers and the expectation around omnichannel capabilities, flexibility in education and how that is delivered the way that care is delivered to patients in health care settings. So we really see the pandemic as accelerating what was already underway. I think the second trend we see is the importance of the client device, given how we work and learn and play and, again, how care is delivered, how that has changed and just how important the client device is in terms of driving mobility and productivity, collaboration, et cetera. I think the third thing we saw, again, I would put this under the heading of an accelerant but durable is the importance of multiple consumption models. Obviously, public cloud offers great speed and the ability to scale up. But we're also seeing customers interested in on-prem solutions because of cost or latency or other reasons. I think the impact or the implication of all that is that complexity remains, and we believe that, that will be durable as well. The fourth thing I'd point to is supply chain and the importance of resiliency and flexibility. And we think our distribution and logistics capabilities were a differentiator for us during the pandemic and believe that will be important going forward. And then fifth, obviously, can't have a conversation with a customer without talking about security. So we see those as maybe things that were there even pre-pandemic, but the pandemic has just heightened the importance of those and think that they will be drivers of durable demand going forward.

Perfect. In the earnings call, when I think about calendar '21, maybe just reflecting back on the guide that you folks provided, CDW provided, I think, for the full year, we raised our full year EBITDA top line guide, if you may. You talked about expecting IT spend of, I think, 4%, CDW outgrowth of about 300, 350 basis points. Those numbers are about 100, 150 basis points better than what you had previously expected, I think. Can you just touch on the factors that gave you the increased confidence to raise those expectations? And sort of if you can talk about Corporate versus Public would be helpful as well.

Sure. I'll come at it from 2 perspectives. One is demand and second is supply. On the demand side, we were encouraged by the activity and the building momentum we saw, particularly in those channels that were most impacted by COVID. On the U.S. commercial side of the business, we saw a pretty meaningful improvement in year-over-year growth rates on a sequential basis in both our Corporate and our Small Business. And then our International businesses were also strong. Back to the commercial side of the business, we saw that momentum continue into April, where our writings in both Corporate and Small Business were up healthy double digits on a year-over-year basis. So I would say, on the demand side, very constructive. And again, just based on the activity and the building momentum and confidence we saw, that informed the guide. On the supply side, I would say that uncertainty has increased since the first quarter. Our backlog is higher than normal, and it's increasing, and just seeing lead times extending and visibility challenged. So that demand, particularly with commercial customers, felt stronger than 3 months ago, but supply, incrementally more challenged. I think the last comment I've made, and I know we'll talk about supply a little bit more in a second here, is if supply were to turn out to be more resilient, either allowing us to work down the backlog or keep up with what could be even greater demand, that would be upside to our outlook.

Got it. Now the supply pain points seem to be a very omnipresent challenge for a host of companies. In your comment here already -- CDW touches a wide, wide range of products, wide range of customers as well. I'm curious, how do you think -- how should we think, I guess, about the impact from these component dynamics, supply chain issues to your business? And really, the part I would love to understand is, what are the bottlenecks? Where are these issues more prevalent versus not?

Yes. I would say, Amit, during the quarter, our team has always did a great job navigating the environment and leveraging our competitive advantages, of our distribution centers and our vendor partner relationships. And I would say that the constraints were not a huge factor in the first quarter as our backlog was generally flat from the beginning to the end of the quarter, with some ups and downs in between. As I mentioned, we did see uncertainty increasing from the end of the first quarter, seeing things incrementally more challenging in our backlog growth. That's consistent with what we're hearing from OEMS, a lot of whom have shared results over the past few weeks and have shared more insight on that. I would say the challenges are certainly in the notebook category, higher-end Chromebooks, glass and displays and beginning to become more prevalent in some of the infrastructure categories. So we have seen backlog creeping up in some infrastructure hardware categories.

Got it. And Collin, infrastructure would essentially mean networking, server, storage, those kind of things, right?

Yes. And again, I would say, I would not characterize it as broad-based as perhaps maybe in client device. But if you're looking for a particular switch or model number, you could see your lead times extended beyond what you would expect as a normal lead time.

Got it.

And Collin, just to kind of come back to the backlog briefly. It seems like it's been fairly sizable as a result of the supply chain issues we've seen. So I'm just wondering if you could talk a bit about how this represents future opportunity for the company to kind of backfill and what supply and dynamics -- supply and demand dynamics you've seen for any products in particular?

Yes, sure. I think, maybe, just definitionally, it would be helpful when we say backlog at CDW, to clarify what we mean, for -- so when we say backlog, we have a firm order for the customer. We just haven't shipped and invoiced it yet. And at any given time, we'll be running a backlog. As I mentioned, we started the year higher than normal, just given the COVID dynamics from last year. The first quarter was generally stable. We saw an increase in April and to the tune of 7 -- several hundred million dollars higher than where we were at the end of the year. If I think about it, the backlog exists, really, across all of our end markets, I would say, because of having been there for longer and some of the supply challenges longer. Certainly, Education, because of client devices and Chromebook, would be carrying a significant portion of the backlog, and as I talked about, some parts of infrastructure hardware. I think understanding when we're going to get back to a more normal level and exactly what the new normal looks like is very challenging. Given the current environment, there isn't a lot of visibility. And it feels like we're chasing a moving target, to some extent, given how strong demand has been, as I commented earlier. I think, at some point in the future, and I wouldn't -- I'm not in a position to say when, but if we get to the point that supply normalizes, you could see us shipping ahead of our normal writing patterns and experiencing the benefit of a backlog flush. But it's just premature to say when that is.

Great. That's really helpful. And then next, I just wanted to touch on strategy. So CDW has a 3-part growth strategy. And these 3 parts: acquiring customers and capturing share; enhancing solutions capabilities; and expanding service capabilities, have served the company extremely well over the years. And I'm just wondering, as we go forward into a new world of kind of hybrid work, supply constraints and digital transformation, what does the strategy look like in practice?

Yes, we have had success executing against our 3-part strategy for growth. And as we go forward, you should expect that we'll continue to build on and enhance those 3 pillars to support our growth. Maybe one way to think about it is where we're investing, and I'll break that down into both M&A as well as organic investments. On the M&A front, if you look at where we've been investing -- excuse me, we recently acquired Amplified IT, a Google cloud-based services solutions and software company for Education customers. Last year, we acquired IGNW for cloud and DevOps capabilities. And prior to that, we had done some acquisitions of some services businesses in the ServiceNow space. But I think these just kind of highlight the areas that are important to our customers that they've been talking to us about, and where we have historically served customers in those areas. But this has really just acted as an accelerant and an extension of our capabilities. From an organic perspective, we'll continue to invest to digitally enable our sellers. We've talked about AI and propensity modeling and other things we've done to help them be more efficient. Well invest in capabilities that provide and enhance multiple channels for our sellers to interact with customers and how customers want to talk and do business with CDW. And then we'll continue to invest in our supply chain. I talked about this earlier, but continuing to bolster our logistics capabilities and reinforce our competitive advantages and provide the flexibility that our customers are looking for as they seek to navigate the choppy supply environment.

Okay. So Collin, I guess, when I pooled a few investors kind of what to focus on, and where we're going to spend some time with you, I think a disproportionate number of questions were earlier around the PC markets and what's happened in client devices. Yes, you've touched a fair bit on it already, but I think the question there -- I tend to get a fair amount is, what does the durability of this demand look like as you go forward? And understood that things have been really, really strong in the last 6 months, the last 12 months. But what do you think, inherently, the PC industry can grow? What does the durability look like in the mix? And you've talked about that on the Corporate kind of side and the Public vertical side. That would be helpful to think Education might be a little bit better than the rest of them, perhaps.

Yes, sure. We did have really strong client device growth in the first quarter, up in the mid-20% range, with notebooks up over 40%. Desktops were down double digits. And I do think we'll continue to see that preference for form factor with notebook -- excuse me, over desktop. Not that desktops are going to go away, I mean, they do offer certain cost and durability advantages. But I think, for some of the reasons we talked about earlier, we would expect notebooks to be strong. In the first quarter, we saw excellent notebook growth, really, across all of our channels, so greater breadth than we've been seeing. From a corporate perspective, as we look forward, I think corporate customers are going to be looking to enable hybrid work environments for their employees, and the notebook will obviously play an important role of that. When we think about what happened last year, it was really about enablement, work from home, business continuity. And I think some things were thrown out there pretty quickly. As we talk to customers, now it's more about optimization, given how important it is, and continue to see customers interested in doing client device refreshes, particularly with notebooks. On the Public side, we -- you raised Education, very strong growth there as K-12 customers continue to focus on equity and access as well as ways to address the learning loss. We expect for there to continue to be strong demand. I don't know that the growth will be as much of a growth contributor as it has been, given the unusual out of seasonality we've seen in the Education business. But as I think about client devices longer term from a durability, I think there are some near-term headwinds with some overlaps and some supply constraints. But from a tailwinds perspective, the hybrid enablement, greater device penetration in terms of ratios, whether that's getting 1:1 in a Corporate or Education or a retail environment, or potentially even greater than 1:1 for some employees, accelerated refresh because notebooks tend to refresh faster than desktop. In the Public sector, there's stimulus available to support investments. And then believe it or not, if you go all the way back to 2017, 2018, when we were doing the Win 7, Win 10 upgrade device, right? And we're now kind of 3, 4 years post that, and we would be expecting to see refresh driven by that. So I think those are the puts and takes on the headwinds and tailwinds as we think about PC durability.

Fair enough. Yes. I have a couple of questions from the audience, and we now want to kind of open on the PC side. But I will say this, I'm trying to convince my IT department to give me 2 computers, 1 at home, 1 at work, because I probably don't want to lose the setup I have at home, even if I go back to work right now, given you probably need more flexibility to operate. So I'll see if I get any success over there. But 2 things, I guess, we have 2 questions here. One, as I think about the migration of desktop to notebooks, and it seems to be a very prevalent thing, which I think will -- from a business continuity perspective, should happen as well. Does that matter to CDW? From a revenue or profit basis, does that have any ramifications to you?

The desktop to notebook shift?

Yes.

Yes. The ASP is higher so, obviously, it's a greater revenue per unit. And depending on the channel that you're selling into, the GP per unit might be a little bit better. I think it's probably more what I talked about earlier. It is -- I do think the refresh frequency is greater on the notebook than it is on the desktop. So I think, over the long term, it's probably more of a growth driver than, I would say, a short-term catalyst.

Got it. And then just a second one from Tom on the notebook side. Are you seeing configurations of SKUs get richer, given the supply chain shortages that are out there? Are people buying more premium product because perhaps that's all they can get versus not?

Yes, it's difficult to generalize. But what I would say is, back to the comment I made around optimization, I think last year was more of a "We'll take whatever we can get," because of the premium being placed on speed. What we're seeing now, particularly with our larger customers, and these are the types of customers that would have their standards and more custom orders, is a willingness to wait rather than, "Give me whatever you have." And I think this is one of the contributing factors we've seen to the longer lead time. So they want the SKU, the model they want because it's their standard, and they're willing to wait for it, if it's going to take 12 weeks instead of 6 weeks. Small business might be a little bit different than that, where maybe not as set to send their ways in terms of getting the standard they want and more likely to pursue what's in stock or if I can get it faster. On the Public side, again, I would say last year, Education was more of, "We'll take what we can get." This year more, "No, this is the model we want." I think as the supply situation plays out here, and if it becomes more incrementally challenging, you could potentially see some customers moving towards, "Okay, I just -- I can't wait any longer. I'll take what you have." But for now, I would say, particularly with the larger customers, it's been more of, "We're going to wait and take what our standard is."

Understood. And then you -- maybe we'll shift a little bit to your gross profit dollar mix, if you may, right? And I think less than 1/3, but close to 1/3, of your gross profit dollars tend to be of revenue streams or profit dollars that are netted-down revenue stream, if you may, right? It's things like the cloud business, the warranty stuff, a few other things that you have there. And I always think investors sort of overlook how much of a reoccurring business your gross profit dollars tend to be versus not. So maybe if you could just spend some time on what really goes into these netted-down revenue bucket? And what is the growth rate over there look like versus the gross profit dollars you get from the rest of your business?

Yes, sure. So netted-down revenues are those where CDW is not the primary obligor. We're effectively performing an agent role. So the implication of that is our gross profit dollars equals our net revenue, so they're 100% gross margin items. Those revenues include cloud, Software as a Service, agent commission fees and software assurance. So a lot of security software is delivered that way as well as warranties on some of the hardware we sell. In the most recent quarter, netted-down revenues were 28% of our total gross profit dollars. And over the past 4 or 5 years, that's grown from the low 20 percentages, up into the high 20 percentages. So it just shows that it has been -- that part of the business has been growing faster, which, I think, is logical because software, cloud, security tend to be some of the faster-growing parts of the market. So I think, over the long term, I would expect that to continue to grow faster. That doesn't mean, in the short term, if we're going through a heavy hardware cyclical refresh, that might not bounce around and tick down from quarter-to-quarter. But I do think the longer-term secular trend would be for that to continue to increase.

Perfect. And then maybe just shift a little bit to the Corporate side of the business. And you sort of have 2 buckets in there, the SMB, and I guess, the regular enterprise market. You talked initially, I think, upfront about why things started to improve on the Corporate side. I was curious, like, should we look at SMB trends as a leading indicator to what happens broadly on the enterprise side? And maybe you can just flesh out a little bit more what are you seeing over there?

Yes, sure. I'll talk about our Small Business and our Corporate business. And just definitionally, our Small Business channel, generally speaking, includes customers with fewer than 250 employees. So it's -- our Small Business has a little bit more SB than SMB. I think most people would probably define SMB up to 1,000. What we have historically seen is, on the Small Business side, much quicker to react, both on the downside and upside. So last year, in the second quarter, during the height of the pandemic, that business declined 20% more than our Corporate business, and then has improved sequentially on a year-over-year basis since then. And in the first quarter, it was actually up 12%, lapping a plus 8%. So we have seen Small Business customers come back surprisingly quickly. And as I mentioned earlier, healthy double-digit growth there. So I think on the Small Business side, I would expect that to continue to be a leader in terms of signaling overall confidence in the commercial space. In the Corporate business, as I mentioned, tends to be a little bit slower, both on the downside and on the upside. It didn't decline as much as Small initially, but has not been rebounding as quickly as Small Business. Generally, I think there's going to be a desire to see greater confidence among their customers. They typically -- some of these bigger customers might have somebody like me in the background, wanting to make sure that we're confident on our own demand before we commit to large IT projects. But overall, I would say, for both customers, confidence is increasing, as I mentioned earlier. Activity and momentum feel pretty good from a demand perspective, as we see it in our writings.

Got it. I have a couple of questions over here for you, Collin, really, related to M&A. But maybe I'll frame this slightly differently to start with, which is, you know, given everything you've talked about from a modeling perspective of free cash flow generation and so on, you will end up with a leverage ratio that's below your target rate of 2.5 to 3, I think. And so curious, in that scenario, is the thinking that perhaps the buyback would be a bit more aggressive? Or how do you think about that? Maybe just talk about your capital allocation philosophy level?

Sure. Let me tick through the philosophy, and then I'll provide a little bit more color. So the first priority is to have the dividend at 25% of income and to grow it in line with earnings. And I would expect us to continue to follow that as we go forward. The second is the 2.5 to 3x leverage ratio that you mentioned. We ended the year at 1.7x, and we ended the first quarter at 2x. So we did increase at 3/10 of a turn in the first quarter. It was lower than normal coming out of 2020 because we stopped buying back stock for 2 quarters because we were focused on enhancing liquidity. But in the first quarter, we repurchased a record amount of stock at over $350 million, and we also completed the acquisition of Amplified IT. While on the topic of leverage, some of you may have seen, S&P did upgrade CDW to BBB, so just over the investment-grade threshold. That was not in response to any change in capital allocation priorities or anything like that. So S&P does understand our 2.5 to 3x leverage target, and we continue to believe that, that's the right leverage target. Our next capital allocation priority is M&A, and we'll continue to execute against that, provided we see deals that meet our criteria. And then the fourth is to take excess cash and return it to shareholders. At the beginning of the year, on the most recent call, we said we expect to return over $1 billion in share repurchases. And I think, depending on what happens with M&A and how much we think pulls through the funnel or not, and if it looks like less is going to pull-through, we could see increasing that target over the next couple of quarters.

Perfect. And I think there's been a couple of questions on this call that I have over here around M&A for you are -- one is, how do you think about deal sizes? And I think you've seen smaller tuck-in deals, some slightly bigger like Kelway or Scalar even, perhaps. But how do you think about the optimal deal size for CDW as you go forward?

Yes, I would say, we don't necessarily target deal size. I know some of the deals we have done recently have been on the smaller side, but that is not an intentional choice. It's more an outcome of how we screen deals. And if we saw the right large deal, we would do it. So what's the right deal? We use 4 screens. Obviously, number one, it needs to fit with our strategy; two, from an operational perspective, it needs to fit into our model and believe that we could be successful integrating it; third is cultural fit, and that's really important to us. We are primarily in a people business and buying people and think that, that has been a differentiator for CDW. So getting the culture part is right. And we think that's one of the reasons we've been successful to date. And then the fourth would be financial metrics. So if we could find a large deal that would pass through those 4 screens, we would do it. It just so happens that the ones we've done recently have been on the smaller side, but those are the ones that have cleared those 4 screens.

Perfect. And then just sticking with the M&A narrative, the other one I'd see over here is, how do you think about geographic diversification? And does that play a factor into the M&A perspective at all for you?

Yes. I think the only wrinkle that, that adds is our international strategy is not a flag-planting strategy but more a follow our customers and where they need help. So we have, obviously, large multinational customers in the U.S., U.K. and Canada. And we would go into other markets if we felt we had a critical mass of their needs that we were meeting. And so that would take you into Western Europe or some of the more developed parts of Asia. So we'd be open to that, but again, that acquisition opportunity would need to clear our 4 screens.

Understood. And then maybe I just ask a bit on the Education vertical because the numbers over there have been, I think, strong, fairly phenomenal, I think, in the last few quarters. I think the last quarter literally doubled on a year-over-year basis to you. And I understand what's driving it, right, in terms of the education market. But I'm curious, what do you think is the right way to think about the growth rates in the Education vertical over the next 1 to 5 years? What do you think is a sustainable number should be over here?

Yes. Look, thanks for the question. You're right. The growth rates have been phenomenal. In fact, if you look at the past 2 quarters, Q4 and Q1, our Education business has generally been around $1 billion, up $0.5 billion year-over-year. And that is highly atypical because that's typically out-of-season timing. We continue to believe that demand in Education is going to be strong on a go-forward basis. But just given the law of large numbers and seasonality, I would not expect Education to add $0.5 billion of incremental growth quarter in and quarter out. I think from a demand drivers perspective, obviously, we spent a lot of time talking about Chromebooks and the opportunity to get to a 1:1 device ratio. And earlier, we talked about the backlog and when that backlog flushes at some point would be a growth contributor over the next couple of quarters. I think as you look longer term, though, we're optimistic on Education beyond client devices because there are just a whole host of technology needs that school districts need. So the infrastructure, the networking to support all of these devices, new audio and visual solutions in the classroom to support hybrid learning models. So we think, longer term, there's demand there, but again, not at the growth rates that we've seen over the past couple of quarters. But that then takes you back to the benefit of the CDW portfolio. I think the growth baton is going to get handed off from the Public side of the business back over to the Commercial side of the business over the next several quarters.

Great. And just to kind of continue the conversation a bit on the Public side. Looking at the Government vertical, the Census project was a significant tailwind to the top line that fully wrapped last quarter. And when you look ahead at both the Federal and State & Local verticals, what do you see as kind of the next big projects and drivers of demand there?

Yes. Obviously, the Census was a big project for us, contributing approximately 230 basis points of growth to total CDW in 2020. And we've said we don't expect Government to fully be able to make that up and overlap that growth. That said, though, once you exclude the Census in the first quarter, Federal business did grow at Census. And we saw engagements on the Department of Defense side of the business, both from a transactional and solutions perspective, and beginning to see larger projects returning with the ability to get on-site to basis and things like that. In our State & Local business, this is a dynamic that we've seen play out over the past quarter or so, which is unlike last year, where the stimulus spending had to use it or lose it within a certain amount of time. I think that drove a sense of urgency around spending. What we're seeing now is State & Local customers take a little bit more of a wait-and-see approach. Not that they're not going to spend those dollars ultimately, but again, that heightened sense of urgency, you got to do it this quarter. So they're just being more measured and thoughtful about that. And I would expect that to contribute to growth in the second half of this year and as we move into 2022.

Perfect. I think we're coming up on our time over here, but I should have mentioned this upfront. Collin, you set sail into retirement and you'd do all the things, hopefully, that I've been dreaming about doing in my life. But a, best of luck in your retirement. It generally has been a pleasure working with you the whole time. But I have a question for you, as you set into your retirement, and I hope you realize you have to diversify your portfolio of stock conversion beyond CDW, what does, Collin -- do you want to invest in as you go forward?

Well, thank you for the warm wishes. It's been a pleasure working with you. As a finance person, obviously, I recognize the benefits of diversification. But I'm a loyal CDW coworker and will continue to have an investment of CDW as I go forward, given, I think, the optimistic outlook for this company and would expect it to continue to do as well going forward, as it has historically.

Fair enough. Well, Collin, best of luck. I'm sure we'll stay in touch. But if there's anything I didn't cover, any closing remarks you have, I'll turn the mic back to you.

No. I think we hit all the topics. Amit and Lexi, thank you for having us here today. Really appreciate it.

Perfect. Thanks a lot, everyone. Thank you, Collin. Take care.

Thank you.