CDW Corporation (CDW) Earnings Call Transcript & Summary

[Audio Gap] Kevin, who has some safe harbor FD stuff. Kevin?

Great. Thanks, Jim. As a reminder, forward-looking comments that are made today on this call are as of our second quarter earnings call on August 4. You can find non-GAAP reconciliations on our IR website and we don't provide any specific commentary on vendor partners. As Jim will go through the CDW attendance, I do want to remind people that as previously announced, Al Miralles joined CDW as CFO on September 7, where he succeeded on Collin Kebo, who is retiring after 13 years at CDW. Collin is staying on for the period to ensure a smooth transition and he's joining us today. So Jim, I'll hand it back to you.

Thanks. And to show you how smooth of a transition that they're working on, we are very pleased to have the Chief Executive Officer, Chris, as well as both CFOs on the line, Al and Collin. So welcome everybody so much. And maybe to start kick things off, Al is joining as the new CFO. And since we're fortunate to have all of you here right now, I kind of wanted to ask Chris why she selected Al? Chris?

Well, Jim, let me -- if I go back several months in talking to our investors about what we were looking for in a new CFO, we were pretty straightforward. Number one, it was someone with a track record of partnering with our business to drive profitable growth. Obviously, driving asset efficiency and being a good steward of our capital, and importantly, a culture carrier given how important CDW's culture is. And I think we found that in Al in states. I think about 2 buckets, experience and characteristics. The experience is what he's done and the characteristics is how he's done it. And it really brings a great blend of characteristics and experience to help us deliver against our 3-part strategy for growth and foster our culture. On the experience side, Al, he's a CFO of a public company with a great track record. He's been an operating executive. He's operated very sophisticated services businesses. He has been a leader and driver of business transformation, enterprise-wide business transformation, including of systems. So you can go through and check all the boxes on experience. And from a characteristic perspective, he's a leader who focuses on talent and driving high-performing teams who set incredibly aspirational goals and then they go get them. So that's very important to CDW because we do the same. And then lastly, I'd say, look, in addition to his intellect and curiosity and all those wonderful elements of who Al is, he's got the tri-factor that matters CDW. He's hugely competitive, he's completely customer-centric and he's humble. And so I look forward to him joining the team, and I believe he will do a great job. I do, however, want to say another thank you to Collin. Collin has been an extraordinary leader at CDW, and he's been one of the best professionals I've ever seen in this transition and the support that he's been provided. So excited to have Al in and good luck...

Collin is not off the hook yet. We're going to get to him a little bit later. But Chris, maybe how should we think about the return on small and midsized businesses. I view your company is very well positioned to the return of small and midsized businesses. And when I walk around downtown San Francisco, I still see so many small businesses struggling or not even reopened yet. How should we think about the markets? Is it local governments and schools and restaurants or law firms, doctor firms. Are there -- where are you seeing the strongest growth and which have lagged post this COVID recovery if we hope to actually be in a recovery?

Well, I'll tell you, Jim, as you know, last year, as we entered the downturn and the COVID environment, the macroeconomic environment, a number of our commercial customers and small customers were really hit the most, up in Canada as well, where there's a lot of small businesses operating up there. And as we were coming into 2021 and starting to see some uptick in, call it, confidence, macroeconomic results, expectations, et cetera, we did, as you heard in our Q2 results, start to feel the results of that. Our customers were back in, buying, preparing for the future. Now when you look at where we are now, I think you asked the question about which industries, which types of small business, it varies. It varies by industry, but equally, it varies by geography. It varies by what type of company it is. So it's hard to give you a sense for which industries in particular. But I can tell you, for example, startups, high-growth startups, venture capital funded. Those types of companies have been really buying and investing in their future through the whole of the pandemic, and we continue to support them quite strongly. On the government side, the government channels are recovering, I'd say, at a bit of a slower pace. And that, I think about the gears of governments and what it takes to actually access funds and then apply the funds. So while we're still very optimistic about growth in government, both federal and state and local, it's going to take some time for money to wind its way through the snake, as we say, and get to the front end of buying. But I can't end without stating the obvious, which is technology has just become more important to every organization; small, medium, government, health care, et cetera. It's needed to operate more efficiently to win in the marketplace, to deliver customer experiences that are superior. And I think this past 20 months have really reflected the power of CDW's model, both the diversity of our customer end markets and the breadth of what we deliver to our customers across the full IT stack and life cycle, so that no matter where customers have been, we've been able to continue to help them and plan for their futures, which is where they are now versus kind of managing through crises.

When we think about that though, have the customers change their priorities, I think about my family as an example. First is like, hey, get the kids a notebook or kids a laptop. And now it's more like, hey, maybe we need to upgrade to WiFi 6 in our house for more bandwidth. So it seems like that there may have been some initial purchases and now some shifting, but also I'm starting to go back into the office now and realizing my desktop web camera and audio isn't optimal because it's a lot more collaborative now. So can you talk about what are customers actually prioritizing now versus, say, a year ago?

Yes. Jim, you nailed it there. You basically have customers who are focused on what the future of success means and how it's defined. And at CDW, we talk about it very simply, it's about experience and outcomes, and that's experience for employees. That's experience for customers. Experience for patients, teachers, students. You can go on and on. And then it's the outcomes. In the buying world now while CIOs are still involved, it's also others across the organization, whether it is a business leader or it's a Chief Medical Officer. The decisions around technology are all about outcomes. Are we teaching better and faster, are we getting our products to market more quickly, that all is very important because I just -- having technology work in a frictionless kind of intelligent connected way is now anti. It's no longer send a notebook and let's hope it works. Now it's Jim, you're putting on this fireside chat, you've got your conference, and it's going to be a great experience for those attending, and you need to make sure that everything is working together. So where we sit now is exactly as you described it. Last year, it was crisis management mode, right? Get people working, give them enough so that they can connect virtually. Now it's planning for the future and it's executing for the future. No matter where you're working, your office should feel the same. So yes, it's more sophisticated collaboration tools. It's more sophisticated notebooks. It's infrastructure in the office to ensure that workloads are being optimized. The application performance is where it should be. Said simply, technology should never get in the way. Technology has to be the facilitator. So we're really seeing customers invest across the spectrum of hybrid infrastructure, including on-prem and cloud, all the way into the digital experience, think notebooks and the applications that go with them.

And Chris, sadly, I kind of think of government is not being a leading edge technology adopter. And in fact, when COVID hit many of the programs and services in governments kind of ceased and didn't know how to react. What are you seeing now from the government sector as far as what they're doing in technology solutions for government.

Yes. I think for better or for worse, for truth or not, I think government can get a bad rep. When you think about our business, government for us is our federal customer market and our state and local market. And there are gears that turn in the government and sometimes they turn slowly or sometimes they turn a little more fast, but they have their own speed. And what I would say is 2020 was a very strong year for CDW in the government space because of our tremendous Census project, which we executed. I applaud the team, executed incredibly well. What we're seeing now is the federal government very much like commercial customers where technology is the heart of improvement getting better. And you're also seeing it really mandated by the White House. You're seeing it mandated by Congress. The federal government being behind on technology is no longer going to be acceptable. And some of the sophisticated work we're doing in department for defense, for example, is incredible. Wartime classrooms that are all technology delivered and those then being used for different kinds of opportunities elsewhere in the government. So look, I think that on the government space, very optimistic about how technology can change that space for the better. It's happening now, and we've got some great projects in the pipeline for 2022. On the state and local side, look, we're still working with state and local, they've got money coming, right? There are 3 stimulus bills, the first and third, they get money from, they're still -- we're still helping them work the money through the snake, if you will. But state and local governments also, there's pressure on them to use technology to drive efficiencies, to drive experience and get what they refer to now as a citizen experience.

The stimulus funds, we think about state and local being benefit. Have they already benefited from those? Or is the money still yet to come out? Or are there actually some other channels that could benefit from stimulus funding? And what's the timing we should think about?

Yes. I mean, the answer is kind of yes across the Board on all of those. They had -- the state and local has benefited, but there is more to come. This third stimulus bill back in more is still working its way through the system, as I mentioned. Education, which has had obviously tremendous need and tremendous impact on our growth with 2 billion last year, there's more money coming out of the emergency funds there that we have helped. I mean, if you look at the number of orders that we've helped customers put together, we do this, Jim, as you know, we're very facilitators in terms of accessing funds from the government, done a great job there, and we'll see that -- we'll see the fruits of that in the next several quarters into next year.

I've been doing this job a long time, and I feel like it's been multiple years of supply chain issues, whether it be trade wars and political trade wars of where you can ship things to and not, whether it be boats getting stuck in a canal or cap sizing or labor strikes at ports in San Francisco and L.A. coming from China, and typhoon, power outages, water floods or even droughts that aren't allowing semiconductors to be procured and now COVID. So it seems like the semiconductor and other components have had some shortages and have created some widespread bottlenecks impacting many products and end markets. Has the situation for you gotten worse, stabilized or improved? And how should we think about the backlog and what you're seeing there?

Well, Jim, as you were describing it, it was kind of like reliving a nightmare all over again because we've experienced all of that in these last 20 months. Look, I won't update since the last quarter, as you know. But as of the last earnings call, we had a lot of transactional products in backorder. We mentioned that Chromebooks had eased up a little, we were getting better access. But whether it's notebooks and then also on the solutions side in particular areas, things like networking, monitors, all the web cams, all of the things that we talked about earlier that create an office environment, that feels like an office environment when you're not in the office environment, those all were starting to creep up at the end of Q2. That resulted in our backlog creeping up a little bit more. We shared that as well. And when will that all flush out, that I think is -- I think it's impossible to actually know given the different messages we're getting from the OEMs. What I do feel really good about is demand in our customer end markets has continued to be robust, as we mentioned in Q2. And we are incredibly good at navigating choppy waters when it comes to supply. So we are working with our customers. We're working with our OEMs, haven't had any customers exit because we haven't been able to help them with supply. But we did say, look, it's going to continue through the end of this year and into next year, and we'll do our best to navigate through it. The 1 benefit, a benefit that we have is our distribution centers and our logistics capabilities. And I'll tell you in the last 20 months, that has really been something that our customers have leaned into and appreciated the fact that we get the -- we can get product, we can hold product if we're waiting for last items, and then we can really in an orderly way, get the product out to the customers.

Well, you answered both questions, including, is it factored into your outlook, and you mentioned that. So maybe I'll give you a chance to have a sip of tea or coffee, and I'll switch over to Al and Collin a little bit and talk about comparisons as we look ahead. Anything that we should be mindful of? I mean, we think about a year ago, my family and a lot of small businesses were buying lots of PCs and boom, web cameras and audio stuff and getting it installed. So how should we think about comparisons as we look ahead and anything we should be mindful of, whether it be PC lapping or difficult comps or I think compared to a year ago, logistics and shipping has gotten worse?

Jim, thanks for having me and my dog is barking at something. She's been quiet the entire time Chris was talking. Maybe I'll just go back to supply for a second here in terms of the outlook and then talk a little bit about overlaps. On our last earnings call, our outlook for the full year for net sales was IT market growth of approximately 5%, and we expect to outperform that by 425 to 500 basis points. And then on top of that, expect currency to be at benefit of about 80 basis points. So that was our call, our updated outlook for net sales for the full year. In terms of the assumptions on backlog and added in that, we did assume modest growth in the backlog in the second half of the year. Obviously, if things turn out better, that would be upside. But if supply is more constrained than expected, causing greater growth in the backlog, that would be downside. Now ultimately, that's all timing and at some point it makes its way through. In terms of comparisons that you want to think about in the back half of the year, I mean, we've been overlapping really strong PC numbers for a while. So I don't have anything to add there. Chris did touch a little bit about the government. Obviously, we have the Census sitting in the base, and that contributed 230 basis points of sales last year. And as you get into the fourth quarter, it's not just the device, but also the configuration services that went along with that as those devices came back into our distribution center. And then the other thing to keep in mind in the back half of the year is that our education business was unusually strong in the fourth quarter. Q3 is normally a seasonally strong quarter, but it was just exceptional in Q4 because of what was happening with the pandemic. That was actually a $1 billion-plus sales quarter for education last year in the fourth quarter, which is atypical. That was driven by some large deals. We've talked about the Mississippi Department of Education solution previously. But in Q4, we grew low double digits last year. And if you excluded the Census in Mississippi Department of Education, that would have been more in the 6% to 7% range, just to give you an idea of the magnitude. But I would think about those as some of the bigger overlap considerations in the back half of the year.

Okay. And we're going to have to give you some doggy treats, you got to feed that puppy. That being said, speaking of shipping new stuff, how do you deal with shipping costs? Do you just put the Jim Suva doctor law firm, a line item for additional shipping costs? Do you have to absorb them? Do you increase the list price of what you're installing into the Jim Suva law CPA firm? Or how do you deal with shipping costs?

Well, we have both inbound and outbound shipping costs. I mean, in terms of inbound, that's generally baked into the cost of goods sold or ultimately the COGS that we would show our sellers. And so we operate on a cost-plus basis. And so that, in turn, would get passed along to the customer. So in most instances, we are passing along those shipping costs where we can.

Okay. Got you. Investors do get concerned about gross margin, but they did improve quarter-over-quarter. And I think sometimes what they overlook is gross margin is one thing, operating margin is another thing. And sometimes a PC or a cellphone or a notebook has a very different gross margin. And I think people just get distracted sometimes by gross margin. So I tend to focus on operating margin. Can you talk a little bit about gross margin and the impact from mix, whether it be PCs and kind of the correlation with operating expenses and margins?

Sure, Jim. And I think you're thinking about it exactly right. We did see a sequential gross margin improvement from Q1 to Q2 of 80 basis points. That was driven by mixing more into 100% gross margin items, particularly Software as a Service. Our product margin was a little bit firmer. We had really strong professional services, both inorganic and organic growth. And then we benefited from some seasonality and partner funding. PC mix wasn't really that big of a driver between Q1 and Q2. But your point about certain products having higher gross margins and others being lower, I think you need to think about the higher cost to serve on the solutions part of the business and then as well as the fact that we pay our sellers on a percentage of gross profit. So that variability in the gross margin which can bounce around from quarter-to-quarter does get dampened a bit in the middle of the P&L, and that's why we focus on the operating margin because of the variable nature of our cost structure.

And then how should investors think about longer-term gross and operating margins?

Yes. I think in terms of longer-term drivers, there are some tailwinds out there. I think of netted down revenue or 100% gross margin items, I think over the longer term, you would expect that to grow faster than the total portfolio. That includes things like cloud and a lot of security software that we sell. And then our own services business, which has been a focus area that has a higher gross margin. So I would expect those to be tailwinds, some headwinds at least in the near term or at least can bounce around a little bit is the hardware mix. I think the depth of hardware has been predicted multiple times over the past decade, and yet we continue to see really strong hardware. And then within hardware, we do tend to see commoditization, particularly in some of the core transactional products. So I think those are the -- some of the drivers of gross margin over the longer term over the cycle. In terms of other factors driving the operating margin, as Chris talked about, we think technology is more essential than ever and believe now is the time to invest in the business for future growth. And we've been hiring aggressively and continue to invest in the business. And so that's another factor to consider. But when you put all that together, that gets us to the mid-7% operating margin that we have in our outlook. As I think about that over the longer term, if we were to see a sustained mix into netted down items, and again, I want to see it sustain, we would address the operating margin at that point in time and adjust it. So back at our Analyst Day, we did increase our -- at that time, EBITDA margin, reflecting the fact that we were mixing margin net at down items.

You mentioned some hiring. Can you give us a little bit of insight. There's lots of areas at CDW that could be hiring, whether it be on the software side, the sales side, the corporate side, office of the CEO or CFO. Where's the hiring kind of going on?

I can take that question, Jim. It's across the Board, but we're investing behind the strategy. So obviously, sales players -- we're hiring sales reps as we always do, customer -- their productivity is what drives our growth. We're also continuing to double down in those capabilities areas that I mentioned earlier. So I think back to 2016, I want to say we were about 2,000 folks sitting in our integrated technology solutions team that would be solutions architects and engineers. We're now 3,500 plus. And we continue to invest there in high-growth front tip of the IT value chain areas, like digital solutions, think of our IGNW acquisition, like automation, think of our Aptris, ServiceNow acquisition, like security, think of Focal One. So we're investing there. But equally, we're investing in what we call our backfill in the offices that support our customer-facing organizations because we're treating ourselves as a customer. And we are transforming our own IT systems. We're transforming our own digital approach to business, digitizing and with digital products. So it's really across the Board, but of heavy focus in those areas that we are investing. As Collin said, now is the time to invest and we are investing in people.

Well, that's a great transition, Chris, to the next question about investments. And you recently announced the acquisition of, I think, it was Focal Point, if I remember correctly. Can you let us know little bit about what Focal Point is and the rationale behind this acquisition?

Yes, sure. Very excited about Focal Point. And look, they're a market-leading cybersecurity firm with a really great strength in access management technology and identity theft both across the advisory and integration practice. So they -- I would say, they bolster our security practice in an area, identity and access management that has become kind of a starting place and the hub for real security. So what do they bring to us? They certainly bring relationships, strength of relationships, customer relationships. They -- I think this really accelerates our ability in this space with regard to consultative services, in particular. And it provides an entry point for larger services projects for us to do. But really, Jim, if I boil it down, we want to be known as a security thought leader in the space that matters so much to every element of technology right now and Focal Point is going to help us get there. And it's just a great reflection on the M&A, how inorganic growth and focal points can help us to accelerate the services and solutions capabilities, we're so focused on our 3-part strategy.

Well, I'll tell you, Chris is a good CEO. But let's switch it over to the capital allocation and talk more about some of the numbers, maybe to Al and Collin a little bit. How do you guys see capital allocation, old and new CFO?

Yes, Jim, I'll kick it off there and great to be here today with you. So just a couple of things. For context first, Chris mentioned my direct kind of transparent approach. So I would just note that the walking in, I have an appreciation for the CDW way and really open dialogue with investors, and that really resonates with me. With respect to the question on capital allocation, I've spent a little time with this and obviously spent a lot of time with Collin. And I think the approach on capital allocation makes a lot of sense and really balances near-term and longer term returns for investors, but making space for the company to continue to invest, which is critically important at this point. Just a reminder for folks in terms of those priorities, number one, continue to increase dividends in line with non-GAAP net income. Number two, continue to think -- be thoughtful about the capital structure, and we have a target of net leverage of 2.5x, 3x. At second quarter, we're a bit short of that. Number three, continue to supplement organic growth with strategic acquisitions, and really there with an eye particularly towards capabilities of the company. And then finally, return excess cash after dividends and M&A to shareholders in the form of share repurchases. So look, I add that up, I think it makes a lot of sense. And obviously, I'm looking forward to engaging with investors and getting their feedback, but I wouldn't see any of that changing in the near term.

But I just heard Chris saying she's hiring people. So how do you fund -- I assume that takes more money to fund the growth? How should we think of that?

Yes. Look, I would just say, like I mentioned, the whole construct is predicated on the returning to shareholders, but balancing the near term with the long term and really to continue to bring all the CDW's brain, you need to continue to invest. And so we certainly are focused on that at the same time creating returns for investors.

Chris, you talked about M&A. Is M&A kind of percolating to be a little more important? You mentioned security. I typically don't think about CDW offering lots of security and maybe I'm wrong by that. How should we think about M&A going forward? Is it more important? Is it other value-added resellers the target or more of this kind of security software focus?

Yes. Okay, making sure I was not on mute. Jim, first, let me just tag on to what Al was saying. From an investment in people, it's incumbent on us to create investment capacity. And so that is what the team has tasked with as well. So when we think about our 3-part strategy for growth, there's always an evergreen everyday element of that, which is how we do things better, how digitization can recreate efficiencies. But there's a real need to create that capacity, which we're doing to make those investments. Regarding M&A, look, the team is really proud of the fact that they've done 7 acquisitions in 7 quarters. That's a big deal for CDW. Some of them are smaller tuck-ins, some of them are what we call acquire hires. But the -- those are really great transactions to be able to get a group of technologists, 17, 25, 50 technologists that we can then hold right into a practice like our digital velocity practice. So I would say that inorganic growth has been squarely on our radar and it's squarely part of our strategy. If you take through the acquisitions we've done over the past couple of years, IGNW, Digital Velocity, Aptris, Automation and ServiceNow, Focal Point, security, AmplifiedIT, cloud management services, they all sit at the heart of that front end, as I said, of the IT value chain, which is helping to advise and consult customers as to what they need and then stitching those needs into the full infrastructure and then ultimately providing the hardware and software to make it all happen. So we've been laser-focused on M&A. We'll continue to be laser focused on M&A. And look, we're looking at all sizes, and we're looking at capabilities and geographies. Those are really the 2 areas of Focal Point. But we're disciplined. We're disciplined about it. So want to -- we go to get through our lenses for it to make sense. And financial return is obviously quite important cultural fit quite important part of those lenses.

Chris, you've got a lot of energy and a lot of mojo in a business with razor-thin margins. It's a tough business. It's not like you have a lot of room for blink, blink stuff. It's a razor thin business. What really keeps you motivated and so excited as CEO and what you want to leave investors with about why they should be buying and owning CDW stock?

Well, look, if I -- you tick through the things that everybody knows. Technology is a growing fragmented market. Technology is more important than ever before. CDW has consistently returned superior results. There's a lot of things I could be saying to this group. I would say, I'll keep it really simple. There are 3 things about CDW that we anchor to and that will continue to allow us to return superior results. Number one, there is this notion of consistency, okay, and continuity really. And then the second is evolution. And then the third is execution. And this is a team that has had absolute continuity and consistency in our circle of service, which keeps the customer at the center of everything we do, and our culture, which is understanding very deeply that our people, our talent is what makes a difference with our customers, okay? That has not changed since 1984, a founding principle. So that continuity is important. Evolution. Notwithstanding the fact that, that hasn't changed, what customers need, what's relevant, how they think of technology has evolved dramatically since 1984. And CDW has, without fail, evolved to meet those needs, understand where customers are going and meeting them at the intersection where they're next going to show up. And that includes pivoting to growth areas and providing new and different capabilities and services that our customers need. And the last one is execution. I mean, I cannot say enough about the team at CDW. If you're going to bet on our team that's going to get something done, I would bet -- I bet my house on CDW all day every day. It's a sales execution powerhouse. It's an organizational execution powerhouse. So that's what gets me juice because I know it's a place where we focus on the customer, where coworkers care about each other, we evolve with the market and ultimately, we execute like nobody's business and deliver at a greater rate of return than the market does.

I personally want to thank CDW for their management team here in front of us, and I apologize we couldn't be doing this on stage in front of hundreds of people. Hopefully, next time that will be the case. But until then, we did the best with the technology that CDW allows everybody to do more and more efficient with life. So Chris, Al, Collin and Kevin, thank you so much for joining us here today.

It was a pleasure. Thanks, Jim.

Thanks, Jim.