CDW Corporation (CDW) Earnings Call Transcript & Summary

Okay, everyone, hi. Thank you for joining us. My name is Shannon Cross, and I am the IT hardware analyst here at Credit Suisse. I am pleased to be joined today by the CEO and CFO of CDW. Chris Leahy and Al Miralles. So before we begin, CDW would like to remind you that any forward-looking statements were made as of the company's Q3 2022 earnings release on November 2. In addition, a reconciliation of GAAP to non-GAAP metrics could be found at investor.cdw.com and in the company's SEC filings.

So with that, we'll start some Q&A. I guess, Chris, can you just talk a bit about the macro environment, what you're seeing where there -- clearly, there were significant pockets of growth in your business last quarter, some weakness. But it's not really a conglomerate model because it's segments, but you benefit from focusing on many different segments. So I guess, what are you seeing these days?

Shannon, well, thanks for having us. It's great to be here. Let me just -- I guess I'd start by zooming out a little bit. And as you said, first of all, I don't have -- I read tea leaves as good as the next person. But if you think about our business model and our balanced portfolio of end markets and the breadth and depth of our portfolio of products and solutions, I think the strength of that really came to life -- has come to life in these last 3 quarters, and we've seen that in the performance of the business. As we think about the macro environment, the other thing I would say is -- and again, we all know this, but it really is becoming crystal clear how important technology is. It's absolutely essential to the strategic outcomes and mission outcomes for all of our customers. And more than just important, it is getting more complex. There are more choices, there's more pressure to optimize than ever before. And so the need for expertise and choice along with good judgment and opinions and guidance is higher than it's ever been before. So our value proposition is resonating, and it's more relevant than it's ever been before. When I think about across the segments, I wanted to just start with trends that we're seeing -- that we are seeing across all of the diverse end markets. So when you think about where are folks investing and what are they focused on. Number one, optimizing their infrastructure, including cloud strategies. There's just been massive investment in endpoint devices, and there has not been massive investment to support the distributed devices that are out there now. So there's real focus on modernizing the infrastructure. The other I would say is digital transformation that -- those words get thrown on a lot, I would say, think of that as digitization, automation, right, productivity enhancement, along with all the things required for digital experience and even digital product. That's very much related to infrastructure in terms of, are you choosing cloud on-prem, for example? Or are you -- do you have workloads that are -- that you're driving innovation, agility? Or is it more focused on security and control, okay? But digital transformation, to me, means experience, enablement and products. And then collaboration continues -- I mean the hybrid workspace and the hybrid working world continues to thrive. And so collaboration is also a continued trend. And then the last thing is not going to surprise anybody is security, everywhere. And actually, that probably is at the top at this point. With regard to certain segments, because you asked me about segments, I thought I'd just hit on a couple of things that are interesting or different. Commercial and small businesses, we see the same trends. Small businesses are -- they are very aware of the macro environment. And so they've been focused very much on cloud and software and security. Federal returned to normal seasonality. We had expected that it would. It did, and that was one place that we did see PC refresh. Otherwise, generally, I'd say, there are a lot of investment in PCs. And as we've been saying, and you've been saying and everyone has been saying, it is moderated. And the [ K-312 ] is a great example of that. Healthcare has been interesting, because, obviously, there are challenging times from a cost perspective in the healthcare space, and they are really leaning into CDW to figure out how to drive productivity. And also, I would say, increasingly open to cloud solutions, which for some period of time, had been less on the forefront for healthcare. And then you've got our international, which has really been, I'd say, bucking the trend, and I'm going to give kudos to the team, because it's all about execution. I mean, particularly when you think of the U.K. and really challenging environment there, and they have been growing our portfolio. Again, I think it's because of what we -- the value prop that we bring to bear, plus our execution. It's broad, we can pivot to where there's opportunity and we execute like no one else. So some trends that impact across all of the industries and some things that are a little bit more particular.

And from like a solution sale perspective, over the years, I have watched, you definitely morphed, and the industry is more from a transactional when we buy a PC, let me buy a server too, let me buy something, a solution. We'll fix a problem as opposed to just provide a piece of hardware. And you've hired a lot through acquisition as well as organic growth, a lot of technical salespeople and coworkers in that. How are you leveraging them? How are you expanding your solutions capabilities and maybe teaching your customers sort of what they need?

Yes, it's a great question. And if you will start with the customer angle, right? Because they're coming and they have an outcome in mind. And it might be, they're trying to innovate and speed to market and new products more quickly. It might be agility, it might be more security, but it's a business outcome or a mission outcome, defend the nation. That's what the technology teams have now been tasked to do, not just "get me the right technology right away". It's, "I am now responsible for delivering on this outcome." So that's the first thing. The -- when you think about the people and what that requires because choice and complexity really does play to our strengths and our value prop, our differentiator in the market is a high-performing expert team. And so we invest in people with expertise, who can advise our customers on what the best options are to optimize for the outcome that they're seeking, the biggest return on investment dollars. But really, we talk in terms of outcomes because that's how customers think about it. And most outcomes are built on what we call multi-stack. So it will include some element of software, some element of cloud, some element of services and some element of hardware. We don't think of customers now coming in and say, "I just want a PC." It's "We have a workforce, we need them to collaborate anywhere, we need them to be productive, and we need your advice on how we do that, both with our endpoint solutions and digital experience at the edge, along with the infrastructure that's going to support that." And so we've been building the technical capabilities and refining our sales capabilities to be able to have those conversations with our customers. The good news is we will always have a cost structure that has a level of variable cost. That's how we pay sellers, et cetera. And that will always be there. The other good news is in bringing on these technologists and -- between sales and the technology team to almost 11,000 strong, we're driving higher-margin product, higher value to the customer, higher margin to CDW. So the higher-margin component offsets the cost of the technologies that we're bringing on.

Do you -- where are your customers getting the IT dollar? This is sort of a derivative question, but you -- IT keeps growing, other things don't. I'm just curious, what you think they're de-emphasizing, whether it's within IT itself or just in general, to keep growing their IT budgets?

Yes. I mean I think, it's a variety of things. It depends on the industry. Some places can pretty quickly go to roles, jobs and not necessarily hiring at the same pace. Some can go to real estate facilities. They're going all over. But the one thing I would say is consistent is, technology is being used more and more to drive cost efficiency, right? And in fact, I think the study recently -- digital transformation has been #1 for a while in the minds of CIOs. I think cost efficiency just edged it out, because the concept of automation and the time you can free up, the efficiency, the effectiveness from that, it's just critical to maintain a competitive advantage, going forward.

And one of the things that we've been a big proponent of is this idea of Infrastructure as a Service, sort of layer it on with hybrid cloud and you can sort of more effectively compete with or at least work with the public clouds and some of the offerings there. I know you've embraced GreenLake and some other offerings. What are you hearing from customers with regard to interest, especially as we're going -- I keep saying we're going into, especially as we're in a recession or whatever we're in right now?

Well, it's a great question. And a couple of year -- 2020 in the middle of the pandemic is when we started to have, I'd say, even deeper conversation with customers about optimizing for outcomes and thinking about planning infrastructure and cloud, even though they were focused on prioritizing endpoint devices that we're having the conversations, where, I'd tell you, right now, that there is a real -- there's a sense of urgency and there's an approach that essentially starts with the outcome and how do I optimize my technology estate for that outcome. And the choices now, you've got on-prem -- traditional on-prem, you've got public cloud. You have on-prem cloud gaining a lot of traction, because there's a real use -- there are lots of use cases for it. And then you have edge compute. And you think about retail environment as an example in places where it makes sense to be doing the data compute and analysis closest to a transaction like you're shopping in a store, you're on an app, you're checking to see if they've got your size, et cetera. So our customers are really taking a step back and looking at all of these as viable solutions and breaking it down by what do they bring to the table. Is this more cost efficient or cost elastic? Is this -- are these the gems of the organization I want to control them and keep them secure on-prem? So really breaking it down into the characteristics of what they can get by the solution and then weaving that solution together in a way that works for their business. And that's what we do, help them advise on that. We help advise on that, the design and then implement it, whether it's moving to the cloud or implementing an on-prem solution.

And how have your coworkers -- how do they understand the concept of ratable billing and ratable payment and subscriptions in that from the standpoint of their book of business? Because I remember a few years ago, it was sort of a -- this foreign concept, "No, I sell a PC, I get paid this," as opposed to actually, it's kind of nice to wake up every day and know you've got some -- we have that across research. We had subscriptions, and we had people who come in and paying. And it was nice to know that a certain level is covered.

Yes. I guess the short answer is they learn fast. And you know us well, Shannon, I mean our customer relationships are, on average, 12 years now. And you don't get there without your sales organization, developing the kind of trusted relationships with the customer and doing what's best for the customer. So as elastic cost and ratable billing and consumption-based models work for them, our sellers make it work for us.

And I would just [ mention ] it, right, cloud, a big part of our business. Third quarter cloud spend, for us, was in double digits growth, top workloads, Infrastructure as a Service, as you referenced, productivity and security. So really important part of the business and our DNA of our sellers as well.

Okay. And I was going to ask you a question next, Al, for you into the conversation. How are you thinking about the margin potential contribution from netted-down revenue? And how it will shift the model over time? Because you've always been sort of like this 8% EBIT kind of business. And in theory, it can creep up, I would assume, over time, assuming more and more sales, and you're talking about selling a higher margin business. So how do you think about maybe -- you can both answer, the contribution and the upside on gross margin? And then is it something that you would then reinvest in the business? Or do you think, from an investor perspective, we can see it over time sort of fall through the bottom line?

Yes. So first, just strategically, obviously, customers focused on mission-critical initiatives. And I'd say, netted-down revenues play to that, really talking about software, cloud, security. So thematically, really important in that regard as well as you hit it earlier, kind of consumption-based spending if you will. We've invested behind that, right? Because we saw that theme coming. When you think about our acquisitions, it's been a lot of those areas that have bolstered our investments in that regard. On the gross margin front, so just a reminder, so our netted-down revenues represent where we are not acting as obligor, we are acting as agent. And so essentially, we record at net sales the same as gross profit, so it's 100% gross margin items. So some examples just to bring that to life a bit, it would be a selling Software as a Service, software assurance and warranty, right? So very key areas, again, linked back to that cloud, security and software. And so what we would expect over time is structurally, we think there's great growth opportunities in that regard. We would expect that it does have a dampening effect on our net sales, but certainly bolsters our gross margin, right? And over time, you'd see that drop to the [ margin ] as well.

Yes. Great. And I guess, when we think -- I just want to talk a little bit more about client because when we recently took our numbers down, we'll see if that was sufficient. Obviously, HP's commentary, and Dell's commentary was not exactly rosy around what's going on. Western Digital did see some bottoming, so there's something. But how do you -- how do your customers see the PC at this point? I mean I know they've invested a lot in it. It's important. There's sort of an argument out there of whether or not people went out and bottomed, and they're not going to show up again for 5 years. Or on the other side, it's, during the downturn, everybody realized the importance of the notebook, and there'll be maybe a shorter refresh cycle, or at least the potential sales on an annual basis has just been -- has risen up above where we were at like 250 million pre-pandemic.

Yes. I would say, we're in the camp, consistent with where we've always sat, which is the PC or endpoint solutions are an integral part of the technology solution period. It's a tool of productivity. It's an experience thing. It actually what you're using in the office and how well it works, matters to new hires. There are more and more use cases through -- from a digital transformation perspective, for mobile devices. We have more breakage. We have faster feature functionality enhancements going along. We've got things even impacting it like sustainability, which is as the products evolve from a sustainability perspective. So we see PCs, endpoint devices as absolutely integral to the holistic solution. They're the conduit to the applications of the data, right, and how we all use them. So from a timing perspective, look, that's always the question, right? We just had massive investment whatever we're in, whatever, Shannon, is the recession, where -- right? But we just had massive investment. And at some point, there will be a larger installed base to refresh against. That feels right to me. It's a matter of when. We've got some tailwinds there coming up like when 11, right? And we've already seen some of the catch-up like in Federal for, us where they hadn't upgraded from -- and they are. So look, the good news, again, for our model is whatever customers are buying, we pivot to that opportunity. So as you saw from our results over the last 3 years, we well outperformed the market, particularly in the PC and collaboration space. And we would expect to continue to do that when that market comes back up again after it's moderated down. But in the meantime, where our customers are investing now, it's all those areas infrastructure, digital, security collaboration, and we're helping them do that.

Are there opportunities from the significant stimulus packages that have been signed over the last year for CDW to provide solutions or services or I don't know, something on the broadband side? I'm just -- I'm wondering if there are any areas within the IRA or the Broadband bill or any number of things that have been signed that you can leverage?

Yes. I mean the way I think about -- I mean, we have the stimulus dollars that we've talked a lot about, like state and local, et cetera. And that's really bearing fruit. You saw it in the results in Q3. We really spent a lot of time with our customers sorting through. It's highly complicated, as you can imagine, to figure out where the money is, how you have to spend it, et cetera. But it's bearing fruit. And they had multiyear amounts or horizons and so not used to space -- planning that way. But we're seeing that bear fruit. There are others like the Broadband. Where I would think that would play out for us is not necessarily something specific in that bill, I would say, the ancillary impact. So we're -- 5G, Wi-Fi 6, all of that, as you think about the networking transformations that might take place going forward and the needs that surround what the outputs of that are.

That makes sense. How is the Sirius acquisition going, sort of changing topics? You bought it, sort of got subsumed within the board, and we don't hear a ton about it on a specific basis. So I'm just wondering if you can kind of address what's gone well there, where you've been able to leverage it, how it's progressing?

Yes. No, thanks for the question because it's a big and it's a lot of work. But I'd say, it's really gratifying. The team is doing an outstanding job, a superb job. And first and foremost for us, is ensuring that we can very quickly bring to our customers the benefit that we think we have as a combined organization. So that's where we put our focus at the very front end. And I'd say a couple of things. We've seen our -- the Sirius and CDW teams come together very quickly, pair up organically as some customers, but we really have complementary offerings, and we don't have a lot of overlap in customers, but where we do, we saw that pairing up. We've already made great progress in some of the synergy work. We've integrated our backbone, for example. And we are -- we will be rolling out our new go-to-market starting January of next year. But I think the most important thing from a Sirius perspective is that we always start with the relationships with our customers and with the frontline sellers to build an understanding of the value that we deliver to the market and a trust with each other, the frameworks follow. We've always found if you go the other way around, you just don't build the kind of understanding and belief and conviction. And so the teams did it the right way and really, really, really pleased with how it's going so far. We have customers who are -- we do have -- we are seeing revenue synergies. We've got customers who are buying client devices, who never bought client devices from Sirius, and we're bringing in some of the services capabilities that Sirius brought to the table.

What are your customers saying about their plans, this is holistic CDW, their plans for 2023 in terms of IT spend? I know it's still early. I know things can change, but we're getting pretty close. So I'm just wondering how they're thinking about IT budgets.

Yes. I would -- look, on the earnings call, we said our customers were cautious but committed. And they are cautious and committed. They're prioritizing and they -- we talked about it in Q3, they're being very prudent in how they approach it. I think that most customers are building plans next year and waiting for the most relevant recent signals, because things are changing pretty quickly. What I can say is, I am continuing to see customers prioritize technology, so top of the list, along with scrutiny on the return. So that gets back to -- that's good for CDW because our customers are leaning into us more for the full life cycle end-to-end needs that they have and helping them to determine what is going to be the optimal solution. That's becoming more important because they're getting judged on the return and the outcome.

Has the return timeline shortened? Or -- I'm just thinking about what CFOs are willing to commit to or willing to fund? What are you willing to fund?

I haven't cut our IT budget at all, just saying.

So I guess assuming you get to your deleverage goal by the end of the year, what are your capital priorities? And how are you thinking about -- I mean, obviously, you had a good acquisition with Sirius. How are you thinking about it? And does your thought process change, given the higher interest rate environment that we're in?

Well, I'll start with M&A and just -- and then we can go to relative value, because we've done about [ 8 ] acquisitions in the last 2.5, and Sirius was the largest. I think it's important to note that we're never out of the market. We're always looking. We're always talking with folks about opportunities. And for us, it's really capabilities led, whether it's practice area, whether it might be -- whether it's industry vertical. And it is about, is it speed to build, right, versus buy? And Focal Point is a great example of doubling down on our security practice, probably would have taken us a little longer. And Focal Point was a great organization, so we could double our security practice with that acquisition. So we're not out of the market, but we are really more focused on integrating Sirius and looking at the value of M&A versus the relative value of returning to shareholders through buybacks.

Yes. Look, Shannon, our capital priority is an important part of our overall strategy, and it starts with cash flow. So we've had a great year in terms of free cash flow generation, right, driven by a lot of our growth in profitability. And we've given our guidance for the end of the year. We are expecting we'd be around 5% of net sales. So we're on a good path in that regard. Our capital priorities haven't changed in 2022 that we're approaching the end of the year and to your point, that targeted net leverage ratio that we were striving to get to. So just a reminder, capital priorities, dividend and growing our dividend, consistent with non-GAAP net income. So we just increased our dividend 18%, again, 25% of non-GAAP net income. Number two, staying within that targeted net leverage range. We've gone from 3.4 at the end of the year, times, to 2.7. So we've followed through on our commitments in delevering, if you will, and expect we're going to be right where we need to be by the end of the year. And then when we get there, we expect we'll open up the aperture back to M&A and share repurchases. So we're firmly on that path.

And this is a sort of -- I don't know, it's a question I've gotten from a few people recently, and I've tried to explain it, so maybe you can explain it better. What are the things that's unique, I think, to CDW is that you have a customer base, they have a budget, and you somehow get them to spend their budget every year, and they trust you and you leave them in the right direction, and it just seems to work? Like I don't really hear of, "Oh, I didn't want to buy this, so I bought that" or when you couldn't buy PCs, like I don't know if Dell wasn't available and HP was, your salespeople were able to sort of get people to trust that the PC would work either one. And I guess, how has that -- how do you build that level of trust with your customers? Because you do -- you bring on new salespeople. I know a lot of them stayed for a long time once they get their book of business. But it seems as if CDW has a unique relationship with customers that a lot of other companies in this space, from a distribution or just even the OEMs, aren't able to develop.

Yes. Well, I'd say, it's certainly how we train our sales organization and our technical sellers as well, and it's about a relation -- it's about relationship selling, not transaction selling. That's just not how we think about it. It's about success over the long term. And there are lots of role models at CDW. So the newer hires can see what success looks like when people have built books of business and the kind of trust. I was just at one of our conferences on the healthcare side and talked with 3 different customers, who said to me, when the going gets rougher, I get -- I have a tough question, I call, Imran. Imran's our guy. It's not their guy. It's our guy. And it is because they trust our judgment. They trust our intent and they trust our expertise, and we believe in that. It's not just the words. It means honestly, during 2020, during 2008 and 2009, we stuck with our customers. And I learned this early. In 2009, '10, coming out of that recession, customers would say you were the only one calling on me. Everybody disappeared because we weren't buying. The same thing with COVID, people were needing things, but it's the same thing when there's -- small business was hurting in 2020, we stuck with them. That is how you build relationships over the long term, and we just build our sellers to do that. And that's the kind of people they are.

No, it's unique, definitely. So I guess just in the time we have left, how -- CDW has been such a consistent company. Earnings beat for the most part. You put out numbers, you get there, you grow, you expand, I don't know. It's just been one of these companies that people feel very comfortable investing in. How do you see the next 5 years? Like where do you want -- I know it's tough because you wouldn't have said pandemic a couple of years ago, but -- or if you did, you should have just gone to Vegas -- is still like in a company. But what do you see CDW evolving? Or will it change much? Will it just continue to sort of stay on the same track and keep growing the way you are?

I think if you look at who we are today, that's the picture to have in one's mind. Services-led, full stack, full life cycle, outcomes-oriented, technology integrator. I mean, I don't have a great term anymore. Value-added reseller doesn't seem appropriate anymore. I mean I'm looking at your picture here, actually, which is behind us. That's what we do. That's a depiction of connecting the world through technology, so that the world works. That's what we do. And we are now services led. So everything that we touch is going to have a component of services, and that drives value, whether it's advising to design and build, whether it is creating a kit that a student can take out of the box and everything just works, whether it is building designing and then ultimately managing a secure environment for our customers. It's the full life cycle, it's end to end. And we're adding -- I guess, the one thing to think about is we're adding more digitally-oriented interaction with our customers and digitally-driven agile organizations. When we talk about digital transformation, we're automating at CDW. We are implementing tools for our sellers, for our backbone, for every part of the organization to drive both efficiency as well as effectiveness using recommendation engines and things like that. So we will look like we look today, a heavier mix into services and software as we've been moving, whatever the new hardware is that makes its way to the market, but with a little bit -- with a more digital forward interface, complementary to the salesperson. I don't -- the human relationship and technology sales is not going away. It matters too much, but the ease that's expected and the way that you can bring value through digital technologies and products, has changed enormously. And we're changing with that.

Great. Well, thank you so much for your time. Thank you, everyone, for joining us. And we look forward to watching you along your journey.

Great. Thank you. Thanks, Shannon.

Thank you.

Thank you.