CDW Corporation (CDW) Earnings Call Transcript & Summary

Hello. I'm Samik Chatterjee, I cover hardware companies at JPMorgan. For the next session here, we have CDW, and we have the owner of hosting Chris Leahy, who is the Chairman, President and CEO of the company. Chris, thanks for taking the time. Steve, thanks for being here as well.

Chris, what -- we're generally starting by asking most companies, at least the ones we cover, are sort of 3 base start-up questions. And the first one really is about the macro because that's a big sort of backdrop of this conference. As you think through or look at the remainder of the year, what do you see as the biggest macro risk for your business?

Yes. Well, we're happy to be here. Thank you for having us. And just to dive right in on the macro risks, I think, look, we're watching all the wildcards out there, and they include things like the debt ceiling and liquidity issues and you could tick through interest rates and inflation, and there's just been a lot that's been happening over the last 8 months. And we'll keep an eye on all that. What I would say is our view of the back half of the year is really tied to what we're seeing in the market and our conversations with our customers. So when you've got 11,000 coworkers who are with customers every day, that's a pretty good signal back into the organization as to how our customers are responding to the macro conditions. And I would say if you look at our outlook, that reflects both what we're feeling and seeing from customers along with kind of the environment that I started talking about. And so Q2, we perceive is pretty much looking like Q1, feeling like Q1 with customers, particularly those large customers still in the pause and defer and maintain cost control mode. And then expecting an uptick in the back of the half of the year, moderate uptick, at least that's what we're expecting right now. And then for our own performance, we've got some seasonality kicking in, which will help us in the second, third and fourth quarter and easier compared frankly in the back half of the year. But the macro is what everyone is looking at. And until it shakes out, at least a few things shake out in a way that feels more confident for our businesses, I think we've got a couple more months of uncertainty.

Okay. One of the other things that I've been asking companies about is we're seeing a lot of headwinds across the board, but some of them seem to be just to inventory sort of related headwind in certain product areas versus a demand, real demand issue. When you sort of look across your business, are there any sort of deviations there in terms of which one of those are just inventory-related that could be more short-lived than others?

Yes. It's a really good question. It's something that we've been trying to sort through over the years because as you all know, starting back in 2020 in the pandemic and even through last year, inventory depletions really created a pull forward of demand, if you will. So there was this get in line because we knew we were going to need it, and we saw that across the board from client endpoint devices all the way into the data center. And that pull forward when it comes to PCs, client devices, that's now kind of equalized. The supply deficit or the backlog overage has now evened out, and I would say we're kind of at a PC normal status, if you will. There are a couple of pockets where we still have some backlog is really around NetComm, right? And again, I would say that some of that was pulled forward. But equally, we've been seeing NetComm performed well. So I don't have a quantification for you, but just to say that we did see a pull forward of demand. It's feathered out over time, mostly, and I think we're at a normal junction here to see real demand increase.

Okay. Okay. The third one really what we wanted to get everyone's thoughts on is how is AI going to impact their business? What are sort of the disruptions that you see? What are the opportunities that you see at the same time?

Yes. Look, I think generative AI is really exciting. And someone asked me recently whether I thought it was overhyped or under-hyped and I said both because I think that it's just moving very quickly, and there's just a lot of things people believe it can advance. There's fear out there around how to manage it, I would say, and derisk it and debias it. At the same time, we're going to try use cases and refine them and try again, we're not going to get it right away. What I would say the opportunity for us and for our customers, if I were just to start with CDW and our own operating model, we have already been working on use cases around sales enablement, marketing and sales enablement, our own contact center, as you can imagine, areas of efficiency and streamlining and intelligence, so recommendation engine. And we are moving quickly. The terminology at CDW is speed to sandbox, build a sandbox. We've got private instances of Azure. And let's get in there and play and figure it out and apply it as quickly as possible. For our customers, I mean, look, it's across the board. First of all, the -- when you think about the value chain, you start at the bottom, the compute capability that's needed, the infrastructure is enormous, right, to train those large models, et cetera. So that plays right into CDW's one of our sweet spots, which is the ability to provide the hardware, software, infrastructure generally that goes along with that. But then move up the value chain and whether it's the training the models, whether it's the applications, whether it's the advisory services with our full-stack solution approach and end-to-end capabilities. We feel really good in already advising customers around use cases for them. So consulting with customers particularly in, specific to industry. So our verticalization, as you know, is a big -- as a large company, we are verticalized by industry, and in some cases, geo, but a great example would be health care is a $2.5 billion business. So finding use cases specific to health care, we are advising customers around things like that. The other thing I would just add, and it's important not to forget is one of CDW's main muscles is bringing on new technologies and bringing in new partners. I mean that's what we do. We have a large product partner team that has, over the years, brought in. Converged infrastructure is new. We bring in all those new partners, you can just kind of pick your technical area. I see generative AI and AI generally, as one of those areas. And I think we're going to see a number of partners, new partners emerge, advisory partners, maybe highly verticalized that CDW will be able to bring on to our and into our network and move the needle for them, but also fill and round out our capabilities for our customers. It's pretty exciting.

Moving to some of the more company-specific questions, and I think this goes back to what you're seeing from your customers, what you're hearing from them. Can you just discuss some of the changes that you're seeing in their appetite to spend in the recent months? Particularly as you said, when you're talking to customers, there's the expectation of a sort of pickup in the back half or towards the end of the year, what's driving that sort of expectation from your conversations with them?

Yes. Well, I would say, just starting now with the appetite right now, we're feeling the same thing that I mentioned before, which is just deferring on larger projects, and we feel the knock-on effects to that. It's not just hardware, it's full stack, hardware, software, the services used to implement. And reducing discretionary spend wherever possible. I mean that just continues to feel pretty steady Eddie. All that said, the conversations we are having with our customers are all around the importance of technology. And I think we all -- it's almost like you say it anymore, but technology is essential to any organization, achieving its strategy, achieving its mission, being competitive. There's just no way around it. And so the conversations are more planning. How do we come out of this and accelerate out of the curve? We might not be writing the check right now, but the really beneficial thing for our customers and CDW is we're in there having the conversations bringing our best engineers to bear to help design, possibly redesign in some circumstances and be ready for when our customers are ready to spend. Frankly, we've never had more robust conversations, and we see this as a way to double down on the trust. And we've been here before, in tough times, 2008 and '09, the pandemic. One thing I think is really unique about our sales organization is the effort that is put into sticking with customers and helping them through times when they're not actually spending and the appreciation that comes on the other side because of that.

Okay. And maybe just take another step deeper there in terms of either the size of the customers, large versus SMBs or even if you were to go at it by vertical financials versus others. Like are their certain sizes that stand out in terms of seeing more of that pull back or verticals that stand out more? I mean particularly given some of the headwinds on the banking side, is that segment of the market that's pulled back more recently?

Yes. That's an interesting point. And let me start with -- the first quarter really the uncertainty intensified dramatically right around the banking crisis time. We just -- it was really a moment that seemed to have a number of our customers pull back. Now I would say that was a broad-based impact, not just large and small, et cetera, but across the board. All that said, in terms of who's got a playbook, big companies know how to pause, defer, right, and reduce spend. And so we saw it more dramatically in our large commercial customers, and that makes up over 40% of our business, large commercial customers. So that's a large portion of the business. Small businesses saw a similar. However, they don't have the talent to maintain things that are critical to the business. So cybersecurity is an example and cloud support was very, very strong. So the high-value solutions and services are small businesses, we're still -- using us more extensively, notwithstanding the client devices. We're not doing great. In the -- you asked a question about financial industries, I would say, look, we have a vertical, a subvertical in our commercial space. and we serve financial services. They performed relatively well in the first quarter. And in large part, I think, because it's the same model as our entire organization, which is about balance, right? So we have a balanced portfolio of products, a balanced portfolio of customer end markets. And when you look at the financial services market, our team, we have a balance of customers there. So we've got banks, we've got investment companies. We've got hedge funds. We've got -- it's a balance of high-frequency trading organizations who are buying. So it's a balance of customers. And as a result, we saw good results.

Okay. Okay. Maybe just going into product areas, a bit more client devices, as you mentioned, has been quite low in terms of customer investment priority at this point. We have seen a dramatic drop-off in the volumes on that side. How are you thinking about that demand recovering? Any more color from your customers about what a typical replacement cycle is? When do they start sort of getting to the point where they have to again sort of come back and replace those devices?

Yes. I would say we're in a cycle now where we've got, again, a very large -- larger than it was pre-pandemic, large client device installed base out there that are not just aging, they've aged already. So we're talking 4 to 5 years old. So what we're seeing and hearing, and I think just a fact given the length of time these have been out there is a likely refresh cycle picking up very soon. And then you add Win 11 and end of life coming up in October of 2025, there's a pressure point now to get that done. There are a number of devices that cannot operate with Win 11. So you have a large number of devices that either are going to operate on an old device -- with an old operating system, which won't operate very well or have to actually buy a new device. So we're going to see that come into play as well. The other thing is on even places like K-12, where they are still ingesting many of their devices, you'll remember, they got to almost one-to-one, we went from about 50% to 100%, there's 95% on a one-to-one basis, one device per student. We are kind of back to seasonality with our K-12 segment, and we are seeing a lot of -- we're seeing large RFPs for new Chromebooks. Now those things, kids in the hands of kids break easily. But that's even starting in a refresh cycle now.

Okay. And maybe just a follow-up. I mean we've typically seen that being a revenue impact, not as much on profitability. Any color on how you've managed that business from a profitability standpoint over the years? Should we even think about that business being material to sort of how your earnings plays out through this down cycle on the client devices side?

On the client devices or just across the portfolio?

Client devices alone?

Yes. Well, as we think about the back half of the year, we do have an expectation that there is a mild recovery as I mentioned, and some of that would be client devices coming back, some hardware coming back. And as you know, from a gross margin perspective, when we have more softness in client devices and hardware generally, the client devices, in particular, when their software is there, that actually helps boost our margins, right, because of the mix. And when we are selling more in the high-growth strategic areas like services and software and cloud that we're focused on, much of that nets down so that has a boosting effect to our gross margin. What we're expecting, as we go through this year is a little bit of both. We still expect netted down revenue to be strong as we go into the back half of the year, the solutions that drive that. But because we are expecting some pickup in client devices, there's going to be some moderation on gross margin. But that said, and importantly, the way we run our business is really bottom line profitability. And so when you look at the outlook that we put out, our expectation is to be in about the 9% range because while we're doing all of this, we're also managing the business really prudently and making changes that are both discretionary, but some real structural changes to our cost structure.

Okay. Great. One of the things you mentioned on the -- I think this was the last earnings call that your transactional business has moderated more recently. One of the questions that I got from investors on that front is that largely a function of maybe some tailwinds that you had during the supply constraints where customers instead of going to the OEMs directly because of the supply constraints were just sort of directed towards coming towards CDW for that transactional business itself, and this was more a function of sort of demand elevated because of the supply constraints. Any thoughts around that? This is sort of a popular question that I got from investors on that remark around this business moderates...

Is the question did -- was there a shift from OEM direct to CDW?

Yes. During the supply constraint, particularly.

Yes. I don't -- I wouldn't say there was a shift. I would say that the -- I would -- I felt like customers acted very consistently with how I've seen them at over 20 years, which is using the channel for things like getting product configured ready to go out of the box on a very timely basis. So I don't -- I didn't see a shift from OEM to the channel. The value proposition that we bring to the table is this ability to get our cost -- know what our customers need and deliver it, fully configured, ready to go. Think about the pandemic, a home office in a box. It's ready to go, you take it out, you plug it in, you're ready to go. That's something that we can do and have always been able to do. I wouldn't suggest that our OEMs can't do that, but that's not something where they focus. So again, I don't think those things change the nature of the dynamics of OEM direct versus CDW.

Okay. Okay. On NetComm, you highlighted demand for NetComm is strong and you have a backlog on that front, although some of the OEMs that we cover Cisco and others are already starting to see pretty weak order trends on that front. How are you thinking about sustainability of that demand if the OEMs themselves are reporting quite weak order trends year-over-year?

Yes. Well, look, we're seeing -- we have a lot of customers who were unable to modernize networking capabilities and get into their offices, for example, go places and physically go upgrade. So we are seeing just robust demand for network upgrading. And there's an expectation, particularly in some of our segments, K-12 would be a great example, higher ed would be a great example where you basically are supported very distributed uses of endpoint devices and it's tied to competitive advantage. We haven't seen a diminution in the excitement. Now do we expect it to be growing as much as the last couple of quarters? Maybe not, but it's still part of the solution discussion we're having in a big way.

Okay. Let me open it up here and see if anyone has a question. Any questions?