CDW Corporation (CDW) Earnings Call Transcript & Summary

I'll kick us off. So thanks again, everyone, for joining. I'm David Vogt, the UBS enterprise hardware and networking analyst here. And we're excited to have with us CDW Corp. today. And with us from the management team is Chris Leahy, Chairman and Chief Executive Officer; and Albert Miralles, SVP, Chief Financial Officer. Bear with me, I'm going to read a quick disclosure from UBS perspective. There are important disclosures pertaining to our discussion today and any conversations that we have about any particular company or stock. Please see the UBS research website at www.ubs.com/disclosures. I'll turn it over to Chris for a quick 30-second disclosure if she needs one.

Anything we say today is as of Q3.

Great. So with that out of the way, thank you, everyone, for joining. So Chris, Albert, thank you for joining. I think heading into this event, what we got from questions from investors, we kind of queried them. And I thought it would be a good place to start with, at a high level. I think you'll be at CDW almost 6-years -- 6-years coming in January, if I'm not mistaken. How has the business changed strategically under your tenure over the last couple of years? And kind of how do you see the next couple of years kind of evolving going forward?

Well, let me -- I'm going to zoom way out and kind of come back, if that's okay. So I've been at CDW 20-years and in this role for 6, yes. And the business has been around for just about 40, a little over 40-years. And so I think the way I think about CDW is the way that we do, which is change in continuity. Okay? It's a pretty simple but not easy formula, knowing what to keep with essence of your secret sauce and what to change to evolve to stay in front of our customers. But I think we've done that incredibly well. So when I think about what stayed the same, what's fundamental, our customer obsession, focus -- customer obsession, focus on the customer in every decision we make. Our value proposition hasn't changed at its core. It's about maximizing return on investment for technology dollars. Our culture and values has not changed. It's just amplified and gotten stronger. It's highly competitive, it's highly collaborative. It's highly caring. Our discipline in investment and in execution hasn't changed. Our investment in people and relationships, all of that has not changed. What has changed over the years is what it takes to deliver on that value proposition. The IT landscape, as we all know, is vast and dynamic and it has an immense amount of complexity, whether you're choosing a technology, a type of technology, a brand, a consumption model, an economic model. It is getting more and more complex. And at the same time, it is getting more and more important to competitive advantage, to delivering on outcomes, goals and missions. In addition, what it takes to deliver on those outcomes requires much more than it ever has. So what CDW has done -- and if you look under the hood, we're a different CDW now than we were just 5-years ago. We have invested behind services. Services to advise, consult and manage across emerging technologies as well as legacy technologies, with a real emphasis on growing our cloud capabilities and digital capabilities. We have invested and embraced digital from an experience perspective, enablement perspective and product perspective to drive enablement of our sales organization, frictionless experiences with our customers and products that are sticky with our customers and keep them coming back to CDW. We have refined our go-to-market. Our go-to-market is always something that we're refining to really continue to get the best out of our scale and our One CDW mindset while also leveraging the uniqueness of our vertical markets. Our scale allows us to verticalize, and we continue to use that to great success across all of the end markets that we serve. So I guess what I would say is we've come a long way from a product reseller by staying true to our customer focus, by understanding the evolution and being where our customers need us to be as a trusted adviser is where we need to invest. And we've done that over 20-years. The difference in the last 5 highly service-focused, highly solutions-focused and what we've achieved is a full stack, full life cycle, full outcomes approach to our customers.

That's helpful. So how do you think about that evolution today and what it means for '24? Because you've done a great job. Solutions and services have been relatively strong in a relatively difficult macro environment. It helps you weather the storm, grow margin. So when we think about '24 and beyond, not into specific guidance or anything, but should we expect more of that type of solutions-oriented sort of focus, whether that's organically through tuck-in M&A? And how does that play as maybe some parts of the other parts of the business maybe come back that are more traditional product-oriented?

Yes, it's a great question. So I would say -- when I say full stack, I also mean from core to cloud to the edge, so it includes everything. You will continue to see us focus -- and I'd like to use the word accelerate. Where are we going to accelerate our efforts. Where are we going to focus our efforts and investment. And it will be around some themes. Services, continuing to bolster our services across high-growth, high relevance areas like security, like cloud, like digital, like AI, definitely investing there. Cloud will be a big part of our investment areas as well. Digital, I mentioned this before, continuing to invest in our own digitization, but helping our customers achieve experiences that are intelligent, connected, frictionless and helping to help them with their transformation. We're also working on our agile operations. When you think about the scale that we bring to bear, continuing to make sure that we get the most out of that scale through our own agility is something we're also equally focused on. So yes, you will continue to see us investing behind a high-growth, high relevant strategic areas, Solutions and Services. You'll see us continue to look at acquisitions to do that while we're also investing organically. And you'll see us continue to improve and refine our own operating model to make sure our flywheels, those muscles we have around things like digital experience, core, et cetera, we can do it better than anyone.

Does the pivot or the evolution to a more services- solution-based business with AI and digitization and some of the faster-growing end markets kind of change how you think about the business long term in terms of what you can accomplish in terms of growth and ultimately, profitability long term? Or should investors think about the business as -- obviously, the U.S. IT spending environment has a big impact on your business, presumably going forward as well. And the model as we know it today is kind of what the model looks like going forward with maybe some slight nuances around the edges.

Yes. I think there are 2 parts that I consider in this. I would say, number one, yes, the business is dependent on the IT market rate of growth in any given year. But our commitment is to outgrow the market. We will maintain that commitment. Equally, I think if you look back over the last 10-years and then 5-years, what you'll see is a kind of slow and consistent expansion of our gross margins and our operating margin, our NGOI margin. And that is absolutely intentional. The higher relevance, high-growth areas that customers are needing and in demand should continue to drive that march upward in our profit measures. And so we expect that to happen. We always say, look, depending on what the mix is. If it is more hardware-oriented in a particular year, like a client device refresh, right, that will mute the topline a bit, and that will drive the margins down a bit. So it's not going to be a straight up into the left, but it is going to be a march with a little bit of a kind of up and down, up and to the right.

And maybe just keeping it at a high level, we get a lot of questions from investors. When you think about the journey of your customers along these paths, whether it's enterprise, small, medium business, public sector, can you help us kind of understand where your verticals are relative to maybe where they are in their journey? Where do you see companies or industries maybe a little bit further along and where the opportunity is to maybe obviously hit the steeper part of the inflection curve, if you will?

Yes, it's very interesting because if you had asked me this question 3-years ago, I would have had a very different answer for the various segments in terms of something like cloud, okay? Healthcare is a great example. I would have said, 3-years ago, healthcare is still concerned about cloud-based because privacy is better. Not anymore. Embracing cloud understands the benefits, understands the costs, the economics of it and has conviction around the security that can be maintained. So if you look -- so just starting with something that is similar across, I would say, our enterprise, our small business, our public sector, healthcare, education, all of those segments are really kind of in similar stages of cloud adoption. They get it. They're figuring it out. They're trying to optimize it and use it to drive outcomes. It's kind of interesting. In terms of something like AI, I would say there are pockets in verticals, take financial services, for example, figuring it out fast for very obvious reasons. But I'd say across the rest of our commercial space, there is a lot of energy right now going into advisory and consulting services. Okay? Now we're aware, how do we adapt? Where do we adapt? Why do we adopt, who do we adopt with? What are the real use cases that are going to generate return? Remember, we're talking about scrutiny for a long time, scrutiny on return on investments. And the same holds true for AI. There was a flurry for about 6-months, right? Now customers are settling and saying, what's the return on investment that we're going to get out of this use case? They don't want to make decisions and end up having [indiscernible] to deal with.

So does that mean to your point about maybe increased scrutiny, we've had a challenging macro environment, deal terms, not just what you do but other technology vendors have talked about elongating sales cycles. Do you think AI would fall -- I think it sounds like you just said that, but AI falls under that umbrella as well in the sense that it's not going to be the proliferation of spending next year on AI, just because it's AI and it sounds particularly attractive in terms of what the use cases may be? Maybe the S part of the curve is maybe not as steep or we're not there yet in terms of customers' willingness to really spend aggressively on that part of the ecosystem?

Yes. I would say we are seeing customers be measured in making decisions around AI, with the goal of finding some golden use cases and some maybe smaller return use cases but finding them, testing them, refining them. And then an expectation that return will be faster, that they'll be able to light it up, but very measured right now in terms of what they can be.

And do you think that's because of the broader macro environment? Or maybe companies ran a little bit too fast, too quickly, too far, and the use cases haven't been borne out? I guess what we hear a lot from investors is how do I separate the macro backdrop versus adoption curves? And let's say, hypothetically, the macro improves modestly next year, does that kind of impact how you're thinking about this or customers are thinking or partners are thinking about this?

Yes, that's a really -- that's a fair point. So I would say, I think macro has been driving the business climate and performance. I would say that is the main reason. What is happening, like any other really revolutionary technology change, customers are digging into artificial intelligence and trying to figure out what is best. The good news for CDW is that plays into our strength. Okay? So when I look at the activity in our pipeline, I see a lot of activity around professional services, advisory services, consulting services that are literally geared towards artificial intelligence and use cases over a period of time now to figure it out. So I think that when the macro does start to recover, we're going to have a lot of customers that are prepared. They're not going to start like they're preparing now. And my expectation is that they'll be prepared to make some pretty interesting decisions around use of AI.

That's good. Great. And then maybe if we could just stick to sort of some of your comments that you've made historically given macro, given verticals. How do you think some of your verticals respond to an improvement in macro? Which -- maybe which sectors are more quickly able to turn on sort of the spending decisions, [indiscernible] effectively? Who's a little bit more deliberate, who's a little bit more thoughtful? I know your crystal ball is not perfect but if you had to take an educated guess in terms of where would you see a recovery first, do you think, based on maybe historical analog or how companies think about their spending decisions?

Yes. I mean if you just look historically, even back to -- take the Great Recession, that's probably more relevant than 2020, even. But the Great Recession, the first back in were the enterprise customers. So small business let us -- small business pulls up generally first. And then you've got the commercial customers, but then commercials lead out. So I would expect if history repeats itself for our commercial customers to be the ones who start to see recovery as the macro recovers first. Small businesses, they have been investing in technology. It's just been -- those areas that net down, those areas that are more consumption-based so that they're spending over periods of time, they're very invested in technology driving their competitive advantage. But again, they need to -- they generally lag the enterprise.

And presumably, small business is more impacted by the rate environment, right? So financing availability and rates. So as an outsider looking in, is it a reasonable indicator of what potential demand could look like, maybe change in underlying rate structure, GDP? Is it all of it? Like how do you think about what you're looking at besides your sales funnel and your conversations with your customers and your partners? How to think about -- I'm not asking you to call a turn, but just some of the signposts that maybe some people could look at externally to kind of judge, "Hey, we're moving in the right direction. Things are getting a little bit healthier as we move forward."

Yes, look, I would say stabilization is always a good thing, whether it's stabilization in inflation or interest rates or conflicts across the globe. When you get to a status of stabilization, that starts to feel good to corporations, that's usually a sign -- that's usually an environment where you start to get some more conviction and caution starts to reduce. So I can't call when that will happen, but those are the types of -- I mean, it's about getting stabilization.

Yes, I would just -- I would call this kind of an uncertainty sentiment that's driven a lot of the activities, so just greater clarity across the board, whether it's direct -- direction of rates kind of, are we finding a landing spot on inflation, some of the geopolitical risks abating. All those things, I think greater clarity will drive the greater conviction around buying.

Got it. Maybe on that note, maybe Albert can ask -- we also get a lot of questions on -- I know you guys have made public comments on your earnings, but any help in how -- I know it doesn't feel like Q4 from all of our customer conversations has changed dramatically over the last couple of months. Anything that you see out there on the horizon that's either stronger or softer or status quo, relative to what we've been seeing out there?

Yes. I'll just maybe tick through some of the channels. So coming into the third quarter, we had anticipated that we'd see a modest pickup in activity. And some of that was emanating from commercial sector indications that maybe budgets were loosening up. Lo and behold, it didn't quite play out that way, and the uncertainty persisted. So at this point, for the remainder of the year, we called for probably a lot of the same dynamics that we've experienced, and I would say, in the '24, if I just tick through some of the channels, we talked about small, small spend has been stable, but certainly low, kind of bouncing along the bottom. Enterprise, obviously softer, a bit of a fits and starts, and we've talked about kind of uneven demand that fits and starts indications that things might open up and then they would kind of tighten again and things would get pushed out or they shift to cost optimization. Public sector obviously has been resilient, and I would say largely has followed seasonal patterns, but that's been a resilient segment for us. And then lastly, international worsening. So we would say the international sector there, maybe a couple of quarters behind the U.S., and we'd expect that's going to persist into '24.

Got it, that's helpful. And I'll just remind everyone in the room, if you have a question, feel free to submit one. We'll get them up here and we'll take them. So maybe going back to the macro, and you mentioned international as maybe a couple of quarters behind. Obviously, it's not a big part of the business today, relatively speaking. When you think about maybe the different sort of dynamics that are going on in that market, is it as critical of a business or industry vertical -- or excuse me, geographic vertical as the rest of the business going forward? So what I'm trying to think through is the U.S. is -- North America has tended to be a little bit more resilient in IT spend as of late. So when you think about your priorities over the multiyear period, how important is international expansion for the business?

Well, I think of it this way, two things. First, the CDW U.K. has a track record of growth and success, we bought it. So it's growing within its own [ local ], which is -- yes. And the international component of that business has also been growing. When we bought it, it was about 10% outside of the U.K. Now it's closer to 30%. And so the value proposition that we were going after, which was to serve our multinational customers, has played out. The next question we ask ourselves is, is there another market that can drive the kind of growth -- organic growth, in-country growth that we've seen through Kelway and can also continue to help us service our multinational customers? It's a question that we ask ourselves. It could be very attractive. We look at that in conjunction against other opportunities within the U.S., for example, [ tuck-unders ] in some of those areas that I talked about. So whenever we're looking at growth opportunities where an acquisition is likely required to get that level of scale quick, yes, geographic is always part of the conversation.

So as a follow-up then, when you think about capital allocation priorities, whether it's here domestically or overseas, how do you see the market developing from the opportunity set? What I mean by that is, are there -- I would imagine your pipeline is healthy enough, but have valuations come back to a point where they're attractive? As we think -- because look, leverage is coming down. You've done a great job deleveraging the balance sheet following several transactions. And so we get asked questions all the time, leverage is going to get close to two turns again. So how do we think about what may be -- not specifically next quarter or the following quarter about where your priorities lie today? Maybe some of the metrics that you look at, some of the qualities of the businesses that you're looking at that sort of augment the CDW growth strategy today?

Yes. And we've used this before -- does it fit our strategy? Does it -- will it fit with us operationally? What's the financial return? And culturally, will it fit? And you've all heard us say before, culture is very important. And you've seen 10 successful acquisitions in 5-years. There's a reason for that, and picking companies where the culture fits. So we'll continue to assess based on our high-growth areas that we're focusing on building services, in particular. Tuck-in are large. We'll continue to look at international. And I would just say we do have a strong pipeline. We're always in the market. Has the market become more conducive to an acquisition now? I would say it's better now than it was 12-months ago. But we've got a lot of companies in the pipeline and feel very good about the opportunities we may have.

Got it. That's helpful. And so when you think about your vision for '24, '25, '26 long term, '27. How critical is M&A versus maybe other sources of -- or the uses of your cash flow in terms of -- you do have a buyback in place. Just trying to think through kind of like the priority structure, maybe if you can -- I don't rank, order is probably too strong a statement, but just maybe share with you your views on that.

I was going to start with the services and then I'll let Al respond as well. We think about investing back in the business as a priority. M&A to me is part of that. If we stack rate our priorities, M&A comes before shareholder repurchases, generally. So that's about driving the strategic advantage and winning position of the business. So I would just say that we will -- look, Services is fundamental to our value proposition, period. And so we will continue to find places to accelerate our growth in Services. If we can do that through organic build, great. Oftentimes, that requires, again, back to scale acquisitions.

Yes. I would just add, look, capital allocation, as you'd expect, is a balance of strategic and tactical. We always leave with the strategic in the long term, and how do we build out our capabilities and continue to kind of build our scale where we need it. And then the tactical is holding that constant, where is the best dollar deployed and we'll continue to pivot where we need to. You've seen that in '23, with respect to our share repurchases, paying down some debt, some M&A, pretty balanced. And we'll do the same. I would say on the M&A front, right, in terms of relative value, more opportunities, but to Chris's point, when we think about kind of the increase in cost of capital hasn't come down as much. We are persistently patient and opportunistic.

Can I just follow up on that? So obviously, your cost of capital, I would think, is significantly better or cheaper than maybe some of your competitors in the marketplace today, given your execution and your access to capital in the market. Is that a source of advantage going forward as you think about it today?

It is. But the economics still have to make sense, right? We start from a better square, we think, from multiple components as a buyer, but it has to add up for us.

Got it. And then maybe I know we've got a couple more minutes. We just got one question that talks about your categories. I know you're a little bit reluctant to talk about different sort of end markets, but any -- you talked about regionally, is there anything that maybe you can share with us on what you're seeing, either better, worse, unchanged? Seasonal, sub-seasonal, however you want to define it, up to you, going forward? There's a lot of public data out there. Some of the end markets have been a bit softer, some are coming back. Just anything that you can kind of share with us, if that's okay.

Yes. I think I shared some of the kind of puts and takes across the channels, right? We would expect Small continue to be softer and bouncing along the bottom. Public continue to be resilient. We do think that International is a few quarters behind. Across the product arena, obviously, we've not seen a return to PC. A lot of the strength has been some of the categories Chris talked about, cloud, SaaS, security. For those that are new as investors, a lot of those categories would fall into what we call netted down. And so what we've experienced from that is great growth outpacing our sales overall has the tendency to dampen our net sales but then bolster our gross margins because as we act as agent, we're effectively recording in net sales, the same as we record in gross profit. We think those trends are durable and will continue. At some point, we're going to see a pickup on hardware and particularly client, which will bolster the topline and we'll also likely balance out and dilute our gross margin a bit. We've obviously had benefits from gross margin during this trend towards netted down. At some point, you're going to see a balance in the portfolio.

Got it. And then maybe just another question that we got through e-mail is on margins. Without getting into the specifics, but obviously, mix matters, netted down versus product. You talked a little bit about it on your last conference call. Maybe if you can just kind of share your thoughts on what that might look like in '24 without getting to specifics? But again, to your point about puts and takes. So if the client endpoint, PC market comes back, obviously, that would put a little bit of pressure on gross margin, but Solutions have been strong, Service is strong. So that's kind of an offset. Just maybe kind of help frame that a little bit for, I think, some people that are newer to the story.

Yes. So again, I'll just say that those netted down revenues, SaaS, the biggest one in cloud-oriented software assurance, warranty solutions and anywhere where we're acting as agent. We do think there are durable themes, and even if as we see a mix back into the hardware and PC, we'd expect that those would persist. And so that obviously bolsters our gross margin. You would just see, all else equal, a return to PC cycle diluting our gross margins, but obviously bolstering growth on the topline.

Got it. So I think we like a minute left, Chris, maybe just want to leave it with you. Anything that you want that's pressing, you want investors to walk away from this conversation with in terms of how to think about CDW and kind of what your vision is for the business? And just, I think, because we get a lot of questions from newer investors since we picked up coverage. You've been very clear, at least with us what your vision is, but just anything you want to leave with the audience today? I'll leave the floor to you.

Yes, David. Well, I appreciate that. I think what I would -- I'd like to leave people with is CDW is more well positioned to win today than it's ever been for a number of reasons. It's the investments that we've made in full stack, full life cycle, full outcomes for our customers and what we bring to there in terms of the breadth and depth of our portfolio, the expertise that we bring, the execution, excellence that we bring every single day is resonating. It's an organization that is built on relationships with customers, and they are long and they are enduring and expanding. And the technology world is only getting more complex, massively complex, and we help our customers cut through that complexity in a way that they trust us. So I see CDW of the future is I can't live without a partner, and we're already seeing that right now. So more excited about the future, and I've been at CDW 20-years, more excited about the future of this business than I've ever been before.

Great. All right. Thank you, Chris, Albert, thank you for your time. Thank you, everyone.

Thank you very much.