CDW Corporation (CDW) Earnings Call Transcript & Summary

Okay. As everybody gets situated, I just want to quickly introduce myself. I'm Adam Tindle, and this is part of my technology supply chain coverage here at Raymond James. Very happy to have the team from CDW. I think a lot of you in this room are familiar with the company. We are going to do an overview because there's been a lot of changes over the years. Big success story. Al Morales, CFO, is here. We also have Steve O'Brien from IR. The format is going to be a formal presentation here. But if you do have questions, please raise your hand, and we'd like to keep it interactive. Of course, we will have a separate breakout session downstairs immediately following this. So with that, Al?

Thank you, Adam. -- indeed ask questions because otherwise Adam's going to ask questions. So -- all right. We'll get started. So just a little bit of housekeeping before I begin. Please see our safe harbor statement. I'll be making forward-looking statements referencing non-GAAP metrics. Please use our SEC filings. Okay. So we're going to start here on Slide 3 with a brief overview of CDW. So CDW is a market-leading provider to business, government, education, health care customers. We have approximately 15,000 coworkers, 2/3 of them are customer facing, both sellers and technical specialists. Our purpose is to make technology work that people do great things. And this reflects our culture and our unique value proposition, which I'll get into between our customers and our partners. We've thrived for 40 years under 2 simple principles. The customers at the center of everything we do and happy customers make -- happy coworkers, make happy customers. Being close to the customer is about evolving with them and anticipating their needs. We are their trusted adviser, bringing breadth, depth, expertise and scale to business-enhancing outcomes across the full technology stack and life cycle. We have 100,000 products and more than 1,000 brands. And our sweet spot has been for customers that have less than 5,000 employees. I'll just say that's beginning to inch up a bit from there, I should note. We also do quite well with large enterprise customers, especially in the public segment as well as with our Sirius acquisition, which operates more in the enterprise space. And if you look at customers today, on average, they've been with us for more than 12 years. So pretty significant tenure of our customers. All in, we have an attractive model, consistent track record of achieved above-market profitable growth and superior returns. And my goal for today really to kind of share and unpack some of the elements of our history and how we got here, but also where we're going and how we strive to deliver and position ourselves for growth in the future. Okay. On this slide here, really just depicting the large and growing technology market that we operate in, U.S., U.K. and Canada, the absolute IT market in size is about $1.3 trillion. And we have scaled physical presences around the world. We operate in more than 150 countries. We also do a lot of work to define our market so that we don't waste time determining what we need to go after. Obviously, that 1.3% is kind of the broader IT market. We would conservatively estimate our addressable market to be about $440 billion as of 2023. According to IDC, the -- that market is growing at a 4.2% CAGR from 2018 through 2023. And we have consistently outgrown that market size by 200 to 300 basis points over time. So it is important to understand the composition of the marketplace. Not only is the market large and growing, but it also is highly fragmented with thousands and thousands of value-added resellers. So we literally compete against those 1,000 of value-added resellers and managed service providers. That being said, the highly fragmented marketplace gives us the opportunity to show our competitive advantages and outperform in the market. So there's plenty of room for growth, both from an IT market perspective as well as with our goal and intention and track record of outperforming the market. Okay. CDW has a 3-part strategy for growth. Number one, [ cash or ] share and acquire new customers; #2, enhance our capabilities in high-growth solution areas. And #3, and expand our services capabilities to serve our customers. And each of those pillars is really crucial to our ability to profitably grow and to provide integrated technology solutions that our customers want today and in the future. Our ongoing success in executing the strategy led to our market share growth. Now as you can see on the right side of the chart here, we serve a market that's consistently grown faster than the U.S. economy, and we've grown beyond that. So [indiscernible] remains a critical driver of outcomes, whether growth comes from consumption-based spending, that is as a service solutions, but net down or from hardware sales. We remain positioned to continue our track record of profitably outpacing the IT market by 200 to 300 basis points. So what allows us to execute on this strategy and drive this growth, I would say more than anything is our customer balance and our end market balance. So as you can see on the slide, we have 5 customer channels, each with annualized sales of $1.6 billion or more, plus our international business, which represents Canada and the U.K. together, Canada and U.K. $2.6 billion. Each of these channels, again, is meaningful in size and scale enables us to anticipate customer needs and develop customized solutions suitable for our customers around the globe. And that scale enables us to further align sales teams into vertical customer end markets, including federal government, state and local government, K-12 and education. These unique sales organizations serve us well when end markets behave differently from each other, providing diversification. Sometimes that occurs because markets are disrupted by macro events other external factors. And as you can see on the right box, the balance and resiliency of our business model has played out against those macro factors over time, including through the pandemic. So how do we consistently grow share? I talk about customers and partners. One part of that formula is that unique position we have in the IT ecosystem and our value prop to both partners and customers on this slide. So for our customers, we have large and established customer channels with over 250,000 customers overall. We provide a cost-efficient go-to-market vehicle for our partners. We have the expertise to implement OEM solutions consistent with the experience that those partners would expect for their own customers. And we provide clear roadmaps and extension of the sales and marketing teams of those partners, along with technical capabilities and our vertical go-to-market segmentation. So for our customers, what do we provide? We have breadth of products. We're unbiased on technology, brand or consumption model or an extension of their own IT resources, and we advise, design, orchestrate and manage for our customers. We provide organizational benefits across innovation, cost management, agility, risk mitigation and enhanced experiences for our customers. So all of this results in a virtuous cycle. The more important we are to our vendor partners, the more access we get to their new technology and vendor resources, and then we could add more value to our customers and so on. This is the value proposition that has been enduring for CDW and growing for over 35 years. I call this an eye chart, but it's more than that. This slide can be viewed as the customer win [indiscernible] in which CDW can provide solutions to fit the needs of our customers across all industry verticals. Technology is more essential than ever before, and it's an essential part of a customer's ability to operate, compete, win and grow. Our customers' technology experience are complex and interconnected. Customers use infrastructure, cloud, security and applications all together in unison. And our sweet spot of customers have limited IT resources, including bringing staff and capabilities. They turn to CDW as a trusted adviser to help navigate the whole of the IT ecosystem to drive better outcomes. Further customers turn to CDW because we know their business. We have context. We understand their industry, we understand their IT environments. We have the technical capabilities to serve them, and we offer unbiased advice. We are agnostic across vendor partner, technology or consumption model and build customer trust by focusing only on the best solution to deliver the best outcome. Our extensive portfolio of partners and offerings is critical to our success, to ensure we're providing the right solution to customers no matter how they want to consume it. And to that end, we add 50 to 75 partners per year, reflective on our focus on continuing to build our capabilities.

So AWS is out there a [indiscernible] couple of years ago, a lot of [indiscernible] asked a question about AWS' value proposition as a vendor like an AWS. Maybe if you can just talk about your experience, not specifically, but cloud vendors [indiscernible] those versus the traditional partner vendor that [indiscernible].

Sure. First, Adam, I would just go back to the -- look, our sweet spot is understanding and knowing the full estate of our customers. Cloud is just one aspect of that and obviously an important aspect. So from a customer lens perspective, the most critical thing is we're helping them to navigate kind of what's the place for cloud, how should they go to cloud and to what extent do they want to use cloud, including what workloads they want to send to the cloud. The hyperscalers know our position in significance in the channel in that regard, bringing our vast population of customers, but also understanding of their estates. And so our linkage and our partnership with the cloud partners becoming more and more prevalent in that regard. I would also just note, Adam, that obviously getting the cloud is in a singular motion, right? There are many aspects around that. And the hyperscalers look to players like CDW to help to provide the services that will enable a better experience for the customers that will ultimately get to cloud. And that includes kind of having the proper tooling, the right analytics to be able to determine kind of workload optimization and other factors to really make sure that their spend is being used most wisely. I told you he was going to ask questions if you guys didn't. Okay. Feel free to stop me at any time. I will keep going.

[indiscernible] how will you do that? What [indiscernible] of that moving forward?

Yes. Let me repeat the question. Last year, our top line contracted significantly, but you were able to maintain your bottom line and your EBIT as well as your margins. So what transpired last year was a pretty significant mix shift in business, less in the way of hardware spend, more things like cloud and SaaS kind of consumption-oriented spend. Those latter items are what we call netted down revenues. They come at 100% gross margin, just given the nature of that business. And therefore, they mute our top line, but they fully show up in our gross profit. They also have been the effect of bolstering our gross margins because they're 100% gross margin items. So the bottom line of that is the top line was more muted during the year. Our gross margin was still normalized. Our gross -- sorry, our gross profit was more normalized. Our gross margins were higher. And then looking at tough environment like this, we're focused on protecting profits, protecting margin, protecting cash flow. And so that's how we're able to deliver the bottom line. Other questions for now?

Just going forward, does it go back or you or are on a different trajectory?

That's a great question. At least for '24, I would say, our outlook presumes that this mix shift that we've seen is going to prevail, that is cloud SaaS, if you will. And so therefore, we would expect more muted top line and persistence of our margins. There will come a time, and we believe later in '24 is likely the inflection point where we think hardware will begin to recover. We'll call that a modest recovery in 2024. And at that point, you'd start to see maybe a bit of a shift where the top line is stronger, margins were somewhat diluted and then we'd continue to protect the bottom line. Again, you won't see that fully in '24, but maybe thereafter.

[indiscernible].

I think I got the question. I think I'll just say the essence of it was the how's Gen AI affecting our business and maybe the ecosystem of our partners, and how we think about them? Is that fair? Okay. Gen AI, I would say, formative stages, but burgeoning many, many conversations. I'm sure all of you would share that. There isn't a conversation where AI doesn't come into play, and that is the case with our customers as well. I would put it in 3 buckets right now on the AI front, #1, kind of the easy package stuff like Microsoft CoPilot, many, many conversations on that, lots of interest in that as a formative step for customers to think about how they would use AI and how they deploy it with their employees, that's #1 [indiscernible] packaged, if you will. Number two is, I'll put it in the vein of consulting many, many conversations, workshops, discussions around use cases of AI with our customers and then not many interactions without talking about the use cases that they're thinking about and how we can help them with them. And #3 would be the actual deployment execution of AI which is where some of the hardware components would come in. We don't have those situations. They are, I would say, still formative, but growing. We had a good example in our earnings call where we talked about a semiconductor company that had already launched their own LLM, and we're looking to stand it up and deploy it on premises with all of their own hardware so they could scale it most efficiently and effectively. And so we're certainly seeing those examples. I'd call it the more sophisticated buyers that are in that space now. But we would expect that as time goes by and we continue to kind of evolve through this phase of AI that we'll see more and more of that, and I think it would make its way through our customer base. So that's where I would say we are at this point.

[indiscernible] so far?

It's strong. I mean, a lot of discussions and a lot of activity, I would say, it's moving on maybe a bit quicker than I would have expected. Anyone that's tried it here, I'd say it's a great first step in terms of easing your way into AI, and I think it will condition employees, and we can say for ourself at CDW doing the same, will condition employees in terms of kind of what is AI? How does it work and how could it help me do my job more effectively?

[indiscernible].

Yes. That's a great question. I do think it will definitely have a place and will be prevalent in the PC world. That is evolving. And obviously, we're even early stages there in terms of starting to see flavors of AI PCs. So we may be a bit off before we see that kind of full-fledged or really showing up in a meaningful way. I'll just say that notwithstanding AI, I think PC refresh is definitely coming on the forefront of conversations with customers. I would not say that it's taking off or growing at this point. But all of the data points would suggest that over the next year plus, you will begin to see PC refresh activity and part of our expectation for modest recovery of hardware would include PCs. We're nearer zone for CDW where PCs will be growing, but that's more of a reflection of the compares than the actual sequential growth, if you will. But if you think about the Win 11 currents, the installed user base on Win 10, all of the feature functionality in Win 11 that is there, particularly on the security front and otherwise. And then just the amount or the device per user kind of metrics across our population. All of that would suggest that a refresh is in the future. It's not a matter of if, it's a matter of when.

How about relative to the sizing of the customer? Are you seeing more enterprise right now and then the smaller business? Like are they struggling at all? Do they be kind of device in the malls and wait?

So first, probably our strongest, most resilient segment has been our public sector over the last year, no surprise. Commercial business has been sluggish. And I'd say both our enterprise customers and small, both have been kind of just bouncing along. Small, really kind of just bouncing towards the bottom, if you will. Enterprise starting to see some indications. We talked about this on the earnings call of at least conversations of what they would be thinking about, albeit that activity hasn't yet happened. But it's conceivable as we think about recovery that you could start to see it there before you see it more in small. Obviously, small heavily impacted by interest rates, inflation and so forth. So there is just an element here where the lifting of uncertainty on the interest rates and inflation front will hopefully turn the tides.

You're like 10 slides in 5 minutes.

I can [indiscernible] fast. Is it 5 minutes yet? Is that right? Okay. Just a couple of highlights here. Look, we have really transformed from a technology products reseller into a full stack integrated technology solutions provider. We are focused on customer-centric outcomes. Everything we do starts with listening to our customers, understanding for validation and then ensuring that the solutions we come back with our customers really help them to achieve their goals. It is a perpetual cycle and we are in it with our partner every step of the way. Really, when you think about our competitive advantage beyond kind of this full stack approach, our size, scale and investment in capabilities which sets us apart, and we believe there's no competitor that really can do the same. I'm going to keep moving. Let me just talk a little bit about M&A. So we continue executing, it's our strategy on M&A. And M&A has been an important part of our capital allocation strategy over time, intended to not only achieve our financial goals, but achieve our strategic goals. With 10 acquisitions since 2019, we've deepened and advanced our services capability, and that includes in things like automation, cloud native and DevOps and cybersecurity, all things that in the market have continued to evolve and become more complicated. Each of these acquisitions has done the job for us in terms of checking the boxes on our 3-part strategy. And beyond just checking the boxes, we really do believe we're providing capabilities to our customers that are very meaningful. To support our full stack solutions for outcomes, we've evolved how we serve our customers. What you see on the page here is composition of our coworkers. So today, our solutions are sold by highly skilled specialists and advanced service delivery engineers. We now have 6,500 coworkers in our global technical organization and that's beyond our sellers. So with our sellers more than 2/3 of our coworkers are customer-facing. And our sellers and our technical specialists are paid on gross profit. So we talked about drivers of growth and how we think about that. One of our secret sauce is uber focus on gross profit, make sure that our coworkers are incented to do the same. Another way of serving our customers in internationally strategic rationale is to follow our customers. We've done several acquisitions, including our Kelway acquisition in 2015, and our Scalar acquisition in Canada in February of '19. We recently established presence in the Netherlands, and we operate in 150 countries. I'm going to jump to the numbers. Okay. Our target is to deliver a market profitable growth. We've consistently hit this objective. We grew our top line from 2014 to '23 at a CAGR of 7%, and our revenues are now $21.4 billion. Over that same period, our gross profit at a CAGR of 10% and if you move down the line, our CAGR on non-GAAP net income was 14%. So you can see we're focused on operating leverage down the P&L. Just as important, as driving results through our P&L is managing our balance sheet and our working capital and getting strong returns. Working capital is definitely the biggest investment on our balance sheet. And we've got a super focus on managing our working capital effectively. You can see our strong return on working capital over time, including the last several years. And let me just spend a minute on capital allocation. For those that are not as familiar, we've got 4 capital allocation priorities. Number one, to grow our dividend in line with non-GAAP net income and that 25% of that non-GAAP net income, so you can see that's grown over time. Number 2 is to manage our capital structure. We manage within a range of 2x to 3x. Net leverage, we're currently at 2.4x. And then third and fourth, M&A and share repurchases, important drivers of shareholder return. We target for 2024 to return to shareholders, 50% to 75% of our free cash flow in the form of dividends and share repurchases and an M&A, obviously, an important strategic capability and lever for us and as I indicated in terms of the history. And I know Adam is going to pull the plug here. So I'm going to jump to the conclusion. In closing, just would reiterate CDW's compelling investment opportunity to our investors predicated on the attractive market that we operate in, our market-leading capabilities and ability to capitalize on important IT trends, our unique culture and value proposition between customer and partners and our strong track record of creating significant shareholder value. And with that, have a great afternoon.

Well done. We'll continue the discussion downstairs right now. Thanks, Al.