CDW Corporation (CDW) Earnings Call Transcript & Summary

Okay. All right. My name is Asiya Merchant, I cover the tech hardware, tech supply chain, very pleased to have CDW here with us, Chris Leahy, who is the CEO; and Al Miralles, who is the CFO; as well as members of the IR team who are here in audience. This session is obviously for Citi clients only. CDW safe harbor statements can be found on their website. And with that, we'll just straight away jump into questions. Welcome.

Thank you, Asiya. Sorry, sorry for the delay.

Yes, no worries. I hope that the rest of the meetings are going well. All right, Chris, maybe if you can just talk about, the question that I get most from investors is how CDW works within the broader IT environment. You guys have typically outperformed the IT spending environment. How should we think about your competitive positioning and ability to continue to outgrow the market?

Yes. Well, thanks for the question. If we just zoom out, you started with a role in the IT market, the value position. And then it's pretty straightforward in terms of 2 constituencies, our customers and our partners. And for customers, we provide access to a broad portfolio of products and solutions and a broad portfolio of brands. We have deep expertise in the various technologies. We bring knowledge of the industries that they operate in. We have a massive logistics function, we bring a lot -- we're basically an extension of our -- the IT groups of our customers. On the partner side, it's all about access. There were basically an extension of their sales and marketing arm and it's access to our well-established and very large customer base. It's the verticalization that we bring to bear, that delivers efficiency and effectiveness for them. It is the feedback loop that we provide to our partners on what customers are needing, and it is essentially just our ability to move the needle for them, frankly, and we think of that as a virtuous cycle, one feeds the other and feeds the other. In terms of taking market share and positioning, I don't think there's anyone better positioned than CDW in this space to be bringing value to customers and taking share. And we have done this consistently over time. Our commitment has been and we've delivered against delivering 200 to 300 basis points above market growth over the long term. Now when we think about our confidence in that has to do with the scale of the business, there is nobody in our space that has the scale, the scope, the breadth, the depth that we bring to bear. Ancillary benefits of those things, include, as I mentioned before, verticalization. So in addition to all of those competitive advantages, the intimacy that we have with our customers is unparalleled in terms of understanding the health care landscape, for example, and the education landscape and the government landscape, we just understand very deeply from a business, industry and technology perspective, and that's really a trifecta in our space. So all of those competitive advantages position us incredibly well. The other thing I would say is what CDW has done for 40 years, incredibly well is a simple but not easy formula, it's about change and continuity, okay? Understanding what needs to remain the same and two things really simply customer at the center in everything we do, understanding that our coworkers are our superpower and investing behind our coworkers, our sales organization, our technologists but equally change. And what CDW has done incredibly well for 40 years is understand the technology landscape, the changes coming along, working with our partners to understand the timing of those changes and then evolving to be able to bring the technology, the value, the utility of that technology to our customers. And as the world has become and the technology landscape has become more interconnected, more complex, there's more choice across brand, technology, consumption, CDW's value has only grown. So if you go back, I want to say, 8 years and you looked at the complexion of our business in terms of coworkers. Our largest organization is our sales organization, best-in-class. We invest in training, enablement, best-in-class. Our largest organization now is our technical organization. Our presale solutions specialists and our delivery engineers. And so that is just, I think, a reflection of a testament to our ability to evolve with the landscape, stay ahead of where the world is going and maintain incredible relationships with, I'll call them traditional or legacy partners, I don't like that term. But the big players who have been around and evolving along with bringing in emerging players as things change. So I don't know anybody better positioned to continue to outperform the market and take share, and we will continue to make that commitment to do it.

All right. AI, obviously, top of mind. You guys have talked a lot about it on your earnings calls as well. But given the large amount of spending shifts that are happening towards AI, maybe away from general purpose, what does the AI opportunity really mean for CDW? Maybe if you can just spend some time framing what do you think about the AI opportunity? And where do you think CDW would have the most impact?

Yes. So I'd say 3 key things about AI right now: One, we're in the early innings; two, it is generating a massive number of conversations and some really rich engagements for us; and three, our opportunity, and I think additive value to the customer is our full stack for life cycle approach and capabilities. So if we start with early innings, there's been a frenzy around AI for a while. And now I think every customer is kind of now grounding in what are the use cases? What can really add value to my organization? What tangible return on investment can I show, right? So early innings. We certainly are seeing some growth in the front end of this technology revolution in terms of the cloud providers, for example, scaling up to be able to manage it. But for our customers, it's the front end. That's driving the conversations I talked about. I mean we are having -- we've had a number of customer events oversubscribed, and the question is, how can we help. And so from those -- we run those into workshops, which often turns into engagements around data because data is the starting place. AI is all about harvesting data for competitive advantage to deliver outcomes, to deliver on the mission. It's all about maximizing, extracting way more value-added data, but nobody's data is [ prepared ]. So we've turned those workshops into engagements primarily around data, call that like 101. And we're now moving towards 201, 301, 401, which is more specific proof of concepts and shaping them for our customers and then thinking about moving those forward at the very early stages of that, right? The other part of the engagement from a services perspective and advisory services perspective is stepping back and thinking about architectural road maps and rethinking them in the context of AI. And it's really important to think about it. It is not just an infrastructure conversation or an edge conversation. It's much more holistic at this point because AI, as our customers reflect on the impact it will have on their organizations, they have to think about it from the core to the cloud to the edge, not in silos. And now, I guess, would bring me to the last point, which is about our full staff position. AI is going to be embedded in every part of the stack. Again, edge, core, cloud or think about hardware, software solutions. It's going to be embedded everywhere. And I analogize to security to some extent because like security, we used to buy or sell antivirus software and hardware firewalls that weren't software defined. Now security is in every single component. It's part of the fabric of the entire state, that's what AI is going to be. It's going to be embedded everywhere. It's going to need to be integrated and optimized and then it's going to have to be used by humans. And so we see that as a really great opportunity. I think medium and longer term, the short term is taking off a little bit, but we're going to see that really uptick. AI PCs has been a topic of conversation, and we are seeing heavy interest, I would say, and AI PCs as part of a future-ready discussion and that larger discussion about the full state.

Okay. Yes, we just had Michael Dell before [ E-note ].

Thank you for letting me follow Michael. I appreciate that.

All right. Maybe if I can switch more to the near-term impacts. As you sit here in calendar 3Q and maybe you kind of reflect on, okay, what surprised us from the time that calendar 2024 started across some of your verticals or maybe even your end markets, PCs, servers, storage, security services solution, how are you thinking about those end markets now over the next 6 to 12 months? So what surprised you now up to this point from, let's say, the start of the year? And how you're thinking about the demand over the next 6 to 12 months across those products.

Yes. Let me take the end markets and then the products and feel free to add anything, chime in, Al. From an end market perspective, I'd say, look, the second quarter, in many respects, played out as we expected, except for we had -- federal was a bit of a surprise because they were delays, delays in the budgeting process and then further delays in the kind of trickle out the agency of the funds. And so that impacted our results, but we think that's a timing issue, and it's just going to -- it will push into Q4, probably Q1, Q2 potentially. Snap election, we didn't plan for a snap election in the U.K. That clearly had an impact. We've been saying for a while that the U.K. has been a couple of quarters behind the U.S. in terms of what's happening in the confidence, certainty, economy, and we're still seeing that play out. But the snap election really just closed things for a while, so that's international. The rest of the end markets, look, small business, and we said this was bouncing along the bottom and not getting worse, not getting better, but really bouncing along the bottom. Where we saw a little more firming was on the commercial side. And I have been saying it firming, not turning. So that all kind of was playing out is expected. But as we look forward, there were a couple of things that impacted our view of the second half and the outlook. Number one, the persistent caution and prudence in the conversations with customers is not abating. And so customers are still focused on must dues, not nice to have. They're still absorbing some of the purchases from prior year and networking is a great example. They are pausing a little bit on this AI architecture question. And we've had some other things in the market that have just created some hiccups and disruption. So while we went into the year expecting an uptick in the back half, particularly around solutions, we just didn't feel confident that it was going to happen. Now you add in the election coming up and the very different policy positions, I think customers, the conversations I have with my peers in particular, is we're going to wait and see what's going to happen -- what's going to happen with policy because we can plan for it. Right now without that certainty, there's an added pause in the system as well. So that just made us uncomfortable about that uptick in the back half of the year. What I would say is, look, we've got 11,000 customer-facing coworkers who are -- got the pulse on their end markets. And I feel very confident that our ability to call the market has been incredibly accurate. I'm not always happy with it, don't get me wrong. I'm the first person to say, much rather the market be a little different. I'm confident in our execution. I'm confident in the team, and I'm confident that we're calling the market appropriately and accurate. I don't know if you...

I think you summarized well, just to add the -- we entered the year knowing over these catalysts pent-up demand, particularly in solution space, as Chris noted, expectation like many was that the macroeconomic environment would clear and then be greater confidence and clarity. We haven't seen that. That's been more elongated than expected. That said, that pent-up demand is still out there. So while we think it's going to take longer to get to that spend, it's definitely there. It's just a -- it's a win, not enough.

Okay. And then when you talk about macro, you have this federal election, Europe, but you also have talks more of interest rates, maybe getting some relief there, especially for your end customers that are probably more subject to interest rate fluctuations. Just maybe -- does that come into the conversation right now? Or is that sort of a given?

Yes. Look, I think that there's optimism about interest rate cuts, I think there's still varying data out there. We have more data coming out that's not as positive, but that's certainly making folks feel more optimistic. I just would say, I do think this election year is a bit different than what we've experienced in the past. And with the macro being as elongated as it has been in terms of the uncertainty in the environment and the election just around the corner. More customers than not are saying we want to see what's going to happen because then they can incorporate whatever policy directions we might be going into their decision-making. I mean that said, it's taxes and tariffs, two very different policy positions.

I'll maybe add, Asiya, just on the macro side. Our comments about corporate being firmer footing, I would say, is a reflection on we are starting to see better clarity on the interest rate and the inflation front. If you turn to small, it's a different dynamic because they live by the -- my feeling in my business, rates haven't come down yet. Inflation hasn't materially come down enough for them yet. So they're still bouncing around the bottom. The upside on corporate is, does that greater clarity, that path of lower rates, will it lead to a pickup in spend.

Okay. Since then, I mean, are you seeing the federal -- since we last chatted post your calendar 2Q earnings. Any anecdotally, perhaps is the federal election more on top of mind since we last chatted post your earnings, is it -- so there's an incremental there? Or maybe the rates clarity is further along? Anything incremental on the...

I would say net-net, we're consistent with where we were at the end of the second quarter in terms of the environment. That would be my view.

I agree.

And that reflects both domestic as well as your international markets I think...

Yes. And our outlook has taken the -- there's nothing new that we are adding into the outlook in terms of impacts or inputs.

Okay. Government just maybe talk about -- you guys have pretty decent exposure to the government as well. While there's nothing new incrementally, maybe you can tell us about how do you see the inflection? And is it just past once November elections are done, you kind of see that demand unwinding, so as to speak, that with pent-up demand that was kind of maybe compressed. And you talked a little bit about maybe push out into the first half of calendar '25.

Yes, yes. So I don't think about the federal space as soft demand, the dynamics at play this year are really about timing issues. So we had the budget approved much later than usual. And then either further delay in the dollars moving from the departments to the agencies and then out into the projects. That's the easiest way to think about it. And if you think about a funnel, of administrative things that have to get done and that funnel is getting bigger and bigger. It still has to go through the same number of human beings in the government to get competitive bids done and all the component parts that have to happen, they got kind of stuck. So we have a bigger backlog, I would say, that didn't make its way out to the agency level, which is where the spend actually happens and the POs are written. And then once you're getting to the end of the fiscal year in September, the departments do tend to hold their budget. They'll hold their budget at systems integrators where they've got big programs that they're going to roll out. But they just will pause for a bit until we get past the year-end and then the gear start moving again. So that's why I say it's timing. It's not softness in demand, and it's just going to take some time for the gears of government to actually move the money out so it can be spent. And we've seen this before. I think in 2022, I think maybe back in 2012, we have seen periods before where the slowness has just delayed the spending, but it eventually makes its way through the snake.

Okay. And then just as it relates to your guide for the back half of the year, given that you've had to adjust your expectations twice, just remind us, like the back half, what does that entail? I think you've talked a little bit about seasonality there and for the -- and maybe double-clicking a little bit seasonality across which end markets seems to be playing out versus...

I would say broadly for current outlook for the full year by end market, it looks reasonably seasonal. Now we started the year with an expectation that we would see low to mid-single digits gross profit growth. And that was predicated on that we'd see a recovery and pickup at the end of the year. So the biggest change has been that we don't see that playing out. Now the demand is there, it just won't play out this year. So that's the biggest change. And then the only other thing I'd mentioned is two things that Chris noted federal and international. Federal being more of the timing effects, international turning modestly worse than what we expected.

Okay. The strong pipeline, like you again talked about the funnels there. There's a strong pipeline, a backlog. Just help investors understand, okay, how does that then eventually translate to your income statement, right? When should we start to see the -- not just outside of federal perhaps, but what gives you confidence that this backlog of demand doesn't, perhaps, evaporate, yes, yes.

Yes. It's a great question and just building on what something else that, that demand has been pushed, and at some point, the demand becomes actually more urgent. And PCs is a great example of that. We've got a huge installed base of PCs, for example, that are aging. There are poster that COVID brought PCs. At some point, they have to be refreshed and we're starting in that right now. You can't push that out forever. We saw the same thing with storage actually. While infrastructure conversations are happening generally in particular around the future of AI, storage needed to be refreshed, needed to be upgraded, think about the data explosion that we have, data everywhere, storage just was not sufficing. So we -- you start to get to a point where the urgency to make a change just matters. So we're really confident in that, number one. Number two, look, technology continues to be central to competitive advantage to achieving outcomes to customer experience. It is still at the core, and I would argue even more critical. So that's not changing anytime soon. And if you think about the trends that are durable and the catalyst for growth, security and the increasing threats and sophistication, PCs, I already mentioned; AI, we already talked about; data, everywhere. I mean, as I mentioned, the work that we're getting from these discussions with customers around data governance and cleanliness, is really exciting and rich work. So there are these catalysts that are not going away. And you see some of it in our results. Security results have been strong. Cloud results have been strong in services. That's another catalyst and durable trend that we've been investing for over the years, which is services around everything for our customer. Our partners want us to play there, our partners invest behind that. Our customers appreciate the depth and expertise and the integrated discussions and architecting that we can do for them and we're -- it's the full life cycle from the advisory, to the build, to the implementation and orchestration all the way to manage. So that is also going to be a durable trend and catalyst for growth, particularly in terms of our margins.

Actually, talking about margins. I think we get asked what is the margin trajectory going forward? And what are the drivers that should help push gross margins up maybe not just in the near term, but kind of as you guys look ahead as some of this pent-up demand starts to unwind, will we see a sharp inflection in margins?

I'll start with our strategy. Our strategy, obviously, focused on continuing to drive organic growth in our core business, but then notably continuing to invest behind services and solutions. So the progress we've made on the gross margin front as substantially attributed to those latter two, our investments behind services and solutions. So I'll just say in terms of durability our continued focus and dedication to investing behind that strategy will continue to drive those margins higher. A couple of things I'll give you just in the more near term, what we've experienced. In 2024, obviously, we've seen a significant trade-off there of solutions, which typically we'd come in higher margins, but what we have seen is strength in netted-down revenues and netted-down revenues and think cloud and SaaS certainly have bolstered our margins. Now at the same time in 2024, we've seen a growth pickup in client devices, which you might look at and say, solutions have been weaker. Client devices have picked up, why haven't your margins trailed off. A couple of things that I would say: First, services, Chris said that. Again, investing behind services helped to bolster our margins. But as well on the non-netted down product margins, they've been firm and driven by both, I'd say, overall strength of margins and resilience of our margins, but also a trend where we're seeing more customers kind of choosing to invest more in higher-end products, which come at firmer margins. So when we add that all up, we feel really good about where we are margin-wise here, but also when we think about a more balanced contribution from solutions, and continue to invest behind our strategy. We feel good about the trajectory of margins going forward.

And so Michael Dell talked about AI PCs, as you see AI PCs perhaps come at a higher dollar, is that fair for investors to assume that you guys would also get a better share of that, and that should be a positive for your non-netted down margins?

I think some of that will be -- remain to be seen. I think it's fair to assume you could see higher price points and higher margins, but some of that is still evolving as we go.

And then networking, I think you guys talked about it obviously going through a period of inventory digestion. Those typically tend to be the higher margin on the hardware side of things relative to...

That would fall in solutions, so servers, storage, networking, all of our solutions would come in typically higher margin. So the fact that they've declined and our margins loading up, I'd say, is a pretty good sign.

Yes. Okay. And so as we start to see perhaps some of that come back given inventory digestion has sort of run its course perhaps or coming to an end there, you should see the strength in your gross margins for the non-netted down as well.

I think that's fair. The other variable would be considered how strong we see the growth of client devices. Obviously, client device will be lower margin. But this year as a proof point, we'd say we probably will hold up okay.

Okay. All right. Maybe just a little bit on capital allocation. That's always top of mind. I know you guys do acquire there is opportunity for consolidation. It's a pretty fragmented space. So just a little bit on how investors should think about capital allocation.

I'll start, and Chris may want to jump in. First, free cash flow. So we take seriously our ability to translate profits to cash flow. And I think we've done a nice job on that front. And this year, we're right in our sweet spot of where we'd expect to be. You have to have the free cash flow to be able to allocate capital. So it's a good start, I'd say. Just a reminder on our priorities from a capital allocation perspective, number one, our dividend. We intend to grow our dividend in line with our non-GAAP net income, and we've had a strong track record of increasing our dividend for a long time. Number two, managing our capital structure, including our net leverage ratio. We're currently at 2.4x on our net leverage ratio and that's right in our range of what we shoot for. I will note just more recently, we were upgraded by Moody's. So we're now fully investment grade and we just came to market with $1.2 billion of bond issuance, which extends our maturities and made a very successful raise a few weeks ago on that front. Number three, M&A, I'll just say M&A great track record on that front. We've done 10 acquisitions in 5 years and had a -- have a great track record of growing organically and inorganically. And then obviously, last but not least, share repurchases. We would consider ourselves to be patient, opportunistic on those last 2 categories and knowing when and how to pick our spots, but I think all in, we do a pretty [indiscernible] good job being a capital allocator and using that free cash flow, I mentioned.

I'm going to ask the audience if there's any questions, if you would, please raise your hand. I think I see one in the back there.

Could you talk at all about any impacts you've seen on your business or your customers from Avago's decision to raise pricing on VMware, whether that's positive or negative anyway for your business?

Whenever there is a change in the partner landscape, whether it's acquisition or business model change or pricing, that's actually when our customers lean into us more for guidance and often when our partners rely on us more to be able to really help customers understand the benefits and the utility of what they're going to be getting. So I would say that, that's been the case in these circumstances. Our conversations about the changes have been extensive and it's just a reflection of our trusted partnership. So good for, bad for, it's been a process for our customers to really understand what is going to be best for them over the long term. But I think we've been squarely in the middle of helping them through whatever road map they want to take and showing them the value.

I realize the federal landscape obviously changed on you. But given the last 2 quarters when you had to guide down some, should I think of the guidance going forward has been a little more conservative just to kind of get back on track in terms of that concern?

Yes. I mean I would say our back half guidance is well grounded in what we've seen in the first quarter of the year. So it really reflects the risk that we saw that we experienced, the federal impact. It reflects the impact of international -- two things that we frankly weren't anticipating. And then the persistence of the cautiousness in the macro environment and uncertainty, I think, rounding the corner into this year, we did expect that to abate as we were going into the back half, and it just hasn't. So we feel very -- we feel like we've grounded and it's risk-adjusted for what we've seen, yes.

Yes. Any other questions? Maybe if I can, just people talk about, related to that question, I think I do get questions from investors just about how you guys talk about revenue guidance? I know you tend not to necessarily guide on revenues. You guys talk a little bit more about gross profit and how you guys are seeing that. I think investors have asked us about why does CDW not provide any more color on bookings or billings like maybe some of your peers do, just thoughts on that.

Yes, because we're talking about netted down...

Yes. Yes. Look, I think that ultimately, we feel like gross profit is the right title. Ultimately, it's the equalizer that brings together all the components of what customer spending with the mix reality. It's also critical because it's actually how our sellers are paid. And so for us, centrally, it's a critical metric. So that's why we center on gross profit you can expect that when we talk about outlook, we will always refer to customer spend and what trends we're seeing customer spend, but we choose not to give the specificity of actual dollars on customer spend.

Okay. All right. A few more minutes, a few more seconds here rather, Chris, why should investors in this current landscape look at doubling up on CDW shares, or doubling down, I don't know.

Doubling down. We'll take either I think, look, we're underrated, undervalued given where we are and where we're going. It's just that simple. There is nobody in our space that has the scale, the scope, the reach, the depth, the breadth that CDW has. There's nobody in our space that has the leverage and trust of partners that we have. Technology is only getting more important. CDW's competitive advantage is built over years and now at scale are really a story of the sum is greater than the parts. So I would just repeat that it's, I think, underrated, undervalued for where we are and where we're going. The other thing I'd just say is we have a track record over 40 years of evolving with the market, and our ability to do so and the investments that Al and I referenced over the past 10 years in terms of acquisitions, our ability to execute on those acquisitions, our ability to retain our customers over extended periods on average, it's over 12 years now. Those relationships are so strong and so important, but also our ability to evolve as an organization digitally and all the things that we do internally, the track record speaks for itself.

Our secret sauce is our workers, I'll just add that. It is what makes us really, really unique. And then I'll just maybe earlier missed, if I didn't add the financial component that I think we do a great job executing on our strategy, translating it into profits and margin, compounding cash, and then feeding the virtuous cycle, both organically and inorganically.

Great. I'd like to thank CDW's management here again. Thank you again for coming to Citi's Tech Conference.

Well, thank you very much.

Thank you. Appreciate it Asiya.