CDW Corporation (CDW) Earnings Call Transcript & Summary

Good morning, everyone. My name is Asiya Merchant. Welcome to Citi's TMT Conference. I lead the hardware sector here and the tech supply chain. So happy to kick start at least my sessions here with CDW. Chris Leahy and Al Miralles, Chris here, CEO, Al here, CFO; this is going to be an interactive fireside session. We have a bunch of questions here outlined. If you do have any questions, though, please do raise your hand. We'll give some time for that. So good morning, and thank you for coming to our conference. It's always great to see you both.

So I'm going to start you off here. Chris, AI. I mean, we talked about it last year. It's been loud, much more loud here. I obviously covered Dell and HPE. Those numbers have been staggering. And even the storage guys, to be honest, like they've been growing PCs everybody was talking about Doom's Day, but obviously, that's still been growing from a revenue perspective, and we're starting to see some of that. So maybe just a high level, when you think about AI and everything that's happened over the last couple of years, starting with hyperscalers, where you don't necessarily participate and we're starting to see it more broader. What does it mean for an opportunity now as you think about it for CDW?

Well, Asiya, it's great to be here. Thank you again for having us. And if I just zoom out for a minute and take a step back and we think about the way that AI is massively reshaping demand. Yes, it started with the hyperscalers building capacity, obviously. And then enterprise organizations have been next in line, so to speak, now what we've seen, we focus primarily on the mid-market size companies, those who have the same kind of needs and challenges as enterprise, but do not have the resources and expertise to understand the best ways to implement and put AI to work. We also have a number of verticals where we bring differentiated capabilities, health care, federal, state and local education. We focus on those enterprise areas where we can bring something different in which case we have seen strenuous growth. As we think forward, the need to have an end-to-end strategic technology partner who can turn our customers' ambitions into outcomes is never more important. The gap between acquiring technology and putting it to use is getting bigger. The complexity, the number of choices the impact that it has on an organization's health and growth is just magnifying. So when we think about the opportunity for CDW, particularly in these verticals and then into the mid-market, we see nothing but growth and opportunity ahead. And in particular, across the entire life cycle, as I said, end-to-end is a very important value that our customers lean into and pay for. And that means helping them from the advisory through the integration and the implementation and ultimately to managing. So we just recently did an acquisition last week of Lovelitic, and that's a great example of us investing behind our mission-fod growth strategy to add the services that are critical to put AI to work -- we all know data is still the gating factor for AI, frankly. And I think 12% of organization say they're ready. Their data is ready, and that includes large enterprises by the way. We have lots of customers and large enterprise freights who are still dealing with this issue. So lovelitics gives us capability, 500 engineers, data scientists who can help us with that tip of the spear, if you will, that front end of need and value for AI implementation. So the opportunity for us is the capacity is being implemented. How do we help our customers adopt, then consume and deliver an outcome that gets them the goals that they're looking for.

Okay. And if you think about this AI journey, right, where initially, it's like where do I begin? Then you start saying, okay, I'm beginning here. I don't know, PC was the start, maybe it was something else. As you think about that journey from decision, consulting, to, okay, let's start in one department, let's optimize that's implement, then we are actually consuming it managed services. Can you walk us through like CDW's opportunity, how you see that spending moving from I'm just going to hire CDW for some consulting to now I'm actually hiring them for implementation to now I'm actually doing hybrid like we talked about earlier. So how do you see your growth opportunity across those various scenarios?

Yes. So I would say it this way. When I think about the imperatives that a customer has, there is preparing for AI. So you think about AI infrastructure ready for AI at scale. You think about AI data foundations ready to scale your data. You think about AI in the SaaS applications that customers already have. And then you move to now what do we do with that? And it's how do we apply agents, how do we automate? How do we secure and how do we govern and then how do we make sure that we are optimizing for the economics. And then through all of that, there's a continuous innovation with our customers to drive more and more use cases. So the opportunity is across every component there, wherever our customers need us, we will be welcomed in that environment and then spread from there. The other thing I would say, which is a significant opportunity for us is our ability to have what I'll call a flywheel of experience, expertise and learning. So because of our vertical capabilities, we are able to identify successful patterns and then codify them than packaged technology services and expertise together in a way that we can then replicate in repeatable solutions into the mid-market or into other verticals and drive recurring revenue. So it's across the board. It's across the life cycle, wherever it's needed. It's obviously the purchasing, but it's also the ability to package solutions in a way that drives velocity and value for our customers.

Yes. That was my next question. Like you talked about these repeatable use cases that you could then deploy across various verticals. Maybe if you could just maybe take it down a little later, so that investors, you can appreciate when you're talking about across your customer base, you're doing these repeatable, scalable use cases and how it then flows into CDW from, I don't know, GP dollars and OpEx screening growth?

So a couple of examples where we can do repeatable solutions, let's take the health care industry, for example, a larger enterprise system that buys patient room next from us, which is a proprietary solution to drive clinical outcomes. It reduces the -- prioritizes work for the nursing staff, for example, and it directs them to the right places. Now in one particular case, we saw the productivity go up by 25%. We actually saw a reduction in turnover. So turnover went down by 25%. That is a replicable solution that we take from that system, that health care system and bring to a number of our health care systems, including the mid-market, the rural health care systems and the smaller health care system. Another one, which is one of my favorites is when I think about municipalities and the citizen services like the EMT service, the life-saving services. And we have a circumstance where we took the 911 calls down to 15 seconds from like a minute and 30 seconds. And that was basically reorganizing the process. It was adding a genic workflows and redirecting unnecessary calls so that the emergency calls got to the right place. We take that, we package it and we go to all the municipalities and we can help them reduce the time to receipt of a 911 call. Those are the ways that we actually take ideas from idea to outcome and then broadly across our customer base.

And then obviously, at this conference and what we just heard from the OEMs that just announced earnings, it was only a week ago, hearing a lot more about on-prem versus just on-prem deployments, whether it's token omics or what is driving that? Maybe there's more workloads here. What we throw does that tip it more in favor for CDW? And how would CDW participate, it was more of an on-prem deployment versus a hybrid or maybe it was a totally consumption-based cloud deployment for AI?

Yes. Well, I would start with the fact that CDW is deployment agnostic, I can say it that way. There are so many choices to be made, which plays to our favor. So whether it is in the cloud, whether it is on-prem, whether it is hybrid, whether it's on the edge, whether you're using a neo cloud or a colocation, it's all about optimizing for something. Optimizing for speed and latency, optimizing for performance, optimizing for security, optimizing for data gravity. The bottom line is where should the workload the best served. And so for CDW, that's our sweet spot, helping our customers understand that and then purchase, implement and adapt accordingly. So neutral as to what our customers decision is very invested in their success. That's why customers stay with us so long. And we would get paid in all of the circumstances, including from a professional services perspective, from a purchase perspective, a resell perspective from a consumption perspective and ultimately from a managed perspective, if we actually manage their workloads for them.

And if you were to allocate dollars internally, like where do you generally -- like do you see them equally allocating? I mean complexity also means you have to invest in your part as well. Al has to allocate where am I spending dollars and employees. So when you see the complexity increase on your customer base, how are you then thinking about how you want to allocate your OpEx dollars?

So we think about it in terms of driving outcomes for our customers, okay? And so the areas that are most important to doing that right now are integrating services, integrating workloads and AI capabilities into existing systems. That's critically important right now. So that's one. A second one would be security. Security is obviously a dynamic and concerning area. And so security would be another one. But the bottom line, I would say, where we are going and where the market is pushing us is adoption in whatever form that looks like. So lots of capacity has been created and will continue to be created. What those providers, the OEMs, the chip providers, the hyperscalers, the neo clouds, what they need is they need customers to use the capacity. That's how they get the return on their investment. So we help our customers adapt and consume to deliver the outcome. Whatever that looks like and wherever that resides in the most economic and optimized way. That ultimately drives more investment in use cases, which drives more demand, which drives more capacity. So it's a virtuous cycle with our partner ecosystem, but really specifically driven in the future by adoption and consumption.

I'm going to tip back to the recent acquisition. analytics. Talk to me about -- I mean you already talked about a little bit about data, right, why it's important. You talked about the coworker, the data engineers they bring, the verticals that they have. Why was this the right time to get them? I mean obviously, there's lots of areas that you could have invested in and purchased. Why was this one something that really you went for?

We see data as the tip of the spear in terms of the ability to put to work. And we know Lovelytics well. We've worked with them in the past and they're a leader in their field. They're an extraordinary organization, and this was all about speed to capability. It's a tip of the spear capability and scaling our capability quickly was at the very top of our priority list as we looked at potential partnerships and acquisitions.

Okay. And just walk us through -- I think there were some questions from investors earlier in 1 of the groups about how are they -- how is the sales to motion here? Like are they -- how will the acquisition by CDW help them?

Yes. So the way that we run an acquisition like this, we call it a greenhouse. And so we -- they'll be standalone for a period of time. And we we operate like a CDW as a channel, okay? So they are in a position to continue to grow their business higher for their business and just keep the trajectory going because they're high growth high margin, high profitability. At the same time, we put mechanisms in place to bring opportunities from our much broader customer base into them. So when I think about where they focus now, they're primarily enterprise players in a variety of verticals, energy, retail, health care, financial services, areas that are very complementary to ours. So we'll be able to bring those current skills into our enterprise customers. Equally, we'll be able to take back to the learning expertise, flywheel, we'll be able to take much of the built 4 products and convert those into products that are appropriate for various players in the mid-market. So we see this as really a twofold threefold growth. Current growth of their current customer base, enormous opportunity in our enterprise space and an enormous opportunity in the mid-market at speed and profitably.

Okay. Fair enough. I'm going to switch a little bit to what you guys just reported. It's not been too long. I mean, you guys had pretty great numbers, right, relative to the start of the year. You guys are obviously outperforming that. When you look at the demand and how that shaped out from the start of the year or the last quarter that you just reported and the outlook that you provided for the back half, what were some of the positives that you saw that were surprising and maybe some of the takes on the other hand, that may be surprised a little bit as well?

Yes. I would just self-start, and I would just say that it's been constructive, constructive demand and probably broader than we expected when we went into the year, frankly. The other thing is, while we expected to have strong mix into hardware infrastructure, in particular, at the front end of the year. It was stronger than we expected, which muted some of the other areas of our business just in terms of mix. But it's been robust. The signals continue to be strong in terms of engagement with customers, written business, our backlog, et cetera. So that continues to be very strong.

Yes. Maybe just to add the -- Chris' comment about the enterprise mix. So that had some impact on our gross margin, but we also view it as a very encouraging trend in terms of enterprises getting on with their AI journeys. And then maybe just walking down the P&L. We had talked about inflecting in Q2 and beyond on the operating leverage front. So while we did not see benefit from geared for growth in Q2, the efforts were happening behind the scenes. We had some operating leverage just from kind of good old-fashioned discipline. As we work towards the back half of the year, our year for Growth efforts will accrue benefits and therefore, we'd expect to see additional operating leverage. And then finally, on the capital allocation front, we've been opportunistic on buybacks as well. So that helped us to get to double-digit EPS.

Okay. And if I can, on the geared for growth, right? I mean, investors have been very focused on this OpEx to GP ratio. Maybe you can just provide us an update remind us again where you are on that journey for geared for growth? How much has been done, what innings are we on and that geared for growth initiatives and how much more to go to kind of get to you? And what would be the sweet spot then in terms of SG&A to GP?

So just a reminder, geared for growth is a multiyear effort and focused on effectiveness and efficiency. And just as the name suggest it's just as much about how do we scale our top line but also make sure that our cost base is geared for that growth, if you will. So those efforts began in earnest at the end of last year, the beginning of this year. And again, Q2 did not see significant benefit, but we do expect that the back half of the year, those benefits will begin to accrue. The focus areas for geared for growth include AI productivity, end-to-end automation and efficiency of our operations, ensuring that we have productivity all the way from our kind of sales professionals down through our coworkers across the organization. And then as well, just optimizing our spend, including our own tech spend in some respects, we are customer 0 in that regard. So it's going to play out over the next few years. I would say the original expectations we gave in terms of benefits for geared for growth were at or better than those levels. But importantly, we are going to reinvest. And it's important that we reinvest back in the business, including our services capabilities, including assisting and supporting our sellers on the front end of the curve and our own coworkers capabilities and AI productivity. So we're pleased with the progress we've had so far and what you can expect to see is not only gross profit growth sustaining over time, but also that commitment to operating levers as well.

Okay. That's great. You guys raised your outlook for the rest of the year when you updated it as part of earnings. And I think you now expect, I guess, the U.S. IT market to kind of grow mid-single digits, CDW always outperforming that 200, 300 basis points. But you did bake in some second half prudence. I think you talked about various end markets, I think the word that was used was prudent. Now a couple of months later and having just seen those numbers from some of the OEMs that have just posted results a week ago. How is prudence looking?

I'll start. So again, a reminder, beginning of the year, we did take attack that we expected, the IT market to grow low single digits. And in our typical mode, right, we wanted to see the signals and the data points come through before we increased our outlook, and that's just what we've done over the last 2 quarters. If we look out over the remainder of the year, I would say underlying our expectation of demand and growth is consistent and consistent with what we've seen. That being said, we're still operating in a very dynamic environment, right, whether that's supply chain, price variability kind of typical macro factors, but also importantly, the fact that we're seeing strength in enterprise, there is a timing effect of some of those enterprise spend items. And for those reasons, we have some caution baked into the back half. So for that to play out in a more positive way, all of those factors would go in a more positive direction. And on the downside part of things, I would say the risk would be that supply chain becomes more a disruptor, that the macro becomes a bit harsher than what we've seen and so forth. But as we sit here today, we feel really good about the outlook the direction of spend and the engagement of customers.

Yes. I would just add, generally that the indicators we're seeing now, in particular, what releases last week, suggest optimism, particularly around demand. Demand has remained resilient, and we expect that to continue.

I think one of the -- earlier on, when I would go marketing, a lot of investors would push back and say, where is the budgets coming from for these massive investments, not just PCs, it's servers, it's storage, it's networking, it's services like you talked about consulting. Does you sit back and you think about -- I mean, the price increases that these OEMs have put through as a result of higher component pricing, and that's being reflected in the end demand -- where are you seeing the budget dollars coming towards IT and the areas that you participate in? Where are they coming from? And are they just upping -- is everybody just upping budgets?