CDW Corporation (NASDAQ:CDW) Q1 2024 Earnings Call Transcript

CDW Corporation (NASDAQ:CDW) Q1 2024 Earnings Call Transcript May 1, 2024

CDW Corporation misses on earnings expectations. Reported EPS is $1.92 EPS, expectations were $2.15. CDW Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the CDW First Quarter 2024 Earnings Call. My name is Carla and I’ll be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Steve O’Brien, with Investor Relations to begin. Steve, please go ahead.

Steve O’Brien: Thank you, Carla. Good morning, everyone. Joining me today to review our first quarter 2024 results are Chris Leahy, our Chair and Chief Executive Officer, and Al Miralles, our Chief Financial Officer. Our first quarter earnings release was distributed this morning and is available on our website, investor.cdw.com, along with supplemental slides that you can use to follow along during the call. I’d like to remind you that certain comments made in the presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release and Form 8-K, which we furnished to the SEC today in the company’s other filings and in the company’s other filings with the SEC.

CDW assumes no obligation to update the information presented during this webcast. Our presentation also includes certain non-GAAP financial measures, including non-GAAP operating income, non-GAAP operating income margin, non-GAAP net income, and non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You’ll find reconciliation charts in the slides for today’s webcast and in our earnings release and Form 8-K. Please note all references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2024 unless otherwise indicated. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is the property of CDW and may not be recorded or rebroadcast without specific written permission from the company.

With that, let me turn the call over to Chris.

Chris Leahy: Thank you, Steve. Good morning, everyone. I’ll begin today’s call with a brief overview of our performance, our strategic progress, and view for the balance of the year. Al will provide additional details on our results, our capital allocation priorities, and our outlook. We’ll move quickly through our prepared remarks to ensure we have plenty of time for questions. Market conditions remained challenging and first quarter results came in below our expectations. For the quarter, gross profit was $1.1 billion, 2% lower than last year. Non-GAAP operating income was $404 million, down 7% and non-GAAP net income per share was $1.92, down 6%. In the first quarter, customers demonstrated caution and concern given heightened macro uncertainty, weighing on capital investment decisions.

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Q&A Session

At the same time, the complexity of the tech landscape continued to ratchet up, particularly given the additional layer of AI and changes in the IT market landscape. This lengthened decision making as customers deliberated on both how to navigate technology roadmap and when to spend on infrastructure in a challenging economic environment. While activity was reflected in a solid pipeline with deals being pushed out, our sales and gross profit lagged. Results were also impacted by the federal budget stalemate, which led to a pause in our federal channel. Bottom line, while many of these factors are beyond our control, we are never satisfied and as we do not expect decision cycles to improve in the near term, we remain focused on accelerating pipeline growth and using all of our competitive advantages to take share in this low growth environment.

During the quarter, our teams maintained a high level of engagement, working with customers to implement mission critical projects, help prioritize and evaluate options, develop multi- year plans, and prove out use cases. You see the impact of this in our gross margin, which was a first quarter record, and our excellent cash flow which together reinforced the durability of our underlying profitability and integrity of our strategy. Whatever the market condition, we are laser focused on delivering exceptional value to our customers. To ensure we continue to deliver on this commitment, we remain resolute in our strategy and continue to invest to ensure we have the capabilities to deliver full stack solutions and services. Broadly speaking, customer priorities included cost optimization, data protection and workforce productivity.

This drove focus on security, cloud and as a service, as well as client demand and interest in AI. Let’s take a look at how all of these priorities impacted performance. First, customer and market performance. Recall, we have five sales channels, corporate, small business, healthcare, government and education end markets, each a meaningful business on its own with 2023 annual sales ranging from $1.6 billion to $9 billion. Within each channel, the teams are further segmented to focus on customer end markets, including geography and verticals. Our commercial operations are organized around geographies, verticals, customer size and spend. Teams are similarly segmented in our UK and Canadian operations, which together delivered US$2.6 billion in 2023 sales.

These unique customer end markets often act in a countercyclical way given the different macroeconomic and external factors that impact each of them. Corporate top line declined 3% year-over-year, decision making further elongated with heightened focus on ROI and a high level of project scrutiny given interest rate expectations. Cloud and security prioritization continued to drive excellent increases in customer spend and the team capitalized on client device demand and year-over-year client sales were up low double digits. Corporate saw declines in hardware categories undergoing transition and absorbing capacity, notably servers and Netcomm. Storage, however, was a standout category, up double digits driven by data and workload growth as customers improve efficiency and captured savings from newer solutions.

Small business posted a 7% year-over-year top line decline, but with sequential improvement versus the fourth quarter. The team continued to help customers address mission critical priorities around security and productivity, which drove meaningful increases in cloud and software customer spend. Consistent with corporate Netcomm and servers declined and storage increased. Small business continued to be accretive to overall margins. Client devices posted a sequential increase yet remained down year-over-year. Public sales declined 5% from the prior year. Healthcare declined 2%. Transactional performance was positive with an increase in client devices while solutions declined. Healthcare performance was similar to commercial with customer caution given the significant focus on cost optimization.

Security was also a major focus area, delivering double digit increases in spend and gross profit. State and locals mid teens increase was more than offset by a decline in federal top line and total government declined 1.5%. State and locals performance was broad based with strike across transactional and solutions categories. Client devices sales increased for the third quarter in a row, up high teens. Public safety remained a key focus area with security up substantially double digits. Cloud adoption continued to gain traction. Federal’s mid teens decline was driven by the congressional budget impact, which was not resolved until late March. Some activity related to existing contracts continued, including client device refreshes which drove a mid teen increase.

Larger scale network and data center projects paused. Engagement remains strong and we expect to pick up and spend once agencies are able to allocate their appropriated funds. It continues to be a challenging environment for education and the segment posted a 10% decline. Consistent with recent quarters, higher Ed institutions remain focused on doing more with less and the team posted a mid teens time top line decline. Hardware categories declined across the board, while ongoing focus on cost elasticity led to a strong double digit increase in cloud. K-12 top line decreased by high single digits. Client device sales increased by low single digits, with some school systems refreshing aged [ph] Chromebooks. Several funded via normal operating budgets and not stimulus programs.

Audio visual solutions like smart whiteboards and interactive flat panels posted a substantial decline as schools continue to digest purchases from the past several years. Security remained a top priority in both top line and gross profit increased by mid single digits. Our UK and Canadian international operations which we report as other continued to experience challenging market conditions and each declined by mid single digits. Both teams continue to execute well and are leveraging their capabilities to deliver great outcomes for our customers. For the most part, portfolio performance was consistent across customer end markets. Transactional product sales performed somewhat better than solutions and modestly increased sequentially. Both posted year-over-year declines with a greater decline in solutions from the fits and starts of decision making.

At the portfolio level, hardware top line decreased by 4%. Services also decreased by 4% as weakness in services tied to hardware more than offset growth in managed services, which increased by low teens. Even though software net sales declined by 7%, gross profit increased slightly year-over-year. Top line performance was driven by declines in licensed software due to accelerated transitions to SaaS models. Let’s turn now to the topic that is getting a lot of attention, AI, and specifically what we are doing for our customers in this space. Right now, most of our customers are at the initial stages of the assessment process, developing and analyzing use cases and adopting data governance best practices to deliver insights and ensure end to end security.

Essentially, they are exploring the art of the possibility and working through the science of exactly how do we do this. This is exciting work for all of us and our customers. The complexity of adopting AI plays to our strengths. We know how to bridge the gap between the promise of technology and transformational outcomes. And since deploying AI drives the need for technology investment across the full stack, with entry points across the entire stack, we are uniquely positioned to serve our customers and we are doing that today to support our customers as they navigate successful AI adoption, we offer two broad areas of consulting services. First, connecting AI to outcomes and ROI, which we call AI Discovery and second, a practical approach to implementing AI, including data governance and security, which we call Master Operational AI Transition or MOAT.

While still early innings, these services are gaining traction. We scoped the broad AI opportunity around four areas of focus, workforce productivity, notably end use assistance and edge devices, high value use cases, broad scale vertical solutions and full stack, where customers rely on us to provide the infrastructure underlying applications and solutions. A great example of full stack is the corporate training and development domain specific large language model solution we shared with you last quarter. Our broad scale solutions are vertically based. As you know, we have expertise across many verticals, including healthcare, financial services in many key industry segments, expertise that enables us to deeply understand the unique needs and challenges faced by organizations in these sectors and tailor solutions and services that directly address their opportunities and pain points.

Let’s take a look at a couple of the vertical AI examples. First, our AI offering for the K-12 market, AI presents an exciting opportunity to empower teachers and improve learning outcomes, but it must be done very carefully. Our education team has leveraged its expertise and relationships in this field to offer a safe AI platform that is specifically designed for K-12 classrooms with a custom large language model that generates responses from vetted educational content, not the entire Internet. The second example is a proprietary CDW healthcare solution, Patient Room ‘Next’. While AI holds the promise of medical breakthroughs, our solution addresses the intense pressure institutions face to manage costs while sustaining high levels of patient outcomes.

Our solution combines AI and connected devices to transform Patient Rooms, improve care delivery, and enhance overall healthcare experiences. The solution is HIPAA compliant and runs on an end to end intelligent platform powered by GPU’s, a platform that provides real time insights from data and automated documentation. One current application serves over 300 beds and bills $4 million in annual licensing. Add to that the services and equipment we provide for an end to end solution like cameras, network connections and servers, and you can see the opportunity this represents to deliver value for our customers and for CDW. Of course, AI will take time to become embedded across our entire customer set. We know that, we have been here before as we’ve helped our customers adopt cloud, and while the hype cycle is much shorter than cloud, the arch of [ph] adoption is very similar.

Bottom line, we are here for our customers today and we’ll be there for them in the future as they continue to ramp their efforts. And that leads me to our thoughts on the balance of 2024. You will recall that on last quarter’s conference call we shared our expectations for 2024 US IT market growth in the low single digits and our target to grow 200 to 300 basis points above market. Despite the slow start to the year, we still see potential for market growth. Let me be clear that we do not expect a demand hockey stick, but do see potential for client device refresh and for improved solutions performance. Wildcards include further dampening of capital investment from sustained high interest rates, worsening of geopolitical issues, as well as unusual election year uncertainty.

As we always do, we will update our view of the market as we move through the year. A hallmark of CDW is to serve our customers wherever their priorities lie. As we look ahead, our customers face a compelling need to address cloud workload growth, protect against increasing security threats, manage an aging client device base, and navigate all things data as they build out their plans to leverage AI to capture insights and achieve their productivity aspirations. Armed with our full stack, full outcomes, full lifecycle portfolio and unique vertical expertise, no one is more prepared to help our customers successfully navigate this period of unprecedented change. With that, let me turn it over to Al.

Al Miralles: Thank you, Chris and good morning everyone. I will start my prepared remarks with detail on our first quarter performance, move to capital allocation priorities and then finish with our 2024 outlook. Turning to the first quarter, we began 2024 experiencing the same uneven IT market conditions that we faced throughout last year. Caution and uncertainty reigned, high interest rates and growing pessimism towards the timing of rate cuts, but deals under even greater scrutiny and ultimately led to the dampening of capital investment. Customers are evaluating optimizing their IT spending and while we actively partner with them to build out tech roadmaps to support their strategies, the overhang of economic and financial uncertainty has led the delay in deliberation and ultimate decision making, exacerbating elongated sales cycles.

During the quarter, we were able to capitalize on demand for client devices as some customers could no longer postpone refresh activity, but sales of more complex solutions tied to digital transformation and network modernization were weaker. Notwithstanding, we see the potential for both client device refresh activity to continue and for improved future conversion of our solid solutions pipeline. Moving on to the specific results, first quarter gross profit was $1.1 billion, down 2.4% versus prior year and below our original expectations for low single digit growth for the quarter. Consolidated first quarter net sales of $4.9 billion were down 4.5% versus prior year on a reported and average daily sales basis. Gross margin increased roughly 50 basis points year-over-year and partially offset the impact of lower net sales.

Gross margin of 21.8% [ph] was a first quarter record and was broadly in line with both full year 2023 levels and our expectations for 2024. First quarter margin expansion was primarily driven by higher mix in netted down revenues. This category grew by 6%, once again outpacing overall net sales growth and representing 35.1% of our gross profit compared to 32.3% in the prior year first quarter as our teams were successful serving customers with cloud and SaaS based solutions. While we continue to expect the mix of netted down revenues to be an important and durable trend within our business, it is important to recognize that this mix may fluctuate with customer priorities and product demand. However, even with a higher mix of client devices, margins remained firm in the quarter, consistent with our expectations.

First quarter gross profit was down 7.8% compared to the fourth quarter on a reported basis. On a sequential average daily sales basis, first quarter net sales decreased 4.4%. While first quarter net sales and gross profit were typically low – are typically lower than the fourth quarter, we had anticipated a more modest sequential decline as early 2024 customer engagement suggested more balanced spending across categories than we ultimately experienced. Instead, the sequential decline this quarter was more in line with traditional seasonality, reflecting continued uncertain conditions impacting the spend of our corporate customers in addition to the congressional budget impasse, delaying spending of federal customers. Turning to expenses for the first quarter, non-GAAP SG&A totaled $660 million, a 0.7% year-over-year.

Expenses were consistent with the expectation we shared on our last earnings call, with the first quarter higher than the fourth quarter as we reset some of our variable expenses for the year and accrue for other seasonally higher items. This played out as expected, but our expense efficiency ratio was further elevated due to our lower gross profit production for the quarter. As we scroll forward, we continue to manage discretionary expenses prudently and diligently while balancing this against both our expectations for the year and the need to expand our capabilities and drive future growth. Our discipline was also reflected in our coworker count at the end of the first quarter, which was approximately 15,000 and down slightly relative to year end 2023.

Customer facing coworker count was also unchanged at approximately 10,900. As we expand our solutions and services capabilities, we are concurrently driving efficiency and cost leverage from our broader operations intended to fund these investments. Following along on slide eight, we delivered non-GAAP operating income of $404 million, down 7.1% versus the prior year, driven by the combination of our gross profit shortfall and flat expenses year-over-year. Non-GAAP operating income margin of 8.3% was down 20 basis points from the prior year. As reflected on slide nine, our non-GAAP net income was $261 million in the quarter, down 6.4% on a year-over-year basis. With first quarter weighted average diluted shares of approximately $136 million, non-GAAP net income per diluted share of $1.92 was down 5.5% year-over-year.

Moving ahead to slide 10. At period end net debt was $4.8 billion. Net debt declined by approximately $230 million from the fourth quarter, primarily reflecting our increased cash position alongside modest debt repayment during the quarter. Liquidity remains strong with cash plus revolver availability of approximately $2.1 billion. Moving to slide 11, the three month average cash conversion cycle was 16 days, down two days from the prior year and slightly below our target range of high teens below 20s. Our cash conversion reflects our effective management of working capital, particularly with respect to our inventory levels. As we’ve mentioned in the past, timing and market dynamics will influence working capital in any given quarter or year.

We continue to believe our target cash conversion range remains the best guidepost for modeling working capital longer term. Despite profit that was moderately lower than our expectations, effective working capital management drove strong adjusted free cash flow of $364 million, as shown on slide 12. Over the last 12 months, adjusted free cash flow was 104% of non-GAAP net income well above our stated rule of thumb of 80% to 90%. As we’ve mentioned in the past, timing will impact adjusted free cash flow throughout the year, but we’re pleased with our first quarter performance and we’ll continue to update our outlook on this front as the year plays out. For the quarter, we utilized cash consistent with our 2024 capital allocation objectives, including returning approximately $83 million to shareholders through dividends and $52 million in share repurchases.

We remain committed to our target to return 50% to 75% of adjusted free cash flow to shareholders via the dividend and share repurchases in 2024. That brings me to our capital allocation priorities on slide 13. Our first capital priority is to increase the dividend in line with non-GAAP net income. Last November, we announced a 5% increase of our dividend to $2.48 annually, our 10th consecutive year of increasing the dividend. We will continue to target a 25% payout ratio in 2024, growing the dividend in line with earnings. Our second priority is to ensure we have the right capital structure in place with a targeted net leverage ratio. We ended the first quarter at 2.3 times, down from 2.4 times at the end of 2023 and within our targeted range of two to three times.

We will continue to manage liquidity while maintaining flexibility. Finally, our third and fourth capital allocation priorities of M&A and share repurchases remain important drivers of shareholder value. We currently have over $1 billion of availability under our share repurchase program. And that leads us to our outlook on slide 14. The uncertain market conditions we operated under throughout 2023 have persisted into 2024, and customer sentiment remains cautious and prudent. Last quarter, we spoke about a slow start to the year for 2024 IT spending, which has come to fruition and will likely continue in the near term. However, as we look forward, we continue to see a compelling need to address cloud workload growth, increasing security threats, aging client devices and all things data as we help our customers build out their plans to leverage AI and capture insights and achieve their productivity aspirations.

Our updated full year 2024 expectation is for low single digit gross profit growth, reflecting the slower start to the year. We maintain our view that customers will spend their IT budgets in the upcoming quarters, but within the context of historical seasonality. With this also comes an unchanged expectation for 2024 gross margin to be similar to the full year 2023. Finally, we expect our full year non-GAAP earnings per diluted share to be up low single digits year-over-year. Please remember that we hold ourselves accountable for delivering our financial outlook on a full year constant currency basis. Additional modeling thoughts for annual depreciation and amortization, interest expense and the non-GAAP effective tax rate can be found on slide 15.

Moving to modeling thoughts for the second quarter, we anticipate low single digit gross profit growth compared to the prior year, with no change to our expectation that gross margin will be comparable to full year 2023 and Q1 2024. Our first half/second half split is slightly more weighted to the second half than historical levels, in keeping with our expectation for the market. However, we still anticipate seasonal quarterly patterns to reasonably hold, including a lower fourth quarter compared to the third quarter. Moving down the P&L. We expect second quarter operating expenses to be moderately higher than the second quarter of 2023 on a dollar basis, but reflecting a more normalized ratio relative to gross profit than we experienced in Q1.

Finally, we expect second quarter non-GAAP earnings per diluted share growth to be in the low single digit range year-over-year. For 2024, we’re maintaining our expectation for adjusted free cash flow to be in the range of 80% to 90% of our non-GAAP net income, assuming a higher level of working capital investments to support growth. That concludes the financial summary. As always, we’ll provide updated views on the macro environment and our business on our future earnings calls. And with that, I will ask the operator to open it up for questions. We would ask each of you to limit your questions to one with a brief follow up. Thank you.

Q – Adam Tindle: Okay, thanks. Good morning, Chris. I just wanted to start. You know, one of the big themes during tech earnings season is spending on AI is very, very strong and appreciate all your comments and the prepared remarks, but it’s hard not to dovetail that with CDW results here for Q1 that were a little bit weaker than expected and showing a decline in solutions where presumably AI would be reporting. Just figured I’d throw it [ph] out there to address any investor concerns that perhaps CDW is not participating in AI spending. What would that thesis be missing? And if there’s portions of that, that might be fair, things that you can do to capitalize more on AI spending, whether that’s organic or inorganic. Thanks.