CDW Corporation — 2024 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Welcome to the CDW First Quarter 2024 Earnings Call. My name is Carla and I'll be coordinating your call today.
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.
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.
corporate, small business, health care, 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.
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.
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.
[Operator Instructions]
I just wanted to start one of the big themes during the tech earnings season is spending on AI as very, very strong and I appreciate all your comments in 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 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?
If I could, let me zoom out first and then zoom back into AI. Let me just start with the environment that we experienced in Q1. There are a couple of factors that impacted results in complex solutions results. And look, we had a dynamic in a pretty complex environment that manifested in what I would call fits and starts of both the market and our customers who have lack of certainty and visibility.
Yes. Complexity is typically good for CDW. That makes sense. Just a quick follow-up, Al, on guidance. The gross profit dollar for Q2 where you talked about low single-digit year-over-year growth. I think if I did the math on a sequential basis, it's like low double digits. And the last couple of years, it's been more like 6% to 8% sequentially, so above the last couple of years. Just given a little bit weaker-than-expected trends in Q1 and not wanting to get into that situation again in Q2, maybe just help us with how you thought about that gross profit dollar guidance in Q2? And is there anything that maybe underpins that sequential growth, whether it was maybe pushouts from Q1 or something like that?
Yes, sure, Adam. Happy to address that. A couple of things. First, I think we mentioned in our prepared remarks, look, we feel encouraged by the pipeline that we have and kind of what's out there from a customer spend perspective. And a lot of that would be more in the solutions category as we talked about. So that's number one. The thinking, Adam, is, look, if you look back over history of seasonality -- historical seasonality would be more in like the mid-teens level. And so when we take the sum of the catalysts that Chris mentioned upfront, that is the workload and data growth, the need on the security front and obsolescence of client devices.
Our next question comes from Samik Chatterjee from JPMorgan.
I guess, Chris, I sort of appreciate all your comments about what you're seeing in terms of a challenging sort of customer spending environment. I'm just more curious when I contrast this to last year. Obviously, the challenges or some of the scrutiny on budgets isn't new. But through last year, we did see sort of solutions remaining quite robust, and it was more the transactional business that was sort of impacted.
Yes. Let me start on that one. I think what we're seeing now is we talked about the macro environment and the added complexity now of AI as a consideration and as our customers this year are continuing on that kind of pause in deliberation added to it the AI factor, if you will. They are also faced with the need to refresh client devices. And so I tell you what I think we're seeing is a need to go ahead and spend budget on things that they really can't hold off on any more. They'd like to -- they have old devices. They'd like to get over to the new operating system. They want to make sure the devices are available as demand will start to pick up and there's some switching of the budget over to the devices right now. I think that's a behavior we certainly are seeing. In terms of the trend as we go through the year, I'll let Al speak to the outlook and our expectation regarding the outlook.
Yes, sure. A couple of things I would mention. When we think about the parallel to 2023, look, a year later, a lot of the caution and concern that we experienced has persisted, and I would say, to some extent, in Q1, became even more heightened. And look, there is a mixed story on the economy, but when you think about the financial aspects intra-quarter, we went from an expectation in the market of a number of rate cuts to the potential of now just a few. So there's been quite the whipsaw effect just to give that kind of backdrop, if you will, that is the economic and financial environment continues to get more complicated, Samik, for sure.
Got it. And Al, a quick follow-up for you. Just in terms of expectations for the gross margin as we progress through the year, you sort of get to 21.8% in 1Q, you're guiding to a similar number for the full year. Is it going to be pretty similar through all 4 quarters as you sort of see solutions spend improving maybe through the year, but client devices being a headwind on that margin? Like how should we think about progression here?
Sure, Samik. For the full year, I would say, we're holding to our expectation on gross margin that we gave, which was that it would be similar to 2023 all in. I think there's going to probably be some variability quarter-to-quarter. Obviously, most notably driven by mix, but at this juncture, we would hold to those expectations. Certainly, given that the mix has shifted a bit in Q1 and we saw stronger client device growth and less solutions, you'd expect that, that would have some impact on our gross margin. But I would say when we think about the contribution of netted-down revenue, which we think is durable that's helped to hold those margins. And so at this juncture, we're holding to that expectation of that kind of high 21s gross margin similar to 2023.
Our next question comes from Amit Daryanani from Evercore.
I have, I guess, a question and a follow-up as well. When you folks talked about the hardware categories, one of the things that really stood out was storage performance was fairly good. I'm curious like historically speaking, the storage seems to be a leading indicator for what you see eventually with NetComm and servers or not. I'd love to kind of understand from a software perspective is storage is a better indicator. And then maybe related to that, the NetComm weakness, do you think it's more inventory digestion at this point? Or is it really demand is weak?
Amit, it's Chris. I think what we're seeing with storage right now are a confluence of 2 things. One, we had a number of customers who are investing in networking and implementing networking over the last few years and storage is kind of coming -- storage kind of what's the next investment, if you will. So we're seeing positive results there. The other thing is we've got some new exciting products out in the market, and that's always appealing to our customers. So that's really what I think is driving the storage growth in this period.
Got it. And then I guess, Al, just for you on capital allocation, the buybacks were fairly minimal in the quarter given how the free cash flow generation was and the fact that leverage is towards the lower end of the 2 to 3x range that you folks talk about. How do we think about buybacks for the rest of the year? And is the intent to perhaps show up some capital or cash for the debt paydown that you might have to do by the end of this year and early next year? Or would you use it for buybacks?
Look, we will continue to do what we've done in terms of balancing both the strategic and tactical elements on the capital allocation front. And I think, look, I think 2023 is probably a good guidepost for you in terms of what that looks like. At any given time, we're going to look at all the elements of the -- what's going to provide the best short-term return, how do we feel about the valuation front, and where do we get the most strategic value. I think the opportunity for us on it in 2024 is we'll continue to be patient and opportunistic. But with $800 million of cash on the balance sheet, I'd say, pretty consistent track record here of cash flow generation.
Our next question comes from Matt Sheerin from Stifel.
Chris, I hope you can elaborate more on what you're seeing in the government sectors. You talked about budget-related pushouts in federal. So -- and I know there's obviously some seasonality, particularly in the September quarter. So what should we expect in terms of the seasonality across those markets?
Yes. On federal, I'd tell you that the federal budget delay, which was about -- pushes things out by about 6 to 8 weeks, creates a pretty much a complete pause. But once the budget was implemented, then the trickle-down effect starts to happen and the money is making its way to the agencies. We have seen, I'll call it, very strong activity in both projects and programs that were ready to go, and that's been a positive and very strong activity and those that will take a little while to get through the pipeline.
Okay. And then just as a follow-up, concerning the client device demand that you're starting to see pick up, are you seeing any interest or traction on AI-enabled PCs yet? Or is that still early?
Matt, I would say it's still early. And when we look at the units that we're selling now, really minimally AI PCs. They're the Win 11 and Apple next generation. And the impetus is really threefold. It's just refresh aging machines get to Win 11, frankly. And it's also an interest in getting ahead of any increasing demand. We are finding customers having longer memories when it comes to the pandemic and remembering that sometimes just in time doesn't work because you got to stay ahead of the supply. So that's also been a factor in the positive signs that we're seeing. I'd also say, look, I mentioned it before, it's a low-friction purchase and it's kind of no regrets. When you put together aging machines, the need for Win 11 with that kind of stable landscape, customers are just starting to move forward.
Our next question comes from Erik Woodring from Morgan Stanley.
Chris, maybe I'd love if you could maybe unpackage some of your pipeline comments a bit more. Outside of federal, if we put that to the side, you mentioned broad pushouts. But can you maybe clarify anything you're seeing in terms of customer set or products where you're seeing this behavior most acutely? Are you seeing any cancellations is to push up behavior this quarter, any more notable than past quarters? And is it as simple as the macro is the key factor here that can unlock this spend? Or are there any other factors that you see here when you speak to your clients, where they say, listen, we just have to refresh these devices, for example, where we have to modernize our data center infrastructure? And then I have a quick follow-up.
Yes, sure. Thanks for the question. Let me just start with where you ended. And I would say, as we've suggested, the macro overhang really is the predominant factor in the extended and elongated sales cycles. What we're not seeing is we're not seeing cancellations. We're seeing just more deliberation and greater time and more involvement, frankly, by more business unit constituents in the decision-making process. And as I said, the AI consideration is a real thing. It's a bit of a pause. How do we think about this over the long term? As you know, the progress, the speed with which AI functionality is moving is really fast and they're taking that into consideration.
And maybe, Erik, just adding on to that and to kind of stitch the story together. We talk about these catalysts. Within those catalysts are plenty of opportunities from a solutions perspective. I think that what we saw transpire is this kind of heightened caution and concern kind of the -- as you can see what's around the corner phenomenon, if you will, from a corporate perspective just caused more delay in deliberation.
Yes. And I would just add that the durable categories we've seen over the last several quarters are security and cloud.
Okay, very helpful. And then just maybe a clarification, quick follow-up is, you mentioned expectations at least for 2024, U.S. IT market growth to be relatively similar. You did guide to low single-digit gross profit growth versus low to mid-single-digit growth last quarter. So that would presume weak gross margins would be a bit weaker than when you guided 90 days ago, but Al, you reiterated kind of the expectation for similar gross margins to 2023. So can you just help me maybe on package what is the main factor that is causing the gross profit dollar? The slight change in gross profit dollar growth guidance for 2024? And that's it for me.
Yes, Erik, a couple of things. So look, from just working from the -- from a customer spend perspective, we're calling for low single digits plus our typical premium. So that's come off a bit. And if it were coming off in a category, that would probably be substantially from a solutions perspective. That is the slow start that we experienced in Q1. We're not suggesting we're going to make that up. So that comes off the top. And then that's basically just kind of works its way down to GP. We're getting an earlier start to client device, at least for the first quarter than maybe we would have anticipated.
Our next question comes from David Vogt from UBS.
I just want to come back to maybe a longer-term kind of discussion on AI and some of your hardware categories. As you guys look out maybe beyond this year into '25 as traction starts to really accelerate in AI, how are you thinking about sort of the uplift in maybe configurations, ASPs? And how does that flow through your business? So for example, obviously, AI PC, there's a lot of discussion of having considerably higher price points. The same obviously holds true, I think, with AI-enabled optimized servers. So just trying to think about how you're thinking about that as it impacts your business, maybe not this year but in '25?
Yes, David, I'll take this. Look, I think TBD, to some extent, right, we're going to see how pricing plays out. What I would tell you is in current context, we're not seeing much in the way of ASP changes. I'd say prices broadly, including on the client device front, held pretty firm. So our growth during the quarter was largely units. Certainly, there is plenty of buzz out there that as we start to see AI PCs and other AI categories emerge that you could see price increases. But I'm not sure that we're fully prepared to kind of call on what that would look like. Just remember for us, look, we're going to work closely with our customers as we are now, and we'll continue to in terms of how do you navigate that landscape, how do we help them get in front of it to the extent that they can. But also remember that for us in terms of kind of impacts, any lift there on the ASPs may lift the top line but we're largely still very much a cost-plus provider, so you may not see significant movement from a gross margin perspective.
Got it. So just to clarify, obviously, wouldn't be subject to ASC fixed accounting, these would be grossed up revenue and then the commensurate gross profit dollars associated with the revenue, correct? Is the right way to think about it?
As we understand it now, and what the new product generations would look like, I think that's true.
We currently have no further questions. I will hand it back over to Chris Leahy, Chair and CEO, for final remarks.
Thank you. And let me close by reemphasizing my confidence in this team, our strategy and the durability of our resilient business model. Thank you to our CDW coworkers across the globe for your unwavering commitment to our customers. Thank you to our customers for the privilege and opportunity to help you achieve your goals. And thank you to those listening for your time and continued interest in CDW. Al and I look forward to talking to you next quarter.
This concludes today's call. Thank you for joining. You may now disconnect your lines.