CDW Q1 2024 Earnings Call Transcript

Adam, thanks for the question. 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. You take the first economic and financial uncertainty, in other words, the interest rate and inflation environment. And that was really the primary driver of the impact for our corporate team and our small business team. And that created an overhang in the environment, which drove what I'll call an uneven market condition situation pretty similar to the trends we saw in 2023. And as a result, our customers remained cautious. They remain prudent. There is relentless scrutiny on, on deals across the board in the solutions space, in particular, as customers focused on cost optimization and short-term ROI. And ultimately, that dampened capital investment in the period.

I'd also say to a lesser degree, AI considerations as an added complexity in the deliberation process, enter the picture. We're at a real inflection point with AI, critical decision for all of our businesses, understanding what it means to their business and their workforce, what it means to their road map, technology road maps and what the implications for infrastructure are. I just would highlight a couple of other pressure points during the quarter or a lesser impact, but we, we had some changes in the IT landscape with some consolidation and acceleration into as a service, which creates a natural interruption, I would say, in just the customer process. Fed budgets delayed and then the education market is transitioning really back to a more normalized funding mechanism. And the result of all of that was collectively, we had to spend deficits.

What I would say is, our engagement overall has been incredibly strong. I'm really pleased with the engagement, and we are seeing that our value continues to build as we help our customers manage the complex tech environment and a dynamic period, but what didn't happen is the solid pipeline that, that translated into did not then translate into invoicing in the solutions portfolio, as it would in a normal operating environment. Now while we have seen the pause on the complex solutions, we are helping customers who, who need to refresh client actually start doing that. And that's some positive signs in what I'll call a lower risk, lower friction, client category. But at the end of the day, right, it was solutions that impacted our results overall.

Now, if I flip to your question on AI, here's what I'd say. Look, we're in the early innings. Some of our customers are advance, but really most are in an assessment and experimentation stage, and it's going to unfold over time. CDW is uniquely positioned in the space to take advantage of what will be ubiquitous and a full stack opportunity. We know how to take customers on the journey. We've done it before, this art and science of new technologies. We've got the full stack and broad portfolio. So we can help customers at every entry point. And we've got services against the entire part of the stack and across the life cycle. And so we've got the ability to deliver integrated solutions. We also understand our customers' pain points and opportunities given our deep vertical expertise and our intimacy with our customers. So we create, we can create packaged solutions that can scale pretty quickly as well as customized solutions. So you think about it in terms of the choice, we help them identify the best solution, compatibility, developing road maps for integration and cost and value analysis.

Now in the areas of opportunity, there are four that I mentioned in the prepared remarks, and I'll just emphasize those, and then I'll talk about where we're seeing pick up now and what we anticipate going forward. First, in workforce, think productivity tools and assistance. We're the leader here with regard to many of our partners, and, and there is much interest in workforce AI impact currently. High-value use cases, think horizontal and aligned personas, things like security and customer experience, chatbots that we can, that can be deployed horizontally across many of our customers, think broad-scale vertical applications where they're deeply verticalized and multi-dimensional, and then the full stack infrastructure to underpin the applications and solutions.

Now, we are leveraging our deep partner relationships to understand and use our customer knowledge to influence our road maps, very similar to what we've done in the past, whether it's cloud or security and to bring to market products that are suitable for fit for certain customers. We're expanding our engineering and services capabilities. We're partnering with innovative AI start-ups. And we're developing our own internal experience, which helps us operationally, but builds credibility with our customers. Where we sit now, Adam, is a primarily a services engagement. We have a lot of activity around those two solutions, MOAT and Discovery, that I, that I mentioned. And typically, in those we're finding that customers come to find that their data is not in the shape that it needs to be. And that leads to engagement around data and data governance and data security, et cetera.

Over time, we would expect the arc of AI to move from the application layer and the services that we're providing through to inference at the edge and then into the data center. But it's going to be a journey, and we're in the early innings. And we've seen this before play out. We certainly feel absolutely confident that it will be a full stack play and that our strategy and the strength of the partnerships is going to we're positioned and are already capturing the ability to navigate our customers through the journey.

Yeah, 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, as we talked about. So that's number one.

The thinking, Adam is, look, if you look back over history of seasonality, historical seasonal 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. We think that there's both catalyst there, but also kind of an existing tangible pipeline that we see. And so when you add that together and you think about the context of historical seasonality in the more mid-teens, our Q2 outlook would actually be short of that seasonality modestly, and we think that knowing that Q1 was a slower start, there's a decent pipeline there, and we know that ultimately, our customers have to get back to these critical spend items we have confidence in ability to get to that level from a seasonality perspective in the second quarter.

Yeah. 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, they really can't hold off on any more. They, 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.

Yeah, sure, and good morning, Samik. 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. So just to give that kind of backdrop, if you will, that is the economic and financial environment continues to, to get more complicated Samik, for sure.

The other element I would add is on the solutions front a year, a year later, notwithstanding those comments about macro uncertainty persisting. We've got several categories that obviously have gone through pretty significant market transitions and digestion of capacity. And really, it all points back to as the clock moves forward, we get closer and closer to those catalysts that we talked about, that is need for network modernization, need to address workload and data growth. And so our confidence on the solutions front is that, ultimately, customers will have to act on those things. And I would say our pipeline reflects a lot of those intended actions just the, the space that we're in right now is customers are deferring, taking longer, have more decision-makers to get to that solution spend, but we know that it's out there. So, that would be how I compare the different periods.

Look, hopefully we'll get more economic and financial clarity that will assist. Hopefully, we'll get further down the path of customers thinking about what their IT road maps will look like in this era of AI. And then we do believe that we would see more balanced spending across both solutions and transactions.

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 [Phonetic] gross margin similar to 2023.

Amit, it's Chris. I think what we're seeing with storage right now are a confluence of two 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, 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, the storage growth in this period.

Yeah. Thanks, Amit. I appreciate the question. 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 look 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. We feel like we've got plenty of opportunity and optionality to be, to be able to create value across all four of the priorities in our capital allocation scheme.

Yeah. Good morning, Matt. On federal, I'd tell you that the federal budget delay, which was about, pushes things out by about six weeks to eight 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 we're 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.

So what I would say, Matt is, as we think about seasonality back to the full year, landing more on what you'd see as a federal seasonal year with it being more back-end loaded. And remember, sometimes when you get pushed out by a quarter or so in terms of the government decision-making, oftentimes, you just need to get the PO1 [Phonetic] by the end of the year. So it's possible we see some of it pushed even into the following year that January sometimes happens. But what I would just tell you is, we knew it was coming. We've been working with the customers poised to start moving the orders, and I feel quite good around federal playing out seasonally for the year.

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 is get to Win 11, frankly. And it's also an interest in getting ahead of any increasing demand. We are, 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. The AI PCs will come. There is interest. There's a lot of talk with customers, a lot of talk around which personas are they best going to be used for. But right now, what we're, what our partners are providing have ample compute power to handle the AI that is in current form.

Yeah, 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, the progress, the speed with which AI functionality is moving is really fast and they're taking that into consideration.

But I would say that the, it feels very similar to 2023. And as Al mentioned, I mean, this quarter, we created more uncertainty in some ways than we saw in certain quarters last year. So, it's not that dissimilar. And it really does have to do across what I'll call, complex solution sets. Remember, we don't really have customers buying point products per se. We are seeing in some areas of server, for example, refresh. We're just at the point where customers need to refresh, and we're figuring out how to do that or potentially starting to move some things to cloud. But I would just characterize it very similar to the trend from last year.

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, what's around the corner phenomenon, if you will from a corporate perspective, just caused more delay in deliberation.

And then to Chris' point, you add on AI and the complexity of the, what is it ultimately going to mean for these customers' infrastructure environments, and it's just more impetus to say, let's take a little time. And I think the corollary there, Erik would be that we had a pickup in client device, and it was literally across our end markets. And so we would have said that, that was a catalyst that was out there, and that was a catalyst that started to see some free up call it, modest but some free up of spend in that, in that regards, because despite it being a catalyst kind of been held back before, it really was the lowest friction choice for customers. And so that's how the quarter played out.

Yeah. And I would just add that the durable, the durable categories we've seen over the last several quarters are security and cloud.

Yeah.

Yeah, Erik, a couple of things. So look, from a, 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, 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. So while that doesn't help from a gross margin perspective, it certainly does help from a gross profit perspective, right, because you're getting the volume. And I think if you look down our P&L for the quarter, you'd see the delta on net sales was closer because we saw more from a client device perspective.

So there are some puts and takes within that. But I'd say we're in the range of with solutions being a little lighter, client being a little stronger, and frankly, continued durability of netted down revenues, there's not much of a change there on the gross margin front.

Yeah, 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, 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.

As we understand it now and what the, the new product generations look like, I think that's true.

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.