CDW Corporation

Ladies and gentlemen, thank you for standing by and welcome to the CDW third quarter 2020 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. If you require any further assistance, please press star 0. Thank you. I would now like to hand the conference over to your speaker today, Brittany Smith, VP of IR and FP&A. Please go ahead.

Thank you. Good morning, everyone. Joining me remotely today to review our third quarter financial results are Chris Lacey, our Chief Executive Officer, and Palin Kibo, our Chief Financial Officer. Our third 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 this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release in Form 8-K we furnished to the SEC today 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 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 in Form 8K we furnished to the SEC today. Please note that all references to growth rates or dollar amount increases in our remarks today are versus the comparable period in 2019, unless otherwise indicated. In addition, all references to growth rates for hardware, software, and services today represent U.S. net sales only and do not include the results from CDWUK or Canada. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is a property of CEW and may not be recorded or rebroadcast without specific written permission from the company. With that, let me turn the call over to Chris.

Thank you, Brittany. I'll begin this morning with an overview of third quarter results and drivers of performance. I'll provide our perspectives on the current macro environment, its impact on our customer and market, and how we are responding. Colin will then take you through a more detailed look at our third quarter financials, as well as our liquidity position and capital allocation strategy. We'll move quickly through the prepared remarks to ensure we have plenty of time for questions. For the third quarter, net sales were $4.8 billion, 3.1% below last year and down 3.3% in constant currency. Non-GAAP operating income was $386 million, an increase of 1.5%. Non-GAAP net income per share was $1.83, 8% above last year on a reported basis, and up 7.7% in constant currency. The quarter demonstrated the balance and strength of CDW's business model. The diversity of our customer and markets served us well. For our most impacted customer and markets, the rate of decline stabilized and generally improved in the quarter. Trends for our more resilient customer and markets continued to be strong. Our value proposition really resonated with customers this quarter. There was a flight to quality as customers sought to de-risk projects and their technology investments. Our teams are trusted, strategic partners to our customers. We compete on value and advice, not only price. We helped customers this quarter across a spectrum of IT priorities. Customers were focused on remote enablement, optimization, cost reduction, security, and leveraging technology for better customer and employee engagement through digital transformation, with an increasing focus on cloud. Customer demand for software as a service increased almost 50% quarter over quarter. customers leveraged our cloud solutions capabilities further bolstered by our acquisition of IGNW at the beginning of the quarter. Our solutions business strengthened this quarter, as some customers resumed projects that had been put on hold earlier in the year, and others started new projects. During the third quarter, we continued to leverage our distribution center's extensive logistics capabilities, deep vendor partner relationships, and strong balance sheet and liquidity position to navigate supply challenges. We successfully procured supply in high-demand categories and managed through longer lead times for others. Now let's take a deeper look at the customer and market performance. Corporate declined 13%, markedly better than May and June. Solutions strengthened, increasing low single-digits year-over-year. The significant quarter-over-quarter improvement in solutions reflected customers restarting infrastructure and project engagements. Transactional projects were down double digits, as spending on remote enablement moderated. Small business also declined 13%, a considerable improvement versus the second quarter. Most product categories declined less this quarter, as small business customers remained focused on remote enablement, security, cost management, and optimization. The government team increased net sales high single digits. federal delivered another strong quarter with net sales up mid single digits. During the quarter, our device as a service solution for the U.S. Census Bureau contributed less incremental growth than other quarters since the majority of last year's revenue was recognized in the third quarter. We are in the final phase of the project. Data collection has ended and devices are returning to us for decommissioning. Our team has done an excellent job navigating the complexity of this program from the very start. Outside of the census project, the federal team continued to help civilian agencies with remote enablement and device refresh. Some Department of Defense solution projects got pushed to future quarters, dampening performance. The state and local team delivered high single-digit growth. IT investments continued to be a priority for public safety. In some cases, budget was reallocated to support technology initiatives. Our team helped customers enable remote capabilities, enhance security, and optimize technology assets. Education increased over 30% with excellent growth in both K-12 and higher ed. In K-12, customers continued to focus on equity and access for students. K-12 growth was driven by strong notebook results and related accessories, security, and software, as well as cloud solutions to support remote learning. Higher ed performance strengthened this quarter as schools turned to us to leverage our extensive logistics capabilities and optimize technology to teach in new formats. Healthcare declined about 25% as budget pressures continued to impact spending. Customers are spending where they have to in areas like security and software. Otherwise, projects were still on hold during this quarter. Other, which represents our UK and Canadian operations, decreased 8% on a reported basis. UK net sales declined high single digits in constant currency. UK's corporate and public channels declined as government support programs ramped down during the quarter. Canada net sales decreased low double digits in constant currency, an improvement compared to second quarter performance as some corporate projects came off hold and education remained strong, driven by remote learning needs. As you can see, our third quarter performance benefited from the diversity of our customer base, It also benefited from our deep and broad product portfolio. We were able to meet the varied and shifting demands of our customers. U.S. hardware was down low to mid-single digits, with client devices declining 2% due to desktop performance. Notebook growth was still strong, driven by our public sector. Software increased low single digits, and software gross profit increased strong double digits, reflecting the impact of mixing into software as a service, Services grew high single digits driven by strong professional services. Transactions were down slightly on top of last year's mid-teens growth. Solutions declined low single digits, a significant improvement from last quarter's double-digit decline, as some customers restarted infrastructure and larger project engagement. We again delivered strong growth in our cloud practice. Cloud customer spend increased double digits across all customer end markets given by robust growth in security, collaboration, infrastructure as a service, and productivity. We expect strong customer demand for cloud solutions to continue. Security also continues to be a top priority for customers. Security customer spend grew strong double digits this quarter as customers improved their security frameworks to respond to increasing threats. Our third quarter operating and financial performance reflected the combined impact of our balanced portfolio customer and market, our full fleet of solutions and services across the IT landscape, and our ongoing success executing our three-part strategy for growth. They are important drivers of our past and future performance. Let me review each. As you know, we have five U.S. sales channels, corporate, small business, government, education, and healthcare. This scale enables us to further align sales teams into vertical customer end markets, including federal government, state and local government, K-12, and higher education, providing us deep industry knowledge and insights into our customers' objectives and goals, and positioning us as a trusted partner. In addition, we have our UK and Canadian operations. The diversity of our customer and markets serve us well when macro or other external challenges impact various industries and customers differently. Next, our offerings are broad and deep. With over 100,000 products, services, and solutions from more than 1,000 vendor partners, we are well-positioned to meet our customers' total needs across the spectrum of IT and can pivot quickly to trends in customer demand. As I shared, the balance of our customer and markets in our offerings are especially relevant in the current environment. And the final driver of our performance, our three-part strategy for growth, which is first, to acquire new customers and capture share, second, to enhance our solutions capabilities, and third, to expand our services capabilities. Each pillar is crucial to our ability to profitably assess, design, deploy, and manage the integrated technology solutions our customers want and need today and in the future. Today's environment strengthens our commitment to executing our strategy so we will emerge stronger than ever after this crisis. Let me share a few examples of our strategy in action and how we helped customers this quarter. Our K-12 team was extraordinarily busy this quarter. One reason was the award of a contract from the Mississippi Department of Education to support its equity in distance learning program. This is one of the largest education technology initiatives in the United States in the last decade, funded via the CARES Act. It will help close the technology gap and support all public school districts in the state by providing students and teachers with secure devices and accessories backed by our services. The team leveraged our logistical excellence, our broad services capabilities, and our strong vendor-partner relationships to procure and deploy the devices in a supply-constrained environment, all done within a very compressed timeframe, given the urgency. This is a great example of how our teams align with their customers' missions and deliver creative solutions and differentiated values. Digital transformation, in particular cloud adoption and integration, is a top priority for many of our customers. Cloud creates complexity, especially if customers integrate their infrastructure, balancing applications on-prem and in the cloud. Our team worked with a large retailer to develop its future state business strategy for its on-premise and cloud platforms to operate as one. This is a great example of where our services and products and solutions portfolio combined for the best outcome for our customers. It also demonstrates the value IG&W brings to CW and how we are leveraging its cloud-native service expertise. Another customer in our corporate channel had a problem with its incumbent primary IT partner, which was exacerbated due to the pandemic. The IT director urgently turned to his CW account manager to help move the company's employees to work from home when the other partner failed to deliver. The account manager responded quickly and exceeded expectations, which has since resulted in the customer moving all of its IT business to CDW. Our team has also helped the customer develop a strong collaboration platform and is helping with a variety of initiatives, including lowering IT costs, increasing flexibility of its on-premise backup storage, evaluating cloud options, shoring up its security, and augmenting its IT staff and CDW resources. Our work here represents another example of how customers turn to us for a high level of customer service, expertise across the full IT lifecycle, and thought leadership. These examples highlight CDW's three-part strategy for growth and how IT is crucial to achieving our customers' objectives. This quarter demonstrated the importance of our competitive advantages, the success of past investments in cloud and security, and our trusted partner relationships with customers. I am proud of the way our teams continue to execute and deliver. Let me now update you on our efforts to manage COVID-19's impact on our business. We remain focused on three key principles. Safeguard the health and well-being of our coworkers, serve the mission-driven needs of our customers, and support our communities. Our office coworkers are still working from home, and the team has settled well into the new way of working. We expect most coworkers will be working from home until the start of next summer. Coworker engagement, productivity, and collaboration are strong, testaments to the strength and resiliency of our culture. We are planning for when and how to return to the office and where and how our coworkers will work in the future. We will remain agile in this unpredictable environment. All distribution and configuration centers are operational, and we maintain precautionary measures as advised by public health authorities. These teams have done an exceptional job maintaining the high level of customer service we are known for while taking the necessary precautions. Let's now turn to the fourth quarter. The macroeconomic outlook for the near term and for the foreseeable future remains uncertain. Wildcards include the duration and severity of COVID-19, tomorrow's U.S. elections, additional stimulus programs, supply disruptions, and U.K.-EU trade negotiations. Therefore, we are not providing 2020 targets. Q4 to date writings trends for our corporate channel are in line with Q3. Writings trends have improved for our small business channel. Public strength continues to be driven by education and government offset by healthcare. We are encouraged about our performance and how our teams are executing. That said, we are also cautious about the macro environment. There are a lot of unknowns and factors that we do not control. This is just a time of unprecedented uncertainty. Our customers continue to be in various phases of responding to the macro environment. Some customers remain focused on remote enablement and operational continuity. Others are moving forward with organizational efficiency and optimization. And other customers are investing behind digital transformation, including cloud. It's important to remember that cloud is not an endpoint. Cloud is an element of our customer's IT environment, and it adds complexity, which is a core to our value proposition. Our teams help our customers with a full IT solution stack and full IT lifecycle. We will continue to be trusted partners to help our customers smartly deploy their IT resources, adopt modern software and infrastructure patterns and practices, and solve some of their toughest challenges. We believe that technology will be more essential to all sectors of the economy and will play an increasingly important role in the years to come. We have confidence that we have the right strategy in place. The increase to our dividend and restarting of our share buybacks that we announced today demonstrate the confidence that our board of directors and I have in CDW's strategy and future performance. The investments we have made, including investments to support our cloud and security practices, will enable us to continue to meet our customers' needs. We will help our customers navigate the complex IT landscape and adopt new technologies. While there is uncertainty in the near term, we believe we are making the right moves for long-term success. We are committed to investing in our three-part growth strategy, including the capabilities that will position us to best serve our customers, optimize our productivity, and enhance our competitive position. Our role as a trusted, strategic partner to our customers is more important now than ever. we will continue to do what we do best, leverage our competitive advantages to help our customers address their IT priorities and achieve their strategic objectives, and out-execute our competition. Now Colin will share more details on our financial performance. Colin?

Thank you, Chris. Good morning, everyone. I'm going to provide more detail on our third quarter results, liquidity position, and capital allocation priorities. Turning to our third quarter P&L on slide 9, consolidated net sales were $4.8 billion, down 3.1% on a reported and average daily sales basis. In constant currency, consolidated net sales declined by 3.3%. On an average daily sales basis, sequential sales increased 8.9% versus the second quarter. This was higher than historical seasonality, primarily due to the adverse impact of COVID-19 on second quarter results. Our customer channels generally performed consistent with the demand and writings commentary shared on our last earnings call. Pockets of supply dislocation continued in the quarter, and we leveraged our distribution capabilities and strong vendor-partner relationships to procure the IT products and solutions our customers needed for remote enablement, operations continuity, and resource optimization. Gross profit for the quarter was $826 million, an increase of 1.1%. Gross margin was 17.4%, up 80 basis points over last year. The better than expected gross margin expansion was driven by product margin and mixing into netted down revenues, primarily software as a service, which more than offset mixing into public. Turning to SG&A on slide 10, our non-GAAP SG&A increased 0.7%. The increase was primarily driven by higher payroll costs from the acquisitions of Atris and IG&W and COVID-19 expenses to safeguard and compensate frontline coworkers, partially offset by continued savings measures, including decreased travel and entertainment and hiring restrictions. In September, to ensure the alignment of our cost structure and resources to best position CDW for future growth, we reduced our workforce by approximately 2%. Our realignment measures enable us to continue to evolve with customers' most important priorities, ensuring capacity in high demand areas to support future growth, and to continue investing in the business to emerge stronger from the crisis. We recorded a charge of $8.5 million, which you can see in the gap to non-gap reconciliation on slide 10. Coworker count at the end of the quarter was 9,980, down 68 from the second quarter, reflecting the realignment measures and restrictions on hiring and back bills, partially offset by IG&W. Year over year, coworker count increased to 137, primarily driven by the asterisk in IG&W acquisitions. GAAP operating income was $318 million, down 0.9%. Our non-GAAP operating income, which better reflects operating performance, was $386 million, up 1.5%. Non-GAAP operating income margin was 8.1%. Moving to slide 11, interest expense was $40 million, down 5.1%. The decrease was primarily due to a lower LIBOR rate on the term loan. Our GAAP effective tax rate shown on slide 12 was 22.7% for both the third quarter of 2020 and 2019. This resulted in third quarter tax expense of $57 million compared to $59 million last year. To get to our non-GAAP effective tax rate, we adjust taxes consistent with non-GAAP net income add-backs, including excess tax benefits associated with equity-based compensation, which is shown on slide 13. For the quarter, our non-GAAP effective tax rate was 23.3%, down 250 basis points versus last year's rate. The rate decrease is primarily related to a one-time impact of state tax refunds and reduced global intangible low tax income and non-deductible expenses due to recent IRS regulations. As you can see on slide 14, with third quarter weighted average diluted shares outstanding of $145 million, gap net income per share was $1.33, down 2.6%. Our non-gap net income was $265 million in the quarter, up 6.2% compared to last year. Non-gap net income per share was $1.83, up 8% from last year. Turning to year-to-date results on slides 15 through 20, revenue was $13.5 billion, an increase of 0.1% on a reported basis and down 0.4% on an average daily sales basis, as we had one extra selling day in the first quarter of 2020. The extra selling day will reverse in Q4 when we have one fewer selling day compared to prior year. On a constant currency average daily sales basis, year-to-date consolidated net sales were down 0.3% from prior year. Gross profit was $2.3 billion, up 3%, and gross profit margin was 17.2%, up 40 basis points. Operating income was $847 million, and non-GAAP operating income was $1 billion, up 0.2%. Net income was $550 million, and non-GAAP net income was $691 million, up 2.6%. Non-GAAP net income per share was $4.77, up 5.2%. Turning to the balance sheet on slide 21, as of September 30th, cash and cash equivalents were $1.25 billion, and net debt was $2.7 billion. Liquidity continues to be strong with cash plus revolver availability of approximately $2.2 billion. Year-to-date free cash flow was $837 million as shown on slide 22. This is higher than normal seasonality and above last year's $590 million, primarily due to higher cash profit and lower investment in working capital this year. A portion of the better than normal seasonality is working capital timing that we expect to reverse over the next few quarters. Moving to slide 23, the three-month average cash conversion cycle was 16 days down one day from last year's third quarter. While cash collections were solid in the quarter, DSO increased five days driven by the strength of netted-down items such as software as a service, mixing into some larger public customers who can take longer to pay, and certain commercial customers extending payments. BPO increased six days driven by the strength of netted-down items and mixing into vendors with extended payment terms. In the quarter, we returned $54 million of cash to shareholders through dividends and did not repurchase any stock. Turning to capital allocation priorities on slide 24, as Chris noted, we announced earlier today that the Board of Directors declared a quarterly cash dividend of 40 cents per share to be paid on December 10th to all shareholders of record as of the close of business on November 25th. This represents a 5.3% increase over the current dividend. We also announced that we will be resuming share repurchases this quarter. The dividend and share repurchase actions reflect our strong liquidity position, net leverage below the target range, and the free cash flow generation capability of the business. The decision to return capital to shareholders is consistent with our capital allocation priorities, which are First, increase the dividend in line with non-GAAP net income. The annual dividend of $1.60 is approximately 25% of trailing 12-month non-GAAP net income through September. The Q4 2020 dividend marks the seventh consecutive year of increases since our initial public offering in 2013, with the dividend growing at a compound annual growth rate of 38% from its initial level. We will continue targeting a 25% payout ratio going forward, growing the dividend in line with earnings. Second, ensure we have the right capital structure in place with a targeted net leverage ratio of 2.5 to 3 times. We ended the quarter at 1.8 times below the low end of the range. Our third capital allocation priority is to supplement organic growth with strategic acquisitions. We closed on IG&W at the beginning of the third quarter and remain active in evaluating targets and will seek to be opportunistic in this environment. Any decision to deploy capital for acquisitions will be a function of our usual screens, strategic rationale, operating in cultural fit, and financial return. Fourth, as I previously mentioned, we are resuming our share repurchase program. Going forward, we expect to move closer to our target net leverage range through a combination of organic investments, M&A, and or returning greater than 100% of free cash flow to shareholders. As we always do, and particularly in this uncertain environment, we'll closely monitor the macroeconomic environment, our liquidity, working capital, and leverage, and adjust as needed. Lastly, on the topic of capital, we intend to continue capital expenditure investments in the business. We believe it's important to continue prudently investing in the capabilities that will allow us to better serve customers, drive productivity, and ultimately emerge from this crisis in a stronger competitive position. We previously withdrew our 2020 targets and will not be providing an updated financial outlook. But consistent with the last two quarters, I wanted to provide insights into what we're seeing roughly one month into the fourth quarter from a demand, supply, and operating perspective. On the demand side, activity continues to be mixed across customer and markets. In corporate, October writings declined in line with the level of Q3 writing declines. In small business, October writings improved from Q3 levels. And in public, October writings were up year over year, driven by continued strength in education and government, partially offset by declines in healthcare. While encouraging, as Chris mentioned, we believe it's premature to extrapolate October writings over the balance of the quarter, given the wild cards of COVID-19, the election, stimulus, and supply. We expect commercial customers to continue to be cautious. As I previously mentioned, we have one fewer selling day in the fourth quarter, which adversely impacts quarterly profit growth by approximately 200 basis points. On the supply side, we continue to navigate through a fluid environment with pockets of dislocation, extending lead times in certain categories. Notebook supply, particularly lower end devices such as Chromebooks, is tight. Also, freight challenges may develop as we get closer to the holidays. On the operating front, all distribution centers continue to be operational. Finally, I want to provide an update on the device-as-a-service solution to the U.S. Census Bureau. The contribution to third quarter net sales was in line with expectations as we had deployed all the devices into the field. The contribution to incremental growth was less than preceding quarters since the majority of last year's revenue was recognized in the third quarter. As Chris mentioned, data collection for the U.S. Census has ended and we are in the final phases of the project. Devices are returning to us for decommissioning. From a financial perspective, this year we now expect the Census to contribute up to approximately 180 basis points of incremental net sales growth over 2019. On an absolute basis, we currently expect the Census to contribute over 230 basis points of net sales in 2020. The collection and decommissioning timing remain fluid, so we could see some net sales shift into the first quarter of 2021. That concludes the financial summary. With that, I'll ask Jacqueline to open it up for questions. Can we please ask each of you to limit your questions to one with a brief follow-up? Thank you.

As a reminder, to ask a question, you will need to press star 1 on your telephone keypad. To withdraw your question, press the pound or hash key. Your first question comes from Tim Yang from Citi. Your line is open. Hi.

Hi, thanks for taking my question. In the past three years, your Q4 gross margin was higher than Q3. When we think about Q4 this year, I think your mix should be better on a quarter-to-quarter basis, given the recovery. So your gross margin should be better sequentially. Is that the right way to think about your gross margin for Q4 this year?

Morning, Tim. Thanks for joining the call. We're not going to provide guidance on the Q4 outlook. I guess what I would just share on your observation is that Historically, Q3 has been a seasonally high sales quarter driven by strength in education and government, which tend to have lower gross margins. I think what's happening historically is coming off of that seasonally high quarter where we mix into government and education, you come off of that into Q4, and that's why you would see the gross margin tick up historically. I think given what's happening in the marketplace right now, particularly in education, all bets are off on normal seasonality. So I would just offer those thoughts.

Got you. And then regarding your Q4 corporate and SMB writing commentaries, I think you mentioned the decline since your last quarter. And then last quarter, I think the decline was roughly down on meetings on a year-to-year basis. We have seen many supply chain companies mentioned that projects are coming back. I was wondering why you're not seeing that improvement in your SMB and corporate business? Is that more just a conservatism or just like your visibility is not quite improving compared to last quarter? Thanks.

Hi, Tim. It's Chris. Good morning. And I would say that we saw a nice increase in our solutions project-based business. We had mentioned on the last call that customers had continued to pause on moving forward. They were in planning stages. We did see more customers both in our corporate space and small business space start to move forward on infrastructure projects, for example, and larger projects. I would say, you know, on the corporate side, there's still caution, and they're not quite as nimble as the small business organizations generally have a lot more kind of bureaucracy and approvals to get through. So that seems to be going a little slower, but certainly we're seeing some pickup in both of those segments.

Great. Thank you.

Your next question comes from Amit Daryanani from Evercore. Your line is open.

Good morning, and thanks for taking my question. I guess I have two as well. Just first to just clarify the writings discussion. I think the way you guys characterized this is on the corporate side, things are about stable or they're about what they were in the June, in the September quarter so far. And then the SMB is starting to improve. The pace of declines are starting to ease up. I want to make sure I got that right. And then any sense on how transactional versus solutions is trending from our writings basis so far?

Amit, it's Chris. Yes, you read that right. You got that exactly right on the writing the way we described it. But we're not splitting out writings for solutions versus transactions.

Got it. Maybe I would ask you a different one then. If you could talk about what percent of your gross profit dollars today in the September quarter are agency-based or reoccurring in nature. And as you think longer term, it would be really helpful to understand how What does the growth rate look like for that gross profit dollar bucket versus the overall company? And then what are the key components within this agency and reoccurring revenue stream that you have?

Good morning, Ahmed. Netted down items were approximately 30% of total gross profit dollars in the quarter, which is one of the higher numbers we've seen. And that really reflects the strong mix into cloud, specifically software as a service that both Chris and I talked about in our prepared comments. Included in that bucket is cloud. Security software and other software offerings that net down warranties, those would be the primary things that you'd see in that bucket. In terms of how that trends over time, I think we would expect customers to continue moving into cloud and we expect strong demand for security software. So I think we would expect customers Solid growth in that bucket. I think the wild card, again, in terms of where it goes is what happens to the hardware part of the business. Obviously, that's been a little bit more challenged in the COVID environment. In the preceding three years, it was very strong. So I think exactly where that mix goes is probably more a function of how hardware gross profit trends over the next couple quarters and years.

Perfect.

Thank you.

Your next question comes from Adam Tyndall from Raymond James. Your line is open.

Okay, thanks. Good morning, Chris. I just wanted to start on the decision to resume share repurchases and how we should read into that. You still have over $2 billion in liquidity. You're well below your optimal leverage levels. And, you know, previous discussions before COVID, you were not precluding yourself from a larger size acquisition, a billion plus type of an acquisition. So I guess the question would be wondering if you could maybe share your latest thoughts on the M&A landscape and how that's evolved.

Yeah, sure, Adam. Well, you know, the decision to restart our buybacks is a real reflection on both our confidence in our strategy and performance views going forward, in addition, obviously, to our strong free cash flow and liquidity position. On M&A in particular, I'll repeat what I've said over the last few quarters. We are actively looking to invest prudently to supplement high-growth technology areas. You've seen us do a couple of acquisitions recently in ServiceNow capabilities and cloud-native capabilities, both of which have been taken up very well by our sales organization. and really solidifying our advisor position with our customers. Those are the types of acquisitions we'll continue to look at and do look at. I would tell you, Adam, that the market itself feels a little more buoyant. Organizations are out, you know, open to discussion now more than I'd say they were a couple months ago. But you know our lenses. We look for those that fit our capabilities, our strategic capabilities, our culture and operating model, and then ultimately make financial sense.

Okay, that's helpful. Maybe just as a follow-up, I wanted to ask on OpEx. I think if I have it right, you previously talked about letting attrition run its course. It looks like demand is kind of turning a corner a little bit. The down margin was very healthy in the quarter. So I just wanted some more color on why reduce the workforce. I know it's not a significant number in and of itself, but a little bit. unusual for CDW to do that. So maybe more color. Did expectations for future growth change? Why would you undertake that? Thank you.

Yeah, Adam, it's a great question, and you're right. Those are hard decisions for CDW in particular. It's just the second time in our history that we've reduced the workforce, and we reduced it by about 2%. But really, this was all about ensuring alignment of our cost structure and resources to best position us for the future. So we really need to ensure we've got the resources to continue to develop with customers in their most important priorities. We wanted to make sure that there's capacity in the high-demand areas to support the future growth and continue investing in those more emerging areas. So while we have cut back some positions, we also are hiring in those areas that we think are critical to our future growth.

That's helpful. Thank you.

Your next question comes from from Credit Suisse. Your line is open.

yeah thank you uh chris you mentioned a lot of moving pieces out there from a macro standpoint you're prepared to march and clearly spend a year that's below trend from an ips spending point of view i guess just thinking about looking forward curious if you think customers are sitting now at this point with a meaningful amount of pent-up demand as we head the next year that should maybe help turn things around or if there's risk that this more sluggish demand environment continues as we start getting into next year

Yeah, good morning, Matt. Look, I think if it's possible to have both, I would say yes to both. Why do I say that? Because I think until this medical problem is resolved, it's going to be very difficult to have a clear trajectory of the economic environment. And that has an impact, obviously, on certainty. and actions that our customers are taking. So it's just murky, and that murkiness makes it very difficult to predict. I certainly think that we have two things. We have pent-up demand, and we have customers who are frankly pressing advantage, who are buying technology and implementing technology at a higher pace to press their advantage. But as far as pent-up demand, I think the real question becomes when are customers feeling When are they feeling comfortable enough, excuse me, to make larger investments? And, you know, I just think that's incredibly difficult to predict. What we're doing is staying close to the customers. You've heard us talk about the complete spectrum of IT that we're providing, and we're just making sure that they get what they need when they need it better than anyone else in the industry can do it. But it's hard for me to predict the future given the murky nature of the current outlook.

Got it. And then looking by vertical, education was clearly the standout in the quarter. One of you can talk a little bit more about just what you're seeing there and how sustainable you think those tailwinds are, just particularly relative to the ability to actually get enough supply to meet demand going forward.

Yeah, it's a great question. The supply has been an issue, but we've been doing very well with our suppliers to get more than our fair share to help education institutions. It's unfortunate when we can't get the supply to the schools at the very start of the school year, but we have been. moving a very large amount of product through our configuration center and out to the schools. I think what you're going to see, Matt, is demand in Q3. We'll continue to see Q4 because of the supply chain constraints and because of the carryover from Q3. We might see a little bit flow into next year, but it feels like this is really a 2020 pull forward, if you will. A lot of organizations have been looking at equity and access, and these are the plans that they were making over a couple of year period, and it feels like it literally got pulled into 2020 this year. Now, that said, Matt, I would tell you that there will be opportunities, obviously, going forward around things like collaboration and other areas to fortify the remote work requirements as we think forward.

Got it. Thanks for that, Kellya.

Your next question comes from Rupu Bhattacharya from Bank of America. Your line is open.

Hi. Thanks for taking my questions, and congrats on the quarter. I just wanted to ask a high-level question first. As we see new restrictions and lockdown measures in Europe, can you just give us your thoughts on that? And also, what percent of your workforce is now working from home, and do you think CDW is in a better position to handle if there's a resurgence in COVID and lockdowns?

Morning, Ripley. Thank you. Good to hear from you. Yeah, I think that we have to be cautious and all the locations where we start to see more restrictions and lockdowns and for a couple reasons. And for a couple of segments, I think in the UK, as you know, we have some government stimulus money that is rolling off, and that is tending to have an impact that we're seeing. Add to that lockdown and the economic commercial impact that has, we do worry about that. That said, we still have customers, as I said before, who are digitally advanced and really pressing their advantage and absolutely moving forward with some larger projects. Across the US, I would also say that cautiously, if you look over the last week or so, and the trajectory and uptick in cases is worrisome as different states potentially are moving backwards in their restrictions and lockdown. So look, as I said, I'm so encouraged by the team and the execution and the performance of this team, but I'm highly cautious about the exogenous factors that we can't impact. As far as work from home, look, the team settled in. This is a performance-oriented organization, and everybody went home. We got ourselves set up, and we were off to the races. I give our coworker services and sales leadership a huge kudos for figuring out very quickly creative ways to drive productivity, connectivity, and human touch both across our sales organizations and with our customers, and they've been doing just great.

Great. Thanks for that, Ben. I appreciate all the color there. Chris, I wanted to ask you also on the device as a service project, how that the census project is coming to an end. What's the plan for those devices, and can you reuse them in some other program? And how do you see the device as a service business growing over the next couple of years? Thank you.

Good morning, Ruth Blue. I'm going to take that one. Yeah, so we are winding up the device-as-a-service offering to the census. Those devices are coming back to CDW for decommissioning, and what we will do then is turn around and resell those to a remarketer, and we have plans in place to go ahead and execute against that. In terms of devices and services and offering, I think that will continue to be an opportunity for CDW. Clearly, we have competitive advantages in our ability to bundle integrated solutions across multiple vendors, integrating services, as well as our logistics capabilities. And I think what we're doing for the state of Mississippi Department of Education is just another flavor of our ability to deliver that value to customers. And in a world where being able to work productively remotely from anywhere is becoming increasingly important, I think that's going to be an important part of our growth drivers going forward.

OK, thanks for all the details, and congrats on the quarter.

Your next question comes from Shannon Cross from Cross Research. Your line is open.

Thank you very much, and good morning. I'm wondering about the customer demand for staff, and specifically, or actually just MetaDown revenue in general. How much of this revenue is coming from sort of applications versus utilization of the cloud for data storage and processing? I'm just trying to figure out where customers are in their cloud progression, and then I have a follow-up. Thank you.

Yes, Shannon. I guess let me start where customers are in their cloud progression. And I would say that it's the full spectrum. We don't break out application versus consumption usage in those numbers. But I would just tell you that we have customers that are across the full spectrum. Small customers, fully on cloud, high consumption, medium and large customers who are dealing with heavily cloud-oriented applications, but on-prem legacy applications that just don't work in the cloud, and we're working with them in terms of modernizing their data center infrastructure to create one cloud environment, if you will, between their public on-prem private and on-prem legacy work. So it's really hard, I think, to say where customers stand because they're on quite a spectrum, but what I can say is they are all moving to some form of of a cloud environment. And when I say cloud environment, I don't mean landing in the cloud because the cloud is not a place, but it's more an operating system. It's a pattern, not a place, and it delivers an experience, not a destination. So what we see ourselves involved in is that planning and design accelerated by this accelerated digital environment to determine what best cloud environment works for a customer, taking into consideration not just the benefits of a cloud-like environment, agility, flexibility, scalability, but also the cost issues and the legacy technology that they have to deal with. So I'm sorry that's a long-winded answer, but we're selling the spectrum. We're helping customers with the spectrum, and our comprehensive suite of capabilities allows us to do that wherever a customer is on their cloud journey.

Okay, thank you. And then maybe on a segment basis, can you talk about where customers are versus, like, new projects versus continuing to work on remote enablement and continuity. I know you mentioned with education, you think it's going to kind of wind up by the end of this year, or at least hopefully be done pretty much by then. But SMB and maybe enterprise, are you seeing customers still really focused on just making sure their employees have end devices and connectivity, or do you feel like that's kind of done and now people are moving back to, I don't know, prior devices investments or new opportunities. Thank you.

Yes, Shannon, it's a mix across segments. If you look at corporate, for example, we have seen the work from home moderate a bit. And what I mean by that is the notebook devices and the rush to get everybody working from home. I suspect in that segment, for example, We're going to have to see what work in the future looks like and when and how customers start going back to the office. And when they make those decisions, you'd expect a tick up then in terms of things that help optimize either the work from home or the work in the office now. for the hybrid place that they land. But it has moderated a bit in the corporate space. Small business, we continue to see strength in work from home. Now, that could be in some part because small businesses, you know, were a little later to get their devices than maybe the larger businesses. And so it's really different across segments. Healthcare really rushed to the front end. They were obviously a high priority from an allocation perspective for us and others. And so that's moderated in the healthcare space as well. So we're really seeing education, K through 12, higher ed as the primary drivers of continuing work from home. as well as federal. I would say that the government space as well has been continuing to be fairly robust in work from home support.

Thank you. Your next question comes from Katie Huberty from Morgan Stanley. Your line is open.

Thank you. Good morning. Colin, as we think about the Census project wrapping up over the next quarter and one less selling day, is it possible that the revenue decline doesn't improve in the fourth quarter, or do the improved S&B writings create a tailwind that we continue to see a lesser decline trajectory like what you saw in the third quarter?

Yeah, Katie, we're not going to give a specific guide on fourth quarter sales. What I would say is we do have one fewer day. We report sales on an average daily sales basis, so that would normalize for that. The 200 basis points is really a comment about the impact it has on the bottom half of the P&L as we get a little bit of deleverage year over year. As it relates to the census, you know, I would expect the census to provide, you know, solid contribution to the fourth quarter. It is going to provide a benefit. Again, as we look at last year's overlap, most of it was in the third quarter. So it will contribute incrementally year over year. And then I think, you know, as it relates to the comments on writing, we are back to the wild cards. And I think particularly on the commercial side of the business, how those customers choose to react to the election and, you know, what impact the virus and potential additional shutdowns has on their spending plans as we come into the end of the year.

Okay, thank you. And then just on third quarter margins, you mentioned that product margins were better in the quarter in addition to the mix shift to net a down revenue. Can you just talk about what drove the better product margins? Is that a mix shift away from client and starting to see some growth, again, in some of the infrastructure areas like servers and compute?

Yeah, Katie, I would say it was a combination of things. There was some mix within products. So, for example, desktops were pretty soft as notebook has become the form factor of choice. Desktops tend to have low margins. So that helped the product margin a little bit. But I would say that... This pandemic and economic shock is a little bit unique compared to other recessions or slowdowns that we've been through. I think one thing that's different is you have supply-demand imbalance occurring at the same time. And so that supply imbalance, I think, has provided a bit of cushion on the margin. And then I think that the second thing that's unique is just how important technology is to being a part of the solution here. And customers focus on getting things done with partners they trust. And that can manifest itself in speed, level of service, logistics capabilities. But I think what we're seeing is Customers just want it done. They want it done quickly, and they want it done right. And, you know, maybe we're not going to go through another round of bids through the procurement department or whatever it is. And that has played into, I think, some of the product margin durability that we saw in what you might think would be a period of compression on the product margin.

That's great. Very helpful. Thank you.

Your next question comes from Matthew Sheeran from Staple. Your line is open.

Yes, thanks, and good morning. Chris, in your commentary, you mentioned some customer engagements, including some new customer wins due to your capabilities. Can you just talk about that competitive environment? Are you seeing acceleration of new customer wins due to that and due to the fact that customers need more help?

Yes, good morning, Matt. You know, I won't repeat everything that Colin just said, but, you know, when I think about what customers feel today, you know, technology is more critical, technology is more complex, and they need a comprehensive solution to the issues they're trying to solve. And so with a value – trusted partner like CDW, they're more inclined to start leaning into CDW versus, for example, local bars. So what we're seeing out there is while it's a competitive environment, certainly from a pricing perspective, the value that CDW brings to their customers has become more important. I mentioned they're de-risking. their investments they want to ensure that they are getting the full suite comprehensive suite of advice because of the complexity of choice that they're facing and the stakes are high they've got to get technology right and get it to work for them so the value that cdw brings is resonating very well in this environment we are seeing new customers and winning new customers and growing those customers, frankly, pretty quickly. And we're also seeing a quicker move to vendor consolidation. That's always been a value we've brought to customers, but that's ticked up significantly in the environment that we're in across all of our segments, frankly.

Okay, thanks for that. And then I just wanted to ask again on the client devices, particularly on the commercial side where you talked about it being down. You did have some commentary about trends you're seeing. But I just wanted to see, are you just seeing basically that upgrade cycle we saw last year and obviously prepped into this year due to work from home? Are you just seeing signs that that's sort of ending and you're going to be facing some tough times? year-over-year comms in the next couple of quarters on the client device side?

Yeah, Matt, what I'd say is, look, when we were coming into this year, we thought we were in the late innings of client device refresh and growth of moderating. Now, what picked it up early this year, work from home, obviously, learn from home. We're seeing new use cases in the digital world. Think of retail. retail organizations, et cetera. And certainly we might start to see some more pickup and refresh from the 2017 period. But yes, you're right. The overlaps that we're facing from the growth of last year And that's pull forward at the beginning of this year and the education, et cetera, as I said. And then you layer on that just the economic environment, employment. It's hard to say what to expect going into next year. You know, that said, work from home does have a lot of requirements. to make it work effectively. So we continue to help customers even in the medlar space with their security needs, for example, with their collaboration needs, with their productivity suites that they're working through. So even if we don't see notebooks as robust right now, it's the whole solution, work-from-home solution, including the accessories and the services and the collaboration, et cetera.

Got it. Thanks a lot.

Your next question comes from Keith Hasem from North Coast Research. Your line is open.

Good morning, guys. Hey, I want to explore the supply constraints challenges in the corridor. I think it's well known that the challenge is getting the Chromebooks in the door. But perhaps we can provide a little commentary. Did you see that easing at all during the end of the corridor? And then are there other areas of the technologies that you see having also some supply constraints that can help out in the fourth corridor? Good morning, Keith.

Yeah, I think The constraints within Chromebooks are well documented. I don't know that I would say it eased as we exited the quarter. I think it's going to be tight for a while here. Now, obviously, our scale and the fact that we work with multiple OEMs will hopefully help us manage through that and get at least our fair share, as Chris has talked about earlier. In terms of notebooks in general, I would say, again, high demand, and we're just seeing longer lead times than normal. We are hearing about component shortages for things that go into Chromebooks and notebooks, things like panels. In terms of other parts of the market, I would say on the solution side of the business, the supply environment is maybe a little bit better than it was a quarter or two ago. You know, and other areas where we see pockets of dislocation or delays would be other remote work mission-critical categories like collaboration hardware, headsets, and webcams.

Gotcha. Is it possible to quantify, I guess, what the supply shortage is perhaps costing business in the third quarter?

Boy, it would be really difficult to put a number on that. I mean, I could say our backlog is up meaningfully in the notebook category over where it's running, where it's run historically. Great.

Thank you.

And your last question comes from Paul Croster from J.B. Morgan. Your line is open.

Yeah, thanks for taking my question. I'm wondering, Chris, if you could just elaborate a little bit on the uncertainty you're seeing. I think we all understand the whether and when part of it, but I'm wondering if the how is part of the uncertainty as well, given that COVID seems to have been an accelerant, as you described, of change and digitization in particular. How many of your customers just feel unsure of what to invest in given the change to their processes and sort of infrastructure paradigm?

Yeah, that's a great question. I think here's how I would answer it. There are Projects that many customers had in queue, they're rethinking what those look like now, infrastructure projects, for example, in particular. The good news is we've got the capability to sit down and work through that design with them. And in last quarter's earnings call, I mentioned that that had picked up. We were starting to sit down and help customers design for a new world. Every customer understands the criticality of technology and the need to get it right and how different it is today than it was literally just 12 months ago. You know, the acceleration of digital, not a new trend, but an acceleration. So we see that as an opportunity to help our customers get the other side of this stronger than ever. So yes, we have lots of customers who are just wondering what to do, how to do it, and making sure that they are optimizing for their futures. That's a consistent drumbeat with customers, certainly surviving through this pandemic, but absolutely the notion of competitive advantage and how do we come out the other side better and faster and leaner and more agile is what we're talking to them about.

Gotcha. And one quick follow-up for Colin. Can you sort of quantify the revenue headwind associated with the netting down effects of the cloud revenue, of the cloud contracts?

Oh, yeah. paul what i would say is um we have historically seen netted down items growing faster than full revenue items so you know in normal periods of time i would say it that impact has a couple hundred basis points impact so uh a little bit more than than that given um given the acceleration of it gotcha thanks very much yeah

There are no further questions. I will turn the call back over to Christine Leahy, CEO. Please go ahead.

Thank you, Jacqueline. I want to take a moment to acknowledge the continued challenges due to the COVID-19 pandemic. I want to recognize the remarkable dedication of all of our coworkers around the globe and their extraordinary commitment to serving our customers, our partners, and all of our CDW stakeholders. They continuously impress me and reaffirm my conviction that we will emerge stronger from this. Thank you. And thank you to our customers for the privilege and opportunity to serve you. To our investors and analysts participating in this call, we appreciate you and your continued interest in and support of CDW. Colin and I look forward to talking with you again next quarter. Take care.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.