CDW Corporation

Hello and welcome to the CDW first quarter 2023 earnings call. My name is Alex. I'll be coordinating the call today. If you'd like to ask a question at the end of the presentation, you can press star one on your telephone keypad. If you'd like to withdraw your question, you may press star two. I'll now hand over to your host, Steve O'Brien with Investor Relations. Please go ahead.

Thank you, Alex. Good morning, everyone. Joining me today to review our first quarter 2023 results are Chris Leahy, our Chair and Chief Executive Officer, and Al Morales, our Chief Financial Officer. Our first quarter and full earnings release was distributed this morning and is available on our website, investor.cdw.com, along with the 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 8K refurnished to the SEC today and in the company's other filings with SEC. CDW assumes no obligation to update the information presented during this webcast. Our presentation also includes certain non-GAAP financial measures, including non-GAAP operating income, non-GAAP operating income margin, non-GAAP net income, and non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You'll find reconciliation charts in the slides for today's webcast and in our earnings release in form 8K. Please note, all references to growth rates or dollar amounts changes in our remarks today are versus the comparable period in 2022, unless otherwise indicated. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is the property of CDW and may not be recorded or rebroadcast without specific written permission from the company. With that, let me turn the call over to Chris.

Thank you, Steve. Good morning, everyone. We have a lot to cover today. I'll begin with an overview of our results and our outlook, and Al will provide a deeper view into the financials, as well as an overview of our capital allocation priorities, and then we'll move right to your questions. Market conditions were turbulent, with a marked downshift in demand as the quarter progressed, translating into lower business volume. For the first quarter, net sales were $5.1 billion, 16% lower than last year. Non-GAAP operating income was $434 million, down 6%. And non-GAAP net income per share was $2.03, down 8%. While clearly not satisfied with these results, our excellent cash flow and record gross margin reinforce the durability of our underlying profitability and integrity of our strategy. So let's take a look at what happened in the puts and takes of the quarter. First, what happened? In short, demand was weaker than anticipated in our commercial business. When we exited 2022, our forecasts called for a moderate softening of IT demand in 2023 and a mid-single-digit year-over-year decline in first quarter sales. As the quarter progressed, IT demand weakened more than expected as a confluence of events intensified already heightened economic concerns and recession fears. This led to a fairly rapid shift in customer behavior, most notably in our large commercial customers. Projects that drove cost reduction, productivity, and financial returns were prioritized. Project justification and budget scrutiny ruled the day, and although deals were not canceled, sales cycles elongated, written sales slowed, and deal sizes compressed. While all of this translated into lower sales, the value of the solutions we provided customers continued to grow. You see the impact of this in our gross margin momentum. Margins were consistent with last quarter with meaningful year-over-year expansion in each of our customer end markets. But unlike the fourth quarter, our strong margins did not fully offset the magnitude of our net sales decline. Let's take a look at the puts and takes of the quarter by customer end market. Recall we have five sales channels. Corporate, small business, healthcare, government, and education, each a meaningful business on its own, with 2022 annual sales ranging from $1.9 billion to over $10 billion. Within each channel, the teams are further segmented to focus on customer end markets, including geography and verticals. Our commercial operations are organized around geographies, verticals, and customer size. Teams are similarly segmented in our UK and Canadian operations. which together delivered 2.9 billion U.S. dollars in 2022 sales. These unique customer end markets often act in a countercyclical way given the different macroeconomic and external factors that impact each, as was the case this quarter. The shift in large commercial customer behavior had an outsized impact on corporate results with sales down 17% year over year. Declines were particularly steep in client devices, servers, and storage. Three meaningful hardware categories that require capital outlays, outlays under pressure and out of favor. The corporate team's success helping customers achieve ongoing network and application modernization led to excellent NetCon performance, up double digits. Momentum continued around projects focusing on increasing productivity and enhancing customer and coworker experiences. which drove strong growth in cloud and software spend. The small business team posted another quarter of solutions growth, driven by success helping customers address mission-critical priorities around security and productivity, priorities that drove meaningful increases in cloud and software customer spend, on pace with recent quarters. Network upgrade activity also drove a high single-digit increase in netcom with resilience and demand for solutions, the gross margin of the small business channel continued to be accretive to overall margins. Strong solutions performance was more than offset by the ongoing impact of economic uncertainty on transactions, and small business net sales declined 23%. Public sales declined 12%. Performance in government and healthcare held firm, as organizations called on CW to help them extract more value out of their IT footprints, while education remained under pressure. Solutions momentum in healthcare was strong, driven by continued success helping customers adopt technology to drive productivity as an offset to higher costs from rising labor and materials inflation. Cloud performance was excellent as hesitancy over privacy concerns waned and healthcare systems embraced the speed and efficiency that cloud solutions can deliver. Talent needs and data center projects remained focus areas. with customers increasingly using technology to address complex industry challenges. Patient care and patient experience continue to be mission critical, driving ongoing investment in collaboration solutions. However, similar to our commercial markets, greater focus on shorter-term ROI and tight budgets resulted in elongated client devices replacement cycles, and overall sales were flat. Government activities levels were strong. The credibility and track record of the combined and now fully integrated teams of Legacy, CDW, and Sirius opened doors and led to more seats at the table. Since the first quarter is a seasonally light quarter for both federal and state and local spending, our progress is a bit harder to see. Federal's low teens growth was offset by a mid-single digit decline in state and local, and sales were flat to last year. Federal growth was balanced across solutions and transactions categories. The team's ability to help civilian agencies achieve their priorities around data management drove strong server and storage performance and contributed to high single-digit growth and solution. Services increased high teams and cloud spend remained strong. Underscoring the value of our diverse end markets, Federal posted year-over-year transactions growth, which was driven by client video and audio and collaboration. State and local's low single-digit growth in solutions reflected the team's success helping customers address talent gaps through enhanced training, as well as professional services engagement. Double-digit cloud spend was driven by both software and security upgrades. Consistent with the fourth quarter, customers made due with their current client devices, and client-device declines continued. For education, solid higher ed growth was more than offset by the year-over-year declines in K-12. and overall sales declined 27%. Higher ed sustained their track record of enabling student success programs used to promote enrollment. These programs, which are focused on improving security, campus connectivity, and delivering enhanced dorm room experiences, drove double-digit growth across cloud, netcom, storage, software, and security. K-12 posted another quarter of excellent solutions performance. Solutions mid-teens increase was driven by networking and data center efforts, with substantial double-digit increases in storage, servers, and netcom. Our ability to wrap services around applications and physical security drove excellent services performance. The K-12 team's solutions performance was more than offset by a meaningful year-over-year decline in client devices, and overall sales declined. Similar to last year, customers placed a lower priority on client devices, as schools reach student-to-device ratios near or at parity and continue to digest endpoint investments made over the past several years. Instead, schools were focused on networking and data center needs, as well as planning for the next horizon of multi-year funding opportunities, opportunities which, given the expertise that we have in this area, will generate even more ways to serve this important customer channel. Our UK and Canadian operations, which we report as other, continued to execute very well in the quarter, delivering consistent profit performance as customers prioritized strategic investments and solutions. Similar to the US, top line growth for both markets experienced the impact of heightened economic uncertainty, which especially impacted client device demand. UK decreased by mid single digits in local currency, while Canada decreased by high single digits in local currency. Similar to the U.S., strong gross margins reflected higher value mix. Now let's take a look at how the end market performance translated into portfolio performance. The economic uncertainty that led to the downshift in our commercial business impacted performance across all three of our portfolio categories, hardware, software, and services. As a full stack, full lifecycle provider, the deferral of major hardware projects results in lower attach of services and other solutions. All the components of the deliverables are delayed pending implementation of the project. Delays and pushbacks in hardware may dampen warranty and security opportunities, and focus on in-year ROI often drives compressed deal sizes, as many customers elected to favor short-term deals versus multi-year agreements. First quarter portfolio results were adversely impacted by all these cascading factors. U.S. hardware decreased by 21%, a further step down from the fourth quarter. Large commercial customer client device declines had the greatest category impact as corporations worked through the impact of slower hiring and layoffs. Netcom hardware growth was very strong in this quarter and increased across all customer end markets. The strong performance was largely driven by improvements in supply, but also reflected better demand than we expected. U.S. services decreased 2%. Growth was impacted by weakness in services tied to hardware, particularly in warranties. Momentum in managed services growth was solid, and professional services continued to grow, though it was impacted by the delayed timing of full-stack IT integrations. U.S. software growth remained strong. Double-digit increases in network management software and storage, SAM, were partially offset by declines in software categories tied to full-stack projects and employment levels. Security remained a key focus area for customers, but results were impacted by the shift in large commercial customers' buying behavior, and U.S. security sales declined slightly year over year. Significant growth in identity management, privileged access management, intrusion detection, and risk in governments was offset by declines in firewalls. Our largest category, which is also tied to either refresh of physical assets or expansion of customers' footprints. Overall, security demand remained very strong in small business. Once again, cloud was a meaningful contributor to performance with double-digit increases in customer spend and gross profit led by security, platform, and productivity. Within this period of economic uncertainty and heightened customer caution, our trust and engagement with customers and partners was never stronger. Trust and engagement that, when coupled with our capabilities and deep expertise, serves us well today, and trust and engagement that will serve us well when the temporal shift in demand recovers. Although volumes are down, our ability to help our customers drive outcomes across the five components of our iCare framework, especially cost management right now, continues to drive our customer value. Our ability to drive outcomes and address customer priorities across the entire IT continuum enables us to pivot where our customers need us most. An ability that reflects the impact of strategic investments we have made to enhance our high relevance and high growth solutions and services. Investments that are exceeding our expectations in both capabilities and performance. Investments like our acquisition of Sirius have maximized our differentiation in the market, provided more and better seats at the table, increased customer stickiness, and contributed to our evolution as a one-stop trusted partner, a partner with the capabilities and expertise that can help customers achieve the outcomes they need from the technology and solutions they can trust. The strategic actions we've taken have not only strengthened our value proposition, They have also fortified our profitability, contributing to our operating profit margin expansion of more than 100 basis points since 2020. It's our strategy, when combined with our flexible business model, execution rigor, and financial discipline that enables our ability to profitably outgrow the US IT market. And that leads us to our view for the balance of 2023. The initial 2023 US IT market forecast we shared with you on our February call was for flattish growth. Given our belief that first quarter business conditions will persist through at least the second quarter, we now look for the US IT market to contract at high single digit rate for the full year. We continue to target outperformance of the US IT market by 200 to 300 basis points. This outlook assumes that we will see a moderate pickup in activity in the back half of the year, and anticipates that ongoing economic uncertainty will continue to impact customer behavior. Wildcards include deeper recessionary conditions, heightened credit tightness, and debt ceiling-driven liquidity events. As we always do, we will provide an updated perspective on business conditions and refine our view of the market as we move through the year. We are operating in choppy waters right now. We have the strategy, capabilities, and discipline to continue to profitably outgrow the market. And while we have durable processes to manage and align cost to opportunity, given our expectation for market demand, we have amplified our expense discipline to preserve profitability. A hallmark of CDW is to serve our customers whenever and wherever their needs may be. The outcomes technology delivers haven't diminished, and our customers know that we will be there for them regardless of market conditions. CDW is an all-weather team. always adapting and evolving to lead in the market. We have faced turbulent markets in the past and have leveraged our proven business model, unmatched competitive advantages, and deep and trusted relationships to come out stronger. We will do so again. Let me turn it over to Al now, who will provide more detail on the financials and outlook. Al?