Megan opened the CDW Second Quarter 2023 Earnings Call and introduced Steve O'Brien, the Chair and Chief Executive Officer, and Al Miralles, the Chief Financial Officer. Steve reminded listeners that certain comments made during the presentation were forward-looking statements and that the company had furnished an earnings release and Form 8-K to the SEC. He also noted that certain non-GAAP financial measures were used and that all growth rates and dollar amounts mentioned were compared to the same period in 2022, unless otherwise stated.

CDW reported net sales of $5.6 billion, down 9% in U.S. dollars and 8% in constant currency, with non-GAAP operating income of $530 million and non-GAAP earnings per share of $2.56, both up 3%. The company's balanced portfolio of end markets, strategic investments, and expense discipline enabled them to pivot to where customers need them most, resulting in margin expansion and strong profitability.

This paragraph discusses the five sales channels of the company, which range from $1.9 billion to over $10 billion in annual sales. Economic uncertainty caused customers to focus more on short-term ROI, resulting in double-digit increases in cloud spending and double-digit declines in client devices. Despite this, corporate sales experienced a sequential volume increase, and client device ASPs were buoyed by mix into higher value, higher functionality units. Network modernization projects also delivered double-digit Netcom growth.

Small businesses saw a 21% decline due to caution from economically sensitive customers, while client devices were flat due to customers focusing on projects with short-term ROI. Sales increased 2% year-over-year with strong performance in government, healthcare, and education. Government saw double digit growth due to successful implementation of efficient solutions to manage and protect data. Cloud adoption drove strong software and security performance, while customer hesitancy around cloud dissipated. Client devices remained under pressure.

K12 experienced success in the quarter, with a significant sequential improvement in client devices driven by summer sales and anticipated back half refresh. In the UK and Canada, there was a low single digit and low double digit decline in local currency respectively. Transactions were down double digits, while solutions saw mid-single digit growth. All three portfolio categories, hardware, software and services, were impacted by commercial pressure, resulting in lower volumes in services and solutions.

Hardware sales decreased 11% year-on-year, while services were relatively flat. Software customer span increased by mid-single digits, but net sales decreased due to declines in software categories tied to full stack projects and employment levels. Security was up single digits, with growth in endpoint security, e-mail security, identity management and physical security. Cloud was a key driver of performance, with double digit increases in customer spend and gross profit across all customer end markets. Strategic investments in cloud capabilities have enabled profitable growth for customers and stakeholders.

CDW's three-part strategy for growth is to acquire new customers, enhance solutions capabilities, and expand services capabilities. To support this strategy, they are investing in data analytics to gain insight into customer buying patterns and create tailored solutions. This investment has produced tangible results in sales conversion and market relevancy, and is beneficial to both CDW and their customers.

CDW has invested in data analytics and AI expertise to bolster their professional services and consulting capabilities. They expect to outperform the U.S. IT market by 200 to 300 basis points in 2023, but this could be affected by macroeconomic conditions, credit availability, and government budget disruptions. They plan to leverage their competitive advantages and out-execute the competition.

Chris discussed the company's strategy and how it enables them to deliver excellent cash flows and outgrow the market. Al then provided details on the second quarter's financial performance, including net sales of $5.6 billion, a 10.2% increase from the first quarter, and a return to year-over-year growth in solutions performance. He also discussed the supply side, where the dollar value of the backlog declined relative to the first quarter.

In the second quarter of 2023, the company saw a 1.1% year-over-year increase in gross profit, with a record gross margin of 21%. This was driven by a mix of complex solutions and a lower mix of transactional products, as well as a greater mix into netted down revenues, which grew 10% year-over-year and represented 31% of the gross profit. Non-GAAP SG&A was flat compared to the prior quarter, due to increased payroll expense being offset by managed discretionary expenses.

Coworker account at the end of the second quarter was approximately 14,900, down from the first quarter due to cost structure alignment. Strategic investments remain key to growth. GAAP operating income was $412 million, and non-GAAP operating income was $530 million, up 2.6%. Interest expense was $58 million and the GAAP effective tax rate was 25.7%. Non-GAAP net income was $349 million, up 2.8%, and non-GAAP net income per diluted share was $2.56, up 3.2%.

Cash and cash equivalents were $204 million and net debt was $5.6 billion at the end of the period, and liquidity remained strong with $1.2 billion available. The cash conversion cycle was 14 days, four days lower than the first quarter, and free cash flow was $684 million. The company also returned $79 million to shareholders through dividends and $196 million in share repurchases. The company is targeting a 25% payout ratio and a net leverage ratio of 2-3 times. They are converting cash profits into cash flow and managing liquidity while maintaining flexibility.

The company expects to return 50-75% of free cash flow to investors through dividends and share repurchases in 2023. They anticipate the IT market to contract at the upper end of high single digits, but they plan to outgrow the market by 200-300 basis points. They also expect a neutral currency impact, a non-GAAP operating income margin of 9%, and a non-GAAP earnings range of flat year-over-year in constant currency.

The speaker is concluding a financial summary and is asking the operator to open up for questions. They recommend limiting each question to one with a brief follow-up. The speaker also mentioned that they expect mid-single digit sequential growth from Q2 to Q3 in terms of average daily sales, as well as gross profit and margins to be below second quarter levels. They also anticipate non-GAAP earnings per diluted share to be flat to slightly down year-over-year, and expect full year free cash flow to be approximately 5% of net sales.

Christine Leahy is encouraged by the end of the second quarter, with commercial customers showing activity and sentiment, public returning to seasonality, international team maintaining their profitability, and small businesses not getting any worse. She expects the second half of the year to be more normalized than pre-COVID.

The team is impressed with the execution and is cautiously optimistic that there will be a mild-to-moderate recovery in the back end of the quarter. Q3 is expected to be the seasonal peak for public and Q2 delivery and allocation across channels is expected to be similar to Q2. Asiya Merchant asked about the use of cash, to which Albert Miralles replied that free cash flow is trending higher than anticipated and the use of cash should be considered.

CDW had two quarters that were different from expectations in Q4 and Q1, but in Q2 they over-delivered. Chris explains that this was due to strong cash profits and judicious management of working capital, as well as making space for an expectation of pulling on working capital in the second half of the year. He also states that the company will use capital where they see best fit in terms of supporting strategic objectives and finding relative value.

Christine Leahy explains the macro environment had a significant impact on Q1 and the beginning of Q2, particularly for their larger commercial customers. She notes that the counter-cyclicality of their end markets is now coming into play, and that they are seeing some stability and a slight uptick in sentiment. Al and the team are leveraging their competitive advantages to capitalize on customers loosening their spending reins. Adam Tindle asked for more in-depth information on guidance.

Albert Miralles and Christine Leahy answer Adam Tindle's question about their confidence in mid-single digit growth in the third quarter, which is typically a big public sector quarter. They explain that the data they are seeing suggests continued strength in the government sector, and that the summer seasonal pickup in activity in K-12 may have contributed to the Q2 results. They also mention that they are seeing at least a modest recovery in the commercial markets in Q4, which could be in the form of PC refreshes or infrastructure and solutions projects getting pushed out.

The market and projects related to growth initiatives are still not on solid footing, so customers are being judicious with their spending and focusing on mission critical, solutions-oriented endeavors. PCs are still the productivity tool, but there is a need to replace aging devices, and customers are exploring the benefits of Windows 11. While this could lead to a tailwind, it is likely to be a longer-term effect. Additionally, component availability and customers moving to a cloud model may lead to a decrease in backlog across many companies.

Christine Leahy states that it is too early to call the full year guidance and that CDW is taking it quarter-by-quarter. She also notes that caution and prudence are still present in the commercial side.

Chris and Albert Miralles are both cautious about predicting a major turnaround in the market, instead expecting a modest recovery. They have good visibility into the seasonality of the market, with K-12 being strong and public refresh needs increasing. They are comfortable with the data they are seeing and expect a pickup in Q3 and Q4 that is above seasonal, but not a major churn.

Albert Miralles explains that gross margins in 2022 ended at nearly 20%, a record level, due to a combination of thematic components such as cloud, SaaS, and security, as well as mix and rate factors. Mix has shifted more customer spend into solutions and services at higher margins, while product margins have been firm due to customers going up market and a firm supply chain.

Christine Leahy of CDW explains that pricing is holding firm in a competitive market, and CDW is delivering value to customers. She expects pricing to remain competitive in the second half, but also for CDW to hold ASPs firm due to the value they offer.

Christine Leahy explains that small businesses are the most sensitive to the economy and are in a holding pattern when it comes to hiring and purchases, while larger commercial customers have started to show signs of stabilizing and purchasing mission-critical projects. Leahy believes that the small businesses will take longer to return to major buying, while the larger entities are beginning to inch back in, giving confidence in the back end of the year.

Christine Leahy is responding to a question from Samik Chatterjee on what customer visibility and activity is like. She explains that they track activity in their CRM system, such as quoting, invoicing, and writing, and that they are starting to see some of those activities loosen up, with writing around solutions increasing slightly. She then goes on to address the sustainability of growth in NetComm, explaining that network modernization will be a factor in how sustainable the growth is.

Chris is discussing the need for network modernization, which is driven by the need for students to have a good experience and the need for hybrid work and back to work. He also mentions that customers are consulting and advising around AI use cases, which require network upgrades, and that the backlog of network modernization is not expected to slow down in the near-term. He also mentions that customers are discussing AI and some customer segments are ahead in their AI discussions and may be thinking about deploying generative AI solutions.

Christine Leahy explains that AI can be broken into two parts: accelerating and expanding CDW's internal use cases and helping customers evolve using their services and transaction capabilities. She explains that CDW's full stack approach allows them to help customers across the entire value chain, from advisory services to applications, modeling, and tools to computing and data structure. She also mentions that contact center and marketing transformation are two popular use cases for AI, as well as knowledge and customer assistance.

Christine Leahy is discussing the use cases for AI, which include customer assistance, retail, food, knowledge assistance, and financial services. She believes that customers are at the start of understanding the potential benefits of AI, but in the current environment, they are not prepared to increase budgets in 2024. However, she predicts that over the next 6-18 months, customers will understand the transformative benefits of AI and it will have a massive impact on how companies operate.

CDW made two acquisitions this year: Locus Recruiting and Enquizit. Locus provides professional and managed services engineers, while Enquizit provides professional services for application modernization and cloud migration, as well as a proprietary tool to automate the migration process. Both acquisitions are relatively small but strategically important to CDW in terms of expanding their technical talent base and providing customers with more efficient solutions.

CDW concluded their second quarter 2023 earnings call with closing remarks from Christine Leahy, thanking their coworkers for their dedication and commitment to serving customers and partners, and thanking their customers and investors for their interest and support. Al and Christine look forward to speaking with the investors and analysts again next year.

This summary was generated with AI and may contain some inaccuracies.