The operator introduces the CDW Third Quarter 2023 Earnings Call and hands it over to Steve O'Brien, the company's Investor Relations representative. Steve is joined by CEO Chris Leahy and CFO Al Miralles to review the third quarter results. The earnings release and supplemental slides are available on the company's website. Steve reminds listeners of the risks and uncertainties associated with forward-looking statements and mentions non-GAAP financial measures. Replays of the webcast will be available on the website.

In this paragraph, the speaker reminds listeners that the conference call is the property of CDW and cannot be recorded or rebroadcast without permission. He then gives an overview of the company's performance, highlighting record sales, operating income, and net income per share. He credits the team's execution and resilient business model for this success and emphasizes the importance of their portfolio in meeting customer priorities. He also mentions the value of the company as a trusted adviser in helping customers navigate their IT spending.

The company's strategy for growth has allowed them to become a vital technology partner for customers across the full stack and life cycle. This has led to consistent growth in customer spending, despite dampened top line growth due to cloud and SaaS-based solutions. The company's quarterly results were driven by a balanced portfolio of customer end markets, a breadth of solutions and services, and successful execution of their three-part strategy. The five build sales channels, as well as UK and Canadian operations, each have their own significant sales. These different markets often act counter-cyclically, providing some mitigation for declines in commercial sales due to cautious purchasing behavior.

Despite expecting modest improvement in hardware, the company experienced pressure in client devices which led to a 12% decrease in corporate net sales. Customers focused on cloud solutions, AI, and security, but AI is still in early stages of development and not translating into significant customer spend. Ongoing network modernization led to double-digit net comp performance. Small business net sales declined 22% due to market conditions and focus on cost management. Projects that were more of a want rather than a need saw an increase in spend. Public sales only increased by 1% year-over-year.

Healthcare and education saw modest growth of 2% each, while government remained flat compared to last year's exceptional growth. The federal team saw success in implementing efficient solutions for data management and protection, resulting in strong double-digit growth. State and local government saw a decline in net sales compared to last year's double-digit growth. Healthcare systems are turning to cloud solutions to address industry challenges and tight budgets, leading to an increase in cloud spend. The company's broad portfolio also contributed to a double-digit increase in security spend. Education saw a low single-digit increase, with growth in K-12 offsetting a decline in higher education.

In the higher education sector, there was a single-digit increase in Solutions but a double-digit decline in transactions due to a decrease in client device spend. However, there was double-digit growth in netcomm, services, and software, as well as low-teens growth in cloud spend. In the K-12 sector, there was strong growth in services and netcomm, but a decline in transactions due to a decrease in client device spend. The UK and Canada business did not meet expectations due to market conditions. The company's diverse end markets and broad portfolio allowed for consistent performance despite an uncertain macro environment. Solutions sales increased while transactions and hardware sales declined. Client device demand remained depressed, particularly in the commercial sector, resulting in a double-digit decline in overall client performance. Net comp increased, and backlog is now at historic levels.

In the third quarter, cloud and security spend increased significantly, contributing to overall software growth. The company's diverse portfolio allows them to meet the needs of different customers and their growth strategy focuses on capturing new customers, enhancing solutions, and expanding services capabilities. Over the past five years, they have invested in comprehensive life cycle management capabilities to better serve customers across various environments and drive positive outcomes.

The company's ICARE framework and consultative approach to problem solving allows them to offer consumption-based solutions with lower upfront costs, which is a major competitive advantage in today's uncertain macro environment. They provided an example of a successful solution they provided to an Illinois school district, and emphasized their investments in a customer-centric growth strategy. They also shared their expectations for the US IT market to decline in 2023.

The article discusses three main points: the expected improvement in the commercial IT hardware market, a decline in the UK and Canada markets, and a return to normal seasonality in the public sector. The company expects to continue outperforming the US IT market, despite potential challenges such as geopolitical instability and government shutdowns. The CFO then discusses the company's financial performance, including record gross margin, operating margin, and earnings per share.

In the third quarter, the company achieved record net sales of $5.6 billion, an increase of 9.4% on a reported basis and a decrease of 8% on an average daily sales basis. This was due to both market conditions and the success of their cloud and SaaS-based solutions. Gross profit remained flat at $1.2 billion, with a record gross margin of 21.8%. This was driven by a higher mix in complex solutions and netted down revenues. Non-GAAP SG&A was down 1.9% year-over-year and the company continues to prioritize investments in their three-part strategy for growth, profitability, and margin goals.

The company's disciplined approach to expenses and strong cash flow performance contributed to a record non-GAAP operating income and net income in the quarter. Net debt declined and liquidity remained strong, and the company's cash conversion cycle was lower than the previous year. Adjusted free cash flow for the year was well above the company's target.

In the quarter, the company followed their 2023 capital allocation priorities by returning cash to shareholders through dividends and share repurchases. They also increased their dividend by 5%, marking their 10th consecutive year of dividend growth. The company aims to maintain a targeted net leverage ratio and plans to return 60-75% of adjusted free cash flow to investors through dividends and share repurchases. Despite ongoing economic uncertainty, the company remains focused on margins, cash flow, and profitability and expects the IT market to contract at the upper end of high single digits.

The company expects to deliver a 200 to 300 basis point growth premium to the market, with a focus on hardware demand. They anticipate a low to mid-9% non-GAAP operating income margin and flat to slightly increased earnings per share in constant currency. For the fourth quarter, they expect a mid-single-digit sequential decline in average daily sales and a low to mid-single-digit decline in net sales. Gross profit and non-GAAP operating margins are expected to be strong, similar to the third quarter.

The company expects fourth quarter non-GAAP earnings per diluted share to grow slightly and adjusted free cash flow to be approximately 6% of net sales for the full year 2023. They remain confident in their ability to deliver profitability, margin, and cash flow while investing in their strategy. The operator will now open the call for questions, and the company asks each person to limit their questions to one with a brief follow-up. The first question is from Samik Chatterjee from JPMorgan, who asks about the resilience of total spending from customers and the sustainability of demand from commercial accounts. The second question is about the company's thoughts on next year's spending, as there hasn't been two consecutive years of significant declines in enterprise spending in a while.

The speaker, Chris Leahy, responds to a question about whether there will be higher spending from customers in the coming year or if there will be another year of declines. He explains that the current business environment has been challenging and cautious, but investments in technology remain a priority for customers. However, customers are more focused on cost optimization and consumption-based solutions like cloud, rather than making significant upfront capital investments. Leahy also notes that hardware and client devices have not seen the anticipated recovery in spending.

In the paragraph, the speaker discusses the current business climate and its impact on customer spending. They mention that there is uncertainty in the market and customers are not increasing their spending. However, the company is still investing in technology, particularly in cloud-based solutions. They also mention that they have not seen signs of improvement in client device sales. The speaker concludes by stating that they are confident in their strategy and the engagement with their customers, and they expect to accelerate their growth once the market improves. During the earnings call, a question was asked about linearity in the quarter, but the speaker did not provide any further details on this topic.

The speaker discusses the stability of trends throughout the third quarter and how it has influenced their expectations for the full year. They also address the potential impact of a mix shift towards more transactional sales on gross margins, and believe that both complex solutions and transactional sales can coexist. They attribute the current trend to commercial customers focusing on cost-saving measures and prioritizing netted down revenue streams over IT hardware spending.

The company expected an increase in hardware sales due to less uncertainty in the economic environment, but the current cautious atmosphere has not reflected this. They are seeing normal levels of demand for public and net comp, but there is a disconnect in timing and demand for PC clients. They are hoping for increased demand in the future with the release of Windows 11.

The demand for PCs has not shown significant improvement and remains stable, with the public sector performing as expected and international markets showing a delay in demand. The backlog is nearing normalization with no major impact at the moment. The consumer sector tends to react earlier to market changes compared to the commercial sector. There is a lag in the timing of inventory being flushed into the market from OEMs and distributors.

The speaker, Chris Leahy, responds to a question about the impact of potential federal budget chaos on the company's performance in the upcoming quarter. He expresses confidence in the team's ability to manage through uncertainty and mentions that projects already in progress will continue, but some may be put on hold. The speaker also discusses the company's strong operating margin performance and notes that while there may be some cyclical factors contributing to this, there are also some long-term tailwinds that will likely sustain the company's margins in the future.

Al Miralles, in response to a question from Amit, discusses the factors contributing to the company's increase in operating margins. He mentions strong gross profit margins due to a mix of business and efforts to align expenses with demand. He also notes that the company will continue to invest in its strategy while driving productivity and efficiency. However, there may be some dilution in operating margins as the company shifts towards more transactional products and PC sales start to rebound.

Chris Leahy, speaking on behalf of the company, addressed the recent weakness in international markets, particularly in Europe. He confirmed that this trend has continued into the third quarter and is affecting all aspects of the business. The company expects this softness to continue for the next few quarters. In regards to the potential for AI-enabled PCs to drive an upgrade cycle, Leahy stated that AI is on everyone's mind and customers are likely to get excited about it. The company is currently working on developing end-to-end capabilities for AI integration in all technology products.

The speaker discusses their company's alignment with partners in building practices around AI technology and their expectation that customers will be excited about it. They also mention their strong position in helping customers make choices across the full stack, but acknowledge the increasing complexity in the market. They see artificial intelligence as an accelerant and believe it will move quickly, but they are still in the early stages. The speaker also addresses share gains and states their long-term goal of outperforming the market by 200-300 basis points, citing 2016 as a similar period of weaker hardware environment.

The company has seen growth in their netted down solutions, such as software and software assurance, which has contributed to their overall success in the market. They are confident in their ability to continue taking share in their markets and plan to do so in 2023 and beyond. As for M&A, they see it as a way to invest in their strategy and have had success with previous acquisitions. They will continue to look for opportunities, but it is not their main focus. Their cash position is strong and they are always open to M&A opportunities.

The speaker discusses their company's capital priorities and the need to balance strategic opportunities with tactical deployment of funds. They mention their recent acquisition and state that their strategy is more focused on capabilities rather than revenue streams. The speaker then takes a question about the impact of netted down items on year-on-year sales growth in 2023 and states that they expect netted down revenues to outpace overall net sales in the future.

The speaker notes that the netted down mix this year has been more extreme than in previous years, with netted down sales accounting for 7% of net sales and 32.6% of gross profit. This has had a significant impact on net sales, but the decline is less than it appears when considering customer spend. The speaker also mentions that device refreshes have been put on hold, but when they do occur, CDW's outperformance to US IT spend is typically at the higher end of the 200 to 300 basis points range. The speaker expects this to continue in the future.

Al reflects on the cost management success in 2023 and mentions that OpEx to GP is their metric. The outlook for 2024 is more muted and they are not investing in headcount, with inventory days being very low.

Al Miralles, the speaker, is answering a question about how the company plans to protect earnings in a slower environment. He mentions that there are efforts to drive productivity and efficiency to stay within a certain expense range, while also investing in opportunities. The company plans to continue these efforts, but will also ramp up investments as demand increases. He also mentions that gross margin may fluctuate quarter-to-quarter due to strategic balancing. The speaker is then asked about traditional hardware gross margin and how it is affected by net revenue.

The speaker is discussing the current levels of gross margin and how it may be impacted by various factors, such as mix movement, product margins, and commoditization. They mention that while some elements are durable, others may be transitory and could potentially decrease over time. They conclude by thanking the CDW team and ending the call.

The speaker acknowledges the dedication and hard work of CDW's 15,000 coworkers and thanks them for their commitment to serving customers. They also thank customers for the opportunity to help them and express gratitude to listeners for their time and interest. The call is now concluded and participants may disconnect.

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