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CDW Q3 2024 Earnings Call Transcript

Operator

Good morning all, and thank you for joining us for the CDW Third Quarter 2024 Earnings Call. My name is Carly, and I'll be coordinating your call today. [Operator Instructions]

I'd now like to hand over to your host, Steven O'Brien of Investor Relations to begin. Steve, the floor is yours.

Steven O'Brien
Vice President, Investor Relations at CDW

Thank you, Carly. Good morning, everyone. Joining me today to review our third quarter 2024 results are Chris Leahy, our Chair and Chief Executive Officer; and Al Miralles, our Chief Financial Officer. Our 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 a number of risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release and 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, 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 and Form 8-K.

Please note, all references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2023, with net sales growth rates described on an average daily sales basis 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.

Chris Leahy
Chair and Chief Executive Officer at CDW

Thank you, Steve. Good morning, everyone. I'll begin today's call with a brief overview of our third quarter performance and view for the balance of the year. Al will provide additional detail on our results, our capital allocation priorities and our outlook. We'll move quickly through our prepared remarks to ensure we have plenty of time for questions.

Market conditions in the third quarter were challenging. While demand for cloud solutions remained strong and we continue to see a pickup in client device growth, hardware solutions remained under pressure and the firmer footing we anticipated for our corporate channel did not materialize. Within this complex environment, the team delivered gross profit of $1.2 billion, 2% lower than last year and gross margin of 21.8%. Net sales of $5.5 billion, 3.5% lower on an average daily sales basis, non-GAAP operating income of $534 million, down 4% year-over-year, non-GAAP net income per share of $2.63, down 3% year-over-year, adjusted free-cash flow of $261 million.

While our success meeting customer priorities with cost effective software and cloud solutions as well as services led to a resilient gross margin and strong cash flow, results did not meet our expectations as lower-than-projected solutions hardware drove a shortfall in volume. This shortfall in volume reflects both external factors and CDW specific dynamics.

Let's take a look at each of these and most importantly, the actions in place to mitigate future impacts. First, the macro and IT spending environment remain challenging. Technology complexity combined with persistent economic and geopolitical uncertainty has led to large project delays and further extension of sales cycles. Layered on top was the uncertainty around the outcome of the US election, which has dampened not only government spending, but also other public sector end markets as well as spend from commercial customers. And finally, this limited demand environment has heightened competition and increased pricing intensity across all end-markets.

Beyond the current environment, market conditions continue to reflect the secular shifts we've experienced over the past several years, shifts that impact how customers consume IT and how customers pay for IT. Consumption -- consumption shifts driven by as-a-service and pay-as-you-go public and private cloud focus have contributed to-market pressure on hardware solutions. And while our conviction toward a hybrid cloud approach for IT is unwavering, market demand continues to reflect unprecedented hardware cyclicality. Cyclicality that resulted from pandemic driven demand for work and learn from anywhere on endpoint collaboration and Netcom solutions, which resulted in an off cycle demand boom, a period of supply chain volatility and subsequent digestion.

All of these external factors have clearly impacted our results in the quarter and over the past year. The impact has been further amplified by three CDW specific dynamics. The first dynamic relates to our long standing financial discipline. While our North Star is to provide value to our customers in highly competitive markets, we maintain our discipline when competitors pursue transactions at -- on uneconomic terms. While this contributed to lower third quarter sales and gross profit, our gross and operating margins held firm even while we mixed into lower margin client devices. We've seen this market behavior before and expected to dissipate as the demand environment improves.

Second, our exposure to larger deals. As we have deepened and broadened our strategic capabilities, including through the addition of Sirius, our ability to deliver large full stack, full outcome projects has expanded. Projects at the higher dollar tier that can be pushed for any number of reasons. This can drive year-over-year performance lumpiness and depending on the size and timing of decisions impact results. Impact that is more acute during periods of low demand. You see this in commercial and federal this quarter were larger deals expected to close were deferred or reduced.

And the third specific item pertains to our cloud and SaaS based business. While we have grown this business significantly during the past several years, we have not yet achieved the scale we desire relative to our overall portfolio. As such, when demand for hardware softens, it has a more outsized impact on our financial results. I hope this perspective helps contextualize how CDW specific dynamics amplified the impact of the low market demand environment and created a near term growth challenge that we have not yet been able to overcome. These are not excuses. We own our results.

So let's turn to what's important. What are we doing? As always, our continuous improvement in seller effectiveness is ongoing. This means delivering repeatable solutions and further streamlining the sales processes to maximize -- to maximize sales professional productivity. I'd like to highlight three additional focus areas. First, we are organically and inorganically growing our capabilities in the fastest growth, highest relevance cloud and software vectors to increase scale in both our services and as a service offerings. This will deliver greater choice and value to our customers and lead to greater recurring and reoccurring revenue streams.

Second, we are further driving exceptional and differentiated customer experience in our core business. We are aligning our digital capabilities to serve customers in the way they want to plan, buy, consume and manage technology.

And finally, we are enhancing our agility in accelerating pipeline growth. We are building on our customer growth engine by opening new lanes with both existing and new customers and we are deepening our technical and industry expertise across all end-markets. We know more than anything customers value our unbiased, highly informed point-of-view, a point-of-view that enables our ability to architect and implement full stack multi-branded solutions, which cut through the noise and deliver the outcomes our customers need.

These are not new efforts, but we have ramped-up intensity. Work is underway and progress is on-track. Some actions will have fairly immediate impact and some will take more time to produce results. In the meantime, we remain laser focused on finding pools of profitable growth and converting sales with rigor and speed.

Now let's take a deeper look at quarterly results. Third quarter corporate net sales decreased 4% as sales cycles further elongated, most notably for large infrastructure investments. Netcomm storage and servers all declined by significant double-digits. We helped customers with client refresh driving growth of high-single-digits. ASPs remained strong as customers' preference continued to drive higher end devices. Cloud solutions was a priority and gross profit from cloud increased by double digits.

Small business continued to bounce along the bottom with net sales down 2%. Cloud solutions remained strong given their low upfront commitment and customers continue to sweat data center assets. Unlike other channels, client refresh continues to be pushed out as customers remain in a cash preservation mode. Security was strong as cyber threats increased for lower profile businesses. The teams success delivering services drove strong double-digit growth in both professional and managed services. Public performance was less than seasonal and sales decreased 5% year-over-year.

Healthcare was a bright spot in the quarter, delivering top line growth of 3%. The team continued its success helping health systems adopt managed services and cloud solutions to better control expenses and they delivered strong double digit growth in services and cloud spend. Similar to corporate, netcomm storage and servers all declined meaningfully. Client was strong, up double digits for the second-quarter in a row.

Government declined 12%, with both state and local and federal government's performance below seasonal in the quarter. Market conditions were challenging for the federal team. Demand impact was felt most acutely in large hardware solutions deals with federal posting double-digit declines in both netcomm and servers. Several agencies moved ahead with refresh and for the third quarter in a row, client devices increased by double digits. Cloud solutions posted a double digit increase in cloud gross profit.

State and local sales declined by low double-digits. Delays due to increased scrutiny and multiple approvals impacted large infrastructure hardware deals with netcomm, storage and servers all posting significant declines. Security remained a top priority, posting a strong double digit increase in gross profit. Services performance was strong, up high double digits, driven by professional services.

Education sales declined 5%. Higher ed's top line declined high-single-digits. Client devices were flat and slow project materialization and budget constraints and cutbacks at some public universities contributed to double digit declines in netcomms and servers. The team's success helping institutions implement cloud solutions to drive cost elasticity delivered double-digit growth in cloud spend and gross profit.

K-12 net sales declined by low-single digits, largely driven by declines in audio visual and netcomm as school systems digested investments made over the past few years. The team continued to help refresh aging [Indecipherable] and delivered high teens client device growth. Cloud delivered double digit gross profit growth. Services adoption was also up double digits, driven by our managed client device lifecycle solution, which streamlines the configuration, deployment, management and refresh process so school systems can focus on what really matters, their students.

Other, our combined UK and Canada business performed above our expectations, up 5%. Both markets experienced stronger demand, albeit off depressed results in the prior year and prior quarter. Both the UK and Canada increased by similar amounts in local currency.

As you can see, end market performance was mixed during the quarter. Let's take a look at how this translated to category performance. Portfolio performance reflected our ability to meet customers where and how they wanted with client device, cloud and software and services growth. Growth that was more than offset by hardware solutions decline. A low single-digit increase in transactions was more than offset by solution sales decreases of double digits. Hardware decreased 7%. High single digit client device growth was more than offset by declines in netcomm, storage and servers. Software increased 3.5% with healthy gross profit growth. Cloud was an important driver of this performance, up double digits in gross profit. Services increased by 13%, driven by managed services and warranties.

As you can see, while demand varied, the diversity and completeness of our portfolio enables us to meet our customers where and how they need us. And that brings us to our expectations for the rest of the year. Given current conditions, we do not anticipate market demand to improve for the balance of the year, and we now look for the US IT market to be roughly flat with 2023. We expect our results to continue to reflect the market and CDW specific dynamics I referenced, with gross profit growth challenged given our mix of hardware and the pronounced cyclicality the market is experiencing. As we always do, we will provide our view on 2025 market conditions in our next call.

There is no denying that we are operating in a tough environment, but we are confident that growth will return. The demand drivers are there, workload expansion and data explosion, increased security threats, client device obsolescence and adoption of AI-powered assistance and applications. And when demand picks up, we will be there to profitably capture these opportunities. In the meantime, we are doubling our efforts to drive profitable growth. While this past year has been challenging for us, it has also been challenging for our customers. As their trusted advisor, customers need us now more than ever. Our relationships are bolstered by our commitment to deliver value to our customers regardless of the demand environment.

Now let me turn it over to Al, who will provide more detail on our financials and outlook.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Thank you Chris, and good morning, everyone. I will start my prepared remarks with details on our third quarter performance, move to capital allocation priorities and then finish with our updated 2024 outlook.

Third quarter gross profit of $1.2 billion, was down 2.2% versus the prior year. This was below our original expectations of low single-digit growth as strength in cloud and client devices across most channels was offset by lower demand for solutions hardware. Gross margin of 21.8% was flat year-over-year and quarter-over-quarter and broadly in line with both full year 2023 levels and our expectations for 2024.

Third quarter margin was aided by a higher mix into sales where CDW acting as agent, also known as netted down revenues. This category grew by 7.1% on a reported basis, once again outpacing overall net sales growth and representing 35.7% of our gross profit compared to 32.6% in the prior year third quarter. Year-over-year expansion came from our teams continuing to successfully serve customers with cloud and SaaS based solutions. This led to our highest quarterly netted down revenues we've seen as a company as we met customers where they needed us most. The netting down category of solutions continues to represent an important and durable trend within our business.

Third quarter gross profit was up 1.5% sequentially compared to the second quarter of 2024 on a reported basis. Net sales were up 1.7% sequentially as well. Higher year-over-year demand in the healthcare and international channels alongside a sequential increase in government drove growth over the second quarter. However, this growth is below both historic seasonal levels and our own expectations at the firmer footing in the corporate space that we saw at the end of the second quarter did not persist through the later months of the third quarter.

We experienced deals getting pushed out and downsized as customers deliberate on where and when to spend and primarily in the solution space. While international outpaced the US business in the third quarter, we still expect volatility in this space as customers face economic and political uncertainty. Overall, we're competing in a challenging low growth environment, and we are focused on achieving profitable growth. We acknowledge that we have work to do to better calibrate market conditions and deliver on our own expectations.

Turning to expenses for the second quarter. Non-GAAP SG&A totaled $667 million, down 0.7% year-over-year. Expenses were down year-over-year and quarter-over-quarter, and the efficiency ratio of non-GAAP SG&A to gross profit of 55.5% was relatively in line with our expectations. We continue to look to align our cost structure with demand and have taken actions early in the fourth quarter to better align expenses to market conditions.

Co-worker count at the end of the third quarter was approximately 15,400, up slightly over the second quarter and modestly above year-end. Customer facing co-worker count was also up slightly at approximately 11,200. Our goal is to balance growth and exceptional customer experience with greater efficiency and cost leverage from our broader operations.

Non-GAAP operating income totaled $534 million, down 4% versus the prior year, driven by our volume shortfall offset by slightly lower expenses year-over-year. Non-GAAP operating income margin of 9.7%, was down from 9.9% in the prior year but up from 9.4% in the second quarter. Our non-GAAP net income of $355 million in the quarter, down 3.9% on a year-over-year basis. With third quarter weighted average diluted shares of 134.9 million, non-GAAP net income per diluted share was $2.63.

Moving ahead to the balance sheet. At period end, net debt was roughly $4.9 billion. Net debt is down $91 million from the second quarter and has decreased by approximately $184 million since year end 2023. During the quarter, we issued $600 million of 2030 senior notes and $600 million of 2034 senior notes. We issued the combined $1.2 billion to settle the tender offers of both the 2024 and 2025 senior notes and for general corporate purposes that will maximize strategic flexibility.

Since Q3 end, we have fully redeemed the 2024 notes. Liquidity remains strong with cash plus revolver availability of approximately $2.2 billion. The three month average cash conversion cycle was 17 days, up 2 days from the prior year and at the lower end of our targeted range of high teens to low 20s. This cash conversion reflects our effective management of working capital, including asset management of our inventory levels. As we've mentioned in the past, timing and marketing dynamics will influence working capital in any given quarter or year. We continue to believe our target cash conversion range remains the best guidepost for modeling working capital longer term.

Adjusted free cash flow was $261 million in the quarter, roughly consistent with our expectations. Year-to-date, adjusted free cash flow was a healthy $764 million and 80% of our non-GAAP net income within our stated rule of thumb of 80% to 90% of non-GAAP net income. We are on track to meet our 2024 objectives. For the quarter, we utilized cash consistent with our 2024 capital allocation objectives, including returning approximately $100 million in share repurchases and $83 million in the form of dividends. We remain committed to our target to return 50% to 75% of adjusted free cash flow to shareholders via the dividend and share repurchases in 2024.

That brings me to our capital allocation priorities. Our first capital priority is to increase the dividend in line with our non-GAAP net income growth. We're announcing an approximate 1% increase of our dividend to $2.50 annually, our 11th consecutive year of increasing the dividend. We will continue to prudently manage our dividend with respect to the growth environment and target a roughly 25% payout ratio of non-GAAP net income going forward.

Our second priority is to have the right capital structure in place. We ended the third quarter at 2.3 times net leverage within our targeted range of 2 times to 3 times. We will continue to proactively manage liquidity while maintaining flexibility as evidenced by our recent debt financings. Finally, our third and fourth capital allocation priorities of M&A and share repurchases remain important drivers of shareholder value. We continually evaluate opportunities that could accelerate our three part strategy for growth. Year-to-date, we've utilized over $350 million of cash on share repurchases and have over $730 million of authorization remaining under our current share repurchase program.

And that leads us to our outlook. The uncertain market conditions we operated under throughout 2023, have persisted well into 2024. Demand has been below what we originally anticipated and customer sentiment remains cautious across the majority of end markets. Last quarter, we spoke about the slow start to the year for 2024 IT spending and shared our expectations for tough continued conditions to persist in the near term. That was the case and was moderately worse than even -- than we even expected in the third quarter.

Customers still have a compelling need to address priorities such as cloud workload growth, increasing security threats aging client devices, but uncertain macroeconomic conditions and a complex technology landscape continue to weigh on customer demand for solutions hardware. Given these conditions, our updated 2024 expectation is for a low single-digit gross profit decline. This implied seasonality is slightly below historical levels for the fourth quarter and second half gross profit and net sales.

We maintain our expectation for 2024 gross margin to be similar to the full year 2023 and much like we've seen year-to-date in 2024. Finally, we expect our full year non-GAAP earnings per diluted share to be down mid-single digits year-over-year. Please remember, we hold ourselves accountable for delivering our financial outlook on a full year constant currency basis.

Moving to modeling thoughts for the fourth quarter. We anticipate low to mid-single-digit gross profit decline compared to the prior year, with gross margin slightly above the first three quarters of 2024, but below the fourth quarter 2023 level. This leads to a slightly worse than seasonal sequential fourth quarter. Traditionally, the fourth quarter is meaningfully lower than the third quarter principally due to seasonally lower demand from education and government customers, but this first fourth quarter, we also do not anticipate this being offset by seasonally strong demand from corporate and small business customers.

Moving down the P&L. We expect fourth quarter operating expenses to be similar to the level of fourth quarter of 2023 on a dollar basis. Finally, we expect fourth quarter non-GAAP earnings per diluted share to decline in the high single-digit range year-over-year.

That concludes the financial summary. As always, we'll provide updated views on the macro environment and our business on our future earnings calls.

And with that, I will ask the operator to open it for questions. We ask each of you to limit your questions to one with a brief follow-up. Thank you.

Operator

Thank you. We'd now like to open the lines for Q&A. [Operator Instructions] Our first question comes from Adam Tindle of Raymond James. Adam, your line is now open.

Adam Tindle
Analyst at Raymond James

Okay, thanks and good morning. I just wanted to start, as we analyze this quarter, understand tough macro to predict volumes, but I really wanted to ask about the negative operating leverage down the P&L. And taking a step back, I think what investors really like about CDW is the variable cost model ability to kind of flex up and down the volumes. Understand some of the rationale in the prepared remarks that this seems to be a pattern from the past few quarters. So I guess the question would be twofold. One for Chris, if you could maybe just assess what is changing and why the negative drop through is increasingly severe down the P&L sounds like you decided to implement some restructuring, so maybe you can tie in some of the rationale for that? And then secondly, for Al, on that restructuring, if you could just help us with the size and what it does to the model in 2025? I think it's about a 10% to 15% of head count based on the reports that we've seen. So just trying to right size how we should think about opex moving forward. Thank you.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Yeah Adam. Actually, this is Al. I will start just to give you a little bit of commentary on the quarter and operating leverage, and I'll let Chris jump in thereafter. So first -- on the quarter, first, I would just say, Adam, we continue to hold strongly to our variable cost model and the impact therein. For the quarter, if you actually look at our non-GAAP SG&A expenses relative to GP, we came in just about at that 55% range, which we've talked about that being kind of the target that we would have. It's maybe slightly higher than we would have anticipated for the quarter, but that was more of a, I'll call it, denominator factor that is the GP was lower than expected. So in the quarter, we did get the movement in our variable expenses as we would expect. I think the challenge there, otherwise, Adam, is that we have a fixed cost base. And while the demand environment has moved pretty dramatically, we certainly have taken action on our fixed cost to try to align with what we were seeing in current demand and what we were seeing as we go forward, it becomes a matter of just the timing they're in on that fixed cost base. That said, as you know, going into the fourth quarter we did take some actions that would reduce our fixed cost base, and that included a reduction in our workforce. Just to size that for you, Adam, it was about 2% of our workforce. So it was not at the level that you quoted there, but certainly, that would align us more closely with where we think we need to be from a fixed cost base perspective.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, and Adam I would just add that we're being very prudent as we look at where we rightsized the business while we continue to invest behind areas that we see will be pocket of growth. So a lot of focus on the demand environment, preserving profitability and also delivering exceptional customer experience for our teams.

Adam Tindle
Analyst at Raymond James

Got it, thank you. Just a quick clarification since I know that was a long one. When you were talking about the increased pricing intensity and competition, just to clarify, is that higher competition between VARs or is that higher competition in pricing amongst the OEM vendors? Thanks.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah Adam, it's a little of both. It's a little both.

Operator

Thank you. Our next question comes from David Vogt of UBS. David, your line is now open.

David Vogt
Analyst at UBS Group

Great. Thanks guys for taking the question. And maybe one for Chris to start. So Chris, I think I heard in your prepared remarks that you'd expect sort of the US IT market to be flat in 2024, and yet you're confident that you can continue to outgrow it. But obviously, the macro has been tough and it looks like you're going to undergrow the market this year. Did I hear that correctly? And how should we think about what that means going forward? I know you're not giving 2025 guidance, but I think that's a little bit disappointing relative to where investors might have been thinking given the challenging backdrop. Is it just really a reflection of where the hardware solutions are ending up? And then along those lines, we're hearing from some of our checks that networking and even to a lesser degree, storage and servers is getting a little bit better. Maybe what are you seeing a little bit differently than maybe what we're picking up and what others are maybe communicating in the marketplace? Thank you.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, let me just start with the market share. That was the beginning of the question. Look, we continue to hold ourselves ample for delivering a premium to the IT market rate of growth. And looking at this year and this quarter, given the low hardware demand and taking into account our mix, I'd say we're holding serve and feeling very confident that we've performed extremely well in certain areas, say cloud, software-as-a-service, services as an example, but other areas have been challenged for us. And our view is that hardware will come back. It's a matter of when will that inflection point take place, and we'll be well positioned to help our customers in those circumstances. You asked specifically about networking and storage. Look, what we are seeing is we're seeing traction in clients pick up. And I wouldn't yet call it the inflection point, but we do think we're outperforming in that area. Data center has really been the area where customers have paused, have moved spend to the cloud and are taking longer time to make decisions. That means we're seeing storage, networking and servers all quite muted, but once we see the client refresh start, one would expect to see data center begin to pick up again. As I said before, the catalysts are all there. Explosion in data, the need for massive bandwidth for networking. Digital transformation isn't going anywhere. Security continues to get more and more focused. So the catalysts for growth are all there. I think we just got to get to the other side of the uncertainty that we sit. And certainly, after we get through the election, there'll be a little more certainty.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

And David, maybe I'll just add a couple of data points there [Speech Overlap] it's okay. Just to add a couple of data points there. So obviously, all of those categories, Chris mentioned in the solutions space, have been softer. We also have the tough comps from a netcomm perspective. Q3 is the last quarter with those tough comps. So while we would not say that demand is picking up meaningfully on netcomm, at least the comps get a bit easier. And then the other data point I would just give you is from our vantage point, just hardware overall, we've now seen eight quarters of declines on hardware. And so again, Chris noted some of the catalysts we think ultimately will play out. We've seen a pretty prolonged period of hardware cyclicality.

David Vogt
Analyst at UBS Group

Great. And just as a quick follow-up. So we think about looking at the recovery or the potential recovery around the timing of the recovery, I know you're not giving '25 outlook, but what are some of the milestones that you're looking at that gives you increased confidence heading into '25? I know obviously, the election is coming up, and hopefully, that kind of changes maybe customer conversations. Anything else sort of maybe at a high level that you're thinking about in your conversations that give you some degree of maybe a leading edge or a leading indicator in terms of what you're thinking about for 2025?

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, you know I think about the things that are creating the current environment and whether or not those change. So uncertainty around the economic environment and geopolitical will have an impact. Obviously, the election policy outcomes of the election are going to be very different. That will have an impact most likely. Those are the things that are at the forefront of our mind, how the economy is doing, frankly, how it's perceived to be doing -- going to be doing in the future and the volatility across the world are the two things that we look at most closely. Now the complexity in IT is not going anywhere. So the requirement now to have more business and IT leaders involved in decision making. It's our new norm is kind of longer decision cycles for these larger complex projects. And so we're getting used to that, but we don't see that going away anytime soon. That's what we focus on.

David Vogt
Analyst at UBS Group

Great. Thank you guys.

Operator

Thank you very much. Our next question comes from Erik Woodring of Morgan Stanley. Erik, your line is now open.

Erik Woodring
Analyst at Morgan Stanley

Great. Thank you so much for taking my questions I have. I have two as well. Chris, if we could just go back to some of your comments on product demand. Obviously, lots of commentary about challenges in infrastructure solutions, double-digit declines with many customers across netcomm, servers and storage. I just want to make sure I understand, are those rates of declines that you're referencing reflective of the broader market or are you seeing those declines simply because you are walking away from some lower profitability deals and therefore you are underperforming in those specific end markets and maybe at the end market, though they aren't declining nearly as much as maybe you're seeing? I'd just love to get a better understanding of this is kind of CDW's view or if this is the broader market view? And then I just have a follow-up. Thanks.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, sure. I would say it is the broader market view possibly tempered a bit by CDW not racing to the bottom because we are walking away from economic deals. It's important to keep protect profitability, etc. So I would say it's a bit of both. I would say it is market and consistent with market, but also we are not racing to the bottom.

Erik Woodring
Analyst at Morgan Stanley

Okay, all right. That's helpful. And then maybe just on the second question, I'd love if you could maybe elaborate a bit on the market competition comments because you're highlighting market competition, which I can't necessarily remember you citing explicitly before. And to be fair, you guys have encountered several challenging and competitive market environments in the history of the company and still manage to materially outperform peers over those years. And so maybe my question is just what has changed with competition that is new? And really, why would that competitive intensity ever go away even in a period of stronger demand? Thanks so much.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, you know, it's a great question, and we do reflect on that. We are used to a highly competitive environment. What I would say we're feeling right now and this quarter and the past couple of quarters, in particular, is irrational pricing. And we know how to compete in the market, but we are seeing deals at below margin, low margin, etc., and that just is not our business model. I -- the last time I saw intensity in pricing like this was years ago. So it has been a little bit more unique over the last couple of quarters, and we're very good with our discipline around financials. So we're holding firm. That's really the answer here. It's a little unique over the last couple of quarters, we've seen it really tick up.

Erik Woodring
Analyst at Morgan Stanley

And just to clarify, that is a rational pricing from VARs, from [Indecipherable] or from both?

Chris Leahy
Chair and Chief Executive Officer at CDW

I would say it's up and down the value chain. So competitors who are value added resellers, direct competitors, distributors, I wouldn't perceive in that chain as much [Speech Overlap] yeah, the behaviors that are going on, every competitor is feeling the elongation in the sales cycle, the chunking up agreements to make them smaller. The deferrals, the reductions, the different ways they want to go at saving money or defer in spending, short-term ROI. That is a market dynamic right now that everybody is feeling.

Erik Woodring
Analyst at Morgan Stanley

Understood. Thank you Chris.

Operator

Thank you. [Operator Instructions] Our next question comes from Amit Daryanani of Evercore. Your line is now open.

Amit Daryanani
Analyst at Evercore ISI

Hello. Good morning. I have two as well. I guess, Chris, just to continue this discussion you had, you folks are on track to have two years of consecutive gross profit declines at the company. And it's something you haven't seen at CDW, I think historically, even if I go back to '03 or '04 or '07 or '08 time frame. I understand all the macros that you're talking about, but it feels like the way CDW has now been getting this macro uncertainty, volatility is worse than what you've seen before? And why do you think that's happening? And what's changed perhaps in the company that you've had multiple years of gross profit declines, which frankly you haven't had a start yet?

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, Amit it is a fair question. I'll tell you we're a company in transformation, and we have been in transformation for several years now. So when you think about the CDW specific factors I mentioned, they have been having a real impact on results, amplified by the unit hardware demand environment. So if we just think about the third one I mentioned, which is our cloud and SaaS business, we've been investing behind that business and the growing incredibly rapidly over the last five years. All of our acquisitions have had a cloud services hook to them. Nonetheless, given the full portfolio that we have, we have not yet attained the scale that we want to be at relative to the full portfolio. So when hardware is muted, it now has even more of an outsized impact because of the secular movement towards cloud. And we're growing that, but we still have a very high mix of hardware.

The other thing is the strategic investments that we've made over the year have been incredibly fruitful in developing broader and deeper strategic capabilities so that we can deliver full stack, full outcomes projects. These now we're seeing a much larger, higher dollar tier levels, and those are the kind of projects that are lumpy. We used to talk about this with our federal contracts all the time. The very big deals become lumpier and depending on when decisions are made, they can get deferred, they can move around, the size can change and therefore, it can impact results. And we saw that it was commercial and federal this quarter. And the last one is what I just talked about in the prior question, which is our financial discipline. We're going to continue to maintain our gross margin discipline as we move forward, and we've hit a couple of quarters where we're seeing behavior that is extreme -- pricing behavior that's extreme. So I just -- I'd say it is a combination of our strategic investments that are working incredibly well vis-a-vis value to the customer and growth in fast growing high relevance areas. In an environment where hardware has been and continues to be muted on a persistent basis. It's a bit of a double whammy for us. But I'm confident in the growth [Speech Overlap] go ahead, Amit.

Amit Daryanani
Analyst at Evercore ISI

[Speech Overlap] I was going to say, Chris, would it be fair to say that as growth resumes presumably in '25, that you should start to see gross profit dollars increase back to the way it normally does it. That would be a fair way to think about it. And then maybe my clarification was going to be, we've worked from Cisco and Microsoft, some of your bigger vendors, on how they're changing the channel pricing and the channel strategy for 2025. Do you see that being a bit of a driver for you as you think about your growth, especially the Asian sales piece of the business into next year and beyond?

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, as I think about the changes, I think about investing behind our cloud business and really, the cloud flywheel where we are trying to -- we are delivering a seamless experience from professional managed services to consumption and transaction based services to managed services around the cloud. And by doing that, delivering higher value to our customers, but that's precisely aligned with what our vendors are the CSPs, the Ciscos of the world exactly aligned with what they're incenting and what they want. So we think we're well positioned and that will be a positive benefit for us as we move into 2025 and beyond because it aligns with our with our strategy and our value that we can deliver to customers. And frankly, it drives -- because of the services wrap around it, it drives better economics for CDW and a stickier relationship with the customer.

Operator

Thank you very much. Our next question comes from Matt Sheerin of Stifel. Matt, your line is now open.

Matthew Sheerin
Analyst at Stifel Nicolaus

Yes, thank you. Good morning everyone. Just another question regarding the comments on client device growth. I think you said mid-single-digit growth, but it sounds like that was skewed more towards the public markets and not so much corporate in SMB. And as you talked about macro, is the expectation for AI PCs, is that another reason why we're seeing that push out? And are you seeing any kind of growth in corporate SMB versus enterprise there?

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah Matt, thanks for the question. On the client side, we're actually seeing -- we're seeing growth across almost all of the end markets. Corporate was -- we saw growth in corporate. It's small business is where we are seeing our customers kind of in a cash preservation mode and so pushing off the client device. But we really have seen a nice pickup in clients across almost all the end markets. So that's been positive.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Yeah, and Matt, I'll just add the -- what has been driving it has been more refresh of aging fleets and need for customers to get on with this activity. It's been less in the way of when 11 drivers and less in the way of AI PCs.

Chris Leahy
Chair and Chief Executive Officer at CDW

So next year, as AI PCs do come on board, that will be another nice accelerant for PC refresh.

Matthew Sheerin
Analyst at Stifel Nicolaus

Okay, great. Thank you. And then relative to your guidance on gross margin out for Q4, which is down year-over-year, and you had a big bump last year. Is that because you're expecting sort of a lower percentage of the advanced hardware solutions, which carries a higher margins or services? What are the other reasons behind that?

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Yeah, great question, Matt. It anticipates that we'll continue to see softness in the solutions side of the business, which comes at moderately higher gross margins. It assumes that client will continue to tick along, not in an outsized way, but that client would continue to move along. And then we would expect that we would get our typical pickup in more than netted down revenues in the fourth quarter. I'll just note the delta versus Q4 of 2023 is that maybe a little bit modest pick there on the netted down revenues versus last year because it was quite outsized at the end of the year.

Matthew Sheerin
Analyst at Stifel Nicolaus

Got it. Okay, thank you.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

You are welcome.

Operator

Thank you. Our next question comes from Keith Housum of Northcoast Research. Keith, your line is now open.

Keith Housum
Analyst at Northcoast Research

Thank you. Two questions as well, if I could. Chris, just trying to reconcile something here. CDW has always thought itself has being a relationship-driven company, providing value for its customers. But we're hearing about transactional competition and losing deals that way. Perhaps can you break it out for us like how much of business [Phonetic] is more transactional, or people are just going with the lowest price versus how much of your business is really driven by that relationship and the value you provide?

Chris Leahy
Chair and Chief Executive Officer at CDW

I would say that when you look at our portfolio and the spectrum of our relationships with our customers, that over 90% of those relationships and those customers would tell you that they buy from CDW because of the value we deliver, the access to the full portfolio, the expertise that we bring to bear, the ease with which they can do business. The agility with which we deliver. That is what every customer says to me when I meet with them. Regarding the pricing and the transaction issues, there are times when there are large rollouts, for example, that -- where the economics just gets lower and lower and lower. And those are transaction purchases, don't typically have the value wrapped around, and those are the ones that we are less interested in pursuing.

Keith Housum
Analyst at Northcoast Research

Okay. Appreciate it. And then you talked about like the move to the as-a-service model. I guess as I think about that, still relatively in infancy, but it's still going to grow as we go from here. So how much of, I guess, a challenge or a headwind is that -- present to hardware sales as we kind of think about just the future?

Chris Leahy
Chair and Chief Executive Officer at CDW

I didn't hear the whole question, I'm sorry.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

I think I got it. Keith, here's what I would say. Obviously, we've seen pronounced cyclicality in hardware, and that would typically be a pretty significant upfront spend. Think about that as kind of capex from a customer's perspective. What we've seen kind of counteracting that in some respects is an increase in our netted down revenues, including SaaS and cloud. Now Keith, historically a lot of that business would be what we would call recurring where we are both seeing that business upfront and recognizing that upfront. But I would say that over the last year or two, more of that business has been moving to a recurring nature, and that is where customers are more making judgments on what they want to spend on cloud, but they're consuming it as they go. And therefore, that shows up over time for us. Now I wouldn't call that a material dollar amount at this point, but it is growing. And therefore, I would say that is part of the calculus of kind of the air pocket when you have pronounced cyclicality of hardware and more business that starts to come on as we go. Certainly, as we continue to grow that sector in that category, we'll report more on kind of that split in details with respect to reoccurring business versus recurring. Hopefully, that's helpful.

Keith Housum
Analyst at Northcoast Research

Yeah, thank you.

Operator

Thank you very much. Our next question comes from Samik Chatterjee of J.P. Morgan. Samik, your line is now open.

Samik Chatterjee
Analyst at J.P. Morgan

Hi, thank you for taking my questions. I guess if I can start with one. Chris, you mentioned in your prepared remarks and in some of the responses as well. The exposure to large projects that you have on account of the capabilities that you've invested in over the years. I mean as you outlined some actions you're taking on the cost structure side. But as you look at the business and the lumpiness that, that drives in terms of exposure to large projects, are there any changes you're contemplating on that side in balancing out the business between larger projects or transactions versus do you still -- or do you still believe that's the right sort of balance or margin mix to have in the portfolio and really just wait for the market to come back on that front? And I have a follow-up. Thank you.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, the way I'd answer that question is kind of yes and yes. In other words, we do have actions underway. Look, we're looking at this quarter in 2025 as an opportunity to accelerate the most important parts of our strategy that we've been working on for several years. But one of them, for example, would be our digital work. We've done a lot of foundational work in digital, and we just need to go faster. And that really means aligning our digital capabilities and our people to deliver personalized recommendations that match how customers want to buy plan, consume, and manage their assets. So think about this in terms of large deals and perhaps smaller deals as an intersection of our sales professionals moving up a value chain and being available to learn and enabled by digital tools to sell at the highest point of the value chain while creating a seamless digital experience for our customers, a flywheel like, if you will, so that we can deliver both velocity in that digital flywheel and serve customers how they like to be served, self-serve, etc., and value with our account managers and sales professionals working together. So that's one area as an example where we -- our intention is to drive velocity in deals at all sizes, lower tier levels while we continue to build engagements at high -- high value levels.

Samik Chatterjee
Analyst at J.P. Morgan

Okay. Got it. And thank you for that. Quickly for my clarification question. I know you mentioned the election related uncertainty and some of the slower spend on the public sector federal side as well. I mean we've seen elections in the past as well. Have you had instances? Are you looking at any scenarios in which you do end up getting like a budget flush post the election outcomes. Are there any sort of scenarios or any indications of that happening in the fourth quarter? Thank you.

Chris Leahy
Chair and Chief Executive Officer at CDW

Yeah, hard to tell. I would say this election cycle, I wouldn't -- I would say there's nothing really normal about it. So hard to tell. I mean, right now, what's happening with the federal government is we've got the knock-on effects from the delayed budget previously. And now we've got -- while we saw strong spending in Department of Defense, we're seeing less than we'd hoped because they're waiting to see what the administration's priorities are. So we -- right now, we just see the federal government paused. One would hope we'll have some more clarity post election, but then the timing comes down to Congress from the President in getting the budget passed.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Maybe Samik, I'll just add on the back end there. Obviously, we play all of the different scenarios and how things could play out when we look at the quarterly outlooks. I would say our Q4 outlook has the appropriate level of caution baked into it based on all the factors that we talked about, the external factors, CDW specifics. And certainly, that would include any political uncertainty.

Samik Chatterjee
Analyst at J.P. Morgan

Got it, got it. Thank you. Thanks for taking the questions.

Al Miralles
Senior Vice President and Chief Financial Officer at CDW

Thank you.

Operator

Thank you very much. We currently have no further questions. So I'd like to hand back to Chris Leahy, Chair and CEO, for closing remarks.

Chris Leahy
Chair and Chief Executive Officer at CDW

Okay. Thank you, operator. Let me close by recognizing the incredible dedication and hard work of our 15,000 co-workers around the globe. It's their ongoing commitment to our customers in this challenging environment that makes us successful over the long term. Thank you to our customers for the privilege and opportunity to help you achieve your goals, and thank you to those listening for your time and continued interest in CDW. Al and I look forward to talking to you next quarter. [Operator Closing Remarks]

Corporate Executives

  • Steven O'Brien
    Vice President, Investor Relations
  • Chris Leahy
    Chair and Chief Executive Officer
  • Al Miralles
    Senior Vice President and Chief Financial Officer

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