Here’s the entire text of the Q&A from CDW Corporation's (ticker: CDWC) Q3 2005 conference call. The prepared remarks are in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
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Q - Craig Scott: Hi, good morning. Barb, just a quick question on the margin assumptions of the 6.1 to 6.6. As we work out. I got a little cut off there, but it sounds like the 6.6 you are looking for in the fourth quarter and then is it realistic to assume we dip down to the bottom of that range, in the first couple of quarters of calendar '06, or is that still a range where you hope to be toward the top end throughout the entire time period?
A - Barbara Klein: What I indicated was that we expect to be at the upper end of that objective range of 6.1 to 6.6% in the fourth quarter of this year, and also at the upper end of that range in the fourth quarter of 2006. I also indicated we would probably be at the lower end of that range in the first quarter of 2006.
Q - Craig Scott: Thanks. I got cut out there a little bit. And then as far as the tax rate goes, is there any opportunity to see a further decline in that? And I guess how do you look at the visibility of that, given that we have seen a couple of positive cuts here to the tax rate over the last couple of quarters?
A - Barbara Klein: The major change in the tax rate from earlier this year was due to the fact that we began collecting sales tax from our customers in the second quarter. And as a result, we become subject to state sales taxes in all of the states that have income taxes. And so the change in our tax rate was primarily driven by that, the reason we had a modification in the third quarter was primarily due to higher levels of municipal bond investments that had pretty good returns. Under accounting guidelines we have to evaluate our tax rate every quarter, so there's possibility that it may change as we go forward into future quarters, but it's really going to be something we'll have to look at on a quarter-to-quarter basis.
Q - Craig Scott: Okay, thanks.
Ben Reitzes - UBS
Q - Ben Reitzes: Yes, good morning. I wanted to just ask with regard to the top line, what do you see? Do you see these segments continuing to be the drivers of growth into '06 with regard to storage and desktop and servers and then again if you could clarify on notebooks, when do you think that the notebooks pick up again for you? And then I have just a followup.
A - Harry Harczak: Ben this is Harry, and I'll take the second part of your question first. Notebooks, part of this, as we indicated, the revenue was a little soft, but our unit volume was very strong, so we actually think that's a positive sign. We have had great response from some of our manufacturers in getting competitive pricing out at the front, makes us much more competitive. When we look at our installed base we have got a lot of opportunity within our existing customer base where we're not penetrated in a notebook category.
And then a couple of manufacturers have had some transitions as well. So we're going to focus our efforts and work closely with the manufacturers to try to drive -- continue to drive unit volume but to start to see the revenue volume increase. We are going to put some focus on that in the fourth quarter.
In terms of segments that will continue to drive, I think you hit on some top ones. When we look at what customers are trying to do, things around server consolidation and storage continue to be critical. Security continues to be a driver, both from a software as well as a hardware side, and I think the upgrade cycle will continue both on the desktop side and the notebook side. I think we'll continue to see good unit volume there with a push towards mobility of many of our customers.
Q - Ben Reitzes: Just with regard to federal, you mentioned that I think things picked up a lot in September, could you just talk a little bit more about that vertical and sustainability you know as we -- as we go forward, and obviously it was year end so that's probably why things picked up, but would you talk about whether you think that's CDW specific or -- and how that looks for you and your results maybe going forward?
A - Jim Shanks: This is Jim Shanks. The federal space, as we had mentioned, the end of their fiscal year is September 30, so we always do see a strong push of activity, this year a little more than we had in the past even, which creates a very competitive environment. The key to our success really came from our continued focus on funded opportunities. We continue to get a lot of detailed experience in that space. We understand how the procurement is going to happen not only in the busy season but also in the off seasons. So we feel that that was key to our success. We feel that it's something that we are going to continue to develop and build upon, as you can also see from some of the other details in the call today, we're continuing to find opportunities to invest in that space of future growth.
Q - Ben Reitzes: Thanks a lot.
Brian Alexander with Raymond James
Q - Brian Alexander: Thank you. Just a couple of questions, one on gross margin. Barb, you talked about product margin being up on a year over year basis. Just trying to get a sense for how much of that was due to product mix versus pricing. And then following on to that, I think an offset to gross margin this quarter was on vender incentives, and as I recall this might be the third straight quarter where those have been down year-over-year. I know you don't have a ton of visibility in to that, but just based on your conversations with vendors, is there any reason for us to believe that that could be a trend, or is this an anomaly in the first few quarters of the year?
A - Barbara Klein: Brian, with respect to your question on margin, we don't really go into the detail behind the factors that I mentioned before. So we did see improvement in product pricing as we went into the third quarter compared to last year. We have seen that, I think, as we have gone through a couple of quarters of this year. With respect to volume rebate, or vendor incentives and volume rebates, you're correct, we don't have a lot of visibility in to that because it really is driven by what our vendor partners decide to do in terms of the programs that they run. As we said before, our goal is to really make sure we know what the goals are, we understand what the programs are, and then we drive to make sure that we maximize our obtainabililty of those products -- of those goals each and every quarter.
Q - Brian Alexander: Can you just talk about how broad based those declines are in terms of vendor incentives? Is it coming from a few major vendors? Is it across the board?
A - Barbara Klein: Brian, one thing that you have probably seen in the press that effected us like a lot of others was the Microsoft changes that they made effective at the beginning their new fiscal year, which was in July. So that was one of the factors that impacted us in the third quarter.
Q - Brian Alexander: Okay. Great. And then, I guess, the final question on -- on HP just a lot of commentary from them around perhaps investing in fewer partners, particularly those that are loyal to HP. Just trying to get a sense for, where do you think CDW fits into that commentary? Do you expect to be a net beneficiary of the changes that they are making around those vendor incentives?
Q - John Edwardson: Brian, John. Our sense from everything that we have heard both directly and indirectly is that HP is -- is going to be putting more eggs into fewer baskets, and what I mean by that, is they are going to be spending more of their money with the partners who generate the most profitable revenue for them. Clearly as their No. 1 partner in the world we get a lot of visibility, and -- and we didn't get to be the No. 1 partner in the world without having a significant attached rate and without being very loyal to HP. But in any event, I am very comfortable with the direction they are heading. It's something that we think makes a lot of sense both for Hewlett-Packard, and for CDW as well.
Q - Brian Alexander: Final question for Harry just an update on solution edge. How many solution providers have you recruited, and just give us a sense for how that's going?
A - Harry Harczak: In solution end Brian, we have got in total about 30 partners at this point in time. We're still working on implementing the program with those partners in terms of converting customers and training their folks. There continues to be a high level of interest, we have had a couple of recent recruiting events with people and there continues to be a high level of interest. It is still not contributing any significant revenue but we are building the blocks and we think ultimate will be successful and we're going to continue to build and invest in it.
Q - Brian Alexander: Okay. Good luck to the other Chicago baseball team.
A - Harry Harczak: You mean the one that's in the World Series?
Bernie Mahon - Morgan Stanley
Q - Bernie Mahon: Hi, good morning. Question for you on the operating margins for 2006. In order to meet the, kind of, high end of that range, say 6.6, do you need to see a meaningful reacceleration in revenue or do you think the 10 to 11% year over year growth rate will get you to the 6.4 to 6.6 range?
A - Barbara Klein: Bernie, you know that we don't give any kind of guidance with respect to future revenue growth. We allow you all to make your estimates based on what we have given to you in terms of information, and just to reiterate my comment that I said earlier, our objective range is 6.1 to 6.6, and our goal is to be at the upper end of that range in the fourth quarter of 2006, but we'll probably be at the lower end of the range in the first quarter of 2006.
Q - Bernie Mahon: Thanks. Then, just a quick question on the federal government. So that was flat on a year over year basis in August. Harry, could you just talk how that played out in the month of September? Just the federal portion, not the entire public sector.
A - Jim Shanks: This is Jim Shanks. I'll take that question. On -- we did see in August that it was flat, and definitely saw a very strong pickup in September. Most of that heavily weighted towards the very back end of the month, so chasing a lot of the different funded opportunities that were out there, a lot of the activity we also saw came in our last 2 days of the month as well. Definitely strong pushup -- pickup on sales but we don't go into the exact percentages on year over year growth for that.
Q - Bernie Mahon: Right. So if you saw a strong pickup in the last week or so, is it safe to assume there's some big deals that maybe slipped into the December quarter?
A - John Edwardson: It is -- there are always deals that don't get shipped until the last week of September so that is a reasonably good assumption.
Q - Bernie Mahon: All right. Thanks a lot.
Operator: Thank you. At this time we do have Matt Sheerin with Thomas Weisel Partners, please state your question.
Q - Matt Sheerin: Yes, thanks. John, I would like to ask the growth target question again. I know you have backed off from specifically giving a target for growth market plus whatever, but obviously you're investing in -- in warehouse, you're investing in people so you -- you are obviously expecting to continue to grow revenue. You have been running in the 10 to 11% range year over year for the last 4 or 5 quarters, without giving a number, because I know -- I know that you won't, could you just talk about the opportunities, where you see opportunities for CDW, whether it be specific markets, specific geographic areas, where -- where do you expect to grow?
A - John Edwardson: A couple of different places, one -- and as the healthcare vertical, and as we look at that opportunity as a significant opportunity, and it was worth doing the reorganization that we went through. So as each of you are looking at your own healthcare costs at your own companies, you know that that market is huge. It is getting more expensive. Automation is ever more important, so that is clearly a focus.
We continue to think that in the markets across the US we have somewhere around 5 to 6% market share, so we believe in every single segment that we have that we have profitable growth opportunities. We will be looking at more industry verticals, and more than likely, some time next year we'll do something similar to what we did with healthcare this year.
We also believe that as we look at the organization of our -- of our sales groups, we need to align them better with our vendor partners, and so there are opportunities there to joint venture more with -- with our significant vendor partners, than we have done in the past, so those are significant. And Canada, which is not a very big operation, but -- but is growing, much more rapidly than the US market, and we're continuing to build resources in the Canadian market, so that will continue to be an opportunity for growth, and -- and I guess as we look at this, we clearly wouldn't be building or doubling the capacity of our distribution center and our configuration center, and if we didn't believe that we had substantial growth opportunities, and we're building ahead.
Usually in the past, we have taken much smaller increments of investment when we built this particular facility, we built it as many of you know in three different pieces that was not a very efficient way to do it. So we have stepped up in this particular case and put most of the money into this facility in the beginning, so we built one building of a half million square feet instead of three buildings that we would continue to add on to. We have put much of the automation equipment into the building, and it will depress earnings a little bit as a result, and Barb has given those numbers to you. But if we didn't feel very good about the future, believe me, we wouldn't be making those investments, and I guess that is the best way to answer your question.
Q - Bernie Mahon: Okay. And then just a follow-up. You talked earlier about the opportunities in building inventory and getting some buying power from vendors for big volumes, when -- or would we expect to see gross margin positively impacted by that?
A - John Edwardson: You know, those are -- are going to be very difficult to measure, and they happen generally at month end or quarter ends with different vendors or end of life on different product runs and we have begun to do a significant amount of business with many vendors at the end of -- of product life. So -- and these have always been in our numbers, and we were not able to do as many of those, or if we did them, we had so much inventory in our facility that it was basically a log jam time. So it will make operations a little more easier. We'll be able to look a little more for these. But I don't know if -- you're not going to see a significant jump in gross margin as a result.
Q - Bernie Mahon: Okay. And just lastly, just quickly, on -- on healthcare, it's the growing part of your business, could you talk about seasonality in that business?
A - John Edwardson: We'll let Jim do that.
A - Jim Shanks: When you look at health care, we really aren't seeing any specific seasonality trend as we look at our data yet.
Q - Bernie Mahon: Okay. Thanks a lot.
Operator: Thank you. At this time we do have Bruce Simpson with William Blair. Please state your question.
Q - Bruce Simpson: Hi, I wonder if you can provide the breakout of how much of the 350 million run rate was classified from commercial and how much was from public sector, so that we can get more of an apples on apples comparison of CDW's growth?
A - Barbara Klein: Bruce this is Barb. We're not going to give you the details of the healthcare channel. We don't give details in general for any of the channels of our business. With the restatement you can get some information from looking at the information from 2004, 2005 on a restated basis, but as a general rule we don't give details for the channels of our business.
Q - Bruce Simpson: Okay. Let's hit the cost side of the income statement a little bit and talk about this incremental leased office expense. Is that downtown? Is that in the suburbs? Approximately what size in terms of square feet, or what capacity in terms of salespeople that you think you'll be able to house in there are built into that estimate that you gave us?
A - John Edwardson: Bruce, what we're doing is two different things here. In the city, as you may know, we have two different buildings in downtown Chicago that are adjacent to each other. We believe that it will be much more efficient and productive to have our people in a single building, so we are moving all of our people into one of those two buildings and we're -- we're also in this particular case committing to growth in the future, so we will be committing to take more in this building over the next several years, and -- and so there's going to be a little bit of transition expense and moving expense next year, and we have about 950 people or whereabouts in downtown Chicago right now. It is where most of our young people want to live and work when they join the Company. After they have been with the Company for a few years and they get married and have children, then the suburbs look more interesting, and many of them want to move, but at this point much of our growth in Chicago is going to be in downtown Chicago.
Likewise, at our corporate offices, we are just completely out of space, and we are renting a space in a building directly across the street from this building. And -- and we'll be working on that building and hopefully moving into it in the next 3 or 4 months. So lots of activity in the real estate group, and those expenses are included in the estimates that Barb has given you for year-over-year SG&A expense change.
Q - Bruce Simpson: Okay. Is the space that you are moving into up in the suburbs are you talking about incremental space for Vernon hills or the sales guys in Woodland Falls?
A - John Edwardson: That space is Vernon Hills, and we have -- as I mentioned in the sales organization, most of the new demand is going to be in downtown Chicago.
Q - Bruce Simpson: Okay. So you have got 950 down there now, when you make this commitment, how many will you be able to house down there?
A - John Edwardson: And everybody is saying more, and -- and Bruce, we -- you know, as you look at, this we're going to be growing that number steadily, and much, but not all of the growth will be in that building, but we have room to grow, in one of our New Jersey facilities. One of our New Jersey facilities is already completely filled up. Our Connecticut facility is completely filled. We have a little bit of room for our Alexandria -- not Alexandria outlet -- Herndon, Virginia facility, and but in many locations we have -- have simply maxed out those locations, and we need to provide more room for growth in each of them.
Q - Bruce Simpson: That was incremental expense that Barb mentioned inclusive of those other kinds of places that you are out of room, or are those going to be --
A- John Edwardson: Yes.
Q - Bruce Simpson: That includes everything?
A - John Edwardson: Yes.
Q - Bruce Simpson: Okay. The Vernon Hills space that you are going rent it sounds like it is not sales space but it's rather operational.
A - John Edwardson: It is operational, yes. The corporate headquarters group, so it's going to be the finance group, and the purchasing group, and the IT group, and the marketing group, and legal, and -- and you know, and those kinds of functions.
Q - Bruce Simpson: Okay. And just to touch on a question that somebody asked earlier, given that there has historically been a relatively limited amount of leverage in this model, when you layer on these incremental expenses, what is the -- the investment thesis that you'll be able to get back into these kinds of 6.5 to 7.0 range by 2007? What's going to drive that kind of leverage once you have this incremental expense?
A - John Edwardson: Key theme is going to be simply revenue growth, and we need more of it, and that is one reason we're investing in the sales force as we mentioned. And -- but revenue growth is going to be it. And as -- as we look at the future, we still see lots of opportunities to grow in the US and the Canadian markets.
Q - Bruce Simpson: Last thing, John, any change at all on either your strategies on acquisition or on what you are seeing in terms of availability out there?
A - John Edwardson: No change, and no comments.
Q - Bruce Simpson: Okay. Thanks.
A - John Edwardson: Okay. Thank you, Bruce.
Operator: Thank you at this time we do have Steven Fortuna with Prudential Equity Group. Please state your question.
Q - Steven Fortuna: Great. Thanks. Just a couple of short ones here. First would be on the productivity side. You guys haven't shown a lot of great year-over-year improvement. Maybe, Harry, you can talk a bit about some of the efforts you're making to try to drive that.
And then second is, I know you guys are trying to drive more education mix, which is generally higher margin than government into the public business. How is that effort going along? And then lastly, kind of a far flung question here, it it's pretty clear that Dell has been backing off on price aggression, particularly on consumer, but also I think to some degree on the corporate side. Have you seen anything, any benefit, as you go to customer that maybe Dell is kind of a little bit less aggressive and maybe that's helping your business a little bit?
A - John Edwardson: Okay. We'll answer your three part question in three parts and Harry will begin.
Q - Harry Harczak: In terms of productivity, we have seen some good results. Some of the things we're doing, Steve, that are helping that is the investment that we've made in our specialist teams. As you recall, specialists operate with the account managers on advanced technology solutions for customers, things like server consolidation, security specialist, mobile wireless. We have seen very good results from our efforts there which are helping to increase overall productivity.
We have put in a number of tools that we're starting to see some results from. It's still early, but things such as our portfolio manager tool which gives an account manager the ability to see their entire account base and better understand where the opportunity is in their account base and develop a business plan for penetration, which is a significant opportunity for us. And then the last thing, I think, that has a positive impact this quarter in particular, is we are a little bit seasonal in the third quarter with the public sector and that certainly helps the productivity in the third quarter.
So, those are -- there are a handful of other things, but if I had to key in a couple I would say those are some of the top ones.
A - Jim Shanks: As far as education, it is definitely one of our key channels. We're continuing our segmentation strategy in that space, allowing us to take and treat private and public higher education differently, K through 12 differently, and also a very extensive amount of work going on with targeting specific accounts in that space, making sure that we are identifying and meeting their unique needs.
So as we continue to sharpen our segmentation and hone our skills at identifying those unique opportunities, we can continue to invest not only from a sales force standard point, both with inside and field, but also we can look at unique product offerings and also unique solution offerings that we can start to provide to those customers to continue to grow.
A - John Edwardson: Third, with respect to Dell, and I can't speak on much of the consumer business, but my sense is this, many of our -- or several of our major vendor partners, due to changes in their company, are getting their cost very much in line with Dell's.
My sense is they are going to be holding Dell's feet to the fire on pricing. Dell -- which will be different than what it has been instead of Dell holding their feet to the fire. I'm seeing a big turn around in that area, and we have some very very competitive partners who are doing a darn good job at getting their costs in line, so that they can be great competitors with Dell.
With that we have time for one more question, and -- and then what we will do is let those of you who wanted to ask questions have first chance to talk with Cindy directly at the end of the phone call, but we have about two more minutes before we need to move on to another meeting.
Joel Wagonfeld - First Albany
Q - Joel Wagonfeld: Thanks very much. I was wondering if you could just comment on the 4% average unit selling price increase in desktops and servers. Was that a result of a mix shift port servers, or are you seeing actually positive ASP trends in both of those categories? Thanks.
A - John Edwardson: That is more of a shift in mix towards servers. Desktop average unit price was down just a tad. Offset by the shift in mix to servers and positive ASP gains in the server line.
Q - Joel Wagonfeld: Thanks.
A - John Edwardson: Okay. So with that we have phone calls left from David Manthey, Bill Fearnley, John Goyle, and Richard Gartner. Cindy will give you guys first opportunity as she takes phone calls. Thank you very much, we are pleased to have another quarter record results. We know that you expect more in the future and -- and what you know we'll be working hard to make that happen. For those of you who are not CDW customers, I want to remind you you can reach us at 1-800-800-4CDW or visit us on our website at CDW.com. And if you are already doing business with CDW, we thank you very much for your business. We'll talk to you again in three more months.
Thank you. All participants, your third quarter conference is now ended. You may now all disconnect.
Related on The Seeking Alpha Network:
- CDW Earnings (CDWC Q3 2005 Conf Call) Prepared Remarks
- A list of full conference call transcripts available on the Seeking Alpha Network.