CDW - NASDAQ

Good morning, all. Thank you for joining us for the CDW Second Quarter 2024 Earnings Call. My name is Carly and I'll be the call coordinator for today. [Operator Instructions] I'll now hand over to Steve O'Brien of Investor Relations to begin.

Thank you, Carly. Good morning, everyone. Joining me today to review our second 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 and you will find 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-ks. Please note all references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2023 unless otherwise indicated. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is the property of CDW and may not be recorded or rebroadcast without specific written permission from the company. With that, let me turn the call over to Chris.

Thank you, Steve. Good morning, everyone. I'll begin today's call with a brief overview of our performance, strategic progress and view on the second half 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. Second quarter market dynamics played out roughly as we expected. Cautious customer behavior once again, elongated sales cycles and drove prioritization of needs over wants and cost savings over expansion. Capital investment in complex solutions, particularly those tied to data center and network modernization continued to be downsized or put on hold, and there was growing refresh activity in client devices. What was not expected were two end-market specific dynamics, a worsening in the UK environment and further federal funding challenges. Within the limited demand environment, we continue to help our customers build out technology roadmaps and our pipeline remains solid in the solution space. Conversion remains challenging with uncertainty weighing on our customers' appetite to spend. The team's value as a trusted adviser and ability to deliver solutions that met our customers' most pressing priorities drove excellent performance across cloud, security and services. Performance that contributed to strong profitability and cash flow, performance made possible by the strategic investments we have made over the past five years to bring full stack, full lifecycle solutions to our customers. For the quarter, the team delivered gross profit of $1.2 billion, flat year-over-year with a gross margin of 21.8%, up 80 basis points, net sales of $5.4 billion, which were down 3.6%, non-GAAP operating income of $510 million, down 3.7% with a non-GAAP operating income margin of 9.4%, which was flat and non-GAAP earnings per share of $2.50, which was down 2.6%. Let's take a look at this quarter's performance drivers. First, our balanced portfolio of end markets. Recall, we have five sales channels, corporate, small business, healthcare, government and education, each a meaningful business on its own with 2023 annual sales ranging from $1.6 billion to $9 billion. Channels are further segmented to focus on customer end markets including geography, verticals, customer size and spend. Teams are similarly segmented in our UK and Canadian operations, which together delivered US$2.6 billion dollars in 2023 sales. These unique customer end markets are typically uncorrelated given the different economic and external factors that impact each of them. Our second quarter results provide a good example of this. Corporate posted a net sales decline of 2%. Robust increases in cloud and security supported profitability with a meaningful increase in gross margin. Client devices increased for the second quarter in a row and posted both year-over-year and sequential sales increases of low double digits. Notably, client device ASPs held firm with a mix into higher value, higher functionality units. Once again, servers and netcomm declined as customers continue to undergo technology transitions in its real capacity. Storage was a standout category increasing double digit driven by upgrades of legacy systems. Small business net sales declined 3%. The team's ability to help customers address mission critical priorities around security and productivity with cost-effective software and cloud solutions contributed to improvements in both gross profit and margin. Small business did not see significant refresh activity and while increasing mid-single digit sequentially, client devices declined slightly year-over-year in the quarter. Consistent with corporate ongoing postponement of infrastructure investments in netcomm and servers drove low double-digit declines. Public sales declined 2% in the quarter with mixed performance by end market. Government decreased 6% as growth in state and local was more than offset by a decline in federal. Federal results were further impacted by the delayed fiscal 2024 budget authorization as several key customers did not receive funding releases until late June, weeks later than expected. These released funds face processing delays from the normal gears of government as hardware and software orders require solicitation, competitive bids and evaluation. We know that ongoing projects will eventually move forward, but some agencies may pause new projects as they await the clarity around the next administration's priority. In light of these layers of friction and uncertainty, we do not expect a federal catch up in the back half of 2024. The state and local team had another solid quarter, up mid-single digits. Security remained a key performance driver. Client devices increased by mid-single digits both year-over-year and sequentially. While early state and local budget dollars are being allocated to improving citizens experience at state and municipal agencies, including enhanced AI-powered automated response and messaging platforms. Healthcare net sales were flat. Security remained a key focus area and the team delivered robust customer spend and gross profit growth, led by security assessments for cloud migration and identity management. Driven by refresh, client devices increased by double digits. The team's ability to deliver cloud migration, including moving applications out of hospital data centers, drove excellent cloud performance and contributed to both increased gross margin and profitability. Education sales declined roughly 1%. K-12's top line was roughly flat year-over-year while profitability grew. For the second quarter in a row, client device sales increased up mid-single digits as school systems refreshed aged Chromebooks. Security and cloud remain top priorities, both delivering strong growth and gross profit. Once again, collaboration hardware, primarily smart whiteboards and interactive flat panels, declined meaningfully as schools continue to digest significant purchases made over the past several years. With the sunsetting of ETF funds and upcoming deadlines for ESSER funds of September 30th, the team is focused on helping their customers pivot to refresh programs funded through traditional mechanisms. Consistent with recent quarters, higher ed institutions remained focused on investments to enhance student experience to drive enrollment, while doing more with less, and the team posted a mid-single-digit top-line decline. Cost elasticity continued to drive strong double-digit growth in cloud. Security remained a top priority, up strong double digits and client devices returned to growth in the quarter, up high single digits driven by refresh. Our UK and Canadian international operations, which we reported other, declined 13%. While both teams continue to execute well, the demand environment, particularly in the UK, worsened during the quarter as the early general election amplified already challenging conditions. UK sales declined high teens in US dollars and Canada declined 4% in US dollars. Given current conditions, we expect the UK market to remain volatile and under pressure through the back half of the year. As you can see, the diversity of our end markets results is fundamental to the first driver of our performance, our balanced portfolio of customer end markets. Category performance demonstrates the benefit of our second performance driver, our broad and deep portfolio of products and solutions. Transactions categories increased during the quarter while solutions categories declined. Both transactions and solutions increased sequentially in the quarter. At the portfolio level, hardware decreased 5%. High single-digit client device growth and mid-single-digit steward growth was more than offset by meaningful declines in netcomm and collaboration. Software customer spend increased mid-single digits while net sales were impacted by our strong mix into netted down revenue and decreased by 1%. Services increased by 6% driven by cloud and security-related services. Once again, cloud was an important performance driver, contributing double-digit gross profit growth across software, services and security. Profitable growth that was enabled by the strategic investments, both organic and acquired, we have made in solutions and services capabilities over the past five years. And this leads to the final driver of our performance in the quarter, our three-part strategy for growth, which is; first, acquired new customers and capture share; second, enhanced our solution of capabilities; and third, expand our services capabilities. Each pillar is crucial to our ability to profitably advise, design, orchestrate and manage the solutions our customers want and need in any environment. Let me share an example of our strategy and action as we delivered on a customer's priority in today's challenging demand environment. An insurance company faced early end of life for its hyperconverged infrastructure equipment, something not contemplated in their already tight budget. Armed with our broad and deep cloud portfolio, our cloud, hybrid infrastructure and services group collaborated to architect a cloud subscription-based solution that delivered cost elasticity, the customer's budget could absorb. The multi-faceted solution seamlessly moved on-premise workloads and data to the public cloud, delivered cloud compute, migrated custom and off-the-shelf applications, created a virtual desktop infrastructure and delivered security measures with virtual firewalls. Plus, it optimized workloads to ensure the customer effectively managed CPU usage, memory and storage, further mitigating costs. This comprehensive solution generated more than $1 million in product revenue and a multi-million dollar CDW professional services engagement. After seeing our cloud expertise in action, the customer engaged us for additional cloud solutions, including identity management and unified cloud call center ongoing managed services. Today, we were one of the customers' most valued strategic partners. A great example of how we're delivering value to our customers both for today and for the future. And that leads me to our expectations for the balance of the year. You will recall that on the last quarter's conference call, we shared our expectations for 2024 U.S. IT market growth in the low single digits. And our target to grow 200 basis points to 300 basis points above market. This factored in a modest improvement in demand conditions in the second half of the year. Given real-time feedback from our large and diverse customer base, we now expect current market conditions to persist throughout the year, not get worse, but not get better. Given the market's slow start to the year, without a second-half demand pickup, we now look for U.S. IT market growth up towards the lower end of a low single-digit range. We continue to maintain our target to grow 200 basis points to 300 basis points above market. Growth will return. The demand drivers are there. Workload and data growth, increased security threats, client device obsolescence, and adoption of AI-powered assistance and applications. But customers need greater clarity and confidence, clarity around economic conditions and clarity around the impact of AI on their tech roadmap, and confidence that investments made today will deliver the right foundations and economic returns in an AI-powered future. Improved demand conditions are a function of when, not if. Wildcards for the balance of 2024 include the potential of greater macro and geopolitical uncertainty, significant degradation of market conditions in the UK, as well as unusual uncertainty in the U.S. election. As we always do, we will provide an updated perspective on business conditions as we move through the year. Whatever the market conditions, we will remain focused on delivering exceptional value to our customers, gaining share and executing with the discipline and rigor that is CDW's hallmark. And we will continue to play the long game, holding steadfast in our commitment to executing against our growth strategy to ensure we have the solutions and services capabilities our customers need to achieve their mission critical outcomes. With that, let me turn it over to Al, who will share more detail on our financial performance.

Thank you, Chris and good morning, everyone. I will start my prepared remarks with details on our Q2 performance, move to capital allocation priorities and then finish with our updated 2024 outlook. Second quarter gross profit of $1.2 billion is roughly flat, up 0.1% versus the prior year. This is modestly below our original expectations for low single-digit growth for the quarter as the aforementioned strength in cloud, security and services was offset by lower demand for netcomm and collaboration hardware. Consolidated second quarter net sales of $5.4 billion were down 3.6% versus the prior year on both reported and average daily sales basis and up 11.3% sequentially, driven by seasonally higher demand in education channels and government channels and especially pursuant to client devices. Gross margin increased approximately 80 basis points year-over-year. Gross margin of 21.8% was flat quarter-over-quarter and broadly in line with both full-year 2023 levels and our expectations for 2024. Second quarter year-over-year margin expansion was primarily driven by the higher mix in the sales, where CDW acts as agent, also known as netted down sales. This category grew by 8.7%, once again, outpacing overall net sales growth and representing 33.2% of our gross profit, compared to 30.6% in the prior year's second quarter. Year-over-year expansion came from our teams continuing to successfully serve customers with cloud and SaaS-based solutions. The netted down category of solutions represents an important and durable trend within our business, contributing to our ability to deliver enhanced gross margins. It is important to note that netted down sales growth and its impact on our mix of business will fluctuate over time with customer priorities and product demand. Second quarter gross profit was up 11.3%, compared to the first quarter of 2024 on both reported and sequential average daily sales basis. While second quarter sequential net sales and gross profit growth were higher than the sequential growth rate seen in the last few years, they were very modestly behind our own expectations, as well as historical seasonal upturn we experienced in pre-pandemic years. This reflected two factors, longer-than-expected delays in spend from our federal customers related to the prior congressional budget impasse and lower performance by our UK business, which is impacted by volatility in the economic and political climate. Turning to expenses for the second quarter. Non-GAAP SG&A totaled $673 million, up 3.2% year-over-year. Expenses were roughly consistent with the expectation we shared on our last earnings call, including expense efficiency ratio more in line with normal levels. The improvement from the first quarter reflected higher gross profit attainment and relatively lower level expenses on a quarter-over-quarter basis. Coworker count at the end of the second quarter was approximately 15,200, up slightly over the first quarter and year-end. Customer facing coworker count was also slightly up at approximately 11,000. Our goal is to balance driving growth and exceptional customer experience with efficiency and cost leverage from our broader operations. Non-GAAP operating income totaled $510 million, down 3.7% versus the prior year, driven by the combination of roughly flat gross profit and moderately higher expenses year-over-year. Non-GAAP operating income margin of 9.4% was flat to the prior year and up from 8.3% in the first quarter. Our non-GAAP net income was $339 million in the quarter, down 2.9% on a year-over-year basis. The second quarter weighted average diluted shares of 135.6 million, non-GAAP net income per diluted share was $2.50. Moving to the balance sheet. At period end, net debt was roughly $5 billion. Net debt has declined by approximately $93 million since year-end 2023, primarily reflecting our increased cash position alongside modest debt repayment. Liquidity remains strong with cash plus revolver availability of approximately $1.9 billion. The three-month average cash conversion cycle was 17 days, up three days from the prior year, but still 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 active management of our inventory levels. As we've mentioned in the past, timing and market 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 $138.4 million in the quarter, consistent with our expectations and seasonal business trends. Year-to-date, adjusted free cash flow was a healthy $503 million, an 84% of non-GAAP net income within our stated rule of thumb of 80% to 90%. First-half performance puts us on track to meet our 2024 objectives. For the quarter, we utilized cash consistent with our 2024 capital allocation objectives, including returning approximately $202 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 non-GAAP net income. Last November, we announced a 5% increase of our dividend to $2.48 annually, our tenth consecutive year of increasing the dividend. We will continue to target a 25% payout ratio in 2024. Our second priority is to ensure we have the right capital structure in place. We ended the second quarter at 2.4 times within our targeted net leverage range of two to three times. We will continue to proactively manage liquidity while maintaining flexibility. Finally, our third and fourth capital allocation priorities of M&A and share repurchases remain important drivers of shareholder value. We continually evaluate M&A opportunities that could accelerate our three-part strategy for growth. Year-to-date, we've utilized over $250 million of cash on share repurchases and have over $830 million 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. Customer sentiment remains cautious and prudent across end markets, particularly in the commercial, international and federal channels. Last quarter, we spoke about the slow start to the year for 2024 IT spending and shared our expectations for tough conditions to persist in the near-term, but to modestly improve in the second half. At the same time, we noted a compelling need for our customers to address cloud workload growth, increasing security threats and aging client devices. These priorities continue to resonate with customers and were brighter spots in the second quarter, while uncertain macroeconomic conditions and a complex technology landscape weigh on customer demand for solutions hardware. Given these market conditions, our updated full-year 2024 expectation is for flat-to-low single-digit gross profit growth, a view that incorporates both our slower start to the year and our view that the mild recovery we anticipated in the second half is not likely to materialize. This leads to seasonality roughly in line with historical levels, with the first half contributing approximately 48% of net sales and gross profit. We maintain our expectation for 2024 gross margin to be similar to the full-year 2023 and much like we've seen throughout the first half of 2024. Finally, we expect our full-year non-GAAP earnings per diluted share to be flat to up slightly 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 third quarter. We anticipate low single-digit gross profit growth compared to the prior year with no change to our expectation that gross margin will be comparable to full-year 2023 and the first half of 2024. This leads to roughly normal seasonality, compared to historical levels and also the moderately lower second quarter base. We continue to expect the fourth quarter to be meaningfully lower, compared to the third quarter, principally due to seasonally lower demand from education and government customers. Moving down the P&L. We expect third quarter operating expenses to be moderately higher than the third quarter of 2023 on a dollar basis given the higher gross profit performance, but at a similar ratio relative to gross profit. We expect third quarter non-GAAP earnings per diluted share to grow in the mid-single-digit range year-over-year. For full-year 2024, we are maintaining our expectation for adjusted free cash flow to be in the range of 80% to 90% of our non-GAAP net income. We currently sit comfortably within that range. 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 up for questions. We would ask each of you to limit your questions to one with a brief follow-up. Thank you.

Thank you very much. [Operator Instructions]. Our first question comes from Amit Daryanani of Evercore ISI. Amit, your line is now open.

Good morning and thanks for taking my question. I guess maybe, just to start with, if I look at your core gross margin, the gross profits excluding netted down revenues, it was up fairly, nicely, sequentially and really flat year-over-year despite what seems like a much higher mix of PCs in the quarter. Could you just talk about what is enabling the sequential gross margin expansion in June for your core business and if there's a structural change to what PC margins may look like going forward?

Yes. Thanks, Amit. Good morning. I'll take that question. Nothing too significant there to report, Amit. I would just say that, within the array of the product sectors, we did see strength in storage in a couple other categories that supplemented our client device margins. And then further, I would note that on the client device side of the house, we continue to see firm margins there including, and Chris alluded to this, kind of a higher mix in the kind of premium product, if you will. So, overall, we continue to see an environment, where product margins appear to be holding up. And obviously, as you pointed out, they are further supplemented by the growth that we continue to see on the netted down revenue stream side.

Got it. And then, yes, I guess, Chris, could you just talk about, if I think about it at the start of the year, the expectation was for gross profit dollars to be up mid-single digits and it kind of went to low single digits and now, it's kind of flat to low. Is this downward revision that you made, is it really around what's happening to the PC recovery and how that's become a bigger part of the mix. Or are there other factors Let me see. How do you weigh the downtick in revisions over the last couple of quarters? And is there any change in how you forecast your forecasting philosophy as you go forward related to that? Thank you.

Yes. Good morning, Amit. Thanks for the question. As we think about, let me start with the first part of that question, the outlook, and I'll just walk you through. I mean, at high level, that our outlook, incorporated a modest uptick in the second half demand of 2024. And that change really reflects, that we think current market conditions will persist. I think, I said not get worse, excuse me, but not get better. And that's just based on our market intelligence with our customers and our frontline coworkers. If you want to go through the puts and takes, look, when we start with corporate after a long period of fits and starts, and what I'll call uneven performance, corporate feels on more solid footing and is demonstrating a steadier rhythm to the business. That said, with signs of stability, it's still a bit too early to call and to bake that into the expectation in the back half of the year. Just need to see a couple more data points to build confidence on that one. Small business, I'd say not getting worse, not quite as volatile, but still bouncing along the bottom, so not seeing an uptick there. And then we've got these two end markets that had very unique impacts and we think will impact going forward. The UK, the degradation in the UK that I mentioned in the environment there, which impacted the second quarter and expecting impact the second half of the year. And then the federal gears of government, these two delays are just creating, frankly, a bottleneck that's not overcomeable at this point, on the federal side. And so, we don't expect to see a pickup back in the second half of the year in federal as we expected to. So, I just say that the outlook net-net reflects that there's no substantive change in the commercial market demand. It incorporates normal seasonality and it also includes, I guess, a moderate IT refresh across primarily client devices and some other solutions that can't be postponed. So, that's the way that we're thinking about the outlook. I think you asked a question on forecasting. And I would just say that on the forecasting, look, the team is doing a phenomenal job staying highly-engaged with our customers and pivoting, when needed. As you can see from our results, security cloud, software services results, it's very clear that we -- our portfolio and our people allow us to be the trusted adviser and support in the moment in the market type solutions. The forecasting is, yes, it's a little bumpier. because you've got lumpy - lumpy-big deals and they're all interrelated. There's no the example that I shared during the script. You see how interrelated and complex the solutions are. So, as those push, they push. but I think the team's doing a great job staying engaged with customers. And I would also say that our solutions pipeline is really quite strong. It's been the conversion given the market that is reflecting the appetite to buy, but the pipeline is really quite strong.

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

Yes. Thanks. Yes. Thank you. Good morning. I wanted to ask about the commentary regarding the continued slow demand for netcomm and servers, advanced solutions products. This is probably the third quarter that we're into that malaise. I know there was a lot of backlog that was worked down. Are you seeing any visibility of signs of pickup there. And then on the server side, we're hearing, particularly, SMBs and middle markets, where there's more an acceleration toward cloud instead of doing their own internal upgrade. So, any visibility into those markets?

Yes. I would say on the networking side, there's certainly interest from customers on network modernization. That is a high priority. but there is still significant digestion going on. The supply chain is normalized, but we still have customers that are digesting what they purchased or actually received, I should say, later in the cycle. I think as we get back to the back half of the year, the overlaps will look a little bit different and so the performance will likely look a little bit different. But I would just say it's high priority. There's just still a lot of excess at our customers that they're digesting. On the server side, on the mid-market server side, we are seeing some strength in that area. but again, it's subject to our customers really, being cautious about where they're spending and pivoting a little more to cloud and elastic advisable solutions at this time.

Okay. Thank you. And then regarding the outlook for the government business, it doesn't sound like there's going to be that seasonal uptick in federal, yet you're guiding the overall company for a seasonality in the next couple of quarters. So, are there any offsets to that weakness in federal.

Good morning, Matt. I would just note, look, we are still going to see reasonably normal seasonality from the government business. And remember, there's significant strength there on the state and local side of things. So look, even in the quarter, state and local offsetted some of that compression from a federal perspective. So, I would say it's all in the realm of regular normal seasonality for government, with just a downtick a bit in federal for Q3 and Q4.

Got it. Okay. Thank you.

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

Great. Good morning. Just one question really. In terms of the CrowdStrike debacle that happened recently, was that a positive or negative for you guys in terms of working with your customers.

Oh, Keith. Thanks for the question. First of all, it was CDW didn't impact us that much, which was great. But I'll tell you, I'm really proud of this team. They were so quick to help customers do boot-refixes and workarounds and essentially, get after customers immediately. So, it just reinforced, I think, the fact that we have such strong relationships with our customers and that the trust adviser role is so important. Once you do a transaction with a customer, it's not one and done, but this just reflected the fact that the aftercare and the relationship ongoing is so important. So, it was a very unfortunate, obviously, circumstance across the world, but really proud of the team for stepping up and stepping in with our customers.

Yes. If I can follow-up on that, is that an opportunity for you guys to gain customers by showing exactly the experience and advisor leadership you guys have.

Oh, absolutely. Yes. So, in circumstances like this, when we have been able to help, when there's a particular issue that's popped up that absolutely goes back and across the sales organization, we take it to other customers to help highlight potential vulnerabilities and then help them resolve those.

Great. Thank you.

Same in the security space. That's what we do.

Our next question comes from Asiya Merchant of Citigroup.

Great. Thank you for taking my question. If I could -- if you could just double click a little bit on the OpEx intensity, where is CDW spending these U.S. -- spending these operational expense dollars on. and how we should think about the trajectory of those expenses as it relates to your overall revenue or gross profit dollar growth in the back half. Thank you.

Sure. Good morning, Assia. A couple of things that I would just note. Number one, remember when we started the year, we indicated that we would have expected the beginning of the year would reflect higher level of expenses than usual and a ratio of SG&A relative to GP would ease as the year played out. Asiya, some of that is a function of just timing and seasonality of certain expenses that we see in the first half, some of it a function of our lower GP production -- gross profit production in the first half. And then just from a compare perspective, I would just note for you that, that last year obviously was a pretty uneven year, if you will. And pretty early in the year, we saw indications that our outlook was coming down. So that has an impact on the timing and our judgments with respect to things like compensation accruals. So, because of that, when you add it all together, our first half, we look a bit more shifting towards deleverage from an expense perspective. And what you should expect in the back half is that, that would ease, that would balance out obviously as our gross profit attainment would be higher. but also, you get a bit kind of a pickup from a seasonality timing of our expenses as well. So, for the full year, we expect it would look reasonably normal. The back half is going to look a lot different than it did in the first half vis-à-vis operating leverage.

Okay. And if I may, just you've talked about a strong pipeline here for your customers. Help us understand how you think about that pipeline conversion to revenues. I understand it's the federal impact and the macro, and the UK. But if you could just as you think about more into, let's say, the next 12 months ahead post-calendar ‘24, how are you thinking about that pipeline conversion. And how would you think about CDW's trajectory of growth ahead. Thank you.

Yes. well, we think about the pipeline -- excuse me, we think about the pipeline, starting first, in terms of engagement with our customers and staying very close to our customers and doing and suggesting solutions that are best for them. In a market now, where cost optimization is high and needs are prioritized over once. A CDW is very careful to help our customers accommodate that, which might mean that not new and not growth revenue, but revenue that is finding cost optimization for them. All that said, what we do in an environment like this is we work hard to increase the pipeline to ensure that when it's time to convert, it's sufficient to drive growth. We do all the things that we do with a lot of rigor. We inspect the pipeline. We grow the pipeline. We measure the pipeline. We drive conversations with our customers. It's really just the appetite to convert at this point that we're not seeing. Now as I said, what has been very positive is the rhythm of the business feels, feels more stable, feels a little more firmer footing. and I think that's a good indicator of moving to more solid footing, which means a pipeline converting it in the not-too-distant future, which will convert into growth.

Okay. Thank you.

Our next question comes from Ruplu Bhattacharya of Bank of America/Merrill Lynch. Your line is now open.

Hi. Thanks for taking my questions. Maybe, the first question I'll ask to Al and it's another question on gross margins. When you look at the core business margins, ex-netted down items, looks like in fiscal 2Q that grew by 40 bps to about 15.7%. Can core business margins continue to grow for the remainder of the year? I guess, Al, my question is the gross profit for the year is lower, is that because the mix of netted down items is lower, or do you think the gross margin of the core business is also lower?

Sure. Thank you, Ruplu. Look, for the full year, we are calling for gross margins to look much like the first half did and frankly then much like 2023 in total. What you can expect there is continued durability and trending of our netted down revenues, which have been extremely strong. We would expect that would continue. And particularly, I'd say, in the year, we typically see more of that with renewals, of cloud and SaaS contracts et cetera. And that would be balanced with our regular mix of business, including expectation kind of a glide path of our client business. Now, on the non-netted down margins, I'll just note again, that product margins there have continued to help hold firm, and that's been quite a run, where they've been firm and we would expect that to continue. So, that's the sum of the different parts, Ruplu, to get us to that gross margin expectation very similar in the back half as what we saw in the first half.

Okay. Thanks for the details there. Maybe, as a follow-up, can I ask, Chris, how are you thinking about AI related spend in 2024. Did you have any AI-related revenues in fiscal 2023 and how do you see the impact of that on hardware and also on your services revenues in the year? Thanks.

Yes. Yes. Thanks for the question, Ruplu. I'd answer it this way. Look, we're really in the very early innings of AI monetization, and CDW is investing behind and doing well frankly. We're investing primarily in people and enablement, and doing well in the areas that are kind of early stage, which I would say, are consultative primarily at this point. AI certainly opens conversations with customers extensively. But I would say our opportunity, the massive opportunity for CDW is full stack over the long run, and I would call this a long a long game. look, it feels very much, and we've said this before that AI is like any other kind of transformative technology of the past. and it plays to CDW's strengths. Complexity and choice always make it more difficult for our customers, and that helps us bring our knowledge, expertise and portfolio to bear. So, as I think forward, we do see it as an accelerant. We're investing behind it. Our customers are still at the stage of what's the art of getting this done and how's the sign what's the science of doing it. It's just a matter, frankly, Ruplu, of what the time frame of growth looks like over the long term. but I feel confident that we'll play it every -- at every layer of the stack. And it will be embedded in every layer of the stack.

Okay. Thanks for all the details. Appreciate it.

Our next question comes from George Wang of Barclays. George, your line is now open.

Hey, guys. Thanks for taking my question. Firstly, I just want to ask about AI, kind of wondering if you have a refresher thought in terms of potential uncertainty related to the AI, especially last quarter, you got called about right now, the CDW customers are still in the assessment, the experimentation stage. So, you have sort of air pocket, if you will, before so the ARRI is further validated. Just curious are you seeing a slightly different behavior right now with the customers as they sort of play into this elongation of sales cycle. Just wondering if you can give a little more thought on that compared to a quarter ago.

Yes. George, I would just -- I would reiterate that we're still seeing that AI has put the architectural roadmap for compute storage and networking under reevaluation and flux, and we're still seeing that play out this quarter. I actually expect that to last for some period of time as we help customers sort through again, what the art of the possibilities. but then what's the actual return on investment dollars.

Okay. Great. Yes. Just a quick follow-up, if I can. Just CDW has pretty good reputation of share gains through the cycle, especially in the fragmented box space. Just curious, are you seeing additional evidence, especially given, sluggish macro, but you're probably seeing the overall, so the four-stack solutions Are you seeing sort of a stronger pickup in sort of a kind of fragmented shed kind of just maybe, you can talk about competition and the kind of the areas CDW is. So, we're doing much better versus the rest of the field.

Sure, George. I would just say that we feel very confident that we continue to gain share in this low demand and limited demand market across virtually every category. You saw our results for security and for services, and cloud, client device refresh is starting to pick up. And this is validated both by, obviously, our own data, but equally our partner reviews. our partners validate that we are indeed taking shares that we're feeling very good about, where we're positioned in a limited growth environment.

Okay. Great. I'll go back to the queue.

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

Hi. Thanks for taking my question. I guess, maybe, Chris, if I could just start with the areas of strength that you're seeing from product perspective. And I think storage, you sort of highlighted that as an area of strength. And not going into every specific category, but in terms of the areas that you're seeing refreshes on, just how do you feel about sustainability of that base. Because it does sound a bit more contrast to when you say customers are not really looking to spend as much and there's sort of a stable environment that there would be sort of a longer-term sustainability of the areas of strength that you're seeing at the same time. Just can you help us think about what is giving you visibility on that front. And I have a follow-up.

Yes. Sure. So, I'd say look, capital investment and complex solutions, especially those tied to data center and network modernization are the ones that I highlighted as areas of more caution right now, given the uncertainty and also the increasingly complex technology landscape. Compute, we did see some pickup. That's really because, it was put off for some quite some time by a number of customers. and so there was a need to upgrade for against legacy systems. And then on the client side, as I said, we started to see, what we think is the beginnings of a refresh. Obviously, given all the catalyst there, that's going to be sustainable. The aged devices, Win 11, AI PCs, et cetera. We expect that to be a real refresh. And then I say sustainability in the clouds, where you saw strength this quarter in particular, cloud security and services in particular, I don't see those slowing down anytime soon. They're a great opportunity to offset some of those capital investments. They're a great opportunity for cost optimization and optimization generally. So, our customers have turned to them and with our portfolio, the beautiful thing about our is whatever our customers are buying, whenever they're buying it, we can give them the solution they need. So, very well prepared to deliver today and as we start to see a recovery in the capital investment appetite.

And for my follow-up, I know you mentioned the netted down revenue mix every quarter. but anything further that you can give us in terms of how to best think about that sort of part of the portfolio, how much of that is security versus some other sort of software, just to be able to sort of more closely sort of correlate with what we're seeing from the peers and how should we really be thinking about which part of sort of software is it more correlated to.

Sure, Samik. I'll take it. This is Al. So, just reminder what categories fall into netted down. You have software assurance. You have warranty. You have SaaS. You have cloud. Right. So, the big components, if you will. The strength that we've seen obviously has been substantially in the SaaS and cloud space. and that runs the gamut in terms of underlying workloads in those categories. Right That includes data, virtualization software, networking to some degree. So, it runs the gamut in those categories. They've been the leaders in that space. I should note, Samik, there, with that over the last year, categories such as software assurance and warranty obviously have lagged. because they are substantially attached to products, hardware and software -- licensed software that is. And so they've been laggards, which at some point as we talk about the catalyst and things beginning to turn from a hardware perspective, you could see some of those categories pick up. But in the meantime, as we are now saying, Hannah, we think that recovery is going to take a little bit more time, the most durable trends are in the SaaS and cloud space.

Thank you. Thanks for taking my questions.

Our next question comes from Adam Tindle of Raymond James. Adam, your line is now open.

Okay. Thanks. Good morning. Al, I wanted to start on guidance. I know, I asked you last quarter on this and some of the explanation was for Q2 was that your modeling is below seasonal. It was off of a weak Q1 and that it seemed like this was sort of a conservative guidance estimate for Q2. and here we are this morning with effectively a miss. That's kind of become a pattern here a couple of quarters now below expectations, and the miss is beyond just the revenue line and mix. So, I just wonder if you might reflect on what has changed in the business to drive this trend; because prior to this period, CDW was kind of a bellwether for visibility into the business, execution on exceeding expectations. So, what has changed And then secondly, how to remediate this issue You know, what kind of changes can you make to your forecasting process or maybe internal analytics to better predict the business.

Sure. Thank you, Adam. Appreciate the question. First, look, no doubt it has been a pretty volatile period of time for now a number of quarters for sure. I would note a couple of things. Number one, when we talked about a Q1, what we were expecting going in Q2, you did ask the question about seasonality. I made the remark that we would expect it would be somewhat short of historical pre-pandemic seasonality and that it was. The delta there, Adam, was essentially the sum of federal business and international. So, two things that we had not factored in. When you actually add those back, we get pretty close to that historical seasonality. So now, so we scroll forward. We have an expectation Q2 leading to Q3, of mid-single-digit sequential growth. And really how we get there, Adam is, it's taken off some of the expectation of meaningful pickup in the business. and I would say it's following now a more normal glide path. Now, that's backed up by a couple things. One, in line or close to historical seasonality, but also just the split between first half, second half. And so, when you think about our 48/52 split between first half, second half, that's not only consistent with the history. but I also would say coming off of a softer Q1. And so, while we are definitely not anticipating an upturn, if you actually look at the trend lines, I would say it's a pretty natural glide path from where we've come from, and we think it's reasonable when you add it up to the back half of the year.

Okay. Thank you. Maybe, just as a follow-up, Chris. Security is obviously a big growth driver for you and you've done well. I think you've even announced $1 billion in sales with CrowdStrike, some earlier this year. So, I guess the first question on that would be what you're seeing now at the end of July in that piece of the business given the global outage, the impact to the cyber business growth trajectory. And then secondly, beyond just the cyber business, there's an investor fear that this might have a ripple effect into other areas of spending and just cause pausing broadly. We're sitting here on July 31st. You're the largest reseller. What customer behavior are you seeing now in the month of July as that closes to indicate that might or might not occur. Thanks.

Yes. Adam, I would say customer behavior is on high alert around cybersecurity, and we're having heightened and more conversations with our customers around that. It does not feel that, that is putting off or, delaying any other engagements and projects at all. But we are seeing heightened conversation around cybersecurity.

We have no further questions. So, I'll hand back to chair and CEO Chris Leahy for closing remarks.

Well, thank you very much. I want to recognize the incredible dedication of our coworkers around the globe and their extraordinary commitment to serving our customers, our partners and all CDW stakeholders. You show the power of execution excellence every day in every way. And thank you to our customers for the privilege and opportunity to serve you, to our investors and analysts participating in this call, we appreciate you and your continued interest in and support of CDW. Al and I look forward to talking with you again, next quarter.