Thomas E. Richards - CDW Corp. Sari L. Macrie - CDW Corp. Ann E. Ziegler - CDW Corp..

Amit Daryanani - RBC Capital Markets LLC Matthew Sheerin - Stifel, Nicolaus & Co., Inc. Matthew Cabral - Goldman Sachs & Co. Shannon S. Cross - Cross Research LLC Sherri A. Scribner - Deutsche Bank Securities, Inc. Adam Tindle - Raymond James & Associates, Inc. Kathryn Lynn Huberty - Morgan Stanley & Co. LLC Jayson A. Noland - Robert W. Baird & Co., Inc.

(Broker) Anil Kumar Doradla - William Blair & Co. LLC.

Good day, ladies and gentlemen, and welcome to the CDW Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Tom Richards, Chairman and Chief Executive Officer. Please go ahead..

Thanks, Candice. Good morning, everyone. It's a pleasure to be with you and to report CDW's third quarter 2016 results. Joining me for the call are Ann Ziegler, our Chief Financial Officer; Chris Leahy, our General Counsel; and Sari Macrie, our VP, Investor Relations. I'll begin with a high level review of our performance and strategic progress.

Ann will take you through a more detailed result review of the financials and then we'll go right to your questions. But before we begin, Sari will present the company's Safe Harbor disclosure statement..

Thank you, Tom. Good morning, everyone. Our third quarter 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 with us 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 risks and uncertainties that could cause actual results to differ materially.

Additional information regarding these risks and uncertainties is contained in the 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 earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules.

You will find reconciliation charts in the slides for today's webcast, as well as in our press release and the Form 8-K we furnished to the SEC today. Please note that all references to growth rates or dollar amount increases in our remarks today are versus the comparable period in 2015, unless otherwise indicated.

In addition, all references to growth rates for hardware, product, software and services today represent U.S. net sales and do not include the results from CDW UK or Canada. There were the same number of selling days in the third quarter of 2016 compared to the third quarter of 2015.

There was one extra selling day in the first nine months of 2016 compared to the first nine months of 2015. All sales growth rates references during the call will use average daily sales, unless otherwise indicated. A replay of this webcast will be posted to our website by this time tomorrow.

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. And with that, let me turn the call back to Tom..

our balanced portfolio of customer end markets; the breadth of our product and solutions portfolio; and our ongoing execution against our three-part strategy, which is focused on taking share and investing in solutions and service capabilities our customers need and want.

Let me walk through each one of these and share some detail about how they contributed to our performance. First, our balanced portfolio of customer end markets. As you know, we have five U.S. sales channels – medium and large business, small business, healthcare, government, and education – each generating annual sales of more than $1 billion.

We also have our Canadian and UK operations, which together, represent more than US$ 1 billion. Given the different macroeconomic and external factors that impact each of these unique customer end markets, our channels often act in a countercyclical way. For example, in last year's third quarter, Public was flat while Corporate increased 6%.

This year, the opposite occurred with Public up 10.6% and Corporate down just under 1%. For Corporate, small business was up 4% and MedLar was down just under 2%.

While we had pockets of strength in MedLar, specifically with financial and not for profit customers where we saw double-digit growth in both transactions and solutions, we also had ongoing pockets of weakness. These were concentrated in markets experiencing macro pressure, notably geographies with heavy oil and gas and manufacturing exposure.

Softer overall demand resulted in typical competitive behavior when revenue is scarce and we saw low ASPs in a number of key hardware categories, as well as deals in the market being done at or even below cost.

Also, as we have seen in previous periods of economic cycles, MedLar customers remain focused on easier to execute transactional products, which increased to mid-single-digits in the quarter versus solutions, which declined high single-digits, with large deals continuing to be delayed. We saw similar buying behavior in small business.

Transaction sales were strong, increasing double-digits with larger projects being put on hold and solutions declining. So, while we saw some highlights and glimmers of positive shoots in Corporate, the economy indeed was the wild card I mentioned it might be on last quarter's conference call and continued to impact buying behavior.

This was not the case in Public where all three of its customer channels performed well. Government posted an 8.8% increase, driven by a strong performance in state and local, which continues to benefit from new contracts and success meeting public safety needs. Federal was up low-single-digits on top of last year's double-digit increase.

As expected, we continue to benefit from our strategic program alignment. In addition, we saw excellent year end budget flush, but delivery of several large, transactional orders will occur in the fourth quarter.

Healthcare increased 6%, as we experienced the positive side of expected lumpiness with activity picking up across a handful of larger customers who have moved through the merger process. Education had a great quarter, up 15%. Higher ed increased mid-single-digits, driven by ongoing refresh opportunities and new collaboration solutions.

K-12 delivered another high teens growth quarter. The team continued to drive excellent client sales to help with digital testing and digital curriculums while also making excellent inroads into other classroom of the future technologies like video equipment.

K-12 networking sales declined as eRate processing issues led to delays in funding letter approvals for the 2016 program year. Once again, CDW was named for the highest percentage of requested funds for the 2016 funding cycle. We feel good about the momentum for the remainder of 2016 and going into 2017.

So, strong results across all channels in public with balanced sales growth across transactions and solutions, both increasing low-double digits. We also had balanced growth across our international operations. We saw a nice pickup in Canada, where they grew mid-single digits in both U.S. and Canadian dollars.

UK also delivered mid-single digits growth in local currency while currency shaved 60 basis points off consolidated results. Clearly, the 4.4% organic growth we delivered in today's challenging market demonstrates the power of the first driver of our performance, our balanced portfolio of customer end markets.

It also demonstrates the power of our second driver of our performance this quarter, the balance across our broad portfolio of products and solutions which you can see in our major category performance. Hardware grew 4% with all but two of our key hardware categories increasing in the quarter.

Customer demand for client devices was strong across all customer end markets up mid-teens. Servers, video and collaboration equipment also increased across all segments. Storage and netcomm declined, reflecting both unique environment in customer end markets as well as product cycle changes and new technologies.

New technologies are also impacting software spend as software becomes a larger component of IT solutions, whether it is being integrated into new advanced architectures, particularly in the data center or standalone, delivering important capabilities like security. You can see the impact of this on our strong software results, up 9%.

We had meaningful increases in application suites and network management software as well as security. Security posted the eighth consecutive quarter of greater than 30% growth and includes many cloud-based solutions. Overall, customer spend on cloud continued its strong momentum, up more than 40%.

We also had excellent success, providing software assurance, which along with cloud is booked net. This quarter boasts software reported gross and reported on a netted down basis increase and gross profit increased in line with sales. We continue to see software becoming an increasingly important component of total customer IT spend.

This is also true of services. Once again, we had another double-digit quarter for service growth, up 12%, driven by continued success delivering security services as well as our focus on providing warranties. Warranties are becoming more important to both partners and customers, as product life cycles become extended in uncertain economic times.

And this leads to the final driver of our performance in the quarter, the impact of investments we are making in our three-part strategy for growth to deliver solutions and service capabilities our customers want and need.

Today, we are better positioned than ever to serve our customers' IT needs in this evolving market, whether in physical, digital or cloud-based environment in the U.S. or international. Let me walk through each of our strategies and how it is contributing. First, our strategy to take share.

As you recall, our acquisition of CDW UK was about meeting our customers' needs for international IT solutions. By doing so, we can gain wallet share of U.S.-based customers with international locations as well as acquire new U.S.-based customers who have international needs.

It has been a year since the acquisition, and we are very pleased with the results to-date. We are making excellent progress on our efforts to develop a seamless experience for customers on both sides of the pond. At the same time, the team continues to execute against the strategy to serve its U.K.-based customers' international needs.

A great example of this is a recent solution the CDW UK team provided to a UK-based international service provider in the energy business that needed to consolidate a complex multi-vendor, multi-technology environment to make it easier to manage.

We developed a single cloud environment that serves nearly 20,000 co-workers across Europe, Asia and the Middle East. A complete turnkey solution, including compute, netcomm and storage and we handled all pre-sales design, logistics and procurement and oversaw installation in each location.

The solution generated more than USD 2 million in hardware sales as well as recurring warranty commission and relieved a big headache for the customer. Of course, we will keep a watchful eye on the progress of the UK's exit from the EU, but in the meantime continuing to invest in our international capabilities to ensure we can deliver what our U.S.

and UK-based customers are looking for, a seamless experience regardless of where they do business with us. We recently added 16 co-workers to our international sales team and are finalizing plans for the launch of new international advertising.

It is clear that this investment has and we believe will continue to contribute meaningfully to our ability to consistently generate profitable growth. Investments we have made to enhance our solutions capabilities, our second strategy, are also contributing to our profitable growth.

Investments that include subscription services quoting and ordering capabilities that streamline the sales, online purchasing experience and overall customer service experience for cloud-based solutions. These investments contributed to our cloud and security practice success, which were once again our fastest growing solution practice areas.

Our third strategy is to increase our service capabilities, like software. Services are becoming an increasingly larger component of total customer IT spend. Today, IT is under more and more pressure to maximize the return of their investment. IT leaders are accountable for both running the business and using technology to transform the business.

To do both, they are looking for ways to direct resources where they can have the greatest impact. When prioritizing spend, it doesn't make economic sense to run a 24x7 operation to support their e-mail or applications nor does it make sense to invest in the resources necessary to effectively monitor a network or public cloud performance.

This is where we come in. CDW Services provide access to our scale and expertise to deliver cost efficiencies and enhance quality. We have built a robust portfolio of professional services, including advisory, architecture and managed services across cloud, collaboration, data center, mobility and security solutions.

These offerings are underpinned by our 24x7 network operating centers, as well as services that include cloud planning services and managed cloud. All of these investments help our customers maximize the return on their IT investment. Let me share a recent example of this.

A mid-sized multi-location company in the insurance space had acquired the insurance operations from a diversified entity. Their IT team needed help operationalizing the combined entity.

They needed to first separate the acquired IT assets including applications, websites, portals and several databases from the existing IT infrastructure and then integrate them into the newly combined infrastructure. From consulting through engineering, migration, hosting and managed services, we architected the entire solution from end to end.

Once this goes live next month, we will manage the customer's entire environment. The solution generated more than $150,000 of one-time revenues for assessment, project management, staff aug and installation. It will also generate more than $30,000 per month in recurring revenues.

This is a great example of our three-part strategy in action, solving key business problems for our customers in today's environment that requires great relationships and strong service and solution capabilities.

These capabilities combined with our competitive advantage of scale, scope and disciplined execution help drive sustainable, profitable growth for us today and in the future.

The tighter market conditions we saw in the quarter influenced our hiring and we remained cautious ending the quarter with 59 additional customer-facing coworkers since the beginning of the year. With similar conditions expected to continue, we currently look to end the year at coworker counts roughly in line with current levels.

Of course, as we always do, we will continue to monitor the marketplace and adjust our plans if we feel necessary. And that leads me to our expectations for the balance of the year. You will recall that on last quarter's conference call, we shared our expectation for U.S. IT market growth in 2016 to come in at the low end between 2% and 3%.

This was predicated on expected improved business investment as we moved through the year. Given third quarter corporate earnings reports in general, as well as the tech industry participants, we now expect U.S. IT growth to come in below that for the full year.

Within this environment, we continue to target our annual medium-term target to outgrow the U.S. IT market by 200 to 300 basis points on an organic constant currency basis. This excludes incremental CDW UK contribution and 150 basis points we plan from Dell.

Excellent results, especially considering our success selling solutions and services that are accounted for on a netted down basis.

While driving our strong gross profit performance in the quarter, we estimate that our success providing warranties, software assurance, cloud and certain software costs roughly a couple hundred basis points of top line growth.

We are well prepared to continue to address the needs of our partners and customers as they move through this IT transformation and manage in a challenging economic environment.

I hope you can tell from my comments that this quarter's performance reinforce our confidence, that we have the right strategy in place, a strategy that serves us well when confronted with macro or channel-specific challenges and positions us for sustainable, profitable growth in the future.

A strategy designed to continue our evolution into the leading IT solution provider in North America and UK. And most importantly, a strategy that delivers profitable growth and strong cash flows.

This confidence has led our board to approve a 49% increase in our quarterly cash dividend, consistent with our capital allocation priority of achieving a dividend payout of 30% of free cash flow by year-end 2019. I know many of you may be wondering what we expect for 2017.

We are in the middle of our planning process, and as we always do, we'll provide our 2017 outlook on our year-end conference call. With that, let me turn it over to Ann who will share more detail on our financial performance.

Ann?.

the ongoing amortization of purchase intangibles; non-cash equity compensation; acquisition and integration expenses; and other non-recurring or infrequent income or expenses.

Since the two discreet tax items in the quarter relate to items that are added back to non-GAAP net income, the tax benefits were reversed, so they are not included in non-GAAP net income. With Q3 weighted average diluted shares outstanding of 165 million, we delivered $0.97 of non-GAAP net income per share, up 16.1% over the prior year.

Turning to year-to-date results on slide 12, revenue was $10.5 billion, an increase of 9.6% on a reported basis and 9% on an average daily sales basis, given one extra selling day in Q1 of this year. On a constant currency basis, consolidated net sales growth would have been roughly 40 basis points higher.

Gross profit during the first nine months of 2016 was $1.7 billion, up 12.3%. Gross profit margin was 16.7%, up 40 basis points. Adjusted EBITDA was $844 million, 10.9% above the first nine months of 2015. Net income was $321 million for the first nine months of 2016, and non-GAAP net income was $429 million versus $380 million in 2015, up 12.8%.

Turning to our balance sheet on slide 13. On September 30, we had $118 million of cash and cash equivalents and net debt of $3.1 billion as compared to $3.2 billion at September 30, 2015. Our cash plus revolver availability was just under $1 billion.

Net debt to trailing 12 month adjusted EBITDA at the end of Q3 was 2.9 times, within our target range of 2.5 times to 3 times. Our current weighted average interest rate on outstanding debt is 4.3%, 10 basis points below last year.

During the quarter, we refinanced our $1.5 billion term loan, which lowered the LIBOR floor to 75 points, down 25 bps, and extended the term loan to December 2023. During the quarter, we also finalized the replacement of $1.2 billion of the current 2% caps for the term loan with new caps at 1.5%, which will become effective at the beginning of 2017.

We intend to purchase interest rate caps on an additional $200 million notional amount by year-end. With roughly 95% of our outstanding debt at either fixed rates or hedged, rates would have to move significantly before they had a material impact on our interest costs.

As you can see on slide 14, we maintained strong rolling three-month working capital metrics during Q3. For the quarter, our cash conversion cycle was 18 days, the same number of days as last year's third quarter and below our target range, which is an annual target. Year-over-year DPO and DSO increased four days.

Note that when we have a higher mix of sales being netted down, we see increases in both DSO and DPO. This is because these sales are booked net on the P&L, but our receivables reflect the gross billings to the customer. At the same time, payables are matched to get zero cost of goods sold, so both these measures increase.

That is why we focus on our cash conversion cycle because that is the best measure of our working capital efficiency. Cash taxes paid for the quarter were $102 million and cash interest was $43.1 million.

Free cash flow for the quarter, which we calculate as operating cash flow plus the net change in our flooring agreement less capital expenditures, was a positive $138.4 million compared to $156.2 million in Q3 of 2015.

Quarterly free cash flow was impacted by our mix into Public sales, particularly to government customers, which are typically slower payers. For the first nine months of the year, free cash flow was $497.1 million, $224 million more than last year's first nine months.

As you recall, free cash flow in 2015 was $100 million lower than normal due to one-time items and timing, which pulled forward roughly $100 million of free cash flow into Q4 2014.

During the quarter, we continued to execute against our capital allocation strategy and repurchased 2.9 million shares for $131 million at an average cost of $44.76 per share. Our capital allocation strategy is comprised of the following four components, which you can see on slide 15. First, increase dividends annually.

To guide these increases, in November 2014, we set a target to achieve a dividend payout of 30% of free cash flow over five years. For this quarter, we will pay a dividend of $0.16 per share on December 12 to shareholders of record as of November 25, up 49% from a year ago.

Since the IPO, our dividend has increased nearly fourfold the initial annual level of $0.17. Second, ensure we have the right capital structure in place. We have set a target to generally maintain net debt to adjusted EBITDA leverage in the range of 2.5 times to 3 times. We ended Q3 at 2.9 times.

Third, supplement organic growth with tuck-in acquisitions. Our CDW UK investment is an excellent example of this. And fourth, return excess cash after dividends and M&A to shareholders via share repurchases. At the end of September, we had $654 million remaining of our current authorization.

These capital allocation priorities support our 2016 to 2018 medium-term targets, which you can see on slide 16. Similar to our 2013 to 2015 targets, we continue to target growth of 200 to 300 basis points, faster than the U.S. IT market. We also continue to target an adjusted EBITDA margin in the mid-7% range.

Reflecting the conclusion of our initial refinancings and absence of earnings amplification from lower interest expense, our 2016 through 2018 medium-term annual target call for low double-digit EPS growth. We intend to use share repurchases and accretive acquisitions to amplify operating results and help achieve this target.

Keep in mind that we hold ourselves accountable for achieving our medium-term targets on an annual, not a quarterly, basis. Let me provide you with a few additional comments for those modeling the balance of 2016. I am on slide 17.

Given our current outlook for Q4, we continue to expect that balance of sales between first and second half to be generally consistent with our normal seasonality, roughly 48% to 52%, weighted towards the back half of the year. We have one fewer selling day in Q4 2016 than we had in Q4 2015, and two fewer days sequentially this year Q3 to Q4.

So, average daily sales growth will be higher than reported sales growth on both a year-over-year basis and on an sequential basis. On an average daily sales basis, we now look for consolidated sales to sequentially decline Q3 to Q4 at a slightly greater level than last year, as fourth quarter 2015 incremental U.K.

sales contribution is partially offset by higher sequential federal sales this year. Given the recent weakening in the pound, we now expect currency to have an impact of roughly 120 basis points in the fourth quarter, as the British pound to U.S. dollar will drive the Q4 impact.

This is in average translation rates of CAD 1 equal to US$ 0.77 and US$ 1.20 to the British pound in Q4. We expect our gross margin percentage to be at, or very slightly above Q4 2015.

This reflects expectations of continued success delivering solutions and services booked at net revenue, partially offset by the impact of Federal sales, which tend to have a lower margin. Turning to expenses.

We expect reported SG&A to grow more in line with reported sales growth as we lap last year's Q4 hiring of roughly 200 coworkers and UK is in our base. Given year-to-date performance and outlook for Q4, we expect our adjusted EBITDA margin for the year to exceed our medium-term annual target of the mid-7% range.

However, given gross margin and adjusted SG&A outlook for Q4, we look for Q4 adjusted EBITDA margin to be within that range. Interest expense, depreciation, amortization, non-cash equity compensation and acquisition expenses are expected to remain at similar rates to Q3 2016.

We continue to look for our 2016 effective tax rate to be in the 37% to 38% range with Q4 at the high end of that range. Given year-to-date performance, we expect full year non-GAAP EPS to exceed our medium-term annual target of low double-digit growth coming in at the mid-teens, reflecting both strong operating results and share repurchases.

Finally, a few notes for those of you modeling our cash flow. We continue to look for capital expenditures to come in at roughly 0.5% of net sales on an annual basis. For free cash flow, we expect to be above, our rule of thumb, of 2.5% to 3% of net sales.

As we have made excellent progress in managing our working capital, you should look for us to sustain our cash conversion cycle at the low end of our target range of a low to mid-20s for 2016.

For the full year, we expect a cash tax rate in the 37% range to be applied to pre-tax book income before acquisition-related intangibles amortization, which is now running at approximately $47 million per quarter.

In addition, we continue to pay approximately $20 million in tax annually, related to the cancellation of debt income we incurred in 2009. That concludes the financial summary. We will provide commentary on our expectations for 2017 on our year-end call.

Before we open for Q&A, let me briefly address the SEC investigation we disclosed in 2015 relating to vendor-partner program incentive. We have no further updates since our last conference call.

We continue to cooperate fully with the SEC and, although we cannot predict the outcome based on what we know to-date, we do not expect this matter to have a material impact on the company. With that, let's go ahead and open it up for questions. Can we please ask each of you to limit your question to one question and one brief follow-up.

Operator, can you please provide the instructions for asking a question?.

Absolutely. And our first question comes from Amit Daryanani of RBC Capital Markets. Your line is now open..

Thanks. Good morning, guys. I guess two questions from me. One, maybe to start with the coworker count, I think it was down on a sequential basis, the first decrease we've seen in a while.

Can you just talk about what drove that and how to think about the head count as you go forward?.

Okay. Good morning, Amit. This is Tom. So, in your first question, as I said at the end, we've remained pretty conservative as we've kind of got into the latter part of the year as far as adding coworkers.

And one of the nice things about the model is we have kind of a built-in purposeful attrition rate as we bring in a lot of young people and they start their careers in selling. So, that gives us the ability to kind of manage that number.

And the other part of that is, I think, keep in mind, Amit, remember last year in the fourth quarter, as you heard Ann say, we added over 200 coworkers. So, that kind of distorts the perfect year calendar year number. And so, absorbing those coworkers and getting them productive has been our priority.

But, look, as I think it sounds like a broken record, if we see some signs that the economy starts to pick up after the election, we're ready and willing and able to increase the coworker count..

Got it. That's really helpful. And I guess, Ann, great to see the dividend increase that you guys announced today. I guess just broadly, what prevents, inhibits you guys from having a more aggressive cap allocation policy, maybe returning all the free cash you generated to shareholders.

Given the fact your leverage is optimized and I think you guys have done three deals in 20 years or something, what's the hesitation not having a more aggressive free cash return to shareholders?.

Thanks, Amit. Actually, we think our capital allocation strategy is relatively aggressive. As we lay out in that strategy, we want to return cash to shareholders via the dividend. As you mentioned, we're going to hold our leverage in the current range.

From time to time, we'll do tuck-in acquisitions and then we'll return remaining cash to shareholders via share repurchases. I think we've done a bit over $350 million of repurchases this year on a year-to-date basis.

And on top of the dividends that we've paid and the dividend that we've declared for this quarter, we have returned a significant amount of our free cash flow to shareholders this year..

Thanks, guys..

All right. Thanks, Amit..

Thank you and our next question comes from Matt Sheerin of Stifel. Your line is now open..

Thanks, and good morning. Just a question, Tom, just regarding your commentary on continued weakness and cautious stance from enterprise customers.

Is there is any signs that some of these push-outs will get done either this quarter or any pipeline looking into next year? Or is that just going to be continued choppy demand environment?.

No. Good morning, Matt, and thanks for the question. Yeah, look, I'm always careful when I describe kind of the current state when it comes to, like within a quarter, especially because a lot of the solutions business has a longer selling cycle.

But as I indicated, we did see some sub-segments, if you will, of our MedLar business pop this quarter, specifically the financial services and non-for-profit segments, had really strong quarters.

And we did see some of the pipeline I referred to last quarter hit in the third quarter, but there's still a meaningful part of it left that we think are going to hopefully pop in the fourth quarter and into next year.

I think the economic overhang, if I can say it that way, I think there's a lot of evidence that it's impacting decision making, whether it's the dramatic success we've had in selling warranties and assurances to kind of extend life cycles or some of the general economic data map.

So, I would say I feel pretty bullish on the work that we're doing and the kind of the tracking of deals and the things we're doing to help customers in the Corporate group. But I think we're just going to have to wait and see kind of how the economy plays out in the next couple of quarters.

But again, I feel good about the – I think the word I used was positive growth or positive shoots we've seen so far since last quarter..

Okay. That's helpful. And on the gross margin guidance were flattish year-over-year following three quarters of pretty strong growth on a year-over-year basis, and I understand that the mix of federal, some of the push-outs into the fourth quarter have something to do with that.

But by in large, are you expecting gross margins to trend higher going forward due to the things that you talked about, the warranties, the netted down revenue, et cetera?.

And, Matt, I think that's a great question. I'll answer the first part and let Ann kind of clean it up, so to speak. I think those two questions you asked are actually linked. I think what you see is if you just think about our product performance, you had hardware growing at 4%. You had software growing at 9%. You had services growing at 12%.

I think where we see kind of the impact when the economy is a little more choppy in the corporate space is in the hardware space. And if we get some of the expected growth I talked about in your first question, those margins tend to put pressure on our total gross profit or gross margin.

And then, couple that with – I talked about we did have a good budget flush in federal. The issue was a lot of it didn't get shipped and that will ship over the next two quarters.

So, that's why you kind of see that pressure comment that we talked about because we do expect some of those things to, in a weird way, offset some of the positive margin we're getting from software assurance, services and cloud..

Yeah. The only thing I would add is I did say flat to very slightly up. You have to remember that our gross margin does move around significantly as we reported at – we talked about repeatedly in the Q driven by mix, right, which is hard to predict and then things as well as vendor funding.

The other thing to keep in mind is we've been getting about a 10 basis points pickup from the mix into the UK business. That is now over with the lap of the acquisition. So, that's been a little part of the pickup you've seen on a year-to-date basis as well..

Okay. That's helpful. Thanks a lot..

Thanks, Matt..

Thank you. And our next question comes from Matt Cabral with Goldman Sachs. Your line is now open..

Thank you. I also have a question about the slowdown in number.

I guess, Tom, taking your commentary on a little bit of a more competitive environment out there, can you just help us understand how much of the decline that we saw in the quarter was driven by maybe CDW participating in some of those ASP declines you mentioned versus walking away from deals that didn't hit your overall profitability thresholds?.

Yeah. I'd say it's more of the latter than the former, Matt. That doesn't say that when we think it's the right situation we aren't willing to compete hard for a piece of business from a strategic perspective. But I think it's more driven by – like your – the second part of your comment, just looking at some of those deals.

Look, we've seen this movie before, quite honestly. Even in my time here at CDW, when there's a tough economic climate, people tend to get really competitive, trying to grab top line revenue growth and it tends to pressure ASPs.

And I think our position and my personal position is you have to be really thoughtful that you can't try to just chase top line growth because it really, I think in the long-term, is not the right thing for the business..

Got it. And then, it sounded like there was a little bit of a pickup in the performance out of servers in the quarter.

I'm just curious what drove that acceleration off of what sounded like a little bit of a weaker first half of the year?.

Yeah. Matt, that's a great question. It was – you heard me say that it grew – servers grew in every one of our segments. I'm going to use my favorite economic term, lumpy. I think we've seen that with the solution business where we – I think we went for, like, four or five quarters last year of server growth.

Then, we went through two or three quarters of server decline. I think a lot of that has to do with the decisions that people are making in the data center, the options they now have and then – so, you see quarters where it just works out that a lot of projects hit where people want to refresh or add edge-based servers. And others, they don't.

So, I wouldn't get – I don't let us get too carried away with one quarter of great performance or one quarter of bad performance. We'll see how it plays out..

Thank you..

Thank you. And our next question comes from Shannon Cross of Cross Research. Your line is now open..

Good morning, Shannon..

Good morning. Nice to talk to you. The first question I have is, looking at the Dell deal, especially now that they've closed EMC, just if you can give any kind of update on what you're hearing from them, any changes, how the relationship is progressing, that would be great. Thank you..

Yeah. I think if they shared that with me, Shannon, I'd be pretty hesitant to share it with everyone else..

No, no, not them specifically with you guys, like, how your relationship is..

But I would say, look, I think they've done a nice job of managing through that. That's always a challenge every time you see a merger. It tends to create a little hesitancy in customers, right, because customers want to understand, like, who the leadership team is going to be and what is the – and so, I think the market clearly saw some of that.

But as far as our relationship with them, it has continued to be strong and robust and everything we expected it to be. So, we feel pretty bullish about that combined company and their ability to help us meet customer needs going forward, just like we do with our other strategic partners..

Great. And then, a question on currency from a UK perspective. Do you think that you can have any kind of pricing power or ability? I mean, I know all the companies are trying to figure out how you offset some of the currency pressure with what's going on with the pound.

But I'm curious, especially given the move in September in the pound, are you able to price up at all? Or are you basically just having to absorb everything at this point?.

So, what we see happen is some of our OEM partners will take pricing increases to offset. And then, from that, we now have this higher level of pricing, which obviously we try and pass through. It remains a competitive marketplace.

But think about our pricing as more of a margin than that we're actually making the price in the market, if that makes sense..

Okay. Thank you..

Thanks, Shannon..

Thank you. And our next question comes from Sherri Scribner of Deutsche Bank. Your line is now open..

Hi. Thank you. Just looking at the corporate business, with MedLar declining, it seems like the small business segment, though, is holding up and staying within the U.S. IT spending type of range.

Is that just because the small businesses are growing a bit more? Or do you think that you're doing better there? Or do you think that your solutions are better there? Just curious about that difference between the two corporate sides..

I would say it's probably all of the above in little pieces, Sherri, as you think about performance. I think one of the things that has really helped keep the small business performance is the affinity of small businesses for a cloud-based solution. And the small business team has done a great job of executing on our cloud strategy.

Now, that is a little more of a complex decision, when you move up market, if you think about it. The previous investment of capital in on-prem or off-prem solutions is a little higher in the corporate – in the enterprise segment, so the decision is a little longer.

So, I would say that I wouldn't try to read too much into it relative to the difference between the two. There's just different buying behaviors in each of the two different marketplaces, and they've kind of just maintained their performance.

They're not quite as impacted by the concentration, if you will, that we have in our enterprise segment in some of the industries like oil and gas and manufacturing down in the small business marketplace because it's such a big base and there are so many customers..

Okay. That's helpful. And then, just looking at the government piece, you guys have had strength in that segment for a number of quarters.

How sustainable do you think that strength is? Is there a certain point where we'll start to see some slower growth in that segment?.

Well, that conversation happens a lot inside of CDW, and I have high expectations in my leadership team for sustainability in government performance.

But I'd say, all kidding aside, I think that group has done a really good job of capturing new contracts, which is an important part of that sustained growth, and we continue to think there's opportunities for that, especially in state and local.

And then, on the federal side, this realignment we did around focusing on programs I think will pay dividends. So, look, it's tough for me to forecast out into the future. But I would expect them to continue to be an important part of our growth profile..

Thank you..

Thank you. And our next question comes from Brian Alexander of Raymond James. Your line is now open..

Okay. Thank you. This is Adam in for Brian. I just wanted to build off the earlier question on the co-worker count decline. I understand that the revenue growth targets through 2018 are unchanged.

But maybe help us understand what this may imply about the more intermediate term organic revenue growth outlook, and I asked because I think the organic growth has been above 5% in maybe two of the last seven quarters. Yet, we're all expecting it to be above 5% each quarter next year.

So, I want to make sure we're thinking about the correct variables..

Yeah. I think you're thinking about it right, and we're going to continue to add co-workers. If you think, Adam, about my point about since the fourth quarter of last year, we added 200 co-workers because we did a big end of the year push and hired a lot of people.

So, as – if I were doing it, I would worry less and focus less on the year-to-date number and more on the last 12 months. We'll continue to focus on adding co-workers based on the market and what we see out there. And I don't think you should, kind of, draw any negative correlations.

I feel pretty good about our organic growth and especially considering what's going on in the marketplace. I think there's lots of opportunity for us. We still, despite our size, have a relatively large share.

And I expect that the growth of the hardware business will come back, and that will stimulate some of the top line revenue growth that has been absent during the kind of the economic period we've been through especially in the corporate..

Okay.

And maybe just building off that answer, why do you think the hardware weakness is more cyclical versus secular?.

Well, I think part of it is driven by – some of it is technologies. And what are going on with technologies is people enhance and innovate, so to speak. I also think that, when you look at, hey, I've got some economic pressures. I may not upgrade certain hardware technologies.

Remember, despite all of the success we've had in cloud and the industry, there's still a predominance of hardware-based, premise-based solutions out there and I think that you're going to – you will see that. Now, look, I don't have perfect vision on this Adam.

But my sense is, when you look at the success of things like converged infrastructure and hyper-converged and some of the innovation that's going on in the client area, I would expect that to re-emerge at some point in time..

Okay. Thank you..

All right. Thanks, Adam..

Thank you. And our next question comes from Katy Huberty of Morgan Stanley. Your line is now open..

Good morning, Katy..

Good morning. Thanks for the questions. It's clear you don't want anyone to get carried away with the 40 basis points increase in gross margin in the quarter and year-to-date. And there are some cyclical factors that you outlined near term.

But if you think about a longer-term view as the business mixes towards more warranties and software assurance and cloud, why isn't there upward pressure just structurally on gross margins?.

Yeah. Well, first of all, I'm glad that that message came through loud and clear. The second is because I think, Katy – and again, none of us have this perfect vision. But I do think you're going to see a couple of things happen.

Just because that part of the business is growing today and is margin rich doesn't mean that some time in that future you won't even have commoditization in that part of the business. That has been the history, as you know, of IT for a long period of time. The second thing is kind of alluding to the question that Adam just answered.

I think you are going to see some increased hardware growth, and that's going to put pressure on it.

But I think, generally, look, I don't deny that, as we continue to be successful in selling the things that customers are most interested in now, be it cloud, software assurance, warranties, that it's going to continue to give us the opportunity for margin expansion going forward..

Okay. Got it.

And then, just as a follow-up, any updated sign as to the impact of the Brexit vote on UK demand? I appreciate that the pound is a headwind, but what are you seeing from an organic demand perspective in that market?.

Yeah, good questions. Thanks for asking it, Katy. It's been interesting. I think it's the way to start. It was a little strange right after Brexit. There was this kind of doom and gloom.

And then, after a couple of weeks, we actually saw the UK customers kind of return to a sense of, okay, normalcy and we'll deal with it when we actually execute the withdrawal so to speak of the EU.

And while I would say there is this notion that if the dates that Theresa May has announced, if she sticks to them, that that will certainly change some things. But I would say, kind of, on the ground, up until that time, it feels pretty normal, and people are just going about their business, making decisions on investing in IT.

But I think all of us have our eye on next spring..

Okay. Great. Thank you..

Thanks, Katy..

Thank you. And our next question comes from Jayson Noland of Robert Baird. Your line is now open..

Okay. Great. Good morning. I wanted to clarify the Dell comment. Tom, you're still on track for 150 basis points of incremental revenue in F 2016, it sounds like.

And I guess, do you feel like you've been able to take on this relationship without serious channel conflict?.

We think – look, we're pleased with what they're doing. I mean, I would say, look, the general economy, Jayson, affects every part of CDW, all right? And you can't just say, well, it affects some people and not others. But I think we're on the whole and on the average really pleased with the performance.

And I think what we said to our other partners has been true – is we have a history of dealing across multiple vendors. We have a thousand partners, and our reputation for integrity stands.

And I think, our other partners, as evidenced by their investment in CDW and some of the things Ann talked about relative to our VIR (55:55) performance suggests we're doing the things they want us to do..

Okay. And then, a follow-up on your software results. Really strong. You mentioned security in the cloud, likely, a trend that continues.

I understand this revenue is netted down, but wanted to follow up on the cash flow economics and how that impacts your business and comp plans, and I'm asking because we've heard it's been tough on some of your peers..

Yeah. I'll give you a high level. I – comp plans, I think our guys would say it's been awesome because we paid people on margin and it's a pretty margin-rich business and we feel good about the impact that it's had. I don't know. I'll let Ann, see I haven't heard anything about cash flow from a negative perspective..

Yeah. It's doesn't – I mean, you hear the commentary that I make about our cash conversion cycle. When we sell things that are netted down, it increases DSO and it also increases DPO as an offset. One of the benefits is things that are digital, if you will, we don't carry any inventory on and therefore don't have inventory rev (57:09).

So, from a return on investment perspective, it can be a very attractive business..

Hey, Jayson, the only I can think of, I was thinking about your comment, is – but this is a little bit of old news, is when we first started to – when we formed our cloud practice, which was, I don't know, 2011 or 2012, we went through a pretty strong education processes and said, look, to the degree that people buy on a subscription-based contract and your compensation will be spread over multiple years, you have to think about that as an annuity stream to your compensation.

And you need to start planning and planting seeds and building for that annuity stream because, once that annuity stream starts to roll, it's a pretty nice day. And I think people listened and took that to heart. And I think that's one of the reasons we haven't had a lot of pushback on those kind of services..

That makes sense. Thanks, guys..

Thank you. And our next question comes from Anil Doradla from William Blair. Your line is now open..

Hey, guys. Thanks for squeezing me in. So, Tom, big picture.

If I look at the macro and the uncertainty persists, do you believe that there's more willingness by many of your corporate customers to switch to the cloud? And another way of looking at it is, are you able to differentiate between demand softness and the cloud transition so to speak?.

So, my answer to the first question is no. I don't think the economy, at its current state, necessarily drives people in the Corporate segment to cloud computing. I mean, in a weird way, cloud computing is an OpEx expense. And so, the driver there is the level of service, the flexibility, the ability to manage the asset on a consumption basis.

Those are things that are kind of compelling independent of what I'll call the surrounding economy. So, I don't really make that connection.

Now, what I do think corporate customers are doing is, if they're thinking about upgrading a certain part of their infrastructure, they may decide to, I'll use the term, sweat the asset for another year and go buy incremental warranty or insurance protection to give them more time to do it.

I think the notion of building a hybrid private public cloud environment is one driven more by the drivers of flexibility cost in the business than it is kind of the general economy..

Great.

And the macro demand versus the cloud transition, are you able to clearly differentiate that when you look on a customer basis?.

Well, I can – I don't know that I can do it in the aggregate. It would be really hard to determine in the aggregate. I think that cloud growth is all about people looking at their business, looking at workloads and deciding which workload is most effectively and efficiently handled either on-prem or in the cloud.

And that's the driver of the growth that you've seen there..

Great. Thanks a lot..

All right. Thank you..

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Richards for closing remarks..

Okay. Look, as always, thank you for your interest in CDW. Thank you for your questions. Your questions help us, so I really do appreciate the thought that's put into them. It helps us make sure we're focused on the right thing. As I always do, if your company needs some help with information technology, I can't think of anybody better to help you.

And as we head into the Thanksgiving season, there's two things I want to ask you to be thankful for. One is that the election is almost over and so are the commercials. And the second thing is that the Cubbies are in the World Series. Go, Cubbies. Thanks, everybody..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Have a great day, everyone..