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

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

Keith Housum - Northcoast Research Partners LLC Kathryn Lynn Huberty - Morgan Stanley & Co. LLC.

Good day, ladies and gentlemen, and welcome to the CDW Corporation Q2 2017 Earnings Conference 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. I would now like to turn the call over to Tom Richards. Please go ahead..

Good morning, everybody. It's a pleasure to be with you today. Joining me in the room today are Ann Ziegler, our Chief Financial Officer; Chris Leahy, our newly minted Chief Revenue Officer; and Sari Macrie, our VP of Investor Relations. I'll begin today's call with a brief overview of our results and key drivers.

Ann will take you through a more detailed results review of the financials. 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 second quarter 2017 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 concerning 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 net income per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules.

You'll find reconciliation charts in the slides for today's webcast 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 2016 unless otherwise indicated.

In addition, all references to growth rates for hardware product, software and services today represent U.S. net sales only and do not include the results from our UK or Canadian operations. There were the same number of selling days in the second quarter and the first six months of 2017 compared to the comparable periods in 2016.

All sales growth rate references during the call will use the 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..

Thanks, Sari. Following our strong first quarter, we delivered another quarter of excellent top line growth and solid profitability. Consolidated sales were $4 billion, up 9% versus last year. On a constant currency basis, sales increased by 10%. Gross profit increased 5% to $641 million.

Adjusted EBITDA increased 5% to $315 million and non-GAAP net income per share increased to 10% to $1.03 per share. On a constant currency basis, non-GAAP EPS increased 11%. Results like this require rigor, discipline and process.

We have been very deliberate about putting the systems, structure and resources in place to ensure we can continue to execute our strategy effectively. Two recent organizational changes are designed to ensure we maintain this discipline as we drive further growth. You may have noticed that I introduced Chris Leahy as our new Chief Revenue Officer.

Creating a new executing role of Chief Revenue Officer accountable for all of our customer-facing channels is the first half these two actions. Chris, who most recently was our Senior Vice President, International and General Counsel, is taking on this new role reporting to me.

As you may know, Chris helped lead the launch of our international strategy, including the acquisition of CDW UK. As evidenced again this quarter, our international business has continued to deliver strong results under Chris' leadership.

As CRO, Chris will ensure we maintain a strong line of sight to customers, align resources and reinforce connection points between our sales and technical organization. So customers benefit from the deep technical capabilities we have built. I am delighted that Chris is taking on this new role. You will be hearing from Chris in future earnings calls.

I'm also delighted that Chris Corley will be taking on an expanded role as we add responsibility for our international business to her current role leading the corporate business segment. Remember that one of the strategic drivers of our international acquisition and expansion is to better serve our U.

S.-based multinationals from our corporate segment. Chris will build on the work already underway to create a one company experience to meet customer needs and drive profitable growth. She will also look to leverage our international capabilities to capture profitable growth opportunities outside the U.S.

This quarter's results demonstrate the power of rigor and discipline. There were three key drivers of our performance. Our balanced portfolio of customer end markets, breadth of product offering and our variable cost structure. Let me walk through how each contributed to performance.

This quarter's top line performance once again demonstrated the power of our balanced portfolio of end markets. We saw excellent top line performance across eight of our nine end markets, all up high single-digits or better. This strong performance more than offset a 7% decline in our healthcare business.

Corporate, which represents sales to business customers with roughly 250 coworkers and above, increased 9%. Momentum that began in the first quarter continued to build with more projects moving from the back-burner to the front. Small business posted an 11% increase as customer confidence remained strong.

Public increased 8% with double-digit increases across all customer end markets except healthcare. Government increased 19%, powered by new contracts in state and local, and ongoing success in meeting public safety needs as well as mid-teens growth in federal.

Federal results include a little more than half of the client devices that had been delayed at the year end of 2016. We expect the remainder to ship in the third and fourth quarter. Education increased 11%, reflecting high teens growth in Higher Ed and high single-digit growth in K-12.

Healthcare declined 7% as uncertainty regarding the fate of the Affordable Care Act, Medicaid funding and overall reimbursements weighed heavily on decision makers. Our other results, which reflect Canada and the UK combined, increased 9%.

Both operations continue to show strong performance with Canada up high single-digits in Canadian dollars and UK up double-digits in local currency. Currency impacted both operations, reducing U.S. denominated growth by 50%. The second driver of results was our broad product and solutions suite.

Our ability to meet the total technology needs, both transactional and integrated solutions of our customers, is one of the fundamental reasons for our consistent performance. This is a key point of differentiation for us in the marketplace.

With over 100,000 products, services and solutions, from over 1,000 vendor partners, we remain well-positioned to meet our customers' total needs across the spectrum of IT. IT market trends were similar to those that we saw in the first quarter.

We continue to see accelerated hardware growth with ongoing focus (08:07) and efficiency, securitization and integration of software into solutions. We also continue to see strong growth in client devices. We had a good mix of business between solutions and transactions with total U.S. solutions growing roughly 6% and transactions growing roughly 10%.

Let's take a closer look at overall product performance. As expected, U.S. hardware sales accelerated, increasing 8%, growing 200 basis points faster than the first quarter. Healthcare performance pressured growth rates across most product categories. Two categories, notebooks and mobile devices and networking were very strong.

Notebooks and mobile devices increased high teens with excellent growth across all customer end markets. This is a noteworthy result given last year's strong low double-digit increase. Chromebooks increased faster than the category, delivering all-time records for both units and revenues, reflecting continued success in K-12.

NetComm sales increased high single-digits with several end markets growing double-digits. Servers increased to mid single-digits in the quarter. Enterprise storage was down low single-digits as strong growth in federal could not offset declines in other markets.

We continue to take stocking positions, and while memory constraints and shortages persisted in the quarter, we did not see any interruption in supply.

While aspects of traditional data center infrastructure continue to be challenged, hybrid infrastructure, which includes converged infrastructure, Infrastructure as a Service, software-defined data center continued to see excellent growth.

Overall, converged infrastructure grew more than 50% in the quarter with hyperconverged driving most of the performance. Services increased 11%, primarily driven by networking solutions. Software sales increased 12%, reflecting strong security and networking growth.

Gross profit from software grew faster than net sales as we continue to see meaningful double-digit increases and netted out (10:17) Software as a Service and Infrastructure as a Service. And that leads us to the third element of our business model that drove performance this quarter, our variable cost structure.

For those of you unfamiliar with our cost structure, after our cost of goods sold, our largest cost element is sales compensation, which represents roughly half of our adjusted SG&A. Sales compensation is highly variable for two reasons. First, it varies with gross profit growth.

Second, it varies with sales mix as solution sales involve technical resources and transactional sales typically do not. This quarter, the strong sales momentum we had in hardware and the ongoing competitive marketplace, especially in notebooks and NetComm, pressured gross market.

Pressure on product margins isn't new, especially during strong client device refresh cycles. With the acceleration in hardware sales growth, we did not get the same benefit from mixing into 100% gross margin revenues as we did all last year.

When top line grows faster than gross profits due to margin compression, as it did this quarter, the variable nature of our sales compensation mitigates this impact. Clearly, our variable cost structure is a key driver of our ability to deliver sustainable profitable growth. Another key of our sustainable growth is our three-part strategy.

During the quarter, we continue to make excellent progress executing this strategy, which is to first capture market share from existing and new customers; second, expand our solutions suite; third, enhance our services capabilities. Capturing market share (11:56) will continue to be a core competency of CDW.

And we take a very disciplined approach towards driving productivity with focused efforts like category penetration and customer acquisition programs. Many of these programs are benefiting from the extensive data we have on our customers.

When we combine these data, the data that we have from our relationships with more than 250,000 customers with the advanced analytic capabilities we have in our data sciences team, we can uncover unique customer knowledge that helps us understand how best to serve them.

A great example of how we are harnessing this information is a new marketing program that went live in the second quarter. This program uses real-time customer intense signals along with propensity models and analytics to target and deliver personalized marketing communication across multiple channels, including e-mail, search, social and digital.

The program also leverages analytics based on behavior to drive up-sell opportunities. You should expect to see us continue to leverage data analytics to drive enhanced customer experience and sales. Our second strategy is to continuously expand our solutions capabilities.

By doing so, we capture important pockets of growth across the IT landscape and ensure we remain relevant to customers. One way we do this is by adding partners, which provides both innovation and a source of growth for us. In the second quarter, sales from security partners, added since 2014, increased over 40%.

New partners are driving growth in security and cloud with spend for both solutions increasing well into the double-digits. Solutions capabilities will continue to drive growth. One great example is the recent award you may have heard we received to provide a Device as a Service solution for the 2020 U.S. Census.

As you know, it's typical for large federal procurements to be protested. Because of this, I can't provide any details right now. We will provide you with more information as appropriate. Another way we remain relevant and capture above market growth is through our third strategic priority, which is to continue to enhance our services capabilities.

Services capabilities are an integral part of many high-end solutions sales and are critical to supporting our cloud and security practice. This quarter, networking services increased double-digits, supporting our NetComm increase.

As you can see, our investments in solutions and services ensure we can meet the needs of our customers today and in the future and further differentiate CDW as a valuable business partner. Our UK investment is another way we are accomplishing this.

As you'll recall, we acquired Kelway in August of 2015 to address requests from U.S.-based customers who were increasingly asking for our help with their international IT needs. U.S. referrals continue to drive meaningful growth for CDW UK, contributing roughly 20% of CDW UK's double-digit growth in the quarter. And it's not just U.S. referrals.

CDW UK is also driving growth from its own UK-based customers, delivering solutions around the world. We are prudently investing to help fuel this growth. This quarter CDW UK marketing spend was nearly twice last year's level.

Building up our very successful U.S.-based orchestration campaign, CDW is working with key partners across several categories and investing, along with our partners, to drive greater awareness of CDW's capabilities to deliver integrated solutions both in and outside of the UK.

Efforts like these, along with our dedicated international sales team and CDW international-branded website are driving excellent results. When we first entered into our 35% equity agreement with Kelway in late 2014, roughly 10% of their customer spend was outside the UK. In the second quarter, that figure was more than 20%.

In fact, approximately 25% of the double-digit growth in local currency this quarter was derived from solutions delivered outside the UK. Our international platform is being leveraged to help both existing and new UK-based customers address their needs around the world. We have also continued to invest in customer-facing coworkers to drive our growth.

These coworkers include account managers, field sellers, solution architects and service delivery engineers. We ended the quarter up roughly 130 customer-facing coworkers since the beginning of 2017, adding over 70 this quarter. Based on what we know today, that feels like the right number to finish the year, plus or minus 10%.

As we always do, we will monitor the market and adjust our plans as appropriate. And that leads me to our expectations for growth for the remainder of the year. Given first half market performance, our current view of the 2017 U.S.

IT market growth is full year growth in the 3.5% to 4% range, driven by continued hardware growth and strength in client devices. That's an increase of roughly 100 basis points from our prior view.

In addition to increasing our view of market growth, given our strong performance to-date, we also expect to exceed our annual medium-term target of growing between 200 basis points and 300 basis points above the market. We currently look for outperformance between 350 basis points and 400 basis points.

Of course, all of this is dependent on how the U.S. economy performs. If the economy stalls, then we would expect to see U.S. IT market growth come back down. We'll keep a watchful eye on things. And is our practice, we will update our view on market growth as we move through the year. Now, let me turn it over to Ann.

Ann?.

Thanks, Tom. Good morning, everyone. As Tom indicated, our second quarter financial results reflect the combined power of our balanced portfolio of channels, breadth of product offerings and variable cost structure.

They also reflect the progress we are making against our long-term financial strategy to drive strong cash flow, deliver double-digit constant currency earnings per share growth and return cash to our shareholders. Turning to our P&L. If you have access to the slides posted online, it will be helpful to follow along. I am on slide 7.

Consolidated net sales were $4 billion, 9% higher than last year on a reported and average daily sales basis. Average daily sales were $62.4 million. On a constant currency basis, consolidated net sales were 9.8% higher than last year. Currency impact was driven by both the British pound and Canadian to U.S.

dollar translation, shaving roughly 80 basis points off of growth. Currency impact was 20 basis points lower than the first quarter. On an average daily sales basis, sequential sales were up 20.1% versus Q1 2017, which was higher than both last year and also our historical Q1 to Q2 increase. Gross profit for the quarter increased 5% to $641 million.

Gross margin in the second quarter was 16.1%, 60 basis points lower than last year. The decline was driven by the impact of increased hardware sales and an ongoing competitive marketplace, which pressured our product margin.

Low teens increases and 100% gross margin revenues, which include commissions, warranties and Software as a Service were not enough to offset our product margin decline. Turning to SG&A on slide 8, consolidated reported SG&A including advertising expense was roughly 6% higher than last year.

Reported SG&A includes $11.5 million of equity-based compensation, $2 million of integration expenses and $4.5 million of other expenses, including payroll taxes on equity-based compensation. Our adjusted SG&A including advertising increased 5%, primarily driven by sales payroll growth and advertising.

Coworker count was up roughly 75 year-over-year to just under 8,800. Our adjusted EBITDA for the quarter was $314.7 million, up 4.7%. This delivered an adjusted EBITDA margin of 7.9%, down 30 basis points from last year. Looking at the rest of the P&L on slide 9. Interest expense was $35.9 million, $1 million lower than last year's Q2 level.

GAAP taxes were $55 million, which resulted in an effective tax rate of 27.9%. The reduction in effective tax rate primarily reflects excess tax benefits from the vesting of equity-based compensation. Tax benefits amplified operating income and GAAP net income was $141 million.

Our non-GAAP net income, which better reflects our operating performance, was $163.2 million in the quarter, up 4.9% over last year. As you can see on Slide 10, non-GAAP net income reflects after-tax add backs that fall in four general buckets.

The ongoing amortization of purchased intangibles, equity-based compensation and the related payroll taxes and excess tax benefits, acquisition and integration expenses and other non-recurring or infrequent income or expenses such as net loss on the extinguishment of debt. This quarter, our performance alignment grant or PAG vested.

The PAG was a one-time equity grant made at the time of our IPO to coworkers up to senior manager. This vest created (21:27) $18.6 million of excess tax benefits. Since we add back equity compensation as a non-GAAP adjustments, we also reversed out this $18.6 million of excess tax benefits.

This adjustment is detailed in the GAAP reconciliation provided with our press release. With Q2 weighted average diluted shares outstanding of $159 million, we delivered $1.03 of non-GAAP net income per share, up 10% over the prior year. As we indicated last quarter, currency impact on EPS was similar to the impact on net sales.

On a constant currency basis, non-GAAP net income per share increased 10.8%. Turning to first half results on slide 11. Revenue was $7.3 billion, an increase of 7.9% on a reported and average daily sales basis. On a constant currency basis, growth would have been roughly 90 basis points higher.

Gross profit during the first half of the year was $1.2 billion, up 5.2%. Gross profit margin was 6.3%, down 40 basis points. Adjusted EBITDA was $564 million, 5.7% above first half 2016. Net income was $199 million for the first half of 2017 and non-GAAP net income was $284 million versus $268 million in 2016, up 6.8%.

On a constant currency basis, non-GAAP net income per share was $1.77, up 11.4%. Turning to our balance sheet on slide 14. On June 30, we had $79 million of cash and cash equivalents and net debt of $3.2 billion as compared to $3.1 billion at June 30, 2016. Our cash plus revolver availability was $1.1 billion.

Net debt to trailing 12 months adjusted EBITDA at the end of Q2 was 2.8 times within our target range of 2.5 to 3 times. Our current weighted average interest rate on outstanding debt is 4.2%, 20 basis points below last year due to the term loan repricing and note refinancing (23:30) completed in Q1.

Roughly 95% of our outstanding debt remained either fixed rate or hedged. As you can see on slide 15, we maintained strong rolling three-month working capital metrics during Q2. For the quarter, our cash conversion cycle was 16 days, down 1 day from last year second quarter (23:50) below our new annual target range of high teens to low 20s.

Year-over-year DSO and DPO each increased 4 days. Cash taxes paid for the quarter were $90.3 million and cash interest was $28.5 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 $40 million compared to $9 million in Q2 of 2016.

Year-to-date free cash flow was $254 million, compared to $359 million in the first six months of 2016. As you'll recall, our first quarter free cash flow was more than $100 million less than last year's due to the year-over-year period and timing differences and a lower-than-expected sequential sales decline.

During the quarter, we continued to execute against our capital allocation strategy and repurchased 3.1 million shares for $184 million at an average cost of $58.89 per share. Our capital allocation strategy is comprised of the following four components, which you can see on slide 16. First, increased dividends annually.

To guide these increase in November of 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 September 11 to shareholders of record as of August 25, up 49% from a year ago.

Since the IPO, our dividends had increased nearly fourfold from its initial annual level. 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 to 3 times. We ended Q2 at 2.8 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. To support this priority, our board has approved an incremental $750 million share repurchase authorization.

This approval augments the balance remaining in the prior $750 million authorization, on which, on June 30, there was $283 million remaining. Our capital allocation priority support our refresh 2016 to 2018 medium-term target which you see on slide 17. These are to grow in constant currency, 200 basis points to 300 basis points faster than the U.S.

IT market with a targeted adjusted EBITDA margin in the high 7% to 8% range. Maintain our net leverage ratio between 2.5 and 3 times and deliver low double-digit non-GAAP EPS growth in constant currency. Keep in mind that we hold ourselves accountable for achieving our medium-term target on an annual not on a quarterly basis.

Let me now provide you with a few additional comments for those modeling the rest of our 2017 financials. I'm on slide 18. We currently expect to exceed our annual medium-term target of delivering full year constant currency growth of 200 basis points to 300 basis points above the U.S. IT market growth.

At this time, we expect to exceed market growth by 350 basis points to 400 basis points.

Based on our first half results and the expectations for the rest of the year, we look for the balance of sales in the second half to be slightly lighter than our normal seasonality, which is roughly 48% to 52% weighted towards the back half of the year in the neighborhood of 50 basis points less than the second half.

This primarily reflects the impact of our second quarter higher than typical sequential sales and its impact on Q3 growth, primarily in CDW UK and our government business. We have one less selling day in Q3 2017, which will result in average daily sales growth higher than our reported sales growth.

This reverses in Q4, where we have one extra day of sales and Q4 reported sales growth will be higher than average daily sales. We currently look for currency headwinds to come in at an annual average rate of roughly 50 basis points. This assumes average annual translation rates of $0.75 to the Canadian dollar and $1.25 to the British pound.

While the pound translation rate is slightly higher than our initial $1.20 to the pound rate, we remain conservative given the volatility around Brexit talks and timing.

Given current expectations for hardware growth to remain strong and the mix impact into 100% gross margin items to remain muted, we expect our full year adjusted EBITDA margin to come in at the low end of our high 7% to 8% annual target range.

With roughly half our adjusted SG&A before depreciation and amortization fixed with the other half variable with gross profit, one fewer selling day in Q3 will drive expense growth higher than gross profit growth, compressing Q3 year-over-year adjusted EBITDA margin. Keep in mind, Q3 2016 adjusted EBITDA margin was 8.4%.

This difference in days will shift roughly 200 basis points of adjusted EBITDA growth from Q3 into Q4. We expect depreciation and amortization to continue at a similar quarterly rate to Q2 at roughly $65 million per quarter, $46 million of which is for purchased intangibles.

We continue to expect total annual book interest expense of roughly $150 million. With the PAG fully vested, we expect second half equity-based compensation to run slightly below first half levels at a couple million dollars below 2016. We will book excess tax benefits related to equity compensation in the fourth quarter.

They're expected to be much lower than Q1 or Q2 in the range of $2 million or so depending on our stock price at the time and performance attainment. Our effective GAAP tax rate in the third quarter will be higher than in the first half, coming in 100 basis points or so above the 2016 level with our second half rate of approximately 37%.

Non-GAAP add-backs for the remainder of the year will be taxed at a 36% rate with any excess tax benefits then reserved out. You should expect us to continue to use share repurchases to achieve our low double-digit non-GAAP EPS annual growth target in constant currency.

Given UK and Canadian operations now represent roughly 10% of our business, it is important to consider currency translation when modeling both top and bottom line in this volatile currency environment. We continue to expect currency to drive similar headwinds as on our top line.

And that leads us to a few notes for those of you modeling cash flow on slide 19. We continue to expect our capital expenditures will be about 0.5% of net sales on an annual basis. We also continue to expect to deliver our cash conversion cycle within our new target range of high teens to low 20s.

For the full year, there was no change to our expected cash tax rate in the 32% range to be applied to pre-tax book income before acquisition-related intangibles and amortization, which is approximately $46 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. Cash taxes will be lower in 2017 versus 2016, primarily due to tax deductions from equity compensation.

We continue to expect to deliver annual cash flow within our recently enhanced range of 3% to 3.5% of net sales. As you'll recall, in 2016, we delivered free cash flow as a percentage of net sales significantly above this target. This reflected the onetime benefit of extending key partners to longer payment terms as well as period end timing.

We exited 2016 with more than $250 million of cash and cash equivalent on our balance sheet. Reinforcing our commitment to return cash to shareholders, we intend to return more than 100% of 2017 free cash flow through dividends and share repurchases and currently expect the bulk of our repurchases to occur in the first three quarters of the year.

That concludes the financial summary. Before we open it up for Q&A, let me briefly address the SEC investigation we disclosed in 2015 relating to vendor partner program incentive. As you may have seen during the second quarter, we were notified by the SEC that they had concluded their review with no action recommended.

With that, let's go ahead and open it up for questions. Can we please ask each of you to limit your questions to one question and one brief follow-up? Operator, please provide the instructions for asking a question..

Our first question is from Matt Cabral with Goldman Sachs. Your line is now open..

Morning, Matt..

Good morning, Tom. Thank you. You touched on this a little bit in your prepared remarks.

But given the acceleration you've seen, just wondering if you could talk a little bit about the sentiment you're hearing from your commercial customers and if you're starting to see some of those expansionary projects that you've talked about in the past come online yet?.

The short answer is yes. As I alluded to, we started to see kind of the continuation of the momentum, Matt, we saw in the first quarter relative to, not only client devices but solutions growth and you saw that reflected in our performance. Those are the more longer tail projects that take a little more time.

So we are continuing to see momentum in corporate..

Got it.

And then just as a follow-up, on the step down in gross margins, was there a conscious change in strategy that you guys made this quarter or was that just more of a function of what the market gave you across the hardware and the competition that you called out previously?.

No, Matt, it wasn't. It's amazingly consistent with the last time we had a strong client refresh, if you look back I think it was in 2014, it's the same phenomenon when you have customers going through strong refresh. Those products typically have lower margins. And so when you get that kind of exponential growth, it tends to just put the pressure on.

So it was just a function of what customers want to be doing at this particular time..

Thank you..

Okay..

Our next question is from Amit Daryanani with RBC Capital Markets. Your line is now open..

Thanks a lot. I guess just to continue on that hardware discussion. Notebook and mobile devices, I think Tom you said, were up high teens from what I recall. You had it very difficult compared to the June quarter on a year-over-year basis at least.

So what's really driving this and comfort that (34:23) this kind of sustains into the back half versus perhaps it was a pull in or something?.

Good morning, Amit. Yeah, it was. It's funny we just talked about that this morning. It's amazing that we had that kind of growth rate on top of, not that strong but pretty strong in quarter last year. I would say a couple of different things. One is, it's about the refresh cycle time.

If you think about it, 2014 was Windows XP expiration timeframe that drove a lot of refresh. We are now three or four years into it. So it's about the cycle.

The second behavior we're seeing is – a little bit of an interesting perspective is that some customers are moving ahead with Win 10, As we've talked about, I think the word I've used is a general breeze that continued. But we also have some customers who are kind of loading up on 7, so to speak. And so I think those two things.

I think the third thing is – and this is amazing performance by the K-12 team. If you look at their comp last year and specially client devices, the fact that they were able to continue to grow and Chromebooks continue to be a strong driver, those things kind of drove that part of the client refresh.

And at this point, Amit, it looks like it's going to continue through the better part of the year. One more thing, the other thing driving it was those big federal client orders that didn't get booked or shipped at the end of last year are kind of coming to the system now..

Got it. That's really helpful. And if I can just really follow-up. You guys have had this renewed focus or new found focus I'd say on the small business, the 90 to 250 employees or so, and you spend a lot of time and the analysts have been talking about this.

Double-digit growth this quarter, how should we think about the potential for you to, I guess, sustain the growth here today? I imagine you actually have much lower market share in this market versus the broader TAM that you guys go after..

Look, I would say it's not much lower market share. I think the opportunity is great though. I agree with you that's why we made the move. I don't know that I'm going to get into giving guidance on small business.

But I will tell you, we're excited about the – like anything else, when you focus on something and it gives you ability to get up every day and think about nothing else other than what small business customers want, and the first half of this year, we saw a lot of client refresh. And we're starting to see momentum in the solutions business.

I mean, we feel really good about the decision and the return on that investment as they start to customize the solutions that they deliver to small business, we would expect to continue strong performance..

Perfect. That's it for me and congrats on the quarter, guys..

Thanks..

Hey, thanks, Amit..

Our next question is from Jayson Noland with Baird. Your line is now open..

Good morning, Jayson..

Okay. Hey, Tom. I wanted to start with UK at double-digits in local. That's surprising. Some others have called out softness there. It sounds like a marketing campaign helped you guys. But maybe if you could talk about your success there a little bit..

Yeah, look, I think it's a combination of factors. One, clearly, the investment we've made in leveraging the orchestration campaign and telling the story about the capabilities of CDW certainly paid dividends. I think the second thing is, you have now UK being part of the CDW family for better part of a year-and-a-half or two years.

So some of the programmatic approaches we take to focusing, sell our productivity, some of the programs you heard me allude to on category penetration and account acquisition, a lot of those things contributed to the performance.

And the last thing is, as I tried to call out, the combination of both referrals increasing from US nationals and the success of the international sales team inside of UK selling capabilities outside of UK, all of those kind of came to a confluence, if you will, and produced that kind of performance in the quarter..

Okay. And that makes sense.

And then a follow-up on the hardware side, storage down with strength in converged and then server up seems surprising, anything to call out there specifically on server and can that continue?.

I'm sorry, Jayson, I didn't hear the very last part..

Can the strength in server continue going forward?.

Well, look, we have some things that give some optimism. You've got the new processor that's coming online at the end of the year. I think there is some anticipation for that, especially in a couple of segments like our financial vertical. So that gives you some excitement there.

And hyperconverged and converged in general to me just makes so much sense for customers relative to giving them the density, and yet at the same time, giving them the on-prem control that some of them want for certain workload. So I think I would be shocked if we don't continue to see the hyperconverged and converged infrastructure grow.

I would be surprised if Infrastructure as a Service doesn't continue to grow. And I think, what I'll call the traditional server business, it'd be hard because it's been somewhat, I'll use my favorite economic term, lumpy, where we have some strong quarters, where we make some meaningful sales.

I think you should expect to kind of continue with that kind of performance in light of what's going on with hyperconverged..

Thanks, Tom. Congrats on the quarter..

All right. Thanks, Jay..

Our next question is from Matt Sheerin with Stifel. Your line is now open..

Good morning, Matt..

Yes, good morning, Tom, and everyone. Just a couple of follow-ups from the previous questions. Just one on the seasonality for the rest of the year and sort of call that out where that typical first half, second half is a little bit different given the strength that you've seen in the first couple of quarters.

But specifically, on government, and you talked, Tom, about the strength that you saw, some push out from last year into this year.

What's the expectations for seasonality in the federal government for the next quarter?.

I would say it feels normal at this point. We won't have the overhang, that'd be the wrong word, the supported growth from the client devices as strong as we've had as we move through the year.

But our federal guys are not saying anything unusual about the normal buying cycles of the federal government, which typically for us ends up being a pretty strong third quarter. But we have seen some things happen lately in the last couple of years, where as you sell more solutions, they tend to spill over into later quarters.

Now, Ann, if there's anything else you want to add?..

Yeah, Matt, my commentary was government had a very strong second quarter. So we won't necessarily see the normal sequential growth. Not that Q3 won't be a normal-ish Q3, but if you're looking at sequential growth, that's what my comments were really pointing out. So very strong growth in our international U.K. business as well as government.

So that's what I was say, would likely impact that said 48/52 balance that we typically see and I said roughly 50 basis points..

Got it. And just on the UK strength there. At your Analyst Day, you called out the fact that you're expanding your fiscal footprint into mainland Europe in several countries now, I believe.

How much of that growth is being driven by that and what's the opportunity to grow beyond the UK?.

Yeah, well, as you heard, we've had significant growth outside of the UK. And Matt, we haven't really opened any new offices. It was really a function of the existing facilities we have in place, the kind of hub-and-spoke strategy that they have.

And it really has just been leveraging, if you will, the international strategy that I alluded to, the orchestration campaign that drove the increased results and the dedicated international sales team, I think, has a lot to do with, like anything else, with us.

When we focus on something, we tend to get a return on our investment from a performance standpoint. I would say it was more that than we didn't open up any new offices..

Got it. Okay. Thanks a lot..

All right. Thanks, Matt..

Our next question is from Shannon Cross with Cross Research. Your line is now open..

Good morning, Shannon..

Good morning.

I'm curious, with dollars shifting to client and the conversations you're having with your customers, where are they shifting away from? I know there are sort of puts and takes and ebbs-and-flows in this business, but I'm curious as to sort of where clients are maybe deemphasizing or if it's just, at this point, they realize they have to spend on everything?.

Okay. I don't know that there's a generalization I can make, Shannon, because it does seem to depend on the customer. And if we hadn't had such strong solutions growth, we had a nice solutions quarter at 6%, you could say there was a substitution effect. I don't believe that's the case.

I believe it's more of coming to grips with the fact that there's a refresh required on the client devices. We also saw, maybe not as evident in my comments, kind of a strong refresh in the NetComm business. And I think both of those are driven primarily by cycle wishes. It's refresh time.

And I don't know, if you look across the board, we really didn't have any product category other than printing, which continues to be an ongoing challenge. Everyone else had really nice growth. So I don't think I saw a substitutionary effect..

Okay. No, that's great.

And then can you talk a bit about what customers are saying on security these days and how that's playing into your solutions business and some of the growth you're seeing?.

Yeah, can't (45:18) enough would be the – or the easiest way to describe it feels like to me. It is interesting though. I think one of the new things we're seeing is, more discussion at the front end in the planning process, how do we design security into the solution.

And we started to see that trend last year as compared to maybe two years ago, where it was, how do I rectify or how do I enhance the current infrastructure. And that discussion is probably playing out a lot more today than it has.

Just because people are saying, look, if we're going to do a refresh cycle, we're going to think about security upfront, therefore, we're going to design it in the solution..

Is there any difference between enterprise and small business within the security discussions or are the small business customers really starting to understand the threats at this point?.

I would say, the only difference is probably the complexity of the solution if you think about just the general nature of the business. But I would say, we have the same kind of interest level – the question even comes up, for example, when somebody's doing a refresh cycle on client devices, right.

Where they're now saying, hey, I want to make sure I'm cognizant of the security capability built into the device. I'm not sure we heard that three or four years ago..

Great. Thank you very much..

All right. Thanks, Shannon..

Our next question is from Sherri Scribner with Deutsche Bank. Your line is now open..

Hi, thanks. Tom, I was hoping you could provide a little more color on the strength in the server market. I know we talked about it in an earlier question, but you guys significantly outperformed the rest of the server market. And I think most people have been talking about some issues in server demand related to higher bill of material costs.

Can you maybe comment on what's helping you outperform the traditional market? And then related to that, talking about component costs, you mentioned it a little bit, but are you guys being impacted at all by higher commodity costs, at least in terms of being able to get product or have you had any issues with that? Thanks..

Okay. Let me go back to the first one on server. I think one of the reasons, Sherri, is, and we've watched this now, I would say it feels like for the last two or three years, the cyclical nature of the server market with all of the other things that are kind of going on around it, whether it's looking at virtualization.

We had a strong virtualization quarter. Looking at Infrastructure as a Service, we had a strong Infrastructure as a Service quarter. Looking at hyperconverged, we had it strong...

So I think what you see is people looking at their landscape and saying, look, there are going to be times when I'm going to decide to extend my on-prem server capability because it doesn't make sense to make a change at this point. And what I see, and this is more something that's true in our corporate space, is that doesn't happen every quarter.

It's not like every quarter somebody's thinking about doing that, which is why I think you see – if you look at us, even over the last two years, it's been up mid single-digits, down low single-digits, up single-digits. So I wouldn't kind of over-index on the performance this quarter. We're thrilled.

Having said that, we have put a lot of resources on focusing on the data center. And I think one of the benefits when you focus on that is you get some improved performance like we saw this quarter. Now, I think that's first part. Second part, obviously, we did see some cost of goods changes in the quarter.

And ironically, in some places, we saw cost of goods increases. We also saw cost of goods decreases. Some of that is a function of our scale, some of it is a function of supply shortages, but I think the point I was trying to reinforce is on the whole and on the average, didn't have a meaningful impact on us in the quarter..

Okay. Great. Thanks..

Thank you..

Our next question is from Mark Moskowitz with Barclays. Your line is now open..

Hey, Mark..

Yes, thank you. Good morning. I was calling to see if you can talk a little more about the executive appointments in terms of Chris and Chris.

What those mean longer-term in terms of – is this more about the need to grow beyond the existing customer base from a land-and-grab expansion perspective in terms of having to really carve out new customer generation from here? Does that mean it's getting harder? And the follow-up will be, does that mean there could be more acquisitions down the road?.

Okay. Okay. So let me take the first one. It isn't about like new challenges in the marketplace, like it's harder to acquire customers. It was really something that I've been thinking about for almost 18 months.

And then, part of it is, I have this kind of personal philosophy that, as a business gets bigger, the way you make sure you execute is you manage smaller.

And that means you constantly look at making sure you have more people with eyes and ears to listen to what's going on with sellers, listen to what's going on with customers and then leverage that across the organization. So it really is more just about that approach and philosophy.

Look, these results aren't the kind of results that say, oh my gosh, we're trying to solve some kind of problem as much as I just want to make sure we're staying a couple steps ahead. And we're constantly listening and focusing on the front line. That was really what drove the first Chris appointment.

And the second Chris appointment was driven by the driver of doing international in the first place was our corporate marketplace. And we've made great progress now in kind of working on the one message platform and you heard the results. So that appointed was, it feels like the right time now to put those two together and expect them to take off.

What was the second part? Oh, do we expect increase or do we expect to do M&A? I think, Mark, I'll answer the same way I did at the Investor Day. That is, we think M&A will continue to be part of our future. It'll be looking for specific strategic opportunities versus some kind of general rollup.

We think there are some technologies out there where it may be to our advantage to acquire rather than try to build based on speed to market..

Thank you..

All right. Thanks, Mark..

Our next question is from Adam Tindle with Raymond James. Your line is now open..

Morning, Adam..

Good morning. Thank you. Tom, you mention an ongoing competitive marketplace in the press release. I don't recall seeing that much in the past.

Could you give maybe give us more clarity on this comment? And does this tie into some of the management changes that you've been making?.

Has nothing do with the management changes. And we've felt like – I think I talked about this, Adam, in the past is that, when you're still – look, GDP as much as it feels a little better now, I don't know what the latest forecast is, like 2.7% or 2.9%, it's still, on the whole and on the average, it's still a relatively slow growth environment.

I think when that happens, people compete hard. And so that doesn't feel like it's changed at all. I think the only difference this quarter is, you had this kind of rapid growth of client devices coupled with what has become kind of the normal course so to speak. And this marketplace, which is hyper competitive and you got to grind..

Okay. And I know margin compression was a bit of a sticking point in the quarter. But it looks like both revenue and gross profit dollars per employee improved on a year-over-year basis again in this quarter.

Can you maybe talk about what's driving that, and if possible, how this is tracking CDW UK since I know that was suppressing metrics a bit last year?.

Yeah, I would say two things. I don't really know that margin was a sticking point in the quarter. It was just a function of us mixing into client devices. I mean, like I said, if you look back at 2014, Ann and I were doing this the other day, it looks remarkably similar when we have this big client refresh cycle.

The second point though I think is a point that we've made, I think, consistently since the IPO, in our business model, the thing we really concentrated on is adjusted EBITDA, and that is a percent of sales. Because it is really that part of the business that is the variable compensation structure.

So, when you think about what happens, like in this quarter and you have transactional business growing at 10% (54:14), you have solutions growing at 6% (54:15), you're going to tend to see some leverage come out of your sales compensation because those transaction sales don't include a technical resource from a compensation perspective.

And we really focus in on that. It's kind of under the theory, you can't totally control GP, but you can control what goes on in SG&A and that's kind of where we focus. And that yielded some of the benefits you're talking about..

Okay.

Just maybe to clarify on, I just mean, in the sense that we were kind of all as the Street expecting higher gross margins or maybe some of that's on us, so just to clarify, I know 3Q typically declines sequentially due to federal mix? Might this be different this year given the starting point is bit lower than we thought?.

Yeah, I don't know that I could get – I mean, the thought of it's going to depend on how much the client refresh continues. At the end of the day, what I would say is don't over think this one. There is just a strong client refresh and we're going to help customers with that.

We're not going to walk away from that maybe because clients may not have a strong a margin as solutions. Because over the long run, when we help clients with these kind of problems, they don't forget that..

Thank you..

Yeah..

Our next question is from Keith Housum with Northcoast Research. Your line is now open..

Good morning, Keith..

Good morning. Thanks for taking my question. Appreciate it. Just wanted to (55:43) the challenges in healthcare. Obviously, your guess is as good as mine, what's going to happen with that in the federal level.

But as you guys you talk to your customers and if it were these trends throughout the quarter where the healthcare challenges were getting worse and what happens if nothing happens over the next six months through congress? Is the headwind going to get worse there?.

Keith, if I could answer that question, I don't know what I'd do next in life. But I would say this, and this was confirmed, we actually have a board member who's in the healthcare industry.

Ironically, his description of what people are experiencing was very similar to what we have been telling you, which is the lack of clarity, especially for the major hospitals. Makes it hard because they're not sure about how they're going to reimbursed. We're not sure on how you're going to be reimbursed. You're going to be cautious on spending.

And that whole scenario just continues to play out. And I don't know that I have the skills to forecast what's going to happen in Washington and how it's going to impact healthcare. I just know that it's amazingly consistent across our healthcare customers. And the story we hear relative to what it means to how they run their business.

I would take that's the one thing that I think keeps coming home. The IT spend or the IT issues are a direct derivative of the overall management of the healthcare institution and facility. And so it gets impacted just like everything else. And I think that's what we're hearing time and time and time again..

Okay. Great. Changing gears, when you slightly hear the product shortages, it sounds like two quarters in a row where the shortages have been out there but you guys made it with a, not get impacted by that.

As you guys exited the quarter, was there any increase or decrease, concerns regarding shortages for the rest of the year?.

Well, yeah. Look, we're always concerned whether there are shortages. I'm hopeful we can continue to take advantage of our scale and buying behavior to mitigate those. But I don't know that I would guarantee that to anybody..

Okay. Thank you..

Okay. Thank you..

And our next question is from Katy Huberty with Morgan Stanley. Your line is now open..

Good morning, Katy..

Hello. Thank you. Good morning. Have you changed your outlook for back half market growth after the strong second quarter? And when you think about the 350 basis point to 400 basis points outperformance, is that mostly flowing through your performance in 2Q or do you think you'll outperform by that much in the back half? Thanks..

So I'll let Ann..

Yeah, so Katy, earlier in the year, we thought market growth was going to be a bit above 2% (58:44) to bit above 3% (58:46). So we have taken up our view of market growth for the year as well as how much we think we're going to outperform the market. We've now saying 3.5% (58:56) to 400 basis points. Those are annual numbers, right.

So keep that in mind. We don't further segment it by quarter or by half. We did think that our sequential – the split, if you will, of first half to second half this year might be a little front end loaded, roughly 50 basis points because of the strong performance, particularly in our UK business and our government business in Q2..

Thank you..

And I'm showing no further questions. I would now like to turn the call back over to Tom Richards for any further remarks..

Okay. Thanks, everybody, as always for your time and your attentiveness and your questions. You've heard me say this before. I find your questions very helpful in making sure we're thinking about the right things. So thank you. And I just want to squelch a rumor. It's not true that you have to be named Chris to advance here at CDW.

So I want to make sure my team hears that. Okay. Thanks, everybody. Have a great summer. See you offline..

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone, have a good day..