CDW Corp (CDW) 2013 Q4 法說會逐字稿

Good morning. My name is Eric, and I will be your conference operator for today's call. At this time, I would like to welcome everyone to the CDW fourth quarter and year-end 2013 earnings conference call.

(Operator instructions)

I would like to remind you that today's conference is being recorded. If you have any objections, please disconnect now.

It is my pleasure to turn the call over to CDW's Chairman and Chief Executive Officer, Tom Richards. Mr. Richards, you may begin your conference.

Thanks, Eric. Good morning, everyone, and thank you for joining us today to discuss CDW's fourth-quarter and full-year 2013 results. With me in the room are Ann Ziegler, our Chief Financial Officer; Chris Leahy, our General Counsel; and Sari Macrie, our VP Investor Relations.

I will begin the call with a review of fourth-quarter and full-year performance, focusing on strategic progress and share some thoughts on 2014. Then I will hand it over to Ann, who will take you through a more detailed review of the financials. After that, we will open it for some questions. But before we begin, Sari will present the Company's Safe Harbor disclosure statement.

Thank you, Tom. Good morning, everyone. Our fourth quarter and full year 2013 earnings release was distributed this morning and is available on our website, along with supplemental slides that you can use to follow along with us during the call.

I would like to remind you that certain statements made during the 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. 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.

Please note that all references to growth rates or dollar amount increases in our remarks today, are versus the comparable period in 2012. The number of selling days for the fourth quarter and full-year are the same in both 2012 and 2013, so there is no difference in growth rates for average daily sales and reported sales.

A replay of this webcast will be posted to our Investor Relations website, investor.cdw.com by this time tomorrow. Finally please note, 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. The combination of our balanced channel portfolio, broad product suite and focus on execution enabled us to deliver our strategic and financial objectives for 2013. At the beginning of 2013, we stated objectives of profitably growing 200 to 300 basis points faster than the market, while making investments for future growth. I am pleased to share that we met or exceeded all of these objectives.

We delivered 2013 sales growth of 6.3%, well above the US IT industry forecast which generally ranged from 3% to 4% for 2013. We achieved this above market growth, while maintaining excellent profitability. We delivered a full year adjusted EBITDA margin of 7.5%, a strong outcome in the face of a highly competitive market, pricing pressures and more transactional products, and headwinds in the federal and healthcare markets.

Our adjusted EBITDA increased 5.5%, and when coupled with our progress deleveraging our balance sheet, we delivered non-GAAP net income per share of 27.1% higher than last year. And we accomplished this, while making significant investments during the year to further our ability to deliver solutions.

We added nearly 120 customer-facing coworkers, the majority in pre- and post sales technical positions. These are our technical specialists and service delivery coworkers, and we broadened our solutions portfolio, including new offerings in cloud, mobility, and security.

Fourth-quarter results represented a solid finish to our year of both strategic progress and financial performance. For the quarter, revenues increased 4.3%, adjusted EBITDA increased 3.2%, and non-GAAP net income per share increased 43.2%. Once again, power of our balanced portfolio that acts as a shock absorber against external factors, be they economic or otherwise, like the extraordinary shutdown of the federal government was front and center this quarter.

Our corporate segment increased 7.6%. Corporate growth was led by continued momentum in our medium and large channel, which increased 8.7%. Small business increased 2.7%, continuing the turnaround we saw in Q3.

Excellent results in education and state and local government, and a return to growth in healthcare nearly offset the a significant drop in federal sales resulting in the decline of our public segment of 1.1%. Education was up 25%, as K through12 continued to deliver excellent sales growth driven by the ongoing adoption of the Common Core curriculum. And for the first time in five quarters, higher ed delivering digit double-digit gains generated by notebooks and network communications equipment.

Healthcare showed a positive momentum, up 2.8% for the quarter, reversing the trend of the past two quarters as we saw some year-end budget flush from major health systems primarily to refresh PCs. On the government side, state and local continued its track record of excellent results, up nearly double-digits driven by our ongoing success delivering public safety solutions.

But federal performance was just as I indicated on our third-quarter call, a real wild card. The government shutdown of 16 days, which represented 12 of our 63 selling days, combined with issues related to delays in decision-making and order processing created a significant headwind for us. In fact, fourth-quarter declines in our federal business were higher than our third quarter, on both a percent basis and a dollar basis.

Our other line, which includes Canada and CDW Advanced Services, grew over 8%. Both businesses performed well. Our advanced services business delivered high teens growth, and after adjusting for currency, our Canadian operations delivered sales increases in Canadian dollars of low double-digits. So all in all, with the exception of federal, we had an excellent performance across the business, driven by the power of the balanced portfolio of channels.

Our suite of over 100,000 products from leading and emerging partners also contributed to our performance. For the quarter, hardware increased 4%, software 7%, and services, 20%. Hardware stand-out performance in the quarter included notebooks and mobile devices, desktops, and the wireless part of our networking business. Once again, we saw double-digit increases in PCs reflecting solid performance across all of our channels, led by our continued success with Chromebooks in K through12.

Software sales were driven by strong performance in solutions-focused software, including security software and network management software. Application software was essentially flat. As in the third quarter, application software results were impacted by a single partners adoption of the subscription-based model, one that delivers higher-margin for us, but precious revenue in the short-term. This was mitigated by growth in other application software.

Growth was strong across all key services categories, with more than double-digit results in field solutions, managed solutions, configurations and warranties. One of the key drivers of our ability to deliver these solid results is the investments we have made in our technical resources.

I mentioned earlier that we added nearly 120 customer-facing coworkers in 2013, with the majority technical pre- and post sales positions. With those additions, we ended the year with more than 800 service delivery coworkers, and nearly 800 technical specialists, who are valuable resources that enhance our ability to provide today's complex integrated solutions, while strengthening our value proposition to our partners. Today, we have five solution practice areas, converged infrastructure, which includes security, unified communications and network communications, software, cloud which includes our infrastructure-as-a-service, software-as-a-service, and platform-as-a-service offerings. Systems solutions, which includes server storage and power and cooling, and our services practice, which includes field services, managed services, configurations, warranties, and third-party services.

To meet the growing demand from our customers to deliver these solutions, we have been both deepening our service capabilities and expanding our geographic footprint. Today we have technical specialists, service delivery and sales coworkers in 24 markets across the country. They are supported by a national traveling team, and a national network of partnerships with OEMs and local service providers to ensure we cover the entire US. We intend to continue to enhance our footprint, and plan to add between one and three new locations annually. These service capabilities help us deliver complex integrated solutions.

When you couple our ability to deliver services with our experienced sellers and a highly-skilled technical specialist, you have a powerful combination. Our sellers develop and manage the customer relationships, identify the opportunities, and bring to bear the right combination of products and services to solve the customer problem. Our specialists work with our customers and partners to whiteboard the design, create a bill of materials for products and services required, and draft the statement of work for services. And our professional services and service delivery engineers, install and maintain the solution.

Let me share a couple examples that demonstrate the power of this combination. As I describe them, you will see how both pre- and post sales technical resources enable our solutions success.

A healthcare organization that operates more than 50 hospitals and more than 500 clinics across the country, wanted to deploy a fully integrated and turnkey approach to providing wireless LANs across several of the facilities they support in 2013 and 2014. Our solution architects designed a phased approach to roll out a standardized wireless infrastructure including access point controllers and switching. But the solution also required professional services, including site surveys, deployment and project management, all of which we provided via CDW Advanced Technology services.

The first phase of the project launched in late Q3, with total hardware revenue of more than $4 million. The second phase closed in Q4 with another $2.9 million in hardware revenue. In addition to this $7 million in hardware revenue, over the last four months of the year, professional services tied to both phases wound up bringing in an additional $300,000 to $500,000 in revenues, and the survey work in deployments that were needed. While the hardware revenues are important, without our ability to perform the professional services required, we would not have been able to deliver the fully-integrated solution the customer wanted.

Here is another example that began its implementation in December. A financial services company wants to enhance customer experience through a next-generation branch banking platform, without congesting their current network. We developed a solution that spans several product and service categories from our broad portfolio. Our solution includes network equipment for each of their locations, and a way to keep end user traffic off the corporate network, and it is a turnkey for the customer.

We do that by configuring the network equipment in our configuration center, and shipping it directly to the customer field location, where our engineers install the equipment. Once installed, the equipment self-registers with CDW's cloud-based management system, where we complete the final configuration and deploy security applications to the equipment. Then the network is added to CDW's 24 by 7 by 365 monitoring and management infrastructure, with a 99.9% up-time service level agreement, a complete end-to-end solution. The customer went live with their first branch in December, and plans call for deploying the solution to most of their more than 3,000 locations over the next 24 months.

Hardware revenues and installation fees run about $1,000 per location, and recurring revenues approximately $300 a month. This is a phased multi-year roll-out but once complete, we anticipate billing more than $10 million a year on a recurring basis. What is great about this solution is that our client both builds their business by retaining and attracting new clients, and lowers the cost of servicing them.

Let me close with a few thoughts about 2014. We currently expect the US IT growth in 2014 to be about 3% or 4%. Recent history has certainly proven that expectations for market growth evolve as the year progresses. While expected market growth may change as we move through the year, our target for top line growth will remain the same, profitably outpace the market by 200 to 300 basis points. We will do that by continuing to execute on our strategic priorities, and leverage the power of our diversified portfolio of channels, partners and products.

We will continue to drive growth in our core business. One key way is through our market segmentation. In fact, due to the success of our finance and legal verticals, we pulled them out of their small business incubator and move them into the MedLar segment to take advantage of their infrastructure. We will also continue to make disciplined investments, building out our solutions capability, with continued focus on enhancing our service capabilities as well as enhancing our cloud, mobility, collaboration and security solutions.

To do this, we are currently planning to add between 150 and 200 new customer-facing coworkers, and similar to 2013, we will add both technical resources and sellers. Of course, as always, we will monitor market conditions to ensure we are investing at the appropriate level, for the current as well as future demand. Investing in our future enables us to ensure we continue to meet the evolving needs of our customers, and become an even more important partner. And just as it has in the past, it will help us to continue to grow faster than the market, while generating superior returns today and in the future.

Now let me turn the call over to Ann. Ann?

Thanks, Tom. Good morning, everyone.

As Tom indicated, Q4 and full-year financial results reflect the benefit of our balanced portfolio, our focus on execution, and our strategic process. They also reflect continued progress we are making against our financial strategy to drive strong cash flow, delever our balance sheet, and deliver mid teens earnings growth.

Let me begin with our P&L. If you have access to the slides posted online, it will be helpful to follow along. I am on slide 7.

Top line growth was solid this quarter, with net sales of $2.713 billion, 4.3% higher than last year on both a reported and average daily sales basis, as we had the same number of the selling days in both quarters. Average daily sales grew to $43.1 million. Q4 was down sequentially 3.8% versus Q3 2013, a bit below our normal seasonality due to federal channel performance. Gross profit for quarter increased 5.4% to $448.3 million. Gross margin was 10 basis points higher than last year, and 50 basis points higher than Q3.

As expected, product margin pressure in transactional products continued in the quarter. This was more than offset by a higher contribution from net service contract revenues which are booked at 100% gross margin. And higher volume incentive rebates reflecting our success in attaining partner-aligned growth goals for certain transactional products and warranties.

Reported SG&A including advertising expense was $306.3 million, up 3.9%. Advertising expense was up $2.6 million in the quarter, as we put more dollars to work to build our brand. This year we continued to highlight our People Who Get IT campaign with Gordon & Taylor featuring Charles Barkley, and we had some of the highest NFL viewership since the People Who Get IT campaign began.

Lower non-cash equity compensation and lower historical retention costs offset nearly half of the increased -- the increase in reported SG&A including advertising. Our adjusted SG&A was $248.1 million, up 7.3% versus last year. As you can see on slide 8, adjusted SG&A for the quarter excluded non-cash equity compensation of $2.2 million, litigation of $4.1 million, secondary offering expenses of $700,000, depreciation and amortization of $51.3 million, and other miscellaneous costs.

As I mentioned it would on our third quarter conference call, our Q4 adjusted SG&A increased at a rate higher than net sales, reflecting higher sales commissions and other variable compensation costs consistent with increased sales and gross profits, as well as the planned investment in coworker count and advertising we shared with you last quarter. One of the reasons we provide our adjusted SG&A to you, is so you can more easily understand our adjusted EBITDA, which you can essentially calculate by taking our gross profit and subtracting our adjusted SG&A.

We ended the quarter with 6,967 coworkers, up 163 coworkers since the beginning of the year. We continue to drive sales productivity with annualized sales per coworker of $1.56 million, up 4.6% over 2012. As you can see on the next slide, adjusted SG&A -- adjusted EBITDA came in for the quarter at $201.2 million, up 3.2%. We delivered an adjusted EBITDA margin of 7.4%, down just 10 basis points from last year.

Looking at the rest of the P&L on slide 10, interest expense for the quarter was 31% lower than last year at $51.5 million, and included a reduction of $2.1 million related to interest equalization from the redemption of $155 million of our 12.535% senior subordinated notes in the quarter. During the quarter, our tax rate was 27.5% versus 30.8% in the fourth quarter of 2012. Our book tax rate for the quarter was below our year-to-date rate, as we booked approximately $7 million of non-recurring tax benefit, most of which are related to deferred state income taxes.

On a GAAP basis, we earned net income of $60 million dollars in the quarter. Looking at non-GAAP net income, which better reflects our operating performance, we earned $93.6 million in the quarter, up 43.5% over last year.

As you can see on slide 11, non-GAAP net income reflects after-tax add backs that fall into four general buckets. The ongoing amortization of intangibles from our going private transaction, any nonrecurring costs related to financings including debt extinguishment and interest equalization, ongoing non-cash equity compensation, and other one-time non-recurring income or expenses, which for this quarter included secondary offering expenses and litigation costs. These adjustments are tax-effected at a normalized effective tax rate of 39%. With Q4 non-GAAP fully diluted average shares outstanding of 172.1 million, we delivered $0.54 of non-GAAP net income per share, up 43%.

Quickly turning to full-year results, revenue was $10.8 billion, an increase of 6.3% both on a reported and average daily sales basis. Gross profit for the year was $1.76 billion, up 5.4%. Gross profit margin was 16.3% versus 16.5% last year.

SG&A including advertising was $1.25 billion, up 8% reflecting one-time IPO and secondary offering related expenses, non-cash equity and retention compensation, and other one-time item. Adjusted SG&A was $955.5 million, up 5.4%, again reflecting higher compensation costs related to increased sales and gross profit, and our investment in additional coworkers. Adjusted EBITDA for the year was up 5.5% to $808.5 million, and our adjusted EBITDA margin was 7.5% versus 7.6% last year. Our effective tax rate was 32.1% in 2013, compared to 36.1% in 2012. Net income was $132.8 million for the year, compared to $119 million in 2012.

Non-GAAP net income was $314.3 million, up 27.2% over last year, and non-GAAP net income per share per share was up 27% at $1.83 per share. As I mentioned earlier, during the quarter we continued to enhance our balance sheet, redeeming an additional $155 million of our senior sub notes. After the October redemption, there was $92.5 million remaining of these notes We redeemed $30 million of this on January 22, and we will redeem another $20 million on February 21. We currently expect to redeem the remaining $42.5 million in the next six months.

On December 31, we had $188 million of cash and cash equivalents, including monies pending for the January 22 and February 21 redemptions. We had $3.06 billion of debt net of this cash on the books, $670 million less than our December 31, 2012 balance. Our cash plus revolver availability was $829 million.

Net debt to trailing 12 month EBITDA at the end of 2013 was 3.8 times, representing a deleveraging of 1.1 turns, compared to our 4.9 times ratio at the end of 2012. On a pro forma basis for the two redemptions in the first quarter of 2014, our weighted average interest rate on our outstanding debt is 6%.

In this potentially essentially increasing interest rate environment, I would like to remind you that our $1.53 billion term loan facility is subject to a 1% LIBOR floor. And we have in place 1.5 -- $1.15 billion principal amount of cash at a weighted average rate of 2.4%. These caps expire in Q1 of 2015.

Pro forma for this quarter's redemptions, 88% of our outstanding debt is effectively fixed or hedged, and rates would have to move significantly before they had a material impact on our interest costs. Free cash flow for the year, which we calculate as operating cash flow plus the net change in our flooring agreement less capital expenditures was $327 million, compared to $246 million in 2012. For 2013, our free cash flow reflects the benefit of lower cash taxes, primarily due to deductions related to the IPO and refinancing related expenses.

Our ability to drive returns in this business is tied to our working capital management. As I mentioned on last quarter's call, our normal seasonality results in an uptick in our cash conversion cycle in the fourth quarter. That said, in the fourth quarter we continue to deliver strong working capital metrics. The details by component are provided on slide 15.

Using a rolling three month calculation, our cash conversion cycle was at 24 days for the quarter, on par with last year. We expect to continue to maintain our cash conversion cycle within our target range of the low to mid 20s in -- in 2014.

Turning to 2014, as Tom mentioned, our for our top line we continue to target growth 200 to 300 basis points faster than the US IT market. We also continue to target three key medium term financial measures, adjusted EBITDA margin in the mid 7% range, mid teens non-GAAP earnings growth per share which we expect to exceed again this year, likely hitting high teens, and deleveraging 1/3 to 1/2 turn per year until we hit our target leverage of 3 times. Keep in mind, that we view the medium-term as the next two years, and we hold ourselves accountable for delivering these targets on an annual basis, not quarterly.

Let me provide you with a few additional comments for those modeling our 2014 financials. The move of our financial services and legal verticals from small business into MedLar results in a move of approximately $150 million of annual 2013 net sales from small business into MedLar. Our book and cash interest expense are both expected to be approximately $200 million in 2014, and we expect our 2014 book tax rate to be higher than 2013 in the 37% to 38% range. For share count, we expect fully diluted shares to be just shy of 173 million.

When modeling our quarterly results, keep in mind that our first quarter sales are typically sequentially below our fourth quarter, so SG&A as a percentage of sales is typically higher. Also we will be lapping a very strong Q1 2013 gross margin percentage at 16.7%. So although we expect to be in our target range for full-year EBITDA adjusted -- adjusted EBITDA margin in the mid 7%, we anticipate that Q1 results will fall below the low end of that range.

Another thing to keep in mind as you model our quarters is the phasing of our book taxes this year, and their impact on our year-over-year EPS growth. Given the overlap of the 27.5% tax rate we had in Q4 of 2013, you should expect 2014 non-GAAP net income growth to be stronger in the first three quarters of the year.

Finally, a few notes for those of you modeling cash flows. Our capital expenditures tend to run 0.5% of net sales. For cash taxes, you should note that this year we begin paying taxes on the cancellation of indebtedness income that we incurred in 2009, and were able to defer to 2014 through 2018. This will result in incremental cash taxes of approximately $21 million to $22 million per year for the next five years.

For 2014, that will be on top of our marginal cash tax rate of 39%. Remember to apply this rate to pretax book income before acquisition-related intangibles amortization which is approximately $40 million for quarter. And remember, cash tax payments tend to fluctuate throughout the year, with lowest in Q1 and highest in Q2 as we pay estimated taxes for both Q1 and Q2 in the second quarter.

One final note. Returning cash to shareholders is an import component of our commitment to build develop shareholder value. And I am delighted to report that our Board of Directors declared our second quarterly cash dividend since our return to the public market.

We will pay a dividend of $0.0425 per share on March 10 to shareholders of record February 25. We intend to revisit our dividend policy annually, and once we achieve our current target leverage ratio of 3 times, we will look at our overall strategy to return cash to shareholders, which depending on tax policy and interest rates at that time could include share repurchases.

That concludes the financial summary. 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 follow-up? Operator, please provide the instructions for asking a question?

(Operator instructions)

Our first question comes from Bill Shope of Goldman Sachs. Please go ahead.

Thank you. It is nice to see the healthcare segment starting to bounce back. As you look at 2014, would you say we are on pace for a potential steady recovery here, or should we expect this to be just a bit choppy, particularly given this quarter's strength was driven by budget flush?

Hello, Bill. Thank you for the question. I think the general saying, of one quarter does not a trend make, is probably appropriate here.

We were encouraged by the improvement, but I think until we get a couple of quarters under our belt, we are going to continue to think about it the way you described. But there was some encouraging signs during the last quarter of the year.

And then on the gross margin side of the equation, a similar type of question, you had I would say, better than expected performance there relative to most expectations. How should we think about the sustainability of this, and if you could just give us a little bit more detail on the drivers for this next quarter, and how we think about those drivers on a quarterly basis going forward?

Yes. Well, first, if you remember last quarter, when we had some questions about gross margin pressure I said, one of the things that our us feel good about is when I can point to exactly what drives a particular result. And last quarter, we had a significant sale of Chromebooks and we saw some pricing pressure.

In this quarter, we have been, as I articulated, investing in our services business, trying to grow our services revenue, and we saw a really strong performance in some of our warranty strategies and those services revenue. Now we hope they will continue, but there is other factors that contribute to the gross margin, like if we see -- we continue to see pricing pressure in the marketplace, and that continues to put pricing pressure on transactional products.

So I think, we have kind of said that we are going to continue to focus on EBITDA -- excuse me -- and I think you should continue to see us kind of staying in that range we have been for gross profit. But it is going to bounce around. As Ann likes to remind everybody all the time, that there are lot of exogenous factors that can influence that.

Yes, the other thing I would just remind you, we are going to overlap 16.7% gross margin in Q1. So you need to keep that in mind.

Okay, great. Thank you.

Thanks, Bill.

Our next question comes from Ben Reitzes of Barclays. Please go ahead.

Hi. Thanks. This is actually Ryan in for Ben. I just wanted ask you quickly on the PC market. I mean, you have had some good results now, and you noted healthcare and education were two areas where that product is seeing success.

Can you talk about how you see this market unfolding over the course of the year? And when we start to get near the point where support is ended for Windows XP, do you -- how do you think about the deceleration or the market after that point?

Well, Ryan, I think we have talked about this on a number of calls, that because of our B2B focus, we continue to see positive growth in the PC marketplace. There isn't a single driver. I know people ask, is it the introduction or the end of XP support or the introduction of 8?

I think what you have seen in our performance is, we have seen segments that continue to see and look at PCs from the value they create in the business. And so, we are expecting that to continue, I think is a fair way to say it. We're not seeing a tremendous amount of success driven just by XP, and people trying to address that. So as we look out onto 2014, we would expect it to continue to perform the way it has in 2013 for next year.

Okay. And then turning to the education market, you have really had I think, three really outstanding quarters in that vertical. And how sustainable is that, as we go through the year? I mean, you start to lap some more difficult persons by the second quarter. So could you just give us some parameters, and how we should think about growth in that business for 2014?

Well, as you know, we don't provide any kind of guidance for the channels if you will, but I think your instinct are accurate. We are going to lap some pretty amazing growth, as we get into the latter part of the year. I will tell you though, that we are making additional investments in that segment. So that tells you that we believe there is incremental opportunity.

One of the things we are seeing play out, just as we had hoped, is those Chromebooks, when they get inside of a school district, create incremental opportunities for network management, and some of the services that Bill kind of asked about, when it comes to the kind of things that enhance gross margins. So we remained pretty -- I don't know the right word is aggressive or favorably disposed to growth in that particular segment. But they are going to jump some pretty amazing comps as we get into the year.

Thanks. Congratulations on the quarter.

Thanks, Ryan.

Our next question comes from Brian Alexander of Raymond James. Please go ahead.

Yes. Tom, you announced an interesting partnership with Google this week. I was hoping you could expand on the scope of the relationship, reselling versus services implementation, the motivation for partnering more deeply with Google, and if there is any offsets with other major software partners that we should consider as you grow this business?

Okay. So there was a lot of that one question, Brian. Let me take them, I hope, one at a time. Let me answer the last first.

Look, this isn't about us doing anything other than finding a particular partner that had opportunity in the marketplace, and us building off of the success we had with the Chromebooks. I don't think it has going to have any impact on other partners. In fact, as it was I think reported in some places, it had nothing to do with our partnership with other people.

We are excited about our partners, and I think the strategy some of our other partners are deploying about pushing people like CDW to the cloud is absolutely the right thing to do. We have been planning for it, investing for it, and feel really good about it.

The actual relationship is, customers are looking for us to represent and include in our recommendations to help them, reselling some of those apps as a software-as-a-service. And as, I think we have talked about a lot, especially on the IPO roadshow, when a customer is moving to cloud-based solutions, there is an integration and aggregation opportunity that exists, as it gets built into their IT infrastructure.

I think as we have talked about, Brian, that takes some services skills sets. We don't have those today, resident, in a meaningful way to scale, so we are going to use partnerships to get there. But just as we have done in other parts of our service business, as we build momentum and we build density, then we are going to look to add that to our service portfolio.

But we are absolutely excited about that partnership. But it is not at the expense of other partnerships. Trust me.

Yes. No, I appreciate that. And just to follow-up on the services strategy. I know you are taking a methodical approach to building out your services footprint. I think you said on the call, one to three locations per year.

If you look out over the next few years, let's say three or four years, how should we be thinking about the services contribution to your gross profit dollars versus where we are today? How meaningful is this opportunity for CDW?

We think it's -- look, I am not going to put a number on 3 to 4 years out, but I will just say this, Brian, we think it is extremely meaningful. If you look at the change in the IT consumption model, if you think about the examples that I talked about in my formal comments, the ability for CDW to have a full suite of services capability -- and I mean the full suite, not just professional services, but managed services, configuration services warranty services -- really has a powerful impact on our ability to win additional business. And, as you I think allude to, services businesses have rich margins.

And part of our strategy has always been to enhance that part of our business, so that we are growing a part of our business rich in margins, to offset the normal commoditization that sometimes happens in a transaction part of the business. So I think you can look for us to continue to invest, and I think you can look for us to continue to grow, and I think you can look for us to continue to expand the locations.

Great Thanks a lot.

Thanks, Brian.

Our next question comes from Rich Kugele of Needham.

Good morning, RIch.

Good morning, Tom and Ann. So quickly, I just wanted to dive a little deeper now that Washington has historically -- returned to somewhat normalcy if you think that these sales could pick up this quarter, over the next couple quarters -- what your salesforce is saying, there could be on the pent-up demand side? And then, I have got a follow-up.

Okay. Yes, I don't know if I am going to comment on the normalcy comment. I will just say that we are excited about some of the clarity that has come to the forefront here. And I -- look, we are hopeful, and I think if you talk to our sellers, they would say encouraged by just having some clarity.

Clarity around budgets, clarity around the debt ceiling kind of going away for a negotiating item. And now we are just kind of working through the process, where, now that the budgets are settled, you have to get to the allocations. But I would say, the activity level has improved, and we feel good about that.

I don't know that we are far enough into it yet for me to kind of predict when will get back to a normal rhythm. But I would tell you we are encouraged at least at this point on the activity level.

Okay. And then just lastly, on the moving of the legal and other segments into MedLar. That is an interesting move. I am just interested, which aspects of the MedLar group do you think can drive that? Obviously, you must be thinking that there is a stronger revenue opportunity for those segments. If you could just expand on that a little bit?

Yes, we are not going to fold them in under any of the existing MedLar group. They will actually report directly to Chris Corley. But they have been performing at a rate -- as I think I have said on the previous calls, that once they demonstrate a sustainable performance that is kind of in excess of the peer group, then we are going to move them to MedLar, because of the resources that are available, be they service resources, be they technical resources. And it also then gives us the ability to kind of move and be consistent with customer size.

And so, we are kind of excited of this moved from the incubator -- I don't know if the term is going to be -- but they are just now going to be moved into a more sizable organization with more infrastructure.

Okay, great, and good job on the quarter. Thank you.

Thank you very much.

Our next question comes from Katy Huberty of Morgan Stanley. Please go ahead.

Thanks. Good morning. I don't think I heard you comment on the swords and server segments. And NetApp last night talked about cloud, perhaps starting to have an impact, at least in delaying deals and large companies sweating assets. So curious if you are seeing that trend.

And then, as my follow-up, a number of big companies that are your partners, have guided to a sub seasonal first-quarter, and they are telling us that the month of January has come in weaker than expected. And so, I know you don't give specific quarterly guidance, I was just wondering if you have any qualitative commentary around the first quarter versus what the normal trends would be in a 1Q? Thanks.

Okay. So let me -- on the first part Katy, our cloud business has been growing pretty impressively, although it is still relatively as you know, compared to the size of CDW -- pardon me, a pretty small number. We are seeing growth in infrastructure-as-a-service, which is really where you see both the compute and storage play out. But I don't know that I would draw a correlation yet to it having an impact on server and storage revenues.

And the reason I say that, is because so much of our storage and server revenues in these last two quarters have been impacted by the federal segment, and what is going on in the federal segment. And as you know, every product category has typically been down.

So I guess, what I would -- I think I would confirm on a positive note, the growth we are seeing in cloud computing, coming in infrastucture-as-a-service as well as software-as-a-service, I don't think I am quite there yet to draw the correlation between what we are seeing in some of the revenues and storage and servers in the quarter. Okay?

Okay.

The second one is, I think for us the first quarter is going to be interesting, because we have never come through a fourth-quarter, where we had the federal government shutdown. And so, while I would call the fourth quarter not normal, it will be interesting to see how the first quarter plays out.

I think Ann alludes to in her comments, that the first quarter for us is generally a slower quarter sales-wise than the fourth quarter. And I think that is our assumption, but I would tell you that I think the real wildcard is, do we begin to see some of the federal stuff return, and how might that impact us.

I can't comment on January obviously, about how it turned out, but qualitatively, it came -- it felt -- the year is starting the way we kind of assumed it would start. So it feels at least normal to us so far.

And Katy, I would say our deviation from normal seasonality had -- has been driven by our federal channel. Right? So as we move through the second half of the year, that is what caused our normal seasonality to deviate a little bit. And so, that still remains a little bit of a wildcard for us, the federal channel.

Okay. Thank you very much.

All right. Thanks, Katy.

(Operator instructions)

And our next question comes from Jayson Noland of Robert Baird. Please go ahead.

Great. Thank you. I wanted to ask about MedLar and small business. MedLar really strong last year, [Cal 13] up 10% year-on-year, small business down slightly. Should we expect to see more balanced growth across corporate in 2014?

I think you got to keep those separate, Jayson. I am continued -- continue to be encouraged by the performance in our MedLar segment. We have had strong growth for a number of quarters now. And so, I am not anticipating any backing off of that strong growth.

And I would say, in small business, it is the second quarter of some positive numbers, and so I am hopeful that that will continue. I think we have gone through some periods of market dynamics relative to customer confidence We have also been making some changes in how we think about and go to market with small business that I think are starting to stabilize our performance.

So I would say, that I am hopeful that what you are seeing in small business is going to continue going forward. But I will say this, as you guys know, the big caveat around that is kind of the general economy and the customer confidence level, that kind of overhangs probably that segment as much as anyone.

Okay. Thanks, Tom. And as a follow-up, we are hearing more about Dell in the field pushing into the channel, pushing a couple hundred thousand accounts into the channel. Do you expect your relationship with Dell to change at all, given their moves in the field?

Well, look, we don't comment on specific -- or excuse me, particular OEMs. We continue to be kind of focused on customers, and we are not at this point in a position to comment one way or the other if -- we will see how things play out here.

I think you got to let some time and some water go under the bridge here, after a company goes private. We know that from first-hand experience, so we will just kind of see what happens here on out.

Thanks, Tom.

Our next question comes from Mark Moskowitz of JPMorgan. Please go ahead.

Hello, Mark.

I wanted to follow-up on the average daily sales growth profile, so that is a metric you have talked about in the past as an important barometer. It did decelerate to about 4.3%. I wonder if you could kind of tease out the government impact, what would the average daily sales growth be, if you kind of teased out the government for the fourth quarter?

And then, for my follow-up question I am going to just throw out now, is as we think about the March quarter, Q1 here, how should we think about the average daily sales growth at the consolidated level all-in? Is it going to be around 4% again, or is it going to be closer to 5% or 6%? Thank you.

All right. So the first one, you I think, Mark probably do the math -- back of the envelope, it would have been pretty meaningful growth, absent federal, it would have been in the high-single digits for the quarter and the year. So that is -- if you can sense a tone of excitement or confidence on my part, it is because of that performance.

And on the second one, look, we are going to kind of stick to our 200 to 300 basis points above the IT market. And if the IT market grows 3% to 4% like it is forecasted, that pretty much tell us you how we think about the whole year. I don't know that we have that kind of clairvoyance, and want to get into the particularly quarterly discussions about what we think is going to happen.

Okay. Thank you.

Thanks, Mark.

Our next question comes from Arun Seshadri from Credit Suisse. Please go ahead. Please go ahead.

Hello, Bill and Ann. Thanks for taking my questions. First I just wanted to ask, versus expeditions going into the quarter, the corporate budget flush, how was it in the fourth quarter?

I would say, if I could, Arun, average, I wouldn't say it was, like a -- kind of felt kind of normal, again, just talking about corporate.

Okay. That's helpful. And then as far as federal being a percent of revenue, can you give us any sort of for Q4 how much was federal as a percent of revenue?

Now we don't break it down by that, but it is an important aspect of our business. As you can see on the slides how big government is as a percent of the business. You get a sense that federal government is generally somewhere between 7% to 10% of our business.

Okay. I appreciate that. And one last question for Ann. I think, Ann, in your prepared commentary, you said -- you referred to current leverage target of 3 times. Any -- maybe I was reading too much into the inflection there, but any sort of thoughts around changing that leverage target? Thank you.

No, we have indicated before one of our key medium-term targets is to delever 1/2 to 1/3 turn per year. And we have indicated that we will stick with that until we get to 3 times leverage. At which point, we will revisit whether that is an appropriate leverage target going forward. It would be depend interest rates at the time, and at that point decide whether it is appropriate to stay there or go down further, and at the same time potentially begin stock buyback.

So no change from prior quarters. Okay. Thank you very much.

No change.

And I see no further questions at this time.

Okay. Just two thoughts in closing. One, as always, thank you. Thanks for your questions, thanks for your interest.

If your company needs help, I can't imagine why you wouldn't talk to CDW. And the last is happy Valentine's Day to all you sweethearts out there. (Laughter). Thanks, everybody. See you.

Ladies and gentlemen, this does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone have a great day.