CDW Corp (CDW) 2015 Q1 法說會逐字稿

Good morning, my name is Sade and I will be your conference operator for today's call. At this time I would like to welcome everyone to the CDW 2015 first-quarter 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, Sade. Good morning, everyone, it is a pleasure to be with you today and to report on our first-quarter results. Joining me on the call today are Ann Ziegler, our Chief Financial Officer; Chris Leahy, our General Counsel; and Sari Macrie, our Vice President Investor Relations.

I will begin today's call with a brief overview of our results and key drivers, Ann will run through the financials and then we will go right to your questions. But before we begin Sari will provide a few important comments regarding what we will share with you today.

Thanks, Tom, good morning, everyone. Our first-quarter 2015 earnings and dividend releases were distributed this morning and are 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 comments made in this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially.

Additional information regarding these concerns -- these risks and uncertainties are contained in a Form 8-K we furnished to the SEC today and in the Company's other filings with the SEC. CDW assumes no obligation to update the information presented during this webcast.

Our presentation also includes certain non-GAAP financial measures including non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You will find reconciliation charts in the slides for today's webcast as well as in our press release and the Form 8-K we furnished to the SEC today.

Please note that all references to growth rates, or dollar amount increases in our remarks today, are versus the comparable period in 2014. The number of selling days for the first quarter are the same for both 2015 and 2014, 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. I also want to remind you 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.

Thank you, Sari. We had a good start to the year as we successfully addressed transitioning customer priorities and leveraged the strength of our business model to deliver excellent profitability on solid top-line growth.

Net sales were $2.76 billion, up 3.9% above last year, 4.5% when adjusted for the impact of currency translation. We delivered adjusted EBITDA growth of 8.8% and non-GAAP EPS growth of 19.5%. These results reflect the impact of three key drivers: our balanced portfolio of channels; our broad product and solution suite; and the impact of mix on our profitability.

The first driver of our results, our balanced portfolio of sales channels, helped us offset the impact of changes in some of our customers' focus and priorities. Corporate performance of 4.5% growth reflected the benefit of our channel balance.

MedLar grew 3.1% as customers pivoted from last year's focus on client devices toward data center and other integrated solutions. MedLar solutions increased in mid-single-digits while transactional sales declined low-single-digits.

Small business performance was more balance between solutions and transactions with excellent growth across the board of 12.7%. Balance also contributed to public performance which was up 3.7% as government and education helped offset a 5% decline in healthcare.

Healthcare results reflect the lumpiness we discussed last quarter as a handful of our largest customers shifted their focus to reducing costs as part of merger consolidations. We also saw a continuation of budget compression given the ongoing reimbursement pressure.

Government results were excellent, up 13.5%, reflecting the overlap of last year's decline in federal and solid state and local performance.

Education increased 6.8% reflecting high teens growth in higher ed and low-single-digit growth in K-12. As expected K-12 buying activity slowed in the quarter as school districts shifted focus to spring Common Core testing as well as completing E-Rate funds applications. Higher ed delivered excellent increases as we helped campuses across the country meet increasing demands for wireless.

ATS increased low-double-digits driven by increases in managed services like remote network monitoring and field services. While Canada showed continued momentum in local currency, growing high-single-digits in Canadian dollars, given currency impact Canadian results were down mid-single-digits in US dollars resulting in our other results line declining just under 1%.

The second driver of results was our broad product and solution suite backed by deep technical resources which helps us make sure our customer priorities are CDW's priorities. This quarter customer focus shifted from desktop refresh towards integrated solutions. Our solutions business grew more than 50% faster than transactional business.

While the sales cycle is longer for solutions, solution sales take us deeper into our customers' IT infrastructure. This leads to richer relationships and stickier customers.

On a net sales basis hardware was up 4.3% and services increased 12.1% while software was essentially flat. Excellent low-double-digit increases in notebook and mobile devices were partially offset by a fairly sharp decline in desktops as customers' XP refresh waned. Overall, client devices increase low-single-digits.

On the solution side we saw continued momentum in servers, which improved for the fifth quarter in a row, up low-double-digits as customers continue to refresh compute as the end of Win 2003 nears as well as meet their overall need for compute capabilities.

Overall storage was down low-single-digits as rapid growth in several emerging technology solutions, including flash, was more than offset by a fairly steep decline in solutions from one major partner. In fact, all of our top storage partners had increases in the quarter except one; networking also had solid mid-single-digit growth.

Our ability to meet both transactional and integrated solution needs of our customers is one of the fundamental reasons for our consistent performance. And that is why we are laser focused on making sure we have the right product portfolio backed by extensive technical resources. This is a key point of differentiation for us in the marketplace.

Let me share a couple of recent examples that demonstrate how this works. As you know, security is an increasingly important area for our customers. In fact, security was a bright spot in our solutions practice this quarter with security hardware, software and service revenues up more than 30%.

Our expertise in this area was a key reason why we won a fairly complex project for a major beverage company. The company wanted to replace an outdated wireless infrastructure with a scalable solution that would provide robust security and visibility. That required the ability to provide levels of differentiated network access for authorized assets, nonstandard and guest assets. Convenience and flexibility to provide secure access for guests were also a key requirement.

Finally, given the complexity of solution, the customer wanted turnkey project management expertise. By bringing in solution architects from our security, wireless and mobility practices, as well as project management we won the more than $3 million project.

Another example of the value of our broad technical expertise is a data center solution we architected for a transportation company in the Southeast. This example also highlights how long the sales cycle can be for more complex sales.

We first met with the prospect in late summer 2014. It was a fairly significant engagement so there was heavy competition. It took five months to close the deal, but when we did we became the customer's single source provider for an integrated solution that captured approximately $5 million in revenues across networking, security server, storage, virtualization and services from three different vendor partners and our own CDW services team.

That was just one engagement that helped drive our overall services growth of 12% in the quarter. Services performance reflected excellent managed and field services growth including the impact from two new markets last year.

On the software side SaaS growth continued robust. Although SaaS sales were up meaningfully in the quarter given sales are recorded net, they also compressed top-line growth. The impact of SaaS combined with lower growth in certain license products resulted in total software sales essentially flat for the quarter. But once again, gross profit from software increased at a faster rate than sales contributing to our overall gross margin improvement.

And that leads us to the final driver of our results this quarter, the impact of mix on our profitability. An essential element of our long-term success has been our ability to consistently deliver profitable growth. This quarter's results provide an excellent example of how the mix of our business influences our ability to achieve this goal.

The combination of improved profitability in notebooks with higher contribution from 100% gross margin revenues, which we call net service contract revenue, or NSCR, helped us achieve a gross profit margin of 16.6% in the quarter, the highest level in seven quarters. Net service contract revenue includes hardware warranty, software maintenance, third-party delivered service and software as a service.

What all of these have in common is that while we have the customer relationship and sell the solution, it is delivered by one of our vendor or third-party partners, so we book the revenues net without a cost of goods sold attached. Since it is booked net, NSCR is 100% gross margin.

As you know, we have made significant investments in our cloud practice to ensure we have the broadest portfolio of SaaS, IAS and platform as a service. So for us cloud is not only a great growth opportunity and one that ensures we stay relevant to our customers, it enhances our profit mix.

We have also been making investments to capture more margin rich net service contract revenue from warranties and assurance, including our 2013 investment in a team of coworkers focused 100% on hardware warranties. The team is tasked with improving both attach and renewal rates for hardware warranties from a specific partner. Over the past 12 months that team helped generate 50% more gross profit than was produced the year before the investment was made.

Delivering long-term sustainable profitable growth requires a constant focus on the balance between expense management and investment. The largest investment we make is adding new customer facing coworkers to enhance our capabilities to deliver a broad spectrum of IT solutions that includes cloud, mobility, data center virtualization, collaboration, networking and security, just to name a few.

We began 2015 with more than 140 additional customer facing coworkers than we had at the beginning of 2014. To ensure we effectively utilize capacity from the new hires made last year, we continue the pause we began late last year adding only 15 customer facing coworkers in the quarter.

We intend to continue to invest prudently to ensure we have the capacity to support acceleration in our solution sales. As we shared with you last quarter, we continue to plan for an additional 150 to 200 customer facing coworkers during 2015. But, just as we always do, we will monitor the marketplace and adjust our hiring plans up or down as needed.

And that leads to our expectations for the rest of the year. We look for K-12 to improve as we move through the year now that Common Core testing is complete and E-Rate funds begin to flow. I am very pleased to report that CDW was named as partner in both the highest number of requests and largest dollar amount of requests for all Form 471s filed for E-Rate Category Two services which are for internal network connections.

These are official requests where the applicant identifies the specific products and solutions they will use and names the partner they intend to use. There is no guarantee that these requests will convert to revenue, but we feel good about where we are positioned. Schools should start spending approved funds this summer and the bulk of spending occurring in the fall.

We expect healthcare results will remain lumpy throughout 2015 as our larger customers continue to focus on cost savings and integration from recent mergers and budgets remain under pressure from lower reimbursement. Healthcare remains an important part of our long-term growth strategy as providers look to technology to help them deliver more effective and efficient care.

We expect federal to be a strong contributor to full-year results despite tough comparisons at the end of the year. And in our corporate business we expect MedLar to see benefit from a building pipeline as earlier customer conversations play out and small business to continue to execute well, although we remain watchful for any signs of slowdown due to concerns over economic conditions.

Given these expectations we remain committed to our target of delivering profitable growth in 2015 and the achievement of our medium-term annual target of growing 200 to 300 basis points above the US IT market, holding our margins in the mid-7% range and growing earnings in the mid teens. You may recall that on our last call we indicated we would look for the US IT markets growth in the 3% to 4% range.

Now let me turn it over to Ann who will share more detail on our financial performance. Ann.

Thanks, Tom. Good morning, everyone. As Tom indicated, we had a good start to the year as we successfully addressed transitioning customer priorities and leveraged the strength of our business model to deliver excellent profitability on solid top-line growth.

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. Net sales were $2.76 billion, 3.9% higher than last year. Average daily sales were $43.7 million. On a sequential average daily sales basis sales were down 9.7% versus Q4 2014, below recent Q1 seasonality.

While sales in Canadian dollars are a relatively small portion of our total revenue, less than 5%, the strengthening US dollar impacted consolidated net sales by approximately 60 basis points in the quarter. This compares to a Q4 and full-year 2014 impact of 40 basis points.

Gross profit for the quarter increased 7.4% to $456.5 million. Gross margin in the quarter was 16.6%, 60 basis points above last year. Improvement was primarily the result of four factors.

First, higher product margin which was primarily driven by improved notebook margins reflecting the impact of fewer large low margin refresh projects as well as mix into higher margin notebook.

Second, the positive impact of higher margin advanced technology services which grew faster than overall sales.

And third, the higher mix of net service contract revenues which are booked at 100% gross margin, including roughly 10 basis points from the higher mix of SaaS. Keep in mind that this reflects mix.

Since Q1 product sales and associated margin growth was substantially slower than last year, although net service contract revenue was still relatively small, its year-over-year impact this quarter is magnified as product growth reaccelerates the net service contract revenue mix impact on gross margin will subside.

The last factor that benefited gross margin was the absence of prior year inventory adjustments which added approximately 10 basis points. As you may recall from my comments on last year's first-quarter call, gross margin was negatively impacted by inventory adjustments, which included a reserve for a large shipment that was received by our customer frozen.

While this particular circumstance certainly was unusual, in the normal course of business we have both positive and negative inventory adjustments all the time. Typically they about balance out. But from time to time we have either a more positive are more negative impact like we did this quarter. And by the way, we did receive payment from our insurer for the frozen product late in 2014. So we reversed the reserve in Q4 and gross margin benefited.

Reported SG&A including advertising expense was $304.9 million, 5.3% higher than last year, attributable to a higher coworker count and other coworker-related costs such as health benefits. We ended the quarter with 7,254 coworkers, up 214 coworkers since the end of Q1 2014. Net advertising expense increased by 3% or $0.9 million in the quarter versus last year.

As you can see on the next slide, slide 8, our adjusted SG&A including advertising was $246.8 million, up 6.1% over last year. Adjusted SG&A for the quarter excludes $4.7 million of non-cash equity-based compensation and other adjustments including historical retention costs and costs related to the planned consolidation of our leased offices north of Chicago.

To make it easier to calculate adjusted EBITDA, which is essentially our gross profit less adjusted SG&A expenses, we also adjust for depreciation and amortization.

Slide 9 shows our adjusted EBITDA for the quarter of $210.8 million, up 8.8%. Our adjusted EBITDA margin was 7.7%, up 35 basis points versus last year. Adjusted EBITDA margin was higher than anticipated as we built our plans and managed our cost structure, as we always do, to an expected mix of sales and a normalized gross margin level.

Looking at the rest of the P&L on slide 10, interest expense was 10.7% lower than last year at $44.8 million and we continue to benefit from refinancing activities completed this past year.

Continuing down the P&L, you see our other income net line where we report our Kelway minority interest income. The majority of this line is Kelway, but other income net also includes other de minimis items.

Turning to taxes, our effective tax rate was 37.1% compared to 37% in last year's Q1 which resulted in a tax expense of $32.3 million versus $29.9 million last year. On a GAAP basis we earned $54.7 million of net income.

Our non-GAAP that income, which better reflects our operating performance, was $97.6 million in the quarter, up 20.3% over last year. As you can see on slide 11, non-GAAP net income reflects after-tax add backs that fall in four general buckets: the ongoing amortization of acquisition-related intangibles; any nonrecurring costs related to financing including debt extinguishment; ongoing non-cash equity-based compensation; and other one-time nonrecurring income or expenses. These are adjustments are tax affected at the statutory rate of 39%.

With Q1 weighted average diluted shares outstanding of 173.5 million we delivered $0.56 of non-GAAP net income per share, up 19.5% over the prior year.

Turning to the balance sheet on slide 12, on March 31 we had $447.4 million of cash and cash equivalents and net debt of $2.8 billion, $106.9 million less than a year ago. Net debt to trailing 12-month EBITDA at the end of Q1 was 3.0 times, within our target range.

During the quarter we issued a new $525 million senior note facility at 5% and redeemed all of the outstanding $503.9 million of our 8.5% senior notes. With this new issue our weighted average interest rate on outstanding debt is 4.5%. We did incur an extra $3.6 million of interest on the amount redeemed as the redemption required 30 days notice.

As a reminder, over 96% of our outstanding debt is effectively fixed or hedge as we have $1.4 billion of interest rate caps in place. We believe rates would have to move significantly before they have a material impact on our interest cost.

As you can see on slide 13, we maintained strong rolling three-month working capital during Q1. For the quarter hour cash conversion cycle was 21 days, down one day versus last year's first quarter and at the low end of our target range.

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 $125.4 million compared to $230.6 million in Q1 of 2014. As you recall, our free cash flow was higher than expected in Q4 of last year due to approximately $100 million of one-time items and timing. And just as I indicated on last quarter's call, these items reversed in Q1.

Cash taxes paid in the quarter were $4.3 million and cash interest was $53.1 million, up $37 million over last year reflecting an incremental $20 million associated with the April refinance of our outstanding 8.5% notes and the inclusion of cash interest payments we now make on the 6% notes we issued in 2014 of another $19 million.

Our priorities for uses of cash remain consistent with our capital allocation strategy and will depend on market conditions and opportunities. Our capital allocation strategy is comprised of the following four components which you can see on slide 14.

First, to increase dividends annually with the goal to hit a payout of 30% of free cash flow over the next five years. For Q2 we will pay a dividend of $0.0675 per share on June 10 to shareholders of record May 26, which represents a 59% increase from a year ago.

Second, to ensure we have the right capital structure in place and 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 Q1 at 3.0 times.

Third, to supplement organic growth with tuck-in acquisitions. As a reminder, we structured the Kelway transaction to provide CDW the right but not the obligation to acquire up to 100% ownership in Kelway. The option to purchase a remaining stake in Kelway runs from June 2015 through June 2017.

And fourth, to return excess cash after dividends and M&A to shareholders via share repurchases for which we currently have a $500 million authorization.

As a reminder, we are committed at a minimum to buying back enough shares to offset dilution from our equity plans, which we expect to be roughly 2 million shares this year on a weighted average shares outstanding basis. Now that we have refinanced the remaining 8.5% notes that had tighter restricted payment limitations we have more flexibility to be in the market.

As a reminder, our repurchase authorization is structured to permit us to buy along with any secondaries that our sponsors may do.

Our capital allocation priorities support our medium-term target which you see on slide 15. We continue to target growth of 200 to 300 basis points faster than the US IT market, delivering an adjusted EBITDA margin in the mid-7% range and through 2015 delivering mid-teens non-GAAP earnings per share growth. Our mid-teens EPS target for 2015 includes the benefit of share repurchases and equity investment income from our 35% investment in Kelway.

Now that we have concluded the initial refinancings of our high cost debt we will start to see the absence of earnings amplification from lower interest expense. Starting in 2016 through 2018, our new medium-term targets call for low-double-digit EPS growth. Share repurchases and accretive acquisitions will continue to amplify operating results and help achieve this target.

Keep in mind that we hold ourselves accountable for achieving our current and refreshed medium-term targets on an annual and not a quarterly basis.

Let me provide you with a few additional comments for those of you modeling the rest of our 2015 financials, I am on slide 16. Based on Q1 results and expectations for the rest of the year we continue to expect the balance of sales between first and second half to be generally consistent with normal seasonality, which has averaged in the range of 47% to 48% to 52% to 53% weighted towards the back half of the year.

We expect gross margin percentage to be lighter in the balance of the year without the impact of one-time item and mix benefits, including from net service contract revenue we experienced in Q1. We also expect SG&A to grow faster than sales in Q2 as we continue to invest in our business.

Since we don't build our plans for one time impacts to gross profit margin, which can be both positive and negative, the key to understanding our profitability is to focus on our adjusted EBITDA margin, that is what we do. We manage our costs to normalized sales and leverage our variable cost structure. And for 2015 we continue to target adjusted EBITDA in the mid-7% range.

Reflecting the impact of refinancing the balance of our 8.5% notes due 2019 during the quarter, we expect full-year book interest to now be in the $157 million to $159 million range. For our other income line, although Kelway delivered excellent results in Q1, given the seasonality of their business where our first quarter is their year end and their busiest quarter, we expect lower contribution for the remainder of our year.

We continue to look for our 2015 book tax rate to be in the 37% to 38% range.

Finally, a few notes for those of you modeling cash flow. Our capital expenditures, which tend to run 0.5% of net sales on an annual basis, will be higher in 2015 at approximately 0.7% of net sales as a result of gross capital investments we are making related to consolidating our headquarters and sales locations north of Chicago.

Adjusting for the impact in Q1 of the approximately $100 million that moved to Q4 2014, we continue to expect 2015 free cash flow to be at the high end of our target range of 2.5% to 3% of net sales.

Keep in mind that our second quarter tends to be the lightest cash flow quarter of the year. This reflects both our payment of estimated cash taxes for the first and second quarter and increasing working capital needs to support what is typically our highest quarterly sequential sales increase.

While we have made excellent progress in managing our working capital, we do not expect to sustain our current cash conversion cycle level, while you should look for us to maintain our cycle within our target range of the low to mid 20s for 2015.

For the full year we expect a cash tax rate in the 39% range to be applied to pretax book income before acquisition-related intangibles amortization which is approximately $40 million per quarter. In addition, we continue to pay approximately $20 million in tax annually related to the cancellation of debt income we incurred in 2009.

That concludes the financial summary. 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). Brian Alexander, Raymond James.

Ann and Tom, if I apply normal seasonality for the second quarter, which is typically up I think around mid-teens sequentially, and then use your roughly 48/52 split for first half second half I get roughly $12.5 billion in revenue for 2015, which is up about 3.5% year over year.

So if that math is roughly right, can you just reconcile that with your goal of growing 200 to 300 basis points above the market? And just indicate whether your market assumptions have changed from the 3% to 4% range you gave a quarter ago. Thanks.

Good morning, Brian, it is Tom. So let me answer the last part first. The market assumptions haven't changed. We still think the market is going to be in the 3% to 4%. And as I stated, we are committed to outgrowing the market by 200 to 300 basis points.

I think one of the things that people need to keep in mind is while I think there will be some sense of normal seasonality, the uniqueness of last year, because of the client refresh and the impact on the business, I think will make comparing normal seasonality a little unusual this year just because, as you heard us talk about, the shifting priorities of customers moving from transactional back to solutions.

So -- and also, I alluded to a number of things that I think will accelerate some of our top-line performance, as an example the K-12 organization and the success in E-Rate as we go through the rest of the year.

Okay, all right, thanks. And just the follow-up would be on Kelway. It sounded like you were very pleased with the results in the quarter, but there is maybe some positive seasonality to the business. Just any more color on the operating performance? I know it is early in the relationship but just how is the relationship going relative to your expectations?

Your assessment is accurate, we are pleased, although it is still relatively early in the process, but Kelway continues to perform well. We are very encouraged by, as we get closer and work closer together, about the way we are going to be able to serve multinational customers. And I would tell you that it is going as planned at this point.

Great. Okay, thank you very much.

Sherri Scribner, Deutsche Bank.

Tom, I was hoping to get a little more detail on your thoughts about the PC business. Obviously we had a refresh last year and now we are seeing some weakness on the desktop side. But are you hearing anything from your customers or suppliers about their expectations for the second half of the year?

I would tell you -- I have said this to our team. I think the PC business for us feels like it felt in 2013 and 2012 which, as you know, when I think people were reporting the death of the PC business, for us it continued to be a growth category because of our exclusive focus on B2B. And that is -- it feels like that is where we are again.

If you heard me talk about our notebooks and mobile device growth, that was -- we had a good quarter. I think we are going to work our way through the desktop issue, which really was driven by Windows XP.

So -- and I think I talked about this last quarter. We wouldn't expect to repeat the kind of exponential tailwind we had last year in the client business. Having said that, we still expect the PC business to be a good part of our growth profile for this year.

Okay, great. And then just following up on the previous question, thinking about growth longer-term, as you shift to more of these cloud services businesses and other things that are 100% gross margin, how do you think that affects your long-term growth profile? How much of a percentage of your business is that now and is that a drag for you? Thanks.

It is still a relatively small part when you think of the $12 billion company. But it is an increasing part as customers look to implement what we have said for a while is hybrid solutions to their computing needs so to speak.

I would say, again, I would point back to the profile for this year feels like the profile of 2013 where we had real balance between client devices and solutions and had the kind of growth trajectory that I think we are talking about this year.

I don't envision -- while we had a really strong quarter from a gross profit perspective and both Ann and I alluded to some of the reasons why, at this point I wouldn't say it is so big that it is going to be a meaningful pressure on our top-line growth.

I think the bigger challenge, as many of you pointed out to me in the first quarter, will be just jumping the comps that we had from last year's phenomenal season is part of the challenge this year.

Thank you very much.

Amit Daryanani, RBC Capital Markets.

This is Mitch Steves filling in for Amit here. I just had a quick question in terms of your debt levels. So you guys are already at three times, so does that imply that you guys are going to do some refinancing or keep the debt levels where they are going forward?

Hey, [Ahmad], you know, we've said that our target ratio is about 2.5 to 3 times, we are at 3 times. We have finished the refinancings of all the high cost debt at this point. So I wouldn't expect us to be doing any refinancings over the short- to medium-term. And we do expect to maintain our leverage ratio in the 2.5 to 3 times range.

Got it. And then on the gross margin side, so since you guys are guiding it to essentially decline a little bit, is that going to be more of a mix issue or a revenue deleveraging or how do I think about that for that next call it three quarters?

It is more of a mix issue, as well as I called out in my remarks we did have a one-time item that benefited us in the quarter. So that obviously won't reoccur, in fact it will reverse in the fourth quarter. And then the other items are more attributable to mix.

The mix into net service contract revenue in the quarter, because net service contract revenues grew at a higher rate than products, you don't see that impact on the top line, but you do see it in the gross profit line. And again, as product growth accelerates a bit as we move through the year that mix impact will dissipate.

Got it. Just real quick to clarify, so for the one-time item on the gross margin, what was the impact on the percentage there?

It was 10 basis points.

10 basis points, okay. Thank you.

Tien-tsin Huang, JPMorgan

Just a question on the solutions side. Any comment or callout on average deal size? It sounds like it could be expanding, so just trying to get some color on that.

No, it would be tough to give you the perspective and dimensionalize average deal size. I think you heard me give you a couple of examples in the text about those kind, but not all solutions are that complex and of that magnitude.

I think the best way to think about it is they tend to be more margin rich as we think about the solutions business. I think that played out a little bit this quarter. And will play out as we kind of mix back into a more balanced approach between transactional and solutions.

Got you. And so just to clarify again on that last comment, Tom, have you changed in any way your outlook for the year in terms of transactional versus solutions growth?

Well, I don't think we gave an outlook on transactional versus solutions. When we talk about it we just generally talk about our commitment to outgrow the IT market by 200 to 300 basis points. And I think one of the things Ann just alluded to -- we would expect the hardware business to accelerate a little bit from what we saw in the first quarter. And that will help drive top-line growth. But it also then puts a little more pressure on the margin.

Understood. Thank you. Good work on the margins. Thanks.

Katy Huberty, Morgan Stanley.

In your remarks you mentioned that you are watchful of the impact of economic conditions on the small business segment. I just wonder if you can give some more context given that that segment actually accelerated in terms of growth in the first quarter. So I guess what drove the acceleration in 1Q and why would you be watchful for the remainder of the year?

Thanks, Katy, good morning. A couple things. One, if you think about small business, they started to accelerate the middle of last year and had a strong quarter in the third and fourth quarter; it obviously continued from an execution standpoint.

But the reason I make that comment is because that group, probably sooner than any other group, recognizes anything that we see as kind of an economic shift, whether it is a change in consumption, a reaction to interest rates. And so we probably look at them closer when it comes to what is going on with the economy.

So it was just to kind of keep that out there as we kind of see how the economy plays out for the rest of the year and what happens with, as I said, interest rates and what impact that might have. That is kind of the reference.

Okay. And as you noted, you are happy with the Kelway results. Can you remind us what the factors are that would influence you to potentially hit the option of acquiring the full business earlier in the timeline versus later in the June 15 to June 17 timeline?

Yes, I don't think we laid out a set of factors, Katy, when we talked about the acquisition. Part of the reason we restructured it the way we did was to kind of follow the typical CDW measured and thoughtful approach to looking at something as significant as this type of acquisition.

Like I said, we are pleased with how things have started. It will be a function of how CDW is doing, how we feel about our readiness to do the integration, how Kelway is doing -- all of those things kind of enter into doing one of these type of things successfully. And that is our most important priority.

Okay, got it. Thank you.

Jayson Noland, Robert Baird.

I will ask on data center. Storage was down and it sounds like that was one partner driven. Are you comfortable with how you are positioned broadly going forward in storage?

Yes, really, really comfortable. If you heard the preamble to that, lots of growth in the -- what I will call the newer technologies, disruptive technologies. You heard me mention flash. You also heard me mention that seven out of our eight top partners grew. So feel really good about that.

And I think if you look back -- I was looking at it yesterday at our storage performance, it has been kind of lumpy, it kind of -- we'll have a really good quarter, then we'll have a flat quarter. And I think some of that is just the shifting that is going on at the storage marketplace both with the incumbents and the new entrants.

And as you know, Jayson, we bring on a meaningful number of new partners every year. A lot of those partners have been in the storage space. And so, you have got a little bit of a transformation going on. And then you couple that with the success of converged infrastructure and the impact that has, it is no wonder that it is kind of got this inconsistent behavior at this point.

Okay, that makes sense. And then elsewhere in the data center it looks like server network is a little more predictable, a little more visibility.

Well, I would say -- I don't know about predictability and visibility. I will say the performance has been more consistent. If you think about it, like I said, I think we have had five quarters of improvement in our server performance. And a lot of that is us being focused on that part of the marketplace, a lot of it is the Win 2003 expiration and the little bit of tailwind that gives you.

And if you look at NetComm for us it has been one of if not the most steady product set of the data center that we've had. They've been a pretty steady performer I think back to almost two to three years now.

Okay, thank you.

Bill Shope, Goldman Sachs.

I wanted to get a bit more color on that net service contract revenue just to make sure I am standing it on a go-forward basis. I guess how should we think about the magnitude of that contribution to gross margin? Is it something we should assume is a naturally lumpy stream?

And I guess for this quarter was it larger than expected on an absolute basis or was it really just a mix dynamic, as you mentioned, with the products coming in a bit -- or transactional coming in a bit lower?

You know, in terms of the magnitude, the dollar amount that it contributes to gross margin or gross profit -- to gross profit, that's relatively consistent. It's a good steady grower quarter in and quarter out. This quarter it grew more rapidly than our product gross profit and, therefore, it had had an outside contribution in the growth. And, therefore, it was really a mix impact that you were seeing.

Okay.

But we do expect it -- it is a good steady grower. We do expect it to continue to grow and contribute to gross profit.

Okay, great. And then the relative strength you are seeing in small business, I just want to clarify because you highlight whether that includes accelerating strength in PCs and across the transactional segments as well. I understand that you are seeing the solutions activity and it is balanced. But are you still seeing accelerating strength across the client side as well within small business?

Yes, we did see growth in client, but it was balanced with equal amount of strength in our solutions business, Bill, which was really encouraging. When we get that kind of balance, it really enables us to not only expand or to maintain the margins that you just talked about with Ann, but also gives us a level of consistency.

Okay, great. Thank you.

(Operator Instructions) Anil Doradla, William Blair.

Tom, I had a couple questions. On the healthcare side, can you give us a sense of what is going on? Clearly, we had Obamacare from last year. There was some pause. We get the sense that people are kind of rushing towards embracing additional technologies, a lot of chaos in the IT systems. So clearly there is a very positive trend.

So trying to reconcile some of your commentary. As the year progresses, how does it play out?

Well, I think what you say is true. I think technology will be an important part of some of the efficiencies and effectiveness, but at least in our customer base. We have had a number of mergers and that is not, I don't think, unique to our customer base. And when those mergers happen, you are going through the process of integrating the two companies and trying to create synergies and cut costs. And I think when that happens, that becomes an important priority for the business.

That isn't to say, as I tried to allude to, that we don't think that when that dust settles that we will continue to see healthcare as a growth segment for CDW.

The second was, look, everybody is under what I would call the pressure of the reimbursement process, the demonstration of meaningful use when it comes to technologies. And I don't think that is going away, that I think will be a consistent for all healthcare organizations.

So when I think about our healthcare business for this year I think -- I wish I had a more articulate word than lumpy. But I think that is what it is going to be. I think it is going to bounce around; we are going to have quarters where we do better than other quarters.

But I continue to maintain that long-term that is a growth segment for us because in spite of how well it has done, we still have relatively small market share in the segment and therefore the opportunities are really significant.

That was really reinforced recently at the HIMSS conference with the number of people that we talked to and their excitement about ways in which CDW can help them. I just think it is going to be a little bit of a lumpy market for the rest of this year.

Good. And, Tom, as a follow-up, when you look at the commentary by some of the IT service providers, whether it is the Cognizant's, (inaudible) and everything, clearly there has been a very material shift in their commentary where they are talking about budgets really freezing, a reallocation towards digital solution. We are seeing some of that in your results too.

But can you walk us through if client budgets are frozen and they are talking about not even expanding it, how does it percolate down to you in this whole shift towards digital? Is that shift good enough for you to offset some of the headwinds? This quarter we saw some of the positive impacts by that. But just walk us through qualitatively how you are looking at the remainder of the year with some of these kind of budget freezes going on across the board.

I will answer that the same way I have answered it with my sales leaders. While there are budget freezes, those budget freezes are on top of budget growth that has happened for the last two or three years. So there still I think represents a significant amount of spend out there for us to kind of go after and help customers with.

What I worry about is when budget freezes turn into budget reductions, because then that reduces the market opportunity. So at this point we still believe, based on my comments about our growth for the year, that there is a significant opportunity of therefore CDW. And despite the fact that we are the largest player of our type by a meaningful factor in the marketplace, we still only have a 5% to 6% share of our addressable market.

So feel comfortable there is enough opportunity out there, at least at this point. Now again, as I answered Katy's question, you have got to kind of monitor what goes on with the economy. And as one example, clearly we had customers impacted this quarter by the foreign-exchange issue. And you've just got to look at that and how does that impact their decisions going forward.

Great, thanks a lot, Tom.

Thank you. At this time I'm showing no further questions. I would like to turn the call back over to Mr. Tom Richards for closing remarks.

All right. Thank you again to everybody for taking the time and joining us this morning. We appreciate your interest and your questions. And as I always say, if you need some help with your technology, CDW is more than happy to help and you know how to get a hold of me. And the last thing is, it is a big weekend for everybody so Happy Mother's Day out there to all you Moms. See you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.