CDW Corp (CDW) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CDW second-quarter earnings conference call. (Operator Instructions) I will now turn the call over to your host, Tom Richards, Chairman and Chief Executive Officer. Please go ahead.

Thank you. Good morning, everyone. It's a pleasure to be with you. Joining me in the room today are Ann Ziegler, our Chief Financial Officer; Chris Leahy, our General Counsel; and Sari Macrie, our VP Investor Relations.

We have a lot to cover this morning. I'll begin with a high-level overview of our second-quarter performance and outlook, as well as the announcement we made today that we acquired the remaining 65% of UK-based IT solutions provider, Kelway, which we initiated last November. Then, Ann will take you through a more detailed results review and share more on our capital strategy priorities and medium-term targets. We will move quickly through our prepared remarks to ensure we have plenty of time for Q&A, but before we begin, Sari will present the Company's Safe Harbor disclosure statement.

Thank you, Tom. Good morning, everyone. Our second-quarter 2015 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'd like to remind you that certain comments made in this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the Form 8-K we furnished to the SEC today and in the Company's other filings with the SEC.

CDW assumes no obligation to update information presented during this webcast.

Our presentation today 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.

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 second quarter are the same in 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. So with that, let me turn the call back to Tom. .

Thanks, Sari. Second-quarter results were strong, and I'm pleased to report that we once again reached all-time records for three key financial metrics. Net sales rose 6.7% to $3.3 billion and 7.2% adjusted for currency. Adjusted EBITDA increased 8.4% to $268 million, and non-GAAP earnings-per-share increased 20.1% to $0.81. This quarter's results reflect the combined power of our balanced portfolio of channels, our breadth of product offerings, particularly our ability to bring innovative emerging technologies to our customers, and the success of our three-part strategy. Let me walk through how each contributed to performance.

First, our balanced portfolio of customer channels. On a segment basis, corporate grew 6.3% with medium/large business up 6.9% and small business up 3.3%. We saw balanced growth in MedLar with solutions and transactional sales increasing at similar rates. Small business delivered excellent growth in solutions, including continuing growth in net service contract revenue from software as a service and warranties. While this did mute topline growth, gross profits grew faster than sales.

Public increased 8.1%, driven by government up 22.9% with both federal and state and local delivering excellent results. Federal continues to benefit from strategic changes made to better align with new purchasing programs implemented by the government last year. We continue to have success in helping the government implement private filed solutions, including the Navy's floating private cloud program called CANES. Public safety continues to drive state and local results.

Education increased 3.6%. K - 12 delivered a mid single-digit increase as activity slowed, especially on the networking side as our customers waited before moving forward with projects until e-rate funding commitment letters were in hand. Higher ed delivered a low single-digit increase bringing six months close to high single digits. Healthcare increased 2.7% as we continued to see the impact of consolidation in the marketplace.

Our other results line, which includes Canada and Advanced Technology solutions, was essentially flat as a midteens increase in advanced technology solutions was dampened by currency impact on our Canadian results. While Canada was up high single digits in local currencies, in US dollars, sales were down mid-single digits.

The second driver of our performance was the breadth of our product offering and our ability to bring innovative emerging technologies to our customers. With over 100,000 products, services, and solutions from over 1000 vendor partners, we remain well-positioned to meet our customers' total needs across the spectrum of IT.

Staying relevant to our customers is critical for our value proposition, and one way to do that is by bringing on between 50 and 60 new partners each year. This content refresh of our portfolio is one of the key ways we outperform the overall market, and you see the impact of this in our second-quarter performance.

Overall, hardware sales increased 8%. Customer demand for client devices was strong, up high single digits, and as expected, customers added notebooks and mobile devices at a good clip, and sales increased by low double digits, while desktop sales declined, although at a lower rate than last quarter.

The impact of new technologies was clearly in play here as more than half of the notebook and mobile device growth came from a recently introduced form factor.

We also continue to benefit from Chromebook sales to support Common Core testing.

Also as expected, solutions growth accelerated and was more than 2 times faster than transactional growth. Solutions-focused products delivered excellent results with both net comm and servers up double digits. Once again, we experienced strong growth in emerging technologies. Storage grew mid-single digits with emerging technology growth more than offsetting declines in more traditional categories.

In total, revenues from flash products grew more than triple digits. Software sales increased 5%, reflecting strong security and storage performance. Gross profit from software increased at a higher rate, reflecting higher contribution from sales that are booked net like warranties, cloud and agency sales.

Services increased 9%, driven by excellent increases in configurations, managed services and field-based services.

The final driver of our second-quarter performance was the success we have had executing our three-part strategy, which is to first capture market share from existing and new customers; second, expand our solutions suite; third, build our services capability. Capturing market share has been and will continue to be a core competency of CDW. We know the power of the disciplined approach we take towards driving productivity from programs like book management and category penetration programs, and we continuously refine and enhance them.

Our teams continue to find ways to work together with our partners. One great example of this was a new customer acquisition program where nine partners joined forces to collectively equip our sellers to call on new customers that had zero business with both us and the partners. The result, our sellers added nearly 3000 new customers to both our partners and CDW in the quarter from this program alone. A true win-win-win for our customers, partners, and CDW.

Our second strategy is to continuously expand our solutions capabilities. By doing so, we remain relevant to our customers and capture sources of growth across the IT landscape. Security is a great example of this. You can't open a newspaper today (if that's even still how you get your news), without seeing some security breach reporting. Because of the investment we've made in our dedicated security practice, we can help our customers address a vital need and participate in one of the fastest-growing areas in technology.

In fact, our security practice was our fastest growing solutions practice, up more than 30%. It is not coincidental that security partners represent the largest category of new partners we have added for the last five years.

This quarter, revenues from new security partners added in the last five years were up over 70%. To help continue our momentum in this area, last week we introduced security Threat Check version 2, our next generation solution that enables small and midsize businesses to assess security threats in a cost-effective and scalable manner. [Emergence] was another great example of how we work together with our partners to create win-win-win solutions.

We introduced security Threat Check in 2013. Version 1 helped hundreds of customers identify and address security risks. Working with our initial partner and through new partners, version 2 provides state-of-the-art testing for network intrusion, internal systems vulnerability and infected files. And because protecting against security threats, takes more than technology, the new solution also includes consulting on enhanced internal processes.

We just launched Version 2 last week and expect it will help us stay ahead of the curve and continue to capture above market growth.

Another way we will continue to capture above market growth is through our third strategic priority, which is to continue to build our services capabilities. Services capabilities are an integral component of many high-end solution sales. We continue to judiciously invest in the capabilities required to deliver services.

Just last week we opened our national Enterprise Command Center. The ECC is a state-of-the-art network operations center that provides 24 x 7 capability. This enables us to deliver advanced managed services so our customers can take advantage of emerging technologies like our recently announced managed services offering for Microsoft Azure and Office 365, as well as VMware vCloud Air.

Once again, this quarter's performance reinforces our confidence in our ability to deliver consistent, sustainable profitable growth and cash flows. This confidence underpins our capital allocation strategy. Our capital allocation strategy is focused on providing both near- and long-term returns to shareholders while ensuring we continue to invest in our future.

Reflecting this balanced approach, we have four capital priorities: first, increase dividends annually; second, ensure we have the right capital structure; third, supplement organic growth with tuck-in acquisitions; and forth, return excess cash, capital dividends and M&A to shareholders via share repurchases.

Today's announcement of the acquisition of the remaining 65% of Kelway fits squarely within this framework.

Our acquisition of Kelway is a natural extension of our long history of following the customer. Over the past several years, we have been increasingly asked to help our US-based customers with their international IT requirements.

Just over two years ago, we performed a thorough analysis to determine the best approach at the time to meet these needs was through referrals, and we entered into a strategic relationship with Kelway. Last November we took a 35% minority position in Kelway.

Over the past two years, this relationship has delivered excellent results. That's because having the ability to bill in multiple currencies, deliver products and services locally and manage complex international tax requirements is no small task. Working with Kelway, they helped us meet these challenges and gave us a seat at the table for deals that we would otherwise have lost, deals that often had a small overall percentage of international revenues but represented significant US opportunity.

A great example of how we have been able to work together via our referral relationships is the solution we provided to a technology company with offices around the world. Because of Kelway's ability to deliver solutions to Asia-Pacific, we were able to help the customer establish a new data center in Singapore. We customized the hardware and services and met the customer's currency and tax requirements. Extending our great US relationship with this customer to include Asia-Pacific led to an incremental $10 million order for CDW.

Let me share a quick snapshot of Kelway. Kelway has nearly 1000 coworkers and was founded in 1990. It's one of the leading integrated technology services and solution companies in the UK focused on the midmarket similar to CDW.

Also similar to CDW, approximately two-thirds of its coworkers are customer facing, and they are very customer-focused. One way Kelway has delivered on this promise is by providing solutions and services to their UK-based customers' international locations through cross-border supply chain relationships. Roughly 10% of Kelway's sales are derived outside of the UK. Headquartered in London, Kelway has regional offices around the UK and locations in Asia-Pacific, the Middle East, and Africa. They also provide data center capability in the UK.

As of March 31, 2015, which is their fiscal year end, at today's currency rate and on a US GAAP basis, Kelway generated roughly $850 million in revenues. When we made our initial investment, we identified several key benefits for the transaction. Our due diligence over the past eight months validated our initial investment thesis, whether it was meeting with customers both in the US and UK who told us how much they valued a simplified approach to solving their international IT requirements, or the annual account audit, or our review of Kelway's data center capabilities, every check we made confirmed our expectation.

At its very core, CDW is about meeting the needs of customers better than anyone else, and Kelway enhances our ability to do that. Kelway provides our customers with international technical expertise and IT solutions and accelerates our ability to profitably grow our core business through increased share of wallet of existing and new US and UK multinational customers.

Most importantly, as I said when we announced the first step, whenever you make an investment in another business, culture is the key determinant of its success. Having worked with Kelway as a strategic partner for nearly 18 months at the time we made the first such investment, we thought their values, culture, and value proposition to customers and vendor partners was very much aligned with ours.

Now having worked with them for over two years, we are more convinced than ever that this is the case. It's a great fit all around, and as I've said before, if you close your eyes and ignore the accent, you think you are talking to a CDW coworker.

You may recall that we structured our initial investment last November with a call option to purchase the rest of the company over a 24-month period beginning in June. The terms of that call were based on Kelway's performance. During the last eight months, Kelway's topline and profit performance continued the improvement that began when we first entered into the referral relationship with them, making now the right time for us to acquire the balance of the Company. This way, we capture ongoing earnings and value creation benefits.

As is our practice, we will take a measured approach to integration. Initially, Kelway will operate as a standalone CDW business. Teams are in place, and work is already underway to determine the steps necessary to create a seamless one company experience. There will be much more to come as we make progress on the plans, but as we do, we will reap the benefits of consolidating 100% of their results. Ann will provide more detail on how do consolidating their results to impact our performance.

But before I turn the call over to Ann, let me leave you with a few comments on hiring and our expectations for organic growth for the remainder of the year. During the quarter, we continued the pause on hiring we put in place late last year to absorb the capacity we created when we added 140 customer facing coworkers in 2014. This pause, coupled with our natural attrition, resulted in a decline of about 15 customer facing coworkers since the beginning of the year.

To make sure we invest ahead of future growth, we have reignited our hiring and now expect to add between 100 and 150 customer facing coworkers in 2015. In fact, sales in Academy class just started in July has over 40 sellers. As we always, do we will monitor the market and adjust our hiring plans as appropriate.

Given first-half marketing performance, our current view of the 2015 US IT market growth is for it to come in at the low end of the 3% to 4% range we shared earlier in the year. We continue to target organic topline growth between 200 and 300 basis points above the market.

Now, let me turn it over to Ann. Ann?

Thanks, Tom. Good morning, everyone. As Tom indicated, our second-quarter financial results reflected the combined power of our balanced portfolio of channel and our breadth of product offering, particularly our ability to bring innovative emerging technologies to our customers and the ongoing success of our three-part strategy.

They also reflect the progress we're making against our financial strategy to deliver double-digit earnings growth, drive strong cash flow, and return cash to shareholders. 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 11.

Topline growth was strong this quarter with net sales of $3.31 billion, 6.7% higher than last year on both a reported and average daily sales basis. Average daily sales were $51.8 million. On an average daily sales basis, sequential sales were up 18.4% versus Q1 2015, which is well above normal seasonality. While sales in Canadian dollars are a relatively small portion of our total revenue, less than 5%, the strengthening US dollar reduced consolidated net sales in the quarter by approximately 50 basis points. Gross profit for the quarter increased 7.6% to $534.5 million.

Given product growth acceleration from Q1, as expected, gross margin declined on a sequential basis. On a year-over-year basis, gross margin was up 10 basis points. The impact of a higher mix of revenues reported at 100% gross margin such as our net service contract revenue and higher partner funding was partially offset by lower product margin due to a higher percentage of sales coming from larger order tiers. Reported SG&A, including advertising expense, was $328.6 million, up 6.5% over last year. This increase was primarily driven by increased sales compensation from higher growth in solutions-related compensation paid to specialists and technical experts and overall growth in sales and gross profit.

We ended the quarter with 7278 coworkers, up 67 coworkers since the end of 2014 and up 127 since the end of last year's second quarter. Annualized sales per coworker were $1.82 million, up 4.2% over Q2 2014. Our adjusted SG&A, including advertising, was $267.6 million, up 6.7% over last year. Advertising expense increased 9.4% as we continue to invest in the business.

As you can see on the next slide, slide 12, adjusted SG&A for the quarter excludes $7.5 million of non-cash equity compensation, $1.4 million of acquisition integration costs, and $0.6 million of historical retention costs and other expenses. To make it easier to calculate our adjusted EBITDA, which is essentially our gross profit, less adjusted SG&A expenses we also adjust for depreciation and amortization.

Our non-cash equity compensation expenses increased $3.2 million year over year, primarily due to annual awards granted in Q1 for our long-term incentive plan. Our adjusted EBITDA for quarter was $268 million, up 8.4% year over year, which translates to an adjusted EBITDA margin of 8.1%, up 10 basis points from last year's strong result.

Let's look at the rest of the P&L on slide 13. Interest expense was 22% lower than last year at $37.8 million, reflecting reductions driven by repayments and refinancing activities completed in 2014 and Q1 of this year. Our effective tax rate was 37.1% versus 36.9% in Q2 2014.

On a GAAP basis, we earned $108.2 million of net income. Our non-GAAP net income, which better reflects our operating performance, was $139 million in the quarter, up 20% over last year.

As you can see on slide 14, non-GAAP net income reflected after-tax add backs in four general buckets: the ongoing amortization of acquisition-related intangibles, ongoing non-cash equity compensation, acquisition and integration costs, and other nonrecurring income or expenses. These adjustments were tax affected at a statutory rate of 39%.

With Q2 non-GAAP weighted average diluted shares outstanding of 172.5 million, we delivered at $0.81 of non-GAAP net income per share, up 20.1% over the prior year.

During the second quarter, we repurchased 2.5 million shares for $91.7 million under our previously announced $500 million repurchase program. 2 million shares were repurchased from our sponsors concurrent with their May offering, and 0.5 million shares were repurchased on the open market.

Turning to first-half results on slide 15. Revenue was $6.1 billion, an increase of 5.4% on both a reported and average daily sales basis as average daily sales grew to $47.8 million. On a constant currency basis, net sales were up 6%. Gross profit during the first half of 2015 was $991 million, up 7.5%. Gross profit margin was 16.3%, up 30 basis points from 2014. SG&A, including advertising expense, increased by $35.4 million or 5.9%. Adjusted EBITDA was $470.8 million, 8.6% above first-half 2014. Non-GAAP net income for the first half of 2015 was $236.6 million, which is $197 million in 2014, up 20.1% driven by our higher operating results and lower interest expense, which was down $16 million.

Turning to our balance sheet on slide 16, on June 30 we had $335.7 million of cash and cash equivalents. We finished the quarter with $2.83 billion of net debt, $32.9 million less than our June 30 of $2.87 billion. Our cash plus revolver availability was $1.22 billion. Net debt to trailing 12-month EBITDA at the end of Q2 was 3 times, 0.4 turns less than Q2 2014. Our weighted average interest rate on outstanding debt is now 4.5%.

In this potentially increasing interest rate environment, I'd like to remind you that our $1.5 billion term loan facility is subject to a 1% LIBOR floor, and we have in place $1.4 billion notional amount of interest rate cap at a weighted average rate of 2%, which don't expire until Q1 2017. The remainder of our outstanding debt is fixed rate. So approximately 97% of our outstanding debt is effectively is fixed or hedged, and rates would have to move significantly before they had a material impact on our interest costs.

Free cash flow, which is calculated as operating cash flow plus the net change in our flooring agreement less capital expenditures, was negative $8.1 million for the quarter, better than last year's negative $20.7 million. Remember, that Q2 was typically our lowest cash flow quarter of the year as we pay cash taxes for both Q1 and Q2 in the second quarter, and we typically have our highest sequential quarterly growth which drives working capital investment.

Cash taxes paid in the quarter were $119 million. Cash interest paid was $28 million, $56 million lower than Q2 of 2014. This reflected the redemption and refinancing of our 8.5% notes, previously paid semiannually in April and October with 5% notes that will be paid in March and September.

On a trailing 12-month basis, free cash flow was $363 million for the 12 months ended June 30, 2015 compared to $316.1 million for the 12 months ended June 30, 2014.

While higher than normal sequential growth drove higher absolute working capital needs, as you can see on slide 17, we maintained strong rolling three months metrics. For the quarter, our cash conversion cycle was 19 days, which was flat compared to last year's second quarter. While pleased with this result, we don't expect to sustain this level and look for our cash conversion cycle to be within our target range of the low to mid 20s for the remainder of the year.

Turning to the rest of 2015, let me start with the impact Kelway will have our results. I am on slide 18.

Starting with revenue, given our current expectations for Kelway, we anticipate the impact of consolidating revenues for the remainder of the year to add between 500 and 600 basis points of incremental growth. Remember, we will be consolidating five months at 100% with no revenues in July since we only held a minority interest at that point.

Also, keep in mind that Kelway's sales and profit are calendar year front-end loaded. For earnings, we expect Kelway to contribute between $0.06 and $0.08 per share on a non-GAAP basis in the second half of 2015. This assumes one month of 35% ownership and five months of 100% ownership and exchange rates consistent with current rates of $1.55 to the pound. Remember, this is non-GAAP earnings-per-share, so it doesn't include amortization of purchased intangibles or acquisition and integration costs or one-time gains and expenses.

You see, the impact of this on our expectations for consolidated results is on slide 19. As Tom mentioned, we continue to target organic growth 200 to 300 basis points above US IT growth, which we expect to be at the low-end of the 3% to 4% range.

As I just mentioned, Kelway will add another 500 to 600 basis points to second-half revenue growth. Given our first-half results, we expect to be at the high-end of our annual adjusted EBITDA margin target of the mid-7% range, and for EPS, given our first-half operating results and the ongoing impact of lower interest expense, we now expect to exceed our midteens non-GAAP earnings-per-share growth target coming in pre-Kelway in the high teens. The $0.06 to $0.08 of non-GAAP EPS from Kelway is incremental.

Let me provide some additional comments for those of you modeling our 2015 financials. I'm now on slide 20. On the expense side, we expect our adjusted SG&A to increase at a rate higher than net sales for the balance of the year from four key drivers: costs related to hire coworker count; planned infrastructure and productivity initiative investments; overlap of last year's lower-cost to serve from transactional sales; and incremental Kelway SG&A. All these puts and takes brings us to a lower adjusted EBITDA margin for the second half of the year than we delivered in the first half. Again, we expect our full-year adjusted EBITDA margin to be at the high-end of our mid-7% target range.

Moving down the P&L, including Kelway, we expect our book interest to be in the $162 million to $164 million range and our effective tax rate to be between 37% and 38%. For full-year 2015, we continue to expect a cash tax rate of 39% to be applied to pretax book income before items related to the Kelway transaction and acquisition-related intangibles amortization.

In addition, we will pay $20 million to $21 million related to the cancellation of debt income we incurred in 2009. Adjusting for the pull forward of approximately $100 million of free cash flow into 2014 and incremental Kelway cash flow, we expect to slightly exceed the high-end of our normalized cash flow target of 2.5% to 3% of net sales.

Keep in mind that Kelway's cash flow is higher in the back half of the calendar year, and don't forget that CDW cash flow tends to increase sequentially in the third quarter. This Q3 will have an incremental cash interest paid on our new 5% notes. Including interest on incremental net debt we consolidated in the Kelway transaction, we expect our cash interest to be in the range of approximately $156 million to $158 million for the full year. In total, we paid $372 million in cash and $59 million in stock before transaction fees and expenses, and we will consolidate approximately $80 million of Kelway net debt for our 100% interest in the Company.

Reflecting this, given the consolidation of Kelway's net debt and EBITDA, our leverage ratio -- our net leverage ratio per our credit agreement will tick up, but pro forma for Kelway we expect to end the year within the high-end of our target range of 2.5 to 3 times. This takes us to our capital allocation priority. We remain committed to all four of our priorities.

I'm delighted to report that our Board of Directors declared the payment of a dividend of $0.0675 per share on September 10 to shareholders of record on August 25. This is 59% higher than last year's September payment and consistent with our target of achieving a 30% payout of free cash flow and dividends over the next four years. There is no change to our commitment to revisit our dividend payments annually.

There was also no change to our intent to continue to make share repurchases under our existing authorization, either alongside our sponsors or in the open market, at a minimum to offset dilution, including the shares issued as part of the Kelway transaction. These shares issued in the Kelway transaction facilitate the rollover of a portion of the transaction proceeds into CDW stock. All of that stock is subject to a multiyear lockup, and a portion of that stock, which was funded by Kelway's founder, has been set aside for a retention pool for the broader Kelway leadership team.

Finally, a few thoughts on how Kelway impacts our medium-term targets on slide 21. Once we anniversary the full acquisition, we currently expect the UK market to grow roughly in line with our North American operations so there is no change to our 2016 to 2018 top-line target. And since strategic acquisitions were included in our 2016 to 2018 medium-term target as one of the ways we intend to grow earnings-per-share faster than revenues, there was no change to our low double-digit earnings-per-share target.

Of course, for 2016 we will have the benefit of incremental Kelway sales and earnings for seven months of the year. So we expect to exceed these targets with non-GAAP EPS growing in the low teens. When we release year-end results, we will provide more on our expectations for next year.

This 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, could you please provide the instructions for asking a question?

(Operator Instructions). Rich Kugele, Needham and Company.

Good morning and congratulations. So you had been talking about a situation with some partners where you were able to collaborate together and get business (technical difficulty)

-- (technical difficulty) market opportunity that involves putting combinations of products together (technical difficulty) success we brought on about 3000 new customers.

Interesting. Okay. And then obviously we get a lot of inbound questions on the eRate program, and it seems to be making some progress again. Can you just talk about what you see in the market there and your expectations for your public opportunities over the balance of the year?

Yes, and really, Rich, it is directly impactful to K-12, and the data we have suggests that only about 20% of the funding letters have been released at this point. And school districts have remained fairly patient to wait until they get their funding letter to begin the network upgrade progress. I think as you remember from last quarter's call, we were named on a significant number of the funding requests. And so it's one of the reasons we remain pretty optimistic about the impact it's going to have.

Having said that, it looks like now, if you think about it, school districts really only can implement during what I'll call vacation time or holiday time. So, if -- a lot -- 80% of them haven't yet received their funding letters, that's why we are believing at this point it's going to be later in the year, maybe some of the implementations will take place over the Thanksgiving holiday or the end of the year holiday. And so we feel it's going to be a little more backend loaded and then obviously carry into next year.

Okay. That's helpful. Thanks very much.

Sherri Scribner, Deutsche Bank.

I was hoping you could elaborate a little more on the opportunities you see with Kelway internationally. I know they are UK-based, but they do have some business in Asia, and what are the synergies there between being able to sell your solutions internationally? Are there any possibilities? I think you mentioned a couple where you are able to cross-sell across geographies.

Yes. The driver -- I think the best way is to go back to the initial kind of thesis, and that was the primary focus initially was to help us better serve those US-based multinational companies that had international needs. And that prior to the partnership with Kelway, that we would have to excuse ourselves sometimes from what I will call combined international opportunities.

Obviously, the reverse is also true. Kelway has customers that have needs obviously internationally but back in the United States.

So really the combination is about better serving those existing customers and then looking for opportunities for growth. One of the things that is apparent to us about Kelway, if you've heard, 90% of the business comes from the UK, and that also is a significant area for a lot of our US-based customers. So there's a strong synergy there. But they've done a nice job of building a platform that enables them to follow their customers, and that's how they've opened those facilities I alluded to in other parts of the world.

So, what we've experienced through the referral relationship is a growth in each of our businesses, and we would expect that to continue. As you heard me allude to, we are going to start out operating Kelway as a standalone business unit and continuing to perform on the referral model until we are comfortable that we've built kind of a single platform for our customers.

Okay. That's helpful. And then I guess with the acquisition and integrating this 100% now, what capability do you have to do new acquisitions? Are you taking a pause now, or do you see opportunities? Is there still bandwidth? Thanks.

Well, look, if you think about CDW, we tend to do things in a deliberate way, and we don't take lightly the integration and what it takes to do this well, which is why we've been pretty thorough in the acquisition process and some would say very deliberate, and we're going to take the same approach on integration. So that I would say right now we've got our hands full and want to stay focused on both the integration of Kelway and our customers because that's important to us.

Thank you.

Tien-tsin Huang, JPMorgan.

Just wanted to ask on Kelway also, just could we see, Thomas, in the short-term impact on revenue and expenses? I'm just curious if it could energize sales, or possibly could we see some risk of attrition?

Well, are you talking about attrition from customers or coworkers?

Yes, I'm thinking about both actually, both on the revenue side, as well as on the employee or coworker front, given sort of the change in control and the event itself.

Yes, well, let me take the first one about growth. You heard us allude to the fact that we think the Kelway acquisition is going to add between 500 and 600 basis points to CDW's topline growth between now and the end of the year. And one of the things I'm really thrilled with is, we've built a -- I think a strong retention program for the people at Kelway and are happy to report that they are signed up, ready to go, and excited about the prospects for this joint company. So we feel really good about both growing the business, retaining and growing customers and retaining the coworkers on both sides.

All right. Terrific. And then we'll you rebrand -- sorry if I missed that -- Kelway itself? And then separate from that one, I wanted to ask on healthcare in Canada, I've been watching what's been going on there in terms of just underlying trends. Any callouts in what you see in healthcare in Canada? Thanks.

Well, right now let me answer the first one. It will be Kelway, a CDW company. We feel that that takes advantage of Kelway's brand recognition and acknowledges the new partnership. As we move through the integration process, we'll think about if there is an enhanced advantage for changing chasing that, but right now that's kind of the go to market plan, and we are both really excited about that. And the second part of that question was any other callouts about healthcare and in Canada.

Canada.

So, Canada was -- if you heard, they did a nice job in constant currency. You're up high mid-single digits, continue to take share in the markets. It's a currency issue, and that kind of about calls it out. You guys know as well as I do the challenges in the Canadian economy, and they continue to kind of operate successfully within those -- within that environment, and healthcare continues to be my favorite word, lumpy, from the perspective of we've got a lot going on in healthcare with mergers, and the impact of a merger can go one of two ways when you are involved in one of those. And so I think the fact that we've got some growth out of healthcare this quarter is a nice sign, and we'll take it.

All right. That's great. Congrats on the deal.

Amit Daryanani, RBC Capital Markets.

I guess I'll start off my first question with Kelway as well. Could you just talk about whats even the current EBITDA margin structure for Kelway is, and to get them to be in line as a target of CDW, what sort of initiatives would you have to take from an integration perspective and what sort of charges entail eventually when you decide to do it?

Well, let me take the first part. One of the things that I alluded to is their profit picture is roughly similar to CDW today, and a lot of that is to their credit that since we started the process, they have been aggressively looking at how do they improve their profitability of their business. They have been exchanging ideas with CDW, and so we are thrilled with the performance they've made up to this point from a profitability perspective and expect it to continue.

I think you also have about integration charges, but keep in mind that this is not a transaction that's about taking costs out of the combined businesses. So, there will not be significant -- won't be any severance charges, things along those lines. There's obviously no facilities to shut down, so you shouldn't be looking for charges along those lines. As we develop an integration program, there will likely be some expenses related to systems integration, and we'll talk about those as we have better clarity around them.

Got it. And I guess let me just follow up, Ann. How do you think about hedging as you go forward, especially with Kelway getting integrated into the business and you having more international exposure? And on the buyback front, is the entire process to continue to participate along with a sponsor that is going to do secondary on a go forward basis? Thank you.

On the hedging, I'm not a big fan of hedging merely translation risk, which is the majority of the exposure that we have today both from Kelway today and Canada.

Now to some extent as you have heard, Kelway has about 90% of their revenue is based in the UK. There is that 10% that is non-UK, and they've done a very good job where appropriate where they actually have translation risk hedging that risk.

So, we anticipate that we would continue to do that going forward, but that we would not be hedging merely translation risk.

In terms of the buyback, yes, I mean we obviously have a $500 million program out there. We have a fair amount of way to go on that program, and we certainly continue to expect to participate with our sponsors and secondaries, and as I indicated, the stock that was issued in the Kelway transaction will be brought back.

Perfect. Thank you and congrats on the quarter.

Brian Alexander, Raymond James.

This is Adam in for Brian. I just wanted to ask a little bit more about the competitive environment, given we've seen some major competitors growing double digits, but had seen triple digit decreases in gross margin. Talk a little bit more about the competitive environment, and would you consider looking at gross profit dollar growth going forward as a possible metric given the focus on profitable growth?

Okay. A couple of different things. One, Adam, as we've said that is why we focus on EBITDA is because it gives us the ability to focus on that which we can't control, and it gives us the flexibility to kind of what I will call manage the profitability of the business.

From a gross profit perspective, it's been fairly constant here for a couple of quarters. We've been in the 16 range, which is where we like to be. But, to be honest with you, we are not going to focus on GP growth per se. We're going to continue to focus on profitably growing the top line, and that profitability is defined by the mid-7% EBITDA margin that we've set as a target for the business.

I can't really comment -- I don't notice the competitive market being any more intense or any less intense than it was three months ago. I think one of the things that I'm proud of is the CDW has continued to grow the business profitably on top of some pretty incredible costs as you guys have pointed out to us, and so I think that's a great testament to the disciplined approach with which we go about serving customers.

Okay. Thanks. And a question specific to the hiring. I know you mentioned that IT market is kind at the low-end of that 3% to 4% range. We've seen all three primary distributors in North America failing to grow and missing their own forecasts. Consolidating I think 1000 Kelway employees that you mentioned, but going to reignite the hiring and adding 100 to 150 headcount in 2015, can you help us reconcile those kind of two differences?

I don't know that there is a reconciliation to think about, Adam. If you just kind of think about them discreetly, if you think about past earnings calls, one of the things that I was paying attention to was kind of the capacity we had already added into the CDW model with the kind of aggressive hiring we had done last year and the year before and felt like we had the capacity to handle the growth for a number of quarters. If you think about it, the IT growth rate of 3% to 4% has been pretty constant from our perspective, and now we said it was at the low range, but we are talking about 3% to 4%. And so we feel like now we are at a point from a capacity standpoint that adding those incremental customer facing coworkers in the US is the right time for us to make that investment now so that we can take advantage of market growth opportunities when they are productive and ready to grow -- go, excuse me, and grow, now that I say it that way.

So I don't know that there is any disconnection there. I think it's really us monitoring as we always do the productive capacity of the CDW engine.

All right. Appreciate the color and congrats on the quarter.

Matt Sheerin, Stifel.

Just a question on your hardware sales growth. Tom, you've talked about 8% growth in hardware double-digit server. Did you see some continued positive impact from the Microsoft server upgrade cycle, and do you see that trailing off at the end of the year? And also, relative to Windows 10, do you see any catalysts in terms of refresh in the corporate environment at the end of this year or into next year?

Okay, Matt. So first, I think the word that I've been using to describe the impact of Win Server 2003 is kind of a mild breeze at our back, so to speak. I would say that a lot of the customers- - and I think I alluded to this last quarter -- have really started preparing for the Win Server 2003 expiration late last year. It has carried into this year, but I also think there is what I would call a natural refresh going on. You have great new technologies like converged infrastructure, which is driving some of the behavior in the marketplace.

So, I would say that I don't know we are in any particular inning. Since it hasn't been such a big driver, I don't know that we are thinking about some drop off as far as its impact on the marketplace.

And as far as Win 10, I think as you know a lot of the early benefits I think are going to be to the retailer/consumer market, which is not part of where we are focused. I think customers typically in the enterprise space take a little bit of a wait-and-see attitude like play with it, wait until the first patch comes out. Let's see how it works. I think there is a fair amount of excitement about the product. I think there's been lots of stuff written about the fact that it may not drive hardware sales. But what I would say for us, if you looked at our PC sales, all the way back to 2013, there's been this constant drumbeat of growth, even before the Windows XP accelerant, if you will. And I think that's because the businesses stay on a normal cycle of investing in PCs for the purpose of productivity. Then you get the incremental benefit of new form factors like I alluded to. So, we are anticipating that there will continue to be steady growth with or without Windows 10.

Got it. That's helpful. And on the government business, you've had several quarters of pretty strong growth here, both on the federal and state and local. You talked about projects on both sides that sound encouraging. As you look out over the next few quarters, obviously comps are going to get tougher, but do you continue to see positive catalysts there?

Yes, we continue to expect it to be a growth part of the business going forward. As you point out, they are going to be facing some tougher comps, but as I just said to the last question, that's kind of more of the same for us it seems like, and but we are looking at them to continue to grow maybe not at the exponential rate but at a good growth rate for the remainder of the year and into 2016.

Okay. Thanks a lot.

Osten Bernardez, Cross Research.

Tom, I just had a quick question with respect to your outlook for the overall market being at the lower end of your original rate, original outlook of 3% to 4%. Could you sort of highlight for us what you're -- what you are seeing that leads you to believe that you will be at that low-end rate? Is it primarily sort of the PC declines that we've seen, or are you seeing evidence of elongated decision-making helped by some of your customers, or is it a macro call in terms of what you're seeing from an overall demand perspective?

I think it feels more of a macro call. If you think about one of the earlier questions that cited some of the forecasts made by some of the distribution companies, I think you've seen other technology companies talk about a more muted growth picture, maybe in the back half of the year. I don't know that I'm smart enough to tell you what's driving the macroeconomic perspective. I do hear people talk about, well, we'll see what happens with interest rates and we'll see what happens with currency. And so I think all of those kind of filter into this macro perspective, but we aren't seeing it from a particular product perspective, more so macro.

Got it. And then secondly, could you highlight -- I don't know if I missed this earlier, but how did Kelway grow? What was Kelway's growth in the first half of the year, year on year?

We didn't provide that detail.

And you won't, I guess?

No.

All right. Thanks.

Katy Huberty, Morgan Stanley.

You mentioned several times the ability for salespeople to bring newer, innovative technologies to market, and I imagine that's helping you offset some of the macro pressures you just talked about. You said security a number of times, but I imagine it's broader than that. Can you just talk about what buckets or it seems you've been able to sign on new partners and where your salespeople are having the most traction in new technologies?

Well, you are, right, security remains one of the big drivers of new partners. Converged infrastructure is another area that has been a source of new partners. Our whole cloud strategy is another area that brings in new partners, and then even inside of the storage business, there are new storage partners.

So I would say, it happens in a broad perspective, but those are the ones where we've had, I think, the most significant additions in the last year or so.

And then the small business segment growth decelerated to 3%, but you talked about strong solutions growth there. What was it that decelerated in small business, and what do you think is driving that?

Yes, it's generally -- well, desktops, as I alluded to, declined across the whole business, but declined in a meaningful way on -- in small business. I think a lot of that was just driven by the expiration of the Windows XP expiration, if you will, and they continue to be a cloud growth engine for us, which is why the gross profits have been growing at an even faster rate than top line.

Great. Thank you. Congrats on the quarter.

Bill Shope, Goldman Sachs.

This is Matt Cabralin for Bill. So can you help us understand the bigger drivers of the step down in gross margin that you saw from the first quarter to the second quarter?

And then just related to that, so you mentioned that a portion of your business is coming in at that 100% gross margin level. How big is that within the mix, and then how should we expect that to grow going forward?

Yes, as you recall from the first-quarter call, we had a very strong gross margin in the first quarter, and as we explained on that call, a big piece of it was driven by mix. We saw with product growth muted in the first quarter, our 100% gross margin items, particularly our net service contract revenues, continue their double-digit growth. And, therefore, it was really a mix impact on the gross margin that we saw in Q1, and we indicated that we saw it as product growth we accelerate as we move through the year. That fixed impact would fade. And that is, indeed, what we've seen.

We also had in the first quarter we mentioned we had a benefit from a -- from not receiving an inventory write-off that occurred in the first quarter of the prior year. So you have that pickup as well.

Got it. Thank you.

Jayson Noland, Robert Baird.

Congrats on the quarter. I wanted to follow-up first, Tom, on the cross-border synergy comment. Is that common, and is it significant to CDW? I could imagine a lot of companies have offices all over the world, and there could be a situation where you couldn't win or couldn't bid on deals. Is that something you see a lot?

Yes, that was actually the driver that got us started down the path with Kelway in the first place was -- and then we went out and studied it externally. So, it was a combination of feedback from our sellers and the selling experience and then some external analysis we did that said the number of situations was increasing. And, therefore, if you didn't have the ability to help a customer with delivering IT internationally, so to speak, you're going to reduce the likelihood of your ability to protect and grow your core business. So that was kind of the genesis of the thesis, and we have just seen that increase as time goes on.

Okay. And then a follow-up. I wanted to ask about public cloud as a competitor comes up somewhat with investors asking about your small business segment specifically, but maybe some updated thoughts there on what you see.

As I said, our cloud business across the CDW has been growing, and we are thrilled with the different ways that we've been able to help customers as they think through which workload, how to build out a hybrid architecture, so to speak, and as I said I think earlier, the small business organization has been one of the leading organizations in selling cloud-based solutions, be it SaaS-based, be it infrastructure as a service based, or agency based.

So I think the breadth of our cloud portfolio truthfully is one of the key reasons we've continued to see the levels of growth. Because just like the value proposition of CDW, it enables us to bring multiple choices to a group of customers that typically wouldn't be able to avail themselves of that kind of choice, and that tends to be rewarded to CDW.

Thanks, Tom.

Anil Doradla, William Blair.

Tom, kind of big picture question. So when I look at the security business, obviously you are very positive on that. When I extrapolate this business call it two, three, four years from now, is this going to be increasingly more services-oriented, or is it going to be primarily a product-oriented business?

Wow. Well, I have a tough time figuring out next quarter, let alone two to three years out. This is a gut response. I think what we are seeing, as I mentioned when we talked about security Threat Check version 2, which includes some consultation aspects on process analysis, I would expect there will be an increasing service aspect of this as we go forward. Because as I think you guys that live in this world know, it's just not about the technology. It's about the what I'll call security policies inside of a business, the security practices, and they all tend to contribute.

So if you force me to answer, I would say yes. I think there will probably be a bigger services practice as product security going forward.

Great. And as a follow-up, Tom, I mean, taking that as a basis and looking at all the other trends, clearly there's greater need for customization, greater need for software development. So, again, longer-term, could you guys be more involved in the IT services? I mean, you are involved, but what I'm talking about is get into the businesses of the TCS, Infosys, get into some of these more IT services product development or IT services businesses?

We have been, as you pointed out, investing in growing our services practice for about three or four years now in a meaningful way, and the growth isn't just in coworkers. It has been in capabilities. I don't know that I could sit here and forecast now kind of which of those will be most important to our customers. That will always be the driver at CDW for the market we serve. But I think it's fair to say we are getting asked to consider services that are more expansive and different than we do today, but again, we've got to make sure we can deliver on the customers' expectations.

So, that's probably a long-winded way of saying I'm not really sure, but we are going to continue to expand our services portfolio.

Great and congrats, once again.

That does conclude the Q&A session. I will now turn the call back over to Mr. Richards for closing remarks.

Okay. Thanks, everybody. I appreciate your interest this morning, and as always, if your company needs some help with IT, we would hope you would come to CDW, and now we can say CDW plus our international partner Kelway. We would be more than happy to help you, and enjoy the rest of your summer. Thank you.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect, and everyone have a great day.