CDW Corp (CDW) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CDW Corporation Q2 2017 Earnings Conference Call.

(Operator Instructions) I would now like to turn the call over to Tom Richards.

Please go ahead.

Good morning, everybody.

It's pleasure to be with you.

Joining me in the room today are, Ann Zeigler, our Chief Financial Officer; Chris Leahy, our newly minted Chief Revenue Officer; and Sari Macrie, our VP of Investor Relations.

I'll begin today's call with a brief overview of our results and key drivers, and we'll take you through a more detailed results review of the financials, then we'll go right to your questions.

But before we begin, Sari will present the company's safe harbor disclosure statement.

Thank you, Tom.

Good morning, everyone.

Our second quarter 2017 earnings release was distributed this morning and is available on our website, investor.cdw.com, along with supplemental slides that you can use to follow along with us during the call.

I'd like to remind you that certain comments made in this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995.

Those statements are subject to risks and uncertainties that could cause actual results to differ materially.

Additional information concerning these risks and uncertainties is contained in the Form 8-K we furnished to the SEC today, and in the company's other filings with the SEC.

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

Our presentation also includes certain non-GAAP financial measures, including non-GAAP net income per share.

Our non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules.

You'll find constellation charts in the slides for today's webcast as well as in our press release and the Form 8-K we furnished to the SEC today.

Please note that all references to growth rates or dollar amount increases in our remarks today are versus the comparable period in 2016, unless otherwise indicated.

In addition, all references to growth rates for hardware product, software and services today represent U.S. net sales only and do not include the results from our U.K. or Canadian operations.

There were the same number of selling days in the second quarter and the first 6 months of 2017, compared to the comparable periods in 2016.

All sales growth rates references during the call we used average daily sales unless otherwise indicated.

A replay of this webcast will be posted to our website by this time tomorrow.

I also want to remind you that this conference call is the property of CDW, and may not be recorded or rebroadcast without specific written permission from the company.

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

Thanks, Sari.

Following our strong first quarter, we delivered another quarter of excellent top line growth and solid profitability.

Consolidated sales were $4 billion, up 9% versus last year.

On a constant currency basis, sales increased by 10%.

Gross profit increased 5% to $641 million, adjusted EBITDA increased to 5% to $315 million and non-GAAP net income per share increased to 10% to $1.03 per share.

On a constant currency basis, non-GAAP EPS increased 11%.

Results like this require rigor, discipline and process.

We have been very deliberate about putting the systems, structure and resources in place to ensure we can continue to execute our strategy effectively.

Two recent organizational changes are designed to ensure we maintain this discipline as we drive further growth.

You may have noticed that I introduced Chris Leahy as our new Chief Revenue Officer, creating a new executive role of Chief Revenue Officer, accountable for all of our customer-facing channels is the first half these 2 actions.

Chris, who most recently was our Senior Vice President, International and General Counsel, is taking on this new role reporting to me.

As you may know, Chris helped lead the launch of our international strategy, including the acquisition of CDW UK.

As evidenced again this quarter, our international business has continued to deliver strong results under Chris's leadership.

As CRO, Chris will sure we maintain a strong line of sight to customers, align resources and reinforce connection points between our sales and technical organization.

So customers benefit from the deep technical capabilities we have built.

I am delighted that Chris is taking on this new role.

You will be hearing from Chris in future earnings calls.

I'm also delighted that Chris Corley will be taking on an expanded role as we add responsibility for our international business to her current role leading the corporate business segment.

Remember, that one of the strategic drivers of our international acquisition and expansion is to better serve our U.S.-based multinationals from our corporate segment.

Chris will build on the work already underway to create a one company experience to meet customer needs and drive profitable growth.

She will also look to leverage our international capabilities to capture profitable growth opportunities outside the U.S.

This quarter's results demonstrate the power of rigor and discipline.

There were 3 key drivers of our performance.

Our balanced portfolio of customer end markets, breadth of product offering and our variable cost structure.

Let me walk through how each contributed to performance.

This quarter's top line performance once again demonstrated the power of our balanced portfolio of end markets.

We saw excellent top line performance across 8 of our 9 end markets, all up high single digits or better.

This strong performance more than offset a 7% decline in our healthcare business.

Corporate, which represents sales to business customers with roughly 250 coworkers and above, increased 9%.

Momentum that began in the first quarter continued to build with more projects moving from the back burner to the front.

Small Business posted an 11% increase as customer confidence remained strong.

Public increased 8%, with double-digit increases across all customer end markets except Healthcare.

Government increased 19% powered by new contracts in State & Local and ongoing success in meeting public safety needs as well as mid-teens growth in Federal.

Federal results include a little more than half of the client devices that had been delayed at year end of 2016.

We expect the remainder to ship in the third and fourth quarter.

Education increased 11% reflecting high-teens growth in Higher Ed and high single-digit growth in K-12.

Healthcare declined 7% as uncertainty regarding the fate of the Affordable Care Act, Medicaid funding and overall reimbursements weighed heavily on decision makers.

Our Other results, which reflect Canada and the U.K. combined, increased 9%.

Both operations continue to show strong performance with Canada up high-single digits in Canadian dollars, and U.K. up double digits in local currency.

Currency impacted both operations, reducing U.S. denominated growth by 50%.

The second driver of results was our broad product and solutions suite.

Our ability to meet the total technology needs, both transactional and integrated solutions needs of our customers is one of the fundamental reasons for our consistent performance.

This is a key point of differentiation for us in the marketplace.

With over 100,000 products, services and solutions from over 1000 vendor partners, we remain well positioned to meet our customer's total needs across the spectrum of IT.

IT market trends were similar to those that we saw in the first quarter.

We continue to see accelerated hardware growth with ongoing focus on optimization and efficiency, securitization and integration of software into solutions.

We also continue to see strong growth in client devices.

We had a good mix of business between solutions and transactions, with total U.S. solutions growing roughly 6% and transactions growing roughly 10%.

Let's take a closer look at overall product performance.

As expected, U.S. hardware sales accelerated, increasing 8%, growing 200 basis points faster than the first quarter.

Healthcare performance pressured growth rates across most product categories.

Two categories, notebooks and mobile devices and networking were very strong.

Notebooks and mobile devices increased high teens, with excellent growth across all customer end markets.

This is a noteworthy result given last year's strong low double-digit increase.

Chromebooks increase faster than the category delivering all-time records for both units and revenues, reflecting continued success in K-12.

NetComm sales increased high single digits with several end markets growing double digits.

Servers increased mid-single digits in the quarter.

Enterprise storage was down low single digits as strong growth in Federal could not offset declines in other markets.

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

While aspects of traditional data center infrastructure continued to be challenged, hybrid infrastructure, which includes converged infrastructure, infrastructure of the service, software-defined data center continued to see excellent growth.

Overall, converged infrastructure grew more than 50% in the quarter with hyper-converged driving most of the performance.

Services increased 11%, primarily driven by networking solutions.

Software sales increased 12%, reflecting strong security and networking growth.

Gross profit from software grew faster than net sales as we continue to see meaningful double-digit increases in netted down Software as a Service and Infrastructure-as-a-Service.

And that leads us to the third element of our business model that drove performance this quarter, our variable cost structure.

For those of you unfamiliar with our cost structure, after our cost of goods sold, our largest cost element is sales compensation, which represents roughly half of our adjusted SG&A.

Sales compensation is highly variable for 2 reasons: first, it varies with gross profit growth.

Second, it varies with sales mix, as solution sales involve technical resources and transactional sales typically do not.

This quarter, the strong sales momentum we had in hardware and the ongoing competitive marketplace, especially in notebooks and NetComm pressured gross market.

Pressure on product margins is not new, especially during strong client device refresh cycles.

With the acceleration in hardware sales growth, we did not get the same benefit from mixing into 100% gross margin revenues as we did all last year.

When top line grows faster than gross profits due to margin compression, as it did this quarter, the variable nature of our sales compensation mitigates its impact.

Clearly, our variable cost structure is a key driver of our ability to deliver sustainable profitable growth.

Another key of our sustainable growth is our 3-part strategy.

During the quarter we continued to make excellent progress executing this strategy, which is to, first, capture market share from existing and new customers; second, expand our solutions suite, third, enhance our services capabilities.

Capturing market share is and will continue to be a core competency of CDW.

And we take a very disciplined approach towards driving productivity with focused efforts like category penetration and customer acquisition programs.

Many of these programs are benefiting from the extensive data we have on our customers.

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

A great example, of how we are harnessing this information is a new marketing program that went live in the second quarter.

This program uses real time customer intent signals along with propensity models and analytics to target and deliver personalized marketing communication across multiple channels, including e-mail search, social and digital.

The program also leverages analytics based on behavior to drive upsell opportunities.

You should expect to see us continue to leverage data analytics to drive enhanced customer experience and sales.

Our second strategy is to continuously expand our solutions capabilities.

By doing so, we capture important pockets of growth across the IT landscape and ensure we remain relevant to customers.

One way we do this is by adding partners, which provides both innovation and a source of growth for us.

In the second quarter, sales from security partners added since 2014, increased over 40%.

New partners are driving growth in security and cloud, with spend for both solutions increasing well into the double digits.

Solutions capabilities will continue to drive growth.

One great example, is the recent award you may heard we received to provide a device-as-aservice solution for the 2020 U.S. Census.

As you know, it's typical for large federal procurements to be protested.

Because of this I can't provide any details right now.

We will provide you with more information as appropriate.

Another way we remain relevant and capture above-market growth, is through our third strategic priority, which is to continue to enhance our services capabilities.

Services capabilities are an integral part of many high end solution sales and are critical to supporting our cloud and security practice.

This quarter, networking services increased double digits supporting our NetComm increase.

As you can see, our investments in solutions and services ensure we can meet the needs of our customers today and in the future, and further differentiate CDW as a valuable business partner.

Our U.K. investment is another way we are accomplishing this.

As you recall, we acquired Kelway in August of 2015 to address requests from U.S. based customers who were increasingly asking for our help with their international IT needs.

U.S. referrals continue to drive meaningful growth for CDW UK, contributing roughly 20% of CDW UK's double-digit growth in the quarter.

And it's not just U.S. referrals.

CDW UK is also driving growth from its own U.K.-based customers delivering solutions around the world.

We're prudently investing to help fuel this growth.

This quarter CDW UK marketing spend was nearly twice last year's level.

Building on our very successful U.S.-based orchestration campaign, CDW is working with key partners across several categories and investing along with our partners to drive greater awareness of CDW's capabilities to deliver integrated solutions both in and outside of the U.K. Efforts like these, along with our dedicated international sales team and CDW International branded websites are driving excellent results.

When we first entered into our 35% equity agreement with Kelway in late 2014, roughly 10% of their customer spend was outside the U.K. In the second quarter that figure was more than 20%.

In fact, approximately 25% of the double-digit growth in local currency this quarter was derived from solutions delivered outside the U.K. Our international platform is being leveraged to help both existing and new U.K.-based customers address their needs around the world.

We have also continued to invest in customer-facing coworkers to drive our growth.

These coworkers include account managers, field sellers, solution architects and service delivery engineers.

We ended the quarter up roughly 130 customer-facing coworkers since the beginning of 2017, adding over 70 this quarter.

Based on what we know today, that feels like the right number to finish the year plus or minus 10%.

As we always do, we will monitor the market and adjust our plans as appropriate.

And that leads me to our expectations for growth for the remainder of the year.

Given first half market performance, our current view of the 2017 US IT market growth is full year growth in the 3.5% to 4% range, driven by continued hardware growth and strength in client devices.

This is an increase of roughly 100 basis points from our prior view.

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

We currently look for outperformance between 350 and 400 basis points.

Of course, all of this is dependent on how the U.S. economy performs.

If the economy stalls, then we would expect to see U.S. IT market growth come back down.

We'll keep a watchful eye on things, and as our practice we will update our view on market growth as we move through the year.

Now let me turn it over to Ann.

Ann?

Thanks, Tom.

Good morning, everyone.

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

They also reflect the progress we are making against our long-term financial strategy to drive strong cash flow, deliver double-digit constant currency earnings per share growth and return cash to our shareholders.

Turning to our P&L, if you have access to the slides posted online, it will be helpful to follow along.

I am on Slide 7.

Consolidated net sales were $4 billion, 9% higher than last year on a reported and average daily sales basis.

Average daily sales were $62.4 million.

On a constant currency basis, consolidated net sales were 9.8% higher than last year.

Currency impact was driven by both the British pound and Canadian to USD translation, shaving roughly 80 basis points off of growth.

Currency impact was 20 basis points lower than the first quarter.

On an average daily sales basis, sequential sales were up 20.1% versus Q1 2017, which was higher than both last year and also our historical Q1 to Q2 increase.

Gross profit for the quarter increased 5% to $641 million.

Gross margin in the second quarter was 16.1%, 60 basis points lower than last year.

The decline was driven by the impact of increased hardware sales and an ongoing competitive marketplace, which pressured our product margin.

Low teens increases in 100% gross margin revenues, which include commissions, warranties and Software as a Service, were not enough to offset our product margin decline.

Turning to SG&A on Slide 8, consolidated reported SG&A including advertising expense was roughly 6% higher than last year.

Reported SG&A includes $11.5 million of equity-based compensation, $2 million of integration expenses and $4.5 million of other expenses, including payroll taxes on equity-based compensation.

Our adjusted SG&A including advertising increased 5%, primarily driven by sales payroll growth and advertising.

Coworker count was up roughly 75 year-over-year to just under 8,800.

Our adjusted EBITDA for the quarter was $314.7 million, up 4.7%.

This delivered an adjusted EBITDA margin of 7.9%, down 30 basis points from last year.

Looking at the rest of the P&L on Slide 9, interest expense was $35.9 million, $1 million lower than last year's Q2 level.

GAAP taxes were $55 million, which resulted in an effective tax rate of 27.9%.

The reduction in effective tax rate primarily reflects excess tax benefits from the vesting of equity-based compensation.

Tax benefits amplified operating income and GAAP net income was $141 million.

Our non-GAAP net income, which better reflects our operating performance, was $163.2 million in the quarter, up 4.9% over last year.

As you can see on Slide 10, non-GAAP net income reflects after-tax add backs that fall in 4 general buckets: the ongoing amortization of purchased intangibles, equity-based compensation and the related payroll taxes and excess tax benefits, acquisition and integration expenses and other nonrecurring or infrequent income or expenses such as net loss on the extinguishment of debt.

This quarter, our Performance Alignment Grant or PAG vested.

The PAG was a onetime equity grant made at the time of our IPO to coworkers up to Senior Manager.

This resulted in $18.6 million of excess tax benefit.

Since we add back equity compensation as a non-GAAP adjustment, we also reversed out that $18.6 million of excess tax benefit.

This adjustment is detailed in the GAAP reconciliation provided with our press release.

With Q2 weighted average diluted shares outstanding of $159 million, we delivered $1.03 of non-GAAP net income per share, up 10% over the prior year.

As we indicated last quarter, currency impact on EPS was similar to the impact on net sales.

On a constant currency basis, non-GAAP net income per share increased 10.8%.

Turning to first half results on Slide 11, revenue was $7.3 billion, an increase of 7.9% on a reported and average daily sales basis.

On a constant currency basis, growth would have been roughly 90 basis points higher.

Gross profit during the first half the year was $1.2 billion, up 5.2%.

Gross profit margin was 6.3%, down 40 basis points.

Adjusted EBITDA was $564 million, 5.7% above first half 2016.

Net income was $199 million for the first half of 2017 and non-GAAP net income was $284 million versus $268 million in 2016, up 6.8%.

On a constant currency basis, non-GAAP net income per share was $1.77, up 11.4%.

Turning to our balance sheet on slide 14, on June 30, we had $79 million of cash and cash equivalents and net debt of $3.2 billion as compared to $3.1 billion at June 30, 2016.

Our cash plus revolver availability was $1.1 billion.

Net debt to trailing 12-month adjusted EBITDA at the end of the Q2 was 2.8x within our target range of 2.5 to 3x.

Our current weighted average interest rate on outstanding debt is 4.2%, 20 basis points below last year due to the term loan repricing and note refinancing that we completed in Q1.

Roughly 95% of our outstanding debt remains either fixed rate or hedged.

As you can see on Slide 15, we maintained strong rolling 3-month working capital metrics during Q2.

For the quarter, our cash conversion cycle was 16 days, down one day from last year's second quarter and below our new annual target range of high-teens to low 20s.

Year-over-year DSO or DPO each increased 4 days.

Cash taxes paid for the quarter were $90.3 million and cash interest was $28.5 million.

Free cash flow for the quarter, which we calculate as operating cash flow plus the net change in our flooring agreement less capital expenditures, was a positive $40 million compared to $9 million in Q2 of 2016.

Year-to-date, free cash flow was $254 million compared to $359 million in the first 6 months of 2016.

As you recall, our first quarter free cash flow was more than $100 million less than last year's due to the year-over-year period and timing differences and a lower-than-expected sequential sales decline.

During the quarter, we continued to execute against our capital allocation strategy, and repurchased 3.1 million shares for $184 million at an average cost of $58.89 per share.

Our capital allocation strategy is comprised of the following 4 components, which you can see on Slide 16.

First, to increase dividends annually.

To guide these increases, in November of 2014, we set a target to achieve a dividend payout of 30% of free cash flow over 5 years.

For this quarter, we will pay a dividend of $0.16 per share on September 11 to shareholders of record as of August 25, up 49% from a year ago.

Since the IPO, our dividends have increased nearly fourfold from its initial annual level.

Second, ensure we have the right capital structure in place.

We have set a target to generally maintain net debt-to-adjusted EBITDA leverage in the range of 2.5 to 3x.

We ended Q2 at 2.8x.

Third, supplement organic growth with tuck-in acquisitions.

Our CDW UK investment is an excellent example of this.

And fourth, return excess cash after dividends and M&A to shareholders via share repurchases.

To support his priority, our board has approved an incremental $750 million share repurchase authorization.

This approval augments the balance remaining in the prior $750 million authorization on which on June 30, there was $283 million remaining.

Our capital allocation priorities support our refreshed 2016 to 2018 medium-term targets, which you see on Slide 17.

These are to grow in constant currency 200 to 300 basis points faster than the U.S. IT market with a targeted adjusted EBITDA margin in the high 7% to 8% range.

Maintain our net leverage ratio between 2.5 and 3x, and deliver low double-digit non-GAAP EPS growth in constant currency.

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

Let me now provide you with a few additional comments for those modeling the rest of our 2017 financials.

I'm on Slide 18.

We currently expect to exceed our annual medium-term target of delivering full year constant currency growth of 200 to 300 basis points above the U.S. IT market growth.

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

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

This primarily reflects the impact of our second quarter higher than typical sequential sales and its impact on Q3 growth, primarily in CDW UK and our government business.

We have 1 less selling day in the Q3 2017, which will result in average daily sales growth higher than our reported sales growth.

This reverses in Q4, where we have 1 extra day of sales, and Q4 reported sales growth will be higher than average daily sales.

We currently look for currency headwinds to come in at an annual average rate of roughly 50 basis points.

This assumes average annual translation rates of $0.75 to the Canadian dollar and a $1.25 to the British pound.

While the pound translation rate is slightly higher than our initial 120 to the pound rate, we remain conservative given the volatility around Brexit talks and timing.

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

With roughly half our adjusted SG&A before depreciation and amortization fixed with the other half variable at gross profit, 1 fewer selling day in Q3 will drive expense growth higher than gross profit growth compressing Q3 year-over-year adjusted EBITDA margin.

Keep in mind, Q3 2016 adjusted EBITDA margin was 8.4%.

This difference in days will shift roughly 200 basis points of adjusted EBITDA growth from Q3 into Q4.

We expect depreciation and amortization to continue at a similar quarterly rate to Q2 at roughly $65 million per quarter, $46 million of which is repurchased intangibles.

We continue to expect total annual book interest expense of roughly $150 million.

With the PAG fully vested, we expect second of equity-based compensation to run slightly below first half levels at a couple million dollars below 2016.

We will book excess tax benefits related to equity compensation in the fourth quarter.

They are expected to be much lower than Q1 or Q2 in the range of $2 million or so depending on our stock price at the time and performance attainment.

Our effective GAAP tax rate in the third quarter will be higher than in the first half, coming in 100 basis points or so above the 2016 level, with our second half rate of approximately 37%.

Non-GAAP add backs for the remainder of the year will be taxed at 36% rate, with any excess tax benefits then reversed out.

You should expect us to continue to use share repurchases to achieve our low double-digit non-GAAP EPS annual growth target in constant currency.

Given U.K. and Canadian operations now represent roughly 10% of our business, it is important to consider currency translation when modeling both top and bottom line in this volatile currency environment.

We continue to expect currency to drive similar headwinds as on our top line.

And that leads us to a few notes for those of you modeling cash flow on Slide 19.

We continue to expect our capital expenditures will be about 0.5% of net sales on an annual basis.

We also continue to expect to deliver our cash conversion cycle within our new target range of high teens to low 20s.

For the full year, there was no change to our expected cash tax rate in the 32% range to be applied to pretax book income before acquisition-related intangibles and amortization, which is approximately $46 million per quarter.

In addition, we continue to pay approximately $20 million in tax annually related to the cancellation of debt income we incurred in 2009.

Cash taxes will be lower in 2017 versus 2016, primarily due to tax deductions from equity compensation.

We continue to expect to deliver annual cash flow within our recently enhanced range of 3% to 3.5% of net sales.

As you recall, in 2016, we delivered free cash flow as a percentage of net sales significantly above this target.

This reflected the onetime benefit of extending key partners to longer payment terms as well as period end timing.

We exited 2016 with more than $250 million of cash and cash equivalents on our balance sheet.

Reinforcing our commitment to return cash to shareholders, we intend to return more than 100% of 2017 free cash flow through dividends and share repurchases, and currently expect the bulk of our repurchase to occur in the first 3 quarters of the year.

That concludes the financial summary.

Before we open it up for Q&A.

Let me briefly address the SEC investigation we disclosed in 2015 relating to vendor partner program incentives.

As you may have seen, during the second quarter, we were notified by the SEC that they had concluded their review with no action recommended.

With that, let's go ahead and open it up for questions.

(Operator Instructions) Operator, please provide the instructions for asking a question.

(Operator Instructions) Our first question is from Matt Cabral with it Goldman Sachs.

You touched on this a little bit in your prepared remarks, but given the acceleration you've seen, just wondering if you could talk a little bit about the sentiment you're hearing from your commercial customers?

And if you're starting to see some of those expansionary projects that you've talked about in the past come online yet?

The answer is -- the short answer is, yes.

As I alluded to, we started to see kind of the continuation of the momentum, Matt, we saw in the first quarter relative to, not only client devices but solutions growth and you saw that reflected in our performance.

Those are the more longer-tail projects that take a little more time.

So we are continuing to see momentum in Corporate.

Got it.

And then just as a follow up.

On the step down in gross margins, was there a conscious change in strategy that you guys made this quarter?

Or was that just more of a function of what the market gave you across the hardware and the competition that you called out previously?

No, Matt.

It wasn't -- it's amazingly consistent with -- the last time we had a strong client refresh, if you look back, I think it was in 2014, it's the same phenomenon when you have customers going through strong refresh.

Those products typically have lower margins.

And so when you get that kind of exponential growth that tends to just put the pressure on.

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

Our next question is from Amit Daryanani with RBC Capital Markets.

I guess, just to continue on the hardware discussion.

Notebook and mobile devices, I think Tom you said, we're up high teens and what I recall yesterday you had a very difficult compared to the June quarter and year-over-year basis at least.

So what's driving this and the comfort that this kind of sustains in the back half versus perhaps it was a pull in or something?

Yes, it was.

It was -- it's funny we talked about that this morning.

It's amazing that we had that kind of growth rate on top of -- not that strong, but pretty strong in quarter last year.

I would say a couple of different things.

One is, it's about refresh cycle time.

If you think about it 2014 was when Windows XP expiration time frame that drove a lot of refresh, you're now 3 or 4 years into it.

So it's about to cycle.

The second behavior we're seeing is a little bit of a interesting perspective is that, some customers are moving ahead with Win 10 as we've talked about.

I think the word I used is a general breeze, that continued.

But he also have some customers who are kind of loading up on 7 so to speak.

And so I think, those 2 things.

I think the third thing is -- and this is amazing performance by the K-12 team.

If you look at their comp last year and specially in client devices, the fact that they were able to continue to grow and Chromebooks continued to be a strong driver.

Those things kind of drove that part of the client refresh.

And at this point, Amit, it looks like it's going to continue through the better part of the year.

One more thing, the other thing driving it was those federal -- big federal client orders that didn't get booked or shipped at the end of last year are kind of coming through the system now.

Got it.

That's really helpful.

And if I just really follow-up.

You guys have had this renewed focus or new found focus, I'd say, on the a Small Business, the 90 to 250 employees or so, and you spend a lot of time and the analysts have been talking about this.

Double-digit growth this quarter, how should we think about the potential to be there to sustain the growth here because imagine you actually have much lower market share in this market versus the broader term that you guys go after?

Look, I would say it's not much lower market share.

I think, the opportunity is great though.

I agree with you, that's why we made the move.

I don't know that I'm going to get into giving guidance on Small Business.

But I will tell you, we're excited about the -- like anything else, when you focus on something and it gives you ability to get up everyday and think about nothing else other than what Small Business customers want.

And the first half of this year, we saw a lot of client refresh.

And we're starting to see momentum in the solutions business.

I mean, we feel really good about the decision and the return on that investment as they start to customize the solutions that they deliver to Small Business.

We would expect to continue strong performance --

Our next question is from Jayson Noland with Baird.

I wanted to start with U.K. at double digits in local, that surprised me and some others have called out softness there.

It sounds like a marketing campaign helped you guys.

So maybe if you could talk about your success there a little bit?

Yes, look, I think it's a combination of factors.

One, clearly the investment we've made in leveraging the orchestration campaign and telling the story about the capabilities of CDW, certainly paid dividends.

I think the second thing is, you have now U.K. being part of the CDW family for better part of 1.5 years or 2 years.

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

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

Okay.

And that make sense.

And then a follow-up on the hardware side.

Storage down with strength in converged and then server up, it seems surprising.

Anything to call out there specifically on server and can that be (inaudible)

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

Can the strength in server continue going forward?

Well, look, we have some things that give some optimism.

You've got the new processer that's coming online at the end of the year.

I think there's some anticipation for that, especially in a couple of segments like our financial vertical.

So that gives you some excitement there.

And hyper-converged and converged, in general, to me, just makes so much sense for customers relative to giving them the density, and yet at the same time, giving them the on-prem control that some of them want for certain workloads.

So I think I would be shocked if we don't continue to see the hyper-converged and converged infrastructure grow.

I would be surprised if Infrastructure as a Service doesn't continue to grow.

And I think the -- what I'll call the traditional server business, it'd be hard because it's been somewhat, I'll use my favorite economic term, lumpy, where we have some strong quarters, where we made some meaningful sales.

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

Our next question is from Matthew Sheerin with Stifel.

Just a couple of follow-ups from the previous questions.

Just one on the seasonality for the rest of the year.

And Ann sort of called that out there that typical first half, second half is a little bit different given the strength that you've seen in the first couple of quarters.

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

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

I would say, it feels normal at this point.

We won't have the overhang, that would be the wrong word.

The supported growth from the client devices near as strong as we've had as we move through the year.

But our federal guys are not saying anything unusual about the normal buying cycles of the federal government, which typically for us ends up being a pretty strong third quarter.

But we have seen some things happen lately in the last couple of years, where as you sell more solutions, they tend to spill over into later quarters.

I don't know Ann, if there's anything else you want to add.

Yes, Matt.

My commentary was, Government had a very strong second quarter.

So we won't necessarily see the normal sequential growth.

Not that Q3 won't be a normal-ish Q3, but if you're looking at sequential growth that's what comments were really pointing out.

So very strong growth in our international U.K. business as well as government.

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

Got it.

And just on the U.K. strength there.

At your Analyst Day you called out the fact that you're expanding your physical footprint into mainland Europe, in several countries now, I believe.

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

Yes, well, as you heard, we've had significant growth outside of the U.K. And Matt, we haven't really opened any new offices.

It was really a function of the existing facilities we have in place, the kind of hub-and-spoke strategy that they have.

And it really has just be leveraging, if you will, the international strategy that I alluded to, the orchestration campaign that drove the increased results and the dedicated international sales team, I think, has a lot to do with -- like anything else with us, when we focus on something we tend to get a return on our investment from a performance standpoint.

I would say it was more that than we didn't open up any new offices.

Our next question is from Shannon Cross with Cross Research.

I'm curious, with dollar shifting to client and the conversations you're having with your customers.

Where are they shifting away from?

I know there is sort of puts and takes and ebbs and flows in this business, but I'm curious is it sort of where clients are maybe deemphasizing or if it's just, at this point, they realize they have to spend on everything?

Okay.

I don't know that there is a generalization I can make, Shannon, because it does seem to depend on the customer.

And if we hadn't had such strong solutions growth, we had nice solutions quarter at 6%, you could say there was a substitution effect.

I don't believe that's the case.

I believe it's more of coming to grips with that there is a refresh required on the client devices.

We also saw, maybe not as evident in my comments, kind of a strong refresh in the NetComm business.

And I think both of those are driven primarily by cycle wishes.

It's refresh time.

And I don't know, if you look across the board, we really didn't have any product category other than printing, which continues to be an ongoing challenge.

Everyone else had really nice growth.

So I don't think I saw a substitutionary effect.

Okay.

That's great.

I then can you talk a bit about what customers are saying on security these days?

And how that's playing into your solutions business.

And some of the other growth you're seeing?

Yes.

Can't get enough would be the probably easiest way to describe it, it feels like to me.

It is interesting though.

I think one of the new things we're seeing is, more discussion at the front end in the planning process.

How do we design security into the solution.

And we started to see that trend last year as compared to maybe 2 years ago, where it was, how do I rectify or how do I enhance the current infrastructure?

And that discussion is probably playing out a lot more today than it had just because people say, "look if we're going to do a refresh cycle we're going to think about security upfront, therefore, we're going to design it in the solution."

Is there any difference between enterprise and Small Business within the securities discussions or are the Small Business customers are really starting to understand the threats at this point?

I would say, the only difference is probably the complexity of the solution.

If you think about just the general nature of the business.

But I would say, we have the same kind of interest level.

The question even comes up, for example, when somebody's doing to refresh cycle on client devices, right?

Where they are now saying, hey, I want to make sure I'm cognizant of the security capability built into the device, I'm not sure we heard that 3 or 4 years ago.

Our next question is from Sherri Scribner with Deutsche Bank.

Tom, I was hoping you could provide a little more color on the strength in the server market.

I know we talked about it in an earlier question, but you guys significant outperformed the rest of the server market.

And I think most people have been talking about some issues and server demand related to higher build material costs.

Can you maybe comment on what's helping you outperform the traditional market?

And then related to that, talking about component costs, you mentioned it a little bit, but are you guys being impacted at all by higher commodity cost, at least in terms of being able to get product or have you had any issues with that?

Okay.

Let me go back to the first one on server.

I think one of the reasons, Sherry, and we've watched this now, I would say, it feels like for the last 2 or 3 years, the cyclical nature of the server market with all of the other things that are kind of going on around it.

Whether it's looking at virtualization.

We had a strong virtualization quarter.

Looking at Infrastructure-as-a-Service, we had a strong Infrastructure-as-a-Service quarter.

Looking at hyper-converged, we had a strong -- So I think what you see is people looking at their landscape and saying, look, there are going to be times when I'm going to decide to extend my on-prem service capability because it doesn't make sense to make a change at this point.

And what I see, and this is more of something that's true in our corporate space is, that doesn't happen every quarter.

It's not like every quarter somebody thinking about doing that, which is why I think you see -- if you look at us even over the last 2 years, it's been up mid-single digits, down low-single digits, up single digits.

So I wouldn't kind of over index on the performance this quarter.

We're thrilled.

Having said that, we have put a lot of resources on focusing on the data center.

And I think, one of the benefits, when you focus on that is you get some improved performance like we saw this quarter.

Now I think that's first part.

Second part, obviously we did see some cost of goods changes in the quarter.

And ironically, in some places we saw cost of goods and increases.

We also saw cost of goods decreases.

Some of that becomes a function of our scale, some of it is a function of supply shortages, but I think the point I was trying to reinforce is, on the whole and on the average, didn't have a meaningful impact on us in the quarter.

Our next question is from Mark Moskowitz with Barclays.

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

What those mean longer term in terms of the -- just more about the need to grow beyond the existing customer base from a land and grab expansion perspective.

And then in terms of having to really just carve out new customer generation from here, and does that mean it's going to be harder?

And the follow up would be, does that mean there could be more acquisitions down the road?

Okay.

So let me take the first one.

It isn't about like new challenges in the marketplace, like it's harder to acquire customers.

It was really something that I've been thinking about for almost 18 months.

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

And that means you constantly look at making sure you have more people with eyes and ears to listen to what's going on with sellers, listen to what's going on with customers and then leverage that across your organization.

So it really is more just about that approach and philosophy.

Look, these results aren't the kind of results that say, "oh my gosh, we're trying to solve some kind of problem," as much as I just want to make sure we're staying seeing a couple of steps ahead.

And we're constantly listening and focusing on the front line.

That was really what drove the first Chris appointment.

And in the second Chris appointment was driven by the driver of doing International in the first place was our corporate marketplace.

And we made great progress now.

And kind of working on the one message platform, and you heard the result.

So that appointment was -- it feels like the right time now to put those 2 together and expect them to take off.

What was the second part?

Oh, do I -- do we expect increase or do we expect to do M&A?

I think, I -- Mark I'll answer the same way I did at the Investor Day.

That is, we think M&A will continue to be part of our future.

It will be looking for specific strategic opportunities versus some kind of general roll up.

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

Our next question is from Adam Tindle with Raymond James.

Tom, you mentioned, an ongoing competitive marketplace in the press release.

I don't recall seeing that much in the past.

Could you maybe give us more clarity on this comment?

And does this tie into some of the management changes that you've been making?

It has nothing to do with the management changes.

And we felt like -- I think I talked about this, Adam, in the past is that, when you're still -- look, GDP as much as it feels a little better now, I don't know what the latest forecast is, like 2.7% or 2.9%, it's still, on the whole on the average, it's still a relatively slow growth environment.

I think when that happens, people compete hard.

And so that doesn't feel like it has changed at all.

I think the only difference this quarter is, you have this kind of rapid growth of client devices coupled with what has become kind of the normal course so to speak, in his marketplace, which is hyper-competitive and you got to grind.

Okay.

And I know margin compression was a bit of a sticking point in the quarter.

But it looks like both revenue and gross profit dollars per employee improved on a year-over-year basis, again in this quarter.

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

Yes, I would say 2 things.

I don't really know that margin was a sticking point in the quarter.

It was just a function of us mixing in the client devices.

I mean -- like I said, if you look back at 2014, Ann and I were doing this the other day, it looks remarkably similar when we have this big client refresh cycle.

The second point though, I think is a point that we have made, I think, consistently since the IPO, in our business model, the thing we really concentrated on is adjusted EBITDA, and that is a percent of sales.

Because it is really that part of the business that is the variable compensation structure.

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

And we really focused in on that.

It's kind of under the theory, you can't totally control GP, but you can control what goes on in SG&A, that's kind of where we focused.

And that yielded some of the benefits you're talking about.

Okay.

Just maybe to clarify on that, I just mean in the sense that we were kind of all, as The Street, expecting higher gross margins or maybe some of that's on us.

So just to clarify, I know 3Q typically declines sequentially due to federal mix?

Might this be different this year given the starting point is a bit lower than we thought?

Yes, I don't know that I can get into -- I mean, a lot of it's going to depend on how much of the client refresh continues.

At that, at the end of the day, what I would say is, don't overthink this one.

There's just a strong client refresh.

And we're going to help customers with that.

We're not going to walk away from that.

Maybe because clients may not have as strong a margin as solutions.

Because over the long run, when we have clients with these kind of problems, they don't forget that.

Our next question is from Keith Housum with Northcoast Research.

Just wanted to examine a little bit the challenges in Healthcare.

Obviously your guess is as good as mine with what's going to happen with that on the federal level.

But as you guys are talking to your customers, and it was the time of the quarter where the healthcare challenges were getting worse.

And what happens if nothing happens over the next 6 months through Congress?

Is the headwinds are going to go worse there?

If I could answer that question, I don't know what I'll do next in life.

But I would tell you this, and was confirmed, we actually have a board member who is in the healthcare industry and ironically his description of what people are experiencing was very similar to what we have been telling you, which is the lack of clarity, especially for the major hospitals, makes it hard, because they are not sure about how they're going to be reimbursed.

When you're not sure on how you're going to be reimbursed, you're going to be cautious on spending.

And that whole scenario just continues to play out.

And I don't know that I have the skills to forecast what's going to happen in Washington and how it's going to impact healthcare.

I just know that it's amazingly consistent across our healthcare customers.

And the story we hear relative to what it means to how they run their business.

I would say, Keith, that's the one thing that I think keeps [coming] home.

The IT spend on IT issues are a direct derivative of the overall management of the healthcare institution and facility.

And so it gets impacted just like everything else.

And I think that's what we're hearing time and time and time again.

Okay, great.

Changing gears, I guess, slightly here, to the product shortages.

It sounds like 2 quarters in a row where the shortages have been out there but you guys have been able to not get impacted by that.

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

Well, yes.

Look, you're always concerned when there are shortages.

I'm hopeful we can continue to take advantage of our scale and buying behavior to mitigate those.

But I don't know that I would guarantee that to anybody.

And the next question is from Katy Huberty with Morgan Stanley.

Have you changed your outlook for back half market growth after the strong second quarter?

And when you think about the 350 to 400 basis point outperformance, is that mostly flowing through your performance in 2Q or do you think you'll outperform by that much in the back half?

So Ann will answer that.

Yes, so, Katy, on the earlier in the year we saw that market growth was going to be a bit above 2 to a bit above 3. So we have taken up our view of market growth for the year as well as a how much we think we're going to outperform the market.

We now think 350 to 400 basis points.

Those are annual numbers, right?

So keep that in mind.

We don't further segment it by quarter or by half.

We did say that our sequential -- the split, if you will, our first half to second year this year might be a little front-end loaded roughly 50 basis points because of the strong performance, particularly, in our U.K. business and our government business in Q2.

And I'm showing no further questions.

So I would now like to turn the call back over to Tom Richards for any further remarks.

Okay.

Thanks, everybody, as always for your time and your attentiveness and your questions.

You've heard me say this before.

I find your questions very helpful in making sure we're thinking about the right things.

So thank you.

I just want to squelch a rumor; it's not true that you have to be named Chris to advance here at CDW.

So I want to make sure my team hears that.

Okay, thanks, everybody.

Have a great summer.

See you all, bye.

Ladies and gentlemen, thank you for participating in today's conference.

You may all disconnect.

Everyone, have a good day.