CDW Corp (CDW) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to CDW's Third Quarter 2017 Earnings Conference Call.

(Operator Instructions) I'd now like to introduce your host for today's conference, Mr. Tom Richards, Chairman and CEO.

Please go ahead.

Thank you, James.

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 Chief Revenue Officer; Collin Kebo, our Vice President Financial Planning and Analysis and CFO International; and Sari Macrie, our VP, Investor Relations.

I'll begin today's call with a brief overview of our results and key drivers.

Chris will run through our sales organization's performance, and Ann will take you through a more detailed review of the financials.

And then we'll you right to your questions, but before you begin, Sari will present the company's safe harbor disclosure statement.

Thanks, Tom.

Good morning, everyone.

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 earnings per share.

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

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

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

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

There was 1 fewer selling day in the third quarter of 2017 compared to the third quarter of 2016, and 1 fewer selling day in the first 9 months of 2017 compared to the first 9 months of 2016.

All sales growth rates provided during the call will reference average daily sales growth, 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 call -- turn the call over to Tom.

Thanks, Sari.

I'm pleased to report that CDW posted another quarter of profitable growth and, for the first quarter in our history, delivered $4 billion of net sales.

Results for the quarter included a 10.5% increase in average daily net sales, with net sales of $4 billion; a 4.5% increase in adjusted EBITDA to $324.3 million and a 10.8% increase in non-GAAP earnings per share to $1.08.

Once again, our ability to deliver this excellent performance was the result of 3 key drivers: Our balanced portfolio of customer end markets; the breadth of our product and solutions portfolio; and our variable cost structure.

You've heard me talk about these drivers since our IPO, but the way they have contributed to our profitable growth has been very different depending on market conditions.

Last year, third quarter results were impacted by macroeconomic uncertainty, which led business customers to focus on sweating assets and optimize every dollar of investment.

The breadth of our product offering enabled us to meet customer demand and drove meaningful growth in many solutions that are netted down, like warranties and software assurance.

This year, we have a very different dynamic playing out in the market.

The business market has been more vibrant and, as expected, hardware growth has accelerated throughout the year, driven by both sustained excellent growth in transactions hardware and acceleration in solutions-based hardware sales.

Let's take a look at how performance drivers helped drive profitable growth again this quarter.

First, our balanced portfolio of customer end-markets.

As you know, we have 5 U.S. sales channels: Corporate, which serves customers with coworkers from roughly 250 and up; Small Business, which serves customers with up to 250 coworkers; Healthcare, Government and Education, each generating annual sales of more than $1 billion.

We also have our Canadian and U.K. operations, which together represent more than USD 1 billion.

Given the different macroeconomic and external factors that impact each of these unique customer end-markets, our channels often act in a countercyclical way.

For example, in last year's third quarter, results were mixed across the business with Public sales increasing 11%, Small Business increasing 7%, and Corporate decreasing roughly 2%.

This year, performance was more balanced across our segments, with Corporate up 11%, Small Business up 12% and Public up 7%.

Chris is going to take you through the performance in each of our sales channels.

Chris?

Thank you, Tom.

Good morning, everyone.

Our Corporate team delivered an 11% increase in the quarter.

We continue to see ongoing focus on refresh, driving excellent growth in client devices.

In addition, continuing the momentum we saw building in the second quarter, solutions growth accelerated as larger projects continued to get the greenlight.

In fact, solutions growth outpaced transactions, but both increased double digits.

Small Business increased 12%.

We saw a slight acceleration in solutions activity, but for the most part, customer focus was on client devices.

Transactions increased mid-teens, solutions increased low-single digit.

Public grew 7% in the quarter.

Government performance drove much of the increase with the team delivering 15% growth, driven by balanced performance across both end-markets.

State and Local delivered low double-digit growth, as we continue to drive results from new contracts and success meeting public safety needs.

Federal increased mid-teens, as we continue to benefit from our strategic program alignment as well as the shipment of a majority of remaining client devices that had pushed into 2017.

Beyond those shipments, we saw excellent growth in client devices as we helped various Department of Defense agencies meet the mandate to move to Windows 10.

Healthcare purchasing behavior was once again impacted by the ongoing uncertainty around reimbursements and the fate of the Affordable Care Act, and sales were flat.

We did see some transactional activity pick up, as some customers determined they needed to move ahead to refresh client devices, but overall, demand remained muted.

Education sales increased 6%.

Higher Ed delivered a high-teens increase, which was driven by client refresh, collaboration and video solutions.

K-12 delivered low single-digit growth on top of last year's high-teens growth.

The team had success delivering networking solutions, utilizing both E-rate and nonfunded dollars, but that was partially offset by flat client device sales as schools digest what they've purchased over the past few years and focus on maintaining existing equipment.

The K-12 team continues to make progress helping schools create the classroom of the future and saw excellent growth in related technologies like video equipment and collaboration.

Our international teams delivered excellent growth with combined sales up 25% in U.S. dollars.

Canada and U.K. grew at similar rates in U.S. dollars, with Canada benefiting roughly 500 basis points from translation and U.K. being negatively impacted by roughly 40 basis points from currency.

Both teams are out-executing their competitors.

In Canada, while concerns regarding trade and the economy remain, the market feels a bit more stable, and we saw excellent results in both the Public and Corporate markets.

In the U.K. Brexit does not appear to be impacting demand yet.

In addition to strong local growth, results continue to reflect excellent success addressing U.S. referrals.

With that, let me turn it back to Tom.

Tom?

Thanks, Chris.

Clearly, the double-digit growth we delivered demonstrate the power of the first driver of our performance, our balanced portfolio of customer end-markets.

These top line results also demonstrate the power of the second driver of our performance this quarter, the more than 100,000 products and solutions in our portfolio and more than 1,000 leading and emerging partners.

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

Our broad portfolio contributed to this quarter's performance, and we saw balanced growth with transactions increasing low-double digit and solutions increasing high-single digits.

As expected, hardware growth continued strong and accelerated in the quarter to 10%, 2.5x faster than last year's 4% growth rate and more than 200 basis points faster than the second quarter.

We continue to see excellent growth in client devices, which once again increased mid-teens.

We also saw continued strength in NetComm hardware, which for the third quarter in a row, increased high-single digits.

Video equipment and collaboration hardware growth also accelerated in the quarter.

Server solutions increased low-single digits.

But the server hardware component decreased low-double digits, as customers focused on memory additions, virtualization, warranties and other accessories.

Enterprise storage growth accelerated in the quarter, up high-teens.

Customers continue to focus on modernizing and optimizing data center infrastructure.

Growth across hybrid infrastructure, which includes converged infrastructure, Infrastructure as a Service and software-defined data center was excellent.

Converged Infrastructure and Flash represented more than 1/3 of our total storage revenues this quarter.

A meaningful part of those revenues come from hyper-converged solutions, which doubled in the quarter.

In fact, hyper-converged contributed more than 75% of enterprise storage growth.

New technologies are clearly impacting hardware growth at CDW.

New technologies are also impacting software spend, as software becomes a larger component of IT solutions, whether it is being integrated into new advanced architectures, particularly in the data center, or a standalone delivering important capabilities like security.

You can see that in our third quarter software results, which were up 7%.

In addition to continued double-digit growth in security, we also saw double-digit increases in storage software.

Both, software booked in the traditional manner and netted down software, which includes software assurance and cloud, increased in the quarter and gross profit increased in line with sales.

Services increased 7%.

Warranties increased high-single digits on top of last year's mid-teens increase.

Recall that warranties like software assurance and Software as a Service are netted down for accounting purposes.

This quarter, the acceleration in hardware and associated product margin compression offset the impact from netted down revenues.

Product margin compression isn't new.

We've seen this before when we have had significant growth in hardware.

There was no change to the impact that vendor incentive rebates have on our gross margin, no change to the ongoing competitive marketplace.

What was different this quarter was the meaningful acceleration in hardware growth.

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.

Sales compensation is highly variable for 2 reasons: First, it varies with gross profit growth; second, it varies with sales mix as solutions sales involve technical resources and transactional sales do not.

When top line grows faster than gross profits, as it did in the quarter, the variable nature of our cost structure mitigates the impact of gross margin compression.

This quarter, as it has in the past, our business model worked exactly as it is intended to, and our adjusted EBITDA grew in line with our gross profits.

Clearly, this is a key driver of our ability to deliver sustainable profitable growth.

Another key driver of our sustainable growth is our focus on staying relevant to our customers as technology and customers' needs change.

A key way we ensure we are focusing resources in the right areas is our in-depth strategic planning review, which we perform every 3 years.

One of the outcomes of our strategic review in 2014 was our decision to invest in international capabilities.

It has been 2 years since we've brought on CDW U.K., and you can certainly see the impact of that investment on our results.

As you recall, this strategic acquisition was made to address requests from U.S.-based customers who're increasingly asking for our help with their international IT needs.

U.S. referrals continue to drive meaningful growth.

For CDW U.K., U.S. generated referrals to the U.K. were 50% higher than the third quarter of 2016.

That increase in referrals generated 1/5 of their 20%-plus growth in the quarter.

These results are terrific and a great validation of our investment thesis for the acquisition.

Let me share an example of how this is working.

A U.S.-based customer in the data analytics field was about to embark on a global network upgrade.

They wanted a single solution across 39 countries.

It was a daunting project for the customer since they had very small teams in country and didn't want to fly IT staff around the world for multiple phases of the rollout.

Now, we don't have coworkers in all 39 countries either, but our model is built on having referral relationships in key markets.

We designed a solution that uses established partnerships with third-party providers to handle the local aspects of the 4-phase rollout.

The solution we designed is comprised of both hardware and services and is delivering revenues to both the U.S. and the U.K. The U.S. and the U.K. portions of the hardware sales are roughly in the same $3 million range.

In addition, the customer spent more than $1 million for services, which included a warranty renewal.

We also provided a proprietary tool, the U.S. team had created, that helps customers manage their networks while monitoring warranty performance.

Clearly, this solution delivered value for our U.S.-based customer.

Value we could not have delivered without the strategic investment we made in international capabilities in CDW U.K. We addressed the need for international capabilities that we identified in our last strategic review via acquisition.

Another way we invest in building strategic capabilities identified in our review process is by adding customer-facing coworkers.

These include field sellers, solution architects and service delivery engineers required to ensure our sellers have the support structure they need to stay relevant to customers.

Field sellers, who work face-to-face with customers in advanced integrated solutions, have grown nearly 40% since 2013.

You can see the impact of our investment in customer-facing coworkers and the results of our security and cloud practices this quarter.

Both areas delivered excellent double-digit increases in customer spend.

We continue to prudently invest in coworkers to ensure we drive profitable growth.

We ended the quarter with new customer-facing coworkers in line with last quarter, up roughly 130 since the beginning of the year.

There is no change to our expectations for the full year, which is to remain at this level, plus or minus 10%.

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

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

Given year-to-date market performance, we have increased our view of 2017 U.S. IT market growth and now look for market growth around the 4.5% range driven by continued strength in hardware, both solutions and transactional.

Reflecting our performance to date, we've also increased our expectations for exceeding market growth and now look to outperform the market between 425 and 450 basis points.

Balancing profitable growth with investing in our future has been a key to our ability to deliver on our annual medium-term targets.

We are in the process of completing our strategic planning process for the 2018-2020 cycle.

As we've done in the past, you should expect us to invest to drive future growth, while at the same time, deliver on our medium-term annual targets.

For 2017, we expect to deliver constant currency earnings per share growth at the midpoint of our medium-term annual target of low-double digits.

I hope you can tell from these comments that this quarter's performance reinforced our confidence that we have the right strategy in place, a strategy that serves us well under different market scenarios and positions us for profitable growth in the future.

This confidence has led our board to approve a 31% increase in our quarterly cash dividend, consistent with our capital allocation priorities of achieving a dividend payout of 30% of free cash flow by year-end 2019.

I know many of you may be wondering what to expect for 2018.

We are in the middle of our planning process.

And as we always do, we will provide our 2018 outlook on our year-end conference call.

As you know, Ann will be retiring from CDW at year-end.

Before I turn the call over to her to review financial results for one last time as CFO, I want to take a moment to thank her for her incredible service and contributions to CDW.

I'd also like to introduce Collin Kebo to you who will be assuming the mantle of CFO on January 1. Ann and Collin have partnered together closely for many years.

This transition is a great example of our succession planning process in action.

Collin is a seasoned thoughtful executive.

He's been with CDW for 9 years with increasing accountability and was deeply involved in our IPO as well as our investment in CDW U.K. In fact, he spent 18 months in London when he assumed the role of CFO International.

Prior to joining CDW, Collin held a number of senior finance roles at PepsiCo.

Ann, you've been a great partner and, on a personal note, great friend.

Thank you.

You will be missed, but you've left us in good hands with Collin.

You'll be hearing from Collin on our next earnings call in early 2018.

With that, let me turn over to Ann who will share more detail on our financial performance.

Ann?

Thanks, Tom.

Good morning, everyone.

As Tom indicated, our third quarter financial results reflect the combined power of our balanced portfolio of customer end-markets, 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 low-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'm on Slide 7. Consolidated net sales were $4 billion, 8.8% higher than last year on a reported basis and 10.5% higher than last year on an average daily sales basis.

Average daily sales were $64 million.

On a constant-currency basis, consolidated net sales were 10.4% higher than last year.

Currency impact was slightly positive this quarter, adding roughly 10 basis points to growth as improvement in translation of the Canadian to U.S. dollar more than offset slightly unfavorable translation of the British pound to U.S. dollar.

On an average daily sales basis, sequential sales were up 2.6% versus Q2 2017, which was higher than last year.

Gross profit for the quarter increased 4.5% to $642 million.

Gross margin in the third quarter was $15.9 million, 70 basis points lower than last year.

The decrease primarily reflects the impact of both hardware rate and mix on product margin, which more than offset the impact we saw from netted down revenues.

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

Reported SG&A also includes $10 million of equity-based compensation and a one-time $4.1 million expense related to the reinstatement of the prior years' unclaimed property balances due to a retroactive Illinois State law change.

Our adjusted SG&A including advertising increased 5%.

This reflected both the benefit of sales compensation bearing in line with gross profit and the expected impact of 1 fewer selling day on expenses.

Coworker count was up roughly 200 since year-end 2016 to more than 8,700.

Our adjusted EBITDA for the quarter was $324.3 million, up 4.5%.

This delivered an adjusted EBITDA margin of 8%, down 40 basis points from last year.

Looking at the rest of the P&L on Slide 9, interest expense was 37.8 million, essentially flat compared to last year's Q3 level.

Turning to taxes.

GAAP taxes were $77 million, which resulted in an effective tax rate of 37.5% compared to 36.5% tax rate in the third quarter of 2016.

The increase in effective tax rate is a result of a change in Illinois State tax rates and lower tax benefits related to equity-based compensation.

On a GAAP basis, we earned $129 million of net income.

Our non-GAAP net income, which better reflects our operating performance, was $168 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 into 4 general buckets: The ongoing amortization of purchased intangibles; equity-based compensation; acquisition and integration expenses; and other nonrecurring or infrequent income or expenses.

Tax adjustments to arrive at non-GAAP net income include tax-affecting add-backs at 36% and the reversal of the excess tax benefits related to equity-based compensation as well as other minor adjustments detailed in the reconciliation provided in our press release.

With Q3 weighted average diluted shares outstanding of $156 million, we delivered $1.08 of non-GAAP net income per share, up 10.8% over the prior year.

There was a de minimis currency impact on EPS.

Turning to first 9 months results on Slide 11.

Revenue was $11.4 billion, an increase of 8.2% on a reported basis.

There were 191 and 192 selling days in the first 9 months of 2017 and '16, respectively.

On an average daily sales basis, net sales growth versus the first 9 months of 2016 was 8.8%.

On a year-to-date basis, currency shaved roughly 50 basis points off-growth.

Gross profit during the first 9 months of 2017 was $1.8 billion, up 4.9%.

Gross profit margin was 16.2%, down 50 basis points.

Adjusted EBITDA was $888 million, 5.3% above the first 9 months of 2016.

Net income was $328 million for the first 9 months of 2017, and non-GAAP net income was $453 million versus $429 million in 2016, up 5.6%.

Non-GAAP EPS growth was 10.7%.

On a constant-currency basis, non-GAAP net income growth would've been roughly 50 basis points higher or 11.2%.

Turning to our balance sheet on Slide 14.

On September 30, we had $98 million of cash and cash equivalents and net debt of $3.3 billion as compared to $3.1 billion at September 2016.

Given the combination of accelerating hardware sales growth and taking strategic stocking positions, we drew down our revolver in the quarter.

Our cash plus revolver availability was just over $940 million.

Reflecting this, our net debt to trailing 12-month adjusted EBITDA ticked up 0.1% versus the second quarter and was flat versus Q3 last year at 2.9x within our target range of 2.5 to 3x.

Our current weighted-average interest rate on outstanding debt is 4.2%, 10 basis points below last year due to the term loan repricing and note refinancing, we completed in Q1.

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

As you can see on Slide 15, we maintained strong rolling 3-month working capital metrics during Q3.

For the quarter, our cash conversion cycle was 19 days, up 1 day from last year's third quarter and within our annual target of high-teens to low 20s.

Year-over-year, DSO increased 4 days, while DPO increased 3 days.

Cash taxes paid for the quarter was $73.5 million and cash interest was $42.5 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 $85 million compared to $138 million in Q3 2016.

Quarterly free cash flow was impacted by acceleration in our sales growth, strategic stocking positions and mixing into sales to government customers, which are typically slower payers.

For first 9 months of the year, free cash flow was $339 million, $158 million than last year's first 9 months.

Recall that one-time items positively influenced free cash flow in 2016.

During the quarter we continued to execute against our capital allocation strategy and repurchased 2.8 million shares for $175 million at an average cost of $62.13 per share.

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

First, to increase our dividends annually.

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

For the quarter, we will pay a dividend of $0.21 per share on December 31 to shareholders of record as of November 24, up 31% from a year ago.

Our dividend is nearly 5x our initial annual level of $0.17 per share at our IPO in June of 2013.

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 2.5x to 3x.

We ended Q3 at 2.9x.

Third, supplement organic growth with tuck-in acquisitions.

Our CDW U.K. investment is an excellent example of this.

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

At the end of September, we had $858 million remaining on our current share repurchase authorization.

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

These are to grow in constant currency 200 to 300 basis points faster than the U.S. IT market with targeted adjusted EBITDA margin in the high 7% to 8% range; maintain our net leverage ratio between 2.5x and 3x and deliver low double-digit EPS growth in constant currency.

As Tom indicated, we expect to deliver full year non-GAAP net income per share growth in constant currency at the midpoint of our medium-term target of low double-digit growth, which we define as 10% to 12%.

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

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

I'm on Slide 18.

Given performance in the first 9 months of the year, we now expect to outgrow the market by more than 400 basis points, likely between 425 and 450 basis points.

We have 1 more selling day in Q4 2017 versus Q4 last year.

The reported sales growth will be higher than average daily sales growth in the fourth quarter.

We have the same number of selling days for the year.

We currently look for currency headwinds to come in lower than our previous estimate, at an annual average rate of roughly 20 basis points for 2017.

This is in translation rate of $0.80 to the Canadian dollar and $1.30 to the British pound in the fourth quarter.

In Q4, we expect positive currency translation impact of about 70 basis points.

Given current expectations that hardware growth will continue to outpace the impact of netting down for the remainder of the year, we continue to look for our annual adjusted EBITDA margin to come in at the low end of our target range.

We expect depreciation and amortization to continue at a same rate as Q3 at roughly $66 million per quarter, $46 million of which is for purchased intangibles.

With the acceleration of sales throughout 2017, we now expect total annual book interest expense to be roughly $151 million, $1 million higher than our previous estimate.

We continue to expect our GAAP tax rate to ramp up as we move through the year.

Due to higher than anticipated benefits relating to the vesting of equity compensation, we now expect our full year effective GAAP tax rate to be between 32% and 33%.

Note that we have not assumed any reduction in the U.S. corporate tax rate.

Our lower effective tax rate primarily relates to the favorable impact of recording excess tax benefits related to equity compensation.

Q4 equity-based compensation is expected to be slightly below 2016 levels.

Remember, since we add back these expenses for non-GAAP net income, the tax benefits will be excluded from our non-GAAP net income.

Our all-in non-GAAP income tax rate is expected to be roughly 37% for the full year.

As we have achieved our annual target level for share repurchases in the first 9 months of the year, average shares outstanding the fourth quarter will be roughly the same level as in the third quarter.

Finally, a few notes for those of you modeling our cash flows.

First, we continue to expect our annual cash flow to come in within our enhanced rule of thumb of 3% to 3.5% of net sales.

As you'll recall in 2016, we delivered free cash flow as a percentage of net sales well above this target primarily due to the one-time benefit of extending a key partner to longer-payment terms.

Second, our capital expenditures will be about 0.5% of net revenues on an annual basis.

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

For the full year, we expect the cash tax rate in the 30% range to be applied to pretax book income before acquisition-related intangibles 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 '16 primarily due to tax deductions from discrete items related to equity and deferred-compensation payout.

That concludes the financial summary.

Before we open it up for questions, I'd like to take a moment for a few "thank yous" myself.

First, thank you, Tom.

It's been a pleasure working alongside you for the past 10 years.

I'd also like to thank my team.

My time at CDW has been some of the most rewarding of my career due in large part to the talented team I have worked with including, of course, Collin.

Finally, let me thank many of you on this call.

I have thoroughly enjoyed my time interfacing with the financial community.

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

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

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

Obviously, there's been renewed talk around corporate tax reform coming to Washington.

I'm just curious if that started to have any impact on your customer-spending plans?

And if at all that anticipation is set into some of accelerating revenue growth you've seen so far this year?

Matt, I would say I don't think it's been a major factor.

I think, like me, many of my peers look at it as something we would like to happen, but we're not spending that buck yet.

So I think, more so, what's happening, Matt, is a general overall increasing confidence about the economy, and where it stands going forward.

I guess, you could indirectly relate that to the potential for tax reform, but I think that's more of what we're feeling as just, as I said, a more vibrant economy and people are moving forward with projects as you heard Chris alluded to.

Got it.

And then as a followup.

You spent some time on this in the prepared remarks, but international continues to significantly outpace the wider business.

So can you just talk a little bit more about what's driving the continued strength there?

And just how you're thinking about the opportunity to expand beyond U.K. and Canada over time?

I'm going to let Chris take a run at that this since she had a lot to do with the success of the international team.

I'd say there's a lot of things contributing to the performance of international.

As you've heard Tom mentioned on past calls, some of the programmatic approaches that we've brought to the U.K. and the prescriptive approaches we've taken have done some good things.

The marketing investment we made to bring the orchestration campaign over there as well as success in the referral model.

We've done a lot of work around that go-to-market and referral model, and we're seeing great strength there.

And then we also have an international team sitting there in the U.K. working on not just U.K. work, but also opportunities outside of the U.K. So it's really what I'd call a confluence of events.

It's focus on that team.

It is the collaboration between the U.S. and the U.K. team and just a real focus on what we need to do for our global customers.

And I would also say that our partners that we're working with have been very collaborative and cooperative in helping us achieve a seamless experience for our customers as well.

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

I guess a couple of questions from me too.

Maybe just start off with on the gross margin line.

I think it was down like 70 basis points year-over-year, and you guys talked about competitive dynamics and hardware mix.

I'm wondering, can just talk about -- maybe help us understand which was the bigger driver in the quarter year-over-year at least for the competition or the hardware mix?

And is the competition really all on the hardware side?

Or is it more broad-based across the portfolio?

Let me talk a little bit about the competitive landscape and then I'll have Ann give you a little more clarity, Amit.

I would say if you look at -- as I said, one of the things to keep in mind, it is amazing how consistent this year looks compared to what we experienced in 2014.

In fact, even from a gross margin tracking through the year, and that was the time when we had the big hardware refresh of client devices because of the Windows XP expiration.

So we are experiencing almost exactly the same thing and that had one impact.

The second thing is, as you heard, we've had this constant increase of what I'll call solution performance as we'd marched through the year and a lot of that has been hardware refreshing of the data center.

So just in general, those 2 things create what I would call the margin pressure.

The competitive landscape hasn't changed dramatically through the year.

It feels intensely competitive.

And in our case, I know we've talked away from deals that just look like they're not worth making the investment of resources because of what the customer feels like they can get in the marketplace, and I love that discipline about us.

I'll let Ann add any additional commentary.

Yes.

The only I would -- the only additional point I'd make is that last year, we saw significant benefit from the "mix into netted-down items." We did not -- if you look at last year's Q, we quantified that at roughly 30 basis points.

We did not have that impact this year.

So it's the absence of that mix, if you will, which you see when you see our hardware sales accelerate across both the transactional and Solutions business.

So that would be the single largest driver and then you have mix in rate as well.

Yes.

Just a really interesting fact.

If you look at the netted-down revenue growth, it was as strong, almost literally as strong this year as last year.

And you just heard Ann talk about the fact that the growth was pretty strong in netted-down revenues.

It just couldn't offset this kind of, I don't know, tidal wave of hardware growth we've had going on in the businesses.

That's really helpful by the way.

I guess, maybe, Tom, just to follow that up.

How sustainable do you think this hardware growth is as you go forward?

I know it sounds like December quarter will be another good quarter for hardware, but broadly do you think this sustains into early to mid-'18, especially as you get the server refresh cycle going?

Which is the 1 product that you mentioned that hasn't grown very well, is the server hardware side.

So maybe you can just talk to the sustainability of this in your go forward?

So I think -- let's break it into pieces.

So the client refresh were into the third or fourth quarter.

If you look back, just history repeats itself.

In 2014, it kind of was a fourth quarter refresh.

So I don't have clairvoyance on this, but I would say we probably are in the seventh to eighth inning, as you guys like to ask about that part of it.

I think in the hardware side, if you look at the hardware side of solutions -- and the one thing I'll say, Amit, is the server solutions business, which includes the software and the warranties, has continued to have a pretty good Steady Eddie kind of growth trajectory.

I would say if the marketplace and the economic perspective stays as vibrant as it has been, then I think we can expect that hardware refresh to continue.

Although, again, if I look at 2014, it was amazing that the flip happened sometime into the next year where -- then the solutions and some of the things Ann talked about, which was the netted-down software seemed to then surpass hardware from a growth perspective.

Our next question comes from Jayson Noland with Baird.

I want to ask on economics.

Tom, I think you mentioned this in the prepared remarks that we hear, generally hear smaller partners saying things have gotten tougher.

But a lot of times larger partners say that services side of the business has created opportunity -- investment and opportunity.

But I'd like to hear you talk about economics to CDW, and if there's been a change there.

Let me make sure I understand, Jayson.

So are you talking about just the services business generally in the marketplace?

Because if you are, I would say that the change of the IT consumption model and where -- how people are preferring to consume IT has continued to provide, if you will, increased services opportunity.

You can see that in our cloud business, the success of our cloud business and our, what I'll call, more professional services business.

I'm not sure I know if that's the connection that you were making to the economics.

Have your vendor partners put incremental pressure on the hardware side of the business?

And is services offsetting that, or...

No, I would tell you.

We talk about this a lot.

They're doing what you would do if we were in that place, which is as you move through the cycle of products, you continue to shift where you motivate people to spend their time to those products that are new and strategic to your business.

And it's incumbent upon people like CDW to anticipate where they're headed.

And then, if you will, go find the cheese.

So we've been pretty good at staying ahead of where they're asking us to go relative to their new capabilities.

And a follow-up on Fed.

Mid-teens growth is strong whereas some others have struggled.

I think client devices played a role there.

Any other color you'd add for Fed?

Yes.

I'll take a shot at it and then let Chris give you any extra color.

I'd say your instincts are right that the client device driven by a combination of the large orders we've been talking about all year and even though you didn't ask, somebody will.

So I'll -- we have shipped 80% of those, they're now out the door.

So we have 20% left.

And then, I think the federal government Windows 10 mandate really has driven a lot of the activity.

But it wasn't just that group that did well.

I would say collaboration services or other areas that did well in the federal government.

So it's been really nice balance.

Our next question comes from Matt Sheerin with Stifel.

Just a question again on the gross margin.

In your commentary, you talked about vendor rebate programs not really impacting the margins, but some of your competitors and distributors have talked about a lot of program changes with some of the big hardware vendors which are putting pressure on margin.

And it sounds like you're managing that pretty well.

What's the difference between what you folks are seeing and how you manage it versus perhaps, others?

I tell you, I don't really know what others do.

So it makes hard for me to comment on that aspect of it.

I think the one thing that I would tell you is, we have a mindset that, look, they're going to change every quarter, they're going to change every period and that doesn't mean that all these changes are layups.

It does mean that you've got to try to stay ahead of them when it comes to where they're -- where they want you to spend their time.

So I don't want to suggest that we aren't experiencing the same changes.

I think the word that I tried to use was we've been able to kind of not have a meaningful impact of those changes relative to where we spend our time.

That's part of, I think, the art, if you will, of this is assessing the changes and assessing where you need to make sure your resources are focused so that you take as much advantage of the changes as you possibly can.

Okay, great.

And on the headcount, which I know is up 200 or so.

What's left in terms of the expansion plans for coworkers?

I'm sorry, Matt, we're going to -- let's make sure I answer it the way I think you asked the question is.

The -- on the customer-facing, it's about 130, right?

And I think Ann alluded to, in the aggregate it's in the 200 range.

Yes.

I think Tom's number is year-over-year and mine was year-to-date.

Mine includes total coworkers.

Remember, roughly 2/3 of our coworker count is customer-facing with the remainder being, as we refer to it, as backbone.

So my number was total, but on the customer-facing, as Tom said, roughly where we sit today, plus or minus 10%.

Our next question comes from Katie Huberty with Morgan Stanley.

A lot of your vendor partners are talking about a shift back from public cloud to hybrid strategies.

Just curious about something that you're seeing in your customer base.

Yes.

The reason I'm laughing is because this pendulum just kind of swings back and forth and back and forth.

Here's what I would say, Katy.

I think if you have the lens on of a customer, that they have been pretty consistent as they kind of march down the evolution of the data center.

The workloads that lend themselves, as you well know, to public cloud are going there, but I think the success of what I'll call the on-prem response, be it converged infrastructure or hyper-converged, has made the decision even more and needing to be more thoughtful, because now we have some on-prem solutions that provide the economics, the flexibility and in the end, I think the customer wins because they sit there and say, "I have the ability to go workload by workload and decide what makes best for us." And I think you saw some of that.

If you just look at our overall success in converged and hyper-converged, clearly, you have customers that are excited about that technology.

But on the other hand, you heard me talk about how great our cloud growth is going.

So I think it's just the pendulum swinging back and forth.

I don't know that I call it dramatic, Katy.

Okay.

That's helpful color.

Ann congrats on the retirement.

Quick question for you.

You talked about the revolver is higher on the back of hardware growth and also some stocking of inventory.

Can you just talk about where that inventory stocking is happening?

And is that just an outlook into the fourth quarter?

Or is that a longer-term bet?

Yes.

Actually, on the inventory, we took some strategic stocking positions in the third quarter in anticipation of price increases across product categories.

So I don't want to be specific on the product categories.

So we saw the opportunity and potentially there could be opportunities in Q4 as well.

Our next question comes from Sherri Scribner with Deutsche Bank.

So the revenue growth continues to be very strong, and you guided revenue growth higher, yet again this quarter.

But it seems like the EPS growth is the similar guidance.

So maybe I'm sort of nitpicking and maybe there's another percent of growth in the EPS and we're at the higher end of the 10% to 12% versus the lower end last quarter.

But could you maybe talk about some puts and takes that aren't giving you as much leverage to deliver that revenue growth down to the bottom line?

Well, there's a lot in that one.

So I would say if you kind go back to what's driving the growth -- again, I think it's always important to look at, at least at a company like CDW, the source of the growth.

And I'll contrast it with last year where you had a lot of growth in netted-down revenues, software assurance, warranty, where you just have less of a cost of goods sold, because you're not buying and so it creates, what I'll call a richer flow-through, if I can say it that way.

But it does as we all spent last year talking about why the top line was pressured, it was because of that netted down.

This year, you just have kind of, I'll use Chris' word, the confluence of the client refresh, which in general has a lower margin than some of the richer solutions and netted-down services has been driving a lot of the top line in that.

So that gives you less that kind of drops down through.

Now what helps us is, then one of the things I love is the beauty of this model where the sales compensation literally follows where the gross profit is, and enables us to make sure we can deliver on our adjusted EBITDA targets going forward, is kind of part of the way this model moves forward as we go through the year.

Okay, that's helpful.

And then just thinking about the Education piece.

It seems like the growth slowed.

You guys have seen some very strong growth over the past couple of quarters.

Is that just sort of anniversary-ing some better growth and some better sales trends there?

What are you thinking about going forward?

I'm going to let Chris walk you through because it is in some ways the tale of 2 cities when you think about Education as kind of the opposite of what Education was growing like in previous years.

So go ahead, Chris.

Katie, when you look at Education overall at 6% growth, we had some solid growth led really by higher Ed in the high teens.

But if we look at K through-12, some of the tailwind from the digital testing mandate and the E-rate funds, we didn't experience, and we expected that.

And so what I'd say about K-through-12 is, we're in a bit of a transition moving away from digitizing devices.

And that's really moving into more of a maintain and refresh cycle.

And we're moving towards the classroom of the future, which as you know, is a combination of technology and reconfiguring classroom layout.

So we've already seen some nice uplift in collaboration and video, and will look to continue to help our K-12 customers on this, I'll call it the transformational journey to the classroom of the future.

Our next question comes from Keith Housum with Northcoast Research.

Ann, congratulations on retirement as well.

Great news.

If you could just explore a little bit more on the Government side of the business.

I understand that it's going through the Windows 10 migration here.

I guess first question there is how long, perhaps, will we expect that to last?

But with the exception of the fourth quarter last year, the Government segment really has grown tremendously for you guys over the past 3 years.

So if you guys could provide a little bit color there.

Is it a matter of taking share because, I mean, certainly, we haven't seen the federal budgets increase by the amount that you guys may able to grow that business.

Yes.

Keith, first, I want to make sure that we don't miss the pretty sustained excellent performance by the state and local part of the government team.

They had another double-digit quarter, and that's kind of become long history of performance there.

And a lot of that was tied to the solutions we've built around public safety and what the value it's adding to state and local as well as some of the larger contracts that we've been able to capture over the last couple of years because of those solutions.

So when you're thinking about government, make sure you're always, at least in CDW's case, thinking about both state and local and federal and then I'll let Chris give some color on federal.

Yes.

On the federal side, we grew mid-teens.

We did see some nice growth there.

And while we did have some uplift from the DoD Win 10 mandate and also the remaining client devices from last year, we also saw some good strength around the strategic-program alignment activities that we had.

So I don't want to miss that kind of base activity on the programs that we implemented several years ago.

So net-net, I would say I don't feel like we're taking share.

We felt a normal budget flush.

And on the DoD, in terms of timing, I think you asked about, that mandated for January 31, 2018, right now.

That could change, but that's what we know right now.

Great.

And let me just turn my focus over to the SMB.

Beginning of the year, you guys, kind of, carved out SMB to be a new focus.

And I guess, any progress in terms of how you think that's progressing.

Obviously, it's been growing well, but timing in line with the rest of the business.

Are you satisfied with how it's growing in introductory time now?

Yes, I'm -- I mean, if Doug wants to grow 12% every quarter, I'll be satisfied till the cows come home.

So that part of it, mission accomplished, I think they're just now kind evolving their technical support.

So we're looking for increased solution performance as we kind of go forward.

But like anything for us, our breadth and scale enables us to focus on either products and/or segments and when we get that kind of focus, we generally get good performance.

Our next question comes from David Stratton with Great Lakes Review.

Looking at Healthcare, you said that it was around flat for the quarter and some transactional activity was pushed through.

What are you seeing deeper, now that there's been 2 unsuccessful attempts to repeal Obamacare?

And if this cycle continues to push out, do you think that this is an inflection point where customers are going to start reinvesting?

Yes.

This is Chris.

And I would say it's really hard to say.

What's happened is it's even more uncertainty and the uncertainty is continuing regarding insurance coverage and reimbursements.

And that's particularly impactful on the larger hospital systems where we have a larger share of the market.

So, while we have had some success delivering what they're buying, which is the client devices, it feels like we just need to hang with these customers until they get better visibility to the income streams and then we'll be prepared to help them with their deeper technology solutions.

But it remains lumpy.

My favorite economic description.

Yes.

And I think it's going to stay that way until we get some clarity.

All right.

And then you mentioned Brexit not impacting your European results yet.

Is there any quantification that you've made as far as how much you think it will impact?

And when you expect to see that?

We've done multiple scenarios, everything from a soft Brexit to a hard Brexit.

Each of them has different implications.

But at this point, I don't know that there's really anything other than scenario planning because we got to wait till we get to the details.

I would tell you, and I think Chris would share this, we have been not only pleasantly, but incredibly surprised by the U.K.'s ability to kind of continue to focus on their customers and meet their needs in light of the Brexit overhang.

Our final question comes from Mark Moskowitz with Barclays.

I wanted to ask about international.

In terms of what do you see looking ahead, Tom, in terms of the customers that inspired you to make the move a few year ago?

Are they asking you for -- for that expansions continue beyond Europe or within Europe deeper, but also beyond Europe?

Mark, that's a good question.

Let me go back to little bit of the history of what they did tell us.

Part of the discussion was, we need you to help us in other parts of the world.

And recognizing that would be hard for a diverse set of customers to match everywhere they wanted us to be.

So they said, "look, over time, you need to be able to get to, I forget the number, north of 70% or something in that range, of the locations." And so then we looked at well where is the majority of their spend today, and the majority of their spend today is in Western Europe.

So that's really what is what drove looking at finding, fortunately, what we call CDW U.K. today.

The one thing that was appealing to us about their approach to the market was that while their base business was headquartered in London, they have this hub-and-spoke approach where they had field sales offices in other parts of the world, and they had these existing third-party relationships, which in essence gives them a distribution channel themselves to extend where customers need us to go.

So, Mark, in a long-winded way, I think we have the platform, would be the way I would say it, to meet customer needs today and tomorrow as they increase.

Having said that, we're always going to look for, are there places across the world that can enhance our performance of that platform?

But the platform today is set up to be successful, and we're going to continue to focus on it.

Okay, and then speaking of that platform.

I was kind of curious if CDW is benefiting from consolidation in the terms of your larger customers out there.

Are they consolidating the number of bars and services and solutions providers that they work with, just to make things more efficient and agile going forward?

Before you answer that, I do want to also extend my congratulations to both you and Ann for having a sterling run here pre- and post-IPO.

It's been really nice to see from the sidelines the consistent focus on operational and strategic excellence.

Thank you.

Thank you, Mark.

So thank you for asking the second part of the question because I should've said that in the first part of the answer, which is one of the things that they said to us, and I say this partially tongue-in-cheek was, "We love you, CDW, but we don't want to love 6 or 7 of you all over the world.

So to the degree you can't help us with our international needs as we try to slim down the number of people we deal with, you're going to put your business at risk." So your instinct was right on relative to what they, at least, shared with us, and was one of the motivating factors for us to look aggressively from an international perspective.

I show no further questions, so I'd like to turn the conference back over.

Okay.

Look, as always, thank you, for your questions and your time this morning.

Let me once again thank, Ann for her partnership.

And I'll leave you with this.

For those of you that have been investing in your children's health by eating their Halloween candy, I would say shame on you, and you better get back in the gym because Thanksgiving is coming soon.

All right.

Thanks, everybody.

See you.

Thank you, ladies and gentlemen.

That does conclude today's conference.

Thank you for your participation.

You may now disconnect.

Have a wonderful day.