CDW Corp (CDW) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CDW Second Quarter Earnings Call.

(Operator Instructions) I would now like to introduce, Chairman and Chief Executive Officer, Mr. Tom Richards.

Please go ahead, sir.

Thanks, Andrew.

Good morning, everyone.

It's a pleasure to be with you today to report our second quarter 2018 results.

This is an exciting anniversary for us, that's been 5 years since our first earnings call after our June 2013 IPO, and once again, we delivered another quarter of strong results.

Joining me in the room today are Collin Kebo, our Chief Financial Officer; Chris Leahy, our Chief Revenue Officer; and Sari Macrie, our Vice President, Investor Relations.

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

Chris will review customer and market performance, and Collin will take you through a more detailed review of our financial results, capital priorities and performance targets.

Then we'll go right to your questions.

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

Thank you, Tom.

Good morning, everyone.

Our second quarter 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 earnings per share.

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

You'll 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 2017, unless otherwise indicated.

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

Also note that our 2018 and 2017 net sales amounts are reported under accounting standard ASC 606.

The number of selling days in the first and second quarter was the same in both 2018 and 2017.

All sales growth rate references during the quarter will use 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.

We had another quarter of strong and profitable top line growth.

For the quarter, consolidated sales were $4.2 billion, up 7.6% versus last year.

On a constant-currency basis, sales increased 7%.

Gross profit increased 8.6% to $696 million.

Adjusted EBITDA increased 9.6% to $345 million and non-GAAP net income per share increased 35% to $1.38.

On a constant-currency basis, non-GAAP EPS increased 34.5%.

Our consistent performance since the IPO has been driven by 3 factors: first, our balance across customer end markets; second, the breadth of our products and solutions portfolio; and third, our ongoing investments and our 3-part strategy for growth.

Let's take a look at how each contributed to this quarter's performance.

First, the balance across our customer end markets.

As you know, we have 5 U.S. sales channels: corporate, small business, healthcare, government and education.

Each of the channels are meaningful businesses generating annual sales of more than $1 billion.

This scale enables us to further align sales teams into vertical customer end markets, including K-12, higher education, state and local government and federal government.

In addition, we have our U.K. and Canadian operations, which together delivered 2017 sales of more than USD 1.5 billion.

These unique sales organizations serve us well when end markets behave differently from each other.

Sometimes that occurs because markets are disrupted by macro or external changes, sometimes it occurs when customer behavior differs due to different priorities.

Our balanced portfolio of customer end markets is one of the hallmarks of our ability to generate consistent profitable growth.

Chris will walk you through more on this quarter's results by end market.

Chris?

Thanks, Tom.

Good morning, everyone.

The power of the diversity of our customer end market is clearly evident this quarter.

5 of our 7 U.S.-based customer-facing end markets as well as both of our international operations posted top line gains.

This more than offset declines in 2 of our end markets, enabling us to deliver our consolidated 7.6% top line increase.

Corporate had an excellent quarter with sales up 10%.

Client refresh remained healthy, driven by strong employment and customers' continued use of client devices to drive productivity.

This contributed to strong transactions growth for the quarter up mid-teens, very impressive results given last year's second quarter low double-digit transaction growth.

At the same time, the team was generating double-digit transactions growth.

They also delivered a mid-single-digit increase in solutions as they continue to help customers drive digital transformation into their businesses.

While customers are not explicitly pointing to tax reform as the driver of incremental spend, it does feel as though it is spurring corporate customer confidence in the economy to move forward with their existing spending plans.

In the small business market, confidence remained strong and the team posted a 5% increase in net sales.

Client refresh driven mid-single-digit increase in transactions, and the team's focus on driving profitable sales drove meaningful product margin improvement.

As the segment, Public was flat for the quarter, performance varied across channels and within customer end market.

Government was down just under 6%, results were mixed across our 2 customer end markets with state and local up and federal down.

State and local performance was solid, even as they jumped from tough compares when sales were up nearly 20% in part from on-boarding a new large stake contract last year.

Two factors impacted several performance in the quarter.

First, the impact of difficult client device compares, given our second quarter 2017 success, meeting the Department of Defense mandate to move to Win 10.

Second, the impact of timing.

Here, we had a double hit, which shifts into the second quarter of 2017, which you may recall included the shipment of 2016 orders that had been delayed to the Department of Defense.

And then we had shift out of the second quarter in 2018 with order delays.

Also given our success helping customers adopt cloud in both government end markets, solutions delivered to government customers via the cloud more than doubled in each end market, which meet the top line growth.

Education increased 1%.

Again, we saw different results from each end market with higher ed up and K-12 down.

Higher ed continued its success maximizing contract capture, and client refresh remained strong.

As we shared last quarter, K-12 is moving through a transition as school systems digested digital devices and networking investments they have made over the past 5 years and focus on collaborative learning environment.

Although lapping last year's record-breaking Chromebook sales, K-12 delivered growth in transactions.

This was offset by declines in networking as schools continued to digest last year's strong networking investments.

In addition, as you may recall, in 2016, E-rate funding was delayed, which pushed spending that typically occurs in the back half of the year into the first half of 2017.

Healthcare had another good quarter, increasing 6%.

Similar to the first quarter, the team helps customers address pent-up demand primarily in client devices.

While the fate of the Affordable Care Act, Medicaid funding and overall reimbursements remain the concern, customers did move forward with projects that they determined needed to be addressed and transactions increased double digits.

Our other results, which reflects Canada and U.K. combined increased 34% in U.S. dollars.

Both operations continued to deliver exceptional local performance with combined constant currency sales increasing more than 25%.

Investments made in further refining our go-to-market and growing our Canadian solutions capabilities continued to pay off.

We had balanced growth in Canada across both transactions and solutions, both up high-teens in local currency.

Once again, U.K. results came in above expectations.

U.K. had excellent results across both transactions and solutions.

Despite moving Brexit decision, the team continues to execute well in market.

They are also doing a great job leveraging our international capabilities to grow outside of the U.K., both with U.K.-based customers and U.S.-based customers.

U.S. referral to the U.K. increased over 30% in the quarter compared to the prior year.

So as you can see, our balanced portfolio of customer end markets delivered a very good top line growth quarter on a consolidated basis.

That wraps up the summary, Tom.

Thanks, Chris.

Clearly, the diversity of our end markets was the key driver of this quarter's performance, but our sellers success, regardless of the end market they serve, is a direct outcome of their ability to provide what customers want and need, and that is where the second driver of our performance this quarter comes in, our broad product and solutions suite, including our on-prem and off-prem offerings.

U.S. hardware sales increased 6%.

Total U.S. client devices increased low double digits.

This is particularly noteworthy, giving last year's mid-teen increase, which included record Chromebook sales and this quarter's decline in federal client device sales.

Video delivered another double-digit growth quarter powered by digital signage and large monitor formats.

Interactive flat panel growth was particularly robust, as price points in this category are becoming more competitive to static displays.

After a lumpy 2017, servers delivered its second consecutive quarter of double-digit growth, up nearly 20%.

The strong results were partially offset by our NetComm and storage performance.

After the first quarter recovery from year-end supply chain issues, shipments did not keep pace with our writings and U.S. NetComm sales declined low double digits.

We remain encouraged about the category as backorders remained strong over the past 30 days, and we expect the majority of these orders to ship in the third quarter.

Strong flash results, which increased 20%, were not enough to offset overall storage performance and the category declined mid-single digits.

Overall, U.S. services increased 3%, primarily driven by double-digit growth in warranties, which was partially offset by services tied to networking like cabling and storage.

For the first time in more than a year, our gross margin improved year-over-year despite our strong client growth, which would typically pressure margin.

One of the contributing factors was our software performance.

U.S. gross profit from software grew low double digits, meaningfully faster than net sales, which were flat year-over-year.

One driver of this success we had in the quarter helping our customers move forward with solutions delivered via cloud, particularly in government and education, as you heard from Chris, which are netted down for accounting purposes.

Overall, customer spend on cloud-based solutions was up nearly 40%.

Productivity, our largest workload, had another great quarter, up nearly 40%.

Security delivered via cloud was one of our top 3 fastest-growing workloads.

The other 2 were business analytics and backup.

All 3 grew at least high double digits.

In total, we had strong U.S. transactions growth, up high single digits.

Solid solutions performance and corporate was muted by cloud success, delays in federal orders and customer transition in K-12.

While U.S. solutions were flat, gross profit increased mid-single digits.

For the U.K. and Canada, we saw excellent increases in solutions together up high-teens.

Clearly, the breadth of our products and solutions portfolio enables us to evolve our -- with our customers and deliver profitable growth.

And that leads us to the third driver of our performance this quarter.

The ongoing investments we are making in a 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.

And third, enhance our services capabilities.

One way to capture market share is by understanding your customers' business as well as you understand technology.

A great example of this in action is the success we have seen in our financial vertical within the corporate end market.

We launched this vertical back in 2014 with a mandate to grow their market faster than the overall corporate business, and they certainly have been doing that.

Dedicated sales teams are aligned around 3 financial markets: banks and credit unions, capital markets and insurance.

Each of these teams understands their market's unique needs.

We have highly knowledgeable coworkers who have deep expertise in the areas these customers prioritize.

For example, in capital markets, we can deliver high-performance compute and artificial intelligence capabilities customers need to drive their competitive advantage.

We have nearly 100 sellers dedicated to this vertical, and through the second quarter, they are on pace to deliver 4 years of double-digit growth.

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.

We accomplished this in 2 ways: First, we invest in coworkers to ensure we can support customer adoption of new technologies.

The creation of our cloud practice in 2011 and our ensuing investments is a great example to that.

The second way we expand our solutions capabilities is by adding partners, which provides both innovation and a source of growth for us.

In the second quarter, we added AWS to our portfolio to supplement our already very strong Microsoft Azure offering.

Our AWS offering includes CDW delivered professional and management services.

Our managed service offerings include 24/7 remote incident cost and service level monitoring.

It also includes technical account reviews and assessments.

These professional services are designed to help our customers through the entire life cycle, including migration and integration services.

This is a controlled rollout to 2 of our customer end markets.

By doing so, we will be able to evaluate our offering and refine it as we learn what's best for our customers.

As such, we don't expect the impact on 2018 performance to be meaningful.

We are taking a measured approach to rolling this out with a keen eye on ensuring the best possible customer experience.

In this hybrid world, our broad portfolio enables us to capture profitable growth in both on-prem and off-prem solutions.

Over the past 12 months, CDW customers have spent roughly $3 billion on solutions delivered via the cloud.

As Chris mentioned earlier, one area that is contributing to this growth is the success we are having, helping our government customers, both state and local and federal, adopt cloud solutions.

We're seeing more and more government cloud adoption as IT organizations set out to drive greater focus on accountability as well as enhance cybersecurity and shared services outcomes.

Agencies aren't just integrating cloud into their IT strategies, they're integrating cloud into their overall strategies as a way of driving change.

A great example of this is the solution we provided to a civilian government agency to help them with their mandate to improve operations.

Not an easy task for a complex organization.

Before they formulate any action plan, they need to deeply understand their operation.

And to do that, they need to find a way to call through volumes of data.

Our solution provided a cloud-based analytics and business intelligence capability, which identifies patterns and trends to help the agency make fact-based decisions.

Since the solution is available as an enhanced feature to an existing package, it can be integrated into their current operations.

The total cost of the solution to the agency was over $2 million.

Of course, cloud sales like this do pressure the top line since we only book our profit as net sales, but at the same time, they contribute to enhanced profitability and just as important, customer value.

Our third strategic priority, which is to continue to enhance our services capability, is also contributing to our profitable growth.

Our services capabilities were one of the main reasons we won the award to provide Device as a Service as a solution for the 2020 U.S. Census.

We combined our service and logistics capabilities with our broad product portfolio and deep partner relationships to create a mobile technology solution that supports field data collection.

Our solution includes the provision of mobile devices and accessories, custom design configuration, wireless services, deployment and secure asset management, along with help desk and field support.

Similar to AWS, this is not expected to impact our 2018 performance, but it is another great example of how our investments in solutions and services are driving profitable growth in 2019 and beyond.

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

Given first half market performance, our current view of 2018 U.S. IT market growth is for full year growth in the 3.75% range, up 50 basis points from our prior view.

In addition to increasing our view of market growth given our strong performance to date, we also expect to exceed our prior target of growing a little more than 300 basis points above market, and we currently look for outperformance of roughly 375 basis points.

With these expectations along with the strong growth we have seen in our U.K. and Canadian operations, we are upping our plans to add customer-facing coworkers from our initial view of adding between 100 and 125.

For the full year of 2018, we now expect to add between 125 and 150 net customer-facing coworkers.

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

We ended the quarter up roughly 75 customer-facing coworkers since the beginning of the year.

As you can see, we feel good about the balance of the year.

That said, this could change based on a number of factors, how the U.S. accounting performs, what happens with trade, what happens with tariffs, what happens with Brexit and are there any potential supply dislocations.

We'll keep a watchful eye on all of this as normal and update our view as we move throughout the year.

Now let me turn it over to Collin.

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 ongoing investments in our 3-part strategy for growth.

They also demonstrate the progress we are making against our long-term financial strategy to drive strong cash flow, deliver sustained profitable growth and return cash to shareholders.

Before I get started, I'd like to remind you that all the financial information I will review reflects the adoption of ASC 606, so it is an apples-an-apples comparisons for 2017 and 2018.

Turning to our P&L.

If you have access to the slides posted online, it would be helpful to follow along.

I'm on Slide 8. Consolidated net sales were up $4.2 billion or 7.6% higher than last year on a reported and average daily sales basis.

Average daily sales were $65.4 million for the quarter.

On a constant-currency basis, consolidated net sales in the second quarter of 2018 were 7% higher than prior year.

Currency impact was driven by favorable translation of the British pound and Canadian dollar, adding roughly 60 basis points of growth.

Currency tailwinds were approximately 60 basis points lower than the first quarter.

On an average daily sales basis, sequential sales were up 16% compared to the first quarter of 2018.

As expected, this is slightly lower than our historical Q1 to Q2 average daily sales increase due to the 2017 year-end delayed orders that shift in the first quarter.

Gross profit for the quarter increased 8.6% to $696 million.

Gross margin in the second quarter was 16.6%, up 10 basis points over the last year and down 10 basis points sequentially from the first quarter.

The year-over-year margin expansion reflected improved product margin from customer mix and positive contribution from U.S. cloud growth, partially offset by other netted down streams not growing as fast as sales.

Turning to SG&A on Slide 9. Reported SG&A, including advertising expense, was roughly 5% higher than last year.

Reported SG&A includes $11 million of noncash equity compensation and $0.5 million of other costs including cost related to payroll taxes on equity-based compensation.

Our adjusted SG&A including advertising increased 7.9% compared to last year.

The increase in adjusted SG&A primarily reflected increased coworker costs, including sales compensation consistent with higher gross profit and higher attainment against goals.

Coworker count was up roughly 130 since the second quarter of 2017 to 8,917.

Adjusted EBITDA for the quarter was $345 million, an increase of 9.6% compared to the prior quarter.

This resulted in an adjusted EBITDA margin of 8.2%, 10 basis points higher than the second quarter of 2017.

Looking at the rest of the P&L on Slide 10, interest expense was $37 million in the second quarter of 2018 compared to $36 million in the second quarter of 2017.

The increase is primarily a result of the amortization of hedging costs associated with interest rate caps.

GAAP taxes in the quarter were $57 million, which resulted in an effective tax rate of 25% compared to an effective tax rate of 28% in the second quarter of 2017.

As you can see on Slide 11, the reduction in effective tax rate primarily reflects the year-over-year impact of lower federal tax rates, which more than offset the impact of lower excess tax benefits from equity-based compensation.

Moving to Slide 12.

On a GAAP basis, we earned $173 million of net income, an increase of $32 million or 23% compared to the second quarter of 2017.

Our non-GAAP net income, which better reflects our operating performance, was $213 million in the quarter, up 31% over last year.

Non-GAAP net income reflects after-tax add backs that fall in 4 general buckets, the ongoing amortization of purchased intangibles, equity compensation and related payroll taxes, integration expenses and other nonrecurring or infrequent income or expenses.

To get to our non-GAAP effective tax rate, we adjust taxes consistent with non-GAAP add backs, including excess tax benefits associated with equity-based compensation.

For the second quarter of 2018, our non-GAAP effective tax rate was 26%, down 11 percentage points compared to last year's 37% rate, primarily due to the lower federal tax rate.

Our non-GAAP effective tax rate of 26% applied to our non-GAAP pretax income of $288 million resulted in non-GAAP net income of $213 million in the second quarter of 2018.

We've provided a more detailed reconciliation in our earnings release.

As you can see on Slide 13, to calculate our non-GAAP pretax income, you can get to this measure starting with either adjusted EBITDA or GAAP pretax income.

With second quarter weighted average diluted shares outstanding of 154 million, we delivered $1.12 of net income per share and $1.38 of non-GAAP net income per share, up 35% over the prior year, as you can see on Slide 14.

Currency impact on EPS added about 50 basis points to second quarter growth.

Turning to first half results on Slides 15 through 18.

Revenue was $7.8 billion, an increase of 9% on a reported and average daily sales basis.

On a constant-currency basis, consolidated net sales in the first half of 2018 were 8.2% higher than the prior year.

Gross profit in the first 6 months of 2018 was $1.3 billion, up 8.8%.

Gross profit margin was 16.7%, which was flat to the first 6 months of 2017.

Adjusted EBITDA was $625 million, 10.6% above the first 6 months of 2017.

Net income was $300 million for the first half of 2018.

Non-GAAP net income was $376 million, 32% above the first 6 months of 2017.

Non-GAAP net income per share was $2.44, up 38% from the first half of 2017.

Turning to our balance sheet on Slide 19.

On June 30, we had $101 million of cash and cash equivalents and net debt of $3.1 billion.

Our cash plus revolver availability was $1.2 billion.

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

Our current weighted average effective interest rate on outstanding debt is 4.1%, 10 basis points below last year, primarily due to repricing the term loan, which lowered the margin to 175 basis points.

While LIBOR increased year-over-year in the second quarter, the impact on interest expense was minimal given the 1.5% caps we have in place on our term loan in the amount of $1.4 billion.

These 1.5% caps expire in December 2018.

In the first quarter of 2018, we purchased an additional $1.4 billion of caps at 2.375 to hedge 2019 and 2020.

With the caps in place, roughly 96% of our outstanding debt is either fixed rate or hedged.

As you can see on Slide 20, we maintained strong rolling 3-month working capital metrics during the second quarter.

For the quarter, our 3-month average cash conversion cycle was 17 days, up approximately 1 day from last year's second quarter and below our annual target range of high-teens to low 20s.

Year-over-year, DSO and DPO increases primarily offset each other, largely reflecting the impact mixing into netted-down revenues has on both metrics.

The remainder of the change is driven by inventory, which reflects higher stocking positions and timing of shipments.

Year-to-date, free cash flow, which we calculate as operating cash flow plus the net change in our flooring agreement less capital expenditures, was a positive $188 million compared to $254 million in the first half of 2017.

The year-over-year change in free cash flow primarily reflects rebuilding inventory and vendor mix.

Last year, we mixed into vendors with extended terms.

And this year, we mixed out of vendors with extended terms.

During the quarter, we continued to execute against our capital allocation strategy and repurchased roughly 864,000 shares for $67 million at an average cost of $77.95 per share.

Our capital allocation strategy is comprised of the following 4 components, which you'll see on Slide 21.

First, increase 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 this quarter, we will pay a dividend of $0.21 per share on September 10 to shareholders of record as of August 24, up 31% from a year ago.

Since the IPO, our dividend has increased nearly 5-fold from the initial annual level of $0.17 per share.

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

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

We ended the quarter at 2.5x.

Third, supplement organic growth with strategic 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 June, we had $682 million remaining at our current share repurchase authorization.

Our capital allocation priorities support our 2018 targets, which you see on Slide 22.

As Tom mentioned, we now expect full year U.S. IT market growth to be in the 3.75% range and CDW to outperform the market by roughly 375 basis points on a constant-currency basis.

We now look for currency to contribute roughly 30 basis points to annual sales growth, assuming year-to-go exchange rates of $1.30 to the British pound and $0.75 to the Canadian dollar.

Given year-to-date exchange rates, this implies currency headwinds of roughly 30 basis points in the second half of 2018.

Given our first half performance and year-to-go expectations, we expect to exceed our previous 2018 non-GAAP EPS growth target in constant currency and now look for a non-GAAP EPS growth to be in the high 20s.

We expect currency to have a similar impact on EPS growth and sales growth.

We continue to expect our adjusted EBITDA margin to come in roughly 5 to 10 basis points or so below the high end of our high 7s to 8% annual target range as tax reform investments impact expenses.

Keep in mind that these are annual targets, not quarterly.

Let me provide you with a few additional comments for those modeling the rest of our 2018 financials.

I am on Slide 23.

Based on first half results and the expectations for the rest of the year, we look for sales in the second half to now be roughly 75 basis points lower than our historical seasonality split of approximately 52% in the second half.

We expect the low single-digit increase in sequential average daily sales from Q2 to Q3, in line with the average of the past 3 years.

We expect quarterly depreciation and amortization to continue at roughly $67 million per quarter, $47 million of which is for purchased intangibles.

Annual book interest expense is now expected to be slightly below $155 million.

We now look for annual equity compensation to be roughly $5 million lower than 2017.

We also now expect to be at the lower half of our full year non-GAAP effective tax rate range of 26% to 27%.

Excess tax benefits will impact our GAAP tax rate in Q3 and Q4, but are excluded from the non-GAAP effective tax rate.

Our annual non-GAAP EPS growth target is now high 20s in constant currency and is expected to grow approximately 350 basis points faster than non-GAAP net income.

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

I'm on Slide 24.

First, we expect our capital expenditures to be slightly above 0.5 point of net sales on an annual basis.

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

For the full year, we expect the cash tax rate in the 26% to 27% range to be applied to pretax book income before acquisition-related intangibles amortization, which is approximately $47 million per quarter.

In addition, with the reduction in our tax rate, we expect to pay approximately $13 million in 2018 for tax related to the cancellation of debt income we incurred in 2009.

2018 is the final year of payments.

We continue to expect annual free cash flow to come in at the low end of our tax reform enhanced rule of thumb run rate between 3.75% and 4.25% of net sales.

This reflects 2017's over-delivery of 50 basis points above our pretax reform rule of thumb due to timing and assumes we manage inventory in the ordinary course during the second half of 2018.

Given 2017's over-delivery of free cash flow, we continue to expect to deploy cash in excess of 2018 free cash flow, and you should expect us to return this cash in order of our capital priorities.

That concludes the financial summary.

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

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

Thank you.

(Operator Instructions) And our first question comes from the line of Amit Daryanani with RBC Capital Markets.

I have a question and a follow-up, I guess, mood to start with.

If I think about the growth rate you saw in Q2 around 7.5% and the first half, I think, averaged at 9%, and suddenly you raised the 2018 guide, but it still implies growth is decelerating in the back half to around 5% versus the 9% you saw in H1.

Could you just maybe walk through what are the drivers that are driving this deceleration in the back half?

Or is it just a healthy dose of conservatism baked into the numbers here?

Yes.

Look, it's a good question.

Some of it is just looking at what's in front of us.

We've got some pretty challenging comps sitting in front of us.

If you think about last year's third quarter, some of it is, you've heard it, some supply chain things knocking around that could impact client devices or another kind of thing that's kind of out there, staring us in the face.

So as we have been thinking about this -- and we felt this way since the beginning of the year.

Truthfully, we knew that the third quarter would be an interesting challenge.

We then have some opportunity to make up some ground in the fourth quarter.

So it's really just trying to look at those things in light of the success we've had in the first half of the year.

I think the general consensus, if you look at whether it's adding additional customer-facing coworkers or some of the other comments we made, we're pretty -- we feel pretty good about our rhythm of the business.

It's just some of those other factors.

Yes, Amit, I'd just add a couple of thoughts to Tom's comment.

One is I think when you think about the first half of the year, we did 9% reported, but obviously currency was a tailwind.

So think of it as 8.2% on a constant-currency basis.

And remember, we also got the benefit of the supply chain backlog that went in the first half of the year.

And so think of it on more of a normalized constant-currency basis, probably something more like in the high 7s is what we ran in the first half of the year.

I know you were doing the math on the fly there.

But if, I think, you take my thoughts on the full year, it will give you something in the back half of the year in the mid-6s, high 6s constant currency around there.

So I don't think the step-down is as great as you thought.

And again, Tom has explained some of the drivers around it, but think about the step-up and the overlap we have as we move into the back half of the year, particularly in the international part of the business.

No, perfect.

That's really helpful, guys.

And if I can just quickly follow-up.

I think I heard the netcomm revenues were down in the quarter.

That -- could you just maybe talk about what drove that down?

I think it's somewhat surprising, given the trends some of the OEMs are seeing?

Would you just flush that piece out of it?

Yes, for us, it was shipping.

We -- our writings, our bookings, whatever term you want to use, felt good.

We just had some challenges getting stuff shipped.

It was not to the same degree we saw in the fourth quarter, but had kind of similar characteristics, which is why I commented, Amit, on the confidence we have of the backorders getting out the system.

I'd say that was the biggest driver.

And then a little bit is, for us, a lot of our netcomm growth in the last year or so was in K-12.

And they've kind of digested a lot under the E-rate program.

So I would say it was really those 2 factors, which I feel more comfortable when we can articulate what impacted something when I talked in with confidence about our business going forward.

Your next question comes from the line of Matt Sheerin with Stifel.

So just a question regarding the guidance, particularly on the government area where you talked about some issues.

You're guiding generally seasonally for Q3.

Does that imply that you'll see the normal federal budget flush?

Or given the issues and given some of the tough comps from last year, is that not going to play out?

I'll give you a headline, and I'll give -- let Chris give you some color, Matt.

I don't know that I would sense that it's a normal year for us, in part because of the slippage that you heard Chris talk about.

That does give us some confidence as far as shipping.

But I think when you think about some of the other factors that are somewhat new, Matt, for example, the success of our cloud selling into the federal government, which kind of has -- it's like a double-edged sword.

On one hand, it pressures your top line, but on the other hand, it creates a significant profit.

I think that's part of the logic behind talking about what we think out of the federal government.

We do expect state and local to continue its pretty amazing track record of growth.

Chris?

Yes, Tom, I would just emphasize that as we think about the third quarter, I would think more about the back half of the year.

Given the shipping delays we've experienced, we're being a little cautious there.

And the positive is the cloud acceleration we're seeing in the federal space is really interesting.

So I would look at the back half of the year and say we're going to have -- we expect to have pretty solid business performance.

And I say solid business performance, because we're overlapping some tremendous comps.

So maybe not ecstatic growth rates, but very solid performance.

That's quite helpful.

And then just shifting gears -- well, tying in the cloud acceleration you are seeing in federal, talk about what you're seeing on the enterprise and SMB side.

I know there's a big client device upgrade refresh going on.

But as clients shift their budgets toward solutions, do you think you'll see an acceleration there?

Or will there continue to be that hybrid model where they're upgrading their hardware and moving certain workloads off-premise?

Yes, Matt.

I continue to be, I guess, a fan of the hybrid answer, because I think customers continue to want to move workloads around.

I think one of the things that we're seeing even more so now is the requirement for flexibility, realizing that in any given period, you may move workloads around.

We do expect continued client growth, as you pointed out, in our Corporate business.

But I also want to make sure that we draw attention to the good performance in solutions.

So it's not just fueled by one particular product category.

And it's ironic.

As far as cloud adoption in our business, while federal and state and local recently have become fast growers and adopters, Corporate is the organization that's got the highest volume of cloud solutions for our customers.

And our next question comes from the line of Adam Tindle with Raymond James.

I just want to stick on the cloud topic.

Tom, could you maybe remind us of some of the cloud metrics?

I think you've given cloud as a percent of gross profit dollars.

And I would have to imagine a good portion of that is Azure, because what I'm trying to get at is -- I know AWS is not going to be meaningful gross profit dollars in 2018, but just trying to get a sense for what it could be in 2019 and beyond.

Yes.

Well, if you think about it, Adam, the -- it is a combination of SaaS and Infrastructure as a Service that make up the bulk of the cloud business we do today.

If you think about it in terms of workloads, its productivity, its backup, its business analytics and security are the ones driving the cloud adoption.

Continues to be -- it had a meaningful high double-digit growth rate and net sales in the quarter.

And as you do point out, since so much of that is netted down, you can assume that the gross profit growth is consistent with the sales growth, because they're virtually equal.

So we've been working on this since 2011, Adam.

And I think the idea of creating kind of a cloud business unit within CDW, which gives you the ability to concentrate expertise, is paying huge dividends for us.

Okay.

And maybe shifting gears to capital allocation.

I know that slide used to say tuck-in accretive acquisitions and was changed to expand strategic capabilities over the past couple of quarters.

Can you maybe just touch on the reasoning for that change?

And with over $1 billion in, I think, availability in terms of credit lines, would you consider an acquisition larger like that?

So I'll take the first part, Adam.

The answer to your last question is yes.

And look, I think we've tried to be really transparent about this, I think demonstrating the U.K. acquisition and the size of that and obviously our ability to successfully execute post the acquisition.

It's a meaningful part of our growth strategy -- its growth strategy, excuse me, at this point.

And the -- there's an interesting reason for the slight change in verbiage.

It had to do with, I think -- the verbiage of course had something accretive and people tended to think that meant immediately accretive versus accretive over the life of the deal.

So we try to get more clarity, but it's interesting when we try to get more clarity, we seem to get more questions along the way.

But inorganic growth will continue to be part of our strategy, and I think I've been pretty clear about that.

Going forward, it'll depend on right situation.

And we continue to look in the marketplace, but are thrilled with our organic growth along the way.

And our next question comes from the line of Shannon Cross with Cross Research.

I just had a -- I'm curious, you're hiring a number of people.

Obviously, your model is to hire.

Given the tight employment market right now, are you seeing any challenges?

Are you having to pay more?

What's it like out there?

I don't know that we have to pay more, because our model is our model.

But that doesn't mean we don't have to be more creative and more thoughtful and more focused on bringing people in.

While we continue to increase the numbers, I don't think the numbers are so big that it overly stresses the system.

But I think your instincts are right, with the labor market, you -- is it a little harder and requires us to be a little more focused today than maybe 4 or 5 years ago, absolutely.

Okay, great.

And then I'm...

I would tell you one thing, Shannon, the one area where you do see is when you're not so much hiring the salespeople, but on the technical side is probably where you see a little more of the cost pressure than on the direct selling organization.

And that's why everybody's kid should go, be a coder.

Touché.

No.

I think business people are important too.

I guess, my other question is just from a client perspective and talking to the OEMs, certainly the leading OEMs, they seem to believe that this is going to be maybe more sustainable at least on the corporate side than sort of historical levels just in terms of relatively mid-innings with the Win 10 refresh overall and people still looking to try to get more feature functionality out of the devices that are out there so they need newer ones.

I'm curious what your customers are saying.

I mean, do you see -- I mean, we hear some stuff.

But do you see any kind of idea that this slows dramatically?

Or do you think this is maybe something that will last for a couple of years, maybe not at these levels, though?

Yes.

Okay.

So I do think it's obviously lasting longer than we thought, which has been great.

One of the things, I think, Chris and her team has pointed out, though, is an interesting fact is some of what we think is driving, especially in the corporate space, the client continued growth is the full employment and that the people are going to need more and more client devices to support full employment.

And so that makes some sense, especially for that part of our corporate world that's in the technology sector.

So that would be #1.

Then you have some -- kind of the counter would be if there is some supply chain shortages, what does that mean.

We've been very proactive in that area as far as -- this is where we get the leverage, our warehouse and distribution capability, because we can aggressively kind of buy more stock and make sure that we have availability for our customers.

So do I think it continues, I think it's proven it's gone longer than normal.

What I'd say -- I think you said multiple years.

I'm probably willing to go out on a limb here and say it's multiple years.

And our next question comes from the line of Katy Huberty with Morgan Stanley.

Everything you've said -- everything that you've said about hiring, the environment is certainly constructive.

But I just wanted to ask about the small business segment, because there was a slowdown, and that was the segment that led you into the acceleration on the better macro environment last year.

So I was just curious whether you would read anything into that slowdown in terms of those businesses starting to react a little bit to whatever it is the trade rhetoric or the stock markets starting to flatten out.

Katy, it's Chris.

I'll start and then Tom can add additional color.

We continue to see confidence in that market.

So I wouldn't read too much into it.

One of the key goals as we created the new business unit was to focus on profitable growth, and the team did a terrific job this quarter doing just that, including frankly improving client margin.

So when you think about cloud growth in that area that would mute the top line and how we sell and what we sell and the discipline around that, I think that may have contributed to a slower growth rate.

But we were very much focused on profitability, particularly as we grow our e-commerce investments and we continue to align resources to best deliver cost-effective value to our customers.

So I really wouldn't read too much into that from a confidence perspective.

I don't have anything that I can add.

Go ahead.

That's a great segue to my second question, which is I was surprised to see or hear that the product margins expanded, given the weakness in netcomm and storage where margins are typically higher.

Can you just talk about what drove the customer mix shift that allowed you to expand margins?

It sounds some like some of that came on the client side.

It did.

I think one of the things is when you mix in and out of some segments, Katy, you remember that those have different margins, had an impact.

When you have the really strong software quarter we had on gross profit, that clearly lifted margins in the quarter.

I would probably look at those 2 things as the biggest contributor.

And then we had, as you heard, a really strong servers quarter, which again contributed.

So I'd probably put it in those 3 buckets.

And our next question comes from the line of Sherri Scribner with Deutsche Bank.

I guess, I thought I would ask about the cloud business and the rollout of the AWS platform this quarter.

How do you think about rolling that out over the next year?

And now you've got Azure and AWS.

Are there other platforms that you have that you think customers are interested in?

Okay.

Well, look, the -- as you heard, we're doing a pretty controlled introduction.

I think one of the things that was really important to us, when you bring on a platform like AWS and a new partner like AWS, is to ensure that the delivery meets everybody's expectations, not just the customers, but AWS' and CDW's.

And so our experience in doing this now, we tend to say, look, let's make sure we get it right.

And then we'll roll it out to the broader group.

Believe me, I've got lots of salespeople in the other part of the organization who are saying, why not us?

But our goal would be over the next probably a quarter or 2 is just to ensure we get the right kind of rollout and then probably more broadly in 2019.

Regarding the second part of your question, we've continued to add partners to our cloud platform and will do so.

I think at this point, though, digesting AWS and then having the Microsoft Azure product, which has been a great source of growth for us, and the AWS product is enough for right now as far as our focus.

Because one of the things we're careful of is we don't dilute our focus in the marketplace.

Okay, perfect.

And then thinking about your international business, Chris, I think you said referrals of the U.K. from the U.S. were up 30%.

Are there additional businesses that you think it would make sense to add on at this point, additional acquisitions?

Or do you feel comfortable with your ability to grow your international business with what you have currently?

Yes, Sherri.

I would echo what Tom said earlier and answer both questions with yes.

We feel confident in our ability to grow internationally.

We have a lot of good things happening.

But particularly with Brexit looming, we continue to think about where it would make sense to expand internationally through acquisition.

Absolutely.

And our next question comes from the line of Paul Coster with JPMorgan.

It sounded like the solutions business in the U.K. and Canada is doing very well.

And it compares to a slower rate of adoption in your North American segments, is that correct?

And if it is correct, what do you think accounts for the rapid place of adoption there on a relative basis?

Yes.

I don't know that I'd say it's a slower rate of adoption, the way I would describe it.

I think there's a lot into a growth rate in a given quarter and some of it is the comp from the year before.

And so I don't think it was anything uniquely different.

I think the referral business has been a good source of stimulus, if you will, for our U.K. business.

In the case of Canada, they have just started within the last 18 months to really focus on solutions.

And so you still have a relatively small base, but they've now developed a good track record.

So I think the characteristics, Paul, are a little different in each.

The supply chain issues become a little different in each.

And the actual composition of solutions are still a little different in each.

So I think that probably is a better way to think about some of the differences you get inside of solutions.

And as you know, more so than the client business, the solutions business can be more lumpy because of the size of the projects.

And I think that's another consideration.

Makes sense.

You don't seem to be impeded in any way by the tight labor market.

But I'm wondering if any of your customers or your customer segments are experiencing bottlenecks that might be slowing down sales a little bit for you as well.

No, I don't know.

Chris, I don't think I've heard that.

And usually, I hear just about every reason that exists on the earth if sales aren't as good as they should be.

But I haven't heard that one.

But now I may after your question.

Chris, anything?

I don't think so.

Yes.

No.

No.

And our next question comes from the line of Keith Housum with Northcoast.

Tom, you provided -- I guess, because we're hearing from some investors these days in terms of a potential trade war in tariffs and how it may impact the demand from your customers.

Are you hearing any concern from your customers about what their spending patterns are?

And that's the first part of the question.

And second, in terms of the tariffs, are you seeing any pressure -- do you anticipate any pressure on pricing of the products as it relates to tariffs?

So let me make sure I get this.

I think the first answer would be, do we hear about it, yes.

Do I think it's impacted their decision making at this point?

No.

So -- I mean, if you look at our results, it would suggest that while there clearly is a lot of rhetoric out there, and every day, it seems like a new bit of news, people seem to continue to focus on their business.

So from that part.

And on the second part, we haven't seen what I would call a meaningful impact on the -- as a result of the tariffs at this point, whether it's in increased costs or costs that we can pass along to customers.

Great.

And then just next question for you.

In terms of the U.K. business, the Canadian business, obviously, you guys have shown some just incredible growth rates in that area.

Is all of that business sustainable in terms of either (inaudible), the sales guys are in place?

Or is someone is being driven by one-off business that concerns you from a sustainability standpoint?

I think I'll let Chris answer that, because I'm interested in her answer.

Go ahead.

I wouldn't think of it as a one-off business.

There's great momentum in both businesses, and I credit the teams there for being very strategically focused on how to grow their businesses and also the, what I call, nonglamarous stuff prescriptively managing the business.

As we think about the second half of the year, 2 things.

First of all, they're both -- they're incredibly high comps over last year.

So while we expect them to continue to perform well and drive growth and out execute in market, we do have 2 incredibly high comps.

The other thing is just the uncertainty in both markets that we're often cautious of.

But I would not think about it as one-off.

I would think about it as strong momentum on business based on implementing strategic initiatives quite well and executing in market prescriptively.

Chris, is it possible to provide any data in terms of the amount of employees you had added over like in U.K. for the past year?

Yes.

I don't think we -- we don't provide that data.

I can give you a little color and tell you that we are hiring in market in a way that is relative to how the growth is.

So we've been positively growing the coworkers -- customer-facing coworkers in both of those markets.

Unfortunately, that's all the time we have today for questions.

So with that said, I would like to turn the call back over to Chairman and CEO, Mr. Tom Richards, for closing remarks.

All right.

Thank you.

Thank you again, everybody, for your time this morning and your questions.

And I'll leave you with a final thought.

For those of you that are parents out there and I'm sure started your summer with blissful dreams about summer vacations, that now has morphed into watching the calendars.

So hang in there.

Schools start soon.

See you.

Thank you.

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

This does conclude the program, and you may all disconnect.

Everyone, have a wonderful day.