CDW Corporation

Hello and welcome to the CDW second quarter 2022 earnings call. My name is Lauren and I will be coordinating your call today. If you would like to ask a question during the presentation, you may do so by pressing star followed by one on your telephone keypad. I will now hand you over to your host, Steve O'Brien, Vice President, Investor Relations to begin. Steve, please go ahead.

Thank you, Lauren. Good morning, everyone. Joining me today to review our second quarter results are Chris Leahy, our president and chief executive officer, Al Morales, our chief financial officer. 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 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 a number of risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release in Form 8-K we furnished to the SEC today and the company's other filings with the SEC. CDW assumes no obligation to update the information presented during this webcast. Our presentation includes certain non-GAAP financial measures, including non-GAAP operating income, non-GAAP operating income margin, non-GAAP net income, and non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You'll find reconciliation charts in the slides for today's webcast and in our earnings release and Form 8K we furnished to the SEC today. Please note our financial results today include results from our acquisition of Sirius Computer Solutions, which closed December 1st, 2021. All references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2021, unless otherwise indicated. References to growth rates for hardware, software, and services today represent U.S. net sales only and include Sirius. They do not include the results for CDW UK or Canada. References to growth rates for specific products and solutions including cloud and security today represent U.S. net sales only and exclude Sirius. The historic combined information of CDW and Sirius discussed herein is for illustrative purposes only and is not necessarily indicative of results that would have been achieved had the acquisition occurred at the beginning of the periods presented. Replay of this webcast will be posted on our website today. I 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. With that, let me turn the call over to Chris.

Thank you, Steve, and good morning, everyone. I'll begin today's call with a brief overview of our results, strategic progress, and outlook, and then Al will run through the financials and our capital allocation priorities, and then we'll move right to your questions. We had an exceptional second quarter. The teams continued to execute well in a challenging supply environment and delivered all-time record sales, margins, and profits. For the second quarter, net sales were $6.1 billion, 19% higher than last year in our first $6 billion quarter. Non-GAAP operating income was $516 million, up 23%. And non-GAAP net income per share was $2.49, also up 23% year over year. These exceptional results reflect our ability to address customers' priorities across a broad array of end markets with solutions across the full spectrum of IT. Digital transformation, agility, and security remain top priorities with ongoing focus on hybrid work and return to office driving collaboration, networking, and endpoint solutions. Customers also continue to seek ways to manage costs while meeting or exceeding coworker and customer service level requirements. Our ability to meet all of these needs led to a broad-based and balanced performance and was a result of three key drivers. Number one, our balanced portfolio of customer and markets. Number two, the breadth of our product and solutions portfolio. And number three, our ongoing execution against our customer-centric strategy. Let's take a look at how each contributed to our growth this quarter. First, the breadth and diversity of our customer and markets. As you know, we have five U.S. sales channels, corporate, small business, healthcare, government, and education. Each channel is a meaningful business on its own, with annual sales ranging from $1.9 billion to over $8 billion. Within each channel, teams are further segmented to focus on customer and markets, including geography and verticals. We also have our U.K. and Canadian operations, which together delivered sales of $2.6 billion U.S., This portfolio approach enables us to toggle to the best pockets of opportunity. Each team did an exceptional job this quarter. Our corporate team delivered another record quarter with a 34% net sales increase. Results were balanced and broad-based. Customers continued to invest to stay ahead of the curve to either begin or advance their efforts to address the accelerating pace of change. Digital transformation drove excellent solutions growth, with strong double-digit increases in netcom, servers, collaboration, cloud, and software. Customers are increasingly seeking our advice and expertise in navigating their IT journeys, and this drove strong performance in professional and managed services and warranties. At the same time, corporate customers continue to turn to us to meet their needs for hybrid and return-to-office solutions, and the team delivered another quarter of double-digit client device growth, reflecting both unit and ASP increases. Small business performance was in line with our expectations, and the team delivered a 4% increase on top of last year's 60% growth. This net sales growth understates demand as customers prioritize cloud and software solutions, which are accounted for on a net-a-down basis. A better barometer of customer demand in the quarter is the gross profit performance of small business, which increased at more than twice the rate of sales growth. During the quarter, customer spend increased more than 20% for both security and cloud as customers modernize, optimize, and secure the applications running on their endpoint devices. Infrastructure spending is the natural follow-on from remote enablement and return to office demand. Remote enablement remained strong and the team produced another quarter of double digit collaboration and client device growth. Public posted an 8% increase this quarter. The healthcare team delivered another excellent quarter, up 30%. We continue to help our hospital systems and healthcare organizations leverage technology to mitigate staffing shortages and wage and cost inflation. A great example of this is seamless patient intake and record keeping solutions that use biometric security to improve emergency department throughput. And while healthcare has taken a more cautious view toward cloud in the past, the benefits of flexibility and reduced IT support burden are compelling more customers to adopt cloud-based solutions, driving a double-digit increase in cloud customer spend. Government posted 19% growth. State and local performance reflected continued success helping customers maximize the value of their IT investments, leveraging our expertise in professional and managed services. At the same time, the team is helping customers navigate through the complexities of funding programs and the impact on their long-term planning efforts. While customers generally have until 2024 to 2025 to spend stimulus, data continues to proliferate, and we delivered excellent cloud and storage performance. Remote collaboration continues to be a priority driving double digit growth in devices and audio video. As we expected, federal return to growth in the quarter. Federal customers prioritized services tied to solution inception and ongoing management. Similar to state and local, remote collaboration led to double digit transactions growth. After the past two years of unusual spending patterns, we anticipate a return to more normal season patterns for federal. including fiscal year-end September budget activity. Higher ed's strong performance was offset by the expected decline in K-12, and overall education sales decreased 6% off of last year's excellent second quarter performance. The higher ed team continues to help universities enable student success and student access programs using technology to give institutions an enrollment edge. This includes deploying comprehensive endpoint solutions, security, and campus connectivity to deliver enhanced dorm room experience. K-12 posted a healthy seasonal increase, but remained below last year's exceptional stimulus-driven results. During the quarter, a third wave of emergency connectivity funding, ECF, was announced, which opened July 1 and extends through December 2023, adding complexity to an already broader way of funding. We continue to work with school systems to help identify how to maximize available funding to maintain equity and access IT advancements into the future. In the near term, the team also continues to help educators implement connected learning spaces and to enhance security. Other, our combined UK and Canada results increased 24% on a reported basis. Both regions delivered excellent growth. UK was up significantly in local currency. and delivered balanced growth across both public and commercial with excellent remote enablement activity. Canada increased double digits in local currency, primarily driven by commercial customers with excellent solutions growth. The second driver of our performance was our broad and deep portfolio. Our ability to address customer priorities across the entire IT continuum resulted in excellent performance across our solutions and transactions portfolios. Solutions grew twice as fast as transactions. U.S. hardware increased low double digits. Growth was broad-based and included double-digit increases in server and server management and video audio. We also continue to see underlying strength in notebooks across our commercial business. Client devices, netcom, enterprise storage, and printing and scanning increased at a healthy signal digit rate. This exceptional performance was on top of 2021 second quarter double digit hardware growth. Demand continued to outpace supply in several key areas, notably in networking and enterprise storage. Customers once again placed orders to get in line for second half 2022 projects, especially in Netcom. While overall backlog ticked down slightly from last quarter, we exited the quarter with backlog at nearly twice last year's second quarter level. And once again, we leveraged our competitive advantages, including our distribution centers, our extensive logistics capabilities, deep vendor-partner relationships, and our strong balance sheet and liquidity position to navigate an ongoing supply challenge. U.S. software increased nearly 40% compared to the prior year. Strength was broad-based as we continued to help customers manage data, enhance productivity, and secure their IT environments. with strong double-digit increases in storage and network management software, application suites, and security software. Cloud was an important driver of performance across the business and was a meaningful contributor to profitability, with customer spend and gross profit increasing by double digits. Infrastructure as a service, productivity, security, application delivery, and connectivity were key growth workloads during the period. U.S. services performance was excellent this quarter. Growth was broad-based and balanced, driven by professional services, managed services, and warranties. Services net sales were roughly twice last year's level and represented 8% of total sales, up from 5% in 2021 and 2020. And that leads to the third driver of our performance this quarter, our customer and coworker-centric strategy. Over the past three years, we have relentlessly focused on executing our strategy to enhance our high relevance and high growth solutions and services fueled by organic and inorganic investments. Eight acquisitions have deepened and advanced our services capabilities, including automation, cloud native and DevOps, and cybersecurity. Capabilities necessary to ensure we remain the trusted advisor to our customers as they accelerate their digital transformation. capabilities that enable us to best serve customers, whether in a physical, digital, or cloud-based environment in the U.S. and internationally. Through our acquisitions, we welcomed nearly 3,000 new coworkers with more than half in technical roles. Since year-end 2018, our technical team has doubled in size. Today, more than 5,400 presale specialists and engineers work alongside our world-class sellers to deliver the complex digital transformation solutions from code to cloud and data center to database that our customers want and need. All of our investments, whether homegrown or acquired, are designed to maximize our key points of differentiation in the marketplace and ensure we continue to help customers achieve the outcomes they need from technology so they can do great things. Let me share a couple of recent examples that demonstrate how our investments are making a difference for customers. In the federal space, the power of bringing three winning teams from CDW, Sirius, and Focal Point together is evident in the cybersecurity solutions we are delivering to the intelligence community. Together, the focus is on enhancing our scope across the Department of Defense and civilian agencies. To gain traction in this space, you must deliver proof of concept, which we do with our dedicated advanced solutions lab. You must provide training and support, and you need agency-to-agency endorsement. While the CDW government team already had both expertise and scale, Sirius' federal team brings a track record of success in solution configuration, technical integration, and managed services. And our cyber experts at Focal Point Academy deliver the professional training these agencies need. Our relevance to federal customers has never been greater. The second example of how our investments enable customers to achieve great outcomes comes from our small business team. A provider of software as a service solutions to pharmaceutical and life sciences companies needed to address their aging data center infrastructure. Their customers' workloads and data were being run on servers that were well beyond end of life. the servers clearly were not capable of supporting their existing business, let alone growing their SaaS offering. The CTO initiated a competitive bidding process for a very small-scale professional services contract to provide proof of concept on cloud migration, starting with a couple dozen servers. CDW and our competitors all utilize the same public cloud provider, but CDW1, based on our experience with migration, our proven post-migration support, and our long-standing trusted relationship with the customer, serving their transactional product needs. The CDW team, bolstered by technical support from our IG&W Digital Velocity Professional Services team, built a secure landing zone in the public cloud, and the proof of concept proved so successful, the customer is now migrating hundreds of servers. Seeing the huge burden CDW lifted off the customer's engineering team, who were having trouble balancing their day-to-day operations while trying to expand their cloud footprint, the customer contracted CDW for ongoing managed services of their rapidly growing cloud environment. The current annual services opportunity is at $750,000 run rate and is on a path to $1.5 million. By staying close to the customer, CDW once again had the opportunity to help make IT work. allowing the customer to improve the scalability and performance of their software offering. Investments in our customer and coworker-centric growth strategy are foundational to our ability to consistently and profitably outgrow the US IT market. And that brings us to our expectations for the rest of the year. Our team's terrific execution and relentless focus on the customer delivered significant outperformance to our baseline outlook in the first half of 2022. Given this excellent performance, we continue to expect to outperform the U.S. IT market by 325 to 425 basis points, 125 basis points higher than both our long-term average level of outperformance and our original view at the end of year 2021. Our estimate of U.S. IT market growth in 2022 remains 4%. Taken together, this equates to constant currency growth of 7.25% to 8.25% above 2021 combined CDW revenues of $22.8 billion. Recall 2021 combined CDW is calculated as though Sirius was acquired on January 1, 2021, instead of its actual acquisition date of December 1. On a reported basis, our outlook represents a 17.5% to 18.5% increase over 2021 results on a constant currency basis. Our outlook continues to reflect our baseline expectations that we will mix into more sales of solutions in the back half of the year, notably cloud and security. Given this expected change in second half mix, we also expect to deliver profit growth faster than sales growth, even as we continue to invest in our future. Our outlook also continues to reflect our expectations that supply constraints remain relatively consistent with the first half of the year. While we're cognizant of economic headlines, to date, we have not seen a change in behavior that would impact our view on the second half of the year. Of course, we remain mindful of economic risks as well as other wild cards, including the potential for further disruption to supply and changes resulting from COVID incidence rates. We will keep a watchful eye, as always, on these and other potential issues. And as we always do, we will provide an updated view on customer activity and and our annual outlook on the next call. In the meantime, we will continue to do what we do best, leverage our competitive advantages and out-execute the competition. We will also continue to invest to ensure we are remaining our customers' trusted technology partner of choice, helping them deliver the business outcomes they need. Now let me turn it over to Al, who will provide more details on our financials and outlook. Al?

Thank you, Chris, and good morning, everyone. I'll start my prepared remarks with additional detail in the second quarter, move to capital allocation priorities, and finish up with our 2022 outlook. Turning to our second quarter P&L on slide 8, consolidated net sales were $6.1 billion, up 19.4% on the reported and an average daily sales basis. On a constant currency average daily sales basis, consolidated net sales grew 20.5%. On an average daily sales basis, sequential sales increased 1.7% versus the first quarter. Second quarter sales were in line with our expectations, reflecting broad-based and balanced growth across our portfolio. On the supply side, consistent with last quarter, we saw pockets of improvement and pockets of pressure. The change in our overall backlog compared to the first quarter was insignificant. Year over year, our backlog remains elevated in both transactional and solution categories, and we continue to manage inventory strategically to support our customers through this uncertain supply environment. The team once again did a great job leveraging CDW's competitive advantages to ensure strong returns on working capital. We had excellent profitability in the quarter. Gross profit was $1.2 billion, a year-over-year increase of 32.3%. Gross profit margin was a record 19%, 180 basis points versus last year. The expansion in gross profit margin was driven by several factors. First, increased netted down revenues, primarily within software as a service, as the category continued to grow faster than overall net sales. Netted down revenues represented 28% of total gross profit. Second, product margins were strong, driven by both mixed and resilient demand for certain hardware products. And third, net sales and high margin professional service business nearly doubled as a result of our recent acquisitions. Turning to SG&A on slide nine, non-GAAP SG&A totaled $652 million for the quarter. The year-over-year increase in non-GAAP SG&A was primarily due to higher payroll consistent with higher gross profit and higher coworker count. Coworker count at the end of the second quarter was nearly 14,600. up roughly 3,900 from the prior year quarter, reflecting organic and inorganic investments in coworkers that support high-growth solution areas and our own digital transformation. Investment in our coworkers and in our strategy are integral to our ability to outgrow the market profitably and sustainably. We are seeing our disciplined and balanced investments pay dividends as evidenced by record sales and profitability in the period. GAAP operating income was $435 million, up 17.7%. Non-GAAP operating income was $516 million, up 23.5%. Non-GAAP operating income margin was a record 8.4%, up 30 basis points from the prior year and 60 basis points from Q1. Moving to slide 10, interest expense was $58 million. Higher interest expense is primarily driven by the senior notes issued last year to fund the acquisition of series, as well as higher interest rates on our floating rate debt. Our GAAP effective tax rate shown on slide 11 was 26%. This resulted in second quarter tax expense of $98 million. To get to our non-GAAP effective tax rate, we adjust taxes consistent with non-GAAP net income add-backs as shown on slide 12. For the quarter, our non-GAAP effective tax rate was 25.9%, up 50 basis points versus last year as a result of an increase in non-deductible expenses. As you can see on slide 13, with second quarter weighted average diluted shares of $137 million, GAAP net income per share was $2.04. Our non-GAAP net income was $340 million in the quarter, up 19%. and non-GAAP net income per share was $2.49 of 23% from last year. Year-to-date results can be found on slides 14 through 19. Moving ahead to slide 20, at period end, cash and cash equivalents were $542 million and net debt was $6 billion. Liquidity remained strong with cash plus revolver availability of approximately $1.7 billion. Moving to slide 20, the three-month average cash conversion cycle was 19 days, down two days from last year's second quarter, and reflecting a tighter spread between DSO and DPO. Year-to-date free cash flow is $717 million, as shown on slide 21. This is higher than a typical first half, reflecting strong growth in the business and effective working capital management. For the quarter, we utilized cash consistent with our 2022 capital allocation objectives, including returning $68 million to shareholders through dividends and further reducing our net leverage ratio. Which brings me to our capital allocation from slide 22. Our objectives remain consistent with what we shared last quarter. First, increase the dividend in line with non-GAAP net income. Last November, we increased the dividend 25% to $2 annually. To guide future increases, we will continue to target the dividend at approximately 25% of non-GAAP net income and to grow in line with earnings. Second, ensure we have the right capital structure in place with a targeted net leverage ratio of 2.5 to 3 times. We ended the quarter at 2.9 times, down from 3.4 at the end of 2021. demonstrating strong growth in the business and excellent cash generation. And while we're at the top of our targeted net leverage range, we are balancing rating agency capital expectations, which would call for us to be towards the bottom of our range. As such, we will continue to prioritize de-levering until we are more firmly in our targeted net leverage range and can satisfy the commitments we made when we financed the acquisition of Sirius. We continue to expect to achieve this by the end of 2022. And while we continue to temporarily put a lower priority on our third and fourth capital allocation priorities of M&A and share repurchases, we are firmly on a path to getting back to delivering on these priorities. Moving to the outlook for 2022 on slide 23. Starting with sales, our outlook remains unchanged from last quarter on a constant currency basis, including holding our second half outlook at our initial aggressive baseline. While we are cognizant of potential market variables as we look forward, we are confident in our ability to execute, pivot to where the growth opportunities are, and outperform the broader market. We continue to expect the back half of the year will reflect a greater mix in the netted down revenues as we overlap 2021's strong client device sales. Recall that the accounting treatment for netted down revenues has a dampening effect on our absolute net sales dollars, but is neutral to gross profit dollars and thus results in higher gross margins, all else equal. With that in mind, our outlook for full year 2022 continues to be U.S. IT market growth of 4% plus 325 to 425 basis points of CDW outperformance in constant currency on a combined basis. Recall that on a combined basis, CDW's net sales would have been $22.8 billion in 2021, including $2.17 billion from Sirius. On a reported basis, our four-year net sales outlook equates to approximately 17.5% to 18.5% growth in constant currency. Currency is expected to be a headwind of approximately $120 million to net sales in the second half of the year. This assumes an exchange rate of $1.22 to the British pound and 78 cents for the Canadian dollar in the second half. Our baseline outlook assumes that supply does not materially impact net sales beyond what we've been experiencing. We would expect to be at the lower end of our premium range if we mix more into netted down revenue streams than expected and or experience elevated levels of supply constraints. We would be at the higher end if hardware growth is stronger or if supply improves. Moving down the P&L, we continue to expect full-year non-GAAP operating income margin to be in the low 8% range. For non-GAAP earnings per share, recall that 2021 would have been $8.49 on a full-year combined basis compared to our reported $7.97, which included only one month of series. We now expect full-year non-GAAP earnings per share growth to be in the mid-teens, call it 14% to 15% in constant currency on a combined basis. This equates to a low 20% full-year growth rate in constant currency on a reported basis. Currency is expected to be a headwind of approximately $0.04 to earnings per share in the second half of the year based on the reference exchange rates. Please remember that we hold ourselves accountable for delivering our financial outlook on a full year constant currency basis. Additional modeling thoughts for annual depreciation and amortization, interest expense, and the non-GAAP effective tax rate can be found on slide 25. Moving to modeling thoughts for the third quarter. We expect a low single digit increase from Q2 to Q3 on an average daily sales basis. This equates to a roughly 17% year-over-year reported net sales growth rate for the third quarter. We expect third quarter non-GAAP earnings per share to grow approximately two percentage points faster than reported net sales. Finally, we now expect to be towards the top end of our long-term free cash flow rule of thumb of three and three quarters to four and a quarter percent of net sales in 2022, assuming current tax rates. As you know, timing has a meaningful impact on free cash flow, and it may ebb and flow by quarter. That concludes the financial summary. As we always do, we will provide updated views on the macro environment and our business on our future earnings calls. And with that, I'll ask the operator to open it for questions. We would ask each of you to limit your questions to one with a brief follow-up. Thank you.

Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two. When preparing to ask your question, please ensure that your phone is unmuted locally. Our first question comes from Sameek Chatterjee from JP Morgan. Sameek, please go ahead.

Great. Thank you. Thanks for taking my questions. I guess, Chris, you mentioned you haven't really seen any impact of the macro on your business yet and You continue to monitor it closely. Maybe if I can ask it another way, when you sort of interact with your customers and we know a lot of the enterprises are starting to slow down their own hiring plans, are you seeing a greater sort of intent in relying on CDW and your service capabilities as we head into sort of the next year just on account of them slowing down their plans in terms of hiring engineering resources, et cetera? And I have a quick follow-up. Thank you.

Good morning, Samika. Thanks for the question. I would say just a short answer is yes. We are seeing our customers rely more heavily on us in the labor shortage world we're in. You know, we've said often that technology has become just absolutely essential, more integral to our customer success and more vital to their businesses, whether it is delivering experience, whether it is profitability, whether it's teaching kids, whether it's, you know, providing health care. It is just essential to what organizations do, and CDW is their trusted advisor, and we are continuing to see our customers lean into us more for some of the things that we referenced in our prepared remarks. For example, advisory services on the front end, professional services as they're going through their discipline planning, et cetera. relieving their staff of important management like data center security and things like that. So it's been a very positive move for us and is driving some of our growth. Thank you.

And for my follow-up, if I can just ask you on the supply chain, I know your guidance around performance is based on certain sort of improvements in supply chain that could potentially happen, but As we talked to a lot of the OEMs, clearly seeing signs of them expecting more availability of components. Where are things in relation to lead times that are communicated to you or sort of what you're seeing in terms of lead times? And are you expecting things to get better or are you sort of not really seeing much change yet in communication from the OEMs themselves?

Yeah, I'll start with that. Al, can add if you'd like. I would tell you that, look, we don't expect supply constraints to meaningfully change beyond what we've experienced in the first half of the year as we look to the back half of the year. I mean, it's still, I'd call it, what's the best word, choppy. We're seeing pockets of pressure and pockets of improvement. As I mentioned in my remarks, I tell you we kind of a tick down, which is barely negligible. So not expecting any necessarily meaningful change in the back half of the year, But for us, that means we just continue to navigate and press our competitive advantages and navigate as we have been through these past several years. And that's what I say about the supply chain.

Thank you. Thanks for taking the questions.

Thank you. Our next question comes from Jim Suber from Citigroup. Jim, please go ahead.

Thank you. Chris, now with the raising interest rate environment, can you talk about have customers changed their behavior at all, asked for some better funding, or talked to you about that at all? And how should we think about that interest rate environment also on the financials of CDW? So that's kind of both my questions on the same topic, on your customers and then on your own self-company. Thank you.

Yeah, Jim, good to hear from you. Let me start with the customers. And what I would just say, and this is more of a general answer to the current environment, some uncertainties out there, interest rates going up, labor shortages, inflation, everything that we hear about in the headlines. What I would say is customers are being disciplined around their investments, and that is good for CDW insofar as they look to a trusted advisor with the depth of experience we have to be able to work with them towards the best solutions. So the environment, frankly, is playing into our competitive advantages, and we're not seeing that type of macro environment impact our sales opportunities, our profit opportunities. On the contrary, it's actually being something that pulls us in more closely with our customers. So I'll just answer that part of it, and I'll turn it to Al, for interest expense, CW.

Yeah, sure, Jim. So first on your question on any change in attitude or direction with customers with respect to financing, et cetera, I would say no, nothing material there. As we typically would with every customer, we're looking at the avenues of whether they would like financing solutions or otherwise, but nothing's changed materially there. With respect to the impact to us, From a financing perspective and interest expense, based on my prepared marks, we do have a component of our debt that's floating rate. We did see in the quarter a bit of a tick up in the interest expense commensurate with that, and we've got that baked into our outlook. We do have interest rate caps in place. We just haven't quite hit those yet. We do feel like that's capped out, and it's certainly manageable.

Thank you so much for the details and clarifications. It's greatly appreciated.

Thanks, Jim. Thank you. Our next question comes from Eric Woodring from Morgan Stanley. Eric, please go ahead.

Thank you so much, and thanks for taking my questions this morning, guys. Maybe, Chris, if I start with you, if we take a step back, CDW has obviously consistently outperformed IT market growth you know, from anywhere between 200 to 500 basis points in any given year. You know, how do you think about, you know, kind of in the potential that this market gets more challenging, how do you think about the potential to increase those share gains? And kind of what I'm getting at is maybe the implication would be slower IT market growth in that type of scenario. But given your scale, your reach, the broad breadth of products that you have, Do you see a more recessionary type of environment as an opportunity for CDW to gain share perhaps in excess of your average annual outperformance versus the IT market? And then I have a follow-up. Thanks.

Yeah, sure, Eric. Again, the answer is yes, some of these short answers. The answer is yes. We certainly perceive and – look, we have historically been well-positioned and outperformed the market and our peers historically. in challenging macro environments, and we would expect that to be similar going forward. In fact, I would say that we are better positioned now than ever to be opportunistic in down markets, given the full spectrum of our technology solutions. For our customers now, needing a trusted advisor that brings a comprehensive suite of solutions and the complete end-to-end services required has become more integral and more essential to how they do business. And so, um, the answer is yes, we, we, we would intend to press our competitive advantages and we see great opportunity. That's been part of what we've been really focused on building over the past couple of years through executing our strategy and ensuring that our portfolio is, is a fulsome and has the services that are relevant to delivering on the solutions our customers need.

Okay. Super. Thank you. And then maybe, Al, one for you. Obviously, 19% gross margins. I think that's an all-time high. Obviously, very strong. You kind of went through the three different drivers earlier in your prepared remarks. I'm just wondering if there's any way you can kind of quantify or help us better understand the significance of those three factors relative to each other, meaning how significant was the mix of netted down revenue to gross margins, perhaps, versus the inclusion of serious versus perhaps you know, mix on the non-netted down revenue side. We'd just love to get a better understanding there. And that's it for me. Thanks.

Sure, Eric. So first, I didn't mention Sirius, right, because we would think of Sirius at more kind of macro level, but I would just note that the contribution from Sirius and really the power of putting the teams together, we are seeing exactly what we would have expected in terms of creative effect on gross margin. On the netted down revenues, I mentioned grew 30% year over year, 28% of gross profit. That was a solid contribution there. Absolute dollar amount consistent with Q1. But what was different for this quarter is we had even stronger contributions from professional services, right, which is coming online and accelerating. And then firm margins on products. And so multiple variables there. In terms of as we look forward and we think about durability, look, there's always going to be puts and takes. And that's why our outlook focuses on end July margin, because it's just a little bit more balanced, a little bit more stable. But certainly this quarter, you saw all those contributions from the gross margin front come to fore.

Great. Thank you, Al.

Thank you. Our next question comes from Matthew Sheeran from Stifel. Matthew, please go ahead.

Yes, thank you, and good morning. I wanted to ask another question regarding the PC market and your outlook there. You talked about double-digit growth on the commercial side and very strong backlog still, but you also talked about solutions growing faster. in the back half as it did last quarter. So could you give us an outlook there in terms of backlog, supply, is supply improving there, and is that enabling you to fill that backlog, and do you see that falling off in the second half?

Hi, Matt. Let me start on this, and then we can dive into the backlog a little more specifically. You know, the way I would characterize it is we do continue to expect resilient commercial demand. As we've said a number of times, client devices, endpoint devices are a low-cost productivity-enhancing investment. And given the changing dynamics of delivering goods, digital, curbside, et cetera, they've just become part and parcel of the solutions for every commercial business. In terms of the total client device sale and backlog, we had healthy, I think it was low single-digit client device growth this year, which compared to anything out there, I think has been really solid. In terms of the backlog, we have had some backlog open up a little bit over the last six months or so, I think. But Al, did you want to add more about the backlog specifically?

Yeah, Matt, I would say, as we mentioned, no significant changes thematically in the backlog in terms of the pressure points versus relief. To Chris's point on client delays, it's just more fluid, right? So we see a bit more flow. And we've mentioned this before, but if nothing else, we have a bit more read into transparency of what to expect on lead times. But look, the friction is still there. on the solution space and we wouldn't expect that that's gonna change. Our job is to continue to navigate it and be there for the customers, get them stuff as quick as we can and most effectively.

Okay, thanks very much for that. And then just turning to your outlook on the solution side and specifically investments from customers. in infrastructure. We're picking up from our VAR survey that customers are taking longer to close larger deals, being a little bit more scrutinous on deals, requiring more sign-offs. Are you seeing that at all in terms of hesitation or a little bit more scrutiny from customers on deals?

Yeah, I guess here's how I characterize it. With the context of the last couple of years, where I'd say your normal purchasing process kind of was put aside a little bit. I would just say that we're kind of back to a normalized, disciplined buying process. And I wouldn't characterize it beyond that. And as I said earlier, that's actually good for CDW because we're a trusted advisor and can help our customers make the best, most cost-effective, most effective decisions in the process.

Okay, thank you.

Thank you. Our next question comes from Rupali Bhattacharya from Bank of America. Rupali, please go ahead.

Hi, good morning. Thanks for taking my questions. Chris, in the past, you've talked about the SMB or small medium business segment as a bellwether for the macro environment as they react fast to the macro changes. This quarter looks like revenue growth slowed to 4% year on year, albeit on tough compares. And you've kept the full year guide unchanged, and you had a strong fiscal 2Q. So first, can you give us your thoughts on what the SMB segment is indicating to you? And then second, in the prepared remarks, you talked several times about continuing to invest in the business. Looks like CapEx as a percent of sales declined slightly to 0.6%. So just give us your thoughts on what areas of investment you would like to make in this environment, and how would you just judge the success of those investments?

Morning, Rupal. Let me start with small business. And look, we're pleased with small business results. We're not seeing weakness to date. And I just would say investors and analysts should not extrapolate from the decelerating growth rate. As I mentioned in my prepared remarks, small business customer spend was up. but it was in the categories of areas that net down. So a more appropriate barometer of the health of demand in small business, we think, is gross profit performance, which increased at more than twice the rate of sales growth. So I would just keep focused on that. Cloud and software solutions were really, really well, delivered really, really well this quarter. We also, just to be clear, continue to see strong momentum in the strategic execution in small business across a wide variety of solutions that customers are investing in. So whether it's solutions to modernize and optimize their infrastructure, whether it's continued remote enablement, which we're still seeing resilience in, but we're not looking at small businesses softening at this point. It's really been resilient and momentum is strong. In terms of investments, what I would tell you is You know, we're a people business, so when you think about investments that are maybe non-capital intensive related, that's all about people. You look at the acquisitions and the number of folks in our technology organization that we've brought to CW, the number that we've hired over the year, they're organically brought in. But then think about things like our CRM program and modernizing our CRM program using Salesforce. If you think about our unique training programs that are very – specific to CDW, you know, our training programs are best in the business. When you think about leadership development, when you think about all of the things that we're doing that drive efficiency and effectively and productivity for our sales organization and the ability for our technical organization and sales organization to go to market as a one CDW company, as one team, all those investments are the kinds of things that we're doing to continue to execute our strategy.

Okay, thanks for the clarification and the details there. For my follow-up, if I can just ask, it was great to see the federal business grew year on year. Do you think that strength continues and within government, how should we think about the relative growth from federal versus state and local in the second half of this year? Thanks again.

I'll start with that one. Yes, we've said that we would expect Fed to continue growth, start growth in the second half of the year and continue. It'll I would expect it to look more seasonal. I think we're kind of back into more of a seasonal rhythm with federal. And state and local has been interesting because, as you know, the budget, the funding that they've received has allowed them to make investment decisions over a more extended period of time versus the one year that they typically do. And we've been supporting customers with that. All that said, given things like data proliferation, et cetera, they're still investing now. So you can expect to see solid growth across both of those sales channels in the second half of the year.

Thanks for all the details and congrats on the strong execution.

Thank you. Really appreciate it.

Thank you. Our next question comes from Keith Hewson from North Coast Research. Keith, please go ahead.

Good morning. Chris, maybe perhaps talk about, you know, CW's own hiring plans for the rest of the year and how you're seeing that growth.

Our hiring plans for the rest of the year? Yeah, we're still investing in people. You know, obviously, we've got our eyes on the headlines. We're being prudent in how we run our business. but we're continuing to invest in those areas that support the important capabilities that our customer needs from us, and we're investing in areas to drive efficiency. So we have not slowed down our investment in people at this point, and we feel very confident with that.

Great. I appreciate it. And then I just want to talk with investors in terms of the concerns about the chip manufacturers and concerns that PCs will be slowing down. How would you address that question? And is it still down in the chips? Is that perhaps a canary in the coal mine for the entire tech industry?

I had a hard time hearing the beginning. Can you just repeat the question, please?

Yeah, absolutely. So the question from investors that we're getting oftentimes is, you know, looking at the sales of PCs and with the chip manufacturers now believing that, you know, the chips will be down to personal computers by, say, 10% to 15% for the rest of the year. there's concerns that that might be a canary in the coal mine for technology spending. How will you respond to that question?

Yeah, what I would say is I think technology spending is going to be even more resilient in the face of all kinds of challenges going forward because it's so essential to businesses, whether it is challenges around chips, challenges around the macro environment, et cetera. Businesses can't win in the marketplace without utilizing technology to drive efficiency, effectiveness, experience, all the things we talk about. So we aren't concerned about some of that talk track. We feel very confident that our customers, and we see the momentum, our customers are continuing to invest in technology across the spectrum from endpoint solutions to hybrid infrastructure. And we feel very confident that we'll be able to press our competitive advantages and have access to the technology needed for our customers, given our size and scale.

Great. Thanks, Chris. I appreciate it.

Yep. Thank you. Our final question comes from Lauren Lucas from Epicor. Lauren, please go ahead.

Hi, this is Lauren on for Amit. So thanks for taking the question. Could you guys... Could you guys provide some more color on the change in expectation to netted down revenues for the second half? So I know you guys talked about SMB shifting spend this way, but I mean, how should we be thinking about this kind of in terms of where gross margins could reach? Thank you.

Yeah, thanks. Thanks, Lauren. This is Al. I think, you know, previous to today, we talked about we expected a higher level of netted down revenues in the second half, and that still holds true. If we look at Q2 and the contributors to our gross margin, otherwise I talked about professional services, obviously at a macro level, the accretive effect of serious and product margins were firm. But the theme, kind of as we look at the second half, as well as really ongoing with net down revenues, which makes up just for clarity, SAS, software assurance, warranty, and commissions, Those themes continue, and we continue to expect that they will outpace our net sales overall.

Got it. Thank you.

Thank you. That is the end of the Q&A session today, so I'll now hand you back over to Chris Leahy for closing remarks. Thank you very much, Lauren.

Let me close by recognizing the incredible dedication and hard work of our over 14,600 coworkers around the globe. Their dedication to serving our customers is what makes us successful, and in particular, embracing a better together approach and philosophy as we've brought together many amazing companies over these last few years. Thank you to our customers for the privilege and opportunity to help you achieve your goals, and thank you to those listening for your time and continued interest in CW. Al and I look forward to talking to you next quarter.

This concludes today's call. Thank you for joining. You may now disconnect your lines.