CDW Corp Q2 FY2025 Earnings Call

Good morning, everyone, and thank you for being here for the CDW Second Quarter 2025 Earnings Call. My name is Carlin, and I will be coordinating today’s call. I would now like to turn it over to our host, Steve O'Brien.

Thank you, Carlin. Good morning, everyone. Joining me today to review our second quarter 2025 results are Chris Leahy, our Chair and Chief Executive Officer; Al Miralles, our Chief Financial Officer. Our 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 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 and 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 and 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 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 8-K. Please note all references to growth rates or dollar amounts, changes in our remarks today are versus the comparable period in 2024, with net sales growth rates described on an average daily basis, unless otherwise indicated. A replay of this webcast will be posted to our website later today. 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. With that, let me turn the call over to Chris.

Thank you, Steve, and good morning, everyone. I'll begin with a high-level overview of our second quarter financial and strategic performance and share some thoughts on the balance of the year. Al will take you through a more detailed look at our results, capital strategy and priorities and outlook for 2025. We'll move quickly through our prepared remarks to ensure we have plenty of time for questions. Second quarter results underscore the power of our full stack, full lifecycle solutions. In a dynamic and complex environment, the team delivered double-digit top-line growth even as federal and education markets faced evolving headwinds. As a result, that reflects not only strong execution, but also the strategic advantage of our diversified portfolio of products, services, solutions and customer end markets. For the quarter, consolidated net sales were $6 billion, up 10% over last year. Gross profit was $1.2 billion, up 5%. Non-GAAP operating income was $520 million, up 2%. Non-GAAP net income per share was $2.60, up 4% and we delivered adjusted free cash flow of $210 million. The team was focused and determined, staying true to our value proposition and customer-centric approach. Customer focus was similar to the first quarter and remained squarely on must-do versus wants with two key priorities: first, client devices, which reflected a baseline replacement cycle amplified by the Windows 10 end-of-life transition and a heightened focus on productivity initiatives. Second, mission-critical infrastructure projects, which were particularly strong across enterprise customers in our corporate channel. The team's success addressing customer priorities delivered gross profit growth of 5%, which exceeded our expectations. Let's take a closer look at how customer priorities and market dynamics shaped performance across our end markets and portfolio in the quarter. As always, there were three main drivers of our results: our balanced portfolio of customer end markets, the breadth of our products, services and solutions and relentless execution of our three-part growth strategy. First, our balanced portfolio of diverse customer end markets. We have five U.S. sales channels: corporate, small business, health care, government and education. Each channel is a $1 billion-plus business annually. Additionally, our U.K. and Canadian operations together delivered sales of USD 2.5 billion last year. Our scale allows us to segment our business into customer-end markets with dedicated sales professionals, industry experts and technical resources who deeply understand the unique priorities of each market. When end markets behave differently from each other, the diversity of our customer base serves us well. The benefits of our scale and diverse end markets were evident once again in the second quarter with strong performance in commercial, health care in the U.K. and Canada, offsetting expected federal and education declines. Commercial performance, which includes corporate and small business was strong and balanced. Both teams did an exceptional job pivoting to customers' shifting needs and areas of focus, with corporate net sales up 18% and small business up 13%. Greater enterprise market penetration in corporate drove excellent hybrid infrastructure growth, and both teams also delivered strong client device growth as they leveraged our comprehensive suite of client solutions and services to help customers meet their priorities to both enhance workplace experience and productivity. Small business also continued its success helping customers use SaaS to drive efficiency and flexibility and delivered strong double-digit cloud performance. Public increased 2% as the team helps customers navigate a dynamic environment marked by changes in funding streams and protocols. Once again, health care was a standout performer with net sales up 24% as they continue to help our customers address clinical continuity. Education posted an 11% decline in top line. K-12 declined by double digits, driven by both changes to federal funding rules and expected changes in funding streams, which included the expiration of stimulus funds. Results also reflect the expected impact of Chromebook buying during the first quarter ahead of anticipated price increases, which we previously identified. Higher ed posted a modest decline as institutions assess the impact of new regulatory and funding pressures, including ramp freezes and student visa uncertainty. Despite these challenges, projects continue to move ahead, most notably, network upgrades vital to student satisfaction. Government increased 3%, mid-single-digit state and local growth more than offset an expected decline in federal. Many state and local jurisdictions move ahead on critical projects as they closed out their fiscal years and the 2025 budget cycle. Services continues to be a focus area for state and local, up by significant double digits. Federal performance reflected the impact of new administration priorities with mixed performance across the various agencies. Some civilian agencies curtailed purchases and others moved forward. With the evolving funding mechanisms and shifting rules of engagement, the team worked with customers to help them prioritize spending and best address mission-critical needs, further deepening relationships and capturing opportunities where budget exists. Standout performance was delivered by our U.K. and Canadian operations, which we reported as others. The U.K. team capitalized on client device demand and captured full stack opportunities with public sector customers, while our Canada team drove meaningful growth despite tariff-related macroeconomic uncertainty. This exceptional execution by both teams delivered a combined top-line increase of 12% on a reported basis, each up high single digits or better in local currencies. Clearly, second quarter results demonstrate the power of our balanced portfolio of customer end markets. Results this quarter also demonstrate the power of our second driver of performance, the breadth of our full stack, full lifecycle offering. The team's ability to address customers' top priorities drove strong performance across software, hardware, and services. Hardware increased 9%, driven by significant increases in infrastructure solutions, notably NetComm storage and servers as well as client devices. NetComm servers both increased top line by meaningful double digits, while storage increased by high single digits. Client devices increased 12%. ASPs held strong and unit growth was solid. Software increased by 16% with excellent growth across all end markets except K-12. Growth was driven by telephony, application suites, network management and backup disaster recovery. Cloud spend increased by double digits with growth driven by security, productivity, data storage and recovery and collaboration. Services had another excellent quarter, up 8% in total with CDW professional managed top line up 13%. And that brings us to the final performance driver for this quarter. The impact of our customer-driven strategic investments, which for the past six years have been focused on expanding the breadth of our services capabilities. Capabilities that are integral to delivering full stack end-to-end outcomes and our key point of differentiation in the market. Today, our comprehensive services portfolio spans the full lifecycle from advisory to implementation, to orchestration and managed services that include cybersecurity readiness, infrastructure planning and execution, strategic IT road mapping, data management, DevOps, and 24/7/365 managed services for infrastructure security, cloud, and digital experience. These capabilities are critical to our ability to help our customers thrive amid the ever-evolving landscape. A great example of this in action is our AI Center of Excellence, a comprehensive approach that helps transform AI from concept to execution. Powered by a multidisciplinary team of data engineers, architects, and analysts, our experts deliver structured workshops to identify use cases, establish governance and security frameworks, and define ROI. From there, our proof-of-concept services provide a scalable path to validate and deploy AI solutions. Rapid prototyping follows where we accelerate adoption and impact using our deep vertical expertise and infrastructure-ready solutions across cloud, edge, and hybrid infrastructures. Finally, our AI managed services operationalize AI at scale, tackling the unique challenges of AI workloads with consulting guidance and purpose-built tooling. As you can see, CDW AI solutions provide comprehensive support across the entire AI lifecycle, solutions that deliver fast, secure, and ROI-driven innovation. Innovation that leads to measurable outcomes for our customers and further deepens our relationship. Let me highlight two examples that demonstrate how our services investments are driving meaningful customer outcomes. First, a rapidly scaling apparel company needed to improve the efficiency of their IT support operations. By integrating our cloud foundation managed services for AWS with our generative AI expertise, we delivered a solution that leverages historical ticket data to streamline workflows. As new tickets arrive, the AI agent references past cases and recommends resolutions in real time. The six-figure engagement included knowledge transfer documentation, infrastructure setup, agents development, testing and integration, and most importantly, transformed the customer support operations, freeing engineers to focus on strategic initiatives. The second example is a comprehensive security solution we are delivering to a leading North American transport company. Their legacy security operations center was one-size-fits-all and did not meet their evolving operational needs. What began as a strategic advisory engagement evolved into a full-scale identity and access management initiative ultimately leading to a multi-year managed services engagement with $10 million total contract value. An engagement that includes 24/7 managed security operations across their entire technology stack, including multi-vendor firewalls, security information, and event management systems, endpoint detection and response, vulnerability scanning, third-party risk management, and identity and access management across each platform. It also includes continuous enhancement through penetration testing, purple team assessments, and embedded automation. Two great examples that underscore our differentiated approach as a trusted partner invested in our customers' long-term success. They also demonstrate how our strategic investments deepen customer relationships and how they drive sustained growth, industry-leading margins, and strong cash flow. And that leads me to our expectations for growth for the remainder of the year. We are maintaining our 2025 outlook, which calls for U.S. IT market growth to be in the low single digits on a customer spend basis with a CDW gross premium of 200 to 300 basis points, a view supported by what we are seeing and hearing in the market, underpinned by a continued level of prudence. Market dislocation in government and education is expected to continue for the balance of the year. Armed with insights into evolving protocols, funding mechanisms, and budget allocations, our teams are drawing on their deep industry expertise and trusted customer relationships to both formulate strategies to navigate this period of change and to emerge even stronger, outcomes only possible by our scale and unique ability to verticalize. The wildcards we spoke about last quarter, including recessionary conditions, higher inflation, increased geopolitical unrest, and outsized changes to announced tariffs still exist. We will keep a watchful eye on market conditions and, as is our practice, update our view as we move through the year. As we look ahead, our priorities remain clear. We will focus on what we can control and execute with precision. We will maximize the strength of our business model and leverage our competitive advantages, including our full stack, full life cycle solutions to help customers navigate complexity and achieve their goals. Our commitment to delivering customer value is unwavering. Our strategy is working, and our teams are energized and executing with discipline and purpose. Now let me turn it over to Al.

Thank you, Chris, and good morning, everyone. I will start my prepared remarks with details on our second quarter performance, move to capital allocation priorities and then finish with our 2025 outlook. Second quarter gross profit of $1.2 billion was up 5% year-over-year. This was above our expectations of low single-digit growth as our teams captured increased demand for software and infrastructure solutions hardware alongside continued growth in client devices and services in this complex and dynamic environment. We did not see any meaningful levels of pull forward this quarter related to tariffs or other factors. Gross margin of 20.8% was below Q2 2024, driven by the impact of a higher contribution from large corporate customers, which tends to carry lower rates, as well as a lower mix of netted down revenues. Gross margin is sensitive to changes in both customer and product mix. This quarter, these changes were notable, and gross margin was down 100 basis points year-over-year. Corporate, small business, and healthcare customers focused on hardware upgrades, including client devices, which, together with meaningful spend on network and data center solutions through a prioritization away from sales transferred at a point of time where CDW's agent, also known as netted down revenues, this led to a lower relative mix of netted down sales compared to last year and a lower percentage of contribution to gross profit at 32.9%. Netted down revenues continue to represent an important and durable trend within our business. Alongside our professional and managed services listed as transferred over time with CDW's principal, which continued their strong growth trajectory, increasing 13% year-over-year and reflecting investments we've made in the business over the last six years. Consistent with recent trends, commercial customers prioritize mission-critical hardware investments that could not be postponed and public customers dealt with shifts in government priorities and funding. Given the unique dynamics impacting several of our end markets, our sales and gross profit performance demonstrates the power of our diverse end markets and how we are meeting our customers where they need us most. I want to thank our teams for navigating this environment and delivering above our expectations. Turning to expenses for the second quarter. Non-GAAP SG&A totaled $722 million, up 7.2% year-over-year. This increase was primarily driven by commissions related to higher gross profit achievement and the impact of higher other performance-based expenses. For the second quarter, the efficiency ratio of non-GAAP SG&A to gross profit was 58.1%, down 230 basis from the first quarter, representing the expected leverage on seasonally greater profit dollars, but up 130 basis points year-over-year. We continue to structurally align our business for stronger future expense leverage. Coworker count at the end of the quarter was approximately 15,000, with customer-facing coworker count at 10,700, both slightly down year-over-year. Our goal is to balance growth, expansion of capabilities and exceptional customer experience with greater efficiency and cost leverage from broader operations. Non-GAAP operating income was approximately $520 million, up 1.8% versus the prior year. Non-GAAP operating income margin of 8.7% was up 20 basis points from the first quarter but down 70 basis points from the prior year's second quarter level of 9.4%. Net interest expense was $4.5 million higher year-over-year, impacted primarily by lower interest earned on cash balances and higher average interest rates on our long-term debt. Non-GAAP net income was $344 million in the quarter, up 1.4% on a year-over-year basis. With second quarter weighted average diluted shares of $132.4 million, non-GAAP net income per diluted share was $2.60, up 3.9% versus the prior year second quarter. Moving to the balance sheet. At period end, net debt was roughly $5.2 billion, roughly flat with the prior year. Liquidity remained strong with cash plus revolver availability of approximately $1.7 billion. The three-month average cash conversion cycle was 16 days, below the low end of our targeted range from high teens to low 20s. This cash conversion reflects our effective management of working capital including disciplined management of our inventory levels even as solutions hardware sales accelerated, and client device growth continues. As we've mentioned in the past, timing and market dynamics will influence working capital in any given quarter or year. We continue to believe our target cash conversion range remains the best guidepost for modeling working capital longer-term. Adjusted free cash flow was $210 million in the quarter, bringing us to roughly $460 million year-to-date. This reflects 73% of non-GAAP net income slightly below our stated rule of thumb of 80% to 90% of non-GAAP net income, but in line with our expectations given the role timing plays throughout the year. We utilized cash consistent with our 2025 capital allocation objectives during the quarter, including returning approximately $150 million in share repurchases and $82 million in the form of dividends. As a reminder, we target returning 50% to 75% of adjusted free cash flow to shareholders in 2025. So we are clearly ahead of pace through the second quarter at 112%. That brings me to our capital allocation priorities. Our first capital priority is to increase the dividend in line with non-GAAP net income growth. We have increased the dividend for 11 consecutive years through 2024. We continue to prudently manage our dividend with respect to the growth environment and target a roughly 25% payout ratio of non-GAAP net income going forward. Our second priority is to ensure we have the right capital structure in place. We ended the second quarter at 2.4x net leverage, with our targeted range of 2 to 3x. We will continue to proactively manage liquidity while managing flexibility as evidenced by our 2024 debt refinancing and redemption actions and the subsequent drawdown of our 2025 senior notes this quarter. Finally, our third and fourth capital allocation priorities of M&A and share repurchase remain important drivers of shareholder value. We continually evaluate M&A opportunities that could accelerate our three-part strategy for growth. Likewise, we remain committed to our targets returning 50% to 75% of adjusted cash flow to shareholders via the dividend and share repurchases in 2025. Now turning to our outlook. We came into 2025 with an appropriately prudent view of the year. And despite the strong first half, we believe this environment calls for continued prudence. Last quarter, we shared that we'll be laser-focused on controlling what we can control and supporting our customers only as we know how to do in this dynamic environment. This has not changed. Our outlook assumes continued frictional impact in the Government and Education segments and a level of general economic uncertainty and caution, but it does not factor in recessionary conditions, higher inflation, increased geopolitical unrest, and outsized changes to announced tariffs. As always, as the landscape changes, we will provide you with updates each quarter. With these factors in mind, we are holding our full year 2025 view of low single-digit growth for the IT market. We continue to target market outperformance of 200 to 300 basis points on a customer spend basis. Based on the anticipated mix of products and solutions, we now expect low to mid-single-digit gross profit growth for the full year 2025, contemplating our strong first half along with our prudent view on the remainder of the year. We continue to expect second half gross profit contribution to be slightly above the first half, but lower than the historical split of 48% and 52%, respectively. And we continue to expect 2025 gross margins to be roughly consistent with 2024 levels and remain well above rates from three-plus years ago. Finally, we expect our full year non-GAAP net income per diluted share to grow low single digits year-over-year as we focus on profitable growth, exceptional customer outcomes, and effective execution of our capital allocation priorities. Please remember, we hold ourselves accountable for delivering our financial outlook on a constant currency basis. On that note, we expect currency to be a slight tailwind through reported growth rates for the year. Moving to modeling thoughts for the third quarter. We anticipate gross profit to grow at a low single-digit rate year-over-year and to be flat to slightly above the second quarter level. Moving down the P&L, we expect third quarter operating expenses to increase slightly quarter-over-quarter, aligned with gross profit and combined with some investments back into the business. This will result in non-GAAP SG&A as a percentage of gross profit levels to be higher than in the third quarter of 2024, but consistent with Q2 2025 levels. Keep in mind that operating expense levels in '24, particularly in the second half of 2024, benefited from lower performance-based attainment and thus the reversal of incentive compensation accruals which will compare unfavorably to 2025. Finally, we expect third quarter non-GAAP net income per diluted share to be flat to modestly up year-over-year and quarter-over-quarter, impacted by the aforementioned factors. That concludes the financial summary. As always, we will provide updated views on the macro environment and our business on future calls. And with that, I will ask the operator to open it up for questions.

Our first question comes from Erik Woodring from Morgan Stanley.

Chris, I just wanted to maybe go with you first. And you guys have strung together three consecutive quarters of nice outperformance versus your stated expectations. You are still telling us though that you expect to outperform IT market spend by 200 to 300 basis points. And so is the outperformance we've seen from CDW over the last, let's call it, nine months, really just entirely market-driven because I'd expect you to gain more than 200 to 300 basis points of share. That was kind of a commonality over the last decade. So maybe can you just help us understand if you are outperforming your expectations by such a degree, why that wouldn't lead to more outperformance versus the market? And then I have a follow-up, please.

Yes. Sure, Erik. When I look at the performance over the last three years and as we look forward for the rest of this year, we are expecting to outperform the market by 200 to 300 basis points premium. And given where the market seems to be residing, we feel very confident that we've been on. We've been delivering that over the past several quarters and will for the year. When you look at customer spend in particular, that's what we compare our growth to in the market. And remember, we're looking at low single-digit growth in the market this year. It would be our take based on a variety of factors. And then our growth would be 200 to 300 basis points over that. I think this quarter, in fact, actually underscores the degree with which we are delivering a premium to market and, in fact, taking share.

Okay. I appreciate that. And then maybe as a follow-up, if we think about your biggest product segments on the hardware side, client devices, NetComm, servers, and storage. I think this is a while where we kind of heard unanimously positive commentary across all of those end markets, especially relative to last quarter, where I think NetComm and storage were declining. Based on your conversations with customers and what you see in your pipeline, can you maybe help us all better understand kind of where we are in the cycle for each of these respective end markets? And how that influences your views as we look out, again, six to 18-plus months in advance?

Thanks, Erik. Let me provide a broader perspective on our current situation since the cycles are influenced by the macro environment. Regarding the hardware cycle, particularly for clients, we have witnessed strong performance over the past few quarters. CDW's team has effectively capitalized on the opportunities presented by our diverse range of client devices and services. We would consider ourselves to be at the midpoint of that refresh cycle. When we look at infrastructure hardware, we are observing an upward trend, which aligns with the timing of endpoint devices, networking, and infrastructure. However, it's important to note that these figures can fluctuate based on specific budget allocations and priorities within various end markets. For instance, the higher education sector, which has been affected by changes in federal funding, is still making significant investments in network and campus devices because they are crucial for attracting students. Therefore, we will see variations based on each end market and their respective needs. I will ask Al to delve into each category in more detail.

Thank you, Chris. Erik, I want to highlight a few points. As mentioned, we've experienced growth in client devices for six consecutive quarters, which has been encouraging. The strength we've seen in hardware so far has mainly come from the transactional side, particularly client devices. We've been suggesting for some time that the question around solutions is when, not if. While it's just one quarter, it's somewhat promising that we observed a positive shift in solutions this time. However, it's important to note that the comparisons were negative, which plays a role in this. Nonetheless, it appears that customers are showing resilience and are eager to proceed with their refresh plans. Although it's early, solutions outperformed transactions this quarter, which is a positive sign for us, and we are monitoring the situation closely.

Our next question comes from David Vogt from UBS.

Chris and Al, can you elaborate on the strength you observed this quarter? Corporate performance was notably strong, and you mentioned that there wasn't a significant impact from pull-forward. Can you clarify what motivated the corporate market to perform better than in the previous quarters, especially considering the comp wasn't significantly easier? Additionally, Al, you mentioned a smaller percentage of netted down in the quarter. If I quickly review the numbers, it appears there might be a slight product gross margin. Is this just a reflection of the larger corporate size this quarter, as you mentioned in your prepared remarks, or is there something else affecting that?

Yes. Thanks, David. In terms of corporate, I'd say it's a couple of things. Number one, we know there's been pent-up demand, particularly in the enterprise space. And there are projects that just had to move forward. I think our customers in the corporate space are getting a little more comfortable with the bouncing around that's happening across the macro environment and making investments in those things as they proceed to be mission-critical. Underpin that with technology is such an important tool for driving all the goals, mission, strategic imperatives of our customers that it is a place that customers prioritize investments. At the same time, I just would say they are cautious and being very prudent as we move forward. That's number one. Number two, I'd say that the team's execution has been very spot on. In terms of having worked over the last several quarters with our customers, I think I mentioned before that we were doing a lot of design work and sorting through its customers' projects to come. That relationship that work is coming to fruition, and we see it in nice growth this quarter, particularly around large enterprise deals and across the full stack, full lifecycle solution.

And David, maybe I'll just provide a little bit more granularity with respect to netted down revenues and gross margin. So to Chris' point, we were quite pleased with the level of customer spend that we saw broadly across the business, and I would say the breadth and depth of the end markets. For this quarter, with that larger customer spend, it just so happens that a greater share of the wallet went to solutions and went to clients and maybe less so from a netted down revenue perspective. Now a couple of things going on there with netted down revenues. One, as I just noted, a bit of kind of dilutive effect there. Number two, I'd say really strong results on SaaS and IaaS, but comps were quite difficult in that space, and therefore, they were kind of coming up against those comps. And then just remember, in the netted down revenue space, there are other categories that will drive the results and namely, in this case, warranties and commissions and things like that, we're a bit lighter, so they diluted the netted down revenue contribution effect as well. So look, I would just caution, just like we would not overextrapolate strength of solutions for one quarter, I would not overextrapolate the effect that we've seen on netted down revenue in this quarter.

Our next question comes from Amit Daryanani from Evercore ISI.

I guess maybe to start with, Chris, your guide, I think, sort of assumes that the back half growth rates on a year-over-year basis will decelerate a good bit from the first half trend that you saw. Given some of the commentary you've had, especially an uptick in solutions, can you just talk about why do you think you're seeing this deceleration in growth in the back half of the year?

Yes, Amit, we have reviewed the education and federal sectors, and we are considering a softer and unseasonal backend. Our customers are taking a step back to comprehend the policy and funding changes as they navigate these transitions and manage their budgets. The positive aspect is that CDW is positioned to assist them through this process. We are approaching the upcoming quarters with a clear perspective. We believe that, once there is more clarity and funds are accessible, we will be able to support our customers in effectively utilizing them to provide efficient technology solutions. However, this situation is guiding us. Regarding other segments, we are still adopting a cautious approach. As Al mentioned, we are being prudent because our customers are exercising caution, and we do not want to take unnecessary risks. We will monitor developments in Q3, which explains the anticipated softness we expect in the latter half of the year.

Got it. Perfect. And then Al, maybe just a quick question for you. Free cash flow conversion in June was somewhat subdued, I think, at 61%. Can you just touch on kind of what's happening there? And then really longer term on a free cash flow basis, what do you think we need to see for CDW to get back to that double-digit free cash flow cadence we used to have?

Sure, Amit. Nothing too extraordinary there on the working capital front. As you know, timing can have an effect. We've seen stronger growth than we would have expected in the first half, and that does draw upon working capital, including inventory. We are super disciplined about how we use our inventory and making sure we're getting the right returns, but you're going to have some timing effect. So through the first half, we're in the 73% range relative to non-GAAP net income. And I would expect, Amit, that for the full year, that will play out right within our range of 80%, 90%. So pure timing, I would call the second quarter solid, but we'd expect that the second half would be even stronger.

Our next question comes from Harry Read from Rothschild & Co. at Redburn.

Apologies if I misheard, but I think that you said SG&A as a percentage of gross profit will be in line with Q2 and Q3. That's two-ish percentage points compression in adjusted margin year-over-year. Just wondering where these costs are coming into the model given you mentioned that coworkers were slightly down year-over-year. And then I guess the follow-up, is that the main driver that's essentially decelerating adjusted EPS growth from 7.5% in the first half to, I guess, flat in H2 implied by the guidance?

Yes, on the SG&A front, you're correct. The efficiency ratio of non-GAAP SG&A relative to gross profit for Q3 should be fairly consistent with Q2, which was 58.1% for that quarter. So, on an efficiency ratio basis, that's what we’re looking at for the second half of the year. As a reminder from the last call, when you consider operating leverage, comparing to the prior year, we had significant operating leverage in the first quarter, including on the expense side. I noted that we expect some asymmetry for the rest of the year. The most notable aspect is that compared to 2024, where our results softened and decelerated, we had considerable drawdowns of our incentive compensation accruals. So, in Q2 and for the remainder of the year, we are seeing negative comparisons versus the previous year when those accruals were decreasing. Another point to highlight is that although we've been disciplined with our spending, our gross profit growth has been somewhat lighter than anticipated. We're in a position where, while striving for operating leverage and expense efficiency, our current expense base is somewhat aligned with a higher gross profit growth. If we reach the growth levels we expect, we will align our expenses accordingly, and that's how we foresee it progressing moving forward.

Our next question comes from Samik Chatterjee from JPMorgan.

Maybe for the first one, Chris, I'm curious, I mean a lot of investors have been asking us about how customers are responding to the provisions under the big beautiful bill and if there is any sort of discussion around accelerated spending from customers to take advantage of some of those provisions like we saw in 2018. Any discussions with customers on that front? Any insights you can share about how customers are even looking at sort of those provisions or reacting to it? And then I have a follow-up.

Yes. Sure, Samik. I think there are really two buckets when I think about commercial customers, those who will potentially benefit from the changes in CapEx. And so we are having conversations about that. That's a tailwind in some ways. And then I'd say on the state and local and federal side, it's what are they potentially going to be defunded in and where are they going to receive funding. So when I think state and local, for example, we view some of the funding as shifting from Fed to state, and state organizations are going to have to pick that up. But then you've got specific federal agencies that are very much the beneficiaries, and we're focused on those. So it's really on the commercial side, what are the things that benefit the company. And in the federal and state, it's really the puts and takes of where the funding is going. And those are the conversations we're having right now with our customers.

Got it. Got it. And for my follow-up, maybe this is more for Al. Al, more curious about the guide, what's implied for 4Q earnings because with the first half and your guide for the third quarter, it looks pretty conservative for 4Q earnings and it looks like unless you're down year-over-year on earnings for 4Q stuff to get to a low single at growth for the full year. Anything to call out there in terms of what impacts 4Q seasonality or what's driving the conservatism on the implied 4Q earnings guide?

Yes, sure, Samik. I wouldn't point out anything very particular. I would say both Q3 and Q4, we have a level of conservatism baked in. The most notable components, as Chris suggested, are more in the federal and the education space. The only thing maybe I would add, otherwise, as you know, corporate can be stronger in Q4 kind of with the year-end push. And there, we are being more modest than what we've seen in the first half. So that may have some effect on Q4 seasonality, but I wouldn't call anything else out as remarkable.

Our next question comes from Asiya Merchant from Citigroup.

Regarding the decline in gross profit margins, I understand this has been occurring for several quarters. You've mentioned data storage, servers, and NetComm products. Could you clarify whether this is due to pricing issues or the competitive landscape preventing you from passing through costs? Also, what is the expected bottom line for gross margins on these products?

Yes. So a couple of things I'd point out, maybe just I'll start with quarter-over-quarter. So I think it is notable to indicate that quarter-over-quarter, when you exclude or isolate the effect of netted down revenues, that non-netted down margin was actually up 10 basis points quarter-over-quarter. So that's been a metric we've been tracking, Asiya, and that was flat to slightly up. So I'd say somewhat reassuring in that regard after several quarters where that non-netted down margin had trailed off. On the year-over-year, the comparison is a little bit different. Number one, definitely impacted by the dilution of netted down revenues, and I spoke to that, but that does have a factor. Let's remind ourselves that netted down revenues come in at 100% gross margin. So any dilution or drop-off of that category will have a pretty profound impact on our gross margin. And then the other factor year-over-year was with our strong solutions, we saw a significant mix in from enterprise customers and some pretty big deals. And very commonly in those cases, they will come at a bit lower margins. And so that had some effect on our gross margin on a year-over-year basis. Again, I would just say caution against over extrapolating while we're pleased with the spend we saw in solutions and certainly, that enterprise customers showing up is more resilient. We're not overreacting to the margin effect at this point.

Our next question comes from Ruplu Bhattacharya from Bank of America.

Chris, you experienced strong growth in client devices. You mentioned refresh cycles. Are customers seizing this opportunity to upgrade their client-side devices? Are they enhancing things like AI PCs? Additionally, are you noticing any AI-driven demand in the data center sector regarding servers? Overall, how is AI affecting your revenues? I have a follow-up question.

On the PC side, the discussion around the Win 10 expiration continues to be a significant driver, and there is an increasing interest in purchasing AI PCs. I would say we are in the middle stages of the client device refresh and early stages of the AI PC growth. In infrastructure, these conversations are part of every discussion we have, and we are making good progress there. Regarding AI, customers seem to be transitioning from experimentation to a greater emphasis and urgency about its potential impact across client devices to infrastructure. We are noticing a rise in these discussions, and we believe we are well positioned to assist our customers in these areas. AI is integrated into every layer of our services, and our comprehensive approach enables us to support customers in designing for future AI applications. Furthermore, we provide consulting services for every aspect of the AI lifecycle, whether that relates to generative, agentic, prescriptive, or predictive AI. Our team is deeply engaged in customer dialogues, exploring what AI means for them. We are optimistic, as we are beginning to see a revenue impact on the hardware side, particularly in consulting, and our managed services segment is also starting to gain momentum. We believe we are at a pivotal moment with customers regarding AI, which is becoming a more integral part of our conversations.

Okay. Chris. For my follow-up, if I can ask you, this environment, do you see scope for M&A? And if so, which areas would you focus on? I think you said your services business is growing strong. So would that be an area or in terms of cloud? Or any thoughts you can give on the size or any potential thoughts you have in terms of scope or end markets or products? I appreciate all the details.

Yes, our standard approach remains the same. We aim to enhance our capabilities in areas that are highly relevant, experiencing significant growth, and offering high margins for our customers. We particularly focus on services-led capabilities and industry verticals. Technologies like AI, cloud, security, and management are essential categories that we believe will aid our service growth. We have recently welcomed a new Chief Services and Solutions Officer, which we are excited about, as we view services as a primary growth engine for our business. Therefore, we are committed to aggressively investing in this area. Our strategy is broad-based, targeting aspects that enhance relevance, drive growth, and support our comprehensive full stack and full lifecycle positioning in the business.

Our next question comes from Keith Housum from Northcoast Research.

The commentary regarding large deals indicates that they are likely performing better than the run rate or the SMB business. Is this a trend expected to develop throughout the year, with more spending coming from large companies?

Keith, this is Al. I would not anticipate that, that's going to be outsized, right? While it was more significant in the quarter, we're not factoring that into our outlook. What I would say, maybe leave you with is we're pleased that we're seeing a breadth and depth of end markets show up. Now we have the effect from education and government, but you're seeing the power of our diverse end markets here and in this case, enterprise. But I would expect that for the remainder of the year, it's going to be more balanced in terms of end market contribution.

We currently have no further questions. So I'd just like to hand back to Steve O'Brien for any further remarks.

Over to Chris.

All right. Let me close by once again thanking our 15,000 coworkers around the globe for their ongoing dedication to serving our customers. You are our true competitive advantage and the sole reason why we consistently deliver meaningful value and exceed our customers' needs and expectations. You are the reason we have and will continue to lead the industry. Thank you to our customers for the privilege and opportunity to serve you and repeatedly earn your trust, and thank you to everyone listening for your continued interest in CDW. Al and I look forward to talking to you next quarter.

As we conclude today's call, we'd like to thank everyone for joining. You may now disconnect your lines.