CDW Corp Q3 FY2025 Earnings Call

Good morning, everyone, and thank you for joining us for the CDW Third Quarter 2025 Earnings Call. My name is Carlie, and I will be coordinating the call today. Now, I would like to hand it over to our host, Steven O'Brien with Investor Relations. The floor is yours.

Thank you, Carlie. Good morning, everyone. Joining me today to review our Third Quarter 2025 results are Chris Leahy, our Chair and Chief Executive Officer; and Al Miralles, our Chief Financial Officer. Our earnings release was distributed this morning and is available on our website, investor.cdw.com, along with the 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 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 the 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 amount 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. Replay of this webcast will be posted to our website later 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 with a high-level overview of our third quarter financial and strategic performance and share some thoughts on the balance of the year. I will take you through a more detailed look at our results, capital strategy and priorities and full year outlook. We will move quickly through our prepared remarks to ensure we have plenty of time for Q&A. Third quarter results underscore the power of our full stack full lifecycle solutions. The team executed well in an extremely dynamic and complex environment. For the quarter, consolidated net sales were $5.7 billion, up 4% above last year. Gross profit was $1.3 billion, up 5%. Non-GAAP operating income was $531 million, down 1%; non-GAAP net income per share was $2.71, up 3%; and we delivered adjusted free cash flow of $209 million. These results reflect the power of strong execution when coupled with our extensive portfolio of products, services, solutions and diverse customer end markets. They also reflect the power of our deep end-market knowledge and strong durable customer relationships. You see the benefit of this in our government education results; armed with insights into evolving protocols, funding mechanisms and budget priorities, our team drew on their combined deep industry expertise and trusted customer relationships to guide clients through an unprecedented period of change. During the quarter, customer priorities remained focused on must-dos, such as security enhancements and client device upgrades that are foundational to enabling modern work. And once again, major capital investments were heavily scrutinized. Corporate and small business customers also prioritized preproduction AI trials to prove out use cases to validate concepts and ROIs. These priorities led to strength in cloud, software and services. Let's take a deeper look at how customer priorities and unique market dynamics shaped performance across our end markets and portfolio in the quarter. As always, there are 3 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 3-part strategy. First, our balanced portfolio of diverse customer end markets. We have 5 U.S. sales channels: Corporate, Small Business, Healthcare, Government and Education. Each channel is a $1 billion-plus business annually. Additionally, our U.K. and Canadian operations together delivered sales of $2.5 billion last year. Our scale allows us to segment our businesses 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 benefit of our scale and end market diversity was evident once again in the third quarter. Small Business delivered double-digit growth in top line and gross profit as customers continue to lean more into technology in this dynamic environment. Growth was powered by success delivering cloud and client device solutions. While still nascent, we saw an uptick in AI workstations, which are particularly well-suited for small businesses. Functioning as mini AI servers capable of running AI models locally at the network edge, AI workstations enable rapid prototyping and deployment of advanced models, helping small businesses innovate faster. Corporate delivered mid-single-digit top line growth with low single-digit gross profit. The team's ability to address customer focus on mission-critical priorities drove excellent performance in security and cloud gross profit and top line. Client Devices also remained a priority, increasing mid-single digits in top line and double digits in gross profit. The team's success addressing these priorities offset lower demand for infrastructure solutions. The public team executed well within unsettled end markets, delivering 1% top line growth with low single-digit gross profit. Government net sales increased 8%. State and local delivered an impressive quarter with double-digit net sales and gross profit growth, which more than offset the anticipated decline in federal. Both teams navigated the post-DOGE landscape with agility and precision, with the federal team showcasing our strategic value to their agency customers, laying a solid foundation for future growth. Growth in higher education was offset by an expected decline in K-12, and total education net sales declined 9%. Gross margin benefited from a shift in K-12 mix away from Chromebooks coupled with strong cloud and software growth, and the teams delivered combined gross profit growth despite the decline in net sales. Similar to education, healthcare gross profit grew faster than its 7% top line growth. Growth was driven by cloud solutions that deliver clinical continuity and security, which remain top priorities. The dynamic in the quarter was consistent with the strong performance in the prior 4 quarters. We are watching for signs of customer hesitancy caused by changes in funding, particularly among healthcare clients relying on Medicare payments, which can constitute up to 30% of their cash flow. Standout performance was delivered once again by our U.K. and Canadian operations together reported as other, which increased net sales by 9%, and both teams executed extremely well under unsettled conditions. U.K. net sales increased by double digits and Canada by mid-single digits. Profitability in both markets grew faster than net sales. Clearly, this quarter's results demonstrate the power of the first driver of our performance, our balanced portfolio of customer end markets. It also demonstrates the power of the second driver of our performance, the breadth of our full stack full lifecycle offerings. The team's ability to address customers' top priorities drove balanced performance across the portfolio. Hardware top line increased 3%. Following last quarter's strong solutions Hardware performance, the lumpiness in enterprise projects we have seen in recent years continued, and growth was more muted with strength in NetComm and Servers, partially offset by a decline in storage. Consolidated client device growth continued at a healthy 7% pace with growth across most end markets, partially offset by declines in K-12 and Federal. Software increased 4% with excellent gross profit performance driven by cloud and security. Beyond security, top customer software priorities included network resiliency, next-generation customer service and support, and application suites tied to operating system and device refresh. Services was the standout performer, up 9% top line and contributing 9% of total CDW top line this quarter, up from 5% in 2020. Strong performance was powered by double-digit top line and profit increases in CDW professional and managed services. This quarter, Services delivered nearly 1/3 of our total gross profit growth and bolstered gross margin. And that brings us to the final performance driver this quarter, the impact of our strategic investments, investments designed to create better outcomes for our business and for our customers, investments that are focused on enhancing our customer-facing capabilities and our internal capabilities, which together drive profitable growth by improving how we operate and how we serve. During the quarter, we made progress on our company-wide evolution to embed AI into the core of how we operate, serve and grow, a strategy designed to drive productivity and efficiency and empower our coworkers. From conversational AI and cdw.com that enhances product discovery and improves sales conversion to intelligent agents that streamline presales qualification and self-directed agents created by our coworkers, we are embedding AI across the enterprise. Efforts, while earlier in the adoption cycle, are already translating into better coworker and customer experiences. As we scale AI across our business, we are unlocking new levels of agility, efficiency and service quality. Our AI offerings enable our customers to unlock value as well. As with prior waves of innovation, customers are focused on translating AI's potential into measurable business impact. This is particularly true for customers looking to harness AI to leapfrog traditional barriers and gain a competitive edge. And just like our prior innovation cycles, while eager to accelerate adoption and capture value, many customers don't have time or resources for trial and error and need a trusted partner to guide them. That's where CDW comes in. With our deep expertise and comprehensive portfolio, we are delivering enterprise-grade AI solutions that are practical, secure and scalable. Whether it's intelligent search, workflow automation or embedded AI powered diagnostics, our solutions unlock real business value without the complexity or cost of building from scratch, while avoiding pitfalls and ensuring long-term success. A standard example of this is a recent engagement with a national service company, an engagement where CDW designed a comprehensive AI data hardware and software solution. By integrating CDW Advisory Services, development cloud architecture and hardware prototyping, our solution delivers cloud-native architecture, embedded systems and centralized observability tools, all tailored to the customer's unique operational needs. The solution includes AI-powered diagnostics and real-time performance dashboards, which together create a smarter, more scalable infrastructure. The outcome: data-driven decisions that are enabling smarter operations with greater efficiency, like predictive maintenance and supply chain management, and data that unlocks new revenue streams aligned to their business goals. This project exemplifies our value proposition for customers, delivering enterprise-grade technology and AI capabilities in a way that's accessible, customizable and outcomes-driven. This is the heart of our value proposition, driving tangible business outcomes that meet customers where they are. Our value proposition shines in AI where we help customers move beyond the hype to unlock tangible value. That leads me to our expectations for growth for the remainder of the year. Given our year-to-date performance and current market conditions, we are maintaining our prudent full year outlook, which calls for U.S. IT market growth to be in the low single digits on a customer spend basis with CDW growth premium of 200 to 300 basis points. Clearly, we are operating under a lot of unknowns, including the duration of the government shutdown, which could not only impact federal results but could have an impact on other end markets, including health care and education. At the same time, the wildcards we spoke about last quarter, including recessionary conditions, higher inflation, increased geopolitical unrest and outside changes to announced tariffs persist. I know many of you may be wondering what we expect for 2026. As is our custom, we are in the middle of our planning process, and we'll provide our thoughts at our year-end conference call. As we look forward, regardless of market conditions, our focus remains squarely on execution, leveraging our competitive strength to deliver consistent customer value and controlling what we can control. In a time of unprecedented technological change and uncertain market conditions, our value proposition has never been stronger. Customers are turning to CDW as a trusted partner to help them navigate complexity, unlock opportunity and drive meaningful outcomes. We're confident in our strategy, grounded in our capabilities and committed to delivering results. With that, let me turn it over to Al, who will share more details on our financial performance.

Thank you, Chris, and good morning, everyone. I will start my prepared remarks with details on our third-quarter performance, move to capital allocation priorities and then finish with our remaining outlook for 2025. Third-quarter gross profit of $1.3 billion was up 4.6% year-over-year. This was above our expectation of low single-digit year-over-year growth, as our teams captured increased demand for Software and Services alongside continued growth in Client Devices and NetComm in this complex and dynamic environment. Similar to the second quarter, we did not see any meaningful levels of pull forward related to tariffs or other factors. Gross margin of 21.9% was up 10 basis points over the prior year's third quarter, back in line with our overall expectations of roughly flat to 2024 levels. Gross margin was also up meaningfully 110 basis points quarter-over-quarter, driven by the impact of a higher mix of netted down revenues, continued strong growth in services and a slight mix out of client devices sequentially despite the category's continued solid growth. Every channel grew year-over-year except education, as our customers balance priorities across our diverse portfolio. Demand for CDW professional and managed services continued to be strong at 14%. This can be seen in net sales transferred over time or CDW's principal. Overall, cloud infrastructure, SaaS and security offerings were strengths in the quarter. These are offerings included in the category of net sales transferred at a point in time or CDW's agent or netted down sales. Netted down revenues continue to represent an important and durable trend within our business, representing 36% of gross profit, up from 35.7% in Q3 2024 and up meaningfully from 32.9% in the prior quarter. Customers across end markets outside of Education and Federal continue to invest in client devices, driven by Windows 10 end-of-life and the enablement of modern work practices. On the solutions front, Software and NetComm growth continued, although storage was softer in the quarter as demand for hardware upgrades in the data center space remains uneven. I would also like to highlight how our small business and international teams are executing exceptionally well in a challenging macroeconomic environment. Alongside this, our public teams continue to manage shifts in government priorities and funding, which I'll touch on a bit more in the outlook section. Our teams navigated this dynamic environment for both CDW and our customers, delivering results that exceeded our expectations and demonstrated the power of our diverse end markets. Thank you to our team for your efforts. Turning to expenses for the third quarter. Non-GAAP SG&A totaled $725 million, up 8.7% year-over-year and consistent with our expectations that asymmetrical timing of expenses compared to 2024 would inflate the year-over-year expense growth comparisons in Q3 and Q4 of 2025. This increase in expense was primarily driven by commissions related to higher gross profit achievement and the impact of higher performance-based expenses relative to the prior year. Notwithstanding the efficiency ratio of non-GAAP SG&A to gross profit for the quarter was 57.7%, representing progress back towards our sweet spot in the 55% to 56% range. We continually work to structurally align our business for stronger future expense leverage. Coworker count at the end of the quarter was approximately 14,900, down both year-over-year and quarter-over-quarter, with the customer-facing coworker count of 10,700 down slightly year-over-year. Our goal is to balance growth, expansion of capabilities and exceptional customer experience with greater efficiency and cost leverage from our broader operations. Non-GAAP operating income was approximately $531 million, down 0.6% versus the prior year. Our non-GAAP operating income margin of 9.2% was up 50 basis points from the second quarter, but down 50 basis points from the prior year's third quarter of 9.7%. Net interest expense was relatively flat year-over-year. Our non-GAAP effective tax rate was marginally below the low end of our range at 25.1%. Non-GAAP net income was $357 million in the quarter, up 0.6% on a year-over-year basis. With third quarter weighted average diluted shares of 131.8 million, non-GAAP net income per diluted share was $2.71, up 3% versus the prior year's third quarter and above our expectations of flat to modestly up year-over-year. Moving to the balance sheet. At period end, net debt was $5.2 billion, roughly flat with the prior quarter. Liquidity remains strong with cash plus revolver availability of approximately $1.8 billion. The 3-month average cash conversion cycle was 11 days, below the low end of our target range of high-teens to low 20s. This cash conversion outcome reflects our effective management of working capital, including disciplined management of our inventory levels, even as hardware sales remain firm and client device growth continues. As we've mentioned in the past, timing and marketing dynamics will influence working capital and cash conversion cycle 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 $209 million in the quarter, bringing us to $668 million year-to-date. This reflects 68% of non-GAAP net income moderately below our stated rule of thumb of 80% to 90% of non-GAAP net income, but relatively in line with our expectations given the role timing plays throughout the year. We expect a seasonally strong fourth quarter free cash flow to move the full year 2025 free cash flow back closer to the rule of thumb. 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 began the year targeting to return 50% to 75% of adjusted free cash flow to shareholders in 2025. Right now, we are clearly ahead of the pace through the third quarter, having returned $747 million to shareholders or 112% of adjusted free cash flow. That brings me to our capital allocation priorities. Our first capital priority is to increase the dividend in line with our non-GAAP net income. We're announcing an approximately 1% increase in our dividend to $2.52 annually, our 12th consecutive year of an increase. We will 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 quarter at 2.5x net leverage within our targeted range of 2x to 3x. We will continue to proactively manage liquidity while maintaining flexibility. 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 3-part strategy for growth. Given our actions to date in 2025, we now expect to meaningfully surpass our return of capital of 50% to 75% of adjusted free cash flow to shareholders via the dividend and share repurchases in 2025. While we remain active in the M&A market, our consistent year-to-date cash flow has allowed us to be opportunistic towards share repurchases as we deem our stock to be attractive at these valuations. Now turning to our outlook. Throughout 2025, we navigated a complex environment with an appropriate level of prudence, a view that we've maintained despite our strong results. We've been laser-focused on controlling what we can control and supporting our customers as we only know how to do in this dynamic market. Given the recent government shutdown, we believe our continued prudence is warranted. Our remaining 2025 outlook assumes continued frictional impacts in the Government Education segments, potential funding shortfalls for healthcare customers, and a level of general economic uncertainty and caution. It does not, however, factor in recessionary conditions, higher inflation, increased geopolitical unrest and outsized changes in announced tariffs. As always, as the landscape changes next year, 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. Our expectations for low- to mid-single-digit gross profit growth for the full year is unchanged. 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%, and we continue to expect 2025 gross margins to be roughly consistent with 2024 levels and remain well above rates from 3-plus years ago. Finally, we continue to 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, our expectation for currency is to be a slight tailwind to reported growth rates for the year. Moving to modeling thoughts for the fourth quarter. We anticipate gross profit to grow at a low- to mid-single-digit rate year-over-year and to be down low- to mid-single digits sequentially, relatively aligned to historical seasonality. Moving down the P&L, we expect fourth quarter operating expenses to be modestly down quarter-over-quarter, aligned with gross profit, but reflecting some investments back into the business. This will result in non-GAAP SG&A as a percentage of gross profit being higher than both the fourth quarter of 2024 and the third quarter of 2025. As a reminder, operating expense levels in 2024, particularly in the second half of the year, benefited from lower performance-based attainment and thus reversal of incentive compensation accruals. This muted the run rate expense load in the second half of last year. Finally, we expect fourth quarter non-GAAP net income per diluted share to be down slightly year-over-year and down sequentially, impacted by the aforementioned factors.

I guess, Chris, maybe just to start with the public vertical, especially the federal part has been challenging this year. Can you just talk about how much of the current shutdown is potentially impacting your guide, so what are you embedding in December quarter from public federal contribution? And then do you think the dollars that are lost from shutdown right now you end up catching up eventually when the government opens or is that an optimistic scenario?

Yes, Amit, of course. First, I want to emphasize that our teams have done an exceptional job navigating the post-DOGE landscape and gaining momentum as we approach the expected shutdown. That being said, we have adopted a conservative outlook for Q4, understanding that we have some pipeline and backlog heading into that quarter, along with a steady stream of business from the agencies that remain operational. So, Q4 will not be a complete loss; there is still substantial business available. However, for the agencies that are closed, we are limited in our ability to build that pipeline. We are actively working with customers to ensure we are their preferred choice once the shutdown concludes. Regarding our guidance, I would describe it as conservative for Q4, which we believe is a sensible approach. We anticipate the shutdown will continue throughout the quarter, and we've factored this into our projections. Historically, during past shutdowns, it is clear that while sales may be delayed, they are not lost permanently. When the shutdown ends, sales may shift in timing, which can lead to a longer recovery period. We do not perceive this as an overly optimistic view; it's consistent with what we've previously experienced and managed. Additionally, I would note that this is just another unexpected challenge we are facing in 2025, and the team is handling it effectively.

Perfect. And if I could just follow-up, the small business growth at 14% was really impressive, and I think it actually accelerated by a couple of points versus June even. Can you just double-click on what is driving that strength? And do you think the trends that we see in SMB are a good leading indicator to what should happen to the overall business going forward? Just from a historical perspective, do you think it's a good leading indicator or not?

Yes. So Amit, small businesses have been, I would characterize it as incredibly resilient, coupled with outstanding execution by the team. And I'd also observe that over the past year to 18 months, we've seen small businesses leaning even more heavily into technology to try to gain a competitive advantage and level the playing field. So there's been a slight shift, I'd say, in the uptick in demand in the small business arena. And those businesses have just shown to be very resilient. In terms of an indicator for the rest of the segments, unclear; I think we need to be a little cautious about that right now, just given how resilient small businesses have been. So we're going to keep a watchful eye across all the end markets, but certainly, the team has done a great job and the small businesses are hanging tight.

I appreciate the opportunity here. In terms of the PC and the endpoint market, obviously, it's been a really good year for these devices. And it looks like things are going to continue for another quarter or two. But as you look out to 2026, expectations that funding will continue for PCs or perhaps shift in other ways or could there be a pretty tough headwind for you guys in '26?

We continue to see solid demand. People often ask what stage we are in, and I would say we're in the later part of the mid innings. If I had to specify, I'd say we're around the sixth inning, approaching the seventh inning stretch. Healthy demand is expected to persist over the next few quarters. We're moving past the end-of-life cycle, and although we typically see a gradual reduction during this time, we do not anticipate a slowdown in the coming quarters. The key drivers include the replacement of Windows 10 as it reaches its end-of-life and an increased focus on GenAI productivity initiatives. Although AI PCs haven't made up a large portion of our conversions, we are starting to see this segment grow, which will serve as an additional boost for PCs. We remain optimistic about the upcoming quarters.

Great. And then in terms of the government funding, can you remind us how much the federal government perhaps funds education, health care and how that contributes to their spending?

Yes. The federal funding for education at the K-12 level saw significant subsidies during COVID, but typically, the main funding comes from the states. Over the past two years, we have been assisting our customers in returning to these usual funding sources, which are primarily state and local. In higher education, we are closely monitoring potential grant cancellations and similar issues, but institutions are also competing for students. The technology they are investing in aims to attract more students, and we have observed strong growth in that area. We had a solid quarter in higher education. Regarding health care, we are vigilant about potential policy changes that could affect revenue streams for health systems. However, as we've seen over the last seven to eight quarters, health care systems are increasingly embracing technology to enhance clinical continuity, improve security, and boost competition within the industry. While we are monitoring the situation, both I and the team feel confident that we can adapt to funding changes, as it's a fundamental part of our operations. We can pivot to identify new funding sources and support our customers accordingly.

Chris, in each of the last four earnings, you've referred to the spending environment as complex or challenging. And I'd love if you could just maybe expand a bit on what is so complex about this environment? And I say that just because CDW has seen basically every type of cycle in its long history. You have been able to grow through those past cycles. This year, we're obviously just seeing a bit more muted gross profit dollar growth of some negative compares. So really just trying to get your viewpoint on really how this complexity is different from history and how it's impacting your gross profit dollar growth? And then a quick follow-up.

Yes, it's a great question. And if I had to boil it down to 1 thing, I would say volatility. Uncertainty might be the word most people would use. But as I think about this past year in particular, the curveballs that have come at every organization rapidly, and without necessarily a lot of time to adjust, have had technology buyers, business owners, schools, all institutions adjusting to the volatility and, therefore, not having a certainty and predictability to invest, that has been a primary reason it's been so uncertain and helping customers unpack both investments and making decisions around new architectures with AI. So we've got questions around new technology, AI; funding shifts that can happen month-to-month; there has been a hesitancy to make commitments on some larger pieces of technology. It's been hard to run a business. Now that said, it feels very much now that the leaders of these institutions are kind of getting used to the unpredictability, the unevenness, and just starting to really pick up and move forward with mission-critical needs and investing behind technology because they feel like they otherwise are going to get behind. So it's really that policy bouncing around, the funding changes that we hear about, the geopolitical world that we live in and the macro uncertainty, the uncertainty around inflation and everything that's impacting the economy. But I'll tell you, for me, it really ultimately comes down to this unpredictability that we've been living in for about nine months.

Okay. Very fair. And Al, just as a quick follow-up. You have been very transparent over the last few quarters about the kind of variable comp headwind you're facing this year. I'm wondering if we take a step back, what type of gross profit dollar growth does CDW have to see to return back to your kind of 10%-plus EPS growth algo of old? Any color there would be super helpful.

Yes. Just a couple of things. First, I would just note for 2025, which we've talked about as a bit of a period of transition for us but also traction, and we're seeing that traction above our expectations, so important in that regard. If you actually take the effect of the '24 compare on expenses, and we talked about kind of these incentive compensation accruals from prior year, we would look like our gross profit and our non-GAAP operating income are a bit closer to parity. So and I would say that is consistent with this period of transition after a pretty dynamic couple of years. To your question, Erik, what's it going to take to get the further traction and get upwards of high single digits, double digits on EPS? I think what we need to see is a sustaining of that gross profit growth and the spend, continuation of our progress on gross margin and then, importantly, a great focus on profitable growth and getting back to operating leverage. We believe kind of with those variables in place and getting operating leverage, we will start to see that efficiency ratio come back down towards the sweet spot. And then I would say then you're going to see the compounding effects down the P&L. So that's what we're focused on. It's obviously a balancing act with all those things, including investing, but that's what the horizon looks like for us.

Chris, maybe if we can start on the services side, pretty strong growth there. Maybe if you can dig a bit deeper in terms of the nature of opportunities you're seeing, particularly the ones associated with the AI deployments you're seeing from your customers? And any thoughts in relation to M&A and further consolidating the services opportunity for the company? And I have a quick follow-up.

Yes, Samik, I'll take that. This is Al. Really strong results on services top line for the quarter. Underneath that 9%, it was 14% growth in managed and professional services. So a couple of themes or practice area details I'd share there. Number one, data and AI definitely a focus; continued focus on security, as you would expect; and then cloud has been a really persistent contributor from a services perspective. We've got a new leader in our services space. We are very, very focused on refining exactly where we play and where the best growth opportunities are, and we're seeing some of the early benefits from that. So as we look forward, Samik, I would expect that the life netted down revenues, services has the potential to be kind of an outlier in terms of growth contribution, and we feel encouraged by the progress we're seeing at this juncture. I'll just remind you, too, just in terms of spotting our progress here. If you go back a few years, Samik, services was about 5% of our net sales; this quarter, it was 9%. And so if we can continue on this growth path, we think it's going to be a meaningful contributor to our top and bottom line.

Okay. Okay. And then just curious, you made a comment about the data center upgrades from your corporate customers, in particular, sort of being uneven. Any thoughts on what's the primary driver there? We understand the macro is challenging. But obviously, in terms of investment, is it really the AI sort of decision-making that's driving this unevenness? Or is it more evaluation of public cloud? What are you seeing on that front in terms of what's sort of causing this lumpiness in those decision-making processes?

Sure, Samik. I would point it more to some of the variables that Chris pointed out that is the overall uncertainty in the environment, the macro and geopolitical trends that we're seeing that are causing a bit of a start and stop in terms of bigger projects. So you saw it over the last couple of quarters, Q2, we saw a bit of a surge, particularly in the enterprise space with bigger projects that aided solutions growth there. And in this quarter, we saw a pullback in that regard. And I think that while we will continue to say, we think it's inevitable that the refresh and the recovery needs to happen in solutions, it's clear that it's going to be more uneven than we anticipated. Now to your question on is AI a factor? I think it's probably a variable, but I would lead more with just the overall macro geopolitical environment, the level of uncertainty causing companies to just question the, is this the time to get on with the spend? or could we kick the can a bit more?

Just looking at SG&A and the year-on-year growth rate, both on a 1- and 2-year view, it looks like it's accelerating quite a lot. But forgive me if I heard it wrong, I think you said that year-over-year margin should expand in Q4, that's EBITDA over gross profit. So just could we have some clarity on what's driving quite a sharp deceleration on SG&A growth, if you do expect gross profit growth year-over-year to slow a little bit? And then maybe if you could break down if that's largely driven by front office wages or back office wages?

Harry, it's Al. I'll go back to my comments: The biggest variable is comparing against our compensation and think of kind of bonus plans and the like from the prior year post-Q1, from last year, while our gross profit was declining and below our expectations, we were pretty considerably taking down those compensation expense items where this year, we don't have that. So it is more than anything, Harry, to compare that. Again, I'll go back to my comment that if you adjust for those factors and you look at both this quarter and the full year, we would expect that gross profit and expense growth would be much more at parity. So I call that kind of for the full year evenness between gross profit and operating income. Now I do believe that kind of part of the calculus here is that we've had obviously very strong growth in the pandemic period and we had deep reduction flattening for 2 years, we did make considerable reductions in our expense base. But in some respects, 2025 is, again, that year of transition where you get back to parity or gearing of our expenses relative to gross profit. So as we look forward and with the expectation that growth can persist and should persist, then you're going to return to operating leverage, and again, to an efficiency ratio that we would be much more comfortable with in that 55%, 56% range.

Yes, that makes sense. I just have a brief question. It appears that stock-based compensation as a percentage of gross profit is nearing the upper end of its historical range. Do you have any insights on what that margin might look like in Q4 and beyond into 2026?

Yes, Harry, I believe you are referring to the comparison with the previous year, and it appears that we have seen significant growth.

Chris, maybe one for you. Can you help us understand and parse out sort of the impact on health care? I guess what we're trying to think through is how much of it is sort of the lingering effects of the efficiency efforts over the past year versus the government shutdown? And how do we think about sort of the effects of those two different dynamics at play going into 2026, just to get a level set for how we should think about that market growth next year? And then I have one for Al on margins.

Yes. In terms of health care, look, when we look over the last several quarters, health care has really been, frankly, on fire. And you'll recall, we talked about a number of investments we've made across the health care segment, both in terms of industry experts, innovation centers, et cetera. And that's really been, in our view, paying off in solidifying our relationship as a trusted adviser as the health care institutions are leaning into technology. As we think about the go-forward, look, we're just going to be very, very clear and very watchful about the trickle-down effect that I had mentioned before, some funding shifts from income stream shifts. We just got to keep an eye on that. But we've been through periods like that before. And you tend to see things like M&A, you tend to see consolidation, and you tend to see movements within the industry itself, all of which requires technology support, so that's an area where we think we could see a second order impact from funding changes. But I'll come back to the notion that what we're doing with our customers in health care right now is not just foundational and optimizing; it really is the future of care. And that we believe is sustainable over the long term. So we might see some lumpiness in health care based on funding. But again, we work hard and know our way around the funding mechanism.

Great. And then, Al, for you, it looks like on a profitability basis, if we make an adjustment for netted down, you guys had a relatively strong performance outside of netted-down gross profit. Should we think about that margin sort of accretion going forward as we mix to maybe fewer client devices in the overall portfolio and some more margin-rich solutions going forward outside of the netted down piece? Just trying to get a sense for how that trends? I know you're still in the planning phases for 2026, but you've had relatively good results in traditional gross margin outside of netted down. So I just wanted to get a sense of how you're thinking about that going forward.

Yes. Thanks for the question, David. Look, very near term, and particularly for Q4, I wouldn't expect much of a change there. We have seen stability over the last couple of quarters and so that's certainly encouraging that those non-netted down margins have held up. As we look forward, David, I think that a mix out of client would marginally benefit there as well. If things play out as we would hope on the services front that will also aid those margins. So I'd say modestly, you could see some tick up, but I'll reserve the right to give you more detail as we get into 2026.

Chris, I wanted to start, I know you're in the middle of the planning cycle for 2026. Just reflect on how this cycle is maybe similar or different than prior years? And curious on the strategic part of that discussion in particular. The Services narrative here is obviously very strong on this call. I wonder how you and the Board think about potentially value creation in the services business and how that works? Would it make sense for maybe even larger scale M&A in Services, would be helpful?

Sure. Let me begin by emphasizing the outcome we aim for. In terms of value creation, we focus on delivering high growth and highly relevant offerings that meet our customers' current and future needs. We have been making significant investments in our industry-specific capabilities, which include expertise and technology. Our investments span both professional advisory services and managed services, both of which we consider essential for future customer value creation. As we've mentioned for the past couple of years, our comprehensive approach, covering the entire lifecycle and outcomes, operates like several interconnected flywheels. Customers are no longer interested in isolated products; they seek outcomes and comprehensive solutions, with services now embedded within those solutions. As we approach next year, we will continue to monitor M&A opportunities while prioritizing investments in services. As Al noted earlier, you will witness accelerated growth in areas that are particularly relevant and important at this time.

Yes. Thanks, Adam. A couple of things. First, on the government federal front, just keep in mind that Q4 is low season, so while we did adjust down our expectations for the quarter, we had the fact that it has less weight on the quarter overall, number one. As Chris suggested, we walked into Q4 with some pipeline, and we have some regular run rate business with agencies that are still open. That being said, we definitely did kind of take out the pen to take down some expectations on government. It's just when you add all those variables, it doesn't end up being an outsized component adjustment, if you will. So that's number one. Number two, on the question of the, are there any offsets there? There are a couple of minor offsets that is the, we walk into a quarter, so we have a pretty good idea of pipeline and what it's going to take to convert that pipeline. And so a couple of other channels that would be more favorable contributors would include small business that has very good momentum and then I would point out the U.K. that, again, has both a very healthy pipeline but has been executing really well. So they serve as some offsets to government, but net-net, it's a modest take down for the quarter.

Thank you, Carlie. Before we wrap up, I want to extend my sincere thanks to our nearly 15,000 coworkers around the world. Their expertise, dedication, and passion are the driving force behind our continued success. I'd like to thank our customers who trust us every day. I also want to thank our more than 1,000 leading and emerging partners for their trust and collaboration in delivering innovative, outcome-driven solutions; and to everyone joining us on today's call, thank you for your time and support. Al and I look forward to speaking with you again in the new year.

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