Good day, ladies and gentlemen, and welcome to the CDW Second Quarter 2019 Earnings Conference Call. [Operator Instructions]. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. I would now like to introduce your host for today's conference, Ms. Chris Leahy, Chief Executive Officer. Ma'am, you may begin.

Thank you, Joelle. Good morning, everyone. It's a pleasure to be with you. Joining me in the room today are Collin Kebo, our Chief Financial Officer; and Beth Coronelli our VP, Investor Relations. I'll begin with a high level overview of our second quarter financial and strategic performance and share some thoughts on our outlook. Then Colin will take you through a more detailed look at the results, capital strategy and priorities and outlook for 2019. We will move quickly through our prepared remarks, to ensure we have plenty of time for Q&A. But before we begin, Beth will present the company's Safe Harbor disclosure statement.

Thank you, Chris. Good morning everyone. Our second quarter earnings release was distributed this morning and is available on our website, investor.cdw.com, along with supplemental slides that you can use to follow along with us during the call. I'd like to remind you that certain comments made in the presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release and Form 8-K we furnish to the SEC today, and in the company's other filings with the SEC. CDW assumes no obligation to update the information presented during the webcast. Our presentation also includes certain non-GAAP financial measures, including non-GAAP operating 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 will find reconciliation charts in the slides for today's webcast, as well as in earnings release and the Form 8-K we furnished to the SEC today. Please note that all references to growth rates or dollar amount increases in our remarks today are versus the comparable period in 2018, unless otherwise indicated. In addition, all references to growth rates for hardware, software and services today represent US net sales only, and do not include the results from CDW UK or Canada. There were the same number of selling days in the second quarter of 2019 compared to the second quarter of 2018. There was one fewer selling day in the first six months of 2019 compared to the first six months of 2018. All sales growth rate references during the call will use average daily sales, unless otherwise indicated. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is property of CDW, and may not be recorded or rebroadcast without specific written permission from the company. With that, let me turn it back over to Chris.

Thank you, Beth. Second quarter results were ,excellent with both strong top line growth and profitability. Consolidated net sales were $4.6 billion, up 10.6% above last year, 11.2% in constant currency. Gross profit increased 11.2% to $774 million. Non-GAAP operating income increased 10.7% to $358 million and non-GAAP net income per share increased 15.7% to $1.60 per share. These results reflect the combined power of our balanced portfolio of customer end markets, our full suite of offerings that address customer priorities across the IT landscape, and ongoing success executing our three part strategy for growth. First, the balance across our customer end markets; as you know , we have five US sales channels; corporate small business healthcare, government and education. Each of these channels are meaningful businesses, generating annual sales of more than $1 billion. This scale enables us to further align sales teams into vertical customer end markets, including K12, higher ed, state and local government and federal government. In addition, we have our UK and Canadian operations, which together delivered nearly $2 billion in 2018. These unique sales organizations, serve us well when end markets behave differently from each other. Sometimes that occurs because markets are disrupted by macro or external challenges. Sometimes it occurs when customers' behavior differ due to different priorities. This quarter, our double-digit sales increase was driven by excellent results across all five of our US channels, each growing high single digits or better. US customers remain focused on client devices to meet growing needs from full employment, as well as refresh, driven by older equipment, new used cases and new security features. At the same time, customers continue to modernize their IT infrastructure and adopt more flexible architectures. The team did an outstanding job helping customers address these priorities. In corporate, the team…

Thank you, Chris. Good morning, everyone. As Chris indicated, our second quarter results reflect the combined power of our balanced portfolio of channels, broad product offerings, and ongoing execution of our three part strategy. They also reflect successful investments in our business, that build on our long-term financial strategy to drive strong cash flow, deliver sustained profitable growth, and return cash to shareholders. Turning to our second quarter P&L on Slide 8; consolidated net sales were $4.6 billion, up 10.6% on a reported basis and in average daily sales basis. On a constant currency average daily sales basis, consolidated net sales grew 11.2%. On an average daily sales basis, sequential sales increased 15.2% percent versus Q1 of 2019. This was modestly below historical seasonality, given the strength of the first quarter, which included the timing benefits from the Netcomm backlog flush in federal, but stronger than expected, driven by one client device growth, which is very strong across the business, with most US channels growing healthy double digits, notwithstanding uncertainty from tariffs and CPU constraints. And to public, where we had really strong growth across three channels. Government was up 17%, even with the federal timing shift into Q1. Education were K-12 as up double-digits and healthcare, which was also up double digits. Gross profit for the quarter increased 11.2% to $774 million, gross margin expanded 10 basis points, driven by an increase in the mix of netted down revenues, including warranties and software-as-a-service, partially offset by year-over-year net sales growth, outpacing the year-over-year growth in partner funding. Turning to SG&A on slide 9; our non-GAAP SG&A, including, advertising increased 11.7%. The increase was primarily driven by sales compensation, which moves in line with gross profit growth, incremental Scalar expenses, performance based compensation, consistent with higher attainment against goals and…

[Operator Instructions]. Our first question comes from Matt Cabral with Credit Suisse. Your line is now open.

Thank you. I wanted to start off on a broader demand environment. So you're continuing to see healthy double digit growth, but some of your vendor partners are starting to see a little bit of softness, particularly on more solutions-oriented categories. So I guess, just wondering if you could talk a little bit about what you're hearing from your customer base, in terms of their budget plans and just what you think may be driving that disconnect?

Yeah. Hi, Matt. Look our -- in conversations with our customers, they are still feeling bullish, and they are still looking to spend. When you think about our customer base, and take a step back and think about some of the exposure that others have, that we don't have, things like China, things like consumer certain other end markets, hyperscaler is another example. But -- that are more challenged, that's not what our customer base is facing. And so we've got a broad portfolio, as you know and we can help our customers, wherever there IT priorities are. The other thing I would just say is, that in an environment like this, where the economy feels pretty strong and customer sentiment remains strong in our view, our competitive advantages allow us to drive even bigger share gains, as we do things like leverage our scale and our distribution centers, as I mentioned. So look, the outlook for the rest of the year is pretty consistent in our view, with how we felt at the beginning of the year. Not a lot of data points out there that has given us any reason to perceive it differently. If you look at -- as you said, peer results, competitive results, the VAR survey, CIO surveys, economic data, there's stuff that's kind of lining up on both sides of the ledger and net-net, we still see a 3% market rate of growth and pretty healthy demand from our customers.

Got it and then government was a stand-out vertical for you in the quarter. Just wondering if you could dig a little bit deeper into what drove the strength there, and just how we should think about the sustainability of it going forward?

Yeah. Federal is doing a terrific job across refresh of those agencies, that didn't -- more mandated and refreshed under the Department of Defense. So we've seen refresh now in agencies that didn't have that mandate, and that's been strong. But what I really say about the Federal team, is they have focused their go-to-market investments over the past several years, on solution capabilities and we're seeing that come to fruition in the types of transactions that they're working on. So if you look at this quarter, they are driving strong results across, not just refresh, but strategic solutions, transactions for cyber security, for modernization of infrastructure, etc. And those are deals that take a long time to develop, and looking at the pipeline, continue to remain strong. So they will got the go-to-market in place to go after those deals. They have got the trust with the customer, that takes long time to develop. We've got the technology and support to be able to help them with that and expand those. And the other thing that they're doing is, they're creating really strong proof-of-concepts for certain agencies, that we're finding, we're now able to take this proof-of-concept and transport them to other agencies that are looking at similar types of problems they are trying to attack, and we have credibility because we've built it for different agencies.

Thank you. And our next question comes from Amit Daryanani with Evercore. Your line is now open.

Thanks a lot. Good morning, guys. Two questions from me as well. I guess first one, if my math is right, I think your share gains have been in the neighborhood of about 600 basis points in the first half of the year, and that's much better than the historical trend lines you've typically talked about. So I am wondering if you could maybe just touch on what are the levers that are enabling this outsized share gain growth rates in the first half, and what elements of that might be sustainable, versus not, as you go forward?

I will start with that. When you think about the first quarter of the year. Remember, we had some one-time events there with the Netcomm flush that was the normalization of the lead time. So that's kind of a one-time that happened in the first quarter, that we wouldn't expect to see a repeat in the back half of the year. Certainly, we had a pull forward with some federal deals. But federal is doing a really good job. But at the end of the day, when you think about client devices, we think about that continuing to be strong but moderating. We think about solutions continuing to be solid. But we're also looking at really tough overlaps. And so if you look at the last year, we've got a number of our businesses and practice areas comping double-digit on double-digit. And so we're quite attuned to that, when we think about the back half of the year.

Got it. That's fair. And then I guess, when I think of the gross margins -- is there a way for us to think about how much of the benefit you're getting on a year-over-year basis or perhaps from increasing contribution from reoccurring business streams or revenue streams on a year-over-year basis. And then I guess broadly is there a way to think about what percent of your gross profit dollars today are reoccurring in nature, and what that trend line or growth rates look like?

Yeah, I'll start and I will let Collin talk a little bit more about the accounting rules. But at a high level, what I will say is, the accounting rules for where we fit in the channel, are really specific. They are complicated and there is not a one size fits all. So where we are fitting in as a service and how that's recognized is complicated. What I would say and what's really important, is that as our customers are having conversations about transactional on-prem-as-a-service other consumption models, we're agnostic to that. So we are having the conversations with them and we're advising them along the way, in terms of assessing, designing, implementing, consuming managing etc. How that reflects in our financial statements, I will let Collin talk through. But it's important to recognize, that we are part of those conversations in driving, as our partners business models change, we are driving what it is that they are bringing to market and bringing to our customers.

Yeah Amit, I would say the traditional pure subscription or recurring revenue is still a relatively small percentage of our business. If you look at the amount of revenue that we're recognizing, that's booked over time rather than upfront or at a point in time, it's probably around 3% of sales. What I would say though is, because of the accounting that Chris mentioned and again, how we participate in this ecosystem, if you look at the percentage of our gross profit that is netted down, it was about 28% in the quarter. So a lot of those things that are getting netted down or things that have a finite term, we're selling a warranty, we're selling software-as-a-service, software assurance, etc. So I think that can give you some idea of the magnitude of what's flowing through our gross profit, in some of those transactional streams.

That's really helpful. Thanks a lot and congrats on the quarter guys.

Thank you. And our next question comes from Katy Huberty with Morgan Stanley. Your line is now open.

Thank you. Good morning. As you highlighted free cash flow has doubled in the first half of the year, and if you look at historical first half versus second half seasonality, it would put you potentially well above the target range for the full year. Can you just talk about what is maybe driving the better first half seasonality, and what might slow free cash flow in the back half of the year?

Yes, sure Katy. You're right. Q2 is typically a seasonally low free cash flow quarter for us, because sales grow sequentially and we have two tax payments we have to make. This year was unusual. I would say the stars aligned for us from a vendor mix perspective, and that's really what drove the free cash flow favorability in the quarter. I'd expect that will normalize, as we move into the back half of the year, would expect us to be within our 3.375% and 4.25% of sales rule of thumb for the full year.

And then, Microsoft expressed the view that Windows 10 upgrades will continue past the January 2020 support expiration, especially for the small-medium business market where you have exposure. Do you tend to agree that you'll continue to see the upgrade cycle in 2020, or do you think that it's difficult to continue growing the client segment, as you annualize the comps from this year?

Hi, Katy, it's Chris. I think it's not unreasonable to think that we will continue to see some of that spill into 2020 into the first quarter, for example, and maybe a little bit beyond. What that looks like over the course of all of 2020, hard to predict, but certainly some of it is spilling into the front half of the year.

Thank you.

Thank you. And our next question comes from Adam Tindle with Raymond James. Your line is now open.

Okay, thanks and good morning. I just have two related strategic questions Chris. In the past you've mentioned being open to a large acquisition, I think over $1 billion. On your slides Scalar is an example and obviously of M&A and it's much smaller than this. So the first question is just kind of update on your thoughts related to executing M&A over $1 billion, and I just mentioned this particularly in light of one of your largest competitors making a sizable transaction recently. That deal was arguably more of a financial transaction, or sizable cost synergies could drive that below five times EBITDA, which kind of leads me to my second question, it sounds like CDW's focus is more on capabilities. So just wanting to understand the part of not pursuing something like an Insight-PCM, given it would be significantly accretive based on where CDW trades relative to others?

Yeah. Thanks Adam. Great question. Yeah, we're still focused on M&A. I think if you look at our track record, Kelway, and even the early proof points with Scalar. Our discipline around the right targets and then our methodical approach to integrating and our focus on getting it right for the customer right off the bat, and empowering our coworkers to deliver for the joint customers, is leading and has led to really positive success. So the model is working. We are in the market. We're looking, constantly, we are proactive. We tend not to be reactive, as you know. But, yeah our -- the way we think about it from a strategy perspective, is kind of pretty straightforward. Two things, expand our solutions capabilities or extend our services capabilities. Those two things plus geo expansion, that's essentially how we think about M&A. As far as the notion of a large, kind of more financial play. Look we have to look long and hard at that, because of the, the difficulty of integrating an organization. As I know, you know, we take that very seriously. That's why cultural fit leadership is so important, and we tick through the things that matter. So that's something we just have to take a look at. But we're really focusing on the capabilities and geographic reach always in the market. But it's got to make sense.

Okay. Maybe just as a quick clarification for Collin on financing for an acquisition. I mean, is there a scenario where it might make sense to use equity in a larger transaction? Stock valuation is quite healthy and it would still be accretive?

Yeah, Adam, given where we sit with our leverage profile, we are 2.3 times below the 2.5 to 3 times, I think that gives us plenty of headroom. And if we had to go above that 3 times and temporarily step out of that range, I think our investors and our rating agencies would give us the flexibility or latitude to do that, as long as we show the clear path to deleveraging and a reasonable amount of time in getting back within the target range. We demonstrated throughout our past, that if we set a leverage target, we'll get there. So I think our preference would be to use leverage, but obviously it will be dependent on situation.

Makes sense. And congrats on the continued strong results.

Thank you. And our next question comes from Param Singh with Merrill Lynch. Your line is now open.

Hi, good morning everybody and thanks for taking my question. So just wanted to get a sense of your productivity here. If I just look at sales per coworker, it was growing at 1% year-over-year this quarter, which is a slowdown from the last year quarters. Is that because you've had incremental co-workers coming in from Scalar, that you need to integrate and get up in productivity, or is there another reason behind that, and do you think the addition of coworkers is, while you're outperforming your competitors? And then I have a follow-up.

Hi Param and welcome to the call. Glad you could join. Yeah, I would say a couple of things are driving that. One is Scalar, because of the high services mix and the service delivery co-workers that go along with it, the sales per coworker productivity isn't comparable to CDW, given the different business mix. Also we're in the summer, so there's a little bit of seasonality, where we bring in a lot of interns. This summer and this year, we brought in more than the prior year so that's impacting it. But I think if you looked at kind of apples-to-apples organic, regular CDW coworkers, you would see productivity levels more in line with historical levels.

Understood, thanks. And then, I mean, just specifically on the educational segment, it was much stronger in seasonality then you've typically seen in prior years. Is it because the March quarter was weaker in education, or were there additional wins in the quarter, and would you expect that to persist?

Yeah. I would describe the K-12 as really strong quarter and when you think about the constraints in the marketplace around client advices, and the summer months being very important for education to buy and implement those devices. We had a couple of things going on. First, the constraints were more severe in K-12, because of Chromebook and where Intel placed their priority around higher performing chips. So the team did really an extraordinary job of working with customers, working with our partners around what the options are, when to get things in, etc. and we're able to deliver over the summer months, which is really quite impressive. In addition, we've seen some net working positivity, and when you think about E-rate and where that falls throughout the -- any given quarter, it's really bumpy. It never falls in the same quarter it seems to be, because of some lag or some paperwork issue. But we did see some growth under the E-Rate program this quarter as well. So I would just say, all in all, solid quarter doing -- executing on the priorities that we typically execute on.

Okay. All right, thank you so much. Really appreciate it, Chris, Colin.

Thank you. And our next question comes from Matt Sheerin with Stifel. Your line is now open.

Yes, thanks and good morning. So a question regarding your commentary on the UK and EMEA regions being somewhat slower growth. Could you give us some more color on what you're seeing? Obviously there is some economic concerns across Europe, but we're still obviously in an upgrade cycle from a corporate standpoint. So any help there would be would be great.

Yeah. Sure, Matt. Thanks for the question, and obviously we watch this closely. First, I would say that the team has been executing extremely well. When you look at overlap, double-digit on double-digit, and we are talking meaningful, last year plus 30%, the year before, high double digits. They're executing well. That said, I would say a couple of things. First, the market outside of the US probably feels marginally a little softer, a little more uncertain than it does in the US, and we're watching that. We hadn't seen in Q2, different buying behaviors but from our customers. But you got to believe Brexit on their mind, given that it's 90 days away, and we've got some new rhetoric and new leadership in place. So it's hard to believe that it's not on their mind. But that said, I'll tell you, our referral business continues to be very healthy. Our international meaning Rest of World business outside the UK, continues to be very healthy, and the team continues to be optimistic in terms of their conversations around customers. So look with the wildcard of Brexit looming, we are just being very cautious. The good news is, we've run this table-top before -- before the October 31st extension. Earlier in the year, we worked with customers to map their need, so that we would be prepared to help them. And we've also opened an office in The Netherlands, and we've got a number of customers actually that are transacting through the Netherlands. So we are getting more and more confident with our ability to deliver to the same service level agreement. So we're doing everything we can to be prepared, but we can't control what happens in the environments, and we'll just keep, I think, out executing as the team has been doing.

Okay, that's helpful. And then just a follow-up question regarding your Census contract. Could you give us an update there in terms of contribution relative to expectations?

Yeah. Well Census is going well. Contribution relative to expectations hasn't changed. We still expect 40 basis points of revenue growth, as a result of Census. I would give a shout out to the team, that it's a lot of hard work, a lot of collaboration, not just at CDW, but with a number of partners as well. And again, think about the number of devices that we have running through our configuration center. At the same time, we've got K-12 busy season. We've got inventory in there under constrained conditions, and we're really doing a great job of getting it in and moving it out. So 40 basis points for the year, so far so good.

Thank you. And our next question comes from Paul Coster with JPMorgan. Your line is now open.

Yeah, thank you for taking my questions. I just wanted to touch on a couple of prior subjects. First up on the client device front, to what extent do you see customers sweating asset beyond the Windows 10 upgrade dates, and is that yielding a service opportunity for you?

Yeah, thanks for the question. You know, we have seen a number of customer -- a very large number of customers now converting to Win 10. And so, I don't know that I would see that as an opportunity that there is going be a number of customers' sweating the assets after this conversion. It just doesn't feel that way with the activity we've seen with current customers, what we're hearing from Microsoft, etc. it doesn't feel like the market is going that way.

Got it. And then, Chris, just on this point of Europe -- a massive plan now, but still small in the context of the overall market. There is obviously a huge opportunity to scale up. But I'm wondering whether you think there is a limitation to how far you can go, given how important the sales culture is, and it's maintaining its integrity? Do you see a natural limitation to the growth?

Yeah, it a spot on question because that sales culture is so important to an acquisition working. I can tell you that we have looked at a number of players. This is a constant rhythm for us, which is meeting with and talking to people, and it's very clear that there are some organizations out there, where there is not a fit. But equally there are organizations where we feel culturally, particularly on the sales side, they could be a really good fit. So is there a natural limitation? Sure there is, because organizations are all different. But we think that is not going to impair our ability to find a good solution or a good expansion path at all.

Okay. Thank you.

Thank you. And our next question comes from Keith Housum with Northcoast Research. Your line is now open.

Good morning. Thanks for the opportunity. Chris, client devices have been strong for a better part, two years now, and if it's the Windows 10 refresh or if it's the full employment. It kind of seems like it's getting more difficult to grow on top of that, just because kind of -- two years into it. Is there a concern or perception that client devices will be slowing down, or do you still see an opportunity for that to grow? And if so, how?

Yeah. We definitely, when we look at client device and we look at the compares over the last couple of years and the quarters, it's going to be tough to grow at those kinds of rates. So we wouldn't expect -- we would expect our client device growth to be at a more muted rate, yet healthy, because we do have customers who continue to -- who are new refresh cycles frankly or continuing to expand their use of client devices for different things in the business, new use cases, etc. But certainly we are facing very difficult comparisons, and we expect that growth to moderate.

Got you. And then if I could just ask a bit more strategic question, following up on the question before regarding acquisitions. Is there assuming -- are your capabilities that you are not going to be able to either grow internally or to acquire, I mean, on the same front geographically is there -- sort of geographics areas that you're more targeted to expansion than others?

Yeah I think when you think about capability, it would be the same areas that we frequently talk about, and you know, Scalar is a great example, infrastructure, security, managed services, digital transformation, those are all areas where -- when you think about bolstering our current capabilities, areas we'd look at. In terms of geographic, that's really driven primarily from what, where our current customers have needs, and that's been our strategy all along. So we look at our UK, US, Canadian customers and where the pipeline is growing, and where they're telling us, they really could use some help. And there certainly are some places on the continent that makes sense, but there are some places in other areas of the world that make equal sense. And at the same time, we do have smaller presence in a variety of locations. Dubai, for example, in Asia, in Singapore, Hong Kong, and we're also focused on bolstering those, to ensure that we can deliver on the current needs that our UK multinationals have

Great. Thank you.

Thank you. I'm not showing any further questions at this time, I would now like to turn the call back over to Chris Leahy for closing remarks.

Well, thank you and let me close by once again thanking our 9.800 coworkers around the globe for their ongoing dedication to serving our customers. They are true competitive advantage and the heart, soul and reason why we consistently deliver meaningful value to exceed our customers needs and expectations. They are the reason we have and will continue to lead the industry. Thank you to our customers for the privilege and opportunity to serve and repeatedly earn your trust, and thank you for your continued interest in CDW. I also want to send a shout out to Gary Woodland, winner of this year's US Open Championship, CDW is the official technology partner to the PGA Tour, and Gary has been a terrific CDW technology ambassador since 2014. Gary, we couldn't be more thrilled for you. With that I'd like to say thanks again and Collin and I look forward to talking to you next quarter.

Ladies and gentlemen, thank you for participation in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day.