Q2 2025 Earnings Call Transcript

Good morning, all, and thank you for joining us for the CDW Second Quarter 2025 Earnings Call. My name is Carlin. I'll be coordinating the call today. [Operator Instructions] I'd now like to hand over to our host, Steve O'Brien, the floor is yours.

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 life cycle 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 2 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 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 growth strategy.

First, our balanced portfolio of diverse customer end markets. We have 5 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 was 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 digit. Federal performance reflected the impact of new administration priorities with mixed performance across the various agencies. Some civilian agencies caused purchases and others move forward.

With the evolving funding mechanisms and shifting rules of engagement, the team work with customers to help them prioritize spend 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 life cycle 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 6 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 life cycle 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. Capability is 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 operationalized 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 life cycle, solutions that deliver fast, secure and ROI-driven innovation. Innovation that leads to measurable outcomes for our customer and further deepens our relationship. Let me highlight 2 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 ticket arrive, the AI agent references past cases and recommends resolutions in real time. The 6-figure engagement included knowledge transfer documentation, infrastructure setup, agents development, testing and integration and most importantly, transform 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 multiyear managed services engagement with $10 million total contract value. An engagement that includes 24/7 managed security operation 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 platforms.

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 is in our practice -- 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 staff 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 customer -- 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 6 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 compared to 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 3-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 3-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 3-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. [Operator Instructions].

[Operator Instructions] 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 3 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, 9 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 outperforming versus the market? And then I have a follow-up, please.

Yes. Sure, Erik. When I look at the performance over the last 3 years and as we look forward for the rest of this year, we are expecting to outperform the market by 200 to 300 basis 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 in 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, 6 to 18- plus months in advance?

Thanks, Erik. Let me zoom out a little bit. I'll just start with the overarching perspective of where we are because, obviously, the cycles are impacted by the macro environment. So I would say, if we think about the hardware cycle, client in particular, we've been seeing strength in client over the past several quarters.

CDW's team has been doing a tremendous job delivering and capturing opportunity given the breadth of client devices and services that we provide. We probably say we're mid-cycle in that refresh, so if you think forward, think about it that way. With regard to the infrastructure hardware, this seems to be on an uptick, and that's not unusual vis-a-vis the timing of endpoint devices, networking and then infrastructure. So again, though I have to note that it's going to bounce around as it always does based on specific budgets and based on the priorities within end markets.

For example, higher ed, which has been feeling some of the impacts from the federal funding changes is still investing heavily in network and campus device -- campus networking because it is a key differentiator for students who are going there. So it's going to bounce around based on the end market that we're -- and what their needs are. I'm going to have Al dive into each of the categories a little more specifically.

Yes. Thanks, Chris. Erik, just a few things that I note. As you know, and Chris noted, for 6 quarters, we've seen client device growth, and that's been quite positive.

And I'd say most of the strength on hardware to date has been in more of the transactional front, specifically client. We've been saying for a while with respect to solutions, it's a matter of when, not if. And while this is a single quarter, I would say somewhat encouraging that we did see a turn on that front for solutions. Now it's 1 quarter, number one.

And two, I would say the comps were negative. So that certainly helps the equation. But I would say there's some indication there that customers are showing resiliency and needing to get -- to move forward with some of their refresh initiatives. So again, early days in that, but for this quarter, solutions actually outperformed transactions.

And so that's somewhat encouraging to us, and we're watching it closely.

Our next question comes from David Vogt from UBS.

So maybe Chris and Al, can you maybe just expand upon sort of the strength that you saw in the quarter. Obviously, corporate was incredibly strong. But I think you also noted that there wasn't a dramatic -- or you didn't see an impact from pull-forward. Can you kind of just maybe expand upon kind of what was sort of the motivating factor kind of worked at the corporate market to be a little bit more -- to be healthier than maybe in the past couple of quarters?

I know the comp wasn't that much easier. And then I'll just give you my follow-up. And so Al, obviously, you talked about a smaller percentage of netted down in the quarter. If I kind of just take the numbers really quickly, it looks like there was a little bit of product gross margin.

Is that just reflective of the larger corporate size in the quarter, which I think you referenced in your prepared remarks. I just wanted to make sure if there was anything else kind of going on under the surface.

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 life cycle 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 1 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, it's really -- we've looked at education and federal and we're really -- we're taking into account what we think is going to be a softer back end and frankly, unseasonal. When I think about what's going on with the policy and the funding changes and protocols, our customers are just taking a step back. They're taking a step back to understand and move through these changes and use the budget they can, but also understand where they're going to come out on the other side of this. And the good news is CDW is right in the middle, helping them do that.

So we're just being very -- we're being clear eyed in terms of what the next several quarters are going to bring. We're confident that once there's more clarity and the money is flowing, that we'll be able to help our customers, use it and deliver efficient and effective technology, but it really is driven by that. On the other -- with regard to the other -- with the other segments, we are still taking a cautious tone. As Al mentioned, we're being prudent because our customers are being prudent, and we don't want to get ahead of our skis.

We want to really just take it as it comes. And we'll see what happens in Q3, but that's the reason you see a little bit more softness in the back 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, 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.

Moving on to the next question. Our next question comes from Harry Read from Rothschild & Co. at Redburn.

Apologies if I miss heard, but I think that you said SG&A as a percentage of gross profit will be in line with Q2 and Q3. That's 2- ish percentage point 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, sure. On the SG&A front, you have it right. The -- that efficiency ratio of non-GAAP SG&A relative to GP for Q3 would be reasonably consistent with Q2, which was 58.1% for the quarter. So on an efficiency ratio basis, I would say that kind of like that's what we're looking at largely for the back half.

Now just a reminder from the last call, when you think about operating leverage, Harry, and comparing to the prior year, in the first quarter, we had very significant operating leverage down the P&L and including on the expense front. And I mentioned there that we expect we would have some asymmetry for the remainder of the year. The most notable component of that, Harry, is that in comparing to 2024, right, where our results were softer and decelerated through the year, we had pretty significant drawdowns of our incentive compensation accruals. And so really, what you're seeing here in Q2 and kind of for the remainder of the year is just negative compares versus the prior year where those accruals were coming down.

The only other factor, Harry, that maybe I would point out is, look, we've done, I think, a really nice job being disciplined about our spending. But the reality is over a number of quarters, our gross profit growth has been a bit lighter than we would have hoped. So we're at a spot that while we continue to drive for operating leverage and expense efficiency, our current expense base is kind of geared towards a bit higher gross profit growth. Now if we achieve the level of growth that we would hope for, we're going to grow right back into parity with respect to our expense base, and that's how we see that playing out as we go 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 accelerate 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 2 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 beneficiary, 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, were -- 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.

On the decrease in gross profit margins, I know that's been happening for a few quarters now. I think you called out data storage, servers, NetComm products. Can you just help us explain like is it a function of pricing that you're not being able to -- is the competitive environment where you're not able to pass through pricing? And where does that kind of bottom out in terms of gross margins on those 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 are 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.

And if I look at that same metric, if I look at it for the guide for the remainder of the year, should I be expecting those levels to be consistent or tick down for fiscal '25 relative to fiscal '24, just given the performance year-on-year for the first half?

No, we are not presuming that you're going to see continued degradation. Our guide for gross margin for the full year is still reasonably similar to 2024 levels.

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

The first one for Chris. You had strong growth in client devices. And Chris, you talked about refresh. Are customers taking this opportunity to upgrade their devices on the client side are they upgrading things like AI PCs?

And are you seeing any AI-driven demand in the data center side in terms of servers? So just -- and overall, your thoughts on how AI is impacting your revenues? And I have a follow-up.

Sure. On the PC side, I would say that the refresh discussion in the Win 10 expiration continues to be the key driver, conversations and some -- and purchasing of AI PCs is picking up. But I think we -- I'd say we're middle innings of the client device refresh and are kind of early innings of the AI PC uptick. On the infrastructure side, yes, those conversations are in every discussion we have about infrastructure generally, and we're seeing some good headway there.

Regarding AI, I think you just asked a general question on AI. I tell you that customers across the board right now feel like they are moving from experimentation to a higher degree of importance and urgency around AI and the impact it can have from client devices all the way into the infrastructure. So we are seeing those conversations pick up quite a bit. We feel very well positioned to help our customers in those conversations across the full stack.

As we've said before, AI is embedded in every layer of the stack and our full stack approach allows us to have those conversations and help customers design for appropriate AI uses in the future. The other thing is every part of the life cycle that customers are interested in, whether it is generative AI, whether it's Agentic AI, whether it is prescriptive or predictive AI, we have consulting services that support our customers there. So the team has been incredibly involved in customer conversations soup to nuts about what does AI mean, let's unpack it. So we're feeling positive.

We are seeing an impact on revenue on the hardware side, just picking it up, but really is at the front end with the consulting, and it's starting to pick up in our managed services area. I just think we're at an inflection point with customers around AI, and it's becoming much more part of the conversation, which excites us.

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. No, sure, Ruplu. It's our -- our standard approach is still holds and that we look to grow the capabilities in areas that are high relevant, high growth, high margin for our customers. We look at services-led capabilities, in particular.

We look at industry vertical capabilities. So you think across the board of technologies, AI, cloud, security, manage, those are all good buckets to think about when you think about the types of things that would help us propel our growth services at the top of the list. And I'm sure you've noticed we've just hired a new executive, Chief Services and Solutions Officer, we're quite excited about. We consider services to be a main growth engine of the business.

And so you can imagine that we're focused on aggressively investing behind that area. So that's how I think about it. It's broad-based. It's things that drive relevance, things that drive growth and things that fuel our full stack, full life cycle positioning in the business.

Our next question comes from Keith Housum from Northcoast Research.

The commentary regarding large deals that probably -- so I assume the large deals are performing better than like the run rate or the SMB business. Is this a trend that we see kind of developing through the rest of the year that more of the spending is going to be coming from the 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 and 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.