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CDW (NASDAQ:CDW)
Q2 2019 Earnings Call
Jul 31, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day, ladies and gentlemen, and welcome to the CDW second-quarter 2019 earnings conference call. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Chris Leahy, chief executive officer.

Ma'am, you may begin.

Chris Leahy -- Chief Executive Officer

Thank you, Joel. 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 Collin will take you through a more detailed look at the results, capital strategy and priorities and outlook for 2019. We'll move quickly to 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.

Beth Coronelli -- Vice President of Investor Relations

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 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 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'll find reconciliation charts in the slides for today's webcast, as well as in our earnings release and the Form 8-K were 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 represents U.S.

net sales only and do not include the results from CDW U.K. 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. A 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.

Chris Leahy -- Chief Executive Officer

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 market, our full suite of offerings that address customer priority across the IT landscape and ongoing success executing our three-part strategy for growth. First, the balance across our customer end market. As you know, we have five years 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 market, including K-12, higher ed, state and local government and Federal government. In addition, we have our U.K. 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 differs due to different priorities. This quarter, our double-digit sales increase was driven by excellent results across all five of our U.S.

channels, each growing high-single digits or better. U.S. customers remain focused on client devices to meet growing needs from full employment, as well as refresh driven by older equipment, new use cases and new security features. At the same time, customers continued 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 delivered just under 9% growth as they successfully addressed ongoing demand for client devices while overlapping last year's strong results. The small business team continued to leverage end market specific offerings and dedicated solution specialists to deliver nearly 15% growth. The government team drove a 17% increase in sales.

Federal had another excellent quarter with sales up more than 20%.The team leveraged our distribution centers to meet customer refresh needs and continued to deliver ongoing projects like the Navy CANES loading cloud initiative and newer cybersecurity-related initiatives as they lap the impact of last year's shipping delays. The state and local team delivered high single-digit growth as they helped customers refresh client devices. Education's 9% increase reflected low double-digit growth in K-12 and low single-digit growth in higher ed. K-12 delivered on networking needs and overcame chip constraints to meet ongoing refresh.

Higher ed continued to leverage our broad portfolio to help campuses use technology to upgrade and enhance student and teacher experiences. Healthcare was up 14% as the team continued to drive excellent results, helping health systems improve end point access and security, as well as address medical records storage and accessibility needs. Other, which represents our Canadian and U.K. operation, increased 8% on a reported basis.

Both markets faced challenging overlaps in local currency. Canadian growth was driven by both organic and Scalar performance. The U.K. team delivered excellent increases in software and services.

But as expected, local currency growth slowed on top of last year's more than 25% growth and U.K. was flat year on year. Clearly, second-quarter results demonstrate the power of our balanced portfolio of customer end market. Second-quarter results also demonstrate the power of our second driver of performance, the breadth of our offering.

With over 100,000 products, services and solutions for more than 1,000 vendor partners, we are well positioned to meet our customers' total needs across the spectrum of IT. U.S. transactions increased mid-teens, led by high-teen increases in client devices. U.S.

Solutions increased mid-single digits, led by double-digit growth in net comm hardware, which drove excellent increases in associated services and software. On a net sales basis, headwind increased 11%, software increased 5% and services increased 26%. Hardware performance was fueled by client devices and net comm, both up double digits. Lapping last year's supply constraints, net comm's growth was driven by data center modernization and campus refresh, including investments to support ongoing digital transformation initiatives.

On the client side, the team did an exceptional job leveraging our unique ability to provide high-value services like preorders, configuration and staging in a supply constrained environment. Video also increased double digits. It's driven by both displays and digital signage. Performance was lumpy in data center hardware.

Both enterprise storage and servers posted mid-single digit decline. Server performance was mixed across channels. Once again, hyperconverged infrastructure posted meaningful double-digit growth. Flash represented nearly one-third of total storage hardware in the quarter, with customer adoption aided by expanded offerings and improved economics.

Software net sales increased 5%. As you know, software is becoming a larger component of IT solutions. Success helping customers adopt new technologies and infrastructure refresh drove double-digit growth in network management, storage management and operating system software. Cloud also contributed to this quarter's results with double-digit increases in customer spend and gross profit.

Growth was driven by productivity, collaboration, mobility and security workload. Services' 26% increase was led by professional services, warranties and configuration. And this leads to the final driver of our performance in the quarter, the impact of investments we are making in our part strategy for growth, investments made to ensure we continue to serve our customers' IT needs in this evolving market, whether in a physical, virtual or cloud-based environment in the U.S. or internationally.

Our three-part strategy for growth is to, first, acquire new customers and capture share; second, enhance our solutions capabilities; then third, expand our services capabilities. Importantly, these three pillars work in tandem. Each is crucial to our ability to profitably deliver the integrated technology solutions our customers want and need today and in the future. The first pillar focuses on continuous productivity improvement.

This is vital to our ability to achieve our overall strategy. Continuous productivity gains fuel our ability to invest while delivering profitable growth. A key way we do this is through disciplined sales management programs like category penetration goals and book management. Prescriptive programs don't work unless we have that talent in place to execute them.

So for CDW, a key way we drive productivity is by hiring and retaining the right talent. This is more critical than ever in today's tight labor market. And we have several innovative programs in place to help ensure we continue to hire, develop and retain the best talent. Our sales residency program is a great example.

Launched in November 2016, the program drives increased performance, both through engagement and enablement initiatives. Residency focuses on CDW account managers between five to 24 months' length of service. After completing four months in sales academy, residents are placed on their permanent sales team and assigned to a dedicated resident sales leader. The program includes mandatory formal training across multiple dimensions, all focused on building both technology and sales skills, with a focus on building solution skills early on our seller's career.

Results have been excellent to date. Customer spend for residents within 13 to 24 months of service was 40% higher this quarter than in the second quarter of 2016. Solutions, as a percentage of total sales for account managers in the program, are 300 basis points higher than in 2016. At the same time, the attrition rate for account managers was zero to 24 months' length of service and declined nearly 25%.

Of course, retaining the right coworkers requires hiring the right coworkers. In this competitive market, we are implementing innovative approaches to ensure we continue to attract targeted talent. We are currently piloting artificial intelligence solutions to identify top talent within an applicant pool. AI tools identify high-potential candidates by finding applicants with characteristics demonstrated by high-performing CDW sales professionals.

When there is a high match, recruiters target the candidate for more intense activity. Our AI pilot build on other investments we are making to drive recruiting productivity. Combining texting software to stay in touch with applicants with our collaboration platform to conduct video interviews has helped us hire 35% more highly qualified and diverse candidates year over year. For our entry-level sales role, integrating video interviews into our process resulted in a 25% increase in the number of candidates screened.

These are just a few handful of the ways we are investing to hire, train and retain talent. These investments, coupled with the strength of our value proposition, contribute to both seller and customer retention. At the end of the quarter, nearly 30% of our sellers had at least 10 years of CDW experience. Longer-tenured account managers have longer relationships with customers and that has a direct impact on sales.

Customers with more than 20 years with us represented just under half of this quarter's spend. Clearly, our investment in our coworkers contribute to our profitable growth. Investments we have made to enhance our solutions and services capabilities, our second and third pillars, are also contributing to our profitable growth. These pillars are designed to ensure we remain relevant to our customers and to our partners.

Our acquisition of Canadian solutions provider, Scalar, is a great example of our second and third pillars in action. Scalar has locations across Canada and bring strong capabilities in fast-growing areas like security, cloud, infrastructure and digital transformation, with deep services capabilities. Our investment thesis is straightforward with Scalar: accelerate our solutions capabilities and expand our geographic reach within Canada. Let me share an example of how we are already benefiting from Scalar's solutions expertise.

A CDW Canada customer needed to upgrade their security environment. Key to the need was the desire to safeguard how they interacted with their clients. The customer had been with CDW Canada for some time, but we had limited success penetrating their solutions business. Knowing the breadth and scope of the Scalar portfolio, the CDW account manager brought Scalar in on the problem.

Scalar's security services team did a deep dive with the customer and developed a comprehensive solution, which included hardware, software and services. The solution centered on a zero-trust security model that utilizes cloud-based firewall virtualization to protect both enterprise and customer-facing environments. Importantly, incorporating Scalar delivered implementation and training services into the solution meant deployment was fast. The solution generated more than CAD 500,000 in product sales and CAD 100,000 in services, great early proof point on the benefit of the technical and services investment made in Scalar.

Cloud is another area where you see the benefit of our technical and services investment. Investments made in our cloud practice since its launch in 2011 have enabled the portfolio solutions that span the entire life cycle, from design, migration, integration, consumption management and managed services. Last quarter, we shared an example of how we helped a customer migrate an electronic medical records workload from the cloud back to on-prem solution. This quarter, let's take a look at an example of how our small business team helped a customer move a backup and recovery workload to the cloud.

A small, rapidly growing global real estate support business housed their data on-site and needed a fail-safe backup solution with no downtime right away. The customer had a cloud-based pay-as-you-go subscription for test dev but did not have any ongoing cloud application. Their dedicated CDW small business account manager brought in one of our small business technical solutions advisors to help. After assessing the situation, the advisor identified that one of our prepackaged small business solutions bundles was well suited for the customer's need.

The bundle included cloud-based recovery with design and migration services, a perfect fit for the customer's needs, including quick implementation. Packaging solutions with services is one of the ways our dedicated small business segment is making solutions more accessible for the customer and easier for the seller to sell. Prior to our investment in dedicated small businesses technical coworkers and development of small business-focused packaged solution, this solution would have required meaningful technical resources and investment of time that would not have met our threshold for profitable growth. Solving key business problems for our sweet spot of customers in today's environment requires the right talent and strong services and solutions capabilities.

These capabilities, combined with our competitive advantage of scale, scope and disciplined execution, help drive sustainable profitable growth for us today and in the future. And that leads me to our expectations for growth for the remainder of the year. Through the first half of the year, we have added approximately 165 customer-facing coworkers, excluding Scalar. We now expect to be at or modestly above the high end of the 125 to 175 full-year range previously shared.

As we always do, we will monitor the market and adjust our plan as appropriate. Given first-half market performance, our current view of 2019 U.S. IT market growth remains in line with the expectations we shared last quarter of full year growth of roughly 3%. Reflecting our share gains to date, we now target constant currency organic growth between 400 and 475 basis points above the market.

In addition, we continue to look for Scalar to contribute an incremental 100 basis points. As you can see, there's no meaningful change in how we feel about the balance of the year. We continue to expect ongoing but moderating strength in client devices and solid growth and solutions as we overlap last year's second half double-digit growth. The wild card we spoke about last quarter, like Brexit and tariffs, have pushed out but still exist.

We'll keep a watchful eye and, as is our practice, update our view as we move through the year. In the meantime, the team will continue to what they do best, out-execute the competition and leverage our competitive advantages to help our customers address their IT priority. Now let me turn it over to Collin.

Collin Kebo -- Chief Financial Officer

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 to 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 an average daily sales basis. In a constant carry average daily sales basis, consolidated net sales grew 11.2%. On an average daily sales basis, sequential sales increased 15.2% versus Q1 of 2019.

This was modestly below historical seasonality, given the strength of the first quarter, which included the timing benefits from the net comm backlog flush in Federal but stronger than expected driven by one client device growth, which is very strong across the business, with most U.S. channels growing healthy double digits, notwithstanding uncertainty from tariffs and CPU constraints; and two, Public, where we had really strong growth across the three channels. Government was up 17%, even with the Federal timing shift into Q1. Education, where K-12 was 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 investments in the business consistent with our Bold Forward strategy, including coworker count. Coworker count of 9,783 was up nearly 870 coworkers from June of 2018, with almost half of the year-over-year increase from Scalar and the remaining from organic coworker investments. Roughly two-thirds of the nearly 870 coworkers added year over year were in customer-facing roles.

Non-GAAP operating income was $358 million, an increase of 10.7%. Non-GAAP operating income margin was 7.7%. Moving to Slide 10. Interest expense was $41 million, up 8.7%.

This was primarily driven by the interest rate caps increasing from a strike price of 1.5% to 2 three-eighths percent. Our GAAP effective tax rate, shown on Slide 11, was 24.7% in the quarter, which is flat compared to last year. This resulted in Q2 tax expense of $65 million. To get to our non-GAAP effective tax rate, we adjust taxes consistent with non-GAAP net income add-backs, including excess tax benefits associated with equity-based compensation, which is shown on Slide 12.

For the quarter, our non-GAAP effective tax rate was 25.6%, down 40 basis points compared to last year's 26% rate, primarily due to guidance issued by the IRS in the fourth quarter of 2018 on foreign taxes creditable against global intangible low-taxed income. As you can see on Slide 13, second-quarter weighted average diluted shares outstanding of 148 million. GAAP net income per share was $1.33, up 17.9%. Our non-GAAP net income, which better reflects operating performance, was $238 million in the quarter, up 11.5% over last year.

Non-GAAP net income per share was $1.60, up 15.7% from last year. Currency headwinds dampened non-GAAP earnings-per-share growth by approximately 70 basis points in the second quarter. Turning to first-half results on Slides 14 through 17, revenue was $8.6 billion, an increase of 10.2% on a reported basis and 11.1% on an average daily sales basis, as we had one fewer selling day in the first half of 2019. On a constant currency average daily sales basis, consolidated net sales were 11% -- 11.8% higher than the prior year.

Gross profit was $1.4 billion, up 11.3% and gross profit margin was 16.8%, up 10 basis points. Non-GAAP operating income was $646 million for the first half of 2019, up 10.7%. Net income was $350 million and non-GAAP net income was $423 million, up 12.5%. Non-GAAP net income per share was $2.84, up 16.8%.

Turning to the balance sheet on Slide 18. As of June 30th, cash and cash equivalents were $195 million and net debt was $3.1 billion. Our cash plus revolver availability was $1.2 billion. As shown on Slide 19, we maintained strong rolling three-month working capital metrics during the quarter.

Our three-month average cash conversion cycle was 16 days, down one day from last year's second quarter and slightly below the low end of our annual target range of high-teens to low 20s. Free cash flow year to date was $407 million compared to $188 million in the first half of 2018. The year-over-year increase in free cash flow primarily reflects higher cash profits and mixing into vendors with extended payment terms. For the quarter, we returned $198 million of cash to shareholders, which included $43 million of dividends and $155 million of share repurchases at an average price of nearly $104 per share.

Turning to Slide 20. Our capital allocation priorities remain the same and continue to reflect our intent to drive shareholder value through returns of capital and strategic investments. In order of priority, first, increase dividends annually. To guide these increases, in November 2014, we set a target to achieve a dividend payout of 30% of free cash flow over five years.

For this quarter, we will pay a dividend of $0.295 per share on September 10 to shareholders of record as of August 26, up 40% from a year ago. Second, ensure we have the right capital structure in place with the targeted net leverage ratio in the range of 2.5 to three times. We ended the quarter at two point three times, slightly below the low end of this range. Third, supplement organic growth with strategic acquisitions.

The acquisition of Scalar is a great example of this. And fourth, return excess cash after dividends and M&A to shareholders through share repurchases. Our capital allocation priorities support our updated 2019 outlook, which you can see on Slide 21. As Chris mentioned, we continue to expect U.S.

IT market growth of approximately 3%. We now expect net sales growth of 400 to 475 basis points above U.S. IT market growth in constant currency on an organic basis. We continue to expect Scalar to contribute an additional approximately 100 basis points of growth on top of the 400 to 475 basis points.

Currency is expected to represent a 60 basis point headwind for the full year, assuming year to go exchange rates of $1.20 to the British pound and $0.75 to the Canadian dollar. Given year-to-date exchange rates, this implies currency headwinds of roughly 60 basis points in the second half of 2019, with headwinds in the fourth quarter expected to be slightly greater than the third quarter. We expect non-GAAP operating income margin to be in the mid-7% range for 2019. We now expect non-GAAP earnings-per-share growth on a constant currency basis to be in the low-teens, call it 13%, plus or minus, 50 basis points.

This range is 150 basis points above our previous constant currency range of 11 to 12%. Currency headwinds are projected to shave approximately 60 basis points from the constant currency rate. Please remember that we hold ourselves accountable for delivering financial targets on an annual basis. Slide 22 provides additional modeling thoughts.

Based on first-half results and the expectations for the rest of the year, we look for sales in the second half to now be roughly 100 basis points lower than our historical sales, seasonality split of approximately 52% in the second half. We expect a low single-digit increase in sequential average daily sales from Q2 to Q3, which will be a couple hundred basis points below the 3% average of the past three years. Moving down the P&L. We continue to expect non-GAAP operating income margin to be in the mid-7% range.

Total annual depreciation and amortization is now expected to be in the range of 265 to $270 million. This includes approximately $180 million of amortization expense for acquisition-related intangible assets, including a preliminary estimate for Scalar that could change slightly once the purchase accounting is final. Depreciation and amortization expense in SG&A, excluding the amortization of acquisition-related intangibles, is expected to be in the range of 80 to $85 million. Equity-based compensation is expected to be approximately 5 to $7 million higher than 2018.

Interest expense is expected to be in the range of 165 to $167 million, with a year-over-year growth driven primarily by the caps increasing from a strike price of 1.5% to two and three-eighths percent. Our 2019 non-GAAP effective tax rate is anticipated to be near the lower end of the 25.5 to 26.5% range. We expect share repurchases to drive non-GAAP earnings-per-share growth approximately 350 to 400 basis points faster than non-GAAP net income. Non-GAAP earnings-per-share growth is expected to have currency headwind of 60 basis points, similar to the top line.

Additional modeling thoughts on the components of cash flow can be found on Slide 23. Our free cash flow rule of thumb remains unchanged to three and three-quarters to four and four-quarters percent of sales. Expectations for capital expenditures, excluding the census, remain unchanged: It's slightly more than 0.5 point of sales. We expect the cash tax rate to be slightly below 25.5% of pre-tax income adjusted for amortization of acquisition-related intangibles.

We expect to deliver a cash conversion cycle within the annual target range of high-teens to low 20s. That concludes the financial summary. With that, I'll ask Joel to open it up to questions. Can we please ask each of you to limit your questions to one with a brief follow up.

Thank you.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from Matt Cabral with Credit Suisse.

Matt Cabral -- Credit Suisse -- Analyst

Thank you. I wanted to start off in the 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 can talk a little 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.

Chris Leahy -- Chief Executive Officer

Yeah. Matt, look, our -- we're in conversations with our customers. They're still feeling bullish and they're still looking to expand. 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, hyper-scalar 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 their 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 an even bigger share gain and as we -- things like leverage our scale in 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 foresee it differently.

If you look at, as you said, peer results, competitive results, the VAR survey, CIO surveys, economic data, they're stuff that's kind of winding 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.

Matt Cabral -- Credit Suisse -- Analyst

Got it. And then the government was a standout 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.

Chris Leahy -- Chief Executive Officer

Yeah. Federal is doing a terrific job across refresh of those agencies that didn't -- were mandated to refresh under the Department of Defense. So we're seeing refresh now in agencies that didn't have that mandate and that's been strong.  But what I'd really say about the Federal team is they have focused their go-to-market investments over the past several years on solutions capabilities and we're seeing that come to fruition in the types of transactions that they are working on.

So if you look at this quarter, they are driving strong results across not just refresh but strategic solutions transactions for cybersecurity, for modernization infrastructure, etc. So -- and those are deals that take a long time to develop and, looking at the pipeline, continue to remain strong. So then we got the go-to-market in place to go after those deals. They've got the trust with the customer that takes a 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 point -- proof of concepts for certain agencies that we're finding we're now able to take that proof of concept and transport them to other agencies that are looking at similar types of problems they're trying to attack, and we have credibility to build it for a different agency.

Operator

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

Amit Daryanani -- Evercore ISI -- Analyst

Thanks, good morning guys two questions for me as well. I guess first one, if I might try to -- 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 line you've typically talked about. So I'm wondering if you could maybe just touch on what are the levers that are enabling this outsized share gain growth rate in the first half.

And what elements of that might be sustainable versus not as you go forward?

Chris Leahy -- Chief Executive Officer

Well, I'll start with that. When you think about order of the year, remember in the first quarter that we wouldn't expect to see 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, when you 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, Amit. 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.

Amit Daryanani -- Evercore ISI -- Analyst

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 are perhaps from increasing contribution from reoccurring business stream, the 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 recurring in nature and what the trend line of growth rates look like?

Chris Leahy -- Chief Executive Officer

Yeah. I'll start now, but I can't talk a little bit more about the accounting rules. But at a high level, what I would say is the accounting rules for where we sit in the channel are really specific, they're complicated and there's not a one-size-fits-all. So where we sit 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're 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 statement, I'll let Collin talk through. But it's important to recognize that we are part of those conversation and driving -- as our partner's business models change, we are driving what it is that they are bringing to market and bringing to bear with our customers.

Collin Kebo -- Chief Financial Officer

Yeah. Amit, I would say we're traditional pure subscription 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 as a service, etc, 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.

Amit Daryanani -- Evercore ISI -- Analyst

Thanks a lot. The rest of the quarter guys.

Operator

And our next question comes from Katy Huberty with Morgan Stanley.

Katy Huberty -- Morgan Stanley -- Analyst

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?

Collin Kebo -- Chief Financial Officer

Yeah. 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.

We expect us to be within our three and three-quarters and four and four-quarters percent of sales rule of thumb for the full year.

Katy Huberty -- Morgan Stanley -- Analyst

And then Microsoft expressed the view that Windows 10 upgrades will continue past the January 2020 support expiration, especially for the small and 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?

Chris Leahy -- Chief Executive Officer

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, it's hard to predict. But certainly, some of it is going into the front half of the year.

Operator

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

Adam Tindle -- Raymond James -- Analyst

OK, thanks and good morning. I just have two related strategic questions, Chris. In the past, you 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 is much more smaller than this.

So the first question is just kind of update on your thoughts related to executing M&A over 1 billion. I just mentioned this particularly in light of one of your largest competitors making a sizable transaction recently. That deal was arguably more financial transaction where sizable cost synergies could drive it 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 wanted to understand the thought of not pursuing something like an Insight PCM given it would be significantly accretive based on where CDW trades relative to others.

Chris Leahy -- Chief Executive Officer

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 target 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 yes, 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 hard -- long and hard at that because of 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 when we kick 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.

Adam Tindle -- Raymond James -- Analyst

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

Collin Kebo -- Chief Financial Officer

Yeah. Adam, given where we sit with our leverage profile, we're at two point three times, below the two and a half to three times. I think that gives us plenty of headroom. And if we had to go above that three 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 showed a clear path of deleveraging in a reasonable amount of time and getting back with them a target range.

We've demonstrated throughout our past that if we set a leveraged target, we'll get there. So I think our preference would be to use leverage, but obviously, it will be dependent on the situation.

Adam Tindle -- Raymond James -- Analyst

Makes sense. And then congrats on the continued strong results.

Operator

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

Param Singh -- Bank of America Merrill Lynch -- Analyst

Hi, good morning everybody and thanks for taking my question. So I 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 coworkers coming in from Scalar that you need to integrate and get up on productivity? Or is there another reason behind that? And do you think the addition of coworkers is why you're outperforming your competitors? And then I have a follow-up.

Collin Kebo -- Chief Financial Officer

Param, welcome to the call. Glad you could join. Yes, I would say a couple of things that are driving that. One is Scalar because of the high services mix and the service delivery coworkers that go along with it.

The sales per coworker productivity is incomparable 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. The summer in this year, we brought in more than the prior year, so that's impacting it. But I think if you look at kind of apples-to-apples organic regular CDW coworkers, you would see productivity levels more in line with historical levels.

Param Singh -- Bank of America Merrill Lynch -- Analyst

Understood. And then I mean just specifically on the educational segment. It was much stronger in seasonality than 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?

Chris Leahy -- Chief Executive Officer

Yeah. I would describe the K-12 as a really strong quarter. And when you think about the constraints in the marketplace around client devices 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 the Intel place their priority around higher-performing chips.

So the team did a really 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, really quite impressive. In addition, we've seen some networking 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 an all-in-all solid quarter doing -- executing on the priorities that we typically execute on.

Param Singh -- Bank of America Merrill Lynch -- Analyst

All right. Thank you so much. I really appreciate it.

Operator

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

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Yeah, thanks and good morning. So a question regarding your commentary on U.K. and EMEA region and a somewhat slower growth. Could you give us more color on what you're seeing? Obviously there's some economic concerns across Europe, but we're still obviously in an upgrade cycle from a corporate standpoint.

So any help there would be great.

Chris Leahy -- Chief Executive Officer

Yeah. Sure, Matt. Thanks for the question. And obviously, we watch it closely.

First, I would say that the team has been executing extremely well. When you look at the overlap, double digit on double digit, we're 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 U.S. probably feels marginally a little softer, a little more uncertain than it does in the U.S. and we're watching that.

We haven't seen in Q2 a different buying behavior from our customers. But you got to believe Brexit is on their mind given that it's 90 days away. And we've got new rhetoric and some new leadership in play. 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 U.K. continues to be very healthy. And the team continues to be optimistic in terms of their conversations around customers.

So look, with the wild card of Brexit looming, we are just being very cautious. The good news is we've run this tabletop before, before the October 31 extension. Earlier in the year, we worked with customers to map their needs so that we would be prepared to help them. And we've also opened that office in the the Netherlands.

And we've got a number customers actually there transacting through the Netherlands. So we're 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.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. That's helpful. And then just a follow-up question regarding your census contract. Can you give us an update there in terms of contribution relative to expectations?

Chris Leahy -- Chief Executive Officer

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. 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 that we've got K-12 busy season. We've got inventory in there under constrained condition, 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.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. Thanks so much.

Operator

And our next question comes from Paul Coster with JP Morgan. Your line is open.

Paul Coster -- J.P. Morgan -- Analyst

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

Chris Leahy -- Chief Executive Officer

Yeah. Thanks for the question. We have seen a number of customers -- 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's going to 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.

Paul Coster -- J.P. Morgan -- Analyst

Got it. And then Chris, just on this point of Europe, a massive play now but still small in the context of the overall market because there's obviously a huge opportunity to scale up. But I'm wondering whether you think there's 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?

Chris Leahy -- Chief Executive Officer

Yeah. It's 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's 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 impair our ability to solution or a good expansion path at all.

Operator

And our next question comes from Keith Housum with Northcoast Research.

Keith Housum -- Northcoast Research -- Analyst

Good morning. Thanks for the opportunity. Chris, your client devices have been strong for the better part of two years now and it's still Windows 10 refresh or if it's out on full deployment. I kind of feel like it's even more difficult to grow on top of that just because 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?

Chris Leahy -- Chief Executive Officer

Yeah. No, we definitely -- when we look at client device and when we look at the compares over the last couple of years in the quarter, it's going to be tough to grow at those kinds of rate. So we wouldn't expect it. 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, new use cases, etc.

But certainly, we are facing a very difficult comparisons, and we expect that growth to moderate.

Keith Housum -- Northcoast Research -- Analyst

Gotcha. And then if I could ask a more strategic question, following up on the question before regarding acquisitions. Is there a certain area of capabilities that you'd love to be able to either grow internally or to acquire? And same front, geographically -- certain geographic areas that you're more targeted toward expansion than others?

Chris Leahy -- Chief Executive Officer

Yeah. I think when you think about capability, it would be the same area that we frequently talk about. Scalar is a great example. Infrastructure, security, managed services, digital transmission, those are all areas where, when you think about bolstering our current capability, 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 in our strategy all along. So we look at our U.K. U.S., 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 and Singapore and Hong Kong. And we're also focused on bolstering those to ensure that we can deliver on the current needs that our U.K. multinational team have.

Keith Housum -- Northcoast Research -- Analyst

Great. Thank you.

Operator

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

Chris Leahy -- Chief Executive Officer

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 our true competitive advantage and the heart, soul and reason why we consistently deliver 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 U.S. 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.

Operator

[Operator signoff]

Duration: 55 minutes

Call participants:

Chris Leahy -- Chief Executive Officer

Beth Coronelli -- Vice President of Investor Relations

Collin Kebo -- Chief Financial Officer

Matt Cabral -- Credit Suisse -- Analyst

Amit Daryanani -- Evercore ISI -- Analyst

Katy Huberty -- Morgan Stanley -- Analyst

Adam Tindle -- Raymond James -- Analyst

Param Singh -- Bank of America Merrill Lynch -- Analyst

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Paul Coster -- J.P. Morgan -- Analyst

Keith Housum -- Northcoast Research -- Analyst

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