CDW Corp

NASDAQ:CDW

Earnings Call Transcript 2019-Q1

[Operator]

Good day ladies and gentlemen and welcome to the CDW First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, President and CEO, Chris Leahy. You may begin.

[Christine Leahy, CEO]

Thank you, Gigi. Good morning everyone. Thank you for joining us today to discuss CDW's first quarter 2019 results. With me on the call are Collin Kebo, our Chief Financial Officer; and Beth Coronelli, our VP of Investor Relations.

I'll begin today's call with a brief overview of our results, key drivers and our expectations for the remainder of 2019. Collin will take you through a more detailed view of the financials. We will then go to your questions. But before we begin, Beth will present the Safe Harbor disclosure statement.

[Beth Coronelli, VP, IR]

Thank you, Chris. Good morning everyone. Our first 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 this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These 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 will find reconciliation charts in the slides for today's webcast, as well as in our earnings release and the Form 8-K we furnished with 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. Conditioned, all references of growth rates for hardware, software and services today represent US sales only, and do not include the results from CDW UK or Canada.

There was one fewer selling day in the first quarter of 2019 compared to the first quarter of 2018. All sales growth rate references during the call will use average daily sales, unless otherwise indicated. Replay of this webcast will be posted to our website later today, in approximately 90 minutes. 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.

[Christine Leahy, CEO]

Thank you, Beth. It's a pleasure to discuss CDW's results and strategic progress with you today. I'm pleased to report that we had an excellent start to the year, with strong top line growth and profitability. In the first quarter, average daily sales increased 11.5%, up 12.4% in constant currency. Net sales of $4 billion were up 9.7% on a reported basis, with one fewer selling day this quarter. Non-GAAP operating income increased 10.7% to $287 million, and non-GAAP earnings per share increased 18.2% to $1.24 per share.

This quarter's results reflect three key drivers. Our balanced portfolio of customer end markets, the breadth of our product and solutions portfolio, and ongoing execution against our three part strategy.

Let's take a look at how each of these drivers helped us deliver profitable growth this quarter. First, our customer end market performance; as you know, we have five US channel, Corporate which serves customers with coworkers from roughly 250 and up; Small business, which serves customers with roughly 20 to 250 coworkers, and healthcare, government and education. Within each channel, we have teams further focused on customer end markets and verticals. For example, in government, we have Federal, with teams focused on serving the Department of Defense and across civilian agencies, as well as state and local teams.

Each of our US channels generated more than $1.3 billion of net sales in 2018. We also have our UK and Canadian operations, which together, delivered nearly $1.9 billion of net sales in 2018. As most of you are familiar, our balanced customer end markets position us to perform, even when external factors impact certain sectors and industries, reflecting a generally healthy economy, all of our customer end markets grew this quarter.

I was particularly pleased with the execution of our government channel, which delivered strong performance, despite the government shutdown. Our Corporate, Small Business and Public segments, as well as our international businesses, all contributed double-digit growth this quarter.

Taking a closer look at this performance, our Corporate team delivered a 13% increase in net sales, with balanced double-digit growth in transactions and solutions. Transactions growth was powered by our unique ability to provide high value services, including pre-orders, configurations and staging and to secure client device inventory in a supply constrained market. This enabled the team to meet strong client device demand, driven by strength in the economy and healthy employment. Client devices grew 20% in the quarter. This was the 11th consecutive quarter of double-digit growth.

At the same time, the Corporate team continued to leverage our deep technical capabilities and strong solutions portfolio, to help customers modernize their IT infrastructure and realize the benefits of more flexible architectures. This drove excellent results in servers, storage, software and netcomm.

Small business net sales increased 10% with double-digit growth in transactions, and high single digit growth in solutions. Small business customers remained optimistic and continued to invest in their businesses and employees. Similar to Corporate, our competitive advantages enabled the Small Business team to deliver client device growth of approximately 20%, on top of similar growth last year.

Small Business continues to benefit from the focus created when we established a standalone segment. For example, our Small Business technical team provided advice tailored to the unique needs of Small Businesses, including emerging technology and consumption alternatives. Our ability to do this contributed to nearly 50% growth in software-as-a service this quarter, in Small Business.

Public's 10% increase in net sales reflected strong contributions from government and healthcare. Government delivered high teen net sales growth, with double-digit growth in both Federal and State and Local. The Federal team delivered these excellent results, despite the partial government shutdown in January and tough year-over-year client device compares. Regarding the shutdown, the team worked closely with impacted civilian agencies when they reopened, and by the end of the first quarter, our sales to civilian agencies were generally in line with plan.

Our ability to support the government's continuing priorities around modernizing infrastructure, enhancing cyber security and combat readiness, drove strong solutions performance. Federal solutions growth also benefited from timing, as we had several larger projects that were delivered earlier than anticipated.

Solutions performance was partially offset by a decline in transactions. As you recall, Federal had tremendous success, helping agencies meet the Department of Defense mandate to move to Win-10 devices through 2017 and into the first quarter of 2018. We have now lapped the Win-10 shipments related to the DoD mandate. State and local performance was driven by contracts and ongoing success in Public safety projects, which contributed to growth in enterprise storage, netcomm and software.

Education increased 2.4%, with both K-12 and higher Ed delivering low digit growth. K-12 net sales performance was driven by solid growth in client devices and video, which was offset by some lumpiness in solutions. The team continues to work with schools to design and transform classrooms, to enable collaborative learning and more active and flexible learning spaces.

Higher education strength in client devices was partially offset by a decline in solutions as we lap strong performance from several large networking projects in the first quarter of 2018. Helping higher education customers address security drove strong growth in security software.

Healthcare was up over 8%. The team continues to help customers secure their IT environments and modernize their infrastructure. This drove double-digit solutions growth in the quarter. Customers also continued to refresh client devices, which drove a mid-single digit increase in transactions.

Our international team delivered strong growth with combined sales up nearly 13% in US dollars. Both teams executed well in the quarter, each posting strong double-digit growth in local currency.

In Canada, solutions growth continued to outpace transactions. Scalar, which closed February one performed in line with expectations. Integration is on track, and we are starting to provide expanded portfolio options to both existing CDW Canada and Scalar customers. We are winning new business based on our enhanced value proposition and the combined breadth of our products, services and solutions.

In the UK, the team did a great job capturing share of Public sector fiscal year end buying, delivering particularly strong growth, as they benefited from a go-to-market refinements we've made in our Government team. Multinational customers continue to leverage our international scope with US to UK referrals growing over 20% this quarter.

To date, we have not seen an impact on demand from Brexit. As I mentioned last quarter, we established a presence on the continent to support CDW UK's broader growth opportunities in the EU. This presence also served as a Brexit contingency plan. With the new entity in place, we've expanded our ability to support customers on the continent.

First quarter results also demonstrate the second driver of performance, our broad portfolio of both transactions and integrated solutions. This quarter, performance was strong across the entire portfolio. Hardware increased 10%, Software increased 18% and services increased 16%. Solutions grew mid-teens, our second consecutive quarter of double-digit growth, while transactions grew 10%.

Solutions performance reflected the ongoing strength in the economy, coupled with customer need to replace aged infrastructure and their desire to take advantage of more efficient and flexible architectures. Our sales and technical teams did an excellent job helping customers successfully address these requirements. Our solutions results also reflect the benefit of backlog flush, as lead times and solutions categories such as netcomm returned to more normal levels.

These trends contributed to our strong hardware growth, as we delivered more than 20% increases in both servers and enterprise storage. Hardware growth was also fueled by double-digit client growth, as we leveraged our competitive advantages of scale in our distribution centers to help customers navigate through supply constraint in the quarter.

Software net sales increased 18%. As you know, software is becoming a larger component of IT solutions. Success helping customers adopt new architectures and secure their IT environments contributed to excellent performance in network management, storage management and security software, all growing strong double-digits in the quarter.

Our cloud solutions capabilities also contributed to this quarter's strong results. We drove significant double-digit increases in customer spend and gross profit, led again by productivity, platform, security and collaboration workloads.

Services' 16% increase was led by professional services and warranties. Strong growth across solutions categories, including software-as-a-service and warranties, both of which are recognized on a net basis, contributed to our 30 basis point gross margin expansion in the quarter.

As you can see, this quarter's results demonstrate the power of our balanced customer end markets and broad products and solutions portfolio; both clearly contributing to our strong top line and bottom line performance. While we benefited from some favorable timing, adjusting for this, net sales still increased double digits in constant currency, a great result by our teams, as they navigated through uncertainties, including the government shutdown, the looming Brexit outcome, and ship constraints.

Our results also demonstrate the power of the third driver of our performance, our three part strategy for growth. For CDW, our strategy starts with our customers, maximizing their technology investments to drive productivity and growth is a priority for them, but given limited IT resources and the pace of technology change, our customers need help making technology decisions, implementing solutions, and managing their technology investments.

Our three part strategy is designed to make sure that customers turn to us for the help they need to make the right decision for their business. Our three part strategy for growth is to first, acquire new customers and capture share. Second, enhance the solutions capabilities. Third, expand our services capabilities. Importantly, these three pillars intersect, together contributing to our ability to profitably deliver the integrated technology solutions our customers want and need.

The first pillar focuses on productivity improvements. We do this through enhanced systems and data, sales force productivity initiatives and investments in our brand and marketing. This underpins our ability to achieve our overall strategy. Productivity gains fuel our ability to invest while delivering profitable growth.

The second pillar ensures we stay relevant to our customers by investing in solutions capabilities that enable us to be their trusted partner today and into the future. And our third pillar ensures we have value added services capability, to deliver many of today's integrated end-to-end solutions. The combination of these three interconnected pillars with our scope and scale, creates powerful differentiation in the market.

Let me share some examples of our strategy in action; our first pillar includes driving productivity through investments in process improvement and automation. Our new proprietary Partner Portal, which was implemented last year, is a great illustration of this. The Partner Portal further enhances our ability to onboard and to collaborate with our vendor partners.

For example, we've enhanced the exchange and presentation of real-time data with our partners, delivering timely analytics and insights to our partners, enables us collectively to deliver more targeted and effective sales programs, training and enablement for our sales and technical organization. The portal will also help us more efficiently onboard the 50 to 75 new partners we add each year, that keep our portfolio optimally relevant for our customers.

An example of the second and third pillars of our strategy is a solution we provided to a 500 location non-profit integrated health network. Having moved its electronic medical record system to the public cloud, the customer who is experiencing increasing costs and performance issues. An integrated team of our healthcare sellers and technical solutions architects worked closely with the customer to assess its IT environment and evaluate options.

The solution was to move their entire electronic medical records platforms, networking storage, software and communication back to an on-premise data center. There were four key reasons why CDW was uniquely qualified to help the customer through this journey.

First, because we are technology-agnostic, we were able to provide unbiased advice on the pros and cons of public cloud, on-premise and hybrid solutions. Second, our broad portfolio of products and solutions enabled us to draw upon multiple technologies and brand to create an integrated solution.

Third, our seasoned healthcare team was able to leverage their deep industry experience, to develop a compelling best-in-breed solution. Finally, we were able to provide professional services capabilities to implement the solution. This project helped our customer reduce costs and improve performance and resulted in over $20 million of net sales.

We have confidence that our strategy positions us for strong growth, serves us well when confronted with macro channel or partner challenges, and leverages our competitive advantages to deliver strong profitability and cash flow. We will continue to make strategic investments to ensure we remain our customers' partner of choice.

One important investment we make is in customer-facing coworkers. In the first quarter, we added 55 excluding the approximately 300 customer facing coworkers from Scalar. We continue to plan to add between 125 to 175 customer facing co-workers in 2019.

Now let me leave you with a few thoughts on the remainder of the year. Clearly, we are off to a great start. Our market outlook for 2019 is generally consistent with our view at the beginning of the year. We continue to expect full year US IT market growth in the 3% range. Given our strong performance in the first quarter, we are increasing our target for outperforming the market to 300 basis points to 375 basis points on a constant currency organic basis.

We continue to expect Scalar to contribute an additional 100 basis points of growth for the year. These expectations recognize our strong 2018 performance and the year-over-year comparisons we face, for both client devices and international performance. We expect ongoing but moderating strength in client devices, as well as solid growth in solutions. That said, while we are pleased that lead times return to more normal levels in solutions categories, the potential for chip shortages remains a wildcard. Of course, we will continue to refine our expectations as we move throughout the year.

Now let me turn it over to Collin, who will share more detail on our financial performance. Collin?

[Collin Kebo, SVP and CFO]

Thank you, Chris. Good morning, everyone. As Chris indicated, our first 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 first quarter P&L on slide 8, consolidated net sales were $4 billion, up 9.7% on a reported basis and 11.5% on an average daily sales basis, as we had one fewer selling day. On a constant currency average daily sales basis, consolidated net sales grew 12.4%. First quarter consolidated results included two months of Scalar, which performed in line with expectations. On an average daily sales basis, sequential sales declined 2.9% versus Q4 of 2018, which was approximately 500 basis points better than the average of the prior three years and better than expected.

This reflected several factors. Client device growth was stronger than expected, particularly in corporate and small business, as we leveraged our competitive advantages of scale in our distribution centers to help customers navigate through supply constraints in the quarter.

In the UK, the team executed really well, capturing March fiscal year end buying, notwithstanding Brexit uncertainty, and FX wasn't as much of a headwind as expected. We also benefited from favorable timing. Last year we shared that lead times have extended in certain categories such as netcomm, which caused our backlog to increase to higher than normal levels. In the first quarter, lead times returned to more normal levels, creating a positive flush that we previously had expected to receive throughout the year.

In addition, Federal benefited from timing, as several large projects were delivered earlier than anticipated. In aggregate, favorable timing contributed approximately $60 million to $70 million to Q1 net sales.

Gross profit for the quarter increased 11.3% to $672 million. Gross margin expanded 30 basis points driven by product margin, which continued to benefit from the strength in solution categories, as well as the overlap of client devices shipped to the Department of Defense last year. Strength in software-as-a- service and warranties which are recognized on a net basis, also contributed to margin expansion.

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 and investments in the business consistent with our go-forward strategy.

Coworker count of 9,434 was up nearly 700 coworkers from March of 2018, with approximately half of the year-over-year increase from Scalar, and the other half from organic coworker investments. Roughly two-thirds of the nearly 700 coworkers added were in customer-facing roles.

Non-GAAP operating income, which replaces adjusted EBITDA as our internal and external pretax operating profit metric, was $287 million, an increase of 10.7%. Non-GAAP operating income margin was 7.3%. Historically, adjusted EBITDA margin was lowest in the first quarter, given that Q1 is a seasonally low sales quarter. We expect quarterly non-GAAP operating income margin to follow similar seasonality, as quarterly adjusted EBITDA margin.

Moving to slide 10; interest expense was $38 million, up 1.8%. This was primarily driven by the interest rate caps increasing from a strike price of 1.5% to 2.375%, and the financing of Scalar, partially offset by savings from the term loan refinancing, which we will overlap beginning Q2.

Our GAAP effective tax rate, shown on slide 11 was 20.2% in the quarter, compared to an effective tax rate of 23.4% last year. This resulted in Q1 tax expense of $39 million, which was flat year-over-year. The lower GAAP effective tax rate was driven by higher excess tax benefits from equity-based compensation in Q1 of 2019 versus Q1 of 2018, and a one-time benefit related to the Scalar acquisition.

Both of these items, along with other tax adjustments consistent with non-GAAP add-backs, are adjusted to derive our non-GAAP effective tax rate, which is shown on slide 12. For the quarter, our non-GAAP effective tax rate was 25.8%, down 50 basis points compared to last year's 26.3% 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, with the first quarter weighted average diluted shares outstanding of $149 million, GAAP net income per share was $1.02, up 25%. Our non-GAAP net income, which better reflects operating performance, was $185 million in the quarter, up 13.9% over last year. Non-GAAP net income per share was a $1.24, up 18% from last year. Currency headwinds dampened non-GAAP earnings per share growth by approximately 90 basis points in the first quarter.

Turning to the balance sheet on slide 14, as of March, 31, our cash and cash equivalents were $285 million and net debt was $3 billion. Our cash plus revolver availability was $1.3 billion.

As shown on slide 15, we maintained strong rolling three month working capital metrics during the quarter. Our three month average cash conversion cycle was 17 days, flat from last year, and within our annual target range of high teens to low 20's.

Free cash flow for the quarter was $303 million compared to $231 million in Q1 of 2018. Remember, Q1 is a seasonally strong cash flow quarter, because sales declined sequentially from Q4 to Q1, and cash tax payments were minimal. 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 $220 million of cash to shareholders, which included $43 million of dividends and $177 million of share repurchases, at an average price of nearly $91 per share.

Turning to slide 16, 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 June 11 to shareholders of record as of May 24, up 40% from a year ago.

Second, ensure we have the right capital structure in place, with a targeted net leverage ratio in the range of 2.5 to 3 times. We ended the quarter at 2.3 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 see on slide 17. As Chris mentioned, we continue to expect US IT market growth of approximately 3%.

We now expect net sales growth of 300 basis points to 375 basis points above US 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 300 to 375 basis points. Currency is now expected to represent a 50 basis point headwind for the full year, assuming exchange rates of $1.25 to the British pound and $0.75 to the Canadian dollar.

We continue to 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 in the 11% to 12% range, which is just above our previous expectation of approximately 10%. Currency headwinds are projected to shave 50 basis points from the constant currency rate.

Please remember, that we hold ourselves accountable for delivering financial targets on an annual basis. Slide 18 provides additional modeling thoughts. We currently expect 2019's first half to second half sales split to be approximately 48.5% first half, 51.5% second half, which is 50 basis points different than historical seasonality of 48% first half, 52% second half. This reflects expected Q2 seasonality below historical levels, given the strength of the first quarter, including the impact from federal timing and backlog flush. It also factors in upcoming client device overlaps in corporate, challenging comparisons in the UK, and a couple of key unknown such as chip availability and Brexit in the back half of the year.

When modeling Q2, please keep in mind that FX headwinds are greater in the first half of the year, we expect second quarter headwinds to be in line with the 90 basis points we experienced in the first quarter.

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 expected to be in the range of $270 million to $275 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 expansion in SG&A, excluding the amortization of acquisition related intangibles, is expected to be around $85 million. Equity-based compensation is expected to be approximately $5 million to $7 million higher than 2018, primarily driven by the true-up of performance-based plants in Q1.

Interest expense is expected to be in the range of $165 million to $167 million, with the year-over-year growth driven by the caps increasing from a strike price of 1.5% to 2.375% and the financing of Scalar. 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 headwinds of 50 basis points, similar to the top line. Additional modeling thoughts on the components of free cash flow can be found on slide 19. Our free cash flow rule of thumb remains unchanged to 3.75% to 4.25% of sales. Expectations for capital expenditures excluding the census remained unchanged at slightly more than half a 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 target range of high teens to low 20s. That concludes the financial summary.

With that, I'll ask the operator to open it up for questions. And we please ask each of you to limit your questions to one with a brief follow-up. Thank you.

[Operator]

[Operator Instructions] And our first question is from Matt Cabral from Credit Suisse. Your line is now open.

[Matt Cabral, Credit Suisse]

Yes. Thank you. Chris, I was just wondering if you could talk a little bit about the health of the broader demand backdrop, particularly for solutions, which it sounded like outperformed in the quarter and if you can just comment about the sustainability of the aged infrastructure refresh that you called out in your prepared remarks?

[Christine Leahy, CEO]

Yes, hi Matt, it's great to have you back on the call again. I'd be happy to do that. I think if we break it down into a number of factors that are impacting the strength in solutions, you really have looking back at five to seven year period, where there is as you know, an accumulation of what we call - people call technical debt, in the traditional datacenter infrastructure.

And whether or not it was budget constraints and customers were extending the useful life of assets, or whether it was a cloud-source strategy that our customers were considering. As we talk to our customers now, they really are looking at the new normal, I'll call it a hybrid enabled datacenter.

So first of all old infrastructure, and certainly the upcoming deadlines of the Windows, End of service for 2008 and SQL Server in January are a catalyst for demand. But, at the same time, we're getting questions around which way to go; hybrid, cloud or a combination of the two. So you've got a couple of factors, aged infrastructure and absolute need to upgrade. You've got some deadlines coming up with - that's driving that.

But at the same time, we've got a lot of conversation around a longer-term roadmap. That implies, I'd say growth for on-prem, growth for cloud and continuing view into, I'll call the on-prem metered model. So the demand continues to feel healthy, as I noted in our remarks, because of the centrality of the datacenter now to customers, as they are using it to drive their businesses.

[Matt Cabral, Credit Suisse]

Great. And then on the international, I know it's early days, but just wondering, if you can talk a little bit more about the integration of Scalar, and just help us with how you're thinking about the opportunity for further international expansion going forward?

[Christine Leahy, CEO]

Okay. Well, let me start with Scalar, and I'd say it's - the integration is on target. As you know from our history, we're very thoughtful about how we do that. Very planned, very focused on our customers first, and our co-workers as well. And it feels good. I would say the teams have come together and sales organizations understand when you bring added benefits to what they can offer to their customers to help their customers. And I'd say the sales organizations across both Scalar and CDW have felt that immediately, with some - frankly some quick wins.

Our teams in the UK, the CDW teams are quite excited about the technical resources that Scalar had, and scalar is quite excited about the added portfolio that they can bring to our customers. So very positive there and on target.

In terms of further expansion geographically, I'd go back to how we think about growth generally. If it's really valuable to our customers, that our starting point needs to fit into our strategy, and that could include extending our capabilities, both on the technical side, or on the geographic side. So at the end of the day, it's one of those two things and the value proposition has to be there and the price has to be compelling.

So look, we are in the market. I think one of the questions that comes up frequently is when you're doing an integration are you not in the market? Are you not looking? And the bottom line is, if there is an opportunity that makes sense to help us drive accelerated capabilities faster than building it, we will absolutely look at it. But we will also want to ensure it's a compelling price.

[Matt Cabral, Credit Suisse]

Thank you.

[Operator]

Thank you. Our next question is from Shannon Cross from Cross Research. Your line is now open.

[Shannon Cross, Cross Research]

Thank you very much for the question. I'm curious, the healthcare company or I misread, the hospital company, you talked about where they shifted back on-prem from the cloud. And we've heard about that or just at Dell World and it's clearly somewhat of a trend. But what I'm trying to understand is, at this point, how much are customers coming to you and saying, look, we don't know what we're doing, we're not sure of the best route here and then taking a look at their entire datacenter and making changes.

Or is it still so early in terms of the cloud proliferation that we're not really there yet? Again it sort of goes back to the prior question about how long can this last. I mean some of the companies we talked to, look at it as sort of a multi-year refresh cycle throughout datacenter and hybrids. So I'm just curious as to your take on it?

[Christine Leahy, CEO]

Yeah, hi, Katie. The question that you - oh, Shannon, I'm sorry. I got a different name up. Hi Shannon. I would say that the question that you articulated is precisely the question that our customers are asking us, taking a step back, understanding that they have infrastructure that needs to be updated, but also wanting to implement the right capacity, the right capabilities for the future needs of their business or their organization.

So it is a roadmap conversation. What that presents for CDW as an opportunity, is the ability to help guide them in this strategy, and when you think about the plethora of choices, including gaining traction in what I'll call the on-premise metered model, and you know some of those providers, you now have legacy on-premise, you have cloud on-prem. You've got on-prem that is metered and as-a-service payment model, and you've got public cloud. The more choices, the more help the customer needs. And yes, it will be an ongoing long-term roadmap. You can't just - they can't - the customer can't just make the change overnight?

[Shannon Cross, Cross Research]

And from a margin perspective for CDW, how should we think about the benefit to you? I guess what I'm trying to get at is, is on-prem a higher margin opportunity than shifting to cloud, which I understand is sort of more of a ratable recurring? Just -

as we think about this playing out over the years, I'm trying to understand how much more sort of margin upside there potentially could be?

[Christine Leahy, CEO]

Yeah, I'll start and I'll let Collin jump in. I think the way we think about margin. There are so many things that impact our margin. From not just mix into solution, but mix within solution as you know well. It's what we're selling, when we're selling it, whether it's radical, whether it's a transaction-based, either it's just quite a mix in the solution business that will drive variability, I would say, in the margin.

[Collin Kebo, SVP and CFO]

Yeah. The only thing I would add to that Shannon is, building on Chris' comment, there's a lot of different kinds of mixes that are going on. I think your intuition is right, that you'd expect solutions to have a higher gross margin. But as we've talked about, it also has a higher cost to serve. So if you look at this past quarter, we did have great solutions performance. We had strong gross margin expansion year-over-year, but you saw the increase in our SG&A as well, reflecting that higher cost to serve. So I think you need to think about that, as opposed to the bottom line.

[Christine Leahy, CEO]

And even in some of those solutions area, Shannon, we have, what I'll call commoditization pricing. So the pricing pressures in the solutions area come down as well.

[Shannon Cross, Cross Research]

Great. Thank you.

[Operator]

Thank you. Our next question is from Katy Huberty from Morgan Stanley. Your line is now open.

[Katy Huberty, Morgan Stanley]

Thank you and congrats on the quarter. I guess first question, how do you know or how did you come to the conclusion that the revenue upside you're seeing is share gains versus just the stronger overall market, given that shrinking lead times and Win 10 upgrades and some of the work around aged infrastructure, could just as well be a market phenomenon. Then I have a follow-up.

[Christine Leahy, CEO]

Hi Katy. Good to hear from you. I think when we look at the market share rate of growth, at least what we're looking at, and we take a look at how the company performed. We are fairly confident that across the Board, we are actually taking share. I mean, when you look at server storage over 20% as an example and other areas, relative to what we're seeing in the market, it feels like a fairly robust share gain to us.

[Collin Kebo, SVP and CFO]

Katy, it's Collin. I would say the market didn't really feel any different than we thought three months ago, and just building on what Chris said. When you look at the areas where we really had a lot of strength, I'm talking about high teens to 20% growth in government, client device growth in corporate, server storage in the data center, I just don't think the market's growing at that rate in those areas, and that's where you assign more of the over performance this year versus the market.

[Katy Huberty, Morgan Stanley]

Okay, that makes sense. And then how should we think about the $60 million to $70 million of earlier deal closings that showed up in the March quarter. Does that come out of the June quarter and should we be modeling slower revenue growth in June, as a result - or are there other factors that come into play in June and backfill that pull forward?

[Christine Leahy, CEO]

Yeah, I'll let Collin take the modeling. But those are really some transactions - deals that were much accelerated. And we - so those come out of the year to go performance in our view, and we would not see them replaced. The flush from the lead time is something that's kind of a one-time impact. As a result, we wouldn't see - we wouldn't expect to see kind of replacement sales in the back-end for that.

[Collin Kebo, SVP and CFO]

Yeah Katy. The way I think about the $60 million to $70 million, and it is a combination of both federal timing and the netcomm backlog flush. I would have expected the netcomm backlog flush to kind of play out over the course of the year.

So some of that's in Q2. Some of it was in the back half of the year, some of the federal deal timing, those were things we thought were more likely to go in the second quarter, that actually shipped in the first. So I think it's a combination of Q2 and year to go, but if you look at the first half-second half splits, we gave and obviously you know, where Q1 came in, you can get our thoughts on Q2.

[Katy Huberty, Morgan Stanley]

Okay, great. Thank you.

[Operator]

Thank you. Our next question is from Adam Tindle from Raymond James. Your line is now open.

[Adam Tindle, Raymond James]

Okay, thanks and good morning. I just wanted to start on EPS growth guidance for 2019. You went from roughly 10% to just above 10% and just beat the quarter in Q1 by over 10%. So I'm trying to figure out why is there not more flow through.

We just got competitor call, and they are experiencing similar trends. Is there an aspect of gross margin headwind from a pricing environment, getting more tough as growth gets more scarce as the year progresses, more investments that increased OpEx, conservatism after a strong Q1. Just any help with the buckets on why not more flow-through as the year progresses?

[Collin Kebo, SVP and CFO]

Yeah, Adam, it's Collin. I think a couple of things are going on. One is the timing impact. So obviously, the timing of the $60 million, $70 million, there is an EPS that goes along with that. Depending on where people were with consensus, for the quarter and the year at somewhere around 12% to 13%.

I think if you take a look at our thoughts on the full year, that would suggest we're flowing through somewhere between $0.08 to $0.11 of that. And so you can think about what's left over is primarily attributable to the timing. Generally speaking, we feel pretty consistent with how we - about a year to go as to how we thought three months ago.

[Adam Tindle, Raymond James]

Okay, that's helpful, Collin, and maybe just question on cash flow. Now within the rule of thumb instead of above the rule of thumb and the cash cycles ticking up, but maybe we got spoiled. But it's a change, so I'm trying to get more color on why the change. You just said the backlog flush, are you investing in inventory to offset that flush as the year progresses? Any color would be helpful. Thanks.

[Collin Kebo, SVP and CFO]

Yes, sure. I think last quarter we could have been a little bit clear on our expectations for the full year. From a free cash flow generation perspective, we expect it to be within the 3.75% to 4.25%. The above 4.25% was more of a statement around capital deployment and how we expect to use our cash, and we expect to return more than the 4.25%, and that was because we over delivered cash flow last year relative to our expectations. So little bit of a catch up there, what I'll call the capital return to shareholders.

So I'd say, we continue to expect to be within the 3.75% to 4.25% this year. I do think it will be a little volatile as we move throughout the year. If you look at our balance sheet, we are carrying some higher than normal inventory levels, but we are doing that to assist customers, as we work through the supply constrained environment. So again, I think it could be a little bumpy from quarter-to-quarter, but as I look at the full year, I'd expect us to be within the 3.75% to 4.25%.

[Adam Tindle, Raymond James]

Got it. Thanks and congrats on the strong results.

[Collin Kebo, SVP and CFO]

Thank you.

[Operator]

Thank you. Our next question is from Matt Sheerin from Stifel. Your line is now open.

[Matt Sheerin, Stifel]

Thank you and good morning. Just a couple of quick questions from me, one, just regarding your federal business, are you yet seeing any contributions from the census contracts, and how should we think about how that rolls into the P&L this year?

[Christine Leahy, CEO]

Yes, very little at this point, Matt. As we've mentioned in the quarter before, we expected to see 40 basis points of growth this year. We're still working through with the census, the timing of the various devices, et cetera, so we don't have any update to that yet, nothing, nothing different from that, and just a little bit rolling right now.

[Matt Sheerin, Stifel]

Okay. And then regarding the healthcare business, and you gave some really good examples of customer engagements there. You've had - looked like there were several years a very choppy business and now you're four - or five quarters into a consistent mid to upper single-digit growth. Is that just a sign that the industry is finally making those investments and moving to sort of the digital world, or are you also just gaining share within that market, given your skill-sets?

[Christine Leahy, CEO]

Yes, I think you've got insight. Well, it's a little bit of both. I think number one healthcare organizations, as you know well, when we were in the Affordable Care Act uncertainty world for a couple of years, our healthcare systems, which are the largest portion of our customers in that space were concerned about their revenue sources, and that caused them to slow down on their spending, notwithstanding aging infrastructure, et cetera.

So number one, you've got that off the table, not as front and center politically it. It pops back up sometimes, but with that off the table and more certainty around income streams, the hospitals have decided to start spending, and - so that's the first part.

The second part to your point is, as they are spending, they're going through the same modernization assessment, that many of our customers are, which is how do we increase productivity? How do we improve customer experience? And that all requires datacenter modernization, and more flexible architectures, et cetera. And so we're having those kinds of conversations.

We do - when we look at the growth rates in healthcare, we do feel confident that we are taking share, on top of both of those trends.

[Matt Sheerin, Stifel]

Okay. Thanks a lot.

[Operator]

Thank you. Our next question is from Jason Rogers from Great Lakes Review. Your line is now open.

[Jason Rogers, Great Lakes Review]

Yes. What was the organic growth in the quarter on a constant currency basis, ex-Scalar?

[Collin Kebo, SVP and CFO]

Yes, we didn't provide that. But we did share that Scalar performed in line with expectations and previously, we said we expected Scalar to contribute about 100 basis points for the full year. So I think that'll get you in the general ballpark.

[Jason Rogers, Great Lakes Review]

All right. And with the hardware increase, the 10% increase for the quarter, what was the growth in client devices, and are you seeing any signs of a slowdown there, keeping in mind obviously, the difficult comps, but just wondering if there's any slowness beyond that?

[Collin Kebo, SVP and CFO]

Yes. We grew client devices double digits in the quarter, and we continue to see healthy demand for client devices. Obviously, there is constrains around supply availability and we have some big overlaps coming up. So while we feel good about the client device business, I would expect the growth rate to moderate as we move throughout the year.

[Jason Rogers, Great Lakes Review]

And then finally, wondering if there has been any change in the competitive landscape, specifically on the solution selling that you're gaining traction with, if you're seeing any emerging competitors there?

[Christine Leahy, CEO]

Yeah, I would say the stable part of our business is that the competitive landscape is always changing. So you have different types of organizations who pop up on the landscape. We have organizations that we're used to competing with. It's just a heavily competitive environment and that's just - that's something we're used to and we control - we can control and face it every day. So I wouldn't say more or less, it's just the continuing high competitive nature of what we do.

[Jason Rogers, Great Lakes Review]

Thank you.

[Operator]

Thank you. Our next question is from Keith Housum from Northcoast Research. Your line is now open.

[Keith Housum, Northcoast Research]

Good morning. Appreciate the opportunity. Chris, I was hoping you could compare and contrast Scalar with the Kelway acquisition. Kelway has provided you several years of revenue upside. And just help me to provide some long term expectations for what do you see in the Canadian market? And then, now with the Scalar acquisition, what is your market share in Canada compared with the US?

[Christine Leahy, CEO]

Okay. Let me, let me take that apart a little bit. I'll start with the back and move forward. The market share in Canada is fairly consistent with our US market share and the UK, somewhere in the 5% range of the whole market. With Scalar, that might increase just a little bit.

In terms of Scalar versus Kelway, they are highly consistent in the purpose of the acquisitions, in terms of bringing value to our customers, in areas where our customers had to ask for that. So you'll remember international customers wanted less touch points across the globe, and that's what we brought them there.

In Canada customers are looking for full suite of portfolio options from single providers across the spectrum of clients, transaction, solutions, et cetera and also, additional expertise in the areas of high growth solutions such as security, managed services, infrastructure, et cetera, so both consistent in that way.

Differences would be that UK, CDW UK also brought us the capability to support customers across the globe. That's a different capability than we had up in Canada. Canada is not a hub for us for supporting across the globe.

So both of them are intended to be growth acquisitions. Both of them are not as focused on synergies, if you will. We will get operating synergies up in Canada as we scale that business, but these were not cost plays, they were growth plays intended to be highly consistent with our strategy of bringing more capabilities that our customers were telling us they wanted and needed. Does that help?

[Keith Housum, Northcoast Research]

It does. I appreciate that. Just a follow-up and changing gears on your government side. Talking about some of the businesses kind of brought forward or - more a timing item. Does that really like reduce the government's overall budgets for technology spend during the year, and does that perhaps, free up your sales guys, your architects, engineers, the opportunity to grow additional revenues just on top of that.

So instead of just pulling forward, the revenue. It just may be a gross add?

[Christine Leahy, CEO]

Yes, it's a great question. I wouldn't think of it that way because many of these projects are multiyear projects. And as you know, when we describe and I know others describe, these solutions projects can be very lumpy. Getting the timing of them exactly right is not necessarily easy. So some projects pull up to January, February, March. Others that might have pushed into the back of the year from last year, frankly.

So I wouldn't think about it is as freeing up dollars. I would just think about it as shifting the timing, and not freeing up sales time to work elsewhere, because they're already working on projects that relate to deliveries later in the year.

[Keith Housum, Northcoast Research]

Okay. Thank you.

[Operator]

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Chris Leahy for closing remarks.

[Christine Leahy, CEO]

Thank you for joining us today and for your questions. As always, I want to especially thank all of our 9,400 CDW coworkers for their exceptional efforts and dedication to serving our customers each and every day. They are our true competitive advantage, and the heart, soul and reason why we consistently deliver meaningful value to exceed our customers' needs and expectations. They are the reason we have and will continue to lead the industry.

I would also like to thank our customers for the privilege and opportunity to serve and repeatedly earn your trust. Thank you and we'll look forward to talking to you next quarter.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.