Prepared remarks
Hello, everyone. Thank you for joining us, and welcome to the CDW Second Quarter Earnings Call. I will now hand the conference over to Steve O'Brien with Investor Relations. Steve, please go ahead.
Thank you, Joel. Good morning, everyone. Joining me today to review our second quarter 2026 results are Chris Leahy, our Chair and Chief Executive Officer; and Al Miralles, our Chief Financial Officer. Our earnings release was distributed this morning and is available on our website, investor.cdw.com, along with supplemental slides that you can use to follow along during the call. I'd like to remind you that certain comments made in this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release we furnished to the SEC today and in the company's other filings with the SEC. CDW assumes no obligation to update the information presented during this webcast. Our presentation also includes certain non-GAAP financial measures, for instance, non-GAAP operating income, non-GAAP operating income margin, non-GAAP net income and non-GAAP earnings per diluted share, non-GAAP selling and administrative expenses, non-GAAP effective tax rate, net sales on a constant currency basis, free cash flow and adjusted free cash flow. 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 made available on our website and in our earnings release. Please note, all references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2025, with net sales growth rates described on an average daily basis, unless otherwise indicated. Replay of this webcast will be posted to our website later today. 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 the call over to Chris.
Thank you, Steve, and good morning, everyone. Before we begin our review of the quarter, I want to briefly address the announcement we issued this morning regarding Al's planned retirement. We shared that Al plans to retire in 2027 after an extensive career following the completion of an orderly transition. He'll remain in his current role until his successor is appointed, and he will then continue to serve in an advisory capacity to ensure continuity. The search for his successor is currently underway. On a personal note, I want to thank Al for his many contributions to CDW's success. He has been a trusted partner to me, an exceptional leader for our coworkers and a driving force behind the growth and evolution of our company. I'm grateful that we will continue to benefit from his expertise as we execute a seamless transition. With that, let me turn to the second quarter performance, strategic progress and outlook. Al will then provide additional details on our financial results, capital allocation priorities and expectations for the balance of the year. The team delivered strong results this quarter through disciplined execution and a clear focus on the priorities driving customer demand. Together, they delivered net sales of $6.6 billion, up 10%; gross profit of $1.3 billion, up 6%; non-GAAP operating income of $556 million, up 7%; and non-GAAP earnings per diluted share of $2.91, up 12%. Net sales, gross profit and non-GAAP earnings per share set new all-time quarterly records. These results demonstrate the strength and resilience of CDW's business model in a dynamic technology environment shaped by growing AI complexity, pricing volatility and ongoing memory challenges. Demand remained healthy with AI increasingly influencing customer activity despite cautious and deliberate customer spending. Customer investment in AI readiness and modernization drove strong infrastructure demand. By bringing together the right technology, expertise and execution, the team delivered double-digit top line growth with substantial gross profit dollars. Strong gross profit, combined with operating leverage and disciplined capital allocation, drove 12% non-GAAP earnings per share growth. Today, AI infrastructure implementation is most advanced among our largest customers, which is typical of a major technology transformation cycle. Infrastructure investment comes first, followed by services, software and life cycle opportunities as adoption expands and deployment activities broaden across customers of all sizes. What shapes demand may change from quarter-to-quarter, but technology remains essential and increasingly complex. Technology changes, customer priorities change, CDW's role does not. That enduring relevance is the foundation of our value proposition. Let's take a deeper look at how we met customer priorities this quarter. There were three primary drivers of performance: our balanced portfolio of customer end markets, the breadth of our full stack capabilities and our growth strategy, which sustains our relevance. First, our diversified customer portfolio. The diversity of our customer end markets is one of the defining strengths of our business model. Today, we operate across three U.S. segments: Commercial, Government and Education. Commercial serves customers through dedicated corporate, health care and financial services teams. Within each end market, we align resources by customer size: enterprise, mid-market and small business. Government is aligned around state and local and federal customers, while Education serves both K-12 and higher education institutions. Our other segment represents our combined U.K. and Canadian operations. Each market has dedicated sales teams and deep industry and technical expertise. Let's take a look at how they performed this quarter. Commercial delivered another strong quarter with net sales increasing 9%. Corporate increased 11%, driven by the demand for infrastructure modernization, cloud and AI-readiness initiatives. Healthcare remained a standout performer, growing 9%, driven by demand for mission-critical outcomes, including AI-enabled claims management and clinical documentation. Financial Services increased 2% with continued healthy customer demand. Government net sales increased approximately 14%, driven by improving federal demand and continued momentum across state and local customers. Clients prioritize infrastructure, software life cycle management and productivity initiatives. Education net sales increased by approximately 1%. K-12 demand remained healthy with a strong mix of software, services and life cycle offerings despite fulfillment timing shifts. Higher education continued to operate in a constrained funding environment. International once again delivered exceptional growth. Net sales increased approximately 23%, led by a record quarter in Canada and continued strong momentum in the U.K. Demand remained healthy across hardware, software and cloud categories with both the U.K. and Canada delivering mid-teens or better local market growth. The second driver of our results this quarter is the breadth of our full stack, full life cycle offering, which enables us to capture demand across evolving customer priorities and technology trends. During the quarter, success addressing healthy demand for modernization, AI readiness and resilience drove a 10% increase in hardware revenue. Servers, storage and networking all delivered very healthy double-digit growth. Notebook and desktops increased a combined 10%, reflecting strong execution and customer willingness to invest in mission-critical technology despite pricing pressures. Higher average selling prices more than offset lower unit volume. Software, cloud and security all delivered healthy top line and gross profit growth. Software increased by low double digits driven by security, application suites and storage and network area management software. Robust cloud growth reflected continued prioritization of application modernization, AI evaluation and hybrid environment optimization. Memory price inflation also contributed to cloud adoption as some customers sought help finding alternatives to hardware expenditures. For security, both top line and gross profit increased double digits, driven by demand for both protecting advanced technology architectures and strengthening governance and compliance capabilities. Services increased 1%. As with every part of the business, services demand follows customer priorities. This quarter, customer focus on hardware and cloud investments, combined with deployment timing, influenced the mix of services demand. We expect a pickup in life cycle and professional services as customers move from procurement to implementation to management. The third performance driver, our growth strategy, is crucial to sustaining our relevance. Our strategy is built around an enduring reality: technology will continue to evolve, but the need for a trusted partner remains constant. As AI adds complexity across the technology landscape, that need has never been greater. Customers increasingly recognize that AI is not a point solution; it's an architectural challenge. AI workloads span on-premises, public cloud, edge and hybrid environments. And as AI scales, organizations must integrate complex technology environments while managing security, governance and risk. Accomplishing this requires a partner that can orchestrate the resources required and deliver the execution needed to turn AI investments into tangible outcomes. CDW is that partner. We bring together the right technology, expertise and execution as we help customers deploy AI with confidence, scale faster and realize value sooner. The strategic implication is straightforward. AI increases our relevance because it increases complexity. And as customers move from AI experimentation to pilots, to implementation, to scaling, we are capturing opportunities today across infrastructure, security, data integration and ongoing life cycle support. Let me share a couple of recent examples that illustrate the role CDW is playing across customers' AI journeys. A Western state's technology office has made substantial progress in its AI journey, launching an AI sandbox, advancing statewide AI literacy and incentivizing agency adoption. As AI activity accelerates, the state faces a challenge common across many organizations: a growing patchwork of AI initiatives without a consistent way to manage, govern and scale them. Through our AI 360 Framework, we designed a solution that is helping the state move from isolated AI projects to a cohesive operating model that integrates strategy, governance, infrastructure, security, data and application development. By bringing together the right technologies, partners and expertise, we are creating a scalable framework for evaluating, deploying and governing AI across agencies, enabling the state to accelerate adoption while maintaining security oversight and ensuring measurable outcomes. This multiyear, multimillion-dollar engagement demonstrates the scalability of our model, and we will drive recurring services revenue. We are now productizing the solution to deliver highly relevant and proven AI-driven outcomes at scale to state and local governments across the country. Another engagement, with a large financial services company, demonstrates the broader services opportunity that is emerging as frontier AI innovation accelerates. Like many enterprise organizations, our customer is dealing with a growing gap between the volume and complexity of new AI-driven threats and the ability of security teams to remediate them quickly and consistently. They need a more coordinated, scalable approach to managing vulnerabilities across their entire technology estate. Through our Claude Mythos AI security vulnerability program, the team brought in CDW expertise across security, observability, cloud DevOps, systems engineering, hybrid infrastructure and global delivery to design a more automated approach to identifying and remediating vulnerabilities at scale. This multimillion-dollar engagement demonstrates the power of CDW's integrated capabilities. By bringing together expertise from across the organization, we are solving complex customer challenges and delivering mission-critical outcomes. Two great examples of how we are helping customers deliver AI-driven outcomes today, and the opportunity broadens from here. As inference moves closer to users and devices, AI deployments will require a wider range of technologies and services, creating additional opportunities for CDW to deliver customer outcomes, capture share and drive profitable growth. The same objective driving customer AI adoption—better business and mission outcomes—is shaping how we are leveraging AI within CDW. Our approach is straightforward: deploy AI to create measurable value, to improve customer experience and outcomes, increase coworker productivity and generate operating leverage. CDW Assist Super Agent, our AI-powered sales tool, delivers on all three. It supports account planning, opportunity identification, customer engagement and workflow automation. CDW Super Agent is just one example of how we are putting AI to work. We are embedding AI throughout the business from sales and finance to operations; AI is simplifying processes, improving consistency and increasing efficiency. We are moving with discipline and speed supported by strong governance and security. AI is strengthening how we operate today while creating a meaningful opportunity to drive productivity and profitable growth over the long term. And that leads me to our full year outlook. Current market conditions remain constructive. Infrastructure demand is strong, cloud consumption trends are favorable, customer engagement is healthy and AI-related activity continues to expand across industries and customer segments. Written demand, shipping activity and backlog trends remain robust, with writings exceeding invoicing and backlog significantly elevated. Operating excellence and expense discipline remain priorities, and we expect continued improvement in our operating leverage as we move throughout the year. Given this backdrop, we are increasing our full year outlook. We now expect the U.S. IT addressable market to grow in the mid-single digits in 2026 on a customer spend basis, with 200 to 300 basis points of CDW outperformance. In an environment where technology decisions are becoming more consequential, CDW has never been more relevant. Our scale, broad capabilities, deep industry and technical expertise and full stack, full life cycle model ensure that our success is not tied to any single technology category. We help customers maximize the value of their technology investments and capture opportunity wherever demand emerges. Customers rely on us to simplify complexity and translate technology investments into tangible outcomes. Partners rely on us to accelerate adoption, extend the reach of their innovation and bring their technology to market at scale. Our position between customers and partners in the heart of the technology ecosystem reinforces our confidence in the durability of our business model, the strength of our competitive position and the opportunity ahead. Technology evolves, customer priorities change, our value proposition endures. With that, let me turn it over to Al for a more detailed review of our financial performance. Al?
Thank you, Chris, and good morning, everyone. It has been a privilege to serve as CFO of CDW for the last five years. I'm proud of what our team has accomplished and how we've continued to help our customers achieve meaningful outcomes, all while transforming our own business and delivering growth and profitability for our shareholders. I am committed to supporting a smooth transition and will ensure the company is well positioned for continued success. Turning to our results, I will begin with details on our second quarter performance, move to capital allocation priorities and then finish with our outlook for the remainder of 2026. Second quarter gross profit of $1.3 billion was up 6.3% year-over-year. This was modestly above our expectation for a mid-single-digit year-over-year increase. The performance reflected solid demand with customers continuing to prioritize technology investments that support AI, productivity, workplace modernization, infrastructure needs and security. Second quarter gross margin was 20.1%, down 70 basis points year-over-year. As we've discussed in prior quarters, gross margin is sensitive to changes in both customer and product mix. In the second quarter, margins reflected the contribution from large hardware infrastructure opportunities tied to modernization and AI readiness and particularly associated with enterprise customers. To a lesser extent, gross margins also reflected a lower relative contribution from services year-over-year. As Chris mentioned, we view these spending patterns as consistent with the early stages of a technology adoption cycle where infrastructure investment by large enterprise clients often leads, followed over time by services, software, security and life cycle opportunities. Importantly, within the quarter, these profitable engagements generated meaningful gross profit dollars and strengthened our position in the AI market. The strategic point is that AI is increasing complexity across the technology stack. Customers are evaluating infrastructure, cloud, security, data and endpoint investments as part of broader modernization programs, and that complexity reinforces the value of CDW's full stack, full life cycle model. Consistent with recent trends, customers navigated a dynamic technology and macro environment. Demand remains stronger where technology investments are tied to operational necessity, productivity, infrastructure and workplace modernization and security. With this being said, netted down revenue streams were up 16.1%, picking back up again this quarter as we expected. They represented 35.9% of gross profit, up 300 basis points year-over-year and 140 basis points quarter-over-quarter. Professional and managed services were impacted this quarter by deployment timing and customer prioritization of hardware and cloud investments. We continue to build our pipeline as customers move modernization, security and AI projects from procurement into implementation, which supports our expectation that the current wave of infrastructure investment will lead to future services growth. Turning to expenses for the second quarter: non-GAAP SG&A totaled $764 million or 57.9% of gross profit, down 20 basis points year-over-year and down 410 basis points quarter-over-quarter. This was consistent with our expectation that the expense ratio would continue to decrease as we approach the second half of the year. Looking forward, we expect our Geared for Growth efforts to pay dividends in the second half of the year and further improve expense efficiency thereafter as initiatives scale across the organization. Coworker count ended at approximately 14,700, and customer-facing coworker count was 10,300, both down modestly year-over-year and quarter-over-quarter. Our ongoing goal is to balance growth, expansion of capabilities and exceptional customer experience with greater efficiency and cost leverage from our broader operations. Non-GAAP operating income was approximately $556 million, up 7% versus the prior year, delivering some incremental leverage as we expected, and that compared to 6.3% gross profit growth. Non-GAAP operating income margin was 8.5%. Net interest expense increased approximately $3 million year-over-year, driven by higher average borrowings during the quarter. Our non-GAAP effective tax rate was within our target range at 26%. Non-GAAP net income was $370 million in the quarter, up 7.8% on a year-over-year basis. Second quarter non-GAAP net income per diluted share was $2.91, up 11.9% year-over-year. This double-digit EPS growth was above our expectation for high single-digit growth year-over-year. Moving to the balance sheet. At period end, net debt was $5.5 billion. Liquidity stands at $2 billion with cash plus revolver availability. The three-month average cash conversion cycle was 21 days, within our target of high teens to low 20s. This cash conversion metric reflects a combination of timing, market dynamics, higher hardware sales and proactive inventory positioning to support customer urgency to secure products amid a dynamic environment. We continue to believe our target cash conversion range remains the best guidepost for modeling working capital longer term. Adjusted free cash flow year-to-date was $278 million or 42% of non-GAAP net income for the first half, below our stated rule of thumb of converting 80% to 90% of non-GAAP net income to cash. We continue to expect cash flow conversion to normalize over the balance of the year and have line of sight towards achieving our expectations. We've been focused on managing working capital in a way that supports our customers and drives shareholder value even as ongoing hardware-driven growth and the inflationary price environment has warranted investing in working capital. We've also effectively utilized cash consistent with our 2026 capital allocation objectives during the quarter, including returning $344 million in share repurchases and $80 million in the form of dividends. Through the first half of 2026, we've returned approximately $545 million to shareholders in the form of repurchases compared to $653 million over the entirety of 2025 and $500 million in each of the years 2023 and 2024. This brings me to our capital allocation priorities moving forward. Our first capital priority is to increase the dividend in line with non-GAAP net income growth. We've increased the dividend for 12 consecutive years through 2025. We continue to prudently manage our dividend with respect to the growth environment and target a roughly 25% payout ratio of non-GAAP net income going forward. Our second priority is to ensure we have the right capital structure in place. We ended the second quarter at 2.5x net leverage, within our target range of 2 to 3x. We continue to proactively manage liquidity while maintaining flexibility. Finally, our third and fourth capital allocation priorities of M&A and share repurchases remain important drivers of shareholder value. We continually evaluate M&A opportunities that advance our capabilities and extend our reach and relevance to customers. While we remain active in the M&A market, we have been opportunistic towards share repurchases. With the additional $1 billion authorization announced in the second quarter, we have more than $1.1 billion remaining capacity under our share repurchase program. Now turning to our outlook. Our first half performance was driven by strong underlying demand as customers built out infrastructure for their AI use cases, secured their networks and innovated at the edge. Importantly, while customers acted with urgency around hardware procurement, our written production and backlog trends support our view that the strength we are seeing reflects healthy and durable underlying demand for modernization, security, resiliency and AI readiness. At the same time, we remain prudent in how we view the remainder of the year given the complex variables in play. Factoring in these variables, we are raising our full year outlook and expect gross profit to grow mid-single digits for the full year 2026. This leads to a first half versus second half split that is more aligned to historical second half-weighted seasonality than we originally expected. Based on the anticipated mix of products and end markets, we expect second half gross margins to be below second half 2025 levels. This means full year 2026 gross margin would be modestly below the full year 2025, although well above the levels from three-plus years ago. Finally, we now expect full year non-GAAP net income per diluted share growth to be at the high end of the high single-digit range year-over-year, reflecting our expected gross profit performance, increasing operating leverage from our Geared for Growth initiatives and disciplined execution of our operational and capital allocation priorities. Please remember, we hold ourselves accountable for delivering our financial outlook on a constant currency basis. On that note, our expectation is for currency to be a slight benefit to reported growth rates for the year. Moving to modeling thoughts for the third quarter: we anticipate gross profit to increase at a mid-single-digit year-over-year growth rate. Moving down the P&L, we expect third quarter non-GAAP SG&A to be lower than the second quarter, driven by our Geared for Growth program benefits. This will result in non-GAAP operating expense as a percentage of gross profit that is down both year-over-year and quarter-over-quarter. Finally, we expect third quarter non-GAAP net income per diluted share to also be at the high end of high single-digit growth year-over-year. With that, I want to thank our teams for delivering another strong quarter of execution. Our performance reflects the strength of our customer relationships, the resiliency of our business model and the ability of our coworkers to help customers solve complex technology problems in a changing environment. This concludes the financial summary. As always, we'll provide updated views on the macro environment and our business on our future earnings calls. I will now ask the operator to open up for questions. Thank you.
Questions and answers
Your first question is from Adam Tindle with Raymond James.
Okay. Congrats, Al, on the announcement. Chris, I wanted to start on AI. Those examples that you gave were helpful. I just wonder: for the customers that are adopting AI, understanding that it's sort of in that larger cohort, maybe you can give investors a view on what the impact is to CDW when those customers are deploying AI. More specifically, what happens to their spend with CDW? And could you touch on any updates on the AI line card business model, a little more fleshing out of the AI potential tailwinds to CDW? That would be helpful.
Yes, sure, Adam. While we see the technology pick up most strongly first in the enterprise space, we are seeing it broaden across all of our industries and customer segments. We are taking use cases that are proven and working in various industries and scaling them in repeatable offerings for customers. In terms of what they're doing to our business, we are not sharing dollar-level details, but we see that AI is part and parcel of most of what we're selling—from the hardware itself to the software implementation and certainly in the services that we're bringing to bear. It's a full stack approach to the technology movement. Regarding customers and where they are in their journey, having moved from pilot to implementation, customers are now working hard on the return on investment and being deliberate and thoughtful about the analysis around that, which has played to our strength with the variety of services, analysis and solutions we bring to bear. We are seeing real focus on use cases that move the needle across industries: in health care, claims assessment and training tools; in retail, demand forecasting and churn projection; in financial services, fraud detection and trading speed. We are starting to see use cases scale more quickly than in the past. It's a full stack opportunity for us, and we believe we're well positioned because CDW has never been about one technology or one part of the stack; it's been about bringing those things together so they work together. AI is a great opportunity for us to do this. We see strong traction across customers and lots of tailwinds to continue the acceleration in services and the hardware components.
Great. Maybe just a quick follow-up for Al. I want to acknowledge that operating income grew faster than gross profit dollars in the quarter. It looks like we're starting to get to a turning point to get CDW back to the business model investors came to know. What drove that trend in the quarter? And any learnings from Geared for Growth or updates on the $100 million to $200 million of savings you outlined previously?
Yes, thanks, Adam, and I appreciate your comments. As we said on the last call, we thought we would see operating leverage inflect in the second quarter. That was more a result of disciplined expense management and broader efficiency efforts, less a direct contribution from Geared for Growth. That being said, our Geared for Growth efforts through the first half have been significant. Our plan always anticipated seeing those benefits start to pay off in the back half of the year. I would say we are at or beyond our expectations in terms of how those efforts are progressing and the benefits. As we approach the back half of the year, those benefits will start to play out, and we expect both operating leverage and our expense ratio to improve sequentially in the back half and into 2027.
Your next question is from Erik Woodring with Morgan Stanley.
Al, can we dig into the non-netted-down gross margin trends? You referenced spending from large enterprises and big infrastructure deals. Were there any instances in the quarter where you weren't able to price on a cost-plus basis because of customer feedback on pricing? Did you see any like-for-like margin pressure year-over-year, whether in services, storage, PC or servers? And then a quick follow-up.
Thanks, Erik. The short answer is no on like-for-like pressure. We operate in a competitive environment, but we focused on pricing discipline and effectively passing through price increases. The primary driver was mix: a shift into infrastructure products, larger order tiers and enterprise customers. As Chris referenced, it's common in early stages of technology adoption to see larger enterprise orders that naturally come at slightly lower margins. At the same time, our netted-down revenues grew 16%, representing 36% of our gross profit, and we felt good about maintaining healthy margins in the core of our business.
That feedback is helpful. A follow-up: if I take your modeling thoughts on Q3—some gross margin pressure year-over-year but gross profit roughly flat sequentially into Q3—that implies revenue down maybe mid-single digits sequentially in Q3, which is historically worse than seasonality. Relative to your comments on backlog and pipeline, that feels prudent. Could you add granular commentary to confirm we're thinking about Q3 correctly and why we might see a below-seasonal quarter relative to the strength you described?
Thanks, Erik. Yes, mid-single digits sequentially, or flatish sequentially, is a reasonable interpretation. While we are optimistic given the health of our underlying metrics, we continue to layer in prudence. Spend and pipeline metrics are strong: through July, written production exceeded invoicing, leading to a higher backlog. The underlying indicators are strong, but we remain cautious as we typically are. We raised our outlook for Q3 and Q4 with respect to gross profit to mid-single digits growth, and there's a level of prudence embedded in our guidance. All the elements are there for us to outperform, and that's what we're focused on.
Your next question is from Asiya Merchant with Citi.
Can we dig down a bit on the AI deals you discussed? I understand initial adoption is largely with larger organizations. As you think about services adoption following the infrastructure deals, how should we think about services attach rates as we progress through this year and into next year? In general, would we expect AI-specific deals to be margin accretive or margin neutral over time?
Yes, Asiya. Right now we are seeing a lot of demand across infrastructure, cloud, security and data foundation. Adoption will be multiyear and not a single product: it requires readiness, deployment, integration, optimization and ongoing operations. Services are embedded at every stage of those requirements. So while attach rates are an element, more importantly our services are integral to each stage of an AI deployment. Adoption is broadening beyond large enterprise into health care, education, commercial and smaller businesses. We are working on productizing solutions for mid-market and smaller customers so they are scalable and proven. As inference moves closer to users and devices, edge deployments will create incremental demand for edge infrastructure, networking, security and endpoints, and services are critical to design, deployment and management in those cases. We expect continued growth, particularly in managed and recurring services, and we see this becoming an increasingly meaningful contributor to profit growth over the next several years. We're building a durable engine to achieve that.
Great. Quick follow-up: earlier in the year there were concerns about hardware availability and memory inflation. How would you characterize what's changed? The backlog remains elevated; how would you characterize availability now to help meet the backlog?
Thanks, Asiya. The environment is more normalized. There is continued urgency from customers—particularly for AI needs—but customers have adapted over the last several quarters. Expectations around pricing and supply chain have become more orderly. The backlog does reflect some product delivery delays, but consistency in hitting delivery dates has improved. We are not seeing double orders and cancellations at the same level as before. Overall, markets are more orderly and customers have adapted, and these variables did not meaningfully influence our results for the quarter.
Your next question is from David Vogt with UBS.
Chris and Al, a question about demand and elasticity. You saw strong growth in server, storage and networking categories. Can you speak qualitatively to customer tolerance for meaningful price increases across large platforms? I ask because many OEM partners have expressed continued price increases. It doesn't sound like you saw pull forward in the quarter or degradation in demand. What feedback are you getting from customers about tolerating higher prices, and how does that affect demand?
We have not experienced meaningful pull forward in the quarter. Customers do not like price increases, but they are engaging in more detailed discussions and rigorous analyses about their choices because they have mandates to deliver mission or business outcomes. Customers are still purchasing technology and spending to their budgets. In some cases, budgets from other functions are being reallocated to technology because technology is essential to delivering outcomes. That gives CDW an opportunity to help customers optimize across their entire technology estate. An example: PCs were very strong this quarter because customers were willing to make mission-critical investments despite pricing. We expect customers to continue taking a rigorous approach and to work with CDW to identify cost optimization opportunities.
If you look across our end markets, there is diversity in practice. At the enterprise level, technology teams are highly attentive to pricing and supply chain because of the scale of their purchases. In the mid-market and smaller education customers, the pace of awareness and action is different. That said, awareness has increased over recent quarters and we're encouraged by opportunities as this demand rolls down the market, particularly around AI needs.
Got it. A follow-up: when you mentioned prioritization earlier, are you seeing a shift away from discretionary programs and products toward mission-critical investments? Does that imply services might suffer as hardware is prioritized, at least in the near term?
I wouldn't frame it as services suffering. There is reallocation of budgets toward technology initiatives, which has been occurring quietly over the last couple of quarters. Technology budgets have increased in areas tied to operational outcomes, and those are being treated as technology spend. What we're seeing is infrastructure spend occurring now, but services remain critical across every component of these deployments. Services will be essential to design, implement and manage these solutions, so we view this as a trigger for increasing services demand, not a step back.
Your next question is from Amit Daryanani with Evercore.
I have two questions. First, on AI infrastructure, are you starting to see increased engagement with the frontier model companies as they look to gain exposure to your customer base? How is that engagement different from how hyperscalers engaged when they started? Second, are you seeing enterprise customers evaluate and repatriate workloads back on-prem to optimize token cost? Is that a better option for CDW versus running things in public cloud and a frontier model?
Amit, thanks. On engagement with AI labs and frontier model companies, we've made great progress. New partners often need to sort through channel strategy, and the model providers have found that the channel is an effective route to market. We've seen strong progress in partner programs, relationships and investments to bring capabilities to market, particularly to the mid-market and vertical segments, which are attractive for scale. On repatriation to on-prem: we are seeing some repatriation as customers optimize for token economics and cost, but it's not inherently better or worse for CDW. We help customers optimize wherever their workloads should be—on cloud, on-prem, hybrid or edge—based on cost, security and performance. We see this as an opportunity to help customers achieve their outcomes in the most cost-efficient and secure way.
Perfect. Al, free cash flow was muted in Q2 at $27 million, and free cash flow as a percent of net income was about 45% for the first half. What needs to happen in the back half of the year for you to reach the 80% to 90% free cash flow conversion? Where would the uptick come from?
Yes, Amit. It's largely a timing effect through the first half, particularly in Q2. We had anticipated making working capital investments in this environment, and we've done that to support our customers and ensure product availability. The primary driver is inventory: we have about a $400 million increase in inventory since the end of last year. As the environment normalizes, we expect to rationalize and reduce that inventory position through the back half of the year. There are also moving parts with AR and AP, but the key variable is inventory. We are focused on delivering free cash flow and expect conversion to improve as we manage working capital down.
Your next question is from Joseph Cardoso with JPMorgan.
Great to see hardware momentum over the past two quarters and signals into the back half. There appear to be several demand drivers: project accelerations due to pricing trajectory, demand stimulated by Mythos/security concerns, and AI inferencing investments. Can you help contextualize what you're seeing from customers around each of those drivers and how you're thinking about their materiality and timing?
Joe, could you clarify the categories you listed? I want to make sure I answer your question precisely.
Yes, sure. I'm trying to understand the demand drivers and timing: project acceleration due to pricing dynamics, demand stimulated by Mythos/security concerns, and investments specifically on AI inferencing.
Okay. On pricing: it's a factor, but the underlying demand is strong and durable based on our metrics—written production, invoicing and backlog. Pricing contributes, but it's not the dominant driver. Regarding Mythos and security: that's an important driver. Model hacking and security concerns have increased interest in security services, consulting and assistance to secure environments at scale. On AI inferencing: token economics matter, and we are seeing significant customer engagement around optimizing models and workload locations. This is driving services demand and is a significant growth vector. Partners and hyperscalers are investing in enabling adoption, and CDW will support customers in adoption and consumption. Overall, pricing, security and inferencing all contribute, with inferencing and security being major catalysts for services and infrastructure demand.
Thanks. One follow-up on services: how should we think about the timing of the services catch-up you noted? Do you have visibility into services timing? Is it simply delayed while installations occur and services will be layered on once infrastructure is installed, or is there another dynamic that makes timing less granular?
It's primarily timing and implementation timing. We have good visibility to customer needs and engagement. Given the timelines from procurement to execution, it will take a bit of time for services to pick up significantly. By the end of the year and into next year, we expect to see the fruits of this work as projects move from procurement into implementation and management.
At this time, I will now turn the call back to CEO, Chris Leahy, for closing remarks.
Thank you, Joel, and let me close by recognizing the incredible dedication and hard work of our coworkers around the globe. Their ongoing commitment to serving our customers is what makes us successful. Thank you to our customers for the privilege and opportunity to help you achieve your goals, and thank you to those of you listening for the time and continued interest in CDW. I look forward to talking to you next quarter.
This concludes today's call. Thank you for attending. You may now disconnect.