Q4 2022 CDW Corp Earnings Call
Results to differ materially additional information concerning these risks and uncertainties is contained in the earnings release and form 8-K, we furnished to the SEC today and in the company's other filings with the SEC CDW assumes no obligation to update the information presented during this webcast our presentation also.
Certain non-GAAP financial measures, including non-GAAP operating income non-GAAP operating income margin non-GAAP net income and non-GAAP earnings per share.
All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules, you'll find reconciliation charts in the slides for today's webcast and in our earnings release and form 8-K, we furnished to the SEC. Today. Please note all references to growth rates or dollar amount changes in our remarks today are versus.
The comparable period in 2021, unless otherwise indicated.
Replay of this webcast will be posted to our website later today I want to remind you that this conference call is the property of CDW and may not be recorded or rebroadcast without specific written permission from the company with that let me turn the call over to Chris.
Thank you Steve good morning, everyone.
Begin our call with an overview of our fourth quarter and full year performance and share some thoughts on our strategic progress and expectations for 2023, and I'll hand, it over to Al who will take you through a more detailed review of the financials as well as our capital allocation strategy and outlook, we will move quickly through our prepared remarks to ensure we have plenty of time for questions.
Our fourth quarter was an excellent example of the power of our business model when coupled with our broad and deep portfolio of technology solutions.
In an extraordinary period of shifting customer priorities, we delivered record profitability.
For the quarter net sales were $5 $4 billion $100 million below 2021, and roughly flat on a constant currency basis.
non-GAAP operating income was 523 million, 23% above last year and non-GAAP net income per share was $2 50.
Up 21% year over year up 22% on a constant currency basis.
These results were driven by the team's ability to pivot to meet customer priorities and capture high relevance high growth opportunities. This led to excellent performance across services cloud security and software.
Performance that drove record profitability and exceptional outcome given market dynamics and an outcome that is a direct result of the investments we have made in solutions and services over the past several years.
<unk> put our ability to deliver outcomes across the full stack and full lifecycle of technology drove strong profit growth notwithstanding a meaningful decline in client devices.
This quarter clearly demonstrates the power of our strategy when combined with the resiliency of our business model.
So what happened to client devices this quarter.
While we expected some level of contraction in client devices and accessories, given the past two years of heavy investment the magnitude of the decline in the fourth quarter was certainly steeper than anticipated. The primary driver was the K 12 market, which represented roughly half of the client device decline.
We also saw a general moderation in client device demand across channels as economic uncertainty increased.
As we always do we stayed the course on our playbook and maintained our discipline with a focus on our customer and our value proposition. This discipline contributed to this quarter's excellent cash flows and strong economic returns.
In Q4, the combination of lower transactional business and the team's success delivering on customer demand for solutions and services led to a meaningful shift in our sales mix.
Let me put this in perspective for you you've heard us speak over time about the impact of solutions mix, and notably netted down revenue streams on our financial results as.
As we have grown our netted down revenue streams over time total annual customer spend has consistently grown a few hundred basis points faster than net sales.
In periods, where remix into more solutions business that nets down and mix out of client device business that fully showed up in net sales that growth rate spreads will be wider in Q4 and extreme mix shift took place.
The result was meaningful customer spend growth significantly dampened net sales growth and very healthy gross margins that drove delivery of gross profit.
Now, let's turn briefly to the full year results 2022 was a year of financial performance underpinned by progress on our three part strategy for growth.
The first pillar of our strategy is to capture share and acquire new customers. One way. We do this is through strategic acquisitions. The addition of Sirius is a great example of this serious elevated and expanded our services capabilities, providing an excellent cross sell opportunity into our existing customer base at the same time serious customers represent X.
<unk> cross sell opportunity given the broader CDW portfolio.
The second pillar of our strategy is to enhance capabilities in high growth solution areas strategic coworker investments contributed to excellent solutions performance through 2022 with strong growth in cloud security and network upgrades.
The third pillar of our strategies to expand services capabilities as a key enabler of our value proposition services are fundamental to our full stack full lifecycle full outcomes go to market approach.
Services engagement solve critical customer problems and drive enduring customer relationships.
In 2022, the team delivered more than 20% services growth across the business.
No doubt our acquisitions have accelerated our services breadth and depth and have been foundational to our success.
2022 was indeed, a year of strategic performance across all three of our priorities. It was also a year of exceptional financial performance. The team delivered record results with constant currency net sales growth of 15% and each profit category down the P&L statement up 20% or more res.
<unk> has enabled by ongoing investment in our three part growth strategy investments that have made us a vital technology partner, whether customers priorities required transactional or highly complex solutions.
You see the impact of these investments on our fourth quarter performance as the team pivoted to meet customer shifting priorities and advise design and orchestrate full outcomes.
Outcomes that deliver five key organizational benefits.
Innovation lower cost agility risk mitigation and enhanced experiences for customers and coworkers.
Let's take a closer look at the fourth quarter.
There were three main drivers of our fourth quarter results, our balanced portfolio of customer end markets.
Breadth of our product solutions and services portfolio and relentless execution of our three part strategy.
First our balanced portfolio of our diverse customer end markets.
As you know we have five U S sales channels corporate small business healthcare government and education each.
Each channel has a meaningful business on its own with annual sales ranging from $1 9 billion to over $10 billion over the last 12 months.
Within each channel teams are further segmented to focus on customer end markets, including geographies and verticals.
We also have our UK and Canadian operations, which together delivered sales of $2 $9 billion.
Our corporate team delivered another strong quarter with a 7% sales increase the team helps customers accelerate implementation of priorities to automate tasks detect fraud and enhanced customer and employee experiences. This drove excellent cloud software and security results are.
Our ability to address priorities focus on application and network modernization and consumption based datacenter solutions led to excellent services and net comp performance each up double digits.
Economic uncertainty led customers to de prioritize and point solutions, which resulted in a decline in client devices.
Small business declined 13% the team pivoted to help customers address priorities to maximize prior investments and identify savings opportunities to fund new and ongoing projects at.
At the same time the team helps customers address mission critical priorities around security and take advantage of the benefits of cloud both with heightened urgency.
Strong growth from security and cloud were balanced against the decline in client devices as customers put upgrades on hold awaiting greater clarity around the economy and employment plans.
Strong results across health care and government cannot offset the decline in education, driven by K 12 client device dynamics and public sales decreased 9% year over year.
The healthcare team delivered another excellent quarter of robust growth up 8%.
Talent needs and datacenter projects remained key focus areas as customers increasingly thought technology solutions to address complex industry challenges.
This drove excellent performance in netcom servers and services.
Mission critical investments to enhance patient care and experienced continued with telehealth and <unk> driving excellent collaboration performance.
Government grew double digits up 13, 5%.
<unk> state and local sales growth continued driven by customer adoption of strategies for hybrid cloud as well as network modernization and zero Trust security frameworks services increased more than 50% as the team helped state and local municipalities address talent gaps through enhanced training as well as professional services.
Engagements.
Federal also continued to grow in the fourth quarter, the team's ability to help agencies achieve their priorities around data management drove excellent server and storage performance.
For education higher Ed's high single digit sales growth was more than offset by declines in K 12, and overall sales decreased.
Higher Ed continued their success, helping implement student's success programs, which institutions used to promote enrollment.
Our ability to help drive program elements that include improved security campus connectivity as well as enhanced dorm room experiences drove double digit growth across cloud Netcom server storage software and security.
For K 12, we expected a continuation of third quarter performance, where sales were down low double digits, but instead experienced a more significant decline with client device units down more than 60%.
As we shared last quarter K 12 customers continued to focus on digesting the past several years investments and evaluating multiyear funding opportunities to ensure they are making the best decisions for the future.
This quarter as many schools achieved one to one student client device ratios. There was a significantly heightened focused on reevaluating plans and demonstrating need for ECF Awards.
When the device per student ratio was below one to one demonstrating need with straightforward today with device per student at or above the one to one ratio demonstrating need is more complex. For example, articulating why new devices with higher processor capability are required to run more complex applications will provide greater security.
<unk> is just a more complicated discussion it takes more time and approvals.
This heightened focus led some customers to defer a retract awarded funding commitments in order to assess reevaluate and potentially reapply under the third and final wave of ECF, which is scheduled to end December 31 2023.
For CDW this equated to several hundred million dollars of CDW awarded funding commitments being pulled back.
I should note that even with these dynamics variables in the K 12 client devices arena. The team successfully executed on infrastructure opportunities across services net common servers, leaving leading to strong gross profit delivery and.
And just as we've been doing in past cycles with K through 12, the team will be there for our customers to help them work through the challenges to achieve their mission critical outcomes and efficiently utilize available funding mechanisms.
Other our combined UK and Canada results reflected broad based and balanced performance in both regions in local currency U K increased low double digits in local currency and Canada increased high single digits in local currency.
These results continue to demonstrate the grit and resilience of our teams and the power of our investments to drive growth in these markets.
As you can see our diverse end markets are both a key strategic advantage and a driver of our differentiated performance.
The second driver of our performance with the broad and deep portfolio our.
Our ability to address priorities across the entire continuum delivered high single digit growth across our solutions portfolio.
U S hardware sales declined mid teens within hardware network modernization upgrades drove double digit increases in netcom. These excellent results were not enough to offset the decline in client devices and wrap around accessories.
Supply conditions continued to improve across core transactional areas, while supply and solutions categories remained tight.
Once again, we exited the quarter with an elevated backlog and extended lead times and solution and notably in Netcom.
We continue to expect this backlog to feather out overtime.
U S software sales increased 8% strength was broad based as we continued to help customers manage data enhanced productivity and secure their it environments with strong double digit increases in operating systems application suites and data management.
Cloud remained an important driver of performance across the business and was a meaningful contributor to profitability. Once again gross profit increased by double digits.
Database storage mobility, and connectivity, where key cloud workloads during the period.
Security remains top of mind for our customers as cyber threats continue to emerge evolve and increase our teams delivered excellent results as they continue to conduct vulnerability assessments implement identity and access management solutions and provide training to our customers to help manage cloud deployments and enhance endpoint in application security.
Services' results were stellar again, this quarter up more than 20% with balanced performance across professional and managed services.
Services are integral to today is complex technology solutions.
Customers continue to lean into CDW as an extension of their own teams and leverage CDW services as part of their strategy.
And that leads to the third driver of our performance this quarter relentless execution of our three part growth strategy.
Clearly investments and our customer centric growth strategy contributed to our strong profitability this quarter investments in services and solutions have elevated our relevance to customers to the highest level it has ever been or.
Our rigorous strategic process that is designed to ensure we can serve customers across the full stack full lifecycle has made us a vital technology partner, whether customers priorities required transactional or highly complex solutions.
And that leads us to our 2023 outlook.
Our baseline view of the U S market in 2023 is for flattish growth factoring in both expected mix and the level of overall economic uncertainty.
With economic forecast this outlook assumes stronger growth in the second half relative to the first half.
We continue to target to UW market outperformance of between two and 300 basis points.
Our current view of the market recognizes we are operating under greater uncertainty as it incorporates the potential impact of some of our recent wildcards and indeed, most notably the economy.
With thousands of sellers connecting with customers every day, we have a real time pulse of the market.
As we always do we will provide an update updated perspective on business conditions and refine our view of the market as we move through the year.
In the meantime, we will continue to do what we do best leverage our competitive advantages and out execute the competition our fourth quarter results highlight that although we cannot definitively know where our customers will place their priorities.
There are two things we know for sure technology will continue to be a critical driver of outcomes and with our agility and broad and deep portfolio, we will be there to support our customers wherever their priority is now live.
Now, let me turn it over to al who will provide more detail on our financials and outlook al.
Thank you, Chris and good morning, everyone I'll start my prepared remarks with additional detail on the fourth quarter and full year move to capital allocation priorities and then finish up with our 2023 outlook.
Turning to our fourth quarter P&L on slide eight consolidated net sales were $5 1 billion down.
Down one 8% on a reported and an average daily sales basis on a constant currency average daily sales basis consolidated net sales declined 4%.
Net sales were impacted by the significant change in client device demand during the quarter.
With the decline in transactional products, there wasn't meaningful mix shift solutions and services.
Before moving down the rest of the P&L I want to take a moment to talk about the impact of mixing into solutions and services on our results.
<unk> solutions, such as software as a service.
For assurance and warranty solutions as well as agent commission fees generate meaningful customer spend but are recorded on a netted down basis.
Since we are not the primary obligor on these solutions, we record gross profit as our revenue.
That is why you sometimes hear us refer to these nose down revenues at 100% gross margin items.
Certainly see the impact of this in both our net sales and our gross margin performance this quarter.
As we continue to execute on our growth strategy and scale, our solutions and services, we expect to continue to grow our netted down revenue streams.
Else equal this mix dynamic will pressure net sales, while remaining neutral to gross profit dollars and expanding gross margins.
While much of what I've described is tied into the accounting treatment. It is also a reflection of our success in the execution of our three part strategy to capture share enhanced capabilities in high growth solutions and expand services.
The impact of this strategy was on full display this quarter as we experienced a significant mix shift out of client devices and into netted down revenues reflective of our customers' priorities.
Returning to the P&L sequentially net sales decreased 12, 5% versus the third quarter.
Fourth quarter sales historically decrease versus the third quarter, but this quarter was exacerbated by the decline in demand for client devices.
To dimensionalize the shortfall in net sales relative to our expectations two thirds of lower net sales were related to the public sector and driven primarily by K 12.
In aggregate solution categories delivered results above our expectations.
Notwithstanding the noted mixed shift of customer priorities with respect to customer behavior, we did see increased scrutiny and deeper evaluation of projects and extra signatures.
Increasingly require.
In this environment, our sellers are staying close to their customers and working with their technical coworkers to help customers maximize return on investments.
While we've not seen meaningful customer cancellations, we have seen some postponements and re architected on more complex hybrid cloud solutions as customer about customers balanced cost and utility.
On the supply side, we saw similar conditions as in the third quarter with some improvement across categories.
It's a pressure remain especially in the solutions space.
Our solutions backlog remains elevated versus historic levels and lead times are still extended.
We expect our backlog to feather out over time as supply conditions ease, although known although not likely symmetrical cross product categories.
We continue to manage inventory strategically to support our customers. So there is still uncertain supply environment.
And just like our customers in this environment. Our team is diligently managing working capital as we seek to enable profitable growth, while ensuring strong economic returns.
Our coworkers delivered excellent profitability in the quarter gross profit was $1 2 billion.
The year over year increase of 21, 1% lapping for the first time, a one month serious contribution in the fourth quarter of 2021.
Gross profit margin was a record 21, 7% up 410 basis points versus last year, and 190 basis points above our prior year quarter record.
Year over year expansion in gross profit margin was driven by several factors first product margins benefited from both mix into complex hybrid cloud solutions and lower mix of transactional products. When we mixed back into transactional products. We would expect for this benefit to moderate.
Second as we expected for the fourth quarter, a greater mix of netted down revenues the category outpaced overall net sales growing 26% in Q4 2022 compared to the prior year quarter.
Primarily driven by software as a service.
And third net sales contribution from high margin services, which increased 28% in Q4 2022 compared to the prior year quarter with significant contribution from our recent acquisitions.
Turning to SG&A on slide nine non-GAAP SG&A totaled $658 million for the quarter of.
The year over year increase in non-GAAP SG&A was primarily due to higher payroll consistent with higher gross profit attainment at higher coworker count.
SG&A declined by $26 million compared to the third quarter, reflecting the variable variable component of our compensation structure, which is principally tied to gross profit attainment.
In this uncertain economic environment, we're also being mindful of our discretionary spending and our pace of our hiring our fourth quarter expense levels reflect both the benefits of our variable cost model and our prudent expense management.
Coworker count at the end of the fourth quarter was nearly 15100 up approximately 1100 in the last year and essentially unchanged since the third quarter.
Investments in our coworkers and in our strategy continue to be integral to our ability outgrow the market profitably and sustainably.
We are focused on disciplined and balanced investments that drive value. This is evidenced by our record profitability in the period.
GAAP operating income was $447 million up 31, 6% compared to the prior year.
non-GAAP operating income was $523 million.
Of 23, 2%.
non-GAAP operating income margin was a record nine 6% up 190 basis points from the prior year and 80 basis points compared to the third quarter.
Similar to the third quarter. This improvement was driven by a confluence of favorable factors within gross margin.
Moving to slide 10 interest expense was $59 million higher.
Higher interest expense compared to the prior year was primarily driven by the senior notes issued last year to fund the acquisition of serious.
This level of interest expense was in line with our expectation for the quarter.
Our GAAP effective tax rate shown on slide 11 was 24, 7%.
This resulted in fourth quarter tax expense of $94 million.
To get to our non-GAAP effective tax rate, we adjust taxes consistent with non-GAAP net income add backs as shown on slide 12.
For the quarter, our non-GAAP effective tax rate was 25, 2% 30 basis points below our expected range of 25.
5% to 26, 5% due to lower state taxes, as well as non deductible items.
As you can see on slide 13, with fourth quarter weighted average diluted shares of 137 million GAAP net income per diluted share was $2 nine.
Our non-GAAP net income was $343 million in the quarter up 20% on a year over year basis non-GAAP net income per diluted share was $2 50 up 21%.
Turning to full year results on slides 14 through 19, as Chris mentioned 2022 performance reflected exceptional execution.
Let's focus on a strategy that is working.
Net sales were $23 7 billion.
An increase of 14% on a reported and an average daily sales basis.
On a constant currency average daily sales basis full year consolidated net sales grew 15, 2%.
On a combined constant currency basis, we estimate full year sales increased 5% below our prior expectation of 8.25% due to the moderation in market growth as well as the contraction in our premium in the fourth quarter.
Gross profit was $4 7 billion.
Up 31, 3% and gross.
19, 7% up approximately 260 basis points year over year.
In 2020 to software and services accounted for more than 40% of the total gross profit.
Organic and inorganic investments and our services and solutions capabilities and a continued shift into netted down revenues are driving growth.
Operating income was $1 7 billion.
And non-GAAP operating income was $2 1 billion.
Up 24, 6%.
Net income was $1 1 billion and non-GAAP net income was $1 3 billion.
Up 19, 9%.
non-GAAP net income per share was $9 79.
Up 22, 9%.
Moving ahead to slide 'twenty at period end cash and cash equivalents equivalents were $315 million and net debt was $5 6 billion.
During the quarter, we reduced borrowings under our senior unsecured term loan by $200 million.
Consistent with our plan to reduce leverage.
Quiddity remains strong with cash plus revolver availability of approximately $1 4 billion.
Moving to slide 21 to three month average cash conversion cycle was 21 days down three days from last year's fourth quarter and well within our range of high teens to low twenties, reflecting our continued diligent management of working capital.
Our effective working capital management, along with strong growth in the business also drove excellent year to date free cash flow of $1 3 billion as shown on slide 22.
For the quarter, we utilized cash consistent with our 2022.
Allocation objectives, including returning $80 million to shareholders through dividends in addition to $200 million.
And debt repayment.
Which brings me to our capital allocation on slide 23.
Our execution remain consistent with the objectives, we commuted.
Communicated last quarter for 2023, we're updating those objectives as follows.
First as always increased the dividend in line with non-GAAP net income last November we increased the dividend, 18% to $2 36 annually.
This increased demonstrate demonstrates our confidence in the earnings power and cash flow generation of the business.
Going forward, we will continue to target a 25% payout ratio growing the dividend in line with earnings.
Second ensure we have the right capital structure in place with a targeted net leverage ratio. We ended the fourth quarter at two six times net leverage down from three four at the end of 2021 <unk>.
Demonstrating strong growth in the business and excellent cash flow generation.
As we expected and communicated communicated during the third quarter call. Two six times had us near the lower end of our 2022 targeted net leverage of two five to three times for.
For 2023 and beyond our targeted net leverage ratio will be two to three times.
Range that is consistent with our commitment to an investment grade capital structure and provides us with flexibility to proactively manage liquidity over time.
Finally, we have successfully satisfied the commitments we made when we finance the acquisition of serious as such we are pleased to reestablish our third and fourth capital allocation priorities of M&A and share repurchases respectively.
In 2023.
For 2023, we will target returning 50% to 75% of free cash flow to investors through dividends and share repurchases. This is supported by the board's authorization for $750 million increase the company's share repurchase programs.
Moving to the outlook for 2023 on slide 24.
While we are cognizant of potential market variables as we look forward, we remain confident in our ability to execute.
With the growth opportunities and outperformed the broader market.
While the overall market growth rate sentiment has been mixed in the near term. We continue to expect netted down revenues will grow faster than other product and solution categories.
With this in mind, we expect the market to be approximately flattish, reflecting our expectation of mix and the level of economic uncertainty.
We maintain our long held expectation to outgrow the market by two to 300 basis points per year.
Currency is expected to be neutral for the full year with modest headwinds in the first half and modest tailwind in the second half.
This assumes an exchange rate of $1 24 to the British pound and 77 for the Canadian dollar in the first quarter.
Moving down the P&L, we expect our full year non-GAAP .
Operating income margin to be in the mid to high 8% range. We expect full year non-GAAP earnings per diluted share growth to be at the upper end of a mid single digit range in constant currency.
Please remember we hold ourselves accountable for delivering our financial outlook on a full year constant currency basis.
Additional modeling thoughts for annual depreciation and amortization interest expense and the non-GAAP effective tax rate can be found on slide 25.
Moving to modeling thoughts for the first quarter related to average daily sales, we expect low single digit sequential growth from Q4 to Q1.
This equates to a mid single digit percent year over year reported net sales declined for the fourth quarter.
We anticipate continued strong gross profit margin and <unk> margin in the first quarter.
Above the full year 2022 levels for both but.
Reflecting some moderation from what we experienced in Q4.
And we expect first quarter non-GAAP earnings per diluted share to grow low single digits year over year.
Finally in line with the reevaluation of our capital priorities were.
Adjusting our long term rule of thumb for full year free cash flow in 2023, we expect full year free cash flow to be within a range of four to four 5% of net sales up from our prior range of three and three quarters percent to form 4.25%.
As you know timing has a meaningful impact on free cash flow and it may ebb and flow by quarter and across years.
That concludes the financial summary, as always we will provide updated views on the macro environment and our business on our future earnings calls.
With that I'll ask the operator to open up for questions. We would ask each of you to limit your questions to one with a brief follow up thank you.
Thank you we will now start today's Q&A session, if you'd like to ask a question. Please press star followed by one on your telephone keypad now if you change your mind. Please press star followed by one.
When comparing to ask your question. Please ensure your phone is on mute locally.
Our first question today comes from Matt Sheerin from Stifel. Your line is now open.
Yes, Thank you and good morning, everyone.
I was hoping to ask just question is regarding your take on the client device environment.
Not a big surprise that it was down significantly, particularly in K through 12.
But could you talk about the commercial side of the business.
Like some customers are being more cautious on upgrades, what's your thought on the PC cycle on the commercial side of the business and how you see that playing out this year.
Good morning, Matt, Yes, that's a good question, we have seen customers elongate the replacement cycle given the uncertain times I mean, youre seeing what were seeing with.
Hiring freezes and layoffs and things like that so right now there's just more pause than we had seen earlier in the year.
Eventually the benefit of enhanced productivity and security from the newer replacements will certainly drive.
Replacement cycle, but.
It's not happening right now with the level of uncertainty.
Okay, that's not contemplated in your forecast for the year.
A rebound in terms of it yes.
Yes.
Forecast contemplates the environment is still pretty much like it feels now.
That's what we've reflected in the in the forecast.
We do expect the PC market to remain larger than it was pre pandemic.
But right now our forecast reflects the current environment and the current temperature.
Okay and then in line with that or are you also seeing pricing pressure or ASP declines as memory and other component prices come down and is that also going to be reflected.
In your business.
Hey, Good morning, Matt. This is al we are not seeing I would say asps in the fourth quarter and ongoing continued to be really firm.
And so that is not contemplated in our outlook.
Okay. Thank you very much.
Our next question today comes from <unk> <unk> from Bank of America Merrill Lynch. Your line is now open.
Hi, Thank you for taking my questions.
Chris from the prepared remarks, I mean, it's clear the client devices are weak and likely will remain weak in the near term.
If we think about it if SMB is really a bellwether for the macro economy are you concerned that demand for advanced solutions or data center devices like servers and storage that demand can also moderate.
What have you assumed for sustainability of that demand through 2023.
And I think in the prepared remarks, you guided for kind of the.
The seasonality in this year to be skewed more to the second half versus the first half. So what are you expecting to be stronger in the second half of 'twenty three.
Good morning, So let me let me break that out there are a couple of questions. In there. Let me just start with a small business and what I would say on small business is the team is really executing well in a fairly cautious environment and as I did mention we are helping customers.
With priority is around infrastructure networking et cetera, primarily led by software and cloud and of course security is still top of mind. So we're not seeing is a dampening in the small business or the need to modernize their.
Their infrastructure and maximize their prior investments. So we're seeing what I would say is continued steady demand from our small business customers for sure with an emphasis again on cloud and security.
In terms of the split first half to second half of the year.
I'm going to let al a dress that in terms of the seasonality there and then I think there was another question in there that you had.
Which was a was there another question that you had.
Or just the sustainability of demand for servers and storage solutions.
<unk> solutions.
The year I mean, do you think that that can.
It can be better in the second half or do you think it's the same at this level throughout the year.
Yes, here's what I'd say.
As we've said for a while now <unk>.
Technology has become more vital to every walk of life into competitive advantage into success et cetera, and we believe it's going to probably be more resilient to a challenging economic environment equally given our business model and the strength of our portfolio our ability to capture opportunity in a more difficult <unk>.
<unk> is pretty strong.
But our expectation is for a level of resiliency in the technology space.
And good morning, <unk> on the on your question on seasonality. So first just look our outlook is based.
Based on the premise, we would continue to see strength in software and services and.
And lower growth in terms of hardware overall with respect to the timing of that.
First half our typical seasonality would be first half 48, 49, we'd expect maybe slightly below that in the first half and that's reflective of that.
Nope.
Towards more netted down revenues and cloud security et cetera, with the expectation that in the second half you may see a pickup there more on the client device and so second half a bit stronger in terms of topline impact if you will.
Fluids, Chris I would just add I, just let me just add that as we think about the customer behavior more recently and a lot of folks have been talking about extra signatures, a little more scrutiny et cetera, yes, we have been seeing that but we haven't been seeing is a pullback wholesale pullback in project and in fact those.
Structure projects that we had talked about being delayed a little bit are actually coming to the forefront again back to the technology being essential to to all of our customer base. So we are seeing that resiliency as well.
Got it thanks for the details there can I ask a follow up.
I may have missed this but on the call did you mention what was netted down items as a percent of gross profit in the fiscal <unk> and sounded like that that percent was unusually high in the quarter and you expect that to moderate but your guide for next year for operating margin I mean, you're guiding it to be higher at mid to high 8%.
<unk> versus the original guide for this year was low 8%. So I guess my question to you would be what are you assuming for netted down items as a percent of gross profit in 2023 and in general can you help us parse out that year on year operating margin improvement what are some of the factors that are driving the increase in and what are some of the headwinds.
Year on year.
Sure. So let me just start with the operating margin so operating margin I would most notably point to expectation that.
We would continue to be.
Somewhat higher there on gross margin in 2023 versus 2022, I certainly would not expect that those gross margins would.
Match, what we saw in Q4, which was really extraordinary but I would just start from that square that.
Somewhat higher gross margins in 2023 will certainly drive.
Our <unk> margin, coupled with expectation we'd have some operating leverage there to your question original question on netted down revenues.
For the quarter you are right. Our prepared remarks noted that netted down revenues grew 26% year over year on a percentage of GP basis, <unk> that was 31% in the fourth quarter, so continuing to be really strong.
Our next question comes from <unk> <unk> from Jpmorgan. Please go ahead.
Yes, hi.
Thanks for taking my questions I guess for the first one in sort of.
The capital allocation priorities that you referenced in your prepared remarks, maybe we can sort of get a bit more color about how you're thinking about the M&A pipeline.
And sort of what are the focus areas, particularly as you look at the changing mix of where customers are looking to spend.
Thinking about the M&A pipeline and what are the focus areas for the company I have a follow up please.
Let me let me let me just start and then Chris can add on from an M&A perspective. So.
As you know our capital priorities reopened both M&A and share repurchase.
And the way that I would think about that I spoke to that range of our free cash flow of 50% to 75%. We would expect to return to shareholders. So if you take the dividend you can get a sense for what that range would look like there is a range there because we view that is.
Really optionality for us to toggle between what's going to drive the longest strategic value, including M&A as well as what's going to maximize shareholder return in the more near term and so both of those options an array of options are available to us. We're certainly back on a path of <unk>.
Our repurchases, but M&A is also on the horizon as well.
Yeah, and I would just add we're never out of the market. We did have a pretty heavy year integrating Sirius which has been incredibly successful and having an impact in the market.
But we're always looking for.
Organizations that can add capabilities in broadened capabilities I should say in high growth high relevant areas and also adds scale to those practice areas that we've built.
We can add scale at a faster pace and we think about geography, and our global presence. So we're always looking and it's good to have a solid year of the serious integration behind us.
Got it and.
So quick follow up.
We are all talking about client devices being softer than expected, but I think you also mentioned on the flip side solutions drive much better than expected, which again sort of is counter to the mixed impressions forget about enterprise spending. So maybe if you can sort of give us a bit more color on is that we need solutions doing better than expected and water.
<unk> dynamic where supply is easing up faster or are you seeing sort of upsize. These from your customers or is it really a strong run rate of autos that you continue to see on that front.
Interest from customers, just trying to sort of parse that out in terms of the backdrop of the.
The macro backdrop that we have.
Yes, no. It's a very fair question and I would I would characterize it. This way we are seeing strong demand in the solutions space.
And while we've had some supply feather out I mean, we're it's really moderated is on the client device space some pockets in.
Solutions, but we're still carrying heavy backlog, particularly in netcom. So the demand that youre seeing reflected in our performance is just that it's demand it's not a flow through of backlog.
Our next question today comes from Amit diarrhea, Gary IRT from Evercore. Your line is now open.
Yes.
Taking my question I have two as well.
Chris maybe to start with you folks were talking about <unk> spend being flat in 'twenty three.
When I listened to IDC Gartner I mean, some of your peers.
Talking about <unk> being up about three 4%. So from your perspective, where is the biggest delta versus what you were talking about versus what maybe IDC got into your peers are saying.
And then how much of the Delta do you think is.
Perhaps conservatism in your income and where you're seeing that versus the netted down revenue impact that you have.
Good morning, Amit.
I wish I could say that it felt stronger out there I really do but that's not what the temperature is that we're feeling so you know we build our expectations by listening to our customers. We've got thousands of sellers and technical advisors out there and it's just the pulse that's coming back to us and looking at industry and partner data.
We're feeling that it's going to be flattish and then the two to three to 100 basis points of premium that we always commit to would be on top of that in terms of mix I guess, what I would say is we don't calculate in our customer spend versus net sales as an example, but of course in this kind of environment as we've explained when <unk> got.
Hardware, that's more muted than you've got in our case netted down solutions more heavily in the mix you can expect more meaningful customer spend than the net sales line reflects but that said we are right now feeling flattish of course, we'll update you as we as we move through the year, but that's that's kind of where we feel right now.
Got it.
It almost seems that you folks you sought to guide gross profit dollars growing at a premium to <unk> spend versus the revenues given the way the mix is going but that may be a discussion for a different day.
I do want to ask you will follow up on the met coal market.
You talked about December quarter, I think it was up in that business I would love to get a sense as you see supply starting to improve especially on the netcom side are you seeing cancellations or deferrals hopping over there and then how do you do a net com into 'twenty three in the slide it spend environment.
Good morning on it we're not seeing any level of cannibalization or postponements there the demand on net com and you can see from our reported.
Reported results really really strong we're not getting a lot of help from a supply perspective honestly.
Extended lead times still there our backlog has not moved substantially with our backlog has moved more and client as Chris suggested.
Supply is still there's still friction there on the netcom side, but that's notwithstanding really strong written Nevada.
Perfect. Thank you.
Our next question today comes from Erik Woodring from Morgan Stanley . Your line is now open.
Great. Thank you good morning, guys.
Chris maybe a high level question for you and that is now that you have a year of serious under your belt.
Alright, and that being one of the larger acquisitions CDW has done.
The last handful of years.
How do you think about doing more transformational deals going forward rather than tuck in deals and then.
Kind of a lower leverage targets that you guys communicated today.
Is that because you want greater flexibility to do larger deals I just wanted to get a sense of how youre thinking about transformational deals because it does seem like serious has been a pretty significant success for you and what your appetite would be for those types of deals going forward and then I have a follow up.
Yes, no look it's a great question, Eric and it's all a matter of supply and demand right.
Pretty particular in looking at organizations that really complement our suite of capabilities and our scale them along with the obviously the financial return, but the fit in terms of culture and I'll tell you we've done eight over eight quarters and check check check they've all been really outstanding now that said there are companies out there that we think are in.
And always reflecting on in some other.
Larger transformational deal would certainly be something we would consider but it's a matter of.
Finding them and making sure theyre going to fit and provide the financial return.
And you asked a question on the on.
On the debt ratio Alan did you want to tackle that sure.
So Eric obviously, we're we're within our stated range and I noted that.
Our new leverage range is two to three times. So certainly we have room in that regard and I would say as we think about M&A certainly.
Smaller bolt on as we've certainly done plenty of.
We can do that with free cash flow and with our existing net leverage capacity as we think about things bigger obviously, we're going to look at what's the best use of our capital which could include.
Taking on more debt and could include other avenues I will just note that while our goal is to stay within that.
Investment grade capital structure, certainly from the rating agencies, we get some room there that if you do larger M&A and you go beyond that you have a grace period. If you will and you have time that you then get back into that range. So all of that would be contemplated in our calculus as we think about deals.
Okay totally understand and then.
Chris I'm not sure who wants to take this one but generally I think we've been hearing in the market kind of more weakness at the large enterprise level versus Smbs your results.
Somewhat suggest the opposite with small business down versus the corporate business up and so can you maybe just talk about some of the high level trends you discussed in terms of extra signatures or deal downsizing how that differs between the corporate business versus SMB business. If you are seeing any differences there.
And again same thing I don't know you asked about pricing earlier on this call, but any difference in pricing between.
Corporate versus SMB and that's it for me thanks.
Okay, Eric Yes, so differences between enterprise and SMB in terms of the process.
No.
I would say that.
Look larger enterprises have a muscle for this.
And we're dealing with that muscle and we know how to deal with the muscle the smaller business frankly turned to us for cost evaluation as a trusted partner and so in some ways. We actually play this added role with them. It which is how do you figure out where you make adjustments in your technology roadmap to achieve the cost cost effectiveness. So in terms of.
The behavior itself I would say small and medium sized businesses are being cautious enterprises of kind of kicked in their muscle and theyre doing the analysis that they do but all of that said, we do continue to feel strong demand across all of our segments.
K 12 that we've talked about that was a real dynamic in the quarter.
Still very successful with them with.
Network modernization and all the things that have to support the client devices.
It's the demand the demand is okay right now.
Okay, great. Thanks for the color.
Our next question comes from Shannon Cross from Credit Suisse. Your line is now open.
Thank you very much I was wondering can you talk a bit about working capital requirements as your model turns more and more than netted down I noticed inventory levels came down quarter over quarter, even with the shortfall in Pcs and you've raised your target for free cash flow. So just how do you see your cash flow.
And balance sheet morphine overtime, and then I have a follow up thank you.
Good morning Shannon.
So a few things one.
Sure.
Talking about a rule of thumb for free cash flow and we raise that and I would say that's a reflection of our continued improvement progress on really effectively managing working capital and also.
Somewhat of a factor are supported by the.
The counter cyclical nature of the business. So obviously is.
Is this in this economic environment kind of moderate a bit.
It actually helps from a cash flow perspective, so both of those things kind of in play.
Your comment about netted down our question about netted down is a good one.
It is a bit of.
Mathematical exercise, but just recall with our netted down revenues that while they show up in our net sales net we're actually collecting gross dollars. So what that does from a.
Cash conversion cycle perspective, it actually has the tendency to increase the DSO increased EPL given the denominators in Nomura.
The numerator so the way we think about that is really on a net basis and.
Can we continue to make progress within that band of high teens low <unk> on cash conversion. So all of those factors, we consider as we're managing the business, including the puts and takes relative to our investments in inventory as well as how we manage AR and AP. So.
That's all part of really a dynamic operating model around working capital and making really good progress on that front.
Great. Thank you and then can you talk a bit about demand youre seeing for device as a service infrastructure as a service.
It seems like in a challenged end market, maybe the ability to pay more ratably would be gaining some traction but I'm. Just curious is let's see here. What you are hearing maybe both from an enterprise standpoint, as well as F&B. Thank you.
Yes, Shannon I'll take that on the infrastructure as a service that has that is picking up.
Our Oems have been building that capability over time, and I would say.
Hitting an inflection point where customers are.
Eager to learn more and invest.
Primarily enterprise I would say is a little stronger than the demand that we've seen in small business on device as a service that's a little more complicated because on the one hand wallets.
Of interest type solution, it's more complicated if it.
It's either a lease or it's more complicated than that and so it hasnt taken off to the extent that one would think.
It may in the future.
Great. Thank you.
Our next question comes from Jim Suva from Citigroup. Your line is now open.
Thank you so much I have a question on theres been a lot of like government stimulus programs.
Was wondering how you've been seeing those rollout develop.
Embrace any potential red tape or slowdowns in them or acceleration of that thank you. So much.
Yes, thanks for the question well.
Can I say they are rolling out as they typically do and sometimes that includes red tape and not all of the things that you expect with government I mean.
Seriously there is when we think about the federal budget that was passed.
Used to dealing with that and we know where we can go find the funds and I think that's been pretty.
Kind of standard operating procedure, if you will the infrastructure acted a little more to figure out where funds that can benefit our customers.
Vis vis technology, that's taken a little bit more time is what I'd say.
But it's nothing that is daunting us or nothing that concerns us frankly.
Okay.
Also been finding a lot of those new programs and systems have been kind of more on that.
Higher end.
Service product offerings that you had say today versus five or 10 years ago, meaning more like cloud and security and software solutions.
Two more.
Kind of plug and play hardware solutions.
Yes, that's a great. It's a great point the ability to access that funding for more advanced solutions is absolutely there.
There's more demand for that versus merely client devices. For example, that's a good point security another one that tends to thread through all of the funding mechanisms at this point.
So yes, that's a good point and the answer is yes.
Our next question is from Keith <unk> from Northcoast Research. Your line is now open.
Good morning, I appreciate the opportunity Chris just looking at the hiring.
Did over a year 1100 people through the first three quarters and then obviously you guys were flat in the fourth quarter.
Two things one is that kind of a testament to your thoughts on the overall market, perhaps weakening here as you guys went through the fourth quarter and then what kind of people where you hiring during the year in order to meet your needs.
Yes, good morning.
As we've been doing over the last few years, we've really been targeting our hiring in a couple of areas is the high demand high capability. So think about the sales organization think about the practice areas like technical.
Technical specialists in security and cloud software the spaces that we've talked about and really targeting those areas along with what I would say is technologists and digital specialists for our own evolution of our business. So that's really where we've been focusing in terms of as we come into the back half of the year.
Just consider that disciplined management of the business.
So as we look out at the economy as we see what's happening we're just being very disciplined in the way that we're approaching our own cost management and Youll see that in some tempering in our hiring in the back half of the year.
Great I appreciate it.
Looking at your guide a little bit more trying to unpack. It as you think about the macro environment are you expecting roughly a flat GDP and where are you what kind of assumptions, you're making for interest rates. As you guys are thinking about your guide.
Yes, good morning, Keith I would say just in terms of broad macro GDP, yes, I'd say flat, maybe slightly down if you will and so and you get your translate inflation.
It market perspective, with all of the components that we talked about both our mix and uncertainty as well.
Interest rates.
Look I don't know if we have a.
Formal market view on that certainly we make sure that the posture of our capital structure is protecting against that we do have largely a fixed rate capital structure, but we do have a component of our debt at term loan that's adjustable rate and so the way we think about that is the most effective way to manage our interest rate risk.
Is where we see there's risk there that we might pay down that debt a bit faster you saw that in the fourth quarter and we will continue to operate in that in that regard and obviously, we think about that in the construct of our overall capital priorities.
Our next question is from Adam Tindle from Raymond James Your line is now open.
Okay. Thanks for squeezing me in I wanted to ask on 2023 revenue growth guidance of 2% to 3% I think it's a lower overall starting point than I can recall in many years. I know you are split says the assumption of no market growth, but the largest global distributor just guided to double the growth rate that youre, describing so for investors that take this to mean that.
Your share gain premium is effectively lowering inherently in this guidance, which is notable as we're shifting away from Pcs, maybe you could Chris opine on that market share premium piece as we move into a different environment from a mixed perspective away from transactional towards solutions and tie into your observations that you saw.
During Q4 thanks.
Alright, Thanks, Adam Let me just let me start with our guide when our guide is coming versus when some of the other.
Observations about the outlook for the market came out a month or month and a half ago and.
Pivot that we've talked about in Q4.
We started to see more dramatically end of November and into December so that might be having an impact on how on the discrepancies that youre hearing in terms of the two to 300 basis points and the validity of the two to 300 basis points. I think that question was when you were asking we still view that as our target go get.
As we mentioned Adam and this might be what youre getting underneath but as we mentioned as we think about 2023 and the dynamics that we've seen in the fourth quarter of 2022 continuing.
Into 2023, namely for a stronger growth in cloud and software as a service and security and more muted hardware sales that does mean that our customer spend will be more meaningfully greater than the number that I think you gave it two 5% figure it will be meaningful meaningfully greater than that number so.
We would look at that outperformance as two to 300 basis points, plus if I could put it that way.
Yeah.
Okay, and maybe just a quick follow up al on the Q1 guidance.
In years past CDW would talk about seasonal being down high single digits sequentially, seven 8% down today, Youre guiding flat to low single digit growth sequentially and as I think about the mix of the business with serious being in there I would think it would be even more seasonal to Q1, given the enterprise focus.
So maybe just help me understand the change now to seasonality versus historically thank you.
Sure. Thanks, Adam.
The most notable thing I would just say is the Q4 with a very extreme period.
And so as we look at Q1, you are right seasonally we typically say there would be a contraction in Q1.
And I guess, what you should take from that as well Ah Mattikalli, we'd still expect this mixing into netted down in lower transactional maybe not as extreme as what we saw in Q4.
And therefore with some of that balancing out we'd expect that we'd have modest growth on the top line in the first quarter and then again a little.
A little more modest in terms of the gross margin. So just really kind of a bit of a dampening effect of the extremity that we saw in Q4.
Got it thank you.
There are no further questions at this time I will now hand, you back to C. D. W for closing remarks.
Thank you drew and let me close by recognizing the incredible incredible dedication and hard work of our 15100 coworkers around the globe your ongoing commitment to serving our customers is what makes us successful and thank you to our customers for the privilege and opportunity to help you achieve your goals and thank you to those listening.
<unk> for your time and continued interest in CDW al and I look forward to talking to you next quarter.
Thank you for joining <unk> fourth quarter 2000, <unk> earnings call.
Connect your line.
Yeah.
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Yeah.