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CDW Q1 2022 Earnings Call Transcript

Corporate Executives

  • Steven J O'Brien
    Vice President of Investor Relations
  • Christine A. Leahy
    President & Chief Executive Officer
  • Albert J. Miralles
    Senior Vice President and Chief Financial Officer
Operator

Welcome to the CDW First Quarter 2022 Earnings Call. [Operator Instructions]

I'd now like to hand over the conference to your speaker today, Steven O'Brien, who's VP, Investor Relations. Thank you. Please go ahead.

Steven J O'Brien
Vice President of Investor Relations at CDW

Thank you, Daniel. Good morning, everyone. Joining me today to review our first quarter results are Chris Leahy, our President and Chief Executive Officer; and Al Miralles, our Chief Financial Officer. Our first quarter earnings release was distributed this morning and is available on our website, investor.cdw.com, along with the supplemental slides that you can use to follow along with this 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 and Form 8-K we furnished to the SEC today and the company's other SEC filings with the SEC.

CDW assumes no obligation to update the information presented during this webcast. Our presentation also includes certain non-GAAP financial measures, including non-GAAP operating income, non-GAAP operating income margin, non-GAAP net income and non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You'll find reconciliation charts in the slides for today's webcast and in our earnings release and Form 8-K we furnished to the SEC today. Please note, our financial results today include results from our acquisition of Sirius Computer Solutions, which closed on December 1, 2021. All references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2021, unless otherwise indicated. References to growth rates for hardware, software and services today represent U.S. net sales only and include Sirius.

They do not include the results from CDW U.K. or Canada. References to growth rates for specific products and solutions, including cloud and security today represent U.S. net sales only and exclude Sirius. The historical combination information of CDW and Sirius discussed herein is for illustrative purposes only and is not necessarily indicative of results that would have been achieved had the acquisition occurred at the beginning of the periods presented. Replay of this webcast will be posted to our website later today. I also want to remind you that this conference call is the property of CDW and may not be recorded or rebroadcast without specific written permission from the company.

With that, let me turn the call over to Chris.

Christine A. Leahy
President & Chief Executive Officer at CDW

Thank you, Steve. Good morning, everyone. I'll begin today's call with a brief overview of our results, strategic progress and outlook, and Al will run through the financials and our capital allocation priorities, and then we'll move right to your questions. We had an outstanding start to the year. The teams continued to execute well in a challenging supply environment and delivered exceptional top line growth and profitability. For the first quarter, net sales were $5.9 billion, 23% higher than last year. Non-GAAP operating income was $462 million, up 26%, and non-GAAP net income per share was $2.20, up 26% on a reported basis. These exceptional results reflect our ability to address customer priorities with solutions across the full spectrum of IT and the inclusion of Sirius. Customers continue to evolve as we move ahead into the new normal, digital transformation, agility and security remained top concerns with return-to-office driving collaboration, networking and endpoint solutions.

Customers want to manage costs while meeting or exceeding coworker and customer service level requirements. At the same time, customers across our diverse end markets are seeking ways to supplement technology resources in today's war for talent environment. Our ability to meet all these needs led to a broad-based and balanced performance. There were three drivers of our performance during the quarter. The first driver was our broad and diverse portfolio of customer end markets. As you know, we have five U.S. sales channels: Corporate, Small Business, Healthcare, Government and Education. Each of these channels is a meaningful business on its own with 2021 annual sales ranging from $1.8 billion to over $6 billion. Within each channel, teams are further segmented to focus on customer end markets, including geography and verticals. We also have our U.K. and Canadian operations, which together delivered USD2.6 billion in 2021 sales.

This scale and balance across customer end markets positions us to perform when external factors impact certain sectors or geographies. This quarter, our commercial markets, corporate and small business, along with our health care and international markets, all delivered strong double-digit growth. As expected, education and government growth was depressed as they lapped strong prior year stimulus and large deal-driven results. Our corporate team delivered a 46% increase. Growth was strong and balanced across transactions and solutions. The team did an excellent job addressing customer demand for return to work solutions, digital transformation and the need for agility and security. Unit growth, coupled with ASP increases, resulted in another quarter of strong double-digit growth in client devices and cloud spend was excellent.

Small Business posted a 21% increase. Performance was broad-based across both transactions and solutions. return-to-office strategy and modernizing workspaces drove strong collaboration, networking and security growth for hybrid work environment. Remote enablement drove another strong quarter of client device growth, up double digits, both in unit and ASPs. Security performance was up mid-teens and cloud spend was robust. Public posted a 6% increase on top of last year's exceptional 20% plus growth. Health care increased 27%, ongoing focus on driving productivity to offset higher costs from staffing shortages and other acute care needs led to double-digit solutions growth. Cloud adoption was strong driven by the speed and efficiency cloud solutions can deliver. Government posted a mid-single-digit increase.

State and local delivered a high single-digit increase driven by client devices and security. As we shared last quarter, we continue to help our customers as they work through the various funding opportunities and multiyear phasing and expect projects to continue to be implemented as we move through 2022. Federal performance played out as expected and was balanced across both the Department of Defense and civilian while lapping tough compares. As we shared last quarter, we continue to experience the lumpiness, the lumpy nature of government contracts and contracting changes. There is no change to our expectation that growth will return later in the year. Higher ed's strong double-digit performance was offset by the expected decline in K-12 and overall education sales decreased 4% off the first quarter of 2021's remarkable 101% growth. The higher ed team continues to help customers implement student success programs using technology to give an institution an edge with comprehensive endpoint solutions, improved security, campus connectivity and enhanced dorm room experiences.

The team delivered excellent client device growth and school systems tapped our capabilities to address the war-for-technology talent, which drove increased usage of CDW services to fill the gap in staffing needs. While K-12 delivered strong nonseasonal results, they posted a year-over-year decline on top of last year's exceptional 100% growth. Emergency connectivity funding, which was expected to end during the first half of 2022 was extended and a third wave was announced, adding complexity to an already challenging process. Many school systems are leveraging the extended funding window to digest better options and plans for their IT spend. Other, our combined U.K. and Canada results increased 13% on a reported basis. U.K. grew double digits in local currency and Canada increased high single digits in local currency. Each market saw balanced strength across both commercial and public customers. Customer priorities remain similar to those in the U.S.

The second driver of first quarter performance with our broad and deep product and solutions portfolio, our ability to address customer priorities across the entire IT continuum drove excellent performance across both our solutions and transactions portfolios. We continue to leverage our competitive advantages, including our distribution centers, extensive logistics capabilities, deep vendor partner relationships and strong balance sheet and liquidity position to navigate an ongoing supply challenge. U.S. hardware increased high teens. Growth was broad-based and included double-digit increases in NetComm, servers and server management, client devices and video/audio. This exceptional performance was on top of 2021's first quarter double-digit hardware growth. Demand continued to outpace supply in several key areas, notably in the networking space and remaining orders built during the quarter.

Customers once again placed orders to get in line for second half 2022 projects, especially in NetComm. U.S. software posted a 40% increase, driven by success helping customers upgrade their edge and secure their IT environments with double-digit increases in network management software and security software. Cloud was a meaningful contributor to this quarter's strong performance with significant double-digit increases in customer spend and gross profit, led by productivity, platform, security and collaboration workloads. U.S. services sales doubled. Growth was broad-based and balanced driven by professional services, managed services and warranties. As you can see, excellent broad and balanced performance across the business. And that leads to the third driver of our performance this quarter, our customer and coworker centric strategy.

Over the past three years, we have executed against our strategy to enhance our high relevant and high-growth solutions and services with both organic and inorganic investments, eight acquisitions have deepened and advanced our services capabilities, including automation, cloud native and DevOps, cybersecurity and our services scale and reach. We welcomed nearly 3,000 new coworkers from these eight acquisitions with more than half in technical roles. Since year-end 2018, our technical team has doubled in size. And at the end of this first quarter was more than 5,000 strong. Today, technical coworkers comprise more than half of all customer-facing coworkers, together with their other CDW colleagues, they form an amazing high-performing team, a high-performing team that is a key competitive advantage for CDW, a team that is the most engaged, enabled and energized team in the industry. All our investments, whether homegrown or inorganic, are intended to maximize our key point of differentiation in the marketplace.

We are a one-stop trusted partner with capabilities across the entire continuum of IT. -- capabilities that help customers achieve the outcomes they need from technology so they can do great things. Let me share a couple of recent customer examples that demonstrate how our investments help customers achieve outcomes. A soft drink manufacturer wanted to upgrade their on-premise voice system. The customer had two desired outcomes for the solution. Number one, flexibility to expand as their business grew, and number two, an excellent user experience. Since IT staff was focused on other priorities, the solution needed to be managed off-premise, leveraging CDW's world-class unified communications as a service capability and ServiceNow capabilities, the team designed a flexible and cost competitive integrated full stack managed collaboration anywhere solution.

The solution included CDW professional services for upfront design, planning, configuration and deployment and CDW managed services to provide ongoing MCA support and integration with our ServiceNow ticketing platform, a great outcome for the customer and for the team who bested large telecom providers to win the deal. They also deepened their relationship with the customer and delivered more than $3 million in licensing and services revenues. The second example of how our investments enable customers to achieve the outcomes they need is the recent adoption of Focal Point Academy by a major technology company. Focal Point Academy is a bespoke training program that delivers workforce development programs that solve today's greatest cybersecurity problems, finding, training and retaining skilled cyber professionals.

Focal Point Academy's operationally focused portfolio, which covers high-demand topics like threat hunting and application security, coupled with its ability to train and develop both senior and junior technical professionals was exactly what the customer needed to achieve its desired outcome of mitigating risk. Prior to our acquisition of Focal Point, we would not have been able to deliver this important global solution and further deepen our relationship with the customer. Investments in our customer and coworker-centric growth strategy are integral to our ability to consistently and profitably outgrow the U.S. IT market. And that leads to our expectations for the rest of the year. During the balance of 2022, we will continue to execute against our strategy to deepen our services and solutions capabilities. We are making excellent integration progress with Sirius, and that will remain a key focus area for the balance of 2022 as will investments in our coworkers and our own digital transformation. We will continue to balance investments with our growth and profitability expectations, which are now higher than previously shared at year-end.

Given our excellent momentum coming into the second quarter and first quarter performance, we now expect to outperform the U.S. IT market by 325 to 425 basis points, 125 basis points higher than our view at year-end 2021. Our view of U.S. IT market growth has also increased, and we now look for 2022 growth of 4%, which is 50 basis points above our prior view. Taken together, this equates to constant currency growth of 7.25% to 8.25%, above 2021 combined CDW revenues of $22.8 billion. Recall, 2021 combined CDW is calculated as those Sirius had been acquired on January 1, 2021, instead of its actual acquisition date of December 1. On a reported basis, our outlook represents a 17.5% to 18.5% increase over 2021 results. This outlook reflects our baseline expectations that given 2021 second half strong hardware performance we will mix into more cloud and security in the back half of this year. It also reflects our expectation that supply constraints remain relatively consistent with the first half of the year.

As always, we remain mindful of our wildcards, the potential for further disruptions to the supply chain, changes in COVID or macroeconomic performance and we will keep a watchful eye on these and other potential issues. As we always do, we will provide an update on our view on our next call. In the meantime, we will continue to do what we do best, which is leverage our competitive advantages and out-execute the competition. We will also continue to invest to ensure we remain our customers' trusted partner who delivers the outcomes they need, whether for innovation, cost management, agility, risk mitigation or user experience. If the past two years have shown us anything, it is that our role as a trusted strategic partner to our customers is more important now than ever.

Let me turn it over to Al now who will provide more detail on our financials and outlook. Al?

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

Thank you, Chris, and good morning, everyone. I'll start my prepared remarks with more detail on the first quarter, move to capital allocation priorities and then finish up with our 2022 outlook. Turning to our first quarter P&L on slide eight. Consolidated net sales were $5.9 billion, up 23% on a reported and average daily sales basis in constant currency. On an average daily sales basis, sequential sales increased 7.4% versus the fourth quarter, which is well above historical average sequential decline of 5%, this reflected two primary factors, first, demand for return to work, and remote enablement solutions remain strong and drove sequential growth in our commercial channels and international. As Chris mentioned, corporate and small business had broad-based and balanced growth across both transactions and solutions.

Second, Q1 reported results reflected three months of contribution from Sirius versus one month in Q4, notwithstanding that Sirius' first quarter has historically been the lowest quarter of absolute sales and gross profit dollars for the business. On the supply side, our overall backlog increased in Q1 at a similar level to the fourth quarter and remain elevated year-over-year in both transactional and solution categories. We continue to make strategic investments in inventory to support our customers through this constrained supply environment, and the team once again did a great job leveraging CDW's competitive advantage to ensure strong returns on working capital. Gross profit for the quarter was $1.1 billion, a year-over-year increase of 38.8%. Netted down revenues grew faster than the underlying business and represented nearly 31% of total gross profit, more than three points over the last year.

The higher mix of net service contract revenue, primarily within Software as a Service, favorable product mix and rate, and increased net sales and margin on professional services combined to deliver a record gross margin of 18.6%, up 220 basis points versus last year. Turning to SG&A on slide nine. Non-GAAP SG&A totaled $642 million for the quarter. The year-over-year increase in non-GAAP SG&A was primarily due to higher payroll as a result of increased coworkers. Coworker count at the end of the first quarter was 14,005, up over 3,800 from prior year quarter, reflecting organic and inorganic investments in coworkers that support high-growth solution areas and our own digital transformation.

Recall that Sirius' payroll as a percentage of net sales is higher than our core operations given their higher mix of solutions and services revenues, and this ratio is historically highest in the first quarter due to sales seasonality. The higher level of SG&A also reflects continued investments in the training and development of coworkers. Our return-to-office efforts and investment in our own digital transformation and technology strategy. As Chris mentioned, we will continue to balance investment with our growth and profitability expectations. Investments in our strategy are integral to our ability to outgrow the market profitably and sustainably. GAAP operating income was $387 million, up 19.6%. Non-GAAP operating income was $462 million, up 25.7% and non-GAAP operating income margin was 7.8%, up 20 basis points from the prior year and 10 basis points from Q4.

Moving to slide 10. Interest expense was $56 million. Higher interest expense is primarily driven by the senior notes issued last year to fund the acquisition of Sirius. Our GAAP effective tax rate shown on slide 11 was 24.3%. This resulted in first quarter tax expense of $80 million. Together, 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 25.7%, up 50 basis points versus last year's rate, primarily driven by higher state taxes as well as taxes on foreign earnings. As you can see on slide 13, with first quarter weighted average diluted shares outstanding of 137 million, GAAP net income per share was $1.83. Our non-GAAP net income was $302 million in the quarter, up 21%. Non-GAAP net income per share was $2.20, up 27% from last year.

Turning to the balance sheet on slide 14. At March 31, cash and cash equivalents were $387 million, and net debt was $6.2 billion. Liquidity remains strong with cash plus revolver availability of approximately of $1.4 billion. Moving to slide 15. The three-month average cash conversion cycle was 20 days, down two days from last year's first quarter and reflecting the impact of the Sirius acquisition. Free cash flow for the quarter was $466 million, as shown on slide 16. This is higher than a typical first quarter, reflecting strong growth in the business and effective working capital management. For the quarter, we deployed cash consistent with our 2022 capital allocation objectives of paying dividends and paying down debt, including 62 -- $67 million of dividends and $260 million in debt repayments. Turning to capital allocation on slide 17.

Our objectives remain consistent with what we shared last quarter. First, increase the dividend in line with non-GAAP net income. Last November, we increased the dividend 25% to $2 annually. To guide future increases, we will continue to target the dividend at approximately 25% of non-GAAP net income and to grow in line with earnings. Second, ensure we have the right capital structure in place with a targeted net leverage ratio of 2.5 to three times. We ended the quarter at 3.1 times, down from 3.4 times at the end of 2021, demonstrating strong cash generation and progress towards returning to our targeted net leverage ratio. We continue to expect to achieve this by the end of 2022. While we continue to temporarily put a lower priority on our third and fourth capital allocation priorities of M&A and share repurchases until net leverage is in our target range, we are on a path to delivering on these priorities. Moving to the outlook for 2022 on slide 18. Starting with sales.

As Chris mentioned, the first quarter was a great start to the year. We have excellent momentum entering Q2, we are cognizant of potential market variables as we look further out. Recall that on a combined basis, CDW's net sales would have been $22.8 billion in 2021, including $2.17 billion from Sirius. With that in mind, our updated outlook for the full year 2022 is now U.S. IT market growth of 4% plus 325 to 425 basis points of CDW outperformance in constant currency on a combined basis. On a reported basis, our full year net sales outlook equates to approximately 17.5% to 18.5% growth in constant currency. Our baseline outlook assumes that supply does not materially impact net sales beyond what we've been experiencing. We would expect to be at the lower end of our premium range and we mix more in the netted down revenue streams than expected and/or experience elevated levels of supply constraints. With that, the higher end of the hardware growth is stronger and supply improves. Our outlook also assumes neutral currency impact for the full year. Moving down to P&L.

We continue to expect full year non-GAAP operating income margin to be in the low 8% range. For non-GAAP earnings per share, recall that 2021 would have been $8.49 per share on a full year combined basis compared to a reported $7.97 per share, which included only one month of Sirius. We now expect full year non-GAAP earnings per share growth to be approximately 13%, plus or minus 50 basis points in constant currency and on a combined basis. This equates to low 20% full year growth in constant currency on a reported basis. Please remember that we hold ourselves accountable for delivering our financial outlook on an annual constant currency basis. Slide 19 provides additional modeling thoughts, including our updated net sales split for the year. We now expect the first half of the year to be approximately 25 basis points above the high end of our historic norm of 48% to 49%. This reflects our overperformance in the first quarter and strong momentum coming into Q2. It also reflects that it's too early to update our expectations for the second half of the year. We continue to expect the back half of the year will reflect a greater mix in the netted down revenues as we overlap 2021 strong client device sales.

Recall that the accounting treatment for netted down revenues has a dampening effect on our absolute net sales dollars but is neutral to gross profit dollars and thus results in higher gross margins, all else equal. Our expectations for the first half split assume a low single-digit sequential increase from Q1 to Q2 on an average daily sales basis. This equates to close to 20% year-over-year reported net sales growth in the second quarter, which is roughly 230 basis points above our Q2 implied growth rate expectations from last quarter. We expect second quarter non-GAAP earnings per share to grow in line with the second quarter reported sales. Finally, as you know, timing has a meaningful impact on free cash flow, and it may ebb and flow by quarter. But over the continuum, we continue to expect to be within our long-term free cash flow rule of thumb of 3.75% to 4.25% of net sales, assuming current tax rates. That concludes the financial summary. As we always do, 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 it up for questions. And can we please ask each of you to limit your questions to one with a brief follow-up. Thank you.

Operator

Thank you. [Operator Instructions] The first question we'll take is from Matt Sheerin from Stifel. Matt, your line is now open. Please go ahead with your question.

Matt Sheerin
Analyst at Stifel Nicolaus

Yes. Thank you. And good morning. My first question is just regarding the strength you're seeing across corporate and SMB customers in terms of the remote enablement. It seems like there's a second wave of work-from-home trends and could you elaborate on that? And then also just in terms of the back to office trends, how long do you see that playing out? And due to the backlog and the supply constraints, do you see this playing out through the year?

Christine A. Leahy
President & Chief Executive Officer at CDW

Good morning Matt, it's Chris. Yes. What we're seeing is customers across our commercial segments kind of, as we mentioned last time, getting on with it, meaning living within the current environment and making decisions about their back-to-work strategy, which means they're bolstering their capabilities in offices, they're bolstering their capability in home environments because they're really focused on their coworkers' ability to be productive and deliver seamlessly moving from remote to in office. And as we expected, we continue to see very strong endpoint solution performance this quarter. And we're also seeing what usually typically follows that and what was delayed a bit over the last couple of years, which is an investment in the hybrid infrastructure to support all the needs of the coworkers and the expectations, both at the workload and application level and everything required to create a stronger and more robust infrastructure for those devices. So we will continue to see those two dynamics play out through the course of the year, would be our view. It's different in different segments, but in the commercial segment, for sure, we'll continue to see that.

Matt Sheerin
Analyst at Stifel Nicolaus

Okay. Thank you for that. And the education market seems to be holding up better than most expect. You talked about some of the dynamics there. Higher ed spending, offset by weakness in K-12, although it seems like that next round of -- or extended funding period, at least helps that market, near term. Should we expect a fall off there, you're following that funding period? Or just general expectations for the K-12 market?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. So Matt, here's how I think about it. The extension and the new -- the -- a little bit of an added round of funding for ECF just is timing, right? So it gave the schools a little bit of a breather to reflect on their planning and not be rushed to buy. So that's just an extension. So we'll see that play out over the next 18 months. At the same time, schools are working very hard on ensuring that they don't lose ground in what they're trying to do, which is teach students and learn. And so when you think about the dynamics of the classroom and the infrastructure needs to support the classroom, including audio/visual, interactive monitors and kind of the new generation of the classroom, we're starting to already help our customers with that. So look, we look at this as a kind of steady eddy long-term growth opportunity for CDW. Every time there's been an inflection point in K-12 in the classroom, the learning space, CDW has been at the absolute tip of the spear in helping customers get there, and we've seen growth as a result.

Matt Sheerin
Analyst at Stifel Nicolaus

Okay. Great. Thank you.

Operator

Thank you very much. Our next question comes from Erik Woodring from Morgan Stanley. Eric, your line is now open. Please proceed with your question.

Erik Woodring
Analyst at Morgan Stanley

Great. Thank you very much. Good morning guys. Congrats on the results. Maybe as we sit here 90 days since you last reported or roughly 90 days, maybe can you just help us understand where some of the supply challenges you've been facing have either worsened or where some have improved? And then I have a follow-up from there.

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. I guess what word would I use? I think I'd say kind of unchanged, meaning the -- we're not seeing a lot of change in the challenges that we're all facing. When we think about the supply chain environment, I'd say two things. Number one, it's an opportunity, but it's also frustrating. It's an opportunity for CDW because we know what's happening. We have more visibility with our partners, I think, than anybody. When you think about our competitive advantages, our ability to take on inventory to support our customers with our balance sheet, having the distribution and logistics capabilities, that's put us in a great position to manage the supply chain issues, I think, again, better than anybody in the market.

But it's frustrating for customers. And we're helping customers get through that because we can help them choose alternatives, which they're a little more open-minded now to which we have a pretty good path to get to. But the short answer is supply chain is what it is, and it's not getting better. It's not getting worse. Some pockets are getting better. Some pockets are getting more difficult. But net-net, we're going to be living with this through 2022, if not into 2023. And again, it's a matter of who manages it the best, and I think we're doing a really good job of that.

Erik Woodring
Analyst at Morgan Stanley

Great. Super helpful. And then maybe my follow-up would just be, you beat the first quarter by a healthy amount, call it, $280 million, $290 million. You raised the full year guide by $400 million, and then your guide implies 2Q needs to come up by, let's call it, $115 million. So most of the raise comes from 1Q and 2Q. Is that just you guys taking the view here that perhaps visibility into the back half might not be as clear as perhaps any other year given the supply challenges and what's going on in the market? Or is there anything else that we should be thinking about just as we think about the second half, mixing netted down revenue, those types of factors?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. No, Erik, it's a fair question. Look, it's our -- it's CDW's typical approach, which is we'll call it when we're ready to call it when we think we have a good visibility. And it's just too early to call that in the back half of the year right now. But that said, outstanding start to the year, as you know, and we see absolutely excellent momentum going into Q2 and expect what a robust 20% profit growth in the second half of 2022. So we look at this and see a really aggressive but achievable goal in front of us. So we're feeling very optimistic about the year. And we'll call the back half of the year when we get a little closer to the back half of the year.

Erik Woodring
Analyst at Morgan Stanley

Great. Thank you. Congrats again.

Christine A. Leahy
President & Chief Executive Officer at CDW

Thank you so much, Eric. Appreciate it.

Operator

Thank you very much. Our next question is from Samik Chatterjee from JPMorgan. Samik, your line is now open. Please go ahead.

Joe Cardoso
Analyst at JPMorgan Chase & Co.

This is Joe Cardoso on for Samik Chatterjee. So my first question is a follow-up on the full year guide question prior. Can we dissect that a little bit, particularly as it relates to the raised outlook for the underlying IT market and CDW's outperformance to it? What are you seeing as the main drivers or contributors to the raised outlook for both? And then, I guess, how much of that raised outlook is being driven by recent acquisitions like Sirius tracking better than expected as opposed to kind of the traditional CDW business? And then I have a follow-up.

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. So let me start with the last part first, which is our premium to market. When we look at the areas that we've outperformed in Q1, let's take notebook overall solutions, several areas where we just -- our view is, look, we're really outperforming the market. It's pretty clear. So that goes into the premium. In terms of whether or not Sirius is contributing, here's how I think about it. On a combined basis, we're responding to customer needs in the current environment and seeing healthy business across both the underlying and Sirius segments. In terms of the underlying IT industry, yes, we brought that up because we're starting to feel real momentum in the business. The demand is there, the writing is there. So it just feels to us like the market is growing a little faster than we would have thought at the beginning of the year. So the IT market generally is kind of the written and demand that we're seeing. The premium is the categories that we're delivering in and looking at what we triangulate the growth rates to be in the market, we just think we're outperforming by a wide margin.

Joe Cardoso
Analyst at JPMorgan Chase & Co.

Got it. And then just quickly for my follow-up. Can you help me understand what you guys are seeing from a pricing perspective versus 90 days ago and whether that's translating into a tailwind or headwind for CDW?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. We are -- look, pricing continues to be fairly dynamic and fluid, I guess, I'd say, and we are continuing to see pricing increases given what's happening out in the macro environment. That said, we are a cost-plus model, as you know, and we're not seeing constraints in IT budgets. Our customers are still buying. They're not cutting IT budgets because of pricing. And as I think I mentioned in our prepared remarks, we're seeing some of the growth kind of split between unit increases and ASP increases. So they're both contributing to growth across the board really.

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

I would just add in, and I think we've mentioned this before. One thing we see in the supply environment is more creativity and agility both ourselves and with our partners in terms of where do we pivot to different products, where do we pivot to different solutions and finding customers are accommodating at and working with us to try to get to their solutions sooner than later. So that certainly has a bit of an impact from a mix and rate perspective. So just I would note that.

Joe Cardoso
Analyst at JPMorgan Chase & Co.

Got it. Thanks. Appreciate the colors.

Operator

Thank you very much. Our next question comes from Ruplu Bhattacharya from Bank of America. Ruplu, your line is now open. Please go ahead.

Ruplu Bhattacharya
Analyst at Bank of America

Thank you for taking my question. Congrats on the strong quarter. Chris, for my first question, I'd like to add something, which is a high-level question. Some investors are concerned that we may be going into a recession in the U.S. because the rates are going up or we might see a slowdown in Europe because of the war there. So can you maybe talk to us about how CDW as a company is different from what it was in the 2008, 2009 time frame? And do you think the company is better prepared now to face the downturn. And in the same way, you've raised your guidance for the full year. Can you talk about what are some of the things that are giving you confidence to do that given all of the macro and supply chain headwinds that are continuing? Thanks.

Christine A. Leahy
President & Chief Executive Officer at CDW

Good morning, Ruplu. Thanks for the comment. Let me start with the second part first. What's raising our -- what's feeding our confidence. It's what we're seeing with our customers. It's the demand, it's the momentum. It's the criticality of IT in every walk of every industry to drive competitive advantage, experience, etc. So we just see technology as absolutely central. And really, it's an investment in innovation. It's no longer viewed as a cost of the business as much as an asset of innovation, and we're seeing that and feel very confident that, that will continue, possibly at the expense of some other investments that organizations make but technology is top of the list. As far as the macro environment, what might happen, here's what I would tell you. First of all, we have -- our broad and deep portfolio is the best it's ever been at any point in time. Secondly, our flexible business model has allowed us -- in any challenging time, has allowed us to outperform the market and deliver results.

And if you look actually at the Great Recession, we did outperform the market. And if you think about the last three years, significant delivery of great performance versus the market. So -- and in those cases, we also emerge stronger. So you've got our portfolio, which is better than it's ever been. You've got our flexible business model, which has a track record of working and having us deliver performance in downtime. And when you think about our value proposition, third thing, I would say, the value proposition for our customers and our partners becomes even more important to them. They become even more reliant on our stability, on our scale and all the things that we deliver. And at the end of the day, that allows us to be opportunistic in helping them and gaining share in the market. So I point you to our track record and our model and our portfolio and our value proposition, which has over 35 years reflected the fact that CDW is a different company performs in tough times and in good times. And typically, in tough times, we come out even stronger than when we entered them.

Ruplu Bhattacharya
Analyst at Bank of America

Okay. Thanks for all the details there Chris. Maybe for my follow-up, if you can talk a little bit about the Government segment. It was good to see revenues grow 5% year-on-year after several -- you've been facing tough comps and several quarters of year-on-year declines. Last year, you talked about some projects that were delayed. Do you think those come back in the first half? And do you think government revenues can continue to grow year-on-year over the next couple of quarters? Thank you.

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. No problem. On the Government side, the Federal side, we have been saying now for a couple of quarters that we expect growth -- to see growth in the second half of the year. And that expectation has not changed. So the projects we've talked about, the green shoots we've talked about, we expect to be taking hold in the second half of this year as expected. As far as state and local, that's playing out as we thought it would as well. If you remember, the funding was coming in a multiyear fashion, the federal funding, and that was extending customers' buying patterns a bit. And we've been really helping them on the planning phase of spending those -- that funding, the federal funding, and we're starting to see that come to fruition, and you see that in the results this quarter, which is those projects starting to flow out now, which is a very positive thing and reflective of what we expected to happen.

Ruplu Bhattacharya
Analyst at Bank of America

Congrats again on the quarter and on the strong guide. Thank you.

Christine A. Leahy
President & Chief Executive Officer at CDW

Thanks. Thanks very much.

Operator

Our next question comes from Adam Tindle from Raymond James. Adam, your line is now open. Please go ahead with your question.

Adam Tindle
Analyst at Raymond James

Okay. Thanks. Good morning. I thought I would just maybe start with a question on margins. If I remember right, when you closed the Sirius acquisition, you talked about it adding just over 100 basis points to gross margin and about 20 basis points to operating margin based on 2020 numbers with no synergy assumption. If we look at this quarter, gross margin was up over 200 basis points, so double of that, but operating margin still up just about 20 basis points year-over-year. Maybe you could give us some color on the better mix on gross margin, the growth metrics being healthy overall, but seeing minimal leverage on the operating line. And I imagine you're going to talk about investments. So more specifics on the nature of those investments and expectations for return would be helpful. Thank you.

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

Sure, Adam. This is Al. So on gross margins, for the quarter, I would comment on a few things. Certainly, you had the impact from Sirius for the quarter. And I would say that accretive benefit was as expected. And we had a couple of other things that benefited our gross margin for the quarter. Number one, stronger netted down revenues that actually grew two times the level of our sales. Product margin, mix and rate were strong. And so they were important components on the gross margin front. So down to your NGOI margin question. So yes, NGOI margin, 20 basis points better than prior year, 10 basis points better than prior quarter, certainly had the benefit of Sirius. Just the one callout I would give you in terms of the accretive benefit there for Sirius is that given the seasonality of their business, Q1 is typically lower on the scale of the full year. And therefore, some of the fixed cost leverage we get from Sirius is more on the latter half of the year. So that has a bit of a dilutive effect for the quarter, but still we're able to turn in really strong 7.8 for the quarter.

Adam Tindle
Analyst at Raymond James

Understood. And maybe as a follow-up for Chris on backlog. You previously talked about feathering in over multiple quarters versus a big bang in one quarter. Just wondering if you could maybe revisit this since we saw such a strong quarter here on growth metrics. I think you did say remaining orders built in the quarter. So I just wanted to clarify that. And certainly, any color on the size and composition of backlog today versus 90 days ago would be super helpful. Thank you.

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. Good morning, Adam. I'd say, look, in terms of backlog building, it was in line with what we saw in Q4. So that would give you kind of -- characterizes the size. In terms of what we're seeing, it is a feathering out. So I think I said we're seeing pockets of improvement, yet new pockets of pressure. So we've seen notebooks free up a little bit. Chromebooks free up a little bit over the course of time, but solutions products really more constrained now than they were before, in particular, NetComm and I'm sure you're hearing that a lot. So look, we're in a -- we still expect it feathering out. We're not seeing anything in our results, frankly, or in our conversations with partners that suggest anything than the way we've already described it to you.

Adam Tindle
Analyst at Raymond James

Understood. Thank you.

Operator

Operator

Thank you very much. Our next question comes from Amit Daryanani from Evercore ISI. Amit, your line is now open. Amit, please ask your question.

Amit Daryanani
Analyst at Evercore ISI

Chris, I'm hoping you could talk about -- so you see this increased complexity of IT operations, I think, especially with the return to work, and there seems to be a sustained and acute labor shortage, especially on the skilled worker side. I'm wondering if that combination of those two factors is resulting in CDW seeing the TAM start to expand as you start to see that you're engaging with more mid- and even larger enterprises who typically would -- I'm just curious like, a, are you seeing this enable their TAM expansion? And what could that do to your growth rate as you go forward?

Christine A. Leahy
President & Chief Executive Officer at CDW

Good morning. In terms of the -- I want to make sure I could -- having trouble hearing you a little bit but you were asking about TAM expansion due to servicing enterprise-size customers and in particular, technology talent supply shortages. Did I get that right?

Amit Daryanani
Analyst at Evercore ISI

Yes. Yes. I mean given the labor shortages, IT is getting more complex, are you getting pulled in by bigger enterprises that you typically wouldn't? And does that expand your TAM? Does it alter your growth rates as you go forward?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. Okay. I got it, a fair question. Yes, when you look at -- a couple of things. You look at Sirius' customer segment, and it's heavily enterprise-oriented. So yes, we are focusing on the enterprise. If you look at CDW's customers, while we have typically said our sweet spot is customers with up to 5,000 end users, we have a very large number of enterprise customers that we service and have served us extremely well in the past five years, given the increase in complexity. So yes, we are in the enterprise space. We're continuing to grow in the enterprise space. And we have not done the calculation regarding the TAM, but we certainly expect to be able to continue to be successful in that space now more than ever. It used to be -- if you think about enterprise, and one of the reasons they might not have turned to CDW was because they would have and could afford the technology talent within their organization to handle everything that they needed. But now given the speed and complexity, even the larger organizations can't keep up with the changing nature of technology. And our ability to supplement and address that problem has really become a very interesting value proposition for those organizations and boy, did we see it play out during the pandemic.

Amit Daryanani
Analyst at Evercore ISI

Thank you. And then I guess, Al, you talked about gross margins and sort of a lever that led to the better performance in March. Could you just talk about the durability of these gross margins? Because I think you talked about mix getting better in the back half of the year with more cloud and security. So it could be run in the mid-18% to 19% gross margins for the remainder of the year? Or what are the puts and takes as you go forward?

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

Sure, Amit. So first, let's just start with our expectation, our outlook of low 8% on NGOI margin, right? So that is what we guide on in that regard. But just back to your comment -- your question on gross margin. Look, if we look at our strategy and the execution, I think that, that has played out over time in terms of expansion of our gross margin. I think this quarter is a great example of that, really bringing the power of all of that, right? Strong netted down revenues, product margin was a factor, Sirius coming online. So a lot of those variables are playing out. We would anticipate that, that would continue, and particularly when we talked about the second half, we expect a higher level of netted down revenues, which certainly is a theme. So if you get back to that NGOI margin, we believe that execution of the strategy and follow through on that will deliver the outcomes we're expecting.

Amit Daryanani
Analyst at Evercore ISI

Thank you.

Operator

Our next question comes from Jim Suva from Citigroup. Jim, your line is now open. Please go ahead with your question.

Jim Suva
Analyst at Smith Barney Citigroup

Thank you. And congratulations. Chris, earlier in the call, you had mentioned that the supply situation largely hasn't changed from, say, 90 days ago when the investors last spoke to you on such a call. I wanted to ask, though, if you dissect the end markets though -- or I'm sorry, not end markets, but end products, whether it be PCs or servers or compute or devices, have you seen some shifts there because there's been indications of things like Chromebooks seeing actually a big deterioration while maybe others seeing higher demand. So I'm wondering if you take it to the device level, have you seen some material puts and takes in shifts?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. Jim, here's what I would say, I would characterize the supply environment as pockets of improvement and pockets of pressure. The pockets of improvement over the past several months have been in the notebook and Chromebook, the transactional side of our business. And the pockets of pressure have really showed up in the solutions side. So we did see a shift, if you will. So we saw some feathering out on the client devices and -- but we've seen backlog grow in the solutions side of the business. And it's complex because in the solutions side, what happens is if you're -- if you've got an integrated solution, if you're missing one part of that, you can't get the software out if you don't have the hardware. So it gets pretty complex. So that's what we're seeing. And I think I mentioned also NetComm was a particular -- networking is a particular area -- a pressure area, I guess, I would say, within the solutions categories.

Jim Suva
Analyst at Smith Barney Citigroup

Okay. That makes a lot of sense. And then as my follow-up, probably more appropriate for Al. Al when we think about cash flow and uses, am I correct that kind of 2022 should be kind of a debt pay down year? Or is there sufficient cash flow because component costs are going higher and high growth, that inventory will need to be cash flow consumed to support the inventory? Or are you guys looking at actually strategically adding in more software services, security skill sets to your portfolio? Thank you.

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

Sure. Thanks, Jim. So first, just on the quarter and free cash flow, we had a strong free cash flow quarter and above our rule of thumb. You'll recall prior quarter, we were somewhat below that rule of thumb. And so I would just note to you, we're seeing some variability in this environment. And some of that Jim is a function of us making those investments and really leveraging our working capital. For the full year, we would still expect to be within our rule of thumb for free cash flow, albeit there may be some variability quarter-to-quarter. All of that intended really to go to, number one, our capital priority of dividend payment and then two, debt repayment. And you -- I will note that for the quarter, we had pretty meaningful repayment of our debt, and we got our net leverage down from 3.4 to 3.1. And our expectation is we'll continue to make that a priority. And our goal is to get back on our net leverage range for the full year by the end of the year.

Jim Suva
Analyst at Smith Barney Citigroup

Thank you so much for the details, Chris and Al.

Operator

Our next question comes from Keith from Northcoast Research. Keith, your line is now open. Please go ahead.

Keith Housum
Analyst at Northcoast Research

Good morning guys. Al, I was wondering, hopefully a little bit more color on the 23% growth. I understand it was a good -- a very good quarter for demand. But can you provide a little bit more breakdown between the three different elements which I think I'm hearing is the Sirius, growth in the volume and growth in price increases. Can you provide a little bit of context about the contributions of each?

Albert J. Miralles
Senior Vice President and Chief Financial Officer at CDW

Sure, Keith. Happy to weigh in and Chris may have something on the back end of that. So 23% is the all-in. As we mentioned in prior quarter, our focus is on integrating the companies and just the nature of integrating our sales, we're looking at it on a combined basis. So that 23% is inclusive of Sirius. And I would just note, notwithstanding my comment about seasonality at Sirius, the business is operating as expected and things are moving a pace on the integration. Otherwise, I would just point back to our comments about end channels and contribution as well as product portfolio. And I'd say, for the quarter, we fired on all cylinders and really contributions came from many of the key spots in the investment areas that we've been focused on.

Christine A. Leahy
President & Chief Executive Officer at CDW

Keith, it's Chris. Just to add on to what Al said. I think he really coined it with hitting on all cylinders. So the business is hitting on all cylinders, the customer end markets, the portfolio and the integration. I know you asked a question about integration. And I guess what I would say is, number one, Sirius, the integration is going outstanding. I could not be more pleased with the pace and with the results and also with the execution in the marketplace. As we said last quarter, we're really, really focused on integrating the businesses and bringing them together and going to market as one CDW and not really parsing out dollars and assigning credit, as we like to say.

So I would just tell you that it's going great. Our focus this first quarter has been all about our customers and our partners and our coworkers, in particular, and creating the road maps and the support and the tools they need to be successful. And at the end of the day, I think we said a couple of quarters ago, we expect one plus one to equal more than two, and there's absolutely nothing that is making us doubt that. We're very excited about what we're bringing to the market and in particular, excited about how our customers are responding to the value add and the combined entity.

Keith Housum
Analyst at Northcoast Research

Okay. I appreciate that. And as a follow-up to that, in terms of like the turnover of the coworker, and I guess the inflationary environment, can you guys provide a little bit of color in terms of how is the turnover of the coworker right now in terms of like compared to prior years? And then in terms of what you guys are forced to do in terms of salary adjustments, perhaps the impact that would have on operating expenses?

Christine A. Leahy
President & Chief Executive Officer at CDW

Yes. Look, it's a great question. And we're facing the same tight labor market that everybody does. The good news is we've been an employer of choice for a very long time, and we've focused on investing in our coworkers since our founding. And so the unique environment, the unique culture is a real draw for coworkers. The ability to grow one's career, the interesting work we do, that all is important, as important as compensation to coworkers staying with CDW. We've seen some tick up -- a little bit of tick up in attrition in certain pockets of CDW but nothing that I would say is kind of worth noting. We're working harder to bring in the talent. It takes a little longer to get new talent in.

But we're, of course, very focused on keeping our talent and that potential for attrition. In terms of the cost and adjustments to our compensation, look, again, we think about total rewards to coworkers and that includes the work, the people, the benefits, everything combined and not just the compensation per se. So we haven't had to make major adjustments. And then don't forget that the large section of our organization is variable comp. And so it's all about driving growth. And the more growth they drive, the more they make. And as you can see from our results, we should have a pretty happy team.

Keith Housum
Analyst at Northcoast Research

Got it. Thanks.

Operator

We have no further questions. [Operator Instructions] Yes. And there's no further questions, so I'd like to hand back to Chris, the CEO, for closing remarks.

Christine A. Leahy
President & Chief Executive Officer at CDW

Well, thank you, Daniel. Appreciate it and appreciate everybody's time today. I just want to emphasize that CDW has never been more well positioned to support our customers in a fast pace and changing technology environment, and we're very excited about the future. So I want to close by recognizing the incredible dedication and hard work of our more than 14,000 coworkers around the globe. It is their ongoing dedication to serving our customers, which is key and will continue to be key to profitably outperforming the IT market going forward. Thank you to our customers for the privilege and opportunity to help you achieve your goals and thank you to those listening for the time and continued interest in CDW. Al and I look forward to talking to you all next quarter. Thank you.

Operator

[Operator Closing Remarks]

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