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 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 8. Consolidated net sales were $5.4 billion, down 1.8% on a reported and an average daily sales basis. On a constant currency average daily sales basis, consolidated net sales declined 0.4%. Net sales were impacted by the significant change in client device demand during the quarter. With the decline in transactional products, there was a meaningful mix shift to 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. Certain solutions such as Software-as-a-Service, software assurance and warranty solutions as well as aging 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 netted-down revenues as 100% gross margin items. You 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. All 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 reflection of our success in the execution of our three-part strategy to capture share, enhance 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 decreased 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 mix shift of customer priorities, with respect to customer behavior, we did see increased scrutiny and deeper evaluation of projects and extra signatures increasingly required. 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 had seen some postponements and re-architecting on more complex hybrid cloud solutions as customers balance cost and utility.
On the supply side, we saw similar conditions as in the third quarter with some improvement across categories but pockets of pressure remaining, 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 not likely symmetrical across product categories.
We continue to manage inventory strategically to support our customers through this 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, a 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. The 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 mix that into transactional products, we would expect for this benefit to moderate.
Second, as we expected for the fourth quarter, a greater mix in the 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 9. Non-GAAP SG&A totaled $658 million for the quarter. The year-over-year increase in non-GAAP SG&A was primarily due to higher payroll consistent with higher gross profit attainment and higher coworker count. SG&A declined by $26 million compared to the third quarter, reflecting the variable component of our compensation structure, which is principally tied to gross profit attainment. In this uncertain economic environment, we are 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 15,100, up approximately 1,100 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 to 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, up 23.2%. Non-GAAP operating income margin was a record 9.6%, 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 interest expense compared to the prior year was primarily driven by the senior notes issued last year to fund the acquisition of Sirius. 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 $2.09. 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 Slide 14 through 19. As Chris mentioned, 2022 performance reflected exceptional execution, relentless focus and 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 increase 5%, below our prior expectation of 8.25% due to the moderation in IT market growth as well as a contraction in our premium in the fourth quarter.
Gross profit was $4.7 billion, up 31.3% and grew 19.7%, up approximately 260 basis points year-over-year. In 2022, software and services accounted for more than 40% of the total gross profit. Organic and inorganic investments in our services and solutions capabilities and a continued shift in the 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 20. At period end, cash and cash 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. Liquidity remains strong with cash plus revolver availability of approximately $1.4 billion.
Moving to Slide 21. The three-month average cash conversion cycle was 21 days, down three days from last year's fourth quarter, and within our range of high teens to low-20s, 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 capital allocation objectives, including returning $80 million to shareholders through dividends in addition to $200 million in debt repayment, which brings me to our capital allocation on Slide 23. Our execution remains consistent with objectives we communicated last quarter. For 2023, we're updating those objectives as follows. First, as always, increase the dividend in line with non-GAAP net income. Last November, we increased the dividend 18% to $2.36 annually. This increase demonstrates our confidence in the earnings power and cash flow generation of the business. Going forward, we'll 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 2.6 times net leverage, down from 3.4 times at the end of 2021, demonstrating strong growth in the business and excellent cash flow generation. As we expected and communicated during the third quarter call, 2.6 times had us near the lower end of our 2022 targeted net leverage of 2.5 times to 3 times. For 2023 and beyond, our targeted net leverage ratio will be 2 times to 3 times, a 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 financed the acquisition of Sirius. As such, we are pleased to have reestablished 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 a $750 million increase in 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, pivoted growth opportunities and outperform the broader market. While the overall IT 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 IT 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 200 basis points 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 tailwinds in the second half. This assumes an exchange rate of $1.24 to the British pound and $0.77 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 decline for the fourth quarter. We anticipate continued strong gross profit margin and NGOI 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, we're 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 4% to 4.5% of net sales, up from our prior range of 3.75% to 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'd ask each of you to limit your questions to one with a brief follow-up. Thank you.
