CDW - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 was a clean beat: revenue $5.20B (+6.7% YoY) and non-GAAP EPS $2.15 both exceeded S&P Global consensus ($4.94B and $1.96), helped by ~2 pts of client device pull‑forward ahead of potential tariffs and broad strength in healthcare, education, cloud and services. Revenue and EPS beats vs consensus: +5.3% and +9.5% respectively*.
• Gross margin held firm at 21.6% (−20 bps YoY) despite client devices rising to 33% of net sales; netted‑down revenue (cloud/SaaS) reached a record 36.5% of gross profit, supporting margin resilience.
• Guidance maintained: CDW still targets US IT market growth low single digits with a 200–300 bps premium, stable margins vs 2024, and low single‑digit non‑GAAP EPS growth; currency view improved to “roughly neutral” vs prior “slight headwind”.
• Capital returns continued: $0.625 quarterly dividend declared; ~$200M repurchases in Q1 and 2025 target of returning 50–75% of adjusted FCF to shareholders.

What Went Well and What Went Wrong

What Went Well

• Cloud/SaaS and services outperformed: netted‑down revenue grew ~12% YoY and comprised 36.5% of gross profit; services top line rose 14% with double‑digit profit in managed/pro services, supporting margin stability.
• End‑market breadth: healthcare net sales +20%, education +11% (ADS), corporate +6%, SMB +8% (ADS); UK/Canada +10% (ADS) with UK leading.
• Management tone confident on strategy and positioning: “value proposition is stronger than ever” and continued goal to exceed US IT market growth by 200–300 bps on constant currency.

What Went Wrong

• Infrastructure softness: NetComm and storage were weaker on digestion and elongated sales cycles; tariff uncertainty slowed larger infrastructure investments even as it boosted client devices.
• Public sector friction: federal spending subdued amid new administration priorities; education pull‑forward likely makes Q2 sub‑seasonal.
• Gross margin mixed headwinds: client devices mix up to 33% of net sales compressed product margins slightly; management continues to “make space” for modest like‑for‑like compression.

Transcript

Operator (participant)

Ladies and gentlemen, the CDW First Course of 2025 Earnings Call will begin shortly with your host, Steve O'Brien. We appreciate your patience as we prepare your session today. During the call, we encourage participants to raise any questions they may have. You can raise a question by pressing star followed by one on your telephone keypad, and to mute yourself and line of questioning will be star followed by two. As a reminder, to raise a question will be star followed by one. We will begin shortly. Good morning, all, and thank you for joining us for the CDW First Course of 2025 Earnings Call. My name is Carly, and I'll be coordinating the call today. If you'd like to register a question during the call, you can do so by pressing star followed by one on your telephone keypad.

To mute yourself and line of questioning will be star followed by two. I'd now like to hand over to our host, Steve O'Brien of Investor Relations. The floor is yours.

Steve O'Brien (SVP of Investor Relations)

Thank you, Carly. Good morning, everyone. Joining me today to review our first quarter 2025 results are Chris Leahy, our Chair and CEO, and Al Miralles, our Chief Financial Officer. Our earnings release was distributed this morning and is available on our website, investor.cdw.com, along with supplemental slides that you can use to follow along during the call. I'd like to remind you that certain comments made in this presentation are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in the earnings release 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 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. Please note, all references to growth rates or dollar amount changes in our remarks today are versus the comparable period in 2024, with net sales growth rates described on an average daily basis, unless otherwise indicated. Replay of this webcast will be posted to our website later today. I want to remind you all 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.

Chris Leahy (Chair and CEO)

Thank you, Steve. Good morning, everyone. I'll begin today's call with a brief overview of our first quarter performance and provide thoughts on our view for the balance of the year. Al will provide additional details on our results, our capital allocation priorities, and further perspective on our outlook. We'll move quickly through our prepared remarks to ensure we have plenty of time for questions. The team had an excellent start to the year with strong execution during a period of rapidly changing market dynamics. Once again, the benefit of our strategic progress was evident with our industry-leading margins. Strong expense management and effective use of capital drove leverage down the P&L. For the quarter, net sales were $5.2 billion, 8% higher than last year on an average daily sales basis. Gross profit was $1.1 billion, 7% higher than last year on an average daily basis.

Non-GAAP operating income was $444 million, up 10%, and non-GAAP net income per share was $2.15, up 12%. Broadly speaking, customers remained focused on mission-critical projects and must-dos, and their priorities were consistent with 2024. Laser focus on operating efficiency and expense elasticity with one addition: client device prioritization, which reflected three factors: need for refresh, the upcoming Windows 10 expiration, and the desire to get ahead of tariff-related price increases. Underlying demand was solid. Commercial market growth was consistent with the favorable trajectory we saw late in the fourth quarter. Tariff uncertainty slowed down major infrastructure investments, but also drove demand for client devices and greater focus on expense elasticity, consumption-based solutions, and services.

Federal government market growth was subdued throughout the quarter as agencies digested the impact of new policy priorities, while education growth accelerated towards the end of the quarter, driven by Chromebook demand ahead of potential price increases. First quarter results underscore the power of our full-stack, full-life-cycle solutions. The team's ability to provide solutions that address customers' priorities for cost optimization drove excellent performance across services, software, and cloud. Let's take a closer look at how customer priorities and market dynamics impacted end market and portfolio performance in the quarter. As always, there were three main drivers of our results: our balanced portfolio of customer end markets, the breadth of our product solutions and services portfolio, and relentless execution of our three-part growth strategy. First, our balanced portfolio of diverse customer end markets. We have five U.S. channels: corporate, small business, healthcare, government, and education.

Each channel is a billion-dollar-plus business annually. Additionally, our U.K. and Canadian operations together delivered sales of $2.5 billion last year. Our scale allows us to segment our business into customer end markets with dedicated sellers and technical resources who deeply understand and address the unique priorities of each market. The benefit of our diverse end markets was evident in the first quarter, with all customer end markets posting average daily sales growth. Commercial top-line performance, which includes corporate and small business, was strong and balanced. Corporate and small business increased by 6% and 8%, respectively. Our ability to address both customer priorities for client devices and customer priorities for cost optimization with as-a-service and radical solutions drove solid profitability, and our commercial gross margin was steady year-over-year. Public top-line increased by 11%.

Healthcare was a standout performer with net sales up 20%, driven by client devices, cloud, and services. Education increased top-line by 11% with balanced performance across both K-12 and higher education. K-12 growth was driven by Chromebook, reflecting both customer refresh needs and buying ahead of anticipated tariff price increases, while higher ed growth was driven by security, data center, and services. Government net sales increased slightly as the impact of pauses in federal agency decision-making due to new administration priorities was offset by state and local growth. Other, which represents our U.K. and Canadian operations, posted a 10% increase, led by the U.K. The second driver of performance was our broad and deep portfolio of solutions and services, a key point of differentiation for us in the marketplace. This quarter, we had balanced performance across hardware, software, and services, with each increasing by high-single-digits or better.

Hardware increased top-line by 7%. Excellent growth in client devices, which increased more than 20%, was partially offset by declines in both net common storage. Software top-line increased by 10%. Top-line growth was primarily driven by the ongoing shift in spend from traditional networking to software-defined networking architectures. Software gross profit increased faster than net sales. Security performance was strong, consistent with the fourth quarter, with both top-line and gross profit growing by low double-digits. Priorities met by as-a-service and radical solutions to optimize spend drove excellent performance in cloud, with spend, top-line, and gross profit all up meaningful double-digits. Customers continued to lean into CDW services to build and execute their strategies, manage expenses, and accomplish mission-critical objectives, which drove a services top-line increase of 14%. CDW managed and professional services top-line and gross profit both increased by double-digits.

The third driver of performance is our ongoing investment in our customer-driven strategy, a strategy designed to maximize our relevance and differentiation in the marketplace and continuously fortify our leading position as vendor partner of choice and trusted advisor to our customers. To meet the accelerated pace of change over the last five years, we have concentrated our strategic investments on key high-growth, high-relevance areas like cloud adoption and optimization, cybersecurity, IT workflow optimization, and AI expertise. Given the vital role services play in today's interconnected solutions, recent investments have been focused on embedding services throughout our entire portfolio, including Mission Cloud Services, which closed last November. Just as our previous investments have done, Mission, a leader in AI and a premier AWS partner, furthers our ability to deliver mission-critical outcomes for customers.

An ability that is more important than ever in today's dynamic environment where customers continue to move forward with mission-critical projects. Movement we are seeing across our portfolio, and especially in security, where the need to deliver seamless access for employees while ensuring data protection is crucial. A need that our full suite of security solutions underpinned by products, services, and deep expertise addresses. A great example of this in action is the solution CDW developed for an American designer and manufacturer of heavy-duty commercial trucks. An industry leader for more than 100 years, the company had multiple HR systems with employees logging in daily across offices in the United States and around the world. Managing trust and identity required manual intervention and made it difficult to get a global view of the data.

Working closely with the company's CISO, our team engineered, designed, and implemented a solution that migrated data from on-premises identity governance to cloud-hosted centralized control. Utilizing artificial intelligence to streamline processes, the solution delivered a zero-trust environment for nearly 25,000 users. Not only did the solution deliver significant measurable outcomes through enhanced user access, compliance, and operational efficiencies, the scalable automated platform also set the company up for future growth. For CDW, the solution represents a multi-million dollar, multi-year software transaction and professional services fees that exceeded $1 million for our team's engineering and implementation work. This is a great example of the power of our strategic investments helping customers achieve mission-critical outcomes. That leads me to a topic that's on everyone's mind: our outlook for the remainder of the year. We are maintaining our 2025 outlook, which calls for U.S.

IT market growth to be in the low-single-digits on a customer spend basis, with a CDW growth premium of 2 to 300 basis points. While market parameters have changed since we first shared our outlook with you in February, our current view is underpinned by what we are seeing and hearing in the market, our first quarter performance, and a continued level of prudence. With the start of the second quarter, the overall rhythm of the business has been solid, and spend in the commercial market remains healthy. Despite the pull forward of client devices at the end of the first quarter, both written and shipped orders have been consistent with overall first quarter performance. Customers indicate that while they are watchful of the environment, they do not intend to alter their course for now.

Maintaining our full year outlook balances our better-than-expected first quarter results and current customer sentiment with two countervailing factors. First, it recognizes that our federal and education customers will need more time to adjust to recent government efficiency initiatives that will impact their IT planning, prioritization, and in some cases, their budgets. Second, it incorporates a level of general economic uncertainty and caution that could mute growth. Our outlook does not factor in potential wildcards such as recessionary conditions. Of course, the environment remains fluid, and as always, we'll continue to monitor the market and update our view as necessary throughout the year. There is no doubt that we are operating in uncertain times, but we have experienced uncertainty in the past.

During prior periods of uncertainty, most recently the pandemic and post-pandemic supply chain crisis, and before that, the financial crisis of 2008 and 2009, our partners and customers turned to us. They recognized the vital role we play in their success and knew that leveraging our strengths would lead to better outcomes for them. Once again, customers and partners are turning to us to help them navigate the challenges of today's dynamic landscape so they can effectively address cloud workload growth, increased security threats, an aging client device base, and significant data challenges, including how to manage data to leverage AI for insights and productivity aspirations. As they always do, our team has rolled up its sleeves. They are working with their customers to scenario plan, determine how to optimize spend, and identify sources of funds.

They are also working with customers to test multiple brands for future projects, providing product optionality depending on different tariff scenarios. To prepare for a potential economic slowdown, the team continues to help customers evaluate the economics of various architectures and procurement models. As our customers navigate this dynamic period, we are ready and confident in the power of our strategy and strength of our business model to weather uncertainty and serve our customers. Regardless of market conditions, we will do what we have done successfully in the past and focus on what we can control. We will manage the business to ensure we remain a vital, valued partner to both customers and vendors and ensure we are well prepared to capitalize on our strengths and accelerate out of the curve. With that, let me turn it over to Al.

Al Miralles (CFO)

Thank you, Chris, and good morning, everyone.

I will start my prepared remarks with details on our first quarter performance, move to capital allocation priorities, and then finish with our 2025 outlook. First quarter gross profit of $1.1 billion was up 5.5% year-over-year on a reported basis and 7.2% year-over-year on an average daily sales basis. This was above our original expectations of low single-digit growth as our teams captured increased demand for client devices, cloud, security, and services in a dynamic environment. We also saw a pull forward of demand for client devices that was most acute in the education channel, but also had a minor influence on other channels. In total, we estimate that we benefited by approximately $100 million in net sales or 2 percentage points of growth in the quarter. In line with our expectation, gross margin of 21.6% was relatively consistent with 2024 levels, down 20 basis points year-over-year.

Gross margins held firm even with strong client device performance, which comprised 33% of net sales, up from 29% of net sales in the first quarter of 2024. The higher contribution from client device sales was partially offset by higher contribution from netted down revenues. Netted down revenues contributed a record 36.5% of our gross profit, compared to 35.1% in the prior year first quarter and 35.8% in the fourth quarter of 2024. Our netted down category solutions, listed as transferred at a point in time for CDW's agent in our earnings release and filings, represent an important and durable trend within our business, alongside our professional and managed services listed as transferred over time for CDW's principal. We continue to expect netted down revenue streams to outgrow the rest of the portfolio, driven by consistently strong cloud infrastructure and SaaS growth.

Netted down revenues increased 12% year-over-year in the first quarter on an average daily sales basis. Moving on to a quick review of our end markets for the quarter. On an average daily sales basis, all of our channels grew on a year-over-year basis. Corporate and small business produced top-line growth for the second consecutive quarter. In the public space, education had a strong above-seasonal quarter as schools both refreshed aging devices and tried to get ahead of potential tariff-related price increases. While the government channel remained challenging, the team achieved our expectations and helped customers navigate a complex environment. Healthcare was a standout performer again this quarter as the team delivered mission-critical outcomes enabled by our strategic investments. International grew, driven by strength in the U.K. from PC refresh activity and full-stack wins with public sector customers, while Canada faced macroeconomic impacts that muted spending.

We still expect volatility in international end markets. Customers in these regions face ongoing economic and political uncertainty. Overall, I want to credit our teams for delivering above our expectations in a rapidly changing market. Our performance shows we continue to meet our customers where they need us most. Turning to expenses for the first quarter, non-GAAP SG&A totaled $678 million, up 2.8% year-over-year. This increase was due to higher gross profit achievement. The efficiency ratio of non-GAAP SG&A to gross profit was 60.4%, down 170 basis points from the 62.1% in Q1 2024, reflecting typical leverage and our disciplined approach to expenses. Coworker count at the end of the quarter was approximately 15,100, and customer-facing coworker count was 10,850, both relatively unchanged quarter-over-quarter and year-over-year. Our goal is to balance growth, expansion of capabilities, and exceptional customer experience with greater efficiency and cost leverage from our broader operations.

Non-GAAP operating income was approximately $444 million, up 10% versus the prior year, driven by expense leverage on our gross profit growth. Non-GAAP operating income margin of 8.5% was up from 8.3% in the prior year first quarter. Our non-GAAP net income was $287 million in the quarter, up 9.9% on a year-over-year basis, impacted by slightly higher interest expense following our debt refinancing last year and lower interest income primarily due to lower cash balances. With first quarter weighted average diluted shares of $133.5 million, non-GAAP net income per diluted share was $2.15, up 11.9% versus the prior year first quarter. Moving to the balance sheet, at period end, net debt was roughly $5.2 billion, up roughly $40 million from the fourth quarter of 2024. Liquidity remained strong with cash plus revolver availability of approximately $1.7 billion.

The three-month average cash conversion cycle was 15 days, down one day from the prior year first quarter, down three days from year-end 2024, and below the low end of our target range of high teens to low twenties. This cash conversion reflects our effective management of working capital, including disciplined management of our inventory levels, even as client device sales accelerated. As we've mentioned in the past, timing and market dynamics will influence working capital in any given quarter or year. We continue to believe our target cash conversion range remains the best guidepost for modeling working capital longer term. Adjusted free cash flow was $249 million in the quarter, consistent with our expectations and reflecting 87% of non-GAAP net income, within our stated rule of thumb of 80-90% of non-GAAP net income.

For the quarter, we utilized cash consistent with our 2025 capital allocation objectives, including returning approximately $200 million in share repurchases and $83 million in the form of dividends. As a reminder, we're targeting 50-75% of adjusted free cash flow to shareholders in 2025. We are clearly ahead of pace through Q1. That brings me to our capital allocation priorities. Our first capital priority is to increase the dividend in line with non-GAAP net income growth. We have increased the dividend for 11 consecutive years through 2024. We continue to prudently manage our dividend with respect to the growth environment and target a roughly 25% payout ratio of non-GAAP net income going forward. Our second priority is to ensure we have the right capital structure in place. We ended the first quarter at 2.5 times net leverage within our targeted range of two to three times.

We will continue to proactively manage liquidity while maintaining flexibility, as evidenced by our 2024 debt refinancing and redemption actions. Finally, our third and fourth capital allocation priorities of M&A and share repurchases remain important drivers of shareholder value. We continually evaluate M&A opportunities that could accelerate our three-part strategy for growth, as shown by our recent acquisition of Mission Cloud Services. Likewise, we remain committed to a target to return 50-75% of adjusted free cash flow to shareholders via the dividend and share repurchases. Now, turning to our outlook. While the strength we saw in the first quarter emanated from solid underlying demand, we also saw some customers trying to get ahead of potential tariff-related price increases, contributing roughly two points of our year-over-year net sales growth. We have contemplated this pull forward into our seasonal view, understanding it does not change the full year 2025 overall.

We came into 2025 with an appropriately prudent outlook, and despite the strong start to the year, we believe this environment calls for continued prudence. We are laser-focused on controlling what we can control and supporting our customers as only we know how to do in this dynamic environment. Our outlook assumes frictional impacts in the government and education channels and a level of general economic uncertainty and caution, but it does not factor in recessionary conditions. As always, as the landscape changes, we will provide you updates each quarter. With these factors in mind, we are holding to our full year 2025 view of low single-digit growth for the IT market. We continue to target market outperformance of 2-300 basis points on a customer spend basis.

Based on the anticipated mix of products and solutions, we continue to expect low single-digit gross profit growth for the full year 2025 and gross margins to remain relatively stable and within the range of 2024 levels. We expect first half gross profit to be slightly lower than the second half, but higher than the historical split of 48% versus 52%. Finally, we expect our full year non-GAAP earnings per diluted share to grow low single-digits year-over-year as we focus on profitable growth, exceptional customer outcomes, and an effective execution of our capital allocation priorities. Please remember, we hold ourselves accountable for delivering our financial outlook on a full year constant currency basis. On that note, we expect currency to be roughly neutral to reported growth rates for the year.

Moving to modeling thoughts for the second quarter, we anticipate mid to high single-digit gross profit growth sequentially, leading to low single-digit year-over-year growth. This factors in the pull forward in client device demand, ahead of tariffs, and subseasonal spending in the government and education channels. We continue to expect gross margin to be similar to overall 2024 levels. Moving down the P&L, we expect second quarter operating expenses to increase quarter-over-quarter seasonally, aligned to gross profit, but for non-GAAP SG&A as a percentage of gross profit levels to be lower than in the first quarter. Finally, we expect second quarter non-GAAP earnings per diluted share to grow at a mid-teens rate sequentially to a level that is nearly flat with the second quarter of 2024. That concludes the financial summary. As always, we'll provide updated views on the macro environment and our business on our future earnings calls.

With that, I will ask the operator to open it up for questions. We would ask each of you to limit your questions to one with a brief follow-up. Thank you.

Operator (participant)

Thank you very much. We'd now like to open the lines for Q&A. If you'd like to ask a question, please press star followed by one on your telephone keypad now. To move yourself to the line of questioning, it will be star followed by two. As a reminder, to raise a question, it will be star followed by one. Our first question comes from David Wright of UBS. David, your line is now open.

David Wright (Senior Wealth Strategy Associate)

Great. Thanks, guys. Good morning. Maybe both for permission now. I don't want to go into the tariffs because you talked a lot about tariffs, but I want to talk about some of the product categories.

You know, I thought you had relatively easy comparisons against Netcom and Storage last year. Obviously, I just want to kind of get your thoughts on what's going on in those markets. Are they seeing a pause in spending by customers ahead of tariffs or uncertainty? Just kind of what are the dynamics going on in those particular end markets that seemed a little bit weaker than I would have thought given some of the checks that we had done? Thank you.

Chris Leahy (Chair and CEO)

Yeah, good morning, and I can start with that. I would say you're absolutely right on the comparisons for networking. We still see some customers that are digesting, number one.

Number two, I'd say that if you look at our networking results, it reflects a continuing shift to software-defined architectures and a bit of a pause in the larger infrastructure deals that we mentioned in terms of the cautiousness right now. We don't see it as a harbinger or a problematic. It's just a timing issue in the first quarter. It's, you know, we are continuing to have what I would say are design discussions extensively, which to us is a leading indicator of what's to come. Not concerned about the categories, in fact, feeling that the services work that we're doing is foreshadowing what will be coming in the future quarters.

David Wright (Senior Wealth Strategy Associate)

Great. Thank you very much.

Operator (participant)

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

Hi, good morning.

This is Maya on for Erik. One question from me. You know, what are you seeing kind of across the pricing landscape? And given some of the competition comments you've made in recent calls, is there any risk that, you know, you would not be able to pass through any tariff-related costs to end customers? Just any color you can share there would be helpful.

Chris Leahy (Chair and CEO)

Yeah, let me, I would start with the resiliency of our gross margin that you saw this quarter notwithstanding tick up in client devices. So regardless of the, I'll call it competitive environment that we are in, we are still continuing to be able to drive profitability.

You know, as we see tariffs implemented down the line, we might continue to, we might see a tick up in competitiveness, but we feel fairly confident that we'll be able to, you know, pass along price increases. You might have customers, for example, buying fewer units of something, et cetera, but they're going to spend their budget. As you know, as the cost of goods sold goes up and the price goes up, the gross margin itself might reduce a little bit mathematically. Otherwise, we feel very confident, as we have in prior circumstances like this, that we'll be able to maintain our profitability.

Al Miralles (CFO)

Maybe I, Maya, I would just add to that. We would observe that in the quarter, despite quite a bit of variability, a pretty orderly market, certainly a variability across the different OEMs and product categories as well as end markets.

Really not the level of variability or, you know, concern there that you might expect in this type of environment. Just a reminder, we're a cost-plus provider. What we did see in that kind of orderly environment is pretty much where customers were taking actions that we were passing through the impact and maintained our margin. To Chris's point, we're able to hold firm in that regard.

Great. Thank you.

Operator (participant)

Great. Thank you. Thank you very much. Our next question comes from Asiya Merchant of Citigroup. Asiya, your line is now open.

Asiya Merchant (Technology Equity Research)

Great. Thank you very much for taking the question and good results here. Just, you know, healthcare has been up strong. I think you referred to that being strong again.

Just if you can parse out what's going on in this healthcare, is it specific to CDW and how you guys are thinking about, you know, it ahead in terms of your channel performance looking ahead to the rest of 2025? Thank you.

Chris Leahy (Chair and CEO)

Yeah, sure. I think, look, I think healthcare, there are the results reflect several things that are specific to CDW. In particular, our strategic progress over the last several years. We have invested behind both our sales organization, our technologists within healthcare, and our industry experts in healthcare. We've invested in things like the transformation centers where our customers can come together and test out technologies with CDW experts and their peers. We have focused our go-to-market on size and type of customer in the healthcare space, and you're seeing really good results based on the tremendous execution of that strategy.

Quarterly results, this, you know, for Q1, we did see a nice uptick in client devices. That reflects top-line growth significantly. The other thing is, we've mentioned this before, but healthcare organizations were a little behind in the adoption of cloud and cloud optimization. We have seen an acceleration over the last couple of years for CDW customers in our ability to help them actually accelerate workloads to the cloud, make decisions around that. Finally, I just say security has been a big driver for our healthcare results.

Operator (participant)

Thank you very much. As a reminder, if you would like to raise a question, please press star followed by one on your telephone keypad now. To remove yourself from the line of questioning, please press star followed by two. Our next question comes from Amit Daryanani of Evercore ISI. Amit, your line is now open.

Amit Daryanani (Senior Managing Director)

Yep. Thanks a lot. Good morning, everyone. I guess maybe to start with, Chris, I realize it's a tough evolving macro environment, but, you know, as you look at the SMB and corporate verticals specifically, are you seeing any change in the orders of buying behavior in Q2 versus what you saw in March? You know, did this pull in potentially sustain into the month of April given Liberation Day technically was in the first week of April?

Chris Leahy (Chair and CEO)

Yeah, good morning, Amit. Yeah, I would say we have been pleasantly surprised by the solid underlying demand and the rhythm of the business as we've moved into the second quarter. It's been a healthy rhythm, which means activity across our commercial sector, and that's been a very positive sign. You know, customers certainly are incrementally more cautious.

As I mentioned in my earlier comment, we are also deeply involved with customers in planning phases and design phases, and we take that as a positive sign for as we move throughout the year. Client devices in the commercial space have been very strong for the reasons we've discussed before. I mean, refreshes, we're probably, you know, we're probably now into the refresh and the early innings, kind of the mid-cycle, I guess I'd say. We got refresh picking up, and that's been a positive as well. I just say, look, we're cautiously optimistic. Our customers are incrementally more cautious. They are disciplined, but yet they're determined. Given the breadth and depth of our portfolio and our capabilities to help customers toggle to the most optimized solution, we are feeling, I would just say, you know, cautiously optimistic.

Amit Daryanani (Senior Managing Director)

Got it.

If I could just follow up with Al. Al, can you, when I think of your calendar 2025 guide and EPS growing low single-digits, can you talk about how are you embedding buybacks in that model? Because if I just assume you do your free cash flow conversion and your buybacks in that kind of 50% free cash flow range, you should be able to achieve your EPS guide on a flat revenue. Just talk about what are you embedding in your guide from a buyback perspective. Thank you.

Al Miralles (CFO)

Yeah, good morning, Amit. We are continuing to bake in an expectation, Amit, that we would be within that 50-75% range in terms of return to shareholders now. That being said, we in Q1 took advantage of valuation opportunities, and we did buy back $200 million in shares.

We certainly are ahead of pace. I would say kind of the front-loading does indeed, Amit, benefit us kind of when you think from an averaging perspective. We're not presuming per se that that pace will continue. I'd say we're still within the range of our 50-75%, albeit with Q1, it's likely towards the top of that range.

Amit Daryanani (Senior Managing Director)

Perfect. Thank you.

Operator (participant)

Thank you very much. Our next question comes from Samik Chatterjee of JPMorgan. Sami, your line is now open.

Samik Chatterjee (Managing Director and Equity Research Analyst)

Yep. Thank you. And thanks for taking the questions. Chris, I wanted to go back to your response to the question from Amit where you said, I mean, order activity and customer spending is still robust as you entered 2Q, but there are customers that are sounding a bit more cautious.

I mean, how much of that are you interpreting as customers want to spend the budget while they have it before they lose some of those IT budgets in the back half of the year versus sort of there being underlying demand for the equipment and there being an underlying demand that drives them to continue to invest in their infrastructure? Maybe like any insights you're getting from your project-driven activity versus transactional business in terms of whether customers are doing sort of choosing one versus the other? I have a follow-up.

Chris Leahy (Chair and CEO)

Sure. It was a little hard to hear the question, but I think I caught it. It was on our commercial spend and kind of dissecting how much of the April activity is related to transactional and spending budgets versus driving, you know, projects forward.

Look, let me start by saying we're sharing an outlook and our perspective based on what we've seen so far. Like everybody else, we can't predict the future. I would say I would call what we're seeing as solid and balanced. When I say balanced, that is across both transactional and activities that suggest that large mission-critical projects will move forward at some point. You know, the timing throughout the year, hard to say, but we're feeling a positivity and a determination amongst our customers. Our outlook does, however, reflect a more muted environment as we go out throughout the year because of the pull forward that we've experienced. We've baked that into our outlook, the incremental cautiousness, but I call it solid, balanced. It feels pretty good.

Samik Chatterjee (Managing Director and Equity Research Analyst)

Okay. Okay. A quick follow-up for Al here.

Al, the first half versus second half split, were you expecting more revenues in the first half versus historical trends? With the pull forward in client devices, how should we think about gross margin percentage rates related to some of the sort of cadence we've seen in the last couple of years? Is there more of a sequential increase as we go through the year on account of the client devices pull forward? Thank you.

Al Miralles (CFO)

Yeah, sure, Samik. No, I would not expect that there's going to be much in the way of variation on gross margin, both say Q2 as well as full year. We would expect gross margins to be reasonably similar to 2024 levels. Now, what we have seen, obviously, in the first quarter was a pretty significant mix shift into client devices and frankly away from solutions.

When you take those elements for the quarter, it explained almost all of the variation versus prior year and prior quarter as well. I will also note, Samik, that our original outlook contemplated some level of like-for-like compression in gross margins. And while we didn't see a ton of that in Q1, we are continuing to make space that you could see some of that. All in, when you add up all of those factors, Samik, I think you get back to something like 2024 levels.

Samik Chatterjee (Managing Director and Equity Research Analyst)

Okay. Got it. Great. Thank you. Thanks for taking the questions.

Operator (participant)

Thank you very much. Another reminder, if you would like to raise a question, please press star followed by one on your telephone keypad and to remove yourself from the line of questioning, please press star followed by two. Our next question comes from Harry Read of Redburn.

Harry, your line is now open.

Harry Read (VP of Equity Research)

Hi, good morning. Just wanted to ask on your hiring plans for the rest of the year. Do you expect to have a sequentially flat coworker base as you've seen in Q1? And then what are you currently seeing in terms of wage inflation in the market? And do you expect, if you see continued growth in gross profits, to see operating leverage like we've seen in the first quarter of this year? Thank you.

Chris Leahy (Chair and CEO)

Yeah, I'll start and then Al can jump in. Good morning. In terms of our plans for the year, we are managing expenses very prudently. At the same time, we are continuing to invest in strategic hires. I would just call it a balanced approach to our coworker investments during the course of the year.

When I say investment in strategic areas, you can think of areas like technology, particular sales roles, particular industry roles, particular technology and digital roles. We'll continue to invest behind that. In terms of wage inflation, we aren't really seeing anything of any note across wage inflation at this point in time. I didn't catch the third part of the question, Al, did you? Okay. Was there a third part of the question?

Harry Read (VP of Equity Research)

Yeah, just if you expect to see continued operating leverage. Can you hear me?

Chris Leahy (Chair and CEO)

Oh.

Al Miralles (CFO)

Yeah. Let me pick up on there.

Harry Read (VP of Equity Research)

Hello.

Al Miralles (CFO)

Harry. Obviously, yes, can you hear us?

Harry Read (VP of Equity Research)

I think there's a bit of a lag there.

Al Miralles (CFO)

[crosstalk] Obviously, what you saw in Q1 was pretty significant operating leverage.

That was partially a function, obviously, from our strong growth, but a little bit impacted as well by the pull forward. I think what you can expect on the operating leverage front is in this environment of low single-digit growth kind of remainder of the year, we wouldn't have quite the operating leverage we had in Q1 because there's a bit of a kind of asymmetry there between what we saw in growth in Q1 and then what kind of plays out for the rest of the year. That being said, you know, like Chris said, we are cautiously optimistic that the solid underlying growth we've seen could play out. Certainly, that would lead to stronger operating leverage for the full year. Maybe, Harry, I would just add to that on Chris's comments on the headcount.

She talked about continuing to invest in the business. That's super, super important. Really, our playbook here has been, while we feel good about the potential inflection point and solid underlying demand, we want to be cautious in terms of our spending and our hiring overall to the extent that if we did see a pullback, we would not want to be in a place where we have to more urgently pull back on expenses. What you're seeing is kind of a careful, thoughtful plotting of our expenses and our hiring to ensure that kind of we're balanced in this dynamic environment.

Harry Read (VP of Equity Research)

Okay. That makes sense. Thanks. Maybe just a very short follow-up. Is that incorporating why the guidance on EPS growth is the same as gross profit growth at this stage?

Al Miralles (CFO)

You've got it, Harry. That's spot on.

It's just essentially with our really strong growth from Q1, you have a bit of kind of a deceleration and a bit of an asymmetry in your operating leverage.

Harry Read (VP of Equity Research)

Great. Thank you.

Operator (participant)

Thank you very much. Our next question comes from Keith Housum of Northcoast Research. Keith, your line is now open.

Keith Housum (Managing Director and Research Analyst)

Good morning, guys. Just understanding that you guys are a cost-plus model. Perhaps can you talk about the impact you've seen on pricing right now? I mean, have vendors on a wide scale, you know, raised their prices? And if they have, you know, to what extent are you guys seeing? And if they haven't, you know, what are your expectations for or what conversations you're having with them in terms of when they may occur and what they're thinking for the rest of the year?

Al Miralles (CFO)

Yeah. Good morning, Keith. A couple of things.

First, look, it did vary quite a bit by OEM, by product category, etc. I will remind you too, Keith, look, more than 50% of our business in the form of gross profit comes from software and services. So you would not see it in those categories. You have kind of the remaining less than 50% focused on hardware. Certainly, there were OEMs, partners that had price increases as we saw tariffs. I will just point back to pretty orderly. We were way in front of those. We had a really good sense of how that was going to play out. We were in constant interaction with our customers in terms of the timing and the quantum of those.

You know, but it is, as you would expect, based on the OEMs that we do business with and where they're located and kind of how tariffs may impact them.

Keith Housum (Managing Director and Research Analyst)

Great. In focusing on the services that you guys offer to your customers, are you guys raising the prices on those or are you guys kind of holding firm?

Al Miralles (CFO)

Sorry, Keith, did you say services?

Keith Housum (Managing Director and Research Analyst)

Yes.

Chris Leahy (Chair and CEO)

Your question was, are we holding prices on services or raising those? Yeah, we're maintaining market competitive pricing right now.

Keith Housum (Managing Director and Research Analyst)

Great. Thank you.

Operator (participant)

Thank you very much. Our next question comes from George Wang from Barclays. George, your line is now open.

George Wang (VP Senior Analyst)

Thanks for taking my question. I just have a question on the AIPC and the kind of increasing AI complexity in general. Just curious if you have any refreshed thoughts in terms of given the dynamic macro and the tariff backdrop.

You know, has anything changed kind of you would like to call out versus three months ago? Just in terms of whether you are seeing a faster or steady or slowdown in terms of AI adoption in general.

Chris Leahy (Chair and CEO)

Yeah, I would say, look, the refresh that we're seeing or the uptick in client devices is coming still primarily from a refresh need and the expiration of Win 10. We are selling AI PCs. We're having more conversations about that. I would say that the majority of what we're selling now continues to be through just refresh and moving to Win 11.

George Wang (VP Senior Analyst)

Okay. Great. Just quick follow-up, if I can, just, you know, in the last couple of days, we saw this new flash in terms of collaboration with Penguin Solutions, which caught my eye.

I'm just curious, you know, is it something you can replicate towards other providers and kind of the vendors in terms of this unique setup? I'm just curious if you can double-click on this partnership and kind of what's the value add from CDW.

Chris Leahy (Chair and CEO)

You know, George, as you know, we don't talk about specific partners. I would say that in all of the various partner relationships and ecosystems, CDW is in conversations with these partners front and center to ensure that our value proposition is appropriate.

George Wang (VP Senior Analyst)

Okay. Great. Thanks a lot.

Chris Leahy (Chair and CEO)

Thank you.

Operator (participant)

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

Ruplu Bhattacharya (Director)

Hi. Thanks for taking my questions. First one for Al. I think you said that in 1Q, the netted down items were 36.5% of gross profit.

Just my math suggests that that means that the core business, ex-netted down items, was sequentially lower and year-on-year lower in terms of gross margin, maybe at like 14.9%. Can you just help us think through how you're thinking about the core business margins as this year you should see client devices come up, but then you've also had a very strong quarter of netted down items. Do you think that core business margins can continue to remain strong for the rest of the quarters in the year? I will follow up on seasonality. Thank you.

Al Miralles (CFO)

Sure. Thanks, Ruplu. You are correct. Our non-netted down gross margins for the quarter were about 40 basis points lower than the prior year.

I think I mentioned earlier, Ruplu, that the delta on our year-over-year delta on our overall gross margins, as well as on non-netted down, was almost entirely a mixed phenomenon. That is, the mixing into client devices, including the pull forward effect, as well as mixing out of solutions, drove that decline. There was very little in the way of like-for-like compression in those margins. Again, I'll just reiterate, Ruplu. That being said, we continue to kind of have some caution and are making space that you could see more like-for-like compression. At this point, we're holding pretty firm.

Ruplu Bhattacharya (Director)

Okay. Okay. Thanks for the clarification there, Al. Then maybe one for Chris. You've seen some pull forward in the education space. Typically, the June quarter is a strong quarter for education.

Is there a change in seasonality that we should think about for education this year as we model out the rest of the quarters? The same question, Chris, for federal. How are you seeing the impact of DOGE? Do you think federal might remain a little bit weaker for the next quarter? How are you thinking about growth in federal in the second half? Thank you for taking my questions. Really appreciate it.

Chris Leahy (Chair and CEO)

Yeah. Thanks for the question. On education, I would think of it simply as a pull forward. The seasonality that we normally see in Q2, we saw a number of our customers pull that forward and buy in ahead of potential tariffs. We have de-risked our second quarter, if you will, as a result of that.

On the federal side, we've also anticipated a more muted environment there as there's more friction in the system as the government determines how to respond, prioritize, manage budgets, etc. We've factored that into our outlook for the full year as well, expecting a little bit more muted. Sometimes you see an uptick once you have a new administration in office. We aren't expecting that as much now, and we haven't seen that as much now. I would say that on the positive side in federal, a number of the agencies that are strong customers of CDW on the non-defense side are agencies that are not yet seeing cuts and are still going strong. That's a positive sign for us.

Al Miralles (CFO)

Ruplu, I would just maybe add, when you add that up for Q2, when you add that up for Q2, including the frictional elements in federal, the pull forward for education, and some frictional elements there, we would expect Q2 to be sub-seasonal.

Ruplu Bhattacharya (Director)

Okay. Understood. Thank you so much.

Al Miralles (CFO)

Thank you very much. We currently have no further questions. I would just like to hand back to Chris Leahy for any further remarks.

Chris Leahy (Chair and CEO)

Okay. Thank you. Let me close by reemphasizing my confidence in this team, our strategy, and the durability of our resilient business model. Thank you to our CDW coworkers across the globe for your unwavering commitment to our customers. Thank you to our customers for the privilege and opportunity to help you achieve your goals. Thank you to those listening for your time and continued interest in CDW.

Al and I look forward to talking to you next quarter.

Operator (participant)

As we conclude today's call, we'd like to thank everyone for joining. You may now disconnect your lines.