Gen Digital Inc (GEN) — Q1 2022 Earnings Call Transcript

Thank you, Chino, and good afternoon, everyone. Welcome to NortonLifeLock's fiscal 2022 first quarter earnings call. Joining me today to review our Q1 results are Vincent Pilette, CEO; and Natalie Derse, CFO. As a reminder, there will be a replay of this call posted on our IR website, along with our earnings slides, press release and supplemental materials, defining our non-GAAP metrics. I'd like to remind everyone that during this call all references to the final metrics are non-GAAP and all growth rates are year-over-year, unless otherwise stated. A reconciliation of non-GAAP to GAAP measures is included in our press release, which is available on our IR website at investors.nortonlifelock.com. Today's call contains statements regarding our business, financial performance and operations, including the impact of the ongoing COVID-19 pandemic on our business and industry, which may be considered forward-looking statements, and such statements involve risks and uncertainties that may cause actual results to differ materially from our current expectations. Those statements are based on current beliefs, assumptions, and expectations and speak only as of the current date. For more information, please refer to the cautionary statement in our press release and the risk factors in our filing with the SEC and in particular our annual report on Form 10-K for the fiscal year ended April 2, 2021. And now, I will turn the call over to our CEO. Vincent?

Thank you, Mary. Welcome, and good afternoon, everyone. So before we dive into our first quarter results, let me start by addressing the possible combination with Avast. We confirm that we are in advanced discussions with the Board of Avast regarding a possible merger. As we have said many times, M&A is a key part of our strategy and we're constantly looking at potential acquisitions and investment opportunities, some small, some larger in size. We believe in being disciplined in our approach and playing for the long term. So if or when we have mature developments, we will share those with you. I'm sure you understand that today we will not be able to answer any questions related to specific cases. So now with that out of the way, just barely over two months ago at our Investor Day, we shared with you our long-term strategic path to meaningful and sustainable growth. The ambitious big goals we set then should tell you everything you need to know about the opportunities that we see in front of us. Big audacious goals are not achieved in the short term, of course, but quarter by quarter strong execution creates the momentum that will allow us to meet our long-term goals. And Q1 is just that, a strong execution and solid results that put us right on track to achieve our ambition. We are off to a strong start to fiscal year 2022, with solid financial results for Q1. The direct-to-consumer demand for cyber safety remains a global opportunity, and our Q1 results are evidence of that evolving and underpenetrated opportunity. Overall, Q1 performance was in line with short-term and long-term commitments. Bookings and revenue growth were 12% and 13% respectively, and EPS grew 35%. We sustained our growth momentum in Q1 managing our business through the unpredictable macro environment and the transition to a post-pandemic environment in many parts of the world. At the heart of it, it is critical for us to focus on product and service innovation. This is the only way we can stay at the forefront of the ever-changing scope and sophistication of cybercrimes and offer consumers the best in cyber safety. In the first quarter, we unveiled four new products, doubling the number of new product introductions compared to a year ago. As we have said at our Investor Day, it is about being nimble, showcasing our ability to move faster and being better by learning along the way. Let me tell you about a couple of these product releases in Q1. As planned and previewed, we launched the very first integrated product with Avira called Game Optimizer. This new feature on the Norton 360 platform is designed to maximize gaming performance while strengthening security, freeing PCs from programs that are typically running in the background and consuming CPU system resources. This is another tool in our expanding toolbox, and we're excited and eager to give gamers tools that they not only need but want. Another new product is Norton Crypto. Although this seed investment is in its infancy, it is another example of how we are committed to innovation and how we are looking to enable and empower the digital lives of consumers. Digital currency is becoming an increasingly important part of consumers’ digital lives, and this feature allows you to use your idle PC time to earn digital currency. Our Norton Crypto allows you to track, transfer, and store earnings in the cloud. We accelerated our pace of innovation to be the first cyber safety company to provide such a feature to help ensure our customers have a safe and easy way to mine crypto without having to make trade-offs that could compromise their cybersecurity. As we transform our company to offer a richer portfolio, we've also made great strides in expanding our overall consumer reach. In Q1, our direct-to-consumer revenue, which represented the majority of our business, was up 11%. Our global expansion efforts are working as Q1 growth was partly driven by record growth in international. While our North America business remains larger than the rest of the world, the international growth rate once again outpaced the Americas. Similar to last quarter, our direct business grew double digits across multiple countries, including the UK, Germany, France, Australia and New Zealand. We continue to make great progress in leveraging Avira’s freemium model to broaden our reach while accelerating their free to paid conversion using our marketing capabilities. Another area of strength is our partner business, which posted double-digit revenue growth for the third straight quarter, up 29% in Q1, including Avira. Key channels continue to drive the growth, from benefits to online retail and service providers. As part of our all-in efforts to build the most comprehensive go-to-market model, we recently expanded our partnerships with Lenovo for our OEM business. Selected 5G Lenovo laptop PCs will be pre-installed with Norton Security and VPN app, available now in selected markets. While our OEM business is small, it demonstrates that we will continue to explore all avenues to reach customers. We have been highly engaged in various opportunities, and end markets globally in our partner business. Our goal is to continue to build and expand these long-term partnerships and increase cyber safety awareness everywhere. In Q1, our direct customer count grew by over 150,000 sequentially and including Avira, over 2.5 million customers year-over-year, bringing our total direct customer count to 23.1 million. This was our 7th straight quarter of net direct customer additions sequentially. Historically, it has been down sequentially driven by normal seasonality. Our customer retention rate remained strong at 85% as we drive new initiatives to further improve retention overall and within specific products and customer cohorts. As we shared at our Investor Day, we have started multiple operational initiatives targeting areas of improvement such as our first-year cohort and geographies with different customer profiles. Customer satisfaction and retention will continue to be a long-term focus for this leadership team. Finally, before I pass it to Natalie, I want to reiterate our core values and our inspiration to fulfill our vision to protect and empower people to live their digital lives safely. We think customer-first, we innovate and grow. We own it, we are open and authentic. These are the core values that push us to be better every single day to make the world cyber safe. Quarter in, quarter out, we have been and continue to exercise financial discipline and reinforce our cadence of innovation. We have demonstrated our ability to grow this business relentlessly, building a strong financial track record with consistent and accelerated growth. We are far from being done, of course, and we're just getting started as we look to transform our company to redefine consumer cybersecurity. And with that, let me turn it over to Natalie.

Thank you, Vincent, and hello, everyone. For today's discussion, I will focus on non-GAAP financials, starting with our Q1 results and then provide our outlook for Q2 and full year. Fiscal year 2022 is off to a strong start. Our Q1 revenue was $691 million, up 13% year-over-year on an as-reported basis, delivering above the high end of our guidance range. We grew bookings by 12% in the quarter. Our growth was driven by broad-based strength across all geographies and products and included a 2-point positive impact from foreign exchange. Our total direct customer count increased to over 23.1 million, adding 2.6 million customers year-over-year and adding 150,000 net new customers quarter-over-quarter. This was our 7th consecutive quarter of sequential net customer additions, a testament to our growing value proposition. Our customer retention rate, a unit retention metric, remains stable at 85%. Our monthly average revenue per user, or ARPU, is up on a sequential basis to $8.84. Our growing customer base, combined with our strong retention rate and expanding ARPU, accelerated the revenue growth of our direct business to 11% year-over-year. We continue to add more in-demand products and features into the portfolio to assist our cross-sell and upsell efforts, keeping loyal customers engaged through their life cycle. As we continue to grow our customer base, it is important to note that our first-year ARPU and retention rate for newly acquired customers is generally lower than our total average. But our growing product portfolio and customer-centric mindset make us well positioned to foster growth with these customers while expanding our reach to new audiences. Our partner business is a key tenet of our go-to-market strategy and once again posted strong results in Q1, up 29% year-over-year, including Avira and with broad-based growth across our distribution channels. Our employee benefits channel continues to post double-digit growth with an expanded pipeline. More small and mid-market employers are discovering that our identity theft protection solutions help mitigate the rapidly evolving cyber safety threats, including recent concerns related to unemployment and tax fraud. We're proud of the progress we've made so far and are excited about the upcoming expansion efforts in this channel. We also drove double-digit retail growth in key European countries as we continue to adapt to the market conditions in each country and focus on building the strategic partnerships needed to achieve our long-term goals. Turning to profitability, we remain focused on executing to achieve our long-term strategy and consistently drive sustainable growth with operational discipline. As I shared at our Investor Day, we continue to drive the core business at or above a 50% margin rate with Q1 operating at 51%, up 410 basis points year-over-year. In the quarter, we invested in performance marketing and product innovation. With our marketing investments, we operate with a disciplined approach to new customer acquisition, measuring and ensuring effectiveness along the way while adapting to consumer behavior shifts in the market and newer media offerings. We keep our eyes on the marketplace and continue to evolve our marketing spend mix to expand our reach in a relevant and efficient manner. With R&D, we continue to accelerate the pace of product introductions, investing to expand our product portfolio and provide an increasingly differentiated value proposition for consumers while focused on operational excellence and funding additional investment capacity through G&A efficiencies. Q1 net income was $248 million, up 32% year-over-year. Diluted EPS was $0.42 for the quarter, up 35% year-over-year and at the high end of our guidance range. We continue to prioritize sustainable growth and maintain strong operational discipline to deliver EPS expansion in line with our long-term strategy. Turning to our cash flow and balance sheet, Q1 operating cash flow was $258 million, and free cash flow was $257 million. We ended Q1 with over $1.2 billion of total cash and $1 billion of undrawn revolver capacity. Please note, this does not reflect the cash proceeds from the sale of our Mountain View Ellis buildings, which closed in mid-July for total cash proceeds of approximately $358 million. We continue to have a strong liquidity position, a healthy balance sheet, and are levered at approximately 2x net debt. Now, let me spend a few minutes specifically on capital allocation. In Q1, we returned approximately $74 million to shareholders in the form of our regular quarterly dividend of $0.125 per common share. At the end of Q1, there was approximately $1.8 billion remaining in the current share buyback program, which we intend to deploy opportunistically. As described in the press release, for Q2, the Board of Directors approved a regular quarterly cash dividend of $0.125 per common share to be paid on September 15, 2021, for all shareholders of record as of the close of business on August 23, 2021. Now turning to our Q2 and full year outlook. We expect Q2 non-GAAP revenue in the range of $690 million to $700 million, which translates to 10% to 12% growth year-over-year. We expect non-GAAP EPS to be in the range of $0.41 to $0.43 per share, assuming stable currency rates. We also reiterate our full year non-GAAP guidance presented in May at Investor Day, which is revenue growth of 8% to 10% plus year-over-year and EPS in the range of $1.65 to $1.75. Q1 was a great start to the year, and we look forward to building on this growth momentum with our scalable foundation. We're excited about the tremendous opportunities ahead. Thank you for your time today, and I will now turn the call back to the operator to take your questions. But please do keep in mind that we are not able to answer any questions related to any specific M&As at this time.

Maybe to start out with you, Natalie. I was wondering if you could talk a little bit about how you think about the seasonality of net adds in a typical year? And perhaps any color that you could give on retention rates in the quarter. Does that make sense?

Yes. And thanks for your question, Saket. On customer count, look, as you heard me say, we added 2.6 million year-over-year, 150,000 quarter-over-quarter. Yes, you're right. Q1 seasonally is lower. Note, last year, we were right in the heart of COVID. But from a seasonality perspective, Q1 honestly landed exactly how we expected it to. In terms of retention, retention is stable. 85% is our overall unit retention. And look, we are where we expected to be. Our focus now is on as we move forward, just driving new acquisition, retaining existing customers, both are key priorities for us. We're not only focused on staying relevant where the consumers are and making their buying decisions but we are just continuously driving and fueling innovation in our product roadmap, coupled with world-class customer service to really keep the current customers happy and satisfied, sustain and grow our retention rate, and again, prioritize new acquisition at the top of the funnel.

Got it. Very helpful. Maybe for my follow-up for you, Vincent. Understanding, we don't want to ask anything about sort of the headlines out there, maybe I can ask a broader question about capital allocation. Maybe outside of M&A broadly, how do you think about the priorities for capital allocation sort of going forward?

Yes, I can talk about capital allocation. But first, let me talk about the overall strategy moving forward, which is really about investing in innovation, bringing more products to redefine cyber safety, investing, as Natalie talked about marketing, while broadly defining investing in the more solid go-to-market model. We know that this market is still vastly underpenetrated when you take a broad definition of cyber safety, and reaching out to our customers is very important. We said it at the Analyst Day, we are operating management team that creates levers within the P&L. So we’re improving capacity to drive more innovations, more productivity there, more marketing spend, but we are also using all levers of our business including the balance sheet, and there you talk about the capital allocation. It's not rocket science. There are really 3 areas we use capital for. One is for inorganic investments, which we talk about M&A and all capitalized investment. The other one is buyback, and the other one is dividend. And we use all three in a balanced way. Now, when we talk about a balanced way, it doesn’t mean that every quarter it will be balanced. Also last year it was sort of exactly a one-third, a one-third, a one-third, but we will take a very long-term view of our business when it comes to investment and use of cash.

So Vince, this is, again, along the lines of trying to understand your thinking around M&A and specifically at the Analyst Day session you highlighted $0.30 to $0.35 from M&A as part of the bridge to $3 in earnings. So I'm just curious if you can add some perspective to that in terms of how scale from an acquisition might change the timing or a contribution to the doubling of that earnings profile? And then kind of as a follow-on, when you think of scale, how does dilution factor into that? Is dilution something you're willing to accept? And if so, for how long?

So to be very clear, right, we are under strict rules, we cannot talk about specific cases, and I want to make sure we follow all the rules, including the UK rules considering the one of the cases I think, as you know. So I'll remind you what we said in May in terms of the broad business, we talked about our long-term aspirational view and we said that we have multiple levers at a high level split between business growth, efficiencies, and then use of capital. And use of capital, we talk about just the capital allocation model, which has two prongs, the buyback and the M&A. We said that the way we manage the business in the long term, all of those levers should be contributors to our long-term aspiration. When we think about more tactical capital or capital structure, we look at again, all levers, all possible with our long-term ambition goal in mind to make sure we achieve those. And I'll leave it at that, and hopefully, you understand that we are under strict rules we intend to respect.

Vincent, I wanted to follow up on Saket's question about retention. It's clear that it remains strong overall at 85%. Could you provide more details on how the initial COVID subscribers are performing in terms of retention, along with information about Avira?

Yes. Overall, the results are quite good. This marks the first full quarter after experiencing significant growth as we entered the COVID lockdowns last year, which began in March and had a notable impact this quarter. It’s the first time we have three months, a full quarter, to reflect on the past 12 months, and many investors were curious about our ability to sustain customer count growth. We certainly experienced the effects of a weaker Q1, as people tend to spend less time engaged in their digital lives during the summer. However, the advancements we’ve made in enhancing our cyber safety platform, which extends beyond just a PC antivirus, demonstrate that we have not only maintained year-over-year growth but also achieved sequential growth, which is quite impressive for Q1. Typically, Q1 shows a decline following the busy Q4, especially due to tax season, but we managed to grow, which makes us very pleased with the outcomes. As Natalie pointed out, our results align with the guidance we provided, putting us on track and contributing positively to our full-year goals. Regarding the second question from investors, concerning customers who signed up for the first time during the COVID period, we wanted to know if they would renew at a similar rate. Over the last four months, from March to the end of June, we have observed stable renewal rates. Although the first-year renewal rates are lower than average at 85%, they align with the rates we saw during the same period last year and the year before. This presents an opportunity to enhance our retention rate through specific operational initiatives aimed at first-year customers and improving their satisfaction and experience. We have not detected any change in the behavior of what some may refer to as the COVID cohort. The third question is about Avira. Their retention rate was slightly below our average for Norton customers, but the difference is minor. Even with a slight increase of under 2 million Avira customers, our overall business retention rate has remained around 85%. There are more specific details I can't share publicly just yet, but I can assure you that we've seen improvements across all metrics, and Avira continues to perform well in both acquisition and retention. Additionally, we are focusing on the conversion from free to paid services and have reallocated some of our marketing resources to boost that conversion rate. Overall, we are very satisfied with the performance across all our business lines.

And then something else that's kind of stood out to me, ARPU grew sequentially. And it hadn't been growing for a while. I think we always thought with Norton 360, there would be an upward bias to ARPU. I know it was a subtle increase sequentially, but it was up. Anything to call out there in terms of trends or anything that you noticed?

Yes. As we mentioned last quarter, the Avira ARPU was roughly half of our Norton ARPU, more focused, of course, on the security. This lowered our aggregated ARPU that was at $9.10 before the acquisition to $8.80 when you take the aggregate by the pure fact of adding new customers that only had exposure to security plus a few other products, but didn't have exposure to a full cyber safety platform. From here, we continue to see good traction on ARPU. Now, as you know, as we continue to acquire new customers and be a net grower overall, the first-year ARPU is lower than the multiyear. The headwind from that first-year cohort growing is then offset by the slight but consistent and incremental improvement from the Norton 360 and the upselling to the portfolio.

I understand from the subscriber perspective that much of this is related to typical seasonality. However, Vince, you mentioned earlier the trends in demand after the pandemic. I'm curious how much of the decline in new subscribers can be attributed to those post-pandemic demand trends we observed last year compared to the usual seasonal changes from Q4 to Q1.

So I just want to be clear when you call it dip, and every time and see that I want to be sure we qualify it correctly. Last year, yes, last year, we grew sequentially between 100,000 net new customers to 400,000 new customers depending on the quarter. We also know that Q1 and Q2 had a seasonally low quarter on a sequential basis, and then Q3 is more security driven, and Q4 is a tax identity-driven quarter. So growing 150,000 a quarter, while it's less than Q4, of course, of last quarter, it is a very strong performance in a first seasonally low quarter of sequential net customer adds. So it's right on our plan. It's right on our short-term and long-term commitments. Would we want to have a higher awareness and penetrate faster? Of course, but we feel pretty good about that plan. What is the impact of the COVID or post-COVID market opening versus the normal effect of more people being in summertime on vacation, they’re mounting on the beach and less on their digital life? That we cannot say. I think it will always be a business that in the winter is a bit more dominant than it is in the summer.

And just maybe a follow-up. The partner revenue continues to grow quite strongly. Obviously, a much lower percentage of the overall revenue. But can you maybe give some color as to what's driving that in your recent partnerships that we should be aware of here?

Yes. And for those of you from NortonLifeLock that are listening, I want to thank you for driving a spirit of growth. I can tell you since we became NortonLifeLock, we told everyone, look, the opportunity also we committed to a mid-single-digit is much bigger than that. Look at the underpenetrated market. It is a business that had not been invested enough in the past as they shifted from partnership, the OEM mainly into direct-to-customer and build a very strong direct-to-consumer engine. We said it will be much more diversified and go in every area. There is no one salesperson within our go-to-market that doesn't come during our weekly or monthly reviews and say I have a new idea, should we invest in that. Natalie and I are going through the review, look at the investment and decide to invest. We have increased our sales capacity in a few of the channels. I mentioned a quarter or 2 quarters ago, our employee benefit channel that has been growing double-digit, and we continue to build that up. Mentioned, of course, the OEM is still small, but we can do more. We have our xSP business that continued to grow. Natalie mentioned that between online and physical retail balancing it and really strategically moving through the different opportunities by local market has always been an effort. Recently, a few months ago, we also started a country-by-country strategy that looks at all of our different channels, if you want, and trying to balance our investment in a coordinated way at the local level, and that also is bearing its fruits. You should see us continue to invest in our go-to-market organization.

Thank you for allowing me back in the queue. Vincent, earlier you mentioned the Avira acquisition. Could you share your insights on their end markets in Europe? What trends are you noticing in that region, particularly regarding market share in core antivirus and the potential to cross-sell your identity monitoring products there?

I think the latter part of your question is the right one. I still get the question around competition and is it like McAfee or Microsoft on antivirus? We see the market cyber safety as much more broad. Antivirus almost being kind of a free or commoditized product, building up the cyber safety platform around identity, around privacy, around new digital services is really where we see the demand. In Europe, it's definitely driven by new concerns around identity and privacy. We introduced monitoring in many of those countries. We are trying to build a richer portfolio around Norton identity for all of those customers. You touched on the opportunity to cross-sell currently strong focus on identity into an Avira freemium installed base, which presents a huge potential. It won't happen over one quarter. It will need multiple quarters to build that offering and drive that awareness and then that conversion. But it's a huge opportunity for us, for sure.

Excellent. Thank you, Chino. Well, let me be very short. Thanks for joining. Thank you for your support. Obviously, we'll continue to drive our business towards our long-term ambition, and we look forward to connecting with you very soon. Thank you.