Gen Digital Inc (GEN) — Q3 2022 Earnings Call Transcript

Thank you, Paul, and good afternoon, everyone. Welcome to the NortonLifeLock fiscal 2022 third quarter earnings call. Joining me today to review our Q3 results are Vincent Pilette, CEO; and Natalie Derse, CFO. As a reminder, there will be a replay of this call posted on the Investor Relations website, along with our earnings slides, press release 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 investor.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 our 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 filings 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, and welcome, everyone. This was another strong quarter, with double-digit growth on both the top and bottom line, and we continue to drive improvements across several key business areas that we believe are critical to our long-term success. Q3 revenue and bookings grew 12% and 11%, respectively. The growth profile we delivered was broad-based, reflective of diversification across our product portfolio, channels, and geographies. And with 16% growth in EPS, our profitability remains strong and continues to grow faster than revenue. Later in this call, Natalie will provide you with more details on our Q3 results, but let's take a step back for a moment. It is clear to all of us that we are living more of our daily lives online: shopping, working, learning, creating, sharing; you name it, we are doing it all online. All of it is designed to make our lives easier, but it does come with the very real risk of more cyber criminality. Every day, this team wakes up driven by a singular purpose: making the world cybersafe for everyone and ultimately powering their digital freedom. Today, we are protecting and empowering approximately 80 million users in more than 150 countries where we are just getting started. Our strategy is built around our customers and their digital lives. We are focused on accelerating innovation, expanding access and reach, and relentlessly serving our customers' needs. Our innovation engine continues to thrive. In Q3, we introduced Avira Breach Monitor, where we actively scan the internet and alert users if their email is part of a data breach. In identity and in privacy, we continue to expand our reach internationally, combining Dark Web Monitoring, anti-tracking, and ID Navigator, bringing it to over 20 countries. Not only do we bring new products to market, we also improve upon category-leading products that we have offered for years. For example, using machine learning, we rolled out new alerts detecting unusual transactions for our LifeLock subscribers, better protecting people from various frauds or unusual activities. Day after day, this team brings energy and new ideas about how we can better build out the Norton 360 cyber safety integrated platform. Within various plans of Norton 360, our members automatically receive the benefits of our latest innovations: simplified and frictionless onboarding experiences, new device detection through QR codes, easy backup activation, software updater, improved integrated VPN, game booster, cryptocurrency mining and wallet options, and enhanced identity protection features like identity lock and social media monitoring. These are just a few of the new features made available in our Norton 360 platform over just the last few months. It is not just innovation; it is a continued commitment to protecting our users, highlighted with multiple AV-TEST awards, including the SE Labs Best Consumer Anti-Malware Awards for 2021. We know we are on the right track, as over 14 million customers are now on Norton 360, with more than one million members added since our Investor Day last May. We are thrilled that over 60% of our direct customers are now protected by the Norton 360 platform, and it keeps growing. Whether launching entirely new products, bringing these products to more people, or improving our industry-leading platform, we know that innovation is a core driver of our success. When customers choose us to help protect their digital lives, they stay with us. We have improved our Net Promoter Score by five points to the high 40s in the last 12 months. That strengthening engagement is also reflected in our retention rate, which is something we are particularly proud of. In Q3, it was slightly above 85%. If you exclude first-year customers, retention is at 87% in aggregate and as high as 90% for some cohorts of customers with the identity offering. This speaks to the power of our Norton 360 platform with identity protection, as traditionally in this industry, renewal rates for first-year customers or security-only customers are lower. But even in this category, we believe we can improve. We've already improved Avira retention to 83%, up three points since we acquired them. Through our evolving and innovative product portfolio and expanding distribution channels, we have added customers to the platform consistently over nine consecutive quarters. Total direct customers are now over 23.4 million, up 12% or 2.4 million customers added year-over-year and 126,000 sequentially. The growth was broad-based, although there was a slightly higher mix in security, as expected for the December holiday-driven quarter. In our direct-to-consumer channel, we observed some market pressure on ad prices, which slightly pushed up our customer acquisition cost. We partially offset those increases with improvements in shopping cart conversion. One of the key investment areas in our go-to-market strategy is the expansion in indirect channels. The net direct customer count increase that I just shared does not include customers coming through our partner channels, including employee benefits or through the App Store. In those two channels alone, we added almost 0.5 million customers year-over-year and over 100,000 sequentially. Interestingly, almost two-thirds of our new customers from app stores have installed the Norton 360 app. You will see us continue to expand and invest in our multichannel approach to reach more customers. While it's great that we've brought innovations to the market, added customers to our platform, and retained them, it is clear that we are delivering value. In Q3, our average revenue per user, or ARPU, was $8.87, but excluding Avira, we achieved a record organic ARPU well above $9, driven by higher Norton 360 adoption and successful cross-sell and upsell activities. Avira's installed base is more focused on traditional security features, which drives an ARPU just below $5. We view this as one of many opportunities to continue to grow and provide more rounded protection for all customers, Avira and internationally. Natalie will provide more details on ARPU in her section. To wrap up, I am excited to announce that we are driving to an accelerated close date for the merger with Avast. As you may recall, we originally expected to close in mid-calendar year 2022. However, while some outstanding regulatory conditions remain, we currently expect to close on February 24, 2022. We have made significant strides towards combining the two companies, including receiving approvals from both NortonLifeLock and Avast shareholders, satisfying regulatory conditions in the U.S., Czech Republic, Australia, and New Zealand, and securing permanent financing commitments. For the remaining regulatory conditions, we have submitted antitrust filings for the U.K., Germany, and Spain and are fully engaged with each of them. We fundamentally believe that this merger will allow us to increase our pace of innovation and better serve consumers globally. In the meantime, we'll keep driving our business forward. We've made great progress and frankly can't wait to merge with Avast. Together, we will accelerate the transformation of consumer cyber safety and power digital freedom for everyone. Now, I will pass the call over to Natalie to cover details of the financial results and the activities supporting our merger with Avast.

Thank you, Vincent, and hello, everyone. For today's discussion, I will focus on non-GAAP financials, starting with our Q3 results and then provide our outlook for fiscal year 2022. We delivered another excellent quarter. Our Q3 revenue was $704 million and at the high end of our guidance range. Revenue was up 10% in USD and up 12% in constant currency, including a two-point currency headwind as the euro and yen weakened against the U.S. dollar. Bookings growth accelerated sequentially and year-over-year, up 10% in USD and 11% in constant currency. We continue to effectively utilize the levers we have at our disposal to accelerate growth. Our total direct customer count increased to 23.4 million, adding 2.4 million customers year-over-year and 126,000 net new customers quarter-over-quarter. This was our ninth consecutive quarter of sequential net direct customer adds, with nearly 0.5 million net new customers added already this year. We remain focused on acquiring more customers at the top of the funnel in an increasingly competitive landscape. Q3 growth was broad-based, with strength in both the U.S. and international regions. Our new products and services in key international markets have improved our overall global reach. While our customer mix still skews higher in the U.S., we are capturing more international opportunities as we scale. Looking at our performance in Q3 across key operating metrics, unit retention was slightly above 85%, and our monthly average revenue per user, or ARPU, expanded sequentially to $8.87. Collectively, this contributed to 9% revenue growth in our direct business versus 5% growth in Q3 last year and no growth the year before. We believe this consistent growth momentum is built on the foundation of our Norton 360 platform, as well as our expanding product portfolio and the increasing value we provide to our customers. Retention is a major area of focus for us. Our renewal rates remain strong across cohorts, including our newer customers, which now reflect a larger mix of our customer base. Our cross-sell and upsell efforts are beginning to bear fruit, supported by new product velocity and expanding feature releases in global markets. While driving strong engagement throughout the customer journey and bringing more value to our customers, we, in turn, continue to increase retention and drive growth in our ARPU over time. Our partner business continued to grow double digits in Q3, with revenue up 17%, scaling in multiple channels, including employee benefits and the app store. Our employee benefits channel continues to grow double-digit, as we broaden our identity offerings to more employees in North America. Our app store channel was up double digits for the fifth consecutive quarter, driven by the success of our Norton 360 app. While our indirect business is just over 10% of our total, we continue to dedicate more resources in this area as we focus on broadening our go-to-market reach, making this a key tenet of our long-term growth strategy. Turning to profitability. We continue to deliver high operating leverage. Q3 gross margin stood at 87%, and operating margin was 52.8%, up 180 basis points year-over-year. We remain diligent in our cost structure in pursuit of efficiency opportunities and to create capacity for reinvestment to drive growth. We are operating our G&A functions at approximately 4% of revenue, down from 10% of revenue just two years ago. We continue to make investments in sales and marketing while navigating through the competitive advertising environment and higher ad costs. In R&D, we are focusing on increasing the pace of new product launches while effectively driving efficiencies. Looking ahead with Avast, we will continue to operate with a disciplined approach in our cost management to drive the synergies we've committed to, and pre-integration plans are already underway. Q3 net income was $260 million, up 14% year-over-year. Diluted EPS was $0.44 for the quarter, up 16% year-over-year and at the high end of our guidance range. We remain committed to driving EPS expansion and achieving our long-term EPS objective of $3. Turning to our cash flow and balance sheet. Q3 operating cash flow was $330 million, and free cash flow was $328 million. Year-to-date operating cash flow is $648 million, growing over 80% year-over-year. We continue to maintain a strong liquidity position and a healthy balance sheet. Our net debt leverage lowered to approximately 1.5 times in the quarter. But please note, this does not include any of our expected acquisition financing, as that does not become funded until the deal closes. In Q3, we returned approximately $73 million to shareholders in the form of a regular quarterly dividend of $0.125 per common share. For Q4, the Board of Directors has approved a regular quarterly cash dividend of $0.125 per share to be paid on March 16, 2022, for all shareholders of record as of the close of business on February 22, 2022, as described in the press release. We still have approximately $1.8 billion remaining in the current share buyback program, which is not being deployed at this time due to the pending Avast transaction. As a reminder, depending on the Avast merger shareholder elections, an incremental share buyback of up to $3 billion is possible, should Avast shareholders elect for the majority stock option. Before I get into our guidance, let me give you a brief update on the Avast merger financing. As you may recall, back in August of last year, we successfully syndicated our term loan A commitments for the acquisition financing. At the start of this calendar year, we launched the syndication of our term loan B commitments to be prepared for the deal close. We received strong interest and great reception in the debt markets. In fact, the demand was notably oversubscribed. We're pleased to report that we have successfully raised all of the required financing we had planned for this merger and will be ready to fund at the accelerated date for the deal close. Now turning to our outlook. We have narrowed our full year fiscal 2022 non-GAAP guidance to the high end of the range. We now expect to achieve fiscal 2022 annual non-GAAP revenue in the range of $2.795 billion to $2.805 billion, assuming stable currency rates quarter-over-quarter, translating to approximately 10% growth year-over-year in constant currency. For fiscal 2022 annual non-GAAP EPS, we expect to be in the range of $1.73 to $1.75, narrowing against that high end. Please note this guidance does not include any impact from the anticipated Avast merger close. We look forward to closing out another successful fiscal year. We remain well-positioned as the leader in cyber safety. We have growing momentum, a very healthy business model, and strong operating capabilities. I want to reiterate what we said last quarter. As we navigate forward, we will continue to challenge ourselves to anticipate, prioritize, and meet customer needs in a growth-focused manner. Thank you for your time today, and I will now turn the call back to the operator to take your questions. Please do keep in mind we are not able to answer any questions related to any specific M&A at this time.

Great. Hey, Vincent. Hey, Natalie, how are you guys doing?

Very good. Thank you for asking.

Absolutely. Thanks for taking my questions here. Great to see the results. Vincent, maybe I’ll start with you. I understand the disclaimer just on talking about specific M&A, but I think the most surprising news with the release here, in my view, is the earlier expected close for Avast on February 24. Could you share with us just some of the regulatory hurdles left, to understand the timeline from here to the 24th? Additionally, what gives you the confidence in that earlier close date compared to the June timeframe we were thinking about earlier?

Yes. To be honest with you, I never believed that I would say what I’m going to say, which is despite the fact that we posted a double-digit quarter, the most exciting news is that we are now closing the merger with Avast for February 24. We, as you can imagine, are super eager to get started. We’ve made great progress in our planning activities, and we know that this merger will offer an increased capacity for innovation and global reach to make cyber safety accessible for consumers. We’ve been patiently working through all the processes. As I mentioned in my prepared remarks, we made great progress on many fronts. We still have regulatory conditions to meet in the U.K., Germany, and Spain. We’ve done all the filings and we are actively collaborating with the authorities, answering all their questions. Based on this progress, and while I won't go into all the details, we’re now confident that we will meet all conditions or be able to waive them by February 24. So that's indeed great news.

Absolutely. We’ll look forward to that. Natalie, maybe for you just to zero in on the core business. Vincent mentioned great to see the double-digit bookings growth. You talked about a couple of the levers in your prepared remarks, including better retention, ARPU, and continued customer acquisition. Can you just go one level deeper into how you’ve been able to accelerate that growth to double digits here?

Yes, hi Saket, thanks for the question. In our prepared remarks, you heard us mention that the growth was broad-based, both in the U.S. and internationally, and across security and identity. We continue to post double-digit growth because we are bringing our new products to market faster, which allows us to offer increasing value to both new and existing customers. We focus our efforts on expanding our customer reach globally, driving both domestic and international growth while leveraging our acquisition of Avira to convert premium to paid subscriptions. We are also diversifying through partner and indirect channels, and all of this is coming together effectively, driving our double-digit growth.

Got it, got it. That makes a lot of sense. Vincent, if I could squeeze another one in, it’s a product question. I thought the social media monitoring solution that was announced recently was very interesting. Could you talk a little bit about the competitive landscape there and the additional value that you can capture with that tool? Because in the unfortunate world of cyber bullying, I imagine that's an interesting product. Can you just dig a little deeper into that?

Yes, I agree. We have a very broad purpose, which is to protect and empower everyone to enjoy safe digital lives and get the maximum value from that. As we move more online, we expose users, their families, and children to increased risks from cybercriminality, which is continuously evolving. I mentioned at our Analyst Day that we are moving up the stack of value from core device security to multi-device, and now including identity and privacy features, all while offering additional services that provide significant value as part of our cybersecurity platform. Social media monitoring fits into that product suite because it addresses online reputation management and protection against harmful activities like cyber bullying. We are focused on building a comprehensive cybersecurity platform and delivering value to our customers. Regarding competition, we observe a lot of innovation from startups, either geographically or product-focused, and we are excited about our position. The merger with Avast will enhance our innovation capabilities and accelerate the value we can offer.

Makes a lot of sense. I'll get back in the queue. Thanks, guys.

Thanks, Saket.

Hi guys, thanks for taking my questions and congrats on the double-digit growth. Vincent, you talked about capturing more international business and that Avast will accelerate that. Can you provide a bit more detail about what’s working internationally? How is Norton 360 resonating in international markets?

Yes. Very good question. Each geography is important, but as you know, Norton has historically had a more U.S.-centric base, with about 70% of our business coming from there. Two years ago, we identified a significant opportunity internationally, starting with our existing product portfolio. We learned that in many local markets, free features garnered attention, so we introduced a freemium model. The acquisition of Avira allowed us to test and successfully combine freemium to premium offerings in markets, proving our ability to grow across cohorts. The merger with Avast will significantly enhance our innovation offerings and our global strategy. We've also noted that as customers receive more value, ARPU and retention improve significantly. In Europe, digital identity has different meanings than in the U.S., so we will remain dedicated to understanding local markets within a global framework.

That's super comprehensive. We all recognize the international opportunities as significant for you guys. The other thing that stood out is your indirect success. I think you mentioned it’s just over 10% of your business. How do you envision developing more success there when historically you've focused on direct?

I completely agree with your observation. To reach five billion Internet users, a direct-to-consumer business model alone won’t suffice. We must continue forming partnerships, whether going indirect, combining solutions, or integrating with other providers, such as insurance companies. As we discussed previously, our employee benefits channel has been a key area of investment, and we now see promising results. It’s essential to maintain brand recognition and engagement with customers from our indirect channels, ensuring that we're moving up the value chain efficiently. We are particularly excited that Avast will enhance our channels, with their VSB/SOHO focus on gig economy and home workers. None of these offerings currently exist in NortonLifeLock.

Super exciting. Thanks, Vincent, and thanks everybody.

Hi everyone. Thank you for taking the question online from Hamza. Our first question is on the net subscription adds, which was a little bit below typical seasonality. I was wondering if you could just please expand on that a little bit. Has there been any change in renewal rates?

Yes. Thanks for the question. Growing our customer base has consistently been and will continue to be a key ingredient to our strategy. We posted our ninth consecutive quarter of quarter-over-quarter net ads. We also chose to report our customer ads defined as direct customers. We will continue to invest in driving this area, as it has been fruitful to acquire direct customers. However, it is not our only avenue for customer acquisition. We have discussed our indirect channels, which are diverse options to go to market. The direct channel is becoming more competitive regarding both spend and acquisition costs. Therefore, we are striking the right balance to leverage our diverse channels to acquire customers.

Just to add, I want to reinforce the indirect adds. A year ago, we launched Norton 360 on mobile for both Android and iOS, which saw an increase of over 100,000 net new customers in mobile and employee benefits quarter-over-quarter. Interestingly, about two-thirds of mobile app purchases were Norton 360. This impacts how we report direct customer counts. As we merge with Avast, we will review how we report customer counts to give investors a comprehensive view of our business across all dimensions.

Got it. Very helpful. One follow-up, if I could. How should we think about ARPU going forward now that the Avira acquisition has lapsed? Any thoughts on price increases, given the current inflation we're seeing? Thank you.

As it pertains to price increases and inflation, it’s very relevant, but for our business, we're software-based, so we don’t see much logistical and raw material inflation. The key for us when considering pricing is how we drive customer value. We focus on innovation and being the number one choice for customers when they decide how to protect themselves and their families. Our approach is on enhancing the price-to-value equation rather than simply raising prices because of inflation.

Regarding growth, we balance retention, ARPU, and new customer acquisitions. If the question is whether we can exceed the $9 average, the answer is yes. The majority of our customers don't currently have identity protection and are only utilizing core security features. Our efforts focus on driving the adoption of identity protection through our innovative portfolio.

Thank you both very much. Congrats on the results.

Thank you.

Thank you, Paul. And thanks everyone for joining us for this call. We appreciate your continued support and look forward to connecting with you very soon. So stay safe and be well. Thank you.