Gen Digital Inc

NASDAQ:GEN

Earnings Call Transcript 2022-Q1

[Operator]

Good afternoon, everyone. Thank you for standing by. My name is Chino, and I'll be your conference operator today. I would like to welcome everyone to the NortonLifeLock Fiscal 2022 First Quarter Earnings Call. Today’s call is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

At this time, for opening remarks, I would like to pass the call over to Ms. Mary Lai, Head of Investor Relations. Ms., you may begin.

[Mary Lai, Head of Investor Relations]

Thank you, Chino, and good afternoon, everyone. Welcome to the 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?

[Vincent Pilette, Chief Executive Officer]

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 advance discussion with the Board of Avast regarding a possible merger. As we 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. And the ambitious big goals we set then should tell you everything you need to know about our 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 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 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 fore front 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 Norton 360 platform is designed to maximize gaming performance, while strengthening security, freeing PCs from programs that are typically running in the background and hugging 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. What 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. And 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 cyber security.

As we transform our company to offer 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, 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 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 adds sequentially. In accordance, it has been historically 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 or 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 [scrub] it, we own it, and 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 cybersafety.

And with that, let me turn it over to Natalie.

[Natalie Derse, Chief Financial Officer]

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 geos and products and included a 2-point positive impact from FX. 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 adds, 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 cybersafety 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 in 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, all the 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, 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, we are not able to answer any questions related to any specific M&As at this time. Operator?

[Operator]

[Operator Instructions] We do have a question from Saket Kalia from Barclays.

[SaketKalia]

Maybe to start out with you, Natalie, just on the core business. 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?

[NatalieDerse]

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, what we -- 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.

[SaketKalia]

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?

[VincentPilette]

Yes, I can talk about capital allocation. But first, let me talk about the overall strategy moving forward is really about investing into innovation, bring more product to redefine cybersafety, investing, Natalie talked about marketing, but broadly define 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 cybersafety 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, and 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 balanced way, it doesn’t mean that every quarter it will be balanced. Also last year it was sort of exactly a 1/3, a 1/3, a 1/3 but we will take a very long-term view of our business when it comes to investment and use of cash.

[Operator]

Next one on the queue is Jonathan Ruykhaver from Baird.

[JonathanRuykhaver]

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?

[VincentPilette]

So to be very clear, right, so we are under strict rules, we cannot talk about specific case 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-prong, the buyback and the M&A. And 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, thereto at 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 respectfully.

[JonathanRuykhaver]

Yes. No, I appreciate that color Vincent. So the other question I have is that it looks like you're dipping your toes back into the PC OEM channel. And so I'm just wondering if you can walk through what you see around the opportunity there? Is this a channel that you're likely to pursue more aggressively going forward? And maybe just remind us on how you see the economics of that go-to-market. Years ago, Symantec walked away from that channel because of those economics.

[VincentPilette]

100%. So Symantec kind of almost owned the majority of those channels in the past decade ago or 5, 6, 7 years ago. Those relationships had long tail, and we still have a little bit of those into our business today. As you know, the economic on a long-term basis take a 7-year or 10-year view, requires more investment upfront and then profitability over time as your total customer value has a long tail 6, 7 years. So that's how it works.

When Symantec decided to really focus on maximizing the profit of the consumer division to fund their enterprise turnaround, they made certain decisions. When we became NortonLifeLock, 100% focused on consumers, really maximizing the protection for digital lives of every consumers connected to the Internet. We said, and I'll confirm that today, we look at always to reach the customers, all go-to-market channels. It's just they have to make sense financially in the short, mid or long-term view and we'll go and develop the best, most diversified distribution channel for reaching all those consumers, creating the awareness and fulfilling the demand.

As part of that, I also said we don't have anything that we want to exclude from and obviously, relationship with PC manufacturers, although we are focused on the user experience and the Internet and the cloud, digital lives is one of the ways that could be favorable. And so the relationship we announced with Lenovo or the few remaining relationship we have in our current distribution channel are important, and we'll continue to look at creating capacity in our P&L to go and develop all channels, if you want, to go to consumers.

[Operator]

Next question comes from the line of Matt Hedberg from RBC.

[MatthewHedberg]

Vincent, I wanted to follow up on Saket's question on retention. Obviously, it's clear that it remains strong, overall, 85%. I guess I'm wondering if you could provide a little bit more color on -- obviously, you noted the strong sub add quarter, last year due to COVID, how some of those initial COVID subs are doing from a retention? And also Avira.

[VincentPilette]

Yes. Fairly good. So you point on the -- and I'm sure Saket meant them behind his questions, which is, this is the first full quarter where you're leaping the first big growth that we had as we entered the COVID locked-in periods last year, as you remember, starting in March, but really impacting this quarter. So it's the first time we have 3 months, a full quarter of 12 months looking back and a lot of investors and a lot of people were wondering, were we going to be able to maintain a customer count growth. And we definitely have seen the impact of a lower quarter Q1, as you know, when in summer, people get out and they're less into their digital lives. But I think the progress we've made in expanding the need for cybersafety platform, which is different than just a PC antivirus, if you want, has shown, and we were able to maintain not only a year-over-year growth but a sequential growth, which is pretty extraordinary continued in Q1, but Q4 is a big quarter with the tax quarter and then normally Q1 sequentially is down and we're able to grow it.

So we’ve very happy by the results, as Natalie mentioned, it's in line to what we had embedded into our guidance. So we are on plan and put a big deposit into our full year plan.

The second question I get from investors is those people or those customers that signed in for the first time during the COVID period, are they going to renew at the same level? And what we have seen in now 4 months looking back March to end of June, we've seen very stable renewal rates. Now they are first year renewal rates so that are lower than average 85% but the first year renewal rates a year ago, 2 years ago, are in line to what we saw this quarter. We believe it's an opportunity to improve retention rate by specific -- or driving specific operational initiatives around the first year cohort and customer satisfaction and experience. But we have not seen a change in behavior with what some of you may have called the COVID cohort, if you want.

The third question I get is around Avira. Avira was slightly below in their retention rate, below our average Norton customers, but not that far behind. And despite the addition of a little bit less than 2 million Avira customers, we've seen an overall retention rate for our business that maintained around 85%. And I have more details and we've not made them public for obvious reasons, but I have more details, and I can tell you that we’ve improved on every line and Avira too continues to have a solid -- although small incrementally a solid performance on both acquisition and retention.

In addition, they have a third dimension we are learning or we're building is really the free to paid conversion and we've redeployed some of our marketing capacity and capabilities to drive and increase that conversion rate as well. So we're very pleased by the performance of all of our lines of businesses.

[MatthewHedberg]

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?

[VincentPilette]

Yes. As we mentioned last quarter, the Avira ARPU was roughly half of our Norton ARPU, more focused, of course, on the security. And so it 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 cybersafety platform. And 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. And so 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.

[Operator]

[Operator Instructions]. Next question on the line is Hamza Fodderwala from Morgan Stanley.

[HamzaFodderwala]

Just on the -- so I understand from the subscriber standpoint, a lot of that had to do with sort of normal seasonality. But Vince I think you mentioned earlier sort of post-pandemic demand trends. I'm wondering how much of maybe the dip in subscriber adds was due to that post-pandemic demand trend that we saw much of last year versus typical seasonality from Q4 to Q1?

[VincentPilette]

So I just want to be clear when you call 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 net new customer 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.

And 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 sequential net customer adds. So it's right on our plan. It's right on our short-term and long-term commitments. Do we -- 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. And I think it will always be a business that in the winter is a bit more dominant than it is in the summer.

[HamzaFodderwala]

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?

[VincentPilette]

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. And 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 continue to grow. And then 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 look at all of our different channels, if you want, in 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 GTM organization.

[Operator]

We do have a follow-up question from Saket Kalia from Barclays.

[SaketKalia]

Thanks for letting me back in queue here. Vincent, you mentioned the Avira acquisition earlier. I was wondering if you could just comment a little bit about what you're seeing in sort of their end markets in Europe specifically? What are you seeing in that market -- maybe just to expand, what are you seeing in terms of Europe around market share in core antivirus as well as perhaps the opportunity to cross-sell your identity monitoring products in that geo?

[VincentPilette]

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? And what is -- we see the market cyber safety as much more broad. Antivirus almost being kind of a free or commoditized product and building up the cyber safety platform around identity, around privacy, around new digital services, if you want, is really where we see the demand. And in Europe is 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. And you touched, the opportunity to cross-sell currently strong focus on identity into an Avira freemium installed base is a huge potential. It won't happen over 1 quarter. Need multi-quarters to build that offering and drive that awareness and then that conversion. But it's a huge opportunity for us, for sure.

[Operator]

At this time, there are no more questions. I will turn the call over back to Vincent Pilette, CEO, for closing remarks.

[Vincent Pilette, Chief Executive Officer]

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.

[Operator]

This concludes the conference call. Thank you.