Gen Digital : Q3 FY23 Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

GEN.OQ - Q3 2023 Gen Digital Inc Earnings Call

EVENT DATE/TIME: FEBRUARY 02, 2023 / 10:00PM GMT

OVERVIEW:

GEN reported 3Q23 non-GAAP revenue of $936m, non-GAAP net income of $291m and non-GAAP diluted EPS of $0.45. Expects 4Q23 non-GAAP revenue to be $935-945m and non-GAAP EPS to eb $0.44-0.46.

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FEBRUARY 02, 2023 / 10:00PM, GEN.OQ - Q3 2023 Gen Digital Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Mary Lai Gen Digital Inc. - Head of IR

Natalie Marie Derse Gen Digital Inc. - EVP, CFO & Principal Accounting Officer

Vincent Pilette Gen Digital Inc. - CEO & Director

C O N F E R E N C E C A L L P A R T I C I P A N T S

Hamza Fodderwala Morgan Stanley, Research Division - Equity Analyst

Saket Kalia Barclays Bank PLC, Research Division - Senior Analyst

P R E S E N T A T I O N

Operator

Good afternoon, everyone. Thank you for standing by. My name is Frances, and I will be your conference operator today. I would like to welcome everyone to Gen's Third Quarter Fiscal Year 2023 Earnings Call. Today's call is being recorded. (Operator Instructions)

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

Mary Lai - Gen Digital Inc. - Head of IR

Thank you, Frances, and good afternoon, everyone. Welcome to Gen's Fiscal 2023 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 IR website, along with our slides and press release.

I'd like to remind everyone that during this call, all references to the financial 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.gendigital.com.

Today's call contains statements regarding our business, financial performance and operations, including the impact on our business and industry, that 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 filings with the SEC and, in particular, our most recent reports on Form 10-K and Form 10-Q.

And now I will turn the call over to our CEO, Vincent?

Vincent Pilette - Gen Digital Inc. - CEO & Director

Thank you, Mary. Good afternoon, everyone, and welcome to our Q3 earnings call. To start, I want to first thank each Gen employee for their contributions in 2022. Merging 2 companies is never easy, and I'm proud of their dedication and the tremendous progress we have made. Quickly getting the integration done right creates the foundation for Gen to keep empowering millions to live their digital lives safely.

We are at the intersection of a digital transformation that touches all aspects of our lives and an ever-evolving threat landscape that threatens our digital security, identity and privacy. Although malware is still one of the biggest threat vectors, hackers and scammers continue to shift to attacking individuals and their data, not just the device anymore. The shift to the individual means that your information needs to be protected in all the digital places where it lives.

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FEBRUARY 02, 2023 / 10:00PM, GEN.OQ - Q3 2023 Gen Digital Inc Earnings Call

In today's world, protecting your device for malware is often not enough. Information, whether it's usage, discovery or manipulation, is more damaging financially and to your reputation than malware has ever been. The threat volume landscape and sophistication have grown, not reduced. Whether it is test identity, fraud, privacy or fake news, people's financials, their reputation and overall digital safety are under threat. We are committed to fulfilling consumers' immediate needs and giving every person connected to the digital world a path towards total cyber safety.

Gen brings together trusted brands, such as Norton, Avast and LifeLock, and combines many capabilities. Our combination of technology, products, marketing and sales channels creates a strong foundation for Gen's long-term growth plan. It strengthens our product innovation efforts, diversifies our business, increases global scale and opens new go-to-market opportunities.

We set a strategy to be the best cyber safety platform for consumers, and we have the growth levers to get us there. As we shared on the last call, the growth levers are extending global reach by leveraging our omnichannel strategy, increasing value for customers expanding to identity and privacy solutions and growing loyalty from customers by improving user experience and retention.

Before I highlight our Q3 results and pass it to Natalie, let me share the progress made on the integration. As you would expect, we've hit the ground running fast. In the first 3 months, we've integrated our back-end systems and processes and deployed a unified go-to-market structure, enabling us to optimize our investments across all brands. We identified and eliminated about 700 duplicative jobs or activities. We are in the process of deploying our new location strategy, leading to facility reductions. And this week, we're integrating our code-to-cash processes.

Product integration will be the long pole where we are striving to not only maintain but accelerate our pace of innovation, which supports our revenue synergies and broader growth objectives. In this case, we are strategically driving the integration of our technology and engineering teams to ensure that we continue delivering innovative products that address the dynamic threats people face every day.

Overall, you can see our progress in the expanding operating margin. We are on track to achieve the $300 million plus annual cost savings exiting fiscal year 2024. Our integrated teams are now coming together across continents sharing knowledge and adopting best practices and technological know-how with a focus on driving customer loyalty, platform adoption, cross-selling activities which are at the core of our revenue synergy plans for the next 2 years.

Let's turn to Q3 results. The market trends we saw in Q3 were consistent with what we have been seeing in the last few quarters, persistent pressure on global e-commerce traffic and lackluster overall consumer demand and inflationary pressures. We believe that consumers have taken a more cautious approach to their spending in this challenging environment.

Despite the macro factors, we delivered our 14th consecutive quarter of growth. And when we look at our direct and partner business combined, which we call now Cyber Safety, our Q3 bookings and revenue were both up 4% in constant currency when including Avast's historical results in the base.

Growth was spread across regions, brands and product lines. We expanded our operating margin by 3 points year-over-year and 4 points sequentially. EPS grew 2%, with the negative impact of currency and interest expense masking the strong execution and operational strength of our business.

Our direct business grew 3%, similar to last quarter's growth rate. In this soft environment, we continue to strategically deploy our marketing spend to achieve the highest returns and efficiency, prioritizing higher ARPU and customer retention but not taking our eyes off the ball on the top of the funnel.

Growth was supported by strong cross-sell, especially with double-digit growth in our privacy offerings and slight sequential improvement in Avast retention, while our direct Cyber Safety customer count declined by slightly over 200,000 quarter-over-quarter.

On the partner business side, we continue to make strong traction with our diversified and omnichannel approach, delivering another double-digit growth quarter. Growth this quarter was primarily driven by wallet share gains from existing partners as we continue to demonstrate our value proposition.

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FEBRUARY 02, 2023 / 10:00PM, GEN.OQ - Q3 2023 Gen Digital Inc Earnings Call

As you've heard me say too many times, the core of Gen's success is product innovation. And the integration of the 2 companies will only accelerate our combined capabilities. In Q3, we introduced several new products. We launched Norton Executive Benefits Program, which is a product that includes both LifeLock and ReputationDefender solutions, and is designed for employers that want personalized concierge support for their C-suite executives and other high-profile individuals.

We continued to expand our identity business internationally with the launch of credit monitoring features in the U.K. market. In the U.S., we launched 2 new products. First, Avast Identity Secure (sic) [Avast Secure Identity] was launched in December, which includes identity test protection, alerts assistance and loss reimbursement. Additionally, LifeLock added an industry-first feature called Utility Alerts, which monitors new utility or telco accounts that are opened in customers' names.

In privacy, we have launched a mobile app for our Norton AntiTrack product to extend our reach. And we've also expanded our global reach with the launch of Norton Privacy Monitor Assistant to Canada for the very first time.

Our strategy in the short and midterm is to expand the value offered to our current customers through new product launches and an improved user experience that comes within our platform that we've developed. We believe these focuses will grow loyalty and retention. Innovation is a top priority, and we will continue to invest to have the strongest portfolio that keeps our customer cyber safe.

Let me wrap up my comments here by saying that our growth strategy remains intact. We will continue to execute to drive profitable growth in this challenging environment and create long-term value for all stakeholders.

And now let me turn the call over to Natalie to cover our results in detail. Natalie?

Natalie Marie Derse - Gen Digital Inc. - EVP, CFO & Principal Accounting Officer

Thank you, Vincent, and hello, everyone. For today's call, I will walk through our Q3 results, give an update on synergies and wrap up with our outlook for Q4. I will focus on non-GAAP financials and year-over-year growth rates unless otherwise stated.

Our Q3 results reflect another solid quarter of performance and consistent execution. We came in above the midpoint of our revenue guidance and at the high end of our EPS guidance. We drove our 14th consecutive quarter of bookings growth supported by our resilient customer base, an expanding product portfolio and our channel and geographic diversification efforts.

We grew Q3 bookings 29% in USD and 35% growth in constant currency. When including Avast's historical financials, Cyber Safety bookings grew 4% year-over-year in constant currency. Our major contributors to growth in Q3 included ARPU expansion as we scale our cross-selling efforts, stable retention with our existing customer cohorts, growing double digits with our partners for the ninth consecutive quarter and driving our direct business to mid-single-digit growth supported by several new product launches.

Q3 non-GAAP revenue was $936 million, up 33% in USD and 38% in constant currency, which includes a full quarter of Avast contribution. This also includes an unfavorable FX headwind of $34 million year-over-year, or 5 points of growth, the highest it's been all fiscal year. When including Avast's historical revenue, Cyber Safety revenue grew 4% year-over-year in constant currency.

Now let me walk through our Cyber Safety key operating metrics for the quarter. Direct revenue of $818 million, grew 31% in USD and grew 3% when including a Avast's historical financials.

Considering the continued macroeconomic pressures persisting in the market, we are proud of our performance in driving higher value and loyalty with our existing customers as measured by ARPU expansion and retention improvement this quarter. Direct monthly average revenue per user, or ARPU, was USD 7.9, an expansion of $0.11 quarter-over-quarter.

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FEBRUARY 02, 2023 / 10:00PM, GEN.OQ - Q3 2023 Gen Digital Inc Earnings Call

We drove growth through our expanded cross-sell and upsell efforts, just like we said we would do back in November. Our scaling privacy offerings have strong traction with our existing customers who choose to attach these incremental services to their existing subscriptions, driving high double-digit growth in the quarter.

Cyber Safety membership adoption has increased again this quarter as customers choose the incremental value and services we offer through our integrated platform versus stand-alone offerings. Direct customer count ended at 38.4 million, a decline of 219,000 quarter-over-quarter as we continue to face into a challenged macroeconomic environment. Traffic to our e-commerce sites is lower than last year and is impacting our new customer acquisition funnel. We continue to invest in a diverse mix of marketing spend to help drive more traffic to our site while optimizing the channel mix and dynamically adapting to market shifts in efforts to drive higher customer acquisition.

We strive to delight and retain our existing customer base, and it's working, with direct retention sequentially up and landing above 75% with pockets of improvement in different cohorts. One of the primary synergy opportunities we shared in November was the Avast retention improvement. In a short period of time, we made early inroads with the vast retention rate sequentially. And while the improvement was nominal, we are encouraged by the early progress. Looking ahead, we expect traction with revenue synergies to be measured directly through ARPU and retention improvements over the coming quarters.

Moving on to partners. We drove partner revenue to $95 million, 40% growth year-over-year as reported in USD and 11% growth when including Avast's historical financials. This was our ninth consecutive quarter of double-digit revenue growth across our partner channels, a result of our growing international portfolio, enabling us to sign new partnerships and capture more new business with existing partners.

We continue to leverage existing telco and retail partnerships to drive the distribution of our expanded product offerings. Our employee benefits channel is a differentiator in the market with a strong growing pipeline, spanning across small, midsized and large employers. With our broad reach in distribution, we will continue to invest and are well positioned for growth in this channel.

Turning to profitability. Q3 operating income was $526 million, up 41% year-over-year. We expanded operating margin to over 56% as a result of our continued cost discipline, our accelerated integration efforts and our strong execution of cost synergies.

Through Q3, we have reduced our overall operating expense profile from 35% to 31% of revenue. Synergistic workforce reductions from approximately 4,500 employees to roughly 3,850, facilities rationalization from a hybrid workforce strategy and early consolidation of duplicative enterprise IT contracts are structural contributors to our lower operating costs.

We are making inroads to the 60%-plus margin framework we've outlined last quarter. At the end of Q3, we achieved approximately 1/3 of the annual cost synergy target from an exit rate perspective, and we remain on track to achieve cost synergies of over $300 million as we exit fiscal year 2024. As planned, this creates more operating leverage to reinvest in product innovation and sales expansion as we move forward in our growth efforts.

Q3 net income was $291 million, up 12% compared to last year. Diluted EPS was $0.46 for the quarter, up 2% year-over-year, or 9% in constant currency, including $0.03 of currency headwind. Interest expense related to our debt was $148 million in Q3 with a negative EPS impact of $0.17 from total cost of debt in the quarter, $0.14 worse than last year. We anticipate the currency headwinds to continue and the interest rate conditions to remain volatile with a projected rise in SOFR in the near future.

Turning to our cash flow and balance sheet. Q3 operating cash flow was $306 million and free cash flow was $305 million, which includes approximately $150 million of interest expense payments for this quarter. This brings our fiscal year-to-date free cash flow to a total of $428 million. Our ending cash balance was over $800 million.

We maintain a balanced approach in our capital deployment. In January, we made a $250 million prepayment of our TLB. In Q3, we deployed $500 million of opportunistic share repurchases, the equivalent of 23 million shares, and we have approximately $870 million remaining in our current buyback program. We also paid $80 million to shareholders in the form of a regular quarterly dividend of $0.125 per common share. For Q3, the Board of Directors approved a regular quarterly cash dividend of $0.125 per common share to be paid on March 15, 2023, for all shareholders of

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