Gen Digital Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-looking statements and factors that may affect future results The discussion below contains forward-looking statements, which are subject to safe harbors under the Securities Act of 1933, as amended (the Securities Act) and the Exchange Act. Forward-looking statements include statements that represent our expectations or beliefs concerning future events, including, without limitation, references to our ability to utilize our deferred tax assets, as well as statements including words such as “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “goal,” “intent,” “momentum,” “projects,” “forecast,” “outlook,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” and similar expressions. In addition, projections of our future financial performance; anticipated growth and trends in our businesses and in our industries; the consummation of or anticipated impacts of acquisitions (including our ability to achieve synergies from our acquisition of Avast), divestitures, restructurings, stock repurchases, financings, debt repayments and investment activities; the outcome or impact of pending litigation, claims or disputes; our intent to pay quarterly cash dividends in the future; plans for and anticipated benefits of our products and solutions; anticipated tax rates, benefits and expenses; the impact of inflation, fluctuations in foreign currency exchange rates, changes in interest rates, Russia’s invasion of Ukraine and other global macroeconomic factors on our operations and financial performance; and other characterizations of future events or circumstances are forward-looking statements. These statements are only predictions, based on our current expectations about 24 Table of Contents future events and may not prove to be accurate. We do not undertake any obligation to update these forward-looking statements to reflect events occurring or circumstances arising after the date of this report. These forward-looking statements involve risks and uncertainties, and our actual results, performance, or achievements could differ materially from those expressed or implied by the forward-looking statements on the basis of several factors, including economic recessions, inflationary pressures and those other factors that we discuss in Part II Item 1A, of this Quarterly Report on Form 10-Q and the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended March 31, 2023. We encourage you to read those sections carefully. There may also be other factors that have not been anticipated or that are not described in our periodic filings with the SEC, generally because we did not believe them to be significant at the time, which could cause actual results to differ materially from our projections and expectations. All forward-looking statements should be evaluated with the understanding of their inherent uncertainty. OVERVIEW Gen is a global company powering Digital Freedom with a family of trusted consumer brands including Norton, Avast, LifeLock, Avira, AVG, ReputationDefender and CCleaner. Our core Cyber Safety portfolio provides protection across three key categories in multiple channels and geographies, including security and performance, identity protection, and online privacy. We have built a technology platform that brings together software and service capabilities within these three categories into a comprehensive and easy-to-use integrated platform across our brands. We bring award-winning products and services in cybersecurity, privacy and identity protection to approximately 500 million users in more than 150 countries so they can live their digital lives safely, privately, and confidently today and for generations to come. Fiscal calendar We have a 52/53-week fiscal year ending on the Friday closest to March 31. The three months ended June 30, 2023 and July 1, 2022 each consisted of 13 weeks. Our 2024 fiscal year consists of 52 weeks and ends on March 29, 2024. Key financial metrics The following tables provide our key financial metrics for the periods presented: Three Months Ended (In millions, except for per share amounts) June 30, 2023 July 1, 2022 Net revenues $ 946 $ 707 Operating income (loss) $ 362 $ 261 Net income (loss) $ 189 $ 200 Net income (loss) per share - diluted $ 0.29 $ 0.33 Net cash provided by (used in) operating activities $ 226 $ 215 As Of (In millions) June 30, 2023 March 31, 2023 Cash and cash equivalents $ 623 $ 750 Contract liabilities $ 1,709 $ 1,788 Below are our financial highlights for the first quarter of fiscal 2024, compared to the corresponding period in the prior year: • Net revenues increased $239 million and Operating income increased $101 million, primarily due to revenue contribution from Avast, which was acquired during the second quarter of fiscal 2023, and higher sales in both our consumer security and identity and information protection products, partially offset by unfavorable foreign currency fluctuations. • Net income decreased $11 million and Net income per share - diluted decreased 0.04, primarily due to increased interest expense associated with our new senior credit facilities and two senior notes. This was partially offset by increased Operating income as a result of our merger with Avast. • Cash and cash equivalents decreased by $127 million compared to March 31, 2023, primarily due to cash interest paid, dividends paid to shareholders, voluntary prepayments of our Term B facility, a mandatory principal amortization payment of our Term A facility, and repurchases of our common stock. • Contract liabilities decreased $79 million compared to March 31, 2023, primarily due to a seasonal decline in billings and fluctuations in foreign currency rates. GLOBAL MACROECONOMIC CONDITIONS Our results of operations and cash flows are subject to fluctuations due to inflation, changes in foreign currency exchange rates relative to U.S. dollars, our reporting currency, changes in interest rates, as well as recession risks, which may persist for an extended period. Additionally, our international results are impacted by the economic conditions in the foreign markets in which we operate and by fluctuations in foreign currency exchange rates. We conduct business in numerous currencies throughout our worldwide operations, and our entities hold monetary assets or liabilities, earn revenues, or incur costs in currencies other than the entity’s functional currency. As a result, we are exposed to foreign exchange gains or losses, which impact our operating results. As part of our foreign currency risk mitigation strategy, we have entered into monthly foreign exchange forward contracts to hedge foreign currency balance sheet exposure. 25 Table of Contents In addition, in early 2022, worldwide inflation began to increase. In response to the heightened levels of inflation, central banks, including the U.S. Federal Reserve and the European Central Bank, raised interest rates significantly in 2022, resulting in an increase in our cost of debt. Interest rates continued to increase in 2023, and while inflation rates have slowed, global inflation remains high and has impacted our results due to higher costs. Volatile market conditions related to Russia’s invasion of Ukraine and retaliatory sanctions against the Russian Federation and Belarus, and other macroeconomic events have, at times, and may in the future negatively impact our results of operations and cash flows. Conversely, we have seen and may continue to see cost savings from the shift to remote and distributed work for certain of our employees in areas including real estate, events, travel, utilities and other benefits. Due to our subscription-based business model, the effect of recent macroeconomic events may not be fully reflected in our results of operations until future periods, if at all. The U.S. banking market has also recently experienced increased volatility as a result of several distressed or closed banks. While we have not realized any losses as a result of this increased market volatility, we continue to monitor the situation and will take appropriate measures, as necessary, to minimize potential risk exposure to our customers’ and our cash and investment balances. While inflation, interest rates and foreign currency exchange rates may be less volatile in the second half of 2023, fluctuations in these indicators are uncertain and could result in further adverse impacts to our reported results. For a further discussion of the potential impacts of the global macroeconomic conditions on our business, please see Part I, Item III and “Risk Factors” in Part II, Item 1A below. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of our Condensed Consolidated Financial Statements and related notes in accordance with generally accepted accounting principles in the U.S. requires us to make estimates, including judgments and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. We have based our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates on a regular basis and make changes accordingly. Management believes that the accounting estimates employed and the resulting amounts are reasonable; however, actual results may differ from these estimates. Making estimates and judgments about future events is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and cash flows. Our critical accounting policies and estimates were disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2023. There have been no material changes in the matters for which we make critical accounting estimates in the preparation of our Condensed Consolidated Financial Statements during the three months ended June 30, 2023. RESULTS OF OPERATIONS The following table sets forth our Condensed Consolidated Statements of Operations data as a percentage of net revenues for the periods indicated: Three Months Ended June 30, 2023 July 1, 2022 Net revenues 100 % 100 % Cost of revenues 19 14 Gross profit 81 86 Operating expenses: Sales and marketing 19 22 Research and development 10 9 General and administrative 6 15 Amortization of intangible assets 6 3 Restructuring and other costs 2 0 Total operating expenses 43 49 Operating income (loss) 38 37 Interest expense (18) (4) Other income (expense), net 1 0 Income (loss) before income taxes 22 32 Income tax expense (benefit) 2 4 Net income (loss) 20 % 28 % Note: Percentages may not add due to rounding. 26 Table of Contents Net revenues Three Months Ended (In millions, except for percentages) June 30, 2023 July 1, 2022 Change in % Net revenues $ 946 $ 707 34 % Net revenues increased $239 million, primarily due to a $197 million increase in sales of our consumer security products and a $36 million increase in sales of our identity and information protection products. This is inclusive of $9 million of foreign exchange headwinds, primarily in our consumer security solutions. Performance Metrics We regularly monitor a number of metrics in order to measure our current performance and estimate our future performance. Our metrics may be calculated in a manner different than similar metrics used by other companies. The following table summarizes supplemental key performance metrics: Three Months Ended (2) (In millions, except for per user amounts) June 30, 2023 (3) July 1, 2022 Direct customer revenues (1) $ 832 $ 624 Partner revenues $ 97 $ 72 Total Cyber Safety revenues $ 929 $ 696 Legacy revenues $ 17 $ 12 Direct customer count (at quarter end) 38.2 24.1 Direct average revenue per user (ARPU) $ 7.26 $ 8.58 (1) Non-GAAP Direct customer revenues differ from GAAP direct customer revenue during the three months ended July 1, 2022, as it excludes a $1 million reduction of revenue from contract liability purchase accounting adjustments. We believe that eliminating the impact of these adjustments improves the comparability of revenues between periods. In addition, although the adjustment amounts will never be recognized in our GAAP financial statements, we do not expect the acquisitions to affect the future renewal rates of revenues excluded by the adjustments. (2) From time to time, changes in our product hierarchy cause changes to the revenue channels above. When changes occur, we recast historical amounts to match the current revenue channels. Direct customer revenue currently includes Mobile App Store customers, and legacy revenues includes revenues from products or solutions from markets that we have exited and in which we no longer operate, have been discontinued or identified to be discontinued, or remain in maintenance mode as a result of integration and product portfolio decisions. As such, prior period performance metrics have been recast to conform to the current period presentation for all periods presented above. (3) The performance metrics for three months ended June 30, 2023 include the revenues earned and customers acquired through our acquisition with Avast. ARPU is based on average customer count and assumes full quarter of revenue for both companies. We define direct customer count as active paid users of our products and solutions who have a direct billing and/or registration relationship with us at the end of the reported period. Average direct customer count presents the average of the total number of direct customers at the beginning and end of the applicable period. We exclude users on free trials from our direct customer count. Users who have indirectly purchased and/or registered for our products or solutions through partners are excluded unless such users convert or renew their subscription directly with us or sign up for a paid membership through our web stores or third-party app stores. The methodologies used to measure these metrics require judgment and are subject to change due to improvements or revisions to our methodology. From time to time, we review our metrics and may discover inaccuracies or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed metrics for any such inaccuracies or adjustments that are deemed not material. ARPU is calculated as estimated direct customer revenues for the period divided by the average direct customer count for the same period, expressed as a monthly figure. Non-GAAP estimated direct customer revenues and ARPU have limitations as analytical tools and should not be considered in isolation or as a substitute for GAAP estimated direct customer revenues or other GAAP measures. We monitor ARPU because it helps us understand the rate at which we are monetizing our consumer customer base. 27 Table of Contents Net revenues by geographical region Three Months Ended June 30, 2023 July 1, 2022 Americas 66 % 72 % EMEA 24 % 17 % APJ 10 % 11 % The Americas include the U.S., Canada and Latin America; EMEA includes Europe, the Middle East and Africa; APJ includes Asia Pacific and Japan. Percentage of revenue by geographic region in the three months ended June 30, 2023 remains primarily in the Americas but is beginning to shift more into the EMEA markets, as the acquisition with Avast has contributed to a stronger presence in those regional countries. Cost of revenues Three Months Ended (In millions, except for percentages) June 30, 2023 July 1, 2022 Change in % Cost of revenues $ 179 $ 102 75 % Our cost of revenues increased $77 million, primarily due to a $52 million increase in the amortization of acquired intangible assets, $15 million increase in payment processing fees, and $8 million increase in revenue share costs. Operating expenses Three Months Ended (In millions, except for percentages) June 30, 2023 July 1, 2022 Change in % Sales and marketing $ 181 $ 156 16 % Research and development 90 61 48 % General and administrative 56 104 (46) % Amortization of intangible assets 61 21 190 % Restructuring and other costs 17 2 750 % Total operating expenses $ 405 $ 344 18 % Sales and marketing expense increased $25 million, primarily due to an $11 million increase in headcount and IT costs, an $8 million increase in outside services and software expenses, a $3 million increase in our investment in advertising, and a $2 million increase of stock-based compensation expense. Research and development expense increased $29 million, primarily due to a $15 million increase in headcount costs, a $9 million increase in outside services and software expense, and a $5 million increase of stock-based compensation expense. General and administrative expense decreased $48 million, primarily due to a $53 million decrease in litigation cost and an $8 million decrease in IT and occupancy costs. This was partially offset by an $8 million increase in headcount costs and a $6 million increase of stock-based compensation expense. Amortization of intangible assets increased $40 million as a result of the acquisition with Avast. Restructuring and other costs increased $15 million, primarily due to severance, termination benefits and other exit and disposal costs in connection with the September 2022 Plan. See Note 12 of the Notes to the Condensed Consolidated Financial Statements for details of the fiscal 2024 restructuring activities. Non-operating income (expense), net Three Months Ended (In millions) June 30, 2023 July 1, 2022 Interest expense $ (170) $ (31) Interest income 6 2 Foreign exchange gain (loss) 1 (1) Gain on sale of properties 4 — Other 1 (2) Total non-operating income (expense), net $ (158) $ (32) Non-operating income (expense), net, increased by $126 million in expense, primarily due to an increase in interest expense associated with our new senior credit facilities and two senior notes, all of which were issued during the second quarter of fiscal 2023. This is partially offset by a $4 million increase in interest income from higher interest rates on our money market funds, a 28 Table of Contents $4 million increase in rental income related to a rent review settlement with our tenant, and a $4 million gain on the sale of certain land and buildings in Dublin, Ireland. Provision for income taxes Three Months Ended (In millions, except for percentages) June 30, 2023 July 1, 2022 Income (loss) before income taxes $ 204 $ 229 Income tax expense (benefit) $ 15 $ 29 Effective tax rate 7 % 13 % Our effective tax rate for income for the three months ended June 30, 2023 differs from the federal statutory income tax rate primarily due to tax benefits related to the set up and write-off of deferred tax items from an internal restructuring, partially offset by state taxes and the U.S. taxation on foreign earnings. Our effective tax rate for the three months ended July 1, 2022 differs from the federal statutory income tax rate primarily due to tax benefits related to the foreign currency remeasurement of an Irish deferred tax asset and discrete legal expenses booked during the quarter, partially offset by state taxes. We are a multinational company dual headquartered in the U.S. and Czech Republic, although our principal executive offices remain in Tempe, Arizona, and we are subject to tax in multiple U.S. and international tax jurisdictions. Our results of operations would be adversely affected to the extent that our geographical mix of income becomes more weighted toward jurisdictions with higher tax rates and would be favorably affected to the extent the relative geographic mix shifts to lower tax jurisdictions. Our results can also be impacted by the costs incurred and the potential deductibility of the expenses. Any change in our mix of earnings is dependent upon many factors and is therefore difficult to predict. The timing of the resolution of income tax examinations is highly uncertain and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. Given the potential resolution of uncertain tax positions involves multiple tax periods and jurisdictions, we are unable to accurately estimate when these unrecognized tax benefits will be realized or released. However, it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next 12 months. We continue to monitor the progress of ongoing income tax controversies and the impact, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. LIQUIDITY, CAPITAL RESOURCES AND CASH REQUIREMENTS Liquidity and Capital Resources We have historically relied on cash generated from operations, borrowings under credit facilities, issuances of debt and proceeds from divestitures for our liquidity needs. Our capital allocation strategy is to balance driving stockholder returns, managing financial risk and preserving our flexibility to pursue strategic options, including acquisitions and mergers. Historically, this has included a quarterly cash dividend, the repayment of debt and the repurchase of shares of our common stock. Based on past performance and current expectations, we believe that our existing cash and cash equivalents, together with cash generated from operations and amounts available under our Revolving Facility, will be sufficient to meet our working capital needs, support on-going business activities and finance the expected synergy costs related to the acquisition with Avast through at least the next 12 months and to meet our known long-term contractual obligations. We are currently not aware of any trends or demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months. However, our future liquidity and capital requirements may vary materially from those as of June 30, 2023, depending on several factors, including, but not limited to, economic conditions; political climate; the expansion of sales and marketing activities; the costs to acquire or invest in businesses; and the risks and uncertainties discussed in “Risk Factors” in Part II, Item 1A below. Cash flows The following summarizes our cash flow activities: Three Months Ended (In millions) June 30, 2023 July 1, 2022 Net cash provided by (used in): Operating activities $ 226 $ 215 Investing activities $ (6) $ 4 Financing activities $ (350) $ (807) See Note 7 of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for our supplemental cash flow information. Cash from operating activities Our cash flows provided by operating activities remained relatively flat. 29 Table of Contents Cash from investing activities Our cash flows provided by and used in investing activities remained relatively flat. Cash from financing activities Our cash flows used in financing activities decreased $457 million, primarily due to the absence of the repayment of our 3.95% Senior Notes. The first three months of fiscal 2024 reflects $150 million voluntary prepayment of Term B Facility, $83 million of dividends and dividend equivalent paid, $58 million principal amortization payments of our Term Loans and mortgages, and $41 million of repurchases of common stock, compared to the $400 million repayment of our 3.95% Senior Notes and $300 million of repurchases of common stock during the first three months of fiscal 2023. Cash and cash equivalents As of June 30, 2023, we had cash, cash equivalents and short-term investments of $623 million, of which $520 million was held by our foreign subsidiaries. Our cash, cash equivalents and short-term investments are managed with the objective to preserve principal, maintain liquidity and generate investment returns. The participation exemption system under current U.S. federal tax regulations generally allows us to make distributions of non-U.S. earnings to the U.S. without incurring additional U.S. federal tax, however, these distributions may be subject to applicable state or foreign taxes. Debt We have an undrawn revolving credit facility of $1,500 million, which expires in September 2027. Stock repurchases During the three months ended June 30, 2023, we executed repurchases of 3 million of our common stock under our existing stock repurchase program for an aggregate amount of $41 million. Material Cash Requirements Our principal cash requirements are primarily to meet our working capital needs, support on-going business activities, including payment of taxes and cash dividends, payment of contractual obligations, funding capital expenditures, servicing existing debt, repurchasing shares of our common stock and investing in business acquisitions and mergers. Debt instruments As of June 30, 2023, our total outstanding principal amount of indebtedness is summarized as follows. See Note 10 of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information on our debt. (In millions) June 30, 2023 Term Loans $ 7,084 Senior Notes 2,600 Mortgage Loans 7 Total debt $ 9,691 The Credit Agreement contains customary representations and warranties and affirmative and negative covenants, including compliance with specified financial ratios . As of June 30, 2023, we were in compliance with all debt covenants. See Note 10 of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information regarding financial ratios and debt covenant compliance. Dividends On August 3, 2023, we announced a cash dividend of $0.125 per share of common stock to be paid in September 2023. Any future dividends and dividend equivalents will be subject to the approval of our Board of Directors. Stock repurchase program Under our stock repurchase program, we may purchase shares of our outstanding common stock on the open market (including through trading plans intended to qualify under Rule 10b5-1 under the Exchange Act) and through accelerated stock repurchase transactions. As of June 30, 2023, the remaining balance of our stock repurchase authorization was $829 million and does not have an expiration date. The timing and actual number of shares repurchased will depend on a variety of factors, including price, general business and market conditions and other investment opportunities. 30 Table of Contents Restructuring In connection with the acquisition with Avast, our Board of Directors approved a restructuring plan (the September 2022 Plan) to realize cost savings and operational synergies, which became effective upon the close of the acquisition on September 12, 2022. We have incurred and expect to incur cash expenditures for severance and termination benefits, contract terminations, facilities closures, and the sale of underutilized facilities as well as stock-based compensation charges for accelerated equity awards for certain terminated employees. We expect that we will incur total costs up to $150 million, with $120 million and $30 million estimated to be incurred within the first and second full years, respectively, following the completion of the acquisition. These actions are expected to be completed by fiscal 2024. During the three months ended June 30, 2023, we made $13 million in cash payments related to the September 2022 Plan. See Note 12 of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further cash flow information associated with our restructuring activities. Significant contractual obligations Our principal commitments consist of principal and interest payments related to our debt instruments, obligations under our purchase agreements, repatriation tax payments under the Tax Cuts and Jobs Acts and obligations under various non-cancellable leases. Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits and other long-term taxes as of June 30, 2023, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $530 million in long-term income taxes payable has been excluded from our quarterly review of timing of contractual obligations. There have been no material changes, outside the ordinary course of business, to the contractual obligations reported in our Annual Report. For additional information about our debt obligations and certain other contingencies, see Note 10 and Note 18, respectively, of the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.