McAfee Corp.
Q2 2021 Earnings Call Transcript

Published: 10 Aug 2021

[Operator:]

Thank you for standing by and welcome to McAfee's Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host, Vice President Investor Relations, Eduardo Fleites.

[Eduardo Fleites:]

Thank you, operator. Good afternoon and thank you for joining us today to discuss McAfee's second quarter earnings results for the period ended June 26, 2021. Participating on today's call are

[Peter Leav:]

Thank you, Eduardo, and good afternoon. Before we move to our quarterly results, we are very pleased to highlight that on July 27 we completed the sale of our Enterprise Business for $4 billion in cash. This was a major accomplishment. And I want to take a moment to thank the team for working diligently over the past several months to make this happen. As we look forward, we are excited about our journey as a pure-play consumer cybersecurity company. Now, to our quarterly results. Q2 was another strong quarter for McAfee as we significantly increased revenue, profitability and free cash flow. We drove very strong performance during the first half of the year with double-digit year-over-year growth for both revenue and adjusted EBITDA. As a result, we are increasing our FY 2021 guidance. In Q2, we delivered revenue of $467 million, an increase of 22% year-over-year as compared to the same period last year. Adjusted EBITDA for the quarter was $218 million, up 38% versus the same period last year, representing a margin of 47%. The adjusted EBITDA for the period included stranded costs of $21 million. We continue to drive double-digit growth along with improved profitability through our differentiated product and omnichannel go-to-market strategy. Consumers are increasingly adopting our powerful online protection services. In Q2, we added organically another industry-leading 556,000 net new core direct-to-consumer subscribers or DTC to our platform, closing the quarter at a cumulative $19.4 versus $16.6 million core DTC subscribers in the same period last year. This marks our 15th consecutive quarter of sequential and year-over-year core direct-to-consumer subscriber ads. In addition to these strong operating results Q2 highlights included signing a multiyear extended agreement to McAfee's longstanding partnership with Samsung to protect Samsung PC users' personal data against online threats worldwide via our McAfee LiveSafe product. Our unique omnichannel go to market strategy continues to allow McAfee to outpace the competition, attracting subscribers at the emanation point and throughout their digital journey. Furthermore, from a product perspective on May 31, the German antimalware test lab, AV-TEST, awarded McAfee's total protection top-product certification for the 6th consecutive time. Additionally, on June 21, AV-TEST also awarded McAfee's Mobile Security for Android a perfect score for the 7th consecutive time. We continue to execute on our plan as we strike the right balance between investing to grow and capture the tremendous market opportunity in front of us, while improving margins. We remain committed to invest in our product portfolio, go-to-market engine and subscriber acquisition and retention motions and plan to continue to drive double-digit revenue growth over the long-term. We are confident in the sustainability of this trajectory, driven by the positive market forces tied to the proliferation of personal devices and data, educational, social, and professional use adoption, the evolving threat landscape, as well as increased public awareness of the importance of privacy, identity protection and security. As we look out over the second half of the year, we are confident that the flywheel effect of our business will continue to benefit from a greater renewal base associated with the trailing 12-month cohort of 2.8 million net new DTC subscribers added as of the end of Q2. We understand the mission-critical role that we play in securing consumers digital lives around the world. The acceleration and digitization that has taken place over the past year has only served to compound that urgency. McAfee's expertise in bringing differentiated security solutions to consumers has never been more timely. New conveniences in the realm of work, learn, shop, bank, exercise and stream have gone from nice-to-haves to must-haves. These digitally enabled experiences have become permanently woven into consumers' daily lives and they expect every interaction to be secure. McAfee is there to provide that peace of mind. Thank you once again to our McAfee team for your dedication and hard work, which has allowed us to focus on customer and partner success, execute on our strategy and deliver very strong Q2 results. I will now turn the call over to Venkat to discuss our financial results in further detail.

[Venkat Bhamidipati:]

Thanks, Peter, and good afternoon, everyone. For today's discussion, I'll be focusing on our non-GAAP continuing operations unless specifically stated otherwise. Also, you'll find a historical view of our continuing operations within the supplemental financials on the IR section of our website. As Peter mentioned, we're pleased that we have closed the transaction to divest our Enterprise Business, and moving forward will be focused exclusively on our pure-play consumer security business. I'll later explain the impact of this transaction on our results. We continued our strong momentum in Q2 with double-digit growth in revenue, profitability and cash flow year-over-year. Overall results exceeded expectations driven by strong execution and increased demand for our holistic personal security offerings. For the second quarter revenue was $467 million, a year-over-year growth rate of 22% driven by strong public awareness of the importance of security, identity and privacy. Direct to Consumer revenue contributed $344 million, an increase of 17% over the same period last year, continuing a strong double-digit growth trend. We also continue to see robust demand for indirect and partner-led business, which includes mobile providers, ISP, search, retail, and e-commerce partners. Revenue from indirect and partner-led channels, which is a mix of both subscription and non-subscription, contributed $123 million, an increase of 38% over the same period last year. This increase was primarily driven by the over-performance of our non-subscription business. Adjusted EBITDA was $218 million, up 38% year-over-year, representing EBITDA margin of 47%. Excluding $21 million of stranded costs, adjusted EBITDA would be $239 million, representing a 51% EBITDA margin. Finally, adjusted EPS for second quarter was $0.28. Moving to spending, we continue to increase operating leverage in our business model. As a percentage of revenue, adjusted gross margins for the second quarter improved by approximately 200 basis points year-over-year due to product mix and cost of sales efficiencies. Adjusted operating margins improved by approximately 600 basis points as a percentage of revenue. Even though, investments increased in product and customer acquisition as compared to last year. We continue to find leverage in our model. Our pure-play Consumer business continues to show widespread strength as we address the increasing demand globally. We thought robust demand and subscriber growth across all geographies, with Americas region contributing $309 million and leading the group with a growth rate of 23% over the same period last year. EMEA contributed $109 million growing year-over-year at 21%, while APJ contributed $49 million and grew 17% over the same period last year. Our team continues to execute well focusing on customer acquisition, conversion and retention. In Q2, we ended with an industry leading $19.4 million Core DTC subscribers, including 556,000 net new subscribers, added in the most recent quarter and 2.8 million in the last 12 months. We believe this reflects the sustainable shift towards digitization of consumers across their online activities, which reinforces the need for the type of online protection McAfee provides. Average revenue per customer, or ARPC, in Q2 was $5.99, up $0.04 from Q1, which reflected the growth and mix of new to renewal subscribers across all geographies. From a retention perspective, our dollar retention rate, or DRR, remained at 100%. Our team's excellent execution through a deliberate focus on user experience, value of our offerings, ease of renewal, and upselling higher value added packages continues to contribute to DRR. Now turning to balance sheet and cash flows, which include results from continuing and discontinued operations, we ended the second quarter with $420 million in total company cash and cash equivalents. We declared a regular dividend in the amount of $0.115 per Class A common share on June 10, 2021, and paid it on July 9, 2021. From a cash flow perspective, we generated $189 million in total company cash flow from operations compared to $117 million in the prior period, an increase of 62%. The improvement is attributable to increased profitability and improvements in management of working capital. Finally, total company unlevered free cash flow was $233 million versus $180 million in the previous period, a year-over-year increase of 29%. This is inclusive of approximately $50 million in onetime costs. Before providing guidance, I wish to remind investors that a portion of our indirect and partner-led revenue is derived from our search partners and as non-subscription in nature. While we over-performed in Q2 within this revenue source, it is normally seasonally lower in Q2 and Q3. Now, turning to guidance, we are providing current quarter and annual guidance ranges for the revenue and adjusted EBITDA for our continuing operations pure-play Consumer business. For the third quarter ending September 25, 2021, we expect revenue and adjusted EBITDA to be in the range of $461 million and $467 million, and $169 million and $175 million, respectively. We expect our Direct to Consumer subscription revenue to increase sequentially from Q2 to Q3. We estimate stranded costs to be in the range of $35 million to $40 million. Furthermore, we anticipate cash interest expense for the third quarter to be in the range of $45 million and $50 million, and you should assume a fully diluted share count of approximately 470 million shares. For the full year ending December 25, 2021, we expect revenue and adjusted EBITDA to be in the range of $1.84 billion and $1.85 billion, and $765 million and $775 million, respectively. For FY 2021, we now estimate annualized stranded costs to be in the range of $120 million and $125 million. This is $25 million to $30 million lower than previous expectations, as we have successfully eliminated some of the stranded costs, and continue to make progress separating the businesses. Cash net interest expense is expected to be in the range of $185 million and $195 million, which incorporates the decrease in that attributable to the $1 billion paid down from the proceeds of the sale of the Enterprise Business. For a fully diluted share count, you should assume approximately 470 million shares. For the third quarter FY 2021, the normalized non-GAAP tax rate for continuing operations is expected to be 22%. As a pure-play consumer-focused company, we have a highly attractive consumer subscription business with industry-leading scale, double-digit growth and high profitability in a growing personal security market. McAfee's sophisticated product platform and loyal long-term relationships constitute sustainable competitive advantage. We're committed to the success of our customers and positioning McAfee for long-term growth and profitability. We look forward to reporting our continued progress to you over time. Before turning it over for Q&A, as Peter mentioned, we recently closed the $4 billion sale of our Enterprise Business. Our Board of Directors have declared a special dividend of $4.50 per Class A common share to be paid out to shareholders with a record date of August 13, 2021. And we're currently in the process of paying down $1 billion of debt. With that, I'll turn the call back to the operator to begin Q&A.

[Operator:]

Thank you. Our first question comes from Rob Owens of Piper Sandler. Your line is open.

[Rob Owens:]

Great. And thank you guys very much for taking my question. Obviously, getting a lot of investor questions relative to some consolidation in the competitive landscape. So maybe if you want to address from a broad stroke, just how you think about some of the consolidation that's occurring, how you guys think about customer acquisition, especially on the international front? And I guess, subscription models versus freemium models, and would McAfee pursue something similar? Or do you think that your customer acquisition strategy is where you're going to go mainly through the OEM channels, some of those MSPs? Thanks.

[Peter Leav:]

Hey, Rob. It's Peter and thanks for the question. So we start where we've typically started as we've talked to you in the past. And that is, this is a very big growing and important market. And it continues to be the case. So for us, it's not really zero sum. We don't look at it exclusively in that sense. And obviously, we're very, very pleased with the fact that we are continuing to do what we've outlined we would. We grew at a 20% clip last year. We grew over 20% in Q1. We grew over 20% in Q2. And by the way, EBITDA has grown commensurate or better with that. All of our geos are growing at a very, very healthy rate. And all of our channels are growing. And that's a real statement about the team, not only operationally but also strategically, how we've thought about it and how we think about the consumer and what consumer needs are. So, as it relates to consolidation, that's fine for us. Again, we feel very good about our strategy, our ability to execute. And we see a massive TAM in front of us, that is going to continue to need what we do. Related to the global component, yes, all of the geographies, as we outlined in Venkat's prepared remarks grew nicely. And that's great to see as well with Americas above 20% and EMEA above 20%, and APJ in the teens. So very, very solid performance. We see opportunities to continue to drive growth and drive profit, and importantly, be there for consumers. And as you asked about channels, by all means, our OEM channel is terrific. We, as you know, are representing 85% of the brand name PCs and represent the vast majority of the volume. But the other channels have also been terrific growth engines for us, inclusive of our direct channel, which is really a nascent piece for us, because so much of our website was dedicated to enterprise until fairly recently. And that's been a great growth engine, in addition to the long-term retail relationships, which are a great feeder. Venkat mentioned this non-recurring business in search, which has grown incredibly well and MISP, it is a growth story for us too. So, again, we feel very good about the routes we're going and what we're doing across the globe.

[Rob Owens:]

Great. And then, as a follow-up, how should we think about ARPC expansion as DTC adds slow, and more specifically, I guess, the pace of that expansion. Thank you.

[Venkat Bhamidipati:]

Hey, Rob. This is Venkat. With respect to ARPC, as you know, ARPC is up $0.04 quarter-on-quarter. We're very pleased with the sequential increase in the ARPC. Certainly, as you alluded, the higher mix of renew helps ARPC. And our team is incredibly focused on driving long-term value to customers, both through upsell and ability to continue to sell value to our customers through holistic packages. So over time, we expect all cohorts to increase ARPC in the long-term. And certainly with a large installed base, we think of that as a large opportunity in front of us.

[Rob Owens:]

Great, thank you.

[Operator:]

Thank you. The next question comes from Brian Essex of Goldman Sachs. Your line is open.

[Brian Essex:]

Hi, good afternoon. Thank you for taking the question. I was maybe if you could perhaps give us a little bit of color into net DTC adds. It looks like it kind of decelerated quarterly, more in line with maybe what you've seen historically. Could you maybe talk a little bit about demand and retention rates and how we should think about net adds going forward?

[Peter Leav:]

Hey, Brian. It's Peter. So why don't I start with retention and then we'll talk about DTC and the 556,000 that were added, which clearly was industry-leading. From a retention standpoint, the DRR is very healthy. So DRR was up 200 bps year-over-year, but call it 100% with the amount of new subscribers that we bring in and the mix of first year. It's just continued strong performance on that front. So the retention rate remains solid and we feel very good. As far as the addition of new subscribers, 15 consecutive quarters year-over-year in sequential is a very positive sign of the future really, because with the flywheel of this business and what happens in year 2 and beyond, it's just very, very strong for us. Now, related to things like ARPC, we don't want to rush and improve ARPC at such a fast clip that we cause a cessation of growth of new. So 17% in what we would call a seasonally softer quarter, which Q2 and Q3 are. I know, you recall, Q4 and Q1 are more robust. That's a solid performance from this team. And the good news as well is, it's coming from a variety of mechanisms. The direct channel is growing nicely. The OEM feed into it is growing nicely. And the indirect side of the business is also doing really well. So it's a very balanced business today, and we're going to continue to drive more and more of that. But no, I think, it was a solid performance for the quarter.

[Brian Essex:]

Okay. I appreciate that. And maybe just a follow-up on that point, one level deeper. I mean, are there any kind of like macro trends that you're attributing that to? Is it more efficient DTC spend? Are there things from the consumer standpoint that are driving more consumer adoption of the platform? How should we think about that, just as we eye growth going forward?

[Peter Leav:]

Well, at a macro level, it's very clear that the behavior for consumers is forever changing. And we've seen that again and again in the digitization of all of our lives. And that's not a one-off, or that didn't happen by chance as a sugar high, it's just the way people are going to start continuing to behave and have been behaving of late, whether that's interaction with your healthcare provider or ordering food online, or how folks opt to bank, whereas that wasn't as pervasive a few years ago. And there's been a hastening of that for reasons that I think are obvious. And we see, by the way, a greater degree of focus from those who are trying to exploit that, and that's going to continue, and it's unfortunate, but the world of cyber-criminal behavior continues to expand as well. Now, for us, one of the things that's important in a differentiated fashion is a group that probably doesn't get enough accolades at McAfee, and that's our McAfee Threat Labs team. I mean, we have telemetry around hundreds of millions of endpoints. And we have a gauge on not only consumer behavior, but importantly, cyber-criminal behavior. And it's only getting bigger and that's going to continue. And I think around the world, folks understand that and consumers and their families understand it. So at a macro level, that's a phenomenon that we expect to continue.

[Brian Essex:]

All right. That's helpful. Thank you.

[Peter Leav:]

Thanks, Brian.

[Operator:]

Thank you. Our next question comes from Hamza Fodderwala of Morgan Stanley. Your line is open.

[Hamza Fodderwala:]

Hey, guys, thanks for taking my questions. I guess, Peter, first question for you. I guess in light of the recent announcements, let's say, I'm wondering from a capital allocation standpoint, and sort of a longer-term growth standpoint, like to what degree does M&A kind of fit into McAfee's growth strategy now that you're obviously a pure-play consumer security company?

[Peter Leav:]

You bet. And Hamza, this is a very, very strong cash producing business. And Venkat has outlined that, and Ashish has outlined that in the past, and that continues to be the case. We're going to be very responsible. We've obviously, I think, done a reasonably good job of giving some of that continuation inclusive of the $4 billion that we just solidified on the 27th of July back to shareholders, both as dividend and, obviously, debt paid down. So we're going to be balanced and responsible not related to the M&A component. I think broadly speaking, what we'll continue to assess, while we feel very good about our organic play, which obviously, we're going to continue to be very focused on and we like what the team is doing and the size of the TAM. But we're going to look at what we call accretive growth areas. Those would be the types of things we would look at, both from a technology and market potential standpoint. And look at that with the lens of what enables us to continue to grow. We're very growth oriented while driving profitability and clearly that's been the case. And that's the type of results driven mindset we have.

[Hamza Fodderwala:]

And just maybe a quick follow-up. Just some of these are extension agreement that you signed with the likes of Samsung and others, to what degree are there additional growth opportunities there in that - was it that previously you were just protecting sort of traditional PC devices. And now you're getting more into smart home device like any anything around that in some of these renewal agreements that you have with the OEM.

[Peter Leav:]

Sure. And these are long-term agreements, and I appreciate you're asking. So part of it is the market itself continues to expand and beyond PCs as well, which obviously impacts the mobile channel, et cetera. But, we're seeing with renewals, and the Samsung example is an important one, it's really a LiveSafe renewal, so it's not just one product component. And as you look at what we've been doing, and I would say, we probably haven't marketed this to the extent that maybe we could or should. But between McAfee LiveSafe and Total Protection, it's really less about features and functionalities. And it's more about an amalgam of offer that consumers are looking for. We've enhanced our McAfee security app with a package, with secure VPN, with identity protection, with safe browsing, with Wi Fi scan. We've enhanced our story related to the proportion of our business that is now being sold as LiveSafe and Total Protection. It's a broader range. The other thing that's really interesting for consumers. And this is across channels including direct, is we came out with - and this is just this past quarter, our McAfee protection score. And that enables consumers. As we've queried consumers and studied consumers, most consumers do not know how safe they are. They know whether or not they have McAfee, and there's a degree of assurance and insurance that they have, but how do they know whether or not they're safe online? And so, what we've done is we've produced a protection score, think of it somewhat akin to like a Z estimate, to provide personalized feedback and help you and your family know whether you're in a safe situation. And it's really, we think going to help us with even greater engagement in a nonintrusive way. So, yes, VPN expansion, all of those are on the docket, but we look at it with a solution mindset, rather than kind of throwing features at the market. And we think there's going to be an opportunity to not only broaden the aperture and the number of DTC subs. But also back to the question about, ultimately ARPU and ARPC improving over time. That'll come from a broader solution set as well. So, probably more of an answer than you wanted, but that's what we're focused on.

[Hamza Fodderwala:]

Thank you.

[Peter Leav:]

You bet.

[Operator:]

Thank you. At this time, I'd like to turn the call back over to CEO, Peter Leav, for closing remarks. Sir?

[Peter Leav:]

Great. Well, thank you all for joining our call today. We look forward to updating you on our next call. Thank you.

[Operator:]

And this concludes today's conference call. Thank you for participating. You may now disconnect.