McAfee Corp.
Q4 2020 Earnings Call Transcript

Published: 23 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the McAfee Fourth Quarter 2020 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 speaker, Mr. Eduardo Fleites, Vice President, Investor Relations. Please go ahead, sir.

[Eduardo Fleites:]

[Peter Leav:]

Thank you, Eduardo, and good afternoon. Q4 was a very strong quarter for McAfee as we significantly increased revenue, profitability and free cash flow. We delivered robust top line results with total revenue of $777 million, growing 14% year-over-year. We also improved profitability with total adjusted EBITDA of $285 million, a 37% margin and growth of 32% versus last year. Similar to last quarter, our Consumer team delivered another exceptional set of results, with Consumer revenue growing 23% year-over-year.

[Venkat Bhamidipati:]

Thanks, Peter, and good afternoon, everyone. We finished the year on a very strong note with revenue, profitability and cash flow all increasing significantly. Across the business, results exceeded expectations, driven by strong execution and increased demand for our security offerings, resulting in double-digit top and bottom line growth. For the fourth quarter, net revenue was $777 million, a growth of 14% over last year. Adjusted EBITDA was $285 million up 32% year-over-year representing a margin of 37% and an expansion of 500 basis points. This resulted in an adjusted EPS of $0.38. Our consumer segment delivered double-digit subscriber growth because of robust demand in large critical and growing personal protection market. In our enterprise segment, we grew revenue by 5% and significantly increased profitable. Moving to fiscal year 2020 results, net revenue was $2.9 billion, representing 10% year-over-year growth. Full year consumer net revenue grew 20% contributing $1.6 billion to the total, and enterprise net revenue was $1.3 billion, an increase of 1% for the full year. Year-over-year, total company adjusted operating expenses declined 2%, even as we invested to drive growth in key consumer channels. Therefore, McAfee's adjusted EBITDA grew 32% topping $1 billion for the year. Adjusted EBITDA margin was 36% versus 30% in FY 2019. We continue to increase our operating leverage resulting in a more efficient business model. For the full year, we generated unlevered free cash flow of $982 million, up 37% versus 2019 and representing an unlevered free cash flow margin of 34%. Our team delivered a solid performance to close out the year. Our consumer business continued its momentum with increasing consumer demand for our security products, as more aspects of our lives are digitized across the work, learn and transact scenarios. As Peter mentioned, this marks 13 consecutive quarters of sequential and year-over-year direct-to-consumer subscriber growth.

[Operator:]

Thank you. Our first question comes from Hamza Fodderwala with Morgan Stanley. Please go ahead.

[Hamza Fodderwala:]

Hey guys, thank you so much for taking my questions. I just wanted to ask a question about sort of the outlook for the full year, right? I know you didn't give sort of explicit guidance. But any sort of guideposts you can give us, in the sense that it seems like consumer from a revenue growth standpoint, given the ARPU uplift that you're about to see, given that it's still a pretty favorable PC demand environment, that should probably be somewhere in the double digits range, right? I think that's pretty reasonable. And then for the Enterprise business that grew this quarter, maybe that's sort of flattish or slightly down. So is there any reason why on a total revenue basis, we shouldn't see revenue growth at least sort of in that mid-single-digit range?

[Venkat Bhamidipati:]

Hey, Hamza, thank you so much for the question. Just a couple of framing things from my side, and Peter might have additional thoughts as well. So if you think about our Enterprise revenue for Q4, overall we grew 5%, right? But if I was to kind of break it down for you, there were kind of three key drivers in there. First, you kind of have to take out the purchase price accounting. So if you take that out, essentially the apples-to-apples growth would be 3%. And now within that, we've certainly benefited in Q4 from high revenue yield on some noncore products, which involved both licensing and hardware. So while we're pleased with the overall growth in our cloud products as we mentioned, there is some onetime element to the Enterprise revenue. So if you adjust for that, I think Enterprise revenue, we're projecting that for the rest of the year, we'll come back to sort of normalized levels. Now with respect to Consumer, I think as we talked about, we're very, very pleased with the strong DTC adds that we've had. We've grown for 13 quarters in a row, and 2.1 million that we added in the last 12 months. Obviously, those constitute a pretty strong tailwind for us, especially as we continue to – as these customers come up for renewal. That's where we see the biggest leverage where we continue to upsell, cross-sell that base. And given the strong dollar retention rate that we have been experiencing, we expect strong tailwinds. And so that's kind of the dynamics of the business. We're not – certainly, we're not guiding for the full year. And we feel pretty good about the 16% to 18% consumer growth that we're guiding to in Q1.

[Hamza Fodderwala:]

Got it. Maybe just one quick follow-up around the Consumer business, so you mentioned some ARPU tailwinds. But I wanted to just drill on the subscriber adds, right? So you added 2.8 million net new subscribers this year, right? I think historically, your net new adds here are a little over 1 million. I know that you've had double-digit growth in this business prior to COVID. But as we look out into 2021, you're facing tougher comps from a subscribers standpoint, right, and it's still a pretty favorable PC demand environment. Do you think that there will be sort of a reversion to the mean as it relates to your net adds? Or do you think that we'll likely continue to see above historical trend in terms of net subscriber adds?

[Peter Leav:]

Hey Hamza, it's Peter. I appreciate the question. So I think yes, your math is right. And the 2.8 million that we added over the past 12 months is a record. We added 668,000 new DTC subscribers in Q4. We added 669,000 in Q3. But I would say things are changing in a sense. And certainly, you know the flywheel of this business. But I think from a new subscriber add over time, there is firm belief on our part, and this will be paced and sequenced over time, that the market is bigger than some understood. And I think we've seen an acceleration of digital transformation. We've seen more people moving into the digital world, banking online, health care online. And the attack surface is continuing to expand. And it's not just the PC piece, right? We've talked quite a bit about what we're seeing in mobile channels, as an example. So there is a degree of broadening, if you will, that we're seeing. Now we've been growing, as you know, year after year after year. And that's been a solid double-digit growth story, 2019 was an interesting year, because PC shipments were down. It was sort of a trough year for PC shipments, but McAfee still grew at a very nice clip. And I think one of the things that's changed for us is we have a much more expansive and broader channel with retail, with etail, with McAfee Direct, and obviously the mobile channel that's growing well. So the flywheel is a component but also it's a changing market. So that's not to overstate how much will come to fruition. There's also a seasonal aspect to the business where Q4 and Q1, from a consumer standpoint, are the most voluminous. Q2 is typically the lightest and actually will be tougher from a compares standpoint. But I think you summarized it well, but the market is changing. We see that as a good story for many years to come, frankly.

[Operator:]

Thank you. Our next question will come from Brian Essex with Goldman Sachs. Please go ahead.

[Brian Essex:]

Hi, good afternoon, and thank you for taking the question. Peter, just had a question on some of the competitive dynamics on the Enterprise side. I mean I know you noted some pretty strong growth in EDR and cloud and EPP with EDR driving traction. I would love to know I guess competitively, where is share in that market coming from? Are there legacy kind of endpoint vendors donating share that you're benefiting from? How are you going head to head? And how is the customer growth? Like was this from your core customers, net new customers? And maybe a little bit of sense of how net customer adds were in the quarter?

[Peter Leav:]

Sure, Brian. I'll try to touch on each. So in a similar vein, and we've talked about this a bit, the market on the Enterprise side is absolutely changing as well. And we see that as something that is going to be really related to increase in spend and a broadening of need. And the cyber threat landscape is forever changed as well, and SolarWinds and Sunburst are an example of that. We talked a bit about it in the remarks earlier where indiscriminate attacks that would occur and entities would be impacted if they hadn't done things like fundamental patching. That's an indiscriminate bomb that goes off. A precision-guided attack, like this was, from nation states is more of a campaign. And customers across the Enterprise and governments are realizing they need a different level of protection. And we anticipate that, that is not going to change. That is going to continue to be the case. I preface all of that by saying the market is also, in many ways, changing. And the need to protect not just against efficiencies but against campaigns is playing very, very well for McAfee. So we have invested, as you know, in EDR with insights, with the capabilities we have. Because we have access to over 1 billion endpoints, and we have telemetry around those endpoints. And we can anonymize that data and help large enterprises and governments and now midsize companies, through and with partners, preempt and predict and think about the world in a preventive way. And we're moving into XDR with data integration in a way that frankly, no one else can either because we have so many different control points. So the wins that we're seeing are coming in many ways because there is an expansive opportunity within our core base. As you know, that's been a very steady base, roughly 1,500 customers, the names that you know, government entities. We averaged 17.5 years. We averaged seven products in our top 250. But there's more and more opportunity because there's so much cloud transition. And of the 3.8 trillion that will be spent globally in IT this year, a large percentage of the growth global IT is expected to spend, a large percentage will come in the arenas that we're focused on. And those are the cloud components with unified Cloud edge and market-leading CASB with secure web gateway and DLP with our EPO and with what we're doing with EDR with Insights, and those have been very good growth stories for us. Now we're absolutely winning against competition, but we're also expanding in our base, and both things are coming to fruition. We also have, as you know, other product lines that we will not grow. so we're going to balance both while we see an opportunity to continue to expand margins. So hopefully I hit most of your questions in that.

[Brian Essex:]

Yes. I appreciate it. Maybe just a quick follow-up. So as you migrate along that path and those other products are declining, I mean might we get a sense of what recurring revenue is on the platform versus nonrecurring? And how you might anticipate that will kind of play out, maybe the rate of that would shift towards more – a greater percentage of recurring revenue over the next kind of year or so?

[Peter Leav:]

I'd absolutely say that we are moving towards more and more ratable and recurring revenue as the cloud business in total grows at a very nice clip. And that will continue to be the case, we expect, for certainly 2021 and beyond. And that gives us also some good headlights into the business. So that's exactly the route that's put in process, and that's what we expect to continue.

[Operator:]

Thank you. Our next question will come from Patrick Colville with Deutsche Bank. Please go ahead.

[Patrick Colville:]

Hi, thank you so much for taking my question and congrats on a great end of the year. Question, are you guys reporting Enterprise billings? Because that was a metric that you provided last quarter, but I can't seem to find it.

[Venkat Bhamidipati:]

Patrick, this is Venkat. I think one of the points that we made last time is for Enterprise, the billings tend to be lumpy and episodic. And given that, I think the two key metrics that we have been focused on is we're giving a view on the core customers and the revenue we derive from the core customers and revenue as it flows through. In the 10-K itself, we're going to have annual billing both for Consumer and Enterprise. So yes, we are going to provide that on an annual basis.

[Patrick Colville:]

Okay. That's appreciated. And could I ask a follow-up on the Consumer segment. I mean the – that business has been firing on all cylinders. In terms of the TC OEM contracts up for renewal in calendar 2021, are there any that you should call out to us that we should be aware of?

[Peter Leav:]

Hey Patrick, it's Peter. The short answer is there's nothing up for renewal in 2021.

[Patrick Colville:]

Okay, that’s very clear. Appreciate the time.

[Peter Leav:]

Thank you.

[Venkat Bhamidipati:]

Thank you.

[Operator:]

Thank you. Our next question will come from Rob Owens with Piper Sandler. Please go ahead.

[Rob Owens:]

Great. Thanks for taking my question. I wanted to drill down a little bit into the rip you talked about here in Q1. You did articulate some of the cost savings. But could you maybe go a little deeper relative to how you forecasted the Enterprise business, and whether or not that's discounted or could create some pressure this quarter? Thanks.

[Venkat Bhamidipati:]

Yes. Rob, this is – so with respect to the restructuring activity I mentioned, most of the expenses will actually hit in Q1 from a restructuring perspective. And it's primarily Enterprise, but there's other aspects of McAfee that we're rationalizing, whether it's IT or facilities or other infrastructure-related activities. Just to put this in perspective, annualized savings, we're expecting in the 100 – a little over $100 million. What we are doing is redeploying about half of that into – strategically into areas that we've previously articulated. Within Enterprise certainly as we reimagine the go to market, we are reinvesting in additional selling capacity, for instance. Or within R&D, we are continuing to invest in some of the strategic priority areas, whether it's endpoint plus EDR or cloud workloads. So the total rationalization is going to yield, like I said, over 100. But we're being smart about making sure that we reinvest where we see areas for growth and strength.

[Rob Owens:]

Great. I appreciate the color. And the second one is around Mac malware. We saw the news recently how it's targeting the M1 processor. I know it's not a big portion of the business, but is that a growing business for you? Are people still running Macs naked? Thanks.

[Peter Leav:]

Yes. It's Peter. I'll jump in. I missed part of it. I think you're asking about Macs, but it was a little fuzzy for us. I'm sorry to ask, Matt, but can you – I'm sorry to ask, Rob, but can you just ask that again?

[Rob Owens:]

Absolutely. Sorry about that. With regard to the new Mac malware that we've seen, and relative to I guess your mix of business, how much of it is Macs-centric? Has this been much of a growing area for you? Are most consumers still running their Macs naked? Thanks.

[Peter Leav:]

I got you. Thanks. So as you know, we cover the gamut including MAC iOS and the entirety of however – what a consumer may have. This is something that we've continued to see growing because of the volume of Macs, but not a massive departure in a sense. But again, the mobile channel is also seeing a bit of an uptick. So we've seen this as something that has been a strong suit for us as we cover the gamut. But it's just been a volume component related to volume, not a massive departure.

[Rob Owens:]

All right, thank you.

[Operator:]

Thank you. Our next question will come from Gregg Moskowitz with Mizuho. Please go ahead.

[Gregg Moskowitz:]

Okay, thanks very much. Hi guys. So first question, I guess just on the trailing 12 months dollar-based consumer retention rate. So it's now reached 100%. And in addition to greater online usage and a greater need for security, can you walk through how you've been able to show so much improvement here over the past couple of years? And then also as you mentioned earlier, you have a larger tranche of renewals coming up in 2021. And so I'm wondering if you think McAfee can sustain this level of dollar-based retention.

[Peter Leav:]

Hey Gregg, it's Peter. So let me start with how and what the team has done because it really has not happened by chance. And you'll recall in FY2017, our DRR was 87%. And every year, it's improved. And now we have gotten into the realm of triple digits, which is really a testament to a number of things. We have invested in performance marketing and digital marketing and improved conversion. We've been very, very deliberate about what we see as an opportunity to make it a better and better experience for our customers and for consumers. And part of what we've been really pleased with is the customer SAT and NPS scores have continued to go up as well. So we've added more and more new subscribers. And by the way, this was pre-COVID we were adding more and more new subscribers. We were retaining a higher component of that base, which becomes part of the renewal engine, as you've outlined. So this has been a focus. There are things that we've done in the last year or so that we did not do two or three years ago. An example would be what we call OOBE, out-of-box experience. We work with our partners and make it easier and easier for a new subscriber. Fewer clicks, easier to pay, just making it a better user experience. So the team has been fixated on that. We still have a lot of work to do, but that's really helped from a DRR perspective. So that's a bit about the how. As far as the expectation of adding 2.8 million new subscribers and ensuring that we continue on this front to have a very solid DRR, that's absolutely what the team is expecting. And that's what we expect of them, and they know that. With and through our partners, we're obviously going to have to see and make sure we hold to that. But one of the things again we're really pleased with is that customer SAT and NPS scores have gone up with this higher percentage. But we're going to work diligently to be in that range and continue on the triple-digit front, if that helps.

[Gregg Moskowitz:]

It helps very much. Very clear, thorough answer. Thanks for that, Peter. A quick follow-up for Venkat. Can you say roughly how much of a tailwind operating margins had in 2020 from lower T&E expenses? And I know you haven't guided of course for 2021. But even just from a high level if you could talk to your assumptions around sort of a return to normalization, if you will, as it relates to OpEx in 2021?

[Peter Leav:]

Venkat may be muted. Let me make sure, sorry, we’ve got…

[Venkat Bhamidipati:]

Yes, sorry I was muted. So a couple of things to consider. Certainly, 2020 was a year where we certainly benefited from almost no travel or little travel. I'll call that in the $25 million to $30 million range is how much we benefited. But one of the things we have been doing is clearly investing for McAfee for the future, which is we have invested in cloud-based tools, collaboration, communication tools. So when the world sort of returns to normal, we do expect – we don’t expect that full level of travel coming back, but certainly where it is required, we’ll be very selective. If it’s with sales or marketing that is required travel, certainly we’ll invest. But for non-customer facing roles, I think some of the investments we’ve made in technology are going to give us some lasting tailwind for the future as well. And like everyone else, we’ve actually learned to run the company on a virtual basis. So that’s – there’s new processes and new lessons learned as a result of being virtual. So again, if it’s customer-facing and if it’s required, we’ll certainly make that investment.

[Gregg Moskowitz:]

Perfect. Thank you for the color.

[Operator:]

Our next question will come from Fatima Boolani with UBS. Please go ahead.

[Fatima Boolani:]

Good afternoon. Thank you for taking my questions. Peter, I’ll start with you, and I’ll follow up with Venkat. Peter, I wanted to talk about the Amazon opportunity. Any early trends you can speak to with respect to adoption? Any impacts to the business? And frankly, what has engagement been looking like from that relatively net new channel for you on the Consumer side?

[Peter Leav:]

Fatima, so on the Amazon piece, it’s still early days, but what we’re seeing is alignment to what we had anticipated. So as you’ll recall, this was a bundle for Business Prime members. And again, it was kind of an opportunity to dip our toe into a little bit beyond the scope of kind of the classic consumer or family. And we also are providing protection, back to the earlier question, for PCs and Macs and iOS and Android devices. But it’s for that sort of licensing option for owners of businesses with about 25 devices. And employees can stay protected, access to 24/7 virus removal services, some additional IT resolution that we’ve built in to ensure additional protection, obviously AV, McAfee support services. And there are agents standing by as well to help. And we’ve also included our VPN solution as part of the offering, and then password manager and comprehensive overview from a tech support standpoint. So it’s still early days. We anticipated that it would take a bit of time to start ramping. That’s about in line with expectations. We’re not looking at it as a big needle mover short-term. That’s not, for example, built into Venkat’s projection for Q1 forecasts. But it’s something that is going to enable us to just broaden the TAM a bit, and we’ll look to see continued progress over the course of time.

[Fatima Boolani:]

I appreciate that color. Venkat, for you just on the Enterprise side, so if I’ve done my math right, the implied growth rate in the Enterprise business based on your first quarter guide implies sort of a mid-single-digit decay and decline. And so I’m wondering if you can sort of help us with some of the puts and takes that underwrite that expectation, especially relative to some of the more positive commentary around Enterprise spending trends on the back of Sunburst and the SolarWinds incident. So I just wanted to better understand how to reconcile some of the tailwinds from that dynamic relative to a pretty precipitous erosion on the Enterprise business in your guide? That’s it for me. Thank you.

[Venkat Bhamidipati:]

All right. Thanks, Fatima, for the question. So the way to think about it is as I talked about the Q4, I sort of unpacked the Q4 revenue results, which is a combination of three things. The first thing is we did – of the 5% growth, I mentioned 2% of that is purchase price accounting. Of the remaining 3%, we did see some end of the quarter increase in revenue yield with respect to increased licensing and hardware, which are largely non-core. I’d call it about 2/3 of that goodness came from that. We don’t expect that to continue. The remaining 1/3 of the goodness actually came from some of the favorable trends we’re seeing both in terms of our cloud products, EDR and continued strong growth of EC, UCE. Those are goodness that we continue to see going into the year. Now – so the last point I’ll make on the sequential decline, clearly Q4 is a strong year – a seasonally strong quarter for us. And Q1 tends to be not as strong seasonally. So the billing trends that we saw earlier will continue. So that’s why we’re guiding to a slight decline in revenue.

[Operator:]

Thank you. Our next question will come from Matt Hedberg with RBC Capital Markets. Please go ahead.

[Matt Hedberg:]

Thanks, guys. Thanks for taking my questions. Obviously, Consumer did exceptionally well this quarter. And I think at the midpoint, you’re guiding for 17% growth in Q1. Looking at that on a sequential basis, I don’t, based on our data, I don’t know that the Consumer has ever been down sequentially. I just wonder, is that just conservatism on your part? Was there anything with – anything unique about Q4? I’m just trying to get a better understanding for sort of the sequential Consumer – obviously, strong year-on-year growth but – in Q1 forecasted. But just that sequential trend is a little different than what we’ve seen historically.

[Venkat Bhamidipati:]

Got it. This is Venkat. So a couple of things to consider, Matt. One is certainly we’re very, very pleased with Q4, right, in terms of total revenue growth of 23%, subscriber growth of 18%. And the momentum has been there quite significantly over the last 13 quarters in subscriber adds. So very, very pleased with that. Going from – it’s a tough compare from 23% going to a midpoint of 17%. We feel pretty comfortable with the 16% to 18% range. But remember, there’s some degree of seasonality between Q4 and Q1. And just going back in time, even though last year we didn’t see that level of decline, but Q1 2019 relative to Q4 of 2018 was actually a sequential decline. So obviously we’re very pleased with the momentum across all channels and all geographies in terms of subscriber growth, but there’s a slight element of seasonality between Q4 and Q1 that we built into the guidance as well.

[Matt Hedberg:]

Okay. Thanks, Venkat, for that. And then maybe just a follow-up. Obviously, you noted that ARPC was down, strong net adds. It was still up on a year-on-year basis, though, for the total fiscal year, and it has been for the last several years. I guess you’re not guiding to the full year, but should we think about – I guess the question is how should we think about ARPC over the course of the year, sort of balancing strong renewals and net adds. I mean is that – should we continue to expect that to trend higher over time? Just trying to get a little bit better sense on that.

[Peter Leav:]

Matt, it’s Peter. I’ll jump in quickly on that. So I think you summarized it very well. And from a full year perspective when we look at 2020, you’re right, full year ARPC did grow, when we look at it broadly, it’s really a business decision and it’s sort of one of those classic trade-off decisions, which will continue to make. This is a decision that we’re happy to make. And when we’re adding that volume of new subscribers, it is going to be somewhat dilutive to our pick over a shorter period of time. That could be a quarter or a few quarters. Over the course of time, and this is just the economics, ARPC is going to improve. But we like the fact that we’re improving ARPC through a level of growth over time, rather than having an ARPC target that we hit with such haste that it’s at the cessation of growth. So I just want to make sure we make that clear. We have every intention to improve our ARPC over time, but we don’t want to do it in such a hasty fashion, that we get there prior to any opportunity to continue on the terrific trajectory of 13 quarters that we’ve been on to add substantive numbers of new subscribers.

[Operator:]

And speakers, I am showing no further questions in the queue at this time. I’ll turn the call back over to you for any further remarks.

[Peter Leav:]

Sorry, I know we’re closing. I want to make sure we answered Matt’s question in its entirety, though. Matt, you may have dropped. But did we get it? Or was there more? I want to make sure we didn’t leave that without a complete answer.

[Operator:]

Okay, go ahead, Matt.

[Matt Hedberg:]

Sorry about that, guys. It sounds like I was on mute again. No, Peter, that makes a ton of sense. I mean I think that’s the right trade-off on the new sub adds. And I think considering the renewal expectations, that makes a ton of sense. That answered the question. And it just was a really strong quarter. Congrats on that, guys.

[Peter Leav:]

Matt, thanks a lot. We appreciate it. With that, I do want to thank you all for joining today. I’d also like to say thank you again to the McAfee team around the world for an incredible 2020. A lot has happened this year, including as you all know, our entree back into the public markets. I’d like to thank our team for their continued focus on our customers and our partners. We’d like to welcome Eduardo. Happy to have him join the IR team. He is the IR team at McAfee, by the way. And we look forward to updating all of you on our next call. Thanks very much.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.