Gen Digital Inc. quarterly report, Q3 FY2020

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Business context and reporting period

NortonLifeLock Inc. (then trading as NLOK; formerly Symantec Corporation) filed this Form 10-Q for its fiscal third quarter ended January 3, 2020. The three-month comparison is against the quarter ended December 28, 2018; the nine-month comparison periods differ by one week (40 weeks versus 39 weeks).

The company completed the sale of certain Enterprise Security assets to Broadcom on November 4, 2019, for a stated purchase price of $10.7 billion. The sale was treated as a strategic shift, with the divested business reported as discontinued operations in all periods presented. Continuing operations now comprise one reportable segment focused on consumer cyber safety, including consumer security and identity and information protection.

Financial performance and liquidity

Amounts below are in millions of dollars, except per-share data and percentages.

  • Third-quarter continuing revenue: $618, up slightly from $615. Gross profit was $515 and gross margin was 83%, compared with $505 and 82%. Operating income was $62 in both periods; operating margin was 10% in both.
  • Third-quarter earnings: Continuing-operations income was $353 ($0.55 diluted per share), versus a $19 loss. Net income was $2,845 ($4.40 diluted per share), but included $2,492 from discontinued operations, substantially reflecting the sale gain after related taxes.
  • Nine-month continuing revenue and operating income: Revenue was $1,876 versus $1,839, with management attributing the increase primarily to about $44 of revenue from the additional fiscal week. Operating income rose to $311 from $86. Continuing-operations income was $429 versus a $147 loss.
  • Nine-month net income and cash flow: Net income was $3,656 versus a $3 loss, including $3,227 from discontinued operations. Cash provided by operating activities was $905, versus $948. Investing activities provided $10,991, primarily from the Broadcom sale; financing activities used $1,037.
  • Cash and liquidity: At January 3, 2020, cash, cash equivalents and short-term investments totaled $12,768, including $1,063 held internationally. Cash and cash equivalents alone were $12,649. The company also had an undrawn $1.0 billion revolving credit facility.
  • Debt: Principal debt was $4.5 billion, including $500 of term loans, $2,250 of senior notes and $1,750 of convertible notes. Balance-sheet debt, net of discounts and issuance costs, was $4,468; $749 was classified as current. The company reported compliance with its debt covenants.
  • Other operating metrics: Direct customer revenue was $542, average direct customers were 20.1 million versus 20.6 million, and monthly direct ARPU was $8.99 versus $8.75. Consumer security revenue was $364 and identity and information protection revenue was $239 for the quarter.

Material changes versus the prior comparable period

  • Quarterly continuing revenue was broadly flat. Management said declining average direct customer count was largely offset by higher ARPU.
  • Quarterly research and development expense fell $38 to $72 and general and administrative expense fell $13 to $85, partly reflecting cost reductions. Sales and marketing expense rose $12 to $178, primarily on increased advertising and promotional spending.
  • Quarterly restructuring, transition and other costs rose to $98 from $50, including contract cancellation charges and asset write-offs associated with restructuring.
  • Other income, net, was $399 in the quarter versus an expense of $18, principally reflecting a $379 gain on the sale of the DigiCert equity investment. Continuing-operations income also reflects this gain.
  • Discontinued operations included a $5,422 gain on the Broadcom sale and $2,808 of income tax expense for the quarter. The nine-month discontinued-operations tax expense was $2,197, including the sale-related tax charge, partly offset by a $665 tax benefit from remeasurement of Irish deferred tax assets.
  • Cash and short-term investments increased substantially from March 29, 2019, primarily due to the Broadcom proceeds and operating cash generation, partially offset by share repurchases.

Outlook, management commentary, risks and unusual items

  • Outlook: The filing provides no specific revenue or earnings guidance. Management describes a strategic focus on consumer operations following the divestiture. It planned to draw $750 million under a delayed-draw term loan in fiscal Q2 2021 to repay the 4.2% senior notes due September 2020.
  • Capital returns after quarter-end: The $12-per-share special dividend was paid January 31, 2020, for aggregate payments of approximately $7.2 billion. On February 4, the company paid approximately $546 million to convertible-note holders in lieu of conversion-price adjustments. These are subsequent events and are not reflected in January 3 cash balances. A further $0.125-per-share dividend was declared for payment in March 2020.
  • Restructuring: The November 2019 plan targets approximately 3,100 employee reductions and other actions. Estimated total costs are $800 million, including about $330 million of expected cash severance and termination benefits and $170 million of expected cash contract-termination costs. Actions were expected to be completed within 12 months; $285 million had been incurred by January 3. A separate August 2019 plan targets a net global headcount reduction of about 7% and estimated costs of $100 million.
  • Transition and execution risks: The company remains dependent on Broadcom for certain transition services and engineering services considered critical to its endpoint security offering. Management cited potential disruption, higher-than-expected costs and employee attrition risks during the business transition.
  • Legal and tax contingencies: The company is cooperating with an ongoing SEC investigation and faces securities and derivative litigation; it could not assess whether a material loss was reasonably possible or estimate a range. In the GSA matter, it accrued $25 million, but said a loss above the accrual was reasonably possible and the high end could not be estimated. Gross unrecognized tax benefits were $569 million; the filing identifies uncertainty around tax controversies, including the Altera litigation.
  • Other investor risks: The filing highlights reliance on consumer cyber-safety demand after the divestiture, competition and pricing pressure, privacy and cybersecurity regulation, and the risks of executing cost reductions and maintaining product and service continuity.

Important facts for investors to verify

  1. Separate recurring consumer-business performance from the one-time Broadcom gain, related tax effects and DigiCert investment gain when assessing earnings.
  2. Assess cash and debt after the $7.2 billion special dividend and approximately $546 million convertible-note payment, rather than relying only on the January 3 liquidity balance.
  3. Monitor customer retention and ARPU trends, restructuring execution and cash costs, and the company’s dependence on Broadcom transition and engineering services.
  4. Track resolution of the SEC investigation, securities litigation, GSA claims and tax uncertainties; the filing does not provide a reliable maximum exposure for several matters.
  5. Confirm the impact of the January 31, 2020 ID Analytics sale, which generated approximately $375 million of net cash proceeds after the reporting date.