Natalie Derse
Chief Financial Officer at Gen Digital
Thank you, Vincent, and hello everyone. It's a very exciting time for our company. We are thrilled to bring the Avast and NortonLifeLock businesses together and move forward as Gen. Our team is highly motivated to get started and bring our vast opportunities to market.
For today's discussion, I will walk you through our Q2 results, outlook for Q3 and wrap up with details on our long-term model. I will focus on non-GAAP financials and year-over-year growth rates, unless otherwise stated. A reminder that our reported results also include a partial quarter of Avast, which was acquired on September 12, 2022.
Before we dive into the results, I would like to share how we evaluate and measure business performance as Gen. Gen is centered on Cyber Safety. Our product portfolio is split by consumer security, identity and information protection and our go-to-market omnichannel business lines are split by direct and partners.
Direct makes up about 90% of our business with subscriptions sold directly through our e-commerce sites or third-party app stores. We have further harmonized our direct channel definitions and aligned to industry standards now including NortonLifeLock mobile app store customers and revenue in this category.
Although partners only account for approximately 10% of our combined business, this channel remains an investment area for us as we further diversify our distribution models to provide multiple entry points for the consumer, including employee benefits, retailers, OEMs, telcos, service providers and small businesses.
With the combined focus on Cyber Safety and go-forward portfolio identified through the integration with Avast, we have also carved out a legacy category, which includes end-of-life products or accident [Phonetic] markets. In total, this makes up less than 3% of our overall revenue base, and we expect it to phase out over the next few quarters.
Going forward, our discussions will be focused on Cyber Safety growth. For more details on our reporting structure, I'd like to point you to Slide 13 in our earnings presentation. Now on to our Q2 results. Q2 results reflect our consistent execution and focus on driving long-term sustainable growth. Q2 is our 13th consecutive quarter of bookings growth, supported by a healthy and robust customer base and strong unit economics.
Q2 bookings grew 11% in constant currency and was in line with our expectations. Excluding Avast, Cyber Safety bookings grew 5% in constant currency as we drove increased value through cross-sells in the Norton customer base and our key partner channels continue to scale, including identity-driven partnerships with international telcos and employee benefit partners in the U. S.
Q2 non-GAAP reported revenue was $748 million, up 12% in constant currency and up 8% in USD. This includes a partial quarter of Avast, which contributed $48 million or 7 points of growth in constant currency. Similar to prior quarters, our top line growth includes an unfavorable impact of 4 points as a result of increased foreign exchange headwinds of over $30 million year-over-year. We expect this currency headwind to continue with both the euro and yen depreciating further against the U.S. dollar in recent weeks.
Despite volatile macroeconomic impacts our cyber safety revenue, excluding Avast continues to grow mid-single digits in constant currency, in line with expectations and, again, a reflection of our focused and consistent execution.
Stepping through our other key operating metrics. Direct revenue of $660 million grew 11% in constant currency and 7% in USD supported by cross-sell and other monetization initiatives with our existing customer base. Direct customer count went from $23.3 million reported at the end of Q1 as NortonLifeLock to $38.6 million at the end of Q2 as Gen, including approximately 15 million Cyber Safety customers from Avast.
Quarterly performance implied a combined decline of $252,000 quarter-over-quarter with $62,000 from NortonLifeLock and $190,000 from Avast. Both companies saw continued headwinds from lower global website traffic to our e-commerce site, impacting new online customer acquisition. But together with Avast, we now have an even larger opportunity to leverage our go-to-market efforts and further optimize our marketing investment across brands and SEO to drive up traffic and conversion.
Q2 direct monthly average revenue per user, or ARPU, was $6.98 in USD, which reflects a blended ARPU of NortonLifeLock and Avast combined with Avast ARPU of approximately $4.30 and mobile ARPU of approximately $2.50. Specifically for NortonLifeLock results, ARPU expanded over $0.30 year-over-year adjusted for FX.
We are proud of the progress we've made in the last year, increasing the value provided to our existing customers through our cross-sell and upsell efforts and are excited to drive similar improvements with the Avast customer base. Our customer base remains loyal with NortonLifeLock retention stable at 85% exiting Q2. As we merge with Avast, our overall customer retention rate moves from 85% to 75% blended. We believe the 20-point retention differential between NortonLifeLock and Avast presents a large synergy opportunity to drive growth with our existing customer base. I will expand on this more as we discuss revenue synergies shortly. For further details on our performance metrics, please refer to Slide 14 in the earnings deck.
Moving on to partners. Partner revenue was $74 million, up 21% in constant currency and 16% in USD, impacted by 5 points of FX headwind. This is our eighth consecutive quarter of double-digit revenue growth in partners as we leverage this channel to extend our reach to consumers and broaden our product and geo-expansion efforts. We will continue to invest in this omnichannel strategy, specifically in telco and retail partnerships that drive distribution of our expanded portfolio offerings, employee benefits where Cyber Safety and identity protection is essential to the employees' lives and through small businesses where entrepreneurs can scale their businesses with peace of mind knowing they are digitally protected. Partners will remain a key cornerstone of our investments going forward.
Turning to profitability. Q2 operating income was $388 million, up 7% year-over-year with partial results from Avast. We continue to run G&A lean at roughly 4% of revenue, which provides the operating leverage to invest in sales and marketing and R&D. We remain disciplined in our cost structure with margins flat year-over-year.
Looking ahead as Gen, we will strike the right balance on investments across our expanded portfolio and channels and will be intentional on how we spend in order to drive the highest returns across the markets, channels and customers we serve.
Q2 net income was $269 million, up 5% compared to last year. Diluted EPS was $0.45 for the quarter, up 5% year-over-year or 12% in constant currency, including $0.03 of currency headwind. Please note that this reflects partial dilution from the $94 million of Avast share issuance and higher cost of our debt. And our non-GAAP tax rate estimate was 23%, which represents a blended rate before any tax restructuring efforts.
Turning to our cash flow and balance sheet. Q2 operating cash flow was a use of cash of $88 million and capex was consistent at $2 million in the quarter. Seasonally, Q2 operating cash flow is the lowest quarter of the year due to the concentration of tax payments. This quarter also includes approximately $110 million of cash payments tied to the closing of the Avast deal and related financing transactions. Looking ahead, we have high confidence in our cash flow generation, which will continue to grow with profitability.
Year-to-date, we have returned over $550 million back to shareholders in the form of both buybacks and dividends. We deployed a total of $404 million towards share repurchases or over 17 million shares in the first half of this fiscal year and have approximately $1.4 billion remaining in our current buyback program.
In Q2, we repurchased $104 million or 5 million shares. We also paid $73 million to shareholders in the form of our 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 December 14, 2022, for all shareholders of record as of the close of business on November 21, 2022.
Moving to our capital structure. We had a lot of activity in Q2 related to the Avast acquisition and maturities that came due during the quarter. We now have a capital structure in place that we believe sets us up well for the long term. Our debt maturities have been extended and staggered through fiscal year 2031 with no near-term maturities due until April of 2025. We remain well positioned with $2.6 billion in liquidity, and our gross leverage is 4.4 times with net leverage just under 4 times. You can refer to Slide 31 in the earnings deck for more details on our go-forward capital structure.
Looking ahead, Gen as a combined business has predictable and highly ratable revenue, generates significant free cash flow on an annual basis and is backed by a strong liquidity position. We will drive a balanced and disciplined capital allocation approach between targeted deleveraging and opportunistic share buybacks. We feel good about where we are at, and we will continue to evaluate and assess our overall debt needs and leverage profile in this ever-changing environment.
Now an update on the Avast integration and expected synergies. We're pleased to report that our pre-integration planning and actions we've taken to date have successfully accelerated our integration timeline from 24 months to 18 months. This is a big undertaking, and we are aggressively going after this. Our integration efforts are well underway with day one of integration officially kicked off a week ago on November 1st and I'm pleased to share with you today that we are increasing our annual gross cost synergy estimate to over $300 million.
In terms of phasing, we intend to exit fiscal year 2023 with 50% of the $300 million annual run rate achieved and exit the first half of our next fiscal year with 70% achieved. 100% completion exiting fiscal year 2024. We expect the post-synergy structure with gross margins of over 88% and opex reduced from approximately 35% of revenue today to 28% to 30%. This translates to an operating margin framework of approximately 60% and any leverage we drive above that creates flexibility to drive even more growth and portfolio diversification.
With the addition of Avast, our complementary strengths provide increased levers to drive top-line growth across the combined $500 million existing user base. We have identified approximately $200 million in revenue synergies over the next two years. Opportunities include Avast retention improvement, increased cross-sell and upsell, leveraging an expanded product portfolio and marketing spend optimization across brands, just to name a few. Achieving these synergies will help strengthen our mid-single-digit growth rate. We expect traction with revenue synergies to be measured directly through ARPU and retention improvements over the coming quarters to support our bookings and top line growth expectations.
Now turning to our Q3 outlook. For Q3, we expect non-GAAP revenue in the range of $925 million to $940 million, which reflects the first full quarter of contribution from Avast and reflects Cyber Safety mid-single-digit bookings growth. This also includes approximately $40 million of headwinds from FX. We expect Q3 non-GAAP EPS to be in the range of $0.42 to $0.45 per share. This reflects the first quarter dilutive impact from Avast. But please note, we expect Avast to be accretive in the first 12 months.
Based on the continued strengthening of the U.S. dollar quarter-to-date, we anticipate the currency headwinds to persist and the interest rate conditions to remain volatile. But I want to emphasize that the underlying health of the business remains strong and durable. And given our high cash flow generation and strong liquidity, we are confident in our ability to navigate through the near-term challenges. Q3 is just the first step post-Avast towards our long-term objectives.
Beyond Q3, we continue to remain focused on our long-term $3 EPS objective that we communicated during our last Investor Day. Given the meaningful macroeconomic changes since then and now that we have merged with Avast, we have looked at a revised path to achieve this. First, we recognize that the rising cost of debt and FX headwinds has created a $0.60 to $0.65 headwind. Beyond that, the building blocks and path remain largely the same as we've laid out previously at Investor Day as well as 15 months ago during the Avast deal announcement.
The annual gross cost synergies of over $300 million, combined with the accretion from Avast profits, will create more capacity for reinvestment in a faster timeline and will fund the diversification efforts and next horizon bet that helps solidify our growth targets. We expect our business to grow at mid-single digits, supported by the revenue synergies I laid out above, the complementary strengths and increased levers as a combined company and the long-term secular importance of Cyber Safety.
These growth drivers are centered on product innovation and new product introductions, expanding reach and distribution through our omnichannel strategy and expansion of our trust-based services. The focus remains on customer experience at the core.
Finally, we intend to use our capital to deliver incremental EPS with a disciplined approach of debt paydown and opportunistic share buyback ultimately offsetting the dilution from the Avast share issuance. This all ladders up to an annualized EPS of $3 as we exit fiscal year 2025 and in line with the timeline we shared with you 18 months back. We are excited about these opportunities for growth and remain relentlessly focused on what we can control to achieve it. For more details, please refer to the whiteboard bridge in Slide 27 of the earnings presentation.
In summary, we remain committed to driving EPS expansion. We are focused on accelerated integration timeline, on execution against our business opportunities and driving towards our long-term objectives. We have a very robust business model with a healthy customer base, and we remain focused on expanding new customer acquisition through new channels and geos, driving more value for our existing customers as well as increasing engagement with new products and services. We will provide updates and increments as we work through integration in these next few quarters.
As always, thank you for your time today, and I will now turn the call back to the operator to take your questions. Operator?