Dropbox, Inc. (DBX) Earnings Call Transcript & Summary

All right. Hi, it's Walter Pritchard. I'm a software analyst here at Citi. Happy to have Tim Regan with us. He is the Chief Accounting Officer and the incoming CFO of Dropbox. And I was going to go -- we also have [Rob Bradley,] who's the Head of IR on the line as well, if needed. And I was going to go through some questions I had -- I had prepared, and there is a window off to the left in your conference panel there that gives anybody connected on an opportunity to question. So I can take those when you send them and you can also e-mail me if that works better. So again, Tim, thanks a lot for joining.

You bet. Nice to be here.

Great. So I guess where I wanted to start is where we started with most companies here, just reviewing and sort of looking forward at what's happened in this COVID, work-from-home environment? What sort of puts and takes have you seen in the business? And how do you expect it to play out as we look into the rest of the year and beyond?

Yes, great question. I think we've been really fortunate, honestly. Our CEO, Drew, talks about this as being a dramatic change similar to the shift to the cloud or mobile. So this move to work from home is definitely a moment, and we think that our product is well suited to the remote distributed work environment. Certainly, something we've been working on for a long time, keeping files and teams in sync anywhere at any time. And so it's really lucky for us to have a product that fits this moment. And I think we're seeing that as far as trials where individuals and team trials are up 20%, and relative to pre-COVID levels and conversion rates of those trials has remained steady and churn has been stable throughout this time. And another space is HelloSign. This is the e-signature and document workflow company that we acquired last year, where really the alternative of pen and paper, which is still how most people execute on signing. The alternative of pen and paper is not only not feasible, it's just not healthy right now. And so that gives us a large opportunity to pursue where usage of HelloSign is up 25% relative to pre-COVID levels. So seeing strong activity on the trial side of both core Dropbox and HelloSign. And then the new Dropbox, which is our smart workspace that we've introduced in this last year. Engagement on that is up 100,000 users sequentially. And so now 450,000 out of our 500,000 business teams are using the new Dropbox as they are figuring out how to engage with their employees and colleagues in this work-from-home environment. So strong top of the funnel momentum. And then it's also honestly been helpful on the profitability front, and we had a quarter last quarter where we did operating margins of 20.5% and that was about double what we did last year. And some of that is due to savings on things like travel, events and other areas. So for the most part, I think we've been fortunate as far as having a product that's resonating well in the market and a team that's been able to produce at high levels, leading to additional efficiencies on the bottom line.

Got it. And maybe I wanted to come back and talk about the new smart workspace offering, which is sort of independent of COVID. But curious what -- you talked about HelloSign and interactions, for example, up a lot with COVID. What other sort of beyond this trial usage and so forth? What are the changes in behavior or new behaviors have you seen relative to your installed base in terms of how they interact with Dropbox in these conditions we're seeing right now where everybody is working from home?

Sure. Good question. Well, I think, to your point on HelloSign, I think that is definitely one area that's doing very well. And one of the points of interaction, we introduced some new capabilities here in this last quarter where now it's a very native and deep integration where just now you can send for signature one of your documents, and you have 3 free, and then you hit a paywall. And so we're seeing strong traction in that e-signature space, partly due to this more native integration. And we've also gone live in international locations, where in the past, it has been only available domestically. But now we're live in 21 additional languages to taking advantage of this international opportunity. So I think to your point on HelloSign, I think that is a space that we're seeing a strong traction. And then one other maybe interesting point to note is just the fact that people use Dropbox not just for their work lives, but for their home lives. And so I think about my own experience where I could go from talking to an investor or talking to a member of our management team in one moment. And then the next moment, I'm chasing the kids to go clean up something that they've spilled in the kitchen. Right. So I'm constantly toggling back and forth between work and home. And so this is where we've introduced some new features and functionality. And I think of things like passwords, which stores and syncs your passwords across devices, we launched that in the second quarter. And Vault, which secures and organizes their most important personal documents and things like your wills or your trust, where you can now give a pin to your family member to help with that information. Computer backup, which automatically backs up your Mac or your PC. And the family plans, we introduced that in this last quarter. So one pattern we're seeing is this blend of work and home. And so this is where we're introducing features and functionality to capture that experience and capture that moment. And this is part of our strategy to move people from basic users, move them into this individual space where we're solving their personal problems. And then we can continue to migrate them towards our team solutions. So just a few examples as far as this blend of work at home and the HelloSign opportunity that you mentioned.

And one question that already came in here that's relevant to the discussion we're having right here is the free user base, the 600 million users has been a big driver of your paid business. What -- are you seeing any changes in behavior in that base around usage or churn and how do you look at the potential propensity for those users to upgrade now versus pre-COVID? Has there been anything notable there or any strategy that you have that Dropbox has to try to monetize those customers more so than in the past?

Yes. Great question. And to the question's point, we do have over 600 million basic users, right? So 600 million people are familiar with our product and using our product. And so it's up to us to keep introducing these new features and functionality to move them along into our paid usage state and then from individuals into teams. And so we continue to see a mix of teams and individuals coming to the top of the funnel and continue to see strong top-of-the-funnel traction. And I mentioned the trials that we're seeing and a lot of the other metrics that we're seeing are consistent with pre-COVID levels, particularly as far as our conversion rates and churn rates. And so certainly, we are closely monitoring these trends. So to figure out how our customers are using us, how can we continue to introduce features and functionality that solve their challenges and both retain them and then continue to drive them up to our premium SKUs.

Got it. One market that you've talked more about recently, including on the last conference call, a couple of large transactions was the education market. And I think that's been a market for the company for a long time. Is there something now that's driving more monetization there? And how do you look at the sort of role of those types of customers, they sort of cross the professional personal boundary that you've already referred to?

Yes. Yes, good question. We've certainly seen strong success in the EDU vertical. A few quarters ago, we closed a deal with [ Kuni ]. We've also closed deals with Oregon, Arizona and the University of Michigan as a deal we closed last quarter. And so if you think about, again, this COVID experience that we're all dealing with, students and faculty need a place to share content back and forth. Certainly not as easy as the old days of just handing in your paper. And so this is another solution, this is another vertical that we've seen accelerate in this COVID moment. And we think it's a great strategy for us because it seeds our future users. And I think about my own way of using products. If I'm already using a product and storing my content in it and getting more acquainted with the ecosystem and figuring out the features and functionality that I enjoy within a product, I'm more likely to stay. And so as we're procuring these users in this, call it, student state, as they exit, we have that advantage to convert them into paid users on our individual plans and ultimately team plans as they exit the university life. And then there's a vitality angle, right? As they become more familiar with our products and are using it more, they'll share their content with family and friends and introduce Dropbox to their own personal ecosystem, if you will. So we think this is ultimately very accretive to ARR and something we will continue to pursue. And some ways that we're working on enhancing that experience is through partnerships with learning tools such as blackboard and canvas. So we're figuring out, hey, what are the tools that faculty and students use to interact with each other. And then engaging with partnerships just to make that experience stronger to really help solve their challenges. And then one other angle to it, of course, is oversight controls where university officials and others just want to make sure that the content is secure and safe. And so this is where we've enabled security and administrative controls to manage users and monitor activity. So doing everything we can to solve for the challenges of our users, both whether it's the students, whether it's the faculty or whether it's the administrators. And this is something that is a strategy, we think, is going to help us in the long term.

And how do you think about from the free user base? There are some users who will probably never pay you anything, and then there's some who are pretty quick maybe to pay and start a trial for a period of time. How important is it to improve the yield of those free users for the company versus how much of a tolerance is there over the long-term to have a very, very large base of -- for users that maybe you're never monetized or weren't monetized in the foreseeable future?

Well, it's great for us to have this large user base that gives us a great opportunity to understand how are people using the tool, how are people using their content? And that helps us educate where to take our product going forward, right? And so that's helped us figure out how to launch some of these new features and functionality passwords involved. And this is the sort of feedback we're getting from customers to say, this is what would be useful for us and that gives us a signal as to what to release and then what potentially can drive conversion down the road. And so I think that's one massive advantage. And so one other, I'd say is, if you look at our acquisitions, right, having this 600 million users with HelloSign, now we can leverage that user base, and we have this built in distribution network. And this is where we can introduce some of these new features and capabilities that, again, can resonate. And maybe one other angle that I can mention is this focus on content and the strength in content, we have these AI capabilities as well. That as I am going to a meeting, for example, I can say I have a meeting with Drew. Our system can see, hey, these are some documents that you've been collaborating on with your CEO and whether it's a board deck, et cetera, and surface the right content for me at the right time as it sees what's on my calendar and what content is perhaps the most relevant to that situation. So having this user base really helps us cultivate our future road map. It helps us cultivate potential M&A opportunities, and it helps give us this opportunity to expand down the line within paid users. And I can talk about, if you'd like, on the infrastructure side, just how we try to manage our cost as well.

That would be -- I guess that would be helpful, especially. I think one thing that's happened there is a couple of years ago, you moved to your own infrastructure, I think costs were a part of that. Maybe you could help us understand where we are in that benefit cycle of having made the move and beat a couple -- maybe 18 months out from that move?

Yes. So to your point, a few years ago, we did shift away from AWS onto our own infrastructure. And that gives us the opportunity to innovate and optimize our gross margin profile. And so a few things we've done there or we've introduced this SMR technology, shingled magnetic recording. Which is the layering of disk drives that store data. And one way I think about it is almost shingles on a roof. And so they're layered on top of each other, which reduces the space required, and it increases storage density per disc by 75%. And so half of our storage is leveraging SMR as of the second quarter. And so that's one point of innovation that is helping to drive our efficiency there. Another is this cold storage, where we've analyzed the usage patterns of how people are accessing their content. And certain content that they access at low frequency rates, we can store at lower cost levels. So these points of innovation that we've been able to drive is due in part due to owning our own infrastructure. And that's where we're delivering 79% margins this year and our long-term target, 78% to 80%. So we are doing quite well as far as driving efficiencies along that space.

And from that perspective, when you highlight that half of your storage is on the SMR technology, is the conclusion there then that the other half can go there and that there's further potential for improvement? Or how should we think about sort of where you are on that curve benefiting from having made this decision?

Yes. Good question, Walter. Yes, we're on the path. It does require some level of exploration of, call it, the existing equipment, and then you shift into the new equipment. So there's a bit of a cycle to it, but we're on -- we're definitely on the path, and it will continue to grow from the 50% that it is today to much higher percentages over time just as we go through our refresh cycles, if you will.

So then as we think about, you're already at 79% margin, you're sort of already within that band that you've highlighted as a long-term goal. What are the -- it sounds like over time, there are additional investments that you would be making to offset some of those savings or how should we think about maybe as the rest of that storage doesn't moves through this new technology? Wouldn't that drive you in excess of the range that you've talked about?

Yes. Good question. We will need to continue to invest in this space. And so we'll -- whether it's -- we just did a new infrastructure up in Portland, a new data center up in Portland. So that's one way we've invested, and then we're also thinking about whether it's international investment. There's new regulations, whether it's GDPR or other that might warrant us building out new infrastructure in areas more regionalized. And so there's more investment to come here. And so we're not lifting those long-term targets from 78% to 80%. We're not lifting those just yet. Something that I will certainly be looking at with my team as we think about, call it, our guidance for next year. But no immediate plans to lift that target right now.

Got it. And then on -- you brought it up earlier, and I was going to return to it on the smart workspace or the new desktop experience, I think the majority of your users have moved there. How many of them have actually sort of changed the behavior that they have with the application. I mean, some of this was just a move that was made on the back end. Could you help us understand sort of what's changed from the user's perspective? And how are you seeing that change how they interact with Dropbox?

Sure. So their engagement, so not only have, call it, 90% of our teams adopted it. Engagement is up 60% from pre-COVID levels, and so they are using it. And maybe to take a step back as far as what is the new Dropbox.

Sure. That would be good.

So it's aimed at solving the problem of fragmentation in your Workday. So right now, our content is scattered. We don't know where to find our various documents and whether it's a cloud doc or a Microsoft doc or Adobe, Google, content is everywhere. And we are constantly toggling between tools, whether it's our Slack or Zoom or Atlassian or Dropbox, constantly bouncing around between tools. And particularly in this time, we don't necessarily know what our teams are up to. We don't know what they're working on. We don't know what they are focused on. We don't know what documents they're engaged with. And so the idea from the new Dropbox is to help solve for that fragmentation of your work experience and bring focus to your day. And so we bring together your content, right? So your cloud docs and Microsoft and Google. Everything is in Dropbox. Your tools, you can go to Dropbox and natively launch Slack, you can launch Zoom, you can launch Atlassian. So you can use all your tools all within Dropbox. And you can see what your teams are up to, whether it's the documents they're operating in or what they're commenting on, et cetera. So this is what we launched in the back half of last year and to what we talked about, it's 90% adopted across our teams and that was our main goal this year is to drive adoption. So we are definitely continuing to monitor how customers are using it to figure out, okay, now how do we evolve the product to make it even more useful. And our head of productivity talks about trying to make this a toothbrush experience where you wake up and you use it, then you go to bed and you use it, and you've been using it throughout your day. And this is where we are looking to launch another update and iteration to the product in the back half of the year. So stay tuned for that. And one of my main focuses is -- okay, now what does this mean for monetization. And so we -- one angle to it is better conversion and better retention, right? As more people are using your product more likely to stay and more likely to convert. But then there's also this concept of the foreground canvas, where with the new Dropbox, if I'm playing in it every day, and this is what I see as a user of it, is that now I can easily see what are the features and functionality that might be pertinent to me and it might be useful to me. And so I can natively click on this HelloSign, as an example, I can see, okay, I'm in this doc, I want to get it signed. So I send it for signature, and I go through this 3 free and then hit the paywall. And so we have this foreground experience where now people can actively see what Dropbox can do for them. And they can see, do I want to transfer a document, do I want to send it for signature, do I want to scan a document? All these sorts of tools that people didn't necessarily know existed, we can bring to them and market to them more efficiently. So there's opportunities there to drive -- upsell to drive additional adoption. And so that's what we are focused on as far as how do we get people using it as much as possible, engage with it as much as possible? And then how do we monetize from that experience?