Dropbox, Inc. (DBX) Earnings Call Transcript
November 17, 2020
Earnings Call Speaker Segments
I cover enterprise software for RBC. I am pleased to be joined by the Dropbox team, Tim Regan and Rob Bradley of Dropbox. Gentlemen, thank you for joining.
Thanks for having us, Alex.
So we'll -- on these, I usually try to ask most of the questions, and then I'll ask investors that are listening in to submit questions on the forum as well. So everybody, please feel free to do that. Tim, you've been -- you're new to the CFO role, but you've been with the company for a while. Walk through kind of the way you think about the various drivers of growth between pricing changes, new product packages, paid user growth. What's the formula that's been working and that you feel like can continue to work here over the course of the next few years?
Sure. I think it's a combination of all of those factors that we focus on as we aim to drive ARR growth. On the paid user front, we added 290,000 new users in the third quarter and certainly working to attract and retain users with introducing new features such as Passwords, Vault and computer backup that we introduced in recent quarters. Certainly also investing in driving awareness of our team's plans. And this is the focus of our recent marketing campaign that we're launching at the end of the third quarter, and it drives through this fourth quarter as well. On the pricing front, ARPU was over $128 in the most recent quarter. And that's driven by the adoption of our premium SKUs, continued expansion of our team plans, cross-selling of HelloSign and add-ons as we add new capabilities to key constituents. And certainly, we'll also consider price changes as we introduce features and functionality to our plans. And on the packaging front, we've also introduced the family plan recently. And we have additional opportunities as we consider strategies such as unbundling as we offer our free and paid users specific jobs to be done, such as Dropbox Transfer to get them familiar with Dropbox, and then bring them along to a full SKU as they try certain parts of our product. So I'd say, again, it's a combination. And we have a large number of bets that we're making to bring value to our users.
Makes sense. I guess maybe just going back to the last quarter, what was the big message that you wanted to make sure you left on investors and listeners? What did you want to make sure that came across? Maybe take another crack at it here.
Yes. I appreciate the opportunity to do that. What I really wanted to get across is a recap of our investment thesis and demonstration of our ability to execute against that thesis. And so I'd summarize it by saying we aim to consistently execute against our guidance. We're investing for a continued revenue growth. We're driving annual improvements in operating margin. And Alex, as you know, we have a target of 28% to 30% in 2024 on the operating margin front. We're doubling free cash flow to $1 billion in 2024, which represents a CAGR of roughly 20% over this time horizon. And then we're going to thoughtfully allocate capital to organic initiatives, M&A opportunities and then return capital to shareholders through share repurchases. And we can talk a little bit about what we're doing on that front as well. And then on top of that, this financial model also includes ongoing investment in future product bets that could yield additional upside. So this model assumes the cost of those product bets, but doesn't layer in the upside just yet as we haven't built the right level of signal. And so I wanted people to understand, hey, this is our investment thesis. This is what we're trying to build. And if you think about what we've done over the first 3 quarters of the year, it's executed against exactly that. It's executed against this path and demonstrating our commitment to and confidence in the strategy. And this is what I'm highly focused on as the incoming CFO. And Ajay and I worked together to develop this plan, and I think he's passed the baton to me to go and do it. And this is my focus in my time at the seat.
When you think about growth, right, you talked about the company when we -- when it went public was a double-digit growth company. It's still a double-digit growth company today. How does double-digit growth factor into that plan? Is that something you're architecting for? Is it not really that -- is it not necessary to achieve your objectives? Where do you see -- well, you're in a really interesting secular growth category around the move to remote. You're -- and you're kind of -- and you're even dogfooding in now, to some extent, going all remote. And maybe we can talk about that, too. But how important is double-digit growth in this narrative and in your objectives?
Yes. Sure. So we'll have more to share in February when we issue our 2021 guidance. But we are investing for double-digit revenue growth. And again, we're extremely focused on executing against our long-term model. And I'd say that even with conservative revenue growth rates, we have confidence in our ability to hit our long-term margin trajectory and our free cash flow target. And I'd say that we don't have to nail any one thing. We have a large basket of initiatives that we're working on, a lot of levers that we could pull on the growth front. And just to name a few and happy to get into any of them, but we're adding new features such as Passwords and Vault and computer backup to help with conversion and retention. We have introduced functionalities such as Dropbox Transfer, where a person can send up to 100 gigabytes of files in each transfer as part of their paid plans. New SKUs such as the family plan, add-ons that serve key verticals and help us expand deal sizes. And we did this with creatives this last quarter as far as this creative add-on that we introduced. HelloSign to offer to new and existing customers. New products such as Spaces. And there was a good TechCrunch article that came out today that describes where we're going with Spaces, and how that's evolving. Pricing and packaging is another lever we can pull and we've shown we have the ability to pull and that users will stay with us despite price increases. And expanding our partner ecosystem. And maybe just to touch on that briefly. This last quarter, we introduced this partnership with Adobe also for creatives. And maybe to give you some statistics around that. In the past 12 months, Dropbox users have stored over 64 billion PDFs, 1.8 billion Photoshop files and 2.4 billion Illustrator files. And so we did this partnership where a creative can leverage Dropbox Transfer natively within Photoshop to easily and securely deliver files to clients. So this is how we're serving key verticals to drive value and give more value to our users. So again, my point with all of this is it's not one thing that is going to contribute to growth. It is all of these initiatives as we bring more value to our users and then move them along this journey to our premium SKUs, to our team SKUs, layer on top additional multiproduct-type functionality to drive ARR growth. And I'm a bit of a conservative person by nature, and I'm not going to build that into our top line until I see the right level of signal, but we are investing in this with our R&D capacity. And we are encouraged by the trajectory of these early initiatives. So hopefully, that gives you some clarity as far as what we're driving to on the growth front.
Makes sense. I'll ask kind of 2 more slightly more harder hitting ones, and then I'll ask a few of the questions that are coming through the portal. So the first one is, why is it that the work-from-home benefit that you guys saw, why was it so concentrated to the very beginning of the pandemic and not more durable like some other vendors in the broader collaboration market?
Yes. It's a fair question. And I'd say, again, that the COVID demand surge we saw was largely constrained to the second quarter as we all had that go-work-from-home moment and shock that we all adapted to. But we're pleased that we converted and retained those users at the levels consistent with historical trends. And that's part of why this last quarter, we beat and raised our guidance for the year. So a strong performance from that COVID cohort, if you will. And then I'd say in the third quarter, trial starts were closer to our historic norms, but we are still seeing pockets of strength relative to pre-COVID levels in some of our premium SKUs and new products. And professional, our professional SKU, that's still up 25% from pre-COVID levels, and HelloSign is up 45% from pre-COVID levels. So potential areas for continued growth with those products, and again, steady conversion and retention relative to historic trends. And I'd say in the long run, we certainly think this shift to remote work benefits us and aligns with our focus on keeping teams in sync anywhere at any time. And this is what Dropbox was built for, is helping teams get their work done asynchronously anywhere at any time. And so this is what we're building. This is what we're orienting our product road map to. Now there are some puts and takes. And one of the downsides that we've seen is really on our outbound side of the house where we've seen a bit less volume in terms of large deals in this environment. And part of that is travel restrictions that have introduced some friction into our new deal pipeline generation. I think we saw a bit of that this last quarter where in the second quarter, we closed on a University of Michigan deal. And in the third quarter, we didn't have one of those large deals. So I think overall, this is going to be a beneficial tailwind for us, and we're excited about how our products can fit into that.
And then the next -- the other question, which is maybe just an adjacency, if you look at ARR growth, right, that decelerated 5 points from 17% to 12%, following an acceleration in the quarter prior. Can you talk about or maybe break apart the drivers of the decel? How much of it was the anniversarying of last year's price increase versus kind of fading work from home benefits?
Sure. So I'm going to start by looking glass half full. And so maybe to recap the quarter for those that may not be as familiar with our recent report, our revenue did increase 14% year-over-year and the operating margins hit 23%. That was up 10 points year-over-year. And we generated free cash flow of $187 million, with ARR ending at nearly $2 billion. So a strong quarter. And for the full year, we did raise by $12 million at the midpoint. We raised operating margin by 1.5 points and raised free cash flow by $15 million. So we did have a strong third quarter that we are all pleased with. To your point, ARR growth did decelerate. And you touched on the 2 key components of that. Where we did lap the Plus repricing initiative, which launched in Q3 2019 and served as a tailwind for us for the last 4 quarters, where lapping of this repricing was the largest driver of the decel. And the COVID spike we saw earlier in the year was being largely constrained in the second quarter. That was a secondary driver of the decel.
Got it. I'll ask some of the investor questions in the forum that I'm seeing come across. The first one is, have you seen any meaningful shift in monthly subscribers versus annual subscribers?
We've seen more of our new adds come in as monthly subscribers. But that said, the vast majority of our subscriber base is still on annual plans, and it takes a lot to shift that mix materially. So this is something we're paying close attention to and monitoring. And this was one of the concerns I think we had with that COVID cohort was that was predominantly a monthly user base that was coming in. But again, we're fortunate that we've retained and converted those users at consistent levels. So something we're paying attention to, but not a material overall shift in our user base. But it is something that in each quarter as we see this shift more towards monthly does move around our billings mix at times.
And to your point, have you -- maybe remind us, what are the retention -- what's the retention delta between the annual cohort and the monthly cohort or the churn delta?
I don't think we've given that level of detail or that level of clarity. I'll just say maybe qualitatively, we do retain annual users at higher rates. But obviously, we also get paid more via monthly users. And so there's a bit of a trade-off on that front.
Got it. The next question is to kind of dial in a little bit to your earlier comment. What does conservative revenue growth mean? What percentage growth is conservative for management?
It's a very fair question. And I think more what I'm trying to get across is we have multiple paths to get to our long-term targets. And we have high confidence in those long-term targets and varying levels of revenue growth. And I understand the desire for what is that revenue growth going to be. And I'll tell you, in all honesty, we are working on that right now. We are finishing the swing on our annual planning. I have meetings the rest of today to talk with Timothy, a meeting with Drew later this week to nail down what is our 2021 plan look like. And obviously, we'll share that turning the corner of the year in February. So my point is not to say it will be X or Y, but to give an indication of the confidence we have in our plans and our ability to hit those long-term targets because we have a lot of levers we can pull to get there.
Okay. And then next question is, I'll -- you can answer how you wish. But -- well, I'll just ask it the way it's written. Is it just a matter of time before Slack or Microsoft Teams absorb more Dropbox workspace functionality? If so, does Dropbox need to add more chat or messaging capabilities to fight back?
Gosh, hard for me to speculate on the future. I'd say we're doing everything we can to bring value to our users and to help users get their best work done. And I think maybe one thing we're trying to do and we can share, there's a blog post about our recent Zoom integration that I think is a helpful way of how we're thinking about how we fit into the long-term nature of work, where we see ourselves as the long-term memory of work and perhaps a Zoom or a Slack is more of that short-term memory. And so we've done this Zoom, Zap's integration that will be live in the early part of next year. Where as we're all today working on Zoom or communicating via Slack, very often, those communications, that interaction goes off into the ether and it's vanished, where Dropbox is that long-term memory that we can bring to that interaction. And this is what that integration is intended to do is in that Zoom space, Dropbox can bring a prepopulated set of attendees, agenda. And we can all be collaborating and updating a document to describe what was discussed in that meeting. And then that transcript, that agenda can be saved within Dropbox, serving again as that long-term memory of that interaction. And so this is where we are trying to bring our strengths in our product road map to this current remote distributed work situation that we all find ourselves working in and really bring value to that user experience. And so just another example of what we're doing with our product road map to adapt to the environment of today.
Makes sense. I'll ask about HelloSign because it's one of the things that's really been outperforming expectations for some time. I guess, it's the fastest-growing part of your business today. How should we be thinking about the scale of the business and the potential for it to be accretive to the total company's growth rate over the next year or 2?
Yes. We're really excited about HelloSign. It's one of our fastest-growing businesses. And I believe in 2019, we said that HelloSign represented over 1.5% of our revenue base, and it has certainly grown from there. I think I mentioned that HelloSign trials are up 45% from pre-COVID levels just to give you a sense of its traction. And we are seeing opportunities to accelerate that growth rate. And so a few things we've done, we've integrated HelloSign natively into Dropbox as the default e-signature option. So now as you're working within Dropbox and you want to send a document out for signature, HelloSign is that default option. And you get 3 free and then you hit a paywall. So that's one way we're working to accelerate HelloSign. And we've also made HelloSign available in 21 additional languages as we try to take advantage of this international opportunity. And so we think this is a big nascent market that HelloSign can help bring value to new and existing users. And if you think about it, before COVID, most people were collecting signatures through pen and paper. And right now, that's not feasible and it's not healthy. And so this is where HelloSign is really taking advantage of this moment that we're in. And I think the pairing with Dropbox is another angle that makes a lot of sense because if you think about the life cycle of an e-signature process, it's finding a document, signing a document and storing a document. And we can -- you can do all of that within Dropbox. And that's part of the value we can bring to the equation.
Tim, as I think about one of the elements of the current investor conversation is around COVID winners, remote work and does that go to -- as we return to work, as there's a vaccine, is there -- who's winning in that? Who's incremental? Who's losing? Who's got tough comps? Who's got easier comps? How does Dropbox fit into a vaccine world in 2021? Does that make it easier for you to grow? More difficult for you to grow? How do you -- as you look at some of your longer -- or your planning initiatives right now, at least anecdotally, how are you thinking about what does a return to work mean for Dropbox on a top line basis?
I don't think that we would materially win or lose based on a vaccine coming. I think we think this shift to remote work is a permanent shift. Employees have had a taste of not commuting. Employees -- as we have 90% of our employees didn't want to come back to the office full time. And I think employers need to react to that and adapt to that. And they're realizing, "We don't need to be in the office all the time to get things done." So Drew talks about the shift to remote work is as dramatic as the shift to mobile and the shift to cloud. And so we think this is a permanent moment that, vaccine or not, we are adapting to and we are going to do our best to take advantage of. And so we think our products are going to resonate in the market. We have a big opportunity. We've got over 600 million people using our products. We've got a big opportunity to bring value to them and to continue to drive growth in our business.
And another investor question, $1.2 billion of cash on the balance sheet growing every quarter. How are you thinking about the trade-off between buybacks, particularly if you believe in the long-term $1 billion free cash flow target versus M&A? Anything truly needle moving that wouldn't be dilutive?
We have the strength to do both, right? So to your point, we've got $1.2 billion in cash and investments on our balance sheet. This year, we're generating between $480 million to $490 million in free cash flow, and we'll hope to do more than that next year. And I said during this earnings call that from a share repurchase perspective, we are -- not only are we going to aim to exhaust our current repurchase program, which has $420 million left on it. We're going to exhaust that by the end of Q1. But beyond that and going forward, we're going to spend a significant portion of our annual free cash flow on share repurchases with at least a floor of at least offsetting dilution. So that gives us a bit of a floor from a share repurchase perspective, and we're committed to that on an ongoing basis. But we still have room from there to do M&A. And we'll be smart about it. We'll be thoughtful about valuations and make sure that whatever we buy is a complement to our product road map. And I think HelloSign is a great example of the type of deal that we would pursue when that leverages our strength in content and our ability to offer value around content. And Vault is another example, and that turned into Password. It's a feature we released recently. So it gives you a bit of context of the types of deals we'd pursue from an M&A perspective. But again, the strength of our business leads to the ability to invest in organic initiatives where, this year alone, we're going to be investing on a non-GAAP basis more than $0.5 billion in inorganic initiatives. We're going to invest in M&A where it's appropriate given valuations and given what fits our road map. And we are going to commit to a share repurchase program. So I think all of this is a testament to the strength of our business model and its ability to generate cash.
Perfect. Maybe just -- there's another question. It's a little bit more aggressively worded, but I'll ask it because it gives you a chance to double down in the statement you just made. Out-of-favor stock, depressed valuation, confidence in the business, what is the view on more aggressive posture around buybacks? Willingness to leverage the balance sheet, lever up to buy stock given the strong cash flow generation, what's holding you back from making a major statement that the stock is undervalued? I think Rob can chime in here, too. Rob likes these questions, getting riled up a little bit.
Maybe I'll start and happy to turn it over to Rob for his input as well. But these are the conversations we're having, right? We feel that, look, we've told the market what we're doing and where we're going. We've executed against that path for the first 3 quarters of the year. We know what our product road map is, and we're excited about the opportunity there. And frankly, we don't think we're getting the credit for it. And that's why we're investing in ourselves through this share repurchase, and we are having those levels of conversation to figure out, okay, what else can we do to express the confidence that we have. And so these are the conversations we're having. We'll continue to have them as we firm up our financial plan for the year, as we continue to have the right dialogue with the Board. And we'll be talking about this more in February on our next call. But Rob, anything you'd want to add on to that?
Yes, please, if I'm allowed to. So appreciate that good question. And we think about this all the time, and this is the dialogue that we're having routinely. And now we're starting to see some sector rotation. I think that we've seen the SaaS stocks start to retreat a little bit in the last 2 weeks, and we're starting to see some movement. And I think SaaS stocks that are growing double digits that are compounding cash flow and earnings are going to start to get some appreciation. And we have every confidence that our earnings per share and our free cash flow per share will grow 20%-plus over the next number of years. And if you think about that, that's a valuation that can work. The times where people are going to pay 50 and 60x sales might -- I'm not going to predict the future. But 60x sales is a big number. So what we do have is we have a very predictable model. We are doing everything we can to sustain and extend our growth rate while getting more profitable on op margin and free cash flow. And then we're returning all that capital back to stockholders. And I think eventually, people will start to pay attention. As we stabilize the growth rate and we return a lot of capital, that's going to get a lot of attention.
Perfect. Gentlemen, I think we can probably leave it there with 30 seconds to spare or 10 seconds to spare. Thank you both for joining. And I hope to catch up with you, with everybody again soon.
Thank you, Alex. We appreciate it, and thanks, everybody, for those questions.
Thank you, guys.
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