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

Thank you, everybody, for joining us here. We're very excited to have Dropbox. Thank you for coming, Tim. I think this company is at a crossroads in terms of trying to expand their product -- go-to-market product first initiatives with becoming a bigger and broader platform in terms of getting into workflows and expanding their sales in that regard. And this is a company that's been very free cash flow positive for a long time and we'll get into all that, but I'm excited to talk to Tim and learn more about this journey. So why don't we just kick it off with the audience and give a 1-minute background maybe on who Dropbox is and maybe a little bit of that evolution in terms of the product company, now platform company?

Sure. Well, first, thanks, Thomas, and thanks KeyBanc for having us. Pleasure to be here. As far as our evolution, so we really evolved from a place to keep your files in sync to a place to keep your teams in sync. And if I think about how that's translated from a scale perspective, we now have over 800 billion pieces of content on our platform. You've got 17.3 million paying users on our platform. The ARR is now $2.333 billion. So certainly hit a large point of scale. As far as the strategic evolution of the company, there's a few things we've really been focused on over the last few years and it's been consistent. Number one is really evolving and strengthening our core file sync and share product. So this is that $2 billion ARR plus base and doing more to make that easy, seamless, intuitive experience for our customers. And we've seen that translate to improving retention where churn has improved year-over-year, the last many quarters in a row. We've also done things like expanding our pricing and packaging. We just did a team's price change that we'll talk about, I'm sure, a little bit more here. So doing a lot more to give our file sync and share customers more of what they're looking for, solving their jobs to be done and strengthening that position because clearly, that's a big catalyst for the business and generating a lot of free cash flow and generating a lot of profitability. And so that then allows us to expand into, call it, really our second strategy, and that's expanding into document workflows and allowing people to do more with their content. And we talk about giving people more verbs, things you can do with your content. And so that's where we -- we acquired a company called HelloSign back in 2019, it's a e-signature company. So it's one way we've demonstrated the ability to give people more to do with their content. DocSend, we acquired them back in 2021 to send and track. You can analyze what you've sent to a vendor or a customer understand how closely they're paying attention or not to your materials. So that's another thing we've done to engage with and give people things to engage with their content. We've launched things like Capture, which is asynchronous communication through replays, it's a lightweight video editing tool. Shop, that's a way for our users to monetize their content on Dropbox so they can sell their content to end users. We've launched passwords and backup. So the engineering velocity has really picked up around these verbs to again, allow people to do more with the content that we've stored. And then really, the third prong of our strategy is really around operational excellence, where this one is near and dear to my financial heart as far as putting out financial targets of $1 billion in free cash flow -- annual free cash flow by 2024, operating margins of 30% to 32% by 2024 and then really also returning capital to shareholders. We've, over the last few years, returned over $1.5 billion to shareholders in the form of share repurchases. That's helping to drive down our share count. So this is just another way we're improving the business and I think putting ourselves in a position of strength to operate in this environment versus others are having to take some more draconian measures to catch up to today's macroeconomic conditions.

Saying it lately. The -- there's a lot there, and I thank you for articulating that so well, specifically on the workflows and the new M&A that you've had with HelloSign and DocSend, just a follow-up there. Retention is really important to you guys. I mean -- correct me if I characterize anything inappropriately, but I think churn could be as high as 10% annually. That's -- as the company, your scale, that's a lot of dollars. So have you started to see the fruits of the labor already in terms of retention related to these expansions?

Sure. Absolutely. So churn has come down year-over-year. So again, we keep investing in that. And to your point, every basis point of improved churn really helps when you're talking about a $2.3 billion ARR base. And so the team is very focused on that, seeing improvements there. And a few of the areas we're focused on, one point is call it the mobile channel, where over half of our new users come in through the mobile channel. So we're doing a lot to improve that experience. We've really improved speeds, upload speeds, the performance of our mobile devices. One thing that I really appreciate is some of it seems basic and intuitive, where in the past, a customer could -- or a user could only upload one photo at a time. This quarter, we enabled the customer user to upload multiple photos at a time. So we saw that double the number of uploads just in the past quarter. So again, giving customers what the tools that they're looking for helps with retention. Sharing is another thing that when people come to the mobile -- to us through the mobile channel, sharing is what they're trying to do. They're trying to share their content. And so now on your mobile device, you can see this blue sharing button. It's a very prevalent sharing button. So again, we're trying to get very easy. In the past, you had to click through a few different drop-downs to get there. Now it's everywhere. So we make it very seamless and intuitive for you. Also, we've introduced a few other products such as passwords and backup where people can store their passwords on Dropbox and then they can back up their hard drives or their computers on Dropbox. And the more that people use multiple points of functionality, we're finding that there's a retention lift there. So they're not just using file sync and share, they're using passwords or backup. There is an improved level of retention when that happens. And then maybe the last dimension I'll talk about before I move off of the churn point is that our external sellers or outbound team. We've now -- we've changed the way we compensate them where instead of it's all just predicated on getting the next new account, they get compensated on retaining their current set of accounts, right? So there's a much greater emphasis on, hey, it's a lot easier to keep your current customers and go get a new one. So let's incentivize them to put their effort towards that. So that's another area that we've seen improved churn.

Very clear. And then Dropbox has a pretty unique exposure in terms of smaller-sized businesses, commercial size businesses, even a consumer business. So we've asked a lot of our companies here at the conference. I'm sure people would like to hear your because given your unique exposure to that kind of more economically sensitive area. Have you seen anything late kind of clarify some of the news read, we also read?

Sure. Yes. so I'd say overall, the business has been quite resilient in this environment. So maybe I'll start with some of them and I'll start with some of the bad news, and then we'll get a good news to start. So Russia, so that's impact like everyone else, Russia, having to discontinue some sales to Russia. That's a mid- to high single-digit million dollar impact to revenue this year. So that's a headwind we'll have to absorb. FX, that really the strengthening of the U.S. dollar, that really turned against us this past quarter. It's now a $34 million headwind to revenue for the year. So I think that's impacting everybody, but we're not immune to those. Our growth businesses have seen some slowdown. HelloSign, not immune to what's going on in the broader e-signature space. So we've seen that really take off after the pandemic, and then that's pulled back a little bit. I know DocuSign has seen similar things. And DocSend, another one of our growth businesses. That -- a fair amount of DocSend relies on the VC fundraising community, which, again, that has seen some pullback in this space. So those are some of the points of bad news. On the good news front, our core file sync and share product continues to do really well. We have not really seen a material deviation in our trends. Things continue to hold steady. As I talked about, churn continues to improve. We actually did raise our constant currency guidance for the full year by about $8 million. We had our earnings call last week. So actually raised our guidance for the full year. We beat our Q2 guidance and raise for the full year. We also just did launch this pricing and packaging change. And so far, churn rates have been better than we had forecasted. So -- and why you may ask? About 80% of our users use us for work. And so if you think about what do people need in recessionary downturn times, they need to be able to do their jobs. They need the tools to enable them to do their work. And so that's where we are helping to solve some of their core challenges. And I think people are turning to us and staying with us.

Well, let's focus on that 20% as an adjunct. I hate when you share a stat and then I jump on you with it, but the -- but that consumer exposure. It's relatively unique to Dropbox with some of your competitors. Have you seen any economic impact there at this time?

No. Again, everything tends to -- so far whether it's on the consumer side or on the team side, everything has been holding steady. So I think our core file sync and share product has been really resilient in this environment. We've seen that in the past, where in pullbacks or downturns, people tend to stay with us. And again, I think the leverage is for.

You do have experience there and the product has been sticky. But your expansion into like workflows and like something, again, a little bit more SMB or commercial, do you expect the skew of your business to maybe, say, a few years from now, expand away from kind of smaller businesses in consumer?

I'd say right now, our business continues to be very well positioned to leverage our self-serve go-to-market motion, right? So that is 90% of our business. And we continue to focus on individuals, freelancers, solar printers, SMBs. It tends to be a very profitable motion for us, where there's minimal discounting on the revenue side, the cost of going down that path is highly profitable. You can see our margins are strong. We do have about 10% of our business is outbound in channel. And so we do have this land-and-expand motion where we try to enable the most efficient motions on our outbound side where they can see pockets of usage of Dropbox in a particular company from a start point, given that self-serve motion and then expand based on that. So it's been very efficient for us. We're going to continue to leverage that. Where we see opportunity on the broader mid-market enterprise space, we'll certainly keep that in mind. But for now, I think the strategy that we've seen in the past will hold the short term here.

Excellent. You mentioned a couple of times as large price increases. It's 20% price increase on the teams. So maybe help kind of formulate what teams is kind of as a percentage -- I think you've broken that out in the past and to just kind of show the magnitude of what this could drive in terms of revenue growth?

Sure. So what we did is we raised prices on our standard and advanced plans. And so that's about 1/3 of our total ARR base. And we have not raised prices on these plans since 2017. And so we've been adding a lot of value to these plans over the last handful of years. And then recently, we also started offering our customers these more robust security capabilities and features. Things like external sharing reporting where you can see how content has been shared external. You can -- we brought in Dropbox Passwords, Dropbox Backup. Then we brought in ransomware detection capabilities. And so we've seen things like ransomware increased 300%, I should say, the industry has seen -- increased 300% over the past year and SMBs are highly the subject. There is about half to 2/3 of all cyber-attacks are towards SMBs. And so we partnered with our customers to really offer this additional functionality. And so again, we're seeing that translate well to our results. Getting back to your maybe perhaps how does this flow through to the model-type questions.

That's the next one to ARPU, yes.

So let's see. So again, it's 1/3 of our total ARR, and it's a 20% price increase. From a modeling perspective, it will flow through according to how the billing cycles occur. And so we have -- 2/3 of our users are on an annual plan and 1/3 are on a monthly plan. And so for new customers, this came into effect in June. Existing customers, this came into effect on July 5. And so I do expect a spike in net new ARR in the third quarter really as the monthly users are subject to this pricing change. And then for it to flow through over time as annual customers are subject to the pricing change. And so this will flow through to net new ARR over that pattern I just described. And then to revenue, it will flow through over -- in 2022 and 2023, it will be a benefit to both. And so far, churn is going well. We've got this early signal of June and July. So far, customers are staying with us better than we had hoped, better than we had forecast, and new customer conversion is coming in strong. So I certainly feel like this is going to be an accretive to ARR event.

So you got that obviously a tailwind. And if retention keeps trending in the right way with all the enhancements you've made, that's going to be another tailwind. In 2Q, you, I think, exceeded both gross margin and operating margin. Maybe you can tease out if there are any onetime items in there, but this just begs to maybe marrying what top line growth is kind of needed to support that kind of double-digit CAGR growth to get to the $1 billion free cash flow?