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

Good afternoon. I'm Jason Ader. Welcome to our virtual fireside chat with Dropbox CFO, Ajay Vashee. Ajay, thanks for being with us today.

Thank you for having me.

Now before we begin, I'm required to inform you that a complete list of research disclosures or potential conflicts of interest is detailed on our website, williamblair.com. Also, there should be a question box in the webcast. So please submit any questions you have during the fireside chat, so we can queue those up without any delay. With that out of the way, let's dive into questions.

So first job for Ajay, for investors who may be less familiar with the Dropbox story, could you talk about the company's evolution over the past 10 years and your strategy going forward?

Sure. Absolutely. Our goal as a company is to build products that allow our users to do their best work with Dropbox. And more than a decade ago, we pioneered the file sync and share category and really transformed the way that hundreds of millions of people shared and accessed their information from wherever they were. And over time, we've evolved from a file sync and share solution to a true collaboration platform. And after many years of helping users sync and share content, we realized we had a huge opportunity to help people collaborate around that content. And along the way, we built one of the biggest self-serve SaaS businesses in the world and continue to tackle the market opportunity ahead of us. And I'd note that because we are a uniquely open and interoperable platform that works seamlessly with Microsoft, Google and folks like Slack, Zoom as well as Atlassian, we're in a position to unify content and the context and collaboration around that content. And more recently, what we've been focused on is creating a smart workspace, essentially a unified home for content and bringing the tools people use on a daily basis into one centralized digital workspace to collaborate around that content with their team.

Okay. Great. The question I hear most from investors on Dropbox is an existential one, is really what is your reason for being in the long term when there are kind of free products out there from Microsoft, Google, Apple in this file sync and share space?

Sure. As it relates to Dropbox in the broader context of platform players like Microsoft and Google as well as Apple, ultimately, people use Dropbox because we are the home for the world's content and the best way to organize share and collaborate around that content. And it's that primary focus on content that differentiates us, along with our scale and network effects, our platform independence that I just spoke to and certainly a superior product experience. And so we end up being a solution for our customers that live side-by-side with Microsoft and Google as well as tools like Slack and Zoom. We're part of that collaboration suite. And in fact, all 4 of those companies are deep integration partners with Dropbox for that reason. And I would note that virtually 100% of our users and customers are also Microsoft or Google customers.

Okay. Great. And I guess it's maybe a little harder for investors in the financial services vertical to see the need for something like Dropbox just because they have embedded solutions essentially in their workflow, primarily Microsoft. So who are the customers here? Who are your main customers that are -- that would be using something like Dropbox Spaces and the new Dropbox Platform?

Sure. Well in general, we really serve all kinds of users. We serve knowledge workers, whether they're an individual freelancer, whether they're part of a small or medium business, whether they're someone or a team working within a larger enterprise or we serve well-to-well enterprise deployments as well. And we serve effectively all verticals. We tend to be pulled into all kinds of deployments. We focus a little bit less on engineering and product for the more regulated industries and verticals. So financial services is a good example as well as health care or government. I would say our strength is where collaboration within a company and collaboration between companies is relatively active. And so while it can be, well, a CIO can try to lock down a computing environment within an organization, say, within a financial services company or a health care organization and try to get employees to adopt more of a closed ecosystem suite like the Microsoft suite of products. The second you start collaborating with another organization, let's say, you're a design firm working with a client on specs, that's when this problem of fragmentation becomes real. And you have one company that's running on Microsoft, one company that's running on Google, you have a whole other fragmentation of tools and products that they're using, and Dropbox is that independent layer that helps to stitch a lot of that together for our users and for our customers. And that's been the problem that we solved with our core products, our FSS products. And we built the new Dropbox, Dropbox Spaces, to address really 3 primary pain points for our users. One is the fact that content is -- tends to be scattered across multiple silos. Two, is this problem of tool fragmentation. You use many different tools to get your work done. And three, I would say, is this problem of team coordination, coordinating your team around a project or run some kind of content workflow can be a struggle. And so we're really easing those pain points by building a single organized place for all of your content. That can be content that's Dropbox content as well as cloud documents that live across other services. So it's a single organized place for all of that. We built deep partner integrations that bring your content to the tools that you use every day. So whether it's Office 365 integration or the G Suite integration or Atlassian and other communication tools, those are all deep integration partners with Dropbox in the smart workspace. And then we've enhanced our shared folder functionality to really bring everyone together and bring team presence into the shared folder. So it's much more of a workspace than it is a traditional legacy folder. And it's really our focus on content and content-based workflows that differentiates us. And our perspective and view is that content represents the most important IP at a company. The most important workflows revolve around it. And it has an inherent gravity. And as the home for the world's content, we naturally have the opportunity to be the place where people launch and manage these high-value workflows. And if I could sum it up, I would say, with Dropbox spaces, we've really evolved the team folder into a team workspace, into a smart workspace.

Okay. Understood. And so relative to Microsoft Teams and Slack, you'd say that your main differentiation is your platform independence?

I would say it's our product orientation and platform independence. So certainly, platform neutrality is very important and independence is important. We really serve as that tool that helps to stitch together other ecosystems and productivity suites. That's really important. Our scale is really important today. We have 600 million of the world's knowledge workers as Dropbox users. So we're operating at a scale that really very few businesses and companies have achieved. And these are folks from all walks of life and industries, verticals and customer segments. And that's a differentiator. And then our product focus on content and facilitating content-based workflows is also a key differentiator for us as well. But the folks that you mentioned, Microsofts and Slacks of the world are deep integration partners and very important parts of our ecosystem. Because we want to make sure that we can help our users get their best work done, there's a lot that we will own in-house to help facilitate that. And I think you've seen that both with the development of our core FSS products as well as the smart workspace and our acquisition of HelloSign. So there's a lot that will facilitate vis-à-vis those content workflows. But then there's a lot that we're going to partner with to offer our users as well. And so we're not going to be out there building the next communications platform. There's some amazing tools for users to group chat or to video conference, and we're going to integrate with those tools, whether they be Slack or Zoom. There's some amazing productivity suites out there like Office 365 and G Suite, and we're going to partner with those as well. And so there's a lot that we'll own and operate ourselves and there's a lot that we'll -- functionality that we'll expose to our users through our deep integrations and partnerships.

Good. Another question I get often is why net subscriber addition have been decelerating every year for the past few years. Are you guys prioritizing ARPU over net additions right now? And what are the chances that Dropbox Spaces could be an accelerant for net additions going forward?

Sure. That's a great question. I would say that both paying user growth as well as ARPU expansion are important to our overall business. However, the rate of paying user growth and ARPU expansion can vary period-to-period based on the product and growth initiatives that we're launching. And as an example, on our Q3 2019 earnings call, we noted that paying user growth would be slightly lower in subsequent quarters as a result of our Plus repricing and repackaging initiative. And I would say, profitably growing our total ARR base versus optimizing for a specific net new paying user or ARPU number is our priority. And this is why we began disclosing ARR as a key metric last quarter, really to better contextualize our business performance relative to the kind of ups and downs of some of these growth initiatives and the impact they can have on paying users and ARPU in a given quarter. As it relates to Dropbox Spaces, our current focus is on driving adoption of our new foreground desktop application, which includes Spaces, to facilitate monetization and business impact as we head into 2021. And in the medium to long term, this gives us leverage to inflect both paying user growth as well as ARPU expansion. And so for example, now that we've begun to land the new desktop application within Business teams, we're in the process of optimizing our onboarding flows and in-product experiences to facilitate viral seat expansion. And so we're doing this by simplifying the process of setting up a Dropbox Business team and then streamlining the invitation process to reduce the friction of finding and adding new team members. Historically, if you wanted to add a new member to a Dropbox Business team, you had to put a request into an IT administrator or whoever your team admin was to provision new license. That's a pretty clunky and friction-full process. That process needs to be seamless and frictionless where you can instantaneously add someone to your team. Really, that's kind of a necessary precondition for you to derive value from a high-velocity collaborative product like Spaces. And so that's certainly a future accelerant to conversion volumes if you can add in a frictionless way of licenses to a team deployment. Then we also plan to promote add-on and partner products to our user base through the new surface. And so again, we're evolving from a background surface on the desktop to a foreground surface on the desktop. And as we get people to engage more and more with that foreground surface, we can promote the right products in context. So we can see, for example, for machine intelligence that you might be a sales rep who is finalizing a contract or generating a PDF, at that point in time we can promote to you the HelloSign, eSignature product to send that out for signature and complete that content workflow. And so things like HelloSign, our partner SKUs with folks like BetterCloud, these are things that we can promote in product in a way that we haven't been able to historically.

Good. Got a question from the audience here. How is the constituency of your paid users developing? The percentage of premium users went from 4% in 2018 to 16% in mid-2019. Has that trend continued? And if so, what pickup, what pace?

Sure. I can provide a bit of color here. So if you think about the ARPU expansion that we've driven over first 8 quarters or so as a public company now, it's been pretty methodical and consistent. And a primary driver there has been the launch of our premium SKUs and the subsequent attach rates that we've been able to drive to those plans from new paying users. And so if you think about the conversion engine that we've built, we've -- it's pretty consistent in its output of kind of net adds and conversions in a given quarter or a given period. And then we've gotten better and better at increasing the gross new ASP, so the average annualized price that these net ads are subscribing at in a given quarter. We've done that by driving higher and higher attach rates to our Dropbox Professional SKU, which is our advanced individual plan as well as our team plans to Dropbox Standard and Dropbox Advanced. So our 2 Business plans. And so in any given quarter, we are able to drive a higher and higher mix shift towards those premium SKUs, and we get better and better kind of fine-tuning that conversion engine output. To do that, that trend has been pretty consistent for us over the last couple of years, and that continues to be consistent today. I will say something else that we're seeing, which is also a tailwind to things like ARPU expansion, in the medium term, is we've seen this increase in demand as people have shifted to -- in an accelerated way to a distributed work and learning environment. We're seeing an increasing demand, top of funnel demand for our products. We can get to maybe some of this a little bit later in the fireside chat today. But a lot of that incremental demand has been monthly demand as well. And so our monthly subscribers subscribe at a higher ASP than our annual subscribers. So that has also been a tailwind to ARPU expansion.

Yes, okay. Let's talk about Q1 and the -- so far, what seems like a positive impact on your business from the global shift to work-from-home? Talk about some of the positive data points you've seen and what your expectations are going forward?

Sure. Well we are fortunate that our product is one that lends itself well to the facilitation of remote work and collaboration. And as I mentioned on our Q1 earnings call, our business at a high level has been resilient and this accelerated transition that you just mentioned to remote work and learning that's underway has resulted in higher demand for our products. So both individual and team trial starts have increased by approximately 25% and 40%. They had increased by those levels, respectively, at the time of our earnings calls. So individual up 25% for Plus trials, team up 40% for team trials. And a little bit of context might be helpful here. If you think about our team acquisition and conversion engine, virtually all of our 450,000 paid Dropbox Business teams or the vast majority of them began their life as trial. And so they start in a trial motion, they convert out of that trial motion after 30 days into a paid team. And so that 40% uplift that we see into team trial starts certainly a significant stat from that perspective. As it relates to the individual business and those -- that increase in Plus trial volume of 25%, the majority of our Plus conversions are Basic to Plus conversions, or free to paid conversions, and they don't hit that trial motion. But a growing portion of our Plus conversions are coming out of trials, in particular mobile trials. And so that's an interesting stat, not quite as meaningful as the team trial volume stat, but certainly an interesting one for us as well. And I can say that we're closely monitoring these newer cohorts for conversion and retention trends and business contribution. I will have more to share on that on our next earnings call in August, but we're monitoring things like the duration of these elevated volumes and what that taper curve will look like for that 25% and 40% increase in trial start volumes. We're monitoring TPCR, which is our internal acronym for Trial To Purchase Conversion Rate. So at what rate are these elevated cohorts going to convert from trials into our paid SKUs. And then we're also monitoring retention sliver really on that dimension, but at what rate that these kind of retain. We're seeing a slightly higher mix shift towards monthly interest from these -- from the increasing demand that we're seeing, the incremental demand that we're seeing. But this is also a very high intent interest from folks that really have a pretty focused need to get up and running on a platform like Dropbox. So we'll be closely monitoring and be interested to see how these cohorts retain. So a lot more of that we'll be sharing there on our call in August.

What is the historical conversion rate for those trials on the team side? And how does that compare with what you've seen, I guess, over the last few months?

I would say, it's still early for us to comment on what we've seen over the last few months. The data is still early, and there's a lot more that we'll be sharing in August. At the time of the earnings call, Drew did mention that we were seeing some consistency from the very earliest cohorts with respect to conversion rates. I think at the volumes that we're seeing, just given how elevated the volumes are, I think we should expect some degradation in conversion rate there, in trial to purchase conversion rate. That being said, I think this surge in top of funnel demand, without question, it's going to have a positive impact on our business. It's a question of kind of the scale of that impact and the benefit that we see and the duration. So that's what you'll hear us share a lot more on in August.

Okay. And then on the -- on Dropbox Spaces, are there any data points or metrics that you can share with us that help investors get some confidence that the adoption of Spaces is going well and as you expected?

Sure. I would say the adoption is still early, but we are encouraged by the early data points that we're seeing. So our new desktop application, which includes Spaces, is now available to all Dropbox users who would like to opt-in, and early adoption has grown to over 350,000 of our 450,000 plus Dropbox Business teams. And as Drew mentioned on our Q1 earnings call, weekly active users on the new desktop application at that point in time had increased by approximately 60% from really pre-COVID to post. And I would say, our focus today is on driving adoption of the new Dropbox across 2020. So we're still iterating on the product experience. There are still some incremental integrations that we'll have to build in to really make it truly high utility inside product that people can live out of on a daily basis. And so that focus is kind of the 2020 name of the game with respect to Spaces. And then in 2021, we're laying the foundation this year to really focus on monetization and business impact.

Okay. On the quarter and on the overall impact from COVID-19, I think there's a sense that you guys should be, let's call it, disproportionately impacted because of your SMB exposure. How come that hasn't happened?

It's a good question. I would say in our -- business, as I mentioned before, has been resilient and a churn for us was stable from Q4 of '19 into Q1 of '20. Like every other company, we are certainly closely monitoring the evolving global environment. And while we're certainly not immune to external pressures, I don't expect us to be immune to external pressures in the future, we do feel that we're uniquely positioned. And this is because the majority of our subscribers are knowledge workers and we play an important role in managing business-critical content for them. But going forward, we will be keeping a close eye on retention in newer cohorts, like I mentioned, where we're seeing these elevated trial volumes as well as a potential impact from broader macroeconomic trends on existing subscribers. And we are proactively investing in levers to improve and mitigate churn in the future. And so things like newer and more flexible cancellation flows to facilitate higher rates of retention if there's some price sensitivity from certain customer segments. And then there are a number of other levers like that, that we're actively developing.

On the price increase on Dropbox Plus, it doesn't seem like it's had a significant impact on your business. I mean, if anything, it's been a net positive. Is that fair to say? And why -- I guess, why hasn't it driven more churn?

Sure. It certainly has been a net positive and a tailwind to the business. And as a reminder, last summer, we announced a number of new product features across our subscription plans. And with the additions that we made to our Plus plan, we raised the price of that SKU by about 20%. And we really want to expose more of our users to our platform's capabilities, and the repackaging of our individual paid plans was a way for us to do this. And the changes have been received well. So the features of our Plus plan were upgraded last June. Existing subscribers began renewing at the higher price point last July. This process will continue through the end of this quarter, so really through the end of June, based on the re-bill cycles of our annual subscribers. And as you noted, net revenue retention for our Plus subscribers has increased meaningfully as a result of the initiative. So it's been a tailwind to growth. And I think it's reflective of -- we do a lot of user testing and A/B testing before launching an initiative like this. And I think the price to value equation that we landed and what we bundled into the SKU really resonated with our user base and it was value that they were willing to pay for.

Can you talk about the conversion engine that you guys have? I know that when I first met with you guys a couple of years ago, that was one of my big takeaways. I didn't realize how much actual science went into that. And I think maybe some investors don't fully appreciate that conversion engine. Can you talk through that?

Sure. Yes. We -- it's a great observation. And we have a highly efficient go-to-market strategy as over 90% of our revenues are generated through our self-serve channels. That is then complemented by a targeted outbound approach, both fueled by some pretty interesting data science initiatives. And so I would say, since we operate one of the largest self-serve conversion engines at scale today, we generate a massive amount of data, and our data science teams are then able to leverage that data to improve conversion and upsell to our paid SKUs. So as users engage with the platform, we can identify and promote specific actions that they can take that are correlated with monetization. So for example, we recently enhanced our mobile onboarding flows for users who sign up for a Dropbox Plus trial. And so our data science team identified certain steps that mobile users can take in their first few weeks of their trial and things like generating a shared link and sharing a link to content, which then increased their propensity to convert into a paying subscriber. And so with those kinds of insets in mind, our engineering teams have been revamping our onboarding prompts and doing a lot of A/B testing there to encourage users on a Plus trial to take these types of actions. And that was a very timely investment for us actually in light of the elevated trial volumes that I just mentioned that we're seeing post-COVID. And then we complement that self-serve conversion engine with a targeted outbound sales force, also fueled by data science. So once we identify pockets of organic penetration and usage at a company, our sales team is then able to strategically identify opportunities and make efficient targeted outbound calls to try to grow teams within an organization. And we prioritize which accounts to target by utilizing a tool internally called Apriori, which is a machine learning tool that notifies a sales rep to reach out to a prospect based on a certain set of signals, like free and paid usage and sharing frequency.

Great. Let's switch gears over to financials a little bit. In terms of balancing growth or profitability, it seems like you guys have tweaked your approach there a little bit coming into 2020 and have more of a focus on margin expansion now. What drove this change? And where do you see operating margin going over time?

Sure. So we've -- I would say we've always been focused on delivering a healthy balance in growth and profitability. And Drew, our CEO, and I want to ensure that we continue to strengthen the investment thesis that we bring to market. And earlier this year, as you noted, we raised our long-term non-GAAP operating margin targets to 28% to 30%. That's up from 22 -- sorry, 20% to 22% previously. And we also set a goal of generating $1 billion in annual free cash flow by 2024. And both our 2020 guidance and our revisions to those long-term margin targets, I would say, are reflective of the inherent operating efficiency of our business we've aligned under our new leadership to drive growth and scale in a more focused way. And that's unlocked opportunities to accelerate margin expansion and free cash flow generation. And in 2020 as well as longer term, I'd also say that we plan to drive more efficiency and higher levels of productivity across each of our operating expense categories. And so across R&D, we'll be more prudent with headcount expansion and we certainly have been as we drive adoption of the new Dropbox and optimize some of those team-oriented expansion and conversion flows as well as invest in some new high ROI product launches that are coming up. And then across sales and marketing, we are focusing our spend to support adoption of the new Dropbox as well as to really put some firepower behind the distributed work opportunity while prioritizing our most important strategic growth and monetization initiatives. And I think one important point to make on that dimension is like as we execute to these expense targets, we will not reduce investment in our growth engine and new product development. This is really about careful consideration of where we can drive material efficiency improvements across the business while preserving investment in our highest potential product and growth bets.

And then on the balance sheet, it's very strong. It's what, north of $1 billion in cash now. How do you think about capital allocation in this environment?

Yes. I would say we're certainly focused on being thoughtful around our capital allocation strategy, something that we talk about quite a bit internally. As of the end of Q1, as you noted, we had over $1.1 billion in cash and short-term investments on our balance sheet, and we continue to generate hundreds of millions of dollars of free cash flow on an annual basis. Earlier this year, our Board of Directors did authorize a $600 million share repurchase program, which we have been utilizing. Over the course of Q1, we repurchased 3.7 million shares. And looking ahead, we feel we have the balance sheet strength and free cash flow profile to continue repurchasing stock. We do plan to continue utilizing that authorization that we have been utilizing it subsequent to Q1. We will, that being said, be prudent about our usage of capital given the evolving macro environment and reevaluate that spend on an ongoing basis. And the final note I would make here is, from a strategic perspective, M&A will continue to be an important part of our growth strategy as well. So we'll continue to be on the lookout for opportunities to accelerate our efforts by adding to our team and product portfolio while certainly being disciplined in that approach.

Okay. Great. And last question from me. You have one of the lowest revenue multiples in the SaaS space. It's got to be frustrating for you and for the team. Why do you think the public market doesn't appreciate what you guys have built or at least maybe, say, under-appreciates the value, right, that you've created?

Yes. It's a good question. Our focus internally is on continuing to execute against the core business, the opportunity we have ahead of us and to continue to build new products that our users and customers will love. And through focused execution, from both a product and growth dimensions, we think that we'll certainly eventually align to the right valuation and perception as a public company. And so I would say our core focus is on execution and on delivering against that execution and less so on kind of near-term fluctuations in valuation or where we're trading. That being said, I think what we need to prove to the public markets, and we have been proving is a thesis around the durability of growth at Dropbox. And so the runway we have ahead of us with the core business, and we do have a long runway there and the core set of products that we have today and then adoption of new products and monetization of new products. So as we really start to drive material synergy revenue from our acquisition of HelloSign as we move from driving adoption into monetization of the new Dropbox and the desktop application as we drive many, many more years of durability and runway of growth with the core business, I think those are really important data points for folks too to really understand how we diversify a durable growth and enduring growth platform that's going to be around for decades to come.

Excellent. Well with that, let's wrap. And appreciate, Ajay, you taking the time and being part of our conference. And thanks, everybody, for joining the fire side chat. And stay well, stay healthy.

Thank you, Jason. Appreciate you having us on today.

Okay. Bye-bye.

Bye.