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

Awesome. I think we're ready to get going. I'm DJ Hynes. I'm the senior software analyst here at Canaccord. Thank you for joining us for the 40th Annual Global Growth Conference. Delighted to have Dropbox here. We have CFO, Ajay Vashee. We get the honor of being his swan song investor conference as I think I'm sure everyone who's tuned in knows that there's a transition going on. But thank you, Ajay, for being here. It's awesome.

I'm going to assume that everyone dialed-in for the session, at least, is somewhat familiar with the business. But maybe just to level set the conversation, can you quickly kind of run us through Q2 highlights, what you saw in the quarter and kind of what you're excited about these days?

Absolutely. And thank you for having me. It's a pleasure to be here and to have the opportunity to chat with all of you. Q2 was a good quarter for us. We reported another strong set of results. We beat the high end of our guidance ranges for both revenue and operating margin, and revenue for us grew 18% year-over-year on a constant currency basis, and we also achieved record non-GAAP operating margins of 21%. And as it relates to guidance, we raised our full year expectations for revenue, operating margin and free cash flow. So overall, I would say it was a great quarter from a financial standpoint, and our underlying business continues to be resilient and strong. And from a product perspective, this was one of our busiest quarters as well. So we continued to expand our product portfolio, and we added a number of valuable features to our Plus SKU. That's our entry-level individual SKU. So things like Dropbox Passwords, which is a new product, Vault and computer backup, all 3, kind of new launches for us. And we also launched a brand-new SKU in beta, and that's Dropbox Family, and that lets up to 6 family members share 2 terabytes of storage under 1 plan and with 1 bill. And then finally, we continued to make progress against our product integration strategy with HelloSign, and HelloSign is now natively embedded into Dropbox product surfaces. So we've, I would say, kind of steadily been ramping up and improving that product integration, but now it's a fully native integration. And so when a user opens a file in Dropbox, they can quickly identify which fields need to be signed and send that file out for eSignature. And once that file is signed by a recipient, the completed document's automatically saved into the appropriate Dropbox folder. And so the authentication there is automatic, and the whole product experience is very frictionless and seamless, so you're not having to move in and out of different surfaces and different tools. And so we kind of solved some of that problem in fragmentation and makes HelloSign kind of the default eSignature tool within Dropbox. And so we're very excited about that. And overall, Q2, a fantastic quarter for us, proud of what we're doing to support our customers during these unprecedented times.

Yes. Perfect. Yes, let's dig in kind of on the times and what you're seeing as kind of a COVID beneficiary to a certain extent. So I think you guys have talked about an uptick in engagement activity, more trials, kind of better top-of-the-funnel activity. Can you talk about what you're seeing in terms of conversion rates on that activity and then kind of the tactics that you're using to help drive conversion today?

Sure. So the impact that we've seen, that's a great question. We've seen higher levels of demand for our products, and that has resulted in higher levels of conversions to our paid plan. So across Q2, trial volumes to our individual and team plans were 20% higher relative to pre-COVID levels, and the conversion rates of these larger cohorts have remained consistent with historical figures, which is really encouraging and, I think, reflective of the value that we're delivering to these users. And then as it relates to HelloSign, usage of their API product and core eSignature solution increased by more than 25% relative to Q1 levels, that's Q2 to Q1. And so those were 2 of the drivers that helped us deliver $67 million of net new ARR this past quarter. And probably the final note I'd make there and then I can talk to a little bit -- your second part of your question on conversion drivers. But that surge in demand that we've experienced, that's been largely focused on Q2, closely correlated to the initial global shift to remote work and remote learning earlier this year. And if you fast forward to today, demand continues to be higher but modestly higher relative to pre-COVID baselines versus what we saw in Q2. And then to touch on conversion and how we manage that process, we really have a highly efficient go-to-market strategy. Over 90% of our revenue is generated through our self-serve channels, and that's complemented by what we call a targeted outbound approach. And there are a number of signals that we look for as drivers of conversion. Data science plays an important part in that aspect of our go-to-market motion. And so since we operate one of the largest self-serve conversion engines at scale today, we generate a massive amount of data. And then our data science team takes that, they're able to leverage it to improve conversion upsell to our paid SKUs. And as users engage with the platform, so you sign up as a basic user or a free user, as you're engaging with the platform, we could identify and promote specific actions for you to take that are correlated with monetization. So an example, over the past few months, our data science team has been experimenting with a HelloSign upsell model that identifies which Dropbox customers are most likely to convert to a paying HelloSign subscriber. And based on things like file types, so what file types you are adding to your Dropbox, shared folder activity and other engagement characteristics, the machine learning model kind of aggregates a list of Dropbox users who would benefit from HelloSign's eSignature capabilities. And then armed with that context, our growth team takes that list, and they surface a series of in-app targeted prompts and notifications, promoting HelloSign and its features that are kind of tailored for our different user architypes. And we've been experimenting with this upsell model, and the results have been pretty promising. So users identified by the model signed up for a HelloSign trial at a 50% higher rate relative to a control group. So that's one example of many ways that we're always fine-tuning that conversion engine to continue to drive healthy levels of conversion volume. And that's how we've scaled to 15 million paying subscribers today.

I remember during the IPO, like one of the most like stunning slides you shared with us during diligence was like the linearity of that conversion. I think you layered like, I don't know if it was quarter-over-quarter or month-over-month, and it was just like almost like a perfectly straight line of how users come in during -- over the course of a quarter, and it was amazing, actually. I hadn't seen anything like that. So that makes sense. There's a lot of data science behind it, obviously. Let's talk about ARPU, obviously an important driver of growth. Can you just talk about what's driving ARPU? Is it landing customers at higher-priced tiers? Is it upgrades to the base? And maybe you could talk about the mix of the business, business versus individual accounts and how that's been changing.

Yes. Yes, those are all great questions. I would say that our ARPU expansion over the past several quarters has been driven by 2 things. So on the one hand, you have our repricing and repackaging initiatives like our press -- Plus -- excuse me, repricing initiative. Back in 2019, we upgraded the features of that Plus SKU, and then we rebilled subscribers at a higher price as a result of that additional value that we're bundling into the SKU, and that went really well for us over the course of the past year. The final cohort of subscribers was rebilled in June there, annual subscribers. And so those repricing initiatives are a tailwind to ARPU. But I would say more importantly, there are a number of kind of natural organic tailwinds to ARPU as well and drivers of ARPU expansion. And so these are things like higher attach rates to our premium plans from new paying users. And so if you look at our gross new conversion volume in any period, any quarter, it's pretty consistent. We converted, and we said in the past, we convert just over 1 million gross new paying users typically in a given period. More and more of those, a higher proportion of those conversions are conversions to either one of our team plans or to our premium individual plan, which is called Dropbox Professional. And so those are higher ASP plans, and they -- those higher attach rates serve as a tailwind to ARPU growth and a driver of ARPU expansion. That's one example. And then another example is -- and I'll give 2 more, is kind of a higher mix towards teams licenses, and you kind of alluded to this in your question, but we've been successful at driving a high -- of this mix shift, I would say, both from gross new paying users but existing paying users moving them along that customer journey so they may start off as an individual subscriber, but over time, they are using Dropbox for work and network, and so we navigate them into a team plan. And so that journey helps to also grow and expand ARPU for us as well because our team plans are priced at a premium to our individual plans. And then the final note I would make on ARPU and the other organic tailwind and driver that we have is HelloSign, and the average ASP there of their products is higher than the average Dropbox core ASP. And HelloSign is our highest growth family of products at Dropbox today, and they've really been knocking the cover off the ball as it relates to kind of scaling the stand-alone business they have. And now that we've gotten to this point of native product integration, that now unlocks the synergy opportunity for us going forward. And so we're pretty excited about the prospects there. But that's all a long way of saying that we're excited about the potential we have to continue growing ARPU in the future. And certainly, we're going to remain on that trajectory going forward.

Yes. I should have mentioned earlier, folks on the line, please send in questions if you have them through the webcast box, and I see them coming in. A couple of questions on this topic were kind of how to think about ARPU Q3, Q4, the Plus pricing increase kind of lapses -- lapsed in Q2. So what should ARPU growth look like in the second half? And then how should we think of like sustainable ARPU growth if we look like intermediate term?

Yes. It's a good question. Let me share a little bit of color on how to think about the rest of this year, and then we'll have more to share about 2021 and beyond certainly on our February earnings call coming up in a couple of quarters. But as it relates to this year, I would think about -- to fit to the revenue guidance that we put out there, you can assume in the zip code of $0.25 or so of ARPU expansion in Q3 and then ARPU growing to roughly $128, plus or minus, in Q4. That's actually a little bit lower than what we were expecting a quarter ago, but there's a great reason for that. It's because we've outperformed on the paying user front and the conversion front. So as part of the COVID tailwinds that we saw, we drove this higher conversion volume from us converting that top-of-funnel demand. We saw that surge in demand trial volume that resulted in higher conversion volumes. We also saw a lot of demand from EDU. And so these higher education institutions that had to really gear up pretty quickly for a remote learning environment, a lot of them have been turning to Dropbox, and we talked about the University of Michigan on our earnings call, and that was one of the drivers to us delivering the 400,000 sequential net adds in Q2. But the mix of it is that we're expecting now a slightly higher paying user number for the year, which means we're expecting a slightly lower ARPU number just because we've kind of outperformed and accelerated some of that paying user growth. But the organic tailwind is absolutely there, and you kind of get a sense for that from the soft guide I just put out there on ARPU, and then those drivers will continue into 2021 and beyond. And again, I would say the primary drivers for us next year are going to be the organic ones that I talked to, so the higher attach rate of gross to paying users to one of our higher-tier plans, that mix shift from individual to team and then the sustained growth at a pretty high level of HelloSign suite of products. And then we'll continue to evaluate our -- the pricing and packaging opportunity that we have going forward. I think one interesting example is that HelloSign has uncertain SKUs priced at a discount relative to some of their competition. And so that's one example where there may be some opportunity for us going forward. And for us, it's all about, are we delivering? Are we generating the right amount of commensurate value relative to what we're delivering to our users? And so that's the most important part of the equation in pricing.

Yes. Makes sense. Let's touch on kind of the intermediate-term targets you have out there, right? You have 2024 financial goals, which are lofty. Can you just remind us what those are and then help us in terms of kind of bridging where we are today with how we get there?

Sure. So we've always been focused on delivering a healthy balance of growth and profitability. And earlier this year, as you are alluding to, we raised our long-term non-GAAP operating margin targets to 28% to 30% and that being up from the prior target of 20% to 22%. And then we also set a goal of generating $1 billion in annual free cash flow by 2024. And I would say that both our 2020 guidance for this year as well as those revisions to our long-term margin targets are reflective of the inherent operating efficiency of our business, and we've aligned, under our current leadership, to really drive growth and scale in a more focused way, and that's unlocked opportunities to accelerate margin expansion and free cash flow generation. And so this year as well as longer term, we plan to drive more efficiency and higher levels of productivity across really each of our operating expense categories. So across R&D, we'll be prudent with headcount expansion as we drive adoption of the new Dropbox and optimize some of those team-oriented conversion flows that are associated with it and then also as we invest in new high ROI product launches. And then across sales and marketing, we'll be focusing our spend to support adoption of the new Dropbox. We've been doing this already this year while prioritizing our most strategic growth and monetization initiatives. And I would note that as we execute to our expense targets, we won't be reducing our investment in our growth engine and new product development. We've really carefully considered where we can drive material efficiency improvements across the business while preserving investment in our highest potential product and growth bets. And if you look at our execution over the course of this year, I think that's emblematic of that philosophy. And if you look really even at Q2, where we delivered a 21% non-GAAP operating margin, that's kind of in the midpoint of the prior long-term guidance range that we had out there. And so certainly, we're well on our way to achieving those targets.

Yes. Makes sense. So I think the question I get most often these days is the strategy around Spaces. And it kind of stems from like if Dropbox is fighting to be like the app that an employee logs into and kind of lives in and works out of, that seems like it's going to be a tough battle with Teams growing so fast and Slack growing so fast. So I guess the question is, are investors misinterpreting the strategy? Or is it Dropbox' view that like this content-centric view of the world is going to win out ultimately and that kind of sets us up for long-term success?

Yes. It's a great question. I would say we've always had competition, and we continue to win because knowledge workers value the Dropbox product experience, our performance, our approach to the ecosystem, our open ecosystem and integration strategy, and finally, our collaboration capabilities. And if you think about where we're going with Dropbox Spaces and this foreground collaborative experience, I would say competing solutions are often focused on just one aspect of that collaborative arc. But only Dropbox offers what we feel is a simple-to-use, an open digital workspace that unifies content, which is really core for us, with communication and project management for individuals and teams. And what really sets us apart is that we support all types of files and content. That includes traditional files and cloud content natively within our Dropbox platform, and that's something that really no one else can do today. And so we help the users organize and collaborate across Microsoft and G Suite and other best-of-breed applications. And as it relates to players like Slack and Zoom, we see our users leveraging them to collaborate around and create content, whether that's a financial model or a board deck, and chat and video conference are what we call internally part of -- a very important part, but part of a company's short-term memory. In other words, once these conversations or meetings happen, then they're largely over. And Dropbox, on the other hand, with our content-centric approach, provides companies and employees with long-term memory. So that's us storing the meeting notes, transcripts or deliverables that employees are discussing via Slack and Zoom and other communication tools and really integrating them into a durable project workspace where they can reside alongside relevant files, web docs and other assets. And so that's really how we're fundamentally differentiated and what we're providing that other competing solutions really don't offer today.

Yes. Okay. So if we think about engagement with Spaces, it's been really strong. I think you guys shared some stats, which you can remind us of like teams engagement, how many active users you have, et cetera. Help us think about like the monetization strategy of Spaces. And you guys are becoming more of a platform company. So what does the product road map look like? And how do you monetize Spaces in the base?

Sure. So we've been focused on driving adoption of Dropbox Spaces this year that facilitate monetization and business impact in 2021 and beyond. And as you noted, that early adoption of our new desktop app has grown to over 450,000 of our 500,000 Dropbox Business teams, which is encouraging. And now that we've begun to land the new desktop application within Business teams, we're in the process of optimizing our -- both our onboarding flows and in-product experiences to facilitate viral seat expansion. And so that's going to be one kind of growth and monetization lever that we have at our disposal here. And so if you think about Spaces and this foreground desktop application, the most value that you get out of that kind of experience is when it's a high-velocity collaborative surface where you can invite in coworkers and colleagues pretty -- in a frictionless way. And the way that it works today on Dropbox, with the kind of -- that legacy teams experience, if you want to add a team member, you have to generate a request and it goes to a team administrator or an IT administrator, and it gets put in the backlog and then they have to process those requests over some period of time. So it doesn't really lend itself well to this process of high-velocity collaboration, and we're kind of going to -- we're going to fix that problem with how the product works and how you can add a team member. That's one lever that we have for monetization. Obviously, it helps us expand and grow license count and team size over time. And then the second lever we have is really the marketing surface that this foreground application and experience provides that we haven't historically had. Dropbox, really since our inception, has really always been this background service that's lived in the [ find ] and it's been a folder on your desktop. But with this new foreground experience, we now have a marketing service, as you're engaging with your content and you're launching some kind of a workflow, for us to promote the right -- both the right products that we own but also partner products. So things like HelloSign, say you're finalizing a sales contract, you generate a PDF, we can see some signature fields there. We can promote HelloSign kind of in context as part of that workflow. "Hey, like here's a tool you can use seamlessly and natively to send this sales contract out for signature." And then we can also promote things like our partner SKUs, partner SKU with BetterCloud, and there are many other options there as well. And so as we mentioned on the call, given how the world has changed, we see a number of opportunities to design new products and experiences for distributed work. We'll also have more to share on that topic later this year and how that integrates with Spaces as well.

Yes. Okay. That all makes sense. Super helpful. At a high level, how sensitive do you think buyers are to price in this market? And how do you think about price as a lever to growth, right? I know you've executed some price increases over the years. Maybe you could use that experience as a guide for how we should think about it going forward. But is there more wood to chop on the price front?

It's a great question. I think it's something that we're always going to be reevaluating, our stance and our approach across our portfolio of products and SKUs and whether there's opportunity for us to pursue a pricing and packaging lever. Again, for us, only a lever we use if we're delivering more value to our customers, and that's what we'll be -- or rather what we'll continue to be most focused on. So I would say it's a little early for us to comment on future initiatives, but we'll continue to evaluate pricing changes as we evolve and grow a product and feature portfolio. And I will say that we have been very successful with them in the past, with -- or rather successful with that integrated approach, of here's a value that we want to bring to market. We see the best way to bring that value through a bundling strategy into some of our existing plants and SKUs. And through a lot of pretty rigorous testing and user feedback, we feel like the appetite is there from a pricing standpoint, and the customer demand is there from a feature and product standpoint. And then if we get through that testing phase successfully, then we go live with that kind of a change. And again, the most recent one that we did was the Plus repricing and repackaging. Back in 2019, that launch, we raised the price of that SKU by 20% in conjunction with the announcement of a number of new product features across that plan and others. And that process for us did go really well for that cohort of users. We saw only a modest impact to churn at the higher price point but obviously a pretty major tailwind to net revenue retention as they were rebilled at the higher price point.

Yes. Okay. I have one that's like a model tactics question that came in from online, and then I have a concluding question for you.

Sure.

The question came in online, you took down the high end of constant currency revenue guidance by $2 million despite accelerating ARR growth and favorable demand commentary. What was behind that?

It's a good question. There wasn't a whole lot specifically behind some of the marginal movements on some of the ranges. I think we overall raised that revenue guidance range for the year. And we brought up the low end of the range pretty maturely so the midpoint came up. I think that's reflective of some of the momentum that we're seeing. What you're seeing with us, effectively preserving the high end of that range is just continued prudence. I would say a couple of factors to think about as you process the revenue guide for the back half of the year and think about the trajectory of the business, which obviously remains very strong, as you guys all saw with our Q2 results. One, I would say, while we've certainly been a work-from-home beneficiary, as I mentioned earlier, that surge in demand we experienced was largely focused on Q2, part of that, initial shift to remote work and remote learning. Second thing I would think about, the tailwind from that Plus SKU repricing and repackaging I was just talking about that ended in June when the final cohort of our annual subscribers were rebilled. So you kind of have 2 of these tailwinds that were present in Q2 that won't be there in the same magnitude across Q3 and Q4. Outside of those factors, core business has certainly remained very resilient, both as it relates to consistency and conversion volume, so that gross new paying user conversion volume as well as stability in net revenue retention. Once again, churn and retention were stable for us quarter-to-quarter. We expect those trends to continue across the second half of the year. And then a couple of points on how to think about the guide. We have a number of new products and feature introductions slated for the fall. We'll factor those into our guidance as we build more signal on their impact. That's been our practice in the past and will continue to be our practice in the future. And then our guidance for Q3 and Q4 continues to reflect prudence as it relates to ongoing macroeconomic uncertainty. And certainly, like we're also managing my transition to my successor, Tim Regan, and so we want to make sure the company adhere -- set up for success in this process as well. So that's how I think about everything. But the core business certainly continues to remain very strong and resilient.

Yes. That's helpful. Last question, we have like a minute. It's kind of like a disclosure question, and it's something I wrestle with in my discussions with investors. So since IPO, you guys have given customer adds and ARPU, right? It gives us a great look into the business. We can do the P times Q and -- that you need for a revenue build. That said, those numbers wiggle around based on like promotional activity and programs that you run during the quarter, right? So I guess the question is like -- and since like these like minuscule misses seem to [ wig ] investors out on a quarterly basis irrespective of what the total ARR is, it's like, "Hey, they missed ARPU." If -- do you wish you hadn't started reporting that way? And do you envision -- is there an opportunity for Tim to maybe change that? And -- or do you always think you'll talk about customers and ARPU the same way?

It's a great question and a totally fair question. I think it's made a lot of sense for us from a disclosure standpoint to provide some context on pricing quantity, just given how the business is structured today. As we continue to grow in scale in other new revenue streams and like, for example, let's say, our app ecosystem becomes a more and more central part of the product strategy going forward, as people -- as adoption of Dropbox Spaces starts to really take off like we're seeing today, and then we're monetizing a lot of the partner ecosystem in a more powerful way, then P and Q becomes perhaps like a little bit less relevant but some of that add-on revenue starts to grow in magnitude, that's a hypothetical example. I think that's reflected certainly in ARR and so that's why we started disclosing that metric because it's kind of the most complete measure of all the ins and outs of the business and our different and various revenue streams. It's not distorted quarter-to-quarter by certain factors, like we closed some large EDU deals because all this demand for remote learning hit us, and then that throws out the balance between P and Q a little bit. So I would say, just stepping back for a minute, our strategy is to drive profitable growth by expanding our total ARR base, with a particular focus on high-value conversion. We don't optimize for a specific net new paying user or ARPU figure in a given quarter. We focus on growing that total ARR base that's why we added and focused disclosure on ARR earlier this year. That being said, paying users and ARPU will continue to be important levers for us to achieve our ARR and revenue targets. So I think they can be important metrics to help contextualize our growth retrospectively. But I certainly wouldn't, and we've been saying this forever, but people continue to do this. I totally understand the thrust of your question. I would not index to a specific quarterly run rate or growth rate for either -- for the reasons that you mentioned because growth initiatives and deal timing can certainly impact them on the margin.

Yes. Awesome. Ajay, this has been a great discussion of the business. I wish you best in your next move, and thanks for participating today.

Awesome. Thank you for having me. I appreciate it.

All right. We'll talk soon. See you.

Okay. Bye.