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

Welcome back, everyone. So look. We're just delighted to have Dropbox joining us; and Dropbox' relatively new CFO, Tim Regan, who is joining us from his lovely office in Tiburon, California, which is also my hometown. So all right. So Tim...

Thanks for having me, Pat.

Yes, thanks so much for joining us.

It's great to be here. And yes, I do have office outside the house. I think it certainly helps my wife, to give her the home for a little bit, get me out; and certainly helps me to have my own space as well. So excited to be here.

No, great. So to start out, we'll -- the next 25 minutes, we'll do in 3 parts. So we'll do a little bit about Tim and taking this role and sort of what his goals and priorities are as CFO. And then we'll ask the 3 questions that I've been asking everyone, and then we'll talk a little bit about sort of current events and what Dropbox is up to today.

So to start with, Tim, tell us a little bit about yourself. Where are you from?

Sure. So I grew up in the Bay Area. I was born just outside of San Francisco and, yes, grew up here, went to high school in San Francisco...

Where did you go to high school?

St. Ignatius...

St. Ignatius, yes, great school.

Yes, in the city. I went to college on the East Coast. I went to Georgetown in Washington, D.C.; came back after college; and started my career at Ernst & Young, the accounting firm. So spent 5 years there. Then -- you'd stop me if you don't want me to give you my whole career history...

No, no. This is what we want. I will be prompting you, anyways.

All right. Well, after 5 years at Ernst & Young, I went to Dolby Laboratories, the surround sound company. We went public in my first year of being there, so I got to be part of that journey. And during my time there, I also went back to Berkeley to get my MBA as part of the evening and weekend program. So that was a great experience for me. Then I went to Pandora, the music company. And I was there in 2011 when we went public, so I got to experience the ride again.

When Cakebread was the CFO. Is that -- yes.

Steve brought me over. And Steve and I and obviously the rest of the team worked to -- worked on the IPO. My second week at Pandora, we were at the printers filing our S-1, so that was quite the ride. And then in 2016, I moved over to Dropbox and did the whole IPO journey once more. So it's been a great ride. It's been a lot of fun. And here we are in my new role, which I took over back in September.

Yes. So we'll get to that in a sec, but let's first talk about the transition from being the Controller at Pandora to taking the Chief Accounting Officer role at Dropbox in 2016, right? So how did that happen? Who called you, the head hunter? And then why did you do it?

Sure. I think it was serendipitous, as far as the interaction with the recruiter. And it was getting to be the point -- I've been at Pandora 6 years. It was getting to be the point for me to try something different, take on a new challenge. And so I got the opportunity to chat with Ajay, the CFO of Dropbox at the time. And what was compelling to me was doing the IPO journey once more. It's a lot of fun. It's one of the few times that finance is celebrated all across the company and everybody is cheering for us.

It really is fun. I agree with you, yes.

So that was a compelling part of the potential opportunity, but also I think a major component to me was to be a more of a strategic adviser to Ajay, where as we just talked about, Steve Cakebread has done this multiple times. And as my CFO at Pandora, he -- yes, he needed me to execute, as far as closing the books and getting the accounting right and making sure we had a solid system and financial foundation, but as far as the strategic partnership and advice, he knew what he was doing. He didn't need that much from me. And Mike Herring, who joined Pandora while I was there as well, he too, seasoned CFO, but Ajay being a first-time CFO, I was more of a, call it, right-hand thought partner with him. And so that...

Yes. Mike had previously been the CFO of Omniture, I think, and then went to -- he was like 1 of the 5 guys at Google, right? So for whatever -- yes.

Yes. So Mike has had -- he's a phenomenal CFO. And I guess, part of my entire journey: Murray Demo was the CFO of mine when I was at Dolby; Kevin Yeaman, who's now the CEO at Dolby. So I've had a phenomenal track record of luck, if you will, as far as...

You really didn't. Well, I don't know about luck. Those are some great mentors. It's incredible...

Terrific set of folks to learn from. And I think, as with everybody, you try to steal something from every manager you have and try to incorporate that into your playbook. And so I was fortunate enough to learn.

Okay, so you land in 2016, and Ajay has looked at you for some strategic finance perspective. And you have these three, Murray, Mike and Steve. So what were some of the -- if you can remember, what were some of the initial perspective that you were able to provide?

I think it was just pretending that we were a public company from day 1.

Yes.

And really getting into that rhythm and setting a high bar of expectations and closing the books and reporting out to management and having a tight control environment, the whole exercise of pretending that we were public immediately. And let's get up to that level of performance. Let's get up to that level of rigor. And as a private company, it takes a while to get there, but let's do it from day 1. And so I think that was part of the mentality. And then of course, it's building out the teams. I think that's, at the time, I might have been the only person in finance with any level of public company experience, so adding in others...

The average age. I'm trying to remember what was -- the average age at Dropbox when they went public was really young...

I think you're right. I think it was in the 26, 27 neighborhood. We -- that's changed a little bit as we've added some more seasoned leaders to our team, which is great. It's great to have that balance.

Most of the people grew up, all right? They grew up, yes.

Right, exactly. So absolutely a fun ride. And we had a terrific and successful IPO. That was, gosh, 18 months or so after I started. So we had a fair amount of time to ramp up and get our processes where they needed to be, and here we are.

Yes. So the -- when was the IPO? Was it '18, '17?

It was March 2018.

'18, okay. So you go public in 2018. Everything is good. Well, how did the next 2 years play out compared to what you would have expected when you went public?

Gosh, next 2 years, we continued to do very well, I would say. So every quarter since we've been public, we've hit our guidance. So we continued to execute on the top line. We continued to do well on the margin and profitability front. We continued to add to our product portfolio. We've rolled out additional SKUs. We've continued to convert users into our paid plans and again drive them up to our premium plans. So we've continued to execute. We continued to execute on the growth front, continued to execute on the profitability front, continued to execute on the free cash flow front. And from my perspective, I guess, as I was running the accounting team, we've -- SOX compliant. That was important, obviously. Rounding out our systems and infrastructure, that was important, but again, continuing to execute and drive and earn credibility in the market, I think that was very important to us from a financial perspective.

Yes. And so for sure, I mean, you guys, basically you don't miss, right? So you hit what you guide, but the growth rate of the guidance has done this. I'm guessing you didn't expect that. What led to the slowdown in the growth?

Well, I think part of it is some of those large -- law of large numbers, right? So we have -- actually, I was looking back at it in preparation for our discussion, Pat.

It's not the first time I've asked you that question, yes.

And we've actually added over $800 million in ARR in the last 3 years, right? So we just crossed $2 billion in ARR. And if you think about it, as also from the profitability front, when we went public in 2018 or in March 2018, the annual profitability, annual operating margins were at 5% -- 5%, 6%. And now we're guiding to 27% to 28%, so we've actually made a ton of progress on a lot of financial dimensions. Now as far as getting, circling back to your question, why has growth decelerated? I think part of it again is the law of large numbers. So whereas our churn has stayed stable from a rate perspective, just as you add more ARR, that churn number does tend to grow. And so that's absolutely something we're focused on is driving the right level of retention and improving our product and trying to add new features and functionality. And I think you've seen us do a lot of that in the last few years, also try to do a lot more from an M&A perspective. So we're trying to do everything we can to stabilize that curve. And if I think about the more recent time periods, last year and the year prior, there's some benefit from a pricing perspective that we've had, which on the one hand is great. We've been able to leverage the pricing tool in the toolkit and continue to add users despite that, but obviously that doesn't help from a comp perspective. So yes. So this year, we're guiding to 10% revenue growth. And myself and the management team is highly focused on stabilizing that growth rate. We understand that the market is -- has questions about that. And we're doing everything we can to stabilize that growth and make sure that we continue to invest for double-digit revenue growth going forward.

Yes, it's really interesting because I -- it's I don't think the absolute growth rate is as much of an issue as it is that investors don't know where it's going to stop, right? I mean, if you look at a company like CoStar, they've grown. I mean it's been -- well, have been a little more recently, but the model has been basically sort of 10% growth plus acquisitions and phenomenal stock, right? But yes, I do think that we need to know -- you guys have got to figure it out too, but we need to know. Where is that level where it's stabilized? Nice to hear you agree, yes.

Which we understand. We agree. And we are doing everything we can to balance that, right? So we're driving for that double-digit revenue growth but also trying to give much more profitability. And you've seen us -- gosh, we added 9 points of margin in -- from '19 to 2020; adding another 6 to 7 this year, doing a lot more on share repurchases. So we are trying to balance this material improvement in growth -- or sorry, in profitability and this material improvement in returning capital to shareholders but also stabilize that revenue growth rate in the right range. And that's where we're excited about the work that Timothy is doing in his organization, as far as rolling out all these new features and functionality. We feel good that we've got this diversified portfolio of initiatives that we're working on. We're not overly reliant on any one single initiative. And so we're excited about the potential we have and feel good about pursuing it.

Okay, so I'm going to divert from our -- my normal part 1, part 2, part 3 because I see 2 questions in the chat that I think are -- we should just ask now, right time to do it. So let me just go to them, and I'll just -- I'll read them to you. All right, so the first one is very timely. Can you provide color on the convertible bond issue and the use of proceeds; why you need to raise so much capital, $1 billion net? Who's selling a $200 million stake? And why you have the structure to the issuance instead of a typical bond. Yes, there's a lot.

Okay. So maybe for context. So it was just -- gosh. I think it was a week ago today. We did -- we raised a convertible debt offering. And so let me just try to parse those questions and walk through this a bit. So to be very clear: The convert does not change our investment thesis or financial strategy. We absolutely plan to remain thoughtful and disciplined in our approach to spending that money. And we'll use the proceeds for organic and inorganic growth initiatives, repurchasing shares. We have a $1 billion share repurchase authorization that we just got from our Board. And then of course, earning interest is also a possibility, right? So the notes that we got carry a 0% coupon. And so even if we sit on the cash and keep it in the bank, we can earn a positive return. So effectively we raised capital given the highly favorable market conditions that exist, and we ended up with pricing terms that really are among the most favorable ever. And we broke up this $1.3 billion between 2 tranches, a 5-year and a 7-year. And again, they carry a 0% coupon. The conversion premium on the 5-year is 65%, and the 7-year has a 52.5% conversion premium. And then on top of that, we added a bond hedge and warrant to protect against dilution. And the cost of that bond hedge and warrant instrument is offset by tax deductions that we're able to take advantage of. So given that we're very profitable, we can actually use the cost of the bond hedge and warrant to offset the tax deductions that we will have going forward because we will be a cash taxpayer here in the not-too-distant future. So effectively the hedge lifts our conversion premium to 100%. So in summary, we're borrowing money at 0% interest, and it only converts to equity if our stock doubles or surpasses effectively $46. So it gives us a lot of dry powder that we can leverage at the right time, but again it does not change our plan to be very disciplined with what we are doing here.

All right. And I'm not sure I understand this point. Tell me if you do. What's this: Who is selling a $200 million stake? What's that part?

So I think that part is we've concurrently repurchased 200 million shares -- sorry, $200 million in shares. And so I think part of it is, as part of the transaction, certain hedge funds will short our stock. And so we wanted to immediately repurchase it, and so we spent $200 million on the day of the convert to repurchase shares. And that's on top of our $600 million share repurchase program that we are still exhausting and plan to exhaust this quarter. So we have $200 million from the former repurchase program, $200 million that we're buying as part of the convert deal and this extra $1 billion in share repurchase authorization that we'll use in the months and years ahead. So I think that's the component that the question was asking about.

All right. So it -- the way the question was asked, it makes it seem like maybe you bought it from one person. That's not the case, right.

Not one person. It's -- tends to be hedge funds.

All right, okay, great. So you've got quite a war chest. HelloSign worked great, right? That was a really good acquisition, in hindsight. What would you like to spend the money on? What are the characteristics of something that you're -- I don't know. Yes, what are the characteristics of the kinds of things you're looking for?

Sure. So HelloSign is a great example of the types of things we're looking to buy, things that complement our product road map, enable our users to do much more with their content. We talk about expanding the number of verbs that our users can do with their content. So you think about storing and thinking and sharing and e-signature and watermarking and securing. So that's part of our journey, if you will, to being a multiproduct company. It's adding to the verbs of what people can do with their content. And so HelloSign again saw terrific momentum last year, 70% increase in the number of e-signature requests that came through last year. And so we are investing in that momentum. We have a native integration with HelloSign. Now it's the default option for e-signature in Dropbox. We've added 21 additional languages where it's available, investing more marketing on HelloSign. So very much an indicator of what we're trying to do.

Okay, here's a funny data point for you. I had a sales panel yesterday, and 1 of my 3 sales panelists was the former Head of Sales for HelloSign, right?

Oh, yes. Okay.

Yes, he's gone. He's been out from Dropbox for a year, but historically, I mean, HelloSign did great, but I would always -- because I cover DocuSign, I would always ask him, "So how is DocuSign doing?" And the answer was typically, "I'm sure they're doing great, but we don't really know because in the enterprise there's all these RFPs and we just can't check all the boxes." And one of the boxes that he couldn't check is the one you just mentioned, right, which is like, look, DocuSign operates all over the globe in all these languages and all these regulatory environments. And they have worldwide customer support. And we're a small company [indiscernible], so -- yes, you're getting there, yes, yes.

Right, right. Well, we're trying to resolve all of these, right? And I think -- maybe just to finish this swing on HelloSign. I think that what we're also doing and what Dropbox helps with is the full life cycle of e-signature, as far as giving a user a place to find their content, send it for signature and store it. And so that's where Dropbox is a nice fit and a nice complement and that we worked well together to make the user experience much better. And then I know you asked me more about our general M&A thinking and strategy, where to your point, we do have a lot of dry powder to work with. We've got a very strong balance sheet. We've got this convert that we just executed, again. So we'll be on the lookout for items that do complement our product strategy and add to the verbs of what people can do with their content, but of course, we will stay disciplined financially. We know valuations are high and we want to be thoughtful about how we spend. So it'll be a combination of product fit, financial fit.

Okay. And then I'm going to ask one more, which I think will probably burn up our remaining time here, but it was Eric Yuan said on his earnings call, Zoom obviously, that he's open for large M&A. Would Dropbox be a better fit within Zoom than on a stand-alone basis?

I don't know how directly I can answer the question. I think maybe what I can share is that we are working closely with Zoom on a partnership. And so for example, this experience that Pat and I are having right now. One of the partnerships that we're working on, and it's in beta and hope to be released more generally quite soon, is Dropbox coexisting with Zoom, where as we're having this discussion, you can have a agenda working alongside us and we can take notes. And we can assign action items, and we can store that agenda or store that meeting notes in Dropbox. You can store that transcript within Dropbox. And it's a much more collaborative experience. And one of the ways that Drew and Timothy talks about the potential with the partnership is Zoom is more of the short-term memory of collaboration, right? So Pat and I, this conversation or many conversations you would normally have on Zoom will often just disappear into the ether, whereas Dropbox can serve as the long-term memory whereas we'd take the notes or take the transcript and that can then reside permanently in Dropbox. And so having that full short-term, long-term memory as a partnership is an angle we're taking with Zoom, and that opens up and unlocks additional possibilities for the 2 companies going forward.

Yes, super interesting. Okay, last one for you: How's business? I'll be the one to ask. What would you say?

Business is busy, but business is going well. I think, gosh, we've got a lot going on in the last handful of months between the convertible debt deal we did. We're shifting to virtual first, all as part of this new COVID moment that we're living through; announced the share repurchase; did a -- we did do a reduction in force. We shed about 8 -- or sorry, 11% of our company in January as we just looked to streamline the team and be more nimble and flexible. So it's been busy, but if you look at just our execution and results, I'm proud that we're doing what we say we will do. And that's really how I want to run things as CFO, is tell the market this is what I'm going to do and then go do it. And I think we're executing against our investment thesis. We're driving significant free cash flow and operating margins, as we said we would. We're returning capital to shareholders through share repurchases, so we're doing everything we said we would do. And now we need to continue to execute, particularly on the growth front, which is I know top of mind for the market and for folks like you, Pat.

All right. Hey, Tim, this is super helpful. Thank you for your time. I know you have a gazillion one-on-ones too. And I know doing that is really exhausting, so I just want to say we appreciate it. And thanks for joining us.

You bet. See you around town.

Okay, yes. Bye.

All right, bye.