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

I'm really excited to have Dropbox present today. With me is CFO, Tim Regan, and we're really excited. How are you doing, Tim?

I'm doing all right, Joey. Thanks for having us.

So we have a number of questions we'll run through, and we'll leave some time at the end if anyone has any questions. But just to kick it off, for those unfamiliar, can you just give a brief overview of Dropbox and the [indiscernible]?

Yes, sure. Well, let me just start off by saying that we're largely pleased with how we did in 2022. It's an ever increasingly challenging macro backdrop. We ended up beating our guidance for each quarter of the year. And if I think through the various components of our strategy. So the first one is our file sync and share business. So this is the bulk of our ARR. This is our core lead product, if you will. This is where we still have over $2 billion in ARR, 700 million plus registered users. So we still have made a lot of progress in strengthening that business. We added some incremental security capabilities, including things like our backup product, our passwords product, some ransomware capabilities. And this turned out to be the basis of a pricing and packaging change that we made and wedded that into the products back in June that's still flowing through our user base. We also have our documented workflows product categories. And this includes some acquisitions we've made over the years as far as e-signature and DocSend and now we acquired FormSwift. So we've really done a lot to enhance our document workflow category and trying to weave those products into our file sync and share into a much more seamless way. We've also been focusing a lot on operational excellence. And over the past few years, you've seen us drive a lot of margin expansion. So this past year, we ended with gross margins of roughly 82%, operating margins of roughly 31%. So we made a lot of progress on that front as well. We've also established this, call it, Virtual First strategy of almost remote working where that's driven a fair amount of leverage. So more than half of our hiring in recent years has been outside of these large tech hubs that you tend to see. So a lot of our hiring has been more dispersed, and we actually introduced a new office in Poland to further that process. And then we've also introduced a fourth core strategy around organizing users' cloud content and leveraging AI as part of that. And so there's been a lot of progress in this past year along many dimensions of our strategy. We also did acquire FormSwift in the fourth quarter. We also acquired a company called Boxcryptor, which is an end-to-end security company. And so we've been a little busy on the acquisition front. Also on the share repurchase side of things, we've repurchased about 36 million shares last year as we continue to allocate a significant portion of our capital towards share repurchases. And so a lot of progress was made in the last year. Now we did see the macro environment place a bit more of headwinds on our business in the fourth quarter in particular. So we know we're up against a few challenges, but we're ready for it, and we're going to make some headway against that, too.

That's great. And our classic question, how's business, what would you say? And maybe on top of that, can you sort of weave in how the macro is impacting you? I know it's hitting your segments in different ways, but I would love to just hear how you describe the current macro as well?

Sure. So we did see, particularly in the fourth quarter, the macro headwinds really start to ramp up. And it did hit the -- really all lines of our business. And so I'll just tick through those. So on the first slide, I'll start with our File Sync and Share business where we do have still our Plus product, this is more individual consumer side of our business. So we've seen churn pick up a little bit on that side of the business. And really what's going on there is the mobile operating system companies have made it a lot easier for you to find and cancel your subscriptions. You can just do that in a couple of clicks now. And so we've seen that put pressure on our business. We also, as I alluded to, a bit earlier, we did roll out our pricing and packaging changes in June. And so we saw some heightened price sensitivity in the fourth quarter on those pricing and packaging changes that are flowing through our team's plans. And so we're seeing more scrutiny on licenses and customers focusing on potentially down-selling. And I know this is something I'm talking to our CIO about is how do we find savings with our software spend. And I think we're not immune to that. So we saw that across our business. And then some of our more nascent categories as far as E-Signature. Certainly, I think other companies in the e-signature space saw a take-off during the COVID time frame, and same things have certainly pulled back on that. And so we're seeing some headwinds in the e-signature side of our business as well. And then DocSend, this is a sharing and analytics tool that we have. This has seen some headwinds in the fundraising space, where fundraising has just calmed down a bit here in this environment. So these are all things that we're seeing. Now we have factored this into our guidance for the year. We have tried to be appropriately conservative with not expecting any sort of turnaround on any of these trends. And so we factored this into guidance. And then it's about -- we're not just sitting idly in watching this, right? So what are we doing about it? And so one of the steps that we're taking is 90% of our revenue is still through our self-serve channels. But one thing we're doing is directing our outbound teams to start engaging with those customers that go through the self-serve channel, particularly those that are facing the price increase, just to help them understand the extra value we've added [indiscernible], right, and educate customers on what we can do to help their problems. And in that way, maybe we can drive up retention, which we've seen in the outbound side of the business. So we are not just standing still. We will take action to course correct against these trends that we saw.

That's super helpful. I did want to ask about your 2024 targets. How confident are you in the 2024 target of $1 billion in free cash flow? What are the current headwinds you foresee that could potentially impact you on hitting that target?

Sure. So for some context, we do have $1 billion annual free cash flow target by 2024. And when we gave that target a few years ago, we were generating about $400 million or so in annual free cash flow. This past year, we ended with $760 million or so in free cash flow. And we guided to $840 million this year. So making a lot of progress over the past few years, but still room to go. And I will say that the road has gotten harder, right? We just talked about the macro backdrop, which is not helping on our path towards that $1 billion. And then there's been a few exogenous headwinds that have come up as well. So for us, because we're profitable, we pay a lot of taxes, there's been a change to R&D taxes as far as that being a $50 million headwind to our business this year. FX has turned against us relative to when we first gave the targets, that's another $40 or so million headwind. And then we're trying to sublease our buildings where that has gotten harder, particularly here in San Francisco. So that's another headwind. So similar to my last response, we are not standing idly by. We've not taken down that target. I still feel like I've got 7, 8 quarters to land that target. And so what are we doing? What are we doing against it? There's a lot of revenue initiatives that we're working on that could side to what we've talked about. There's cost structure changes that we can make to really make our cost structure more efficient and to put us in a better margin type position. There's inorganic things we can do -- so for example, we just bought FormSwift in the fourth quarter, I actually expect it to contribute to free cash flow next year. So inorganic can help. And of course, these exogenous headwinds can turn around, right? I know the R&D tax capitalization is hung up in Congress, who knows how that will actually play out, but it could turn around. So all these factors could bring us back to hitting the $1 billion. And again, I'm not giving up on that target, certainly not waving the white flag. I think we've got time to land it, and we're going to do our best to do so.

That means that still a ton of free cash flow you're generating. So definitely good to see. I do want to touch on FormSwift. You did acquire that in December. What is the plan with this asset? And what do you think it brings to Dropbox?

Yes. Yes, we're excited about it. So FormSwift is a templates company. So it really serves small businesses and individuals. And some of the main forms that it offers are HR type forms or legal type forms, tax or real estate. So these are the forms that can really help our customers get certain tests done. Now one of the things that we find our customers want to do when they're engaging in workflows, they want -- they don't want to start with a blank page. They want to start somewhere, right? So we give them a template that allows them to start a workflow, and then you can weave into our other workflow products, right? So our eSignature product, our DocSend product, the sharing and analytics tool. And then ultimately, if you weave that into file sync and share, you can save those templates within Dropbox. So we think it's a nice product and strategy fit for us. It also fits our self-serve go-to-market motion. And so it checks a lot of the boxes from that standpoint. It also had about 50 million website visitors last year. So it gives us another audience. We can introduce Dropbox and it's our products to give us a brand-new audience. And one thing we're trying to do is to move a lot faster with M&A integration. This has been something that we, frankly, in all candor, have not done a great job of moving swiftly with. And so actually, just this past week, we've introduced FormSwift's templates on the Dropbox website. So even though we finished the acquisition in December, already its templates are up on our website. So we're offering these products much faster to our customers. And then just from a financial perspective, we closed the deal about $95 million, and it brings in about $50 million of ARR, and I expect them to be profitable for next year. And so with maybe the last financial angle being they're growing at a faster clip than Dropbox organically. So it really fits a lot of nice ways. And we think that there's a lot of synergies we can capture from this deal, and so we're excited about it.

And you did mention there is some other M&A potential, some inorganic in potential. So I'm curious, how would you describe your M&A strategy? What's sort of the framework you look at? And how do you think about M&A in the current environment?

Sure. So I think M&A has become a much more feasible proposition these days. Certainly, we were looking at things a few years ago, and the valuations were just too high for us to really engage. We want to be thoughtful and disciplined with our capital. And so we're fortunate to have a strong balance sheet and to generate a lot of cash. So it certainly is in our playbook to execute against M&A. And I think FormSwift and DocSend are great examples of the type of M&A that we will pursue, those that leverage our strength in content and give people more to do with their content. Those are the types of acquisitions that we'll engage in. And then often, we'll also engage in tuck-ins that will help accelerate our product road map. So Boxcryptor, another one we did in the fourth quarter, that's an end-to-end encryption business that helps with security. And then Command E, we did that acquisition a few years ago. That's a universal search company. So anything that accelerates our product road map, that's another angle that we'll take. But we will stay disciplined, we will stay thoughtful with how we allocate our capital.

That's super helpful. Can you talk about your outbound and channel efforts? How do you think about your strategy there? And how do you think about the contributions you could expect to see from those areas this year? I know it's still small share of the business but I'm curious on that strategy.

Yes. No, the outbound team has done really well this past year. They've exceeded their quotas throughout the year. They've really helped on many fronts. Now to your point, our self-serve business is still 90% of our revenue. So it is a smaller part of our business. But we do have them focused on our most efficient motions, right? So a lot of our business continues to be this land-and-expand type motion. So we'll enter into companies through this land motion, the self-serve side and then our outbound team will help us expand from there. We're also -- another major angle that we are taking is cross-selling and introducing the signature product that I talked about and DocSend and now FormSwift to our customer base. And so cross-sell and even trying to bring together this more bundling, this more suite type approach. It's something that we'll be doing really as part of our strategy going forward. And so that's how we can also expand ARPU with our customer base is by engaging the outbound teams in those cross-selling type approaches. And then another angle has been retention. So obviously, a lot easier to keep customers that you have versus going to get new customers. And so in years past, the teams have not been [indiscernible] retention. So now we have them [indiscernible] both the cross-sell and retention, right? So both of those we're seeing is changing sellers' behavior and having them focus on the right things that are most efficient for our business. And so they've been really helping to catalyze some of the growth that we saw this past year. And yes, we'll keep finding the strategies that are working and double down with us.

I do want to touch on DocSend just a little bit more here. What has overall demand look like? And how are your bundling efforts sort of progressing with DocSend?

Sure. So DocSend is a sharing and analytics tool. And so it actually has an interestingly loyal following, particularly amongst fundraisers. And so if you think about a person that's trying to raise money, so they send out their PitchBooks to a lot of potential VCs, but often they have no idea who's engaging with those PitchBooks. And so with DocSend, you can send out your materials and see who on the other side had opened your materials and how much time they spent with it and how -- what pages they've looked at. So it's really helped fundraisers hone in on the most likely candidates, the most likely prospects. And so it really does have a loyal following amongst the fundraising space. Now that space has been hit during the downturn. And so what are we doing about that? How are we approaching it? We're really trying to diversify with DocSend, both in terms of its verticals as far as expanding outside the fundraising space, so we have them focused on professional services, consulting and then in geographies right? So DocSend is primarily in the U.S. right now. And so we're looking at expanding into France and Germany and Spain and expanding internationally and taking advantage of that. So it has its own call it, stand-alone strategies that we're deploying. But also, there's the integration points within Dropbox that we're trying to do a much better job of. So some of this is bundling and making it a much better experience. But some of it is just getting out of our own way and reducing the friction that we've introduced into the process. So to give you an example, right now if a customer wants to try and use both Dropbox and DocSend, they have to signed 2 different terms of service, legal terms of service. And we find that 95% of the customers drop as soon as they hit that second gate, as soon as they hit that second terms of service. So even just unifying to have one terms of service, which we are planning to do imminently, that's something that we think will reduce that friction in the experience and then we'll get them to adopt and leverage DocSend. And so what we really find that as soon as customers use multiple products, they retain at much higher rates. You see the ARPU expansion, obviously. So these are the sorts of things we are working on fixing within our business and looking forward to being done with some of these.

That's great to hear. And I know AI is a big topic right now and all the hype and everything, ChatGPT. But just curious, how do you expect to continue to leverage AI and machine learning in your product road map? And how do you see that sort of benefiting customers?

Yes. Good question. So Drew has been talking about this fragmented tools and trying to play within amongst all your different SaaS apps for quite a while, right? And one of the ways he frames it is -- what used to be 100 files across your desktop is now 100 tabs across your browser. And so that's one of the first things we're trying to solve is bringing that cloud content into Dropbox, right? It's no longer files. In fact, cloud content. So bringing that cloud content into Dropbox is one of the first steps in what we're trying to solve. The next is this universal search capability. I talked about the Command E acquisition we did a little while ago. And so this is the problem of, I may know -- I've seen a document, but I can't remember if it was a Dropbox Paper document? Was it a Google sheet? Was it a word doc? I can't remember who sent it to me and I don't remember the name of it. And so what we're trying to do is implement this universal search capability that allows you to search all throughout different apps, all these different apps and surfaces the right content to you when you need it. And then weave in AI on top of that to not just have your content stored and search for it and find it, but to allow you to do more with your content once you have that to assist you with getting your work done. And so it's clear that AI is here that's having its moment. And we know that the work -- the way this is moving, it's not just going to be human intelligence, but it's going to be machine intelligence on top of that. And so we're excited that we've got a product coming here in the next months and quarters that can react to this. And so we've been working on this for a while, and I'm excited to get this out in the market. Now as a CFO, I'm going to be disciplined with how we spend on the product and make sure that we see the right customer signals and invest at the right pace. And so this is something that we'll be monitoring very closely, but excited to see this coming to fruition.

That's great to hear. Can you talk more about the real estate strategy? I know the impairment charge that showed up in Q4, I would love to maybe understand that a little bit more. And how sort of the real estate market in the Bay Area is impacting you guys?

Sure. Sure. So we did announce this Virtual First strategy a few years back. And so we were actually one of the first to market when going remote. And so we did start our subleasing strategy really at that point. And we put up about 90% of our office footprint available for sublease. And over the past few years, I think the team has done a really nice job executing against that strategy. The vast majority of our real estate outside of San Francisco has been subleased. Now San Francisco, that's the hard part. And we certainly have seen that market deteriorate in recent times. I think a lot of tech companies that are going through layoffs or putting up more space on the market. So the supply is only growing. And so this is where we did have to take an impairment charge on our San Francisco lease in the fourth quarter. And so we still are engaging with our landlord to pursue buyouts and other strategies. We still are looking for opportunities to sublease and we'll take advantage of any that come across. But for now, just given what I'm seeing in the market, it just continues to be challenging. And so we'll just have to proceed and try to find our best outcome from here. But I think by and large, the Virtual First strategy has been paying dividends. I do think that it's enabled us to hire great talent throughout the country and throughout the world. And I think the company has been highly productive through this Virtual First strategy.

I'll pause there and see if there's any questions from the audience.

What initiatives is your CIO taking [indiscernible]?

Yes. So we are looking hard at -- as our customers are doing to us, looking hard at our software spend and making sure that we are utilizing the various tools that we have, that we've almost moving more and more towards centralization of our software spend. So it's not just pursue every solution that our employees want to do, want us to tackle, but do it in a thoughtful, centralized way. So that particularly if we have 2 tools that do similar things, let's aggregate, let's consolidate. And then to the extent we have ex licenses, but we're only using 80% of those, okay, let's true down to save some costs. And then let's be thoughtful with our negotiations, right? And just because inflation is happening, does it mean we need to accept the price increase, just as our customers are demanding of us, right? We should only raise prices when we've introduced a sufficient value. So I think these are some of the strategies that we're talking through. And there may be good or bad news for our CIO that he reports to me. So that's the same thing that I'm paying very close attention to, and we are trying to be as efficient as we can with our [indiscernible].

Any other questions? Can you talk about your hiring plans for this year? How do you feel about your ability to attract or retain talent? And how are you thinking about hiring as you look on to 2023?

Yes. So we didn't expand our headcount materially throughout the pandemic. Actually, we had some attrition during The Great Resignation. And so our headcount investments over the last few years have been going to things like our multiproduct initiatives or acquisitions, this universal search and AI capabilities that we talked about a little bit. So we very much try to be thoughtful with how we're allocating our organic investments. Now I do want to make sure that we're seeing a sufficient level of return relative to those investments, right? And so we will be actively and closely monitoring our spend to make sure that we are seeing that return. I don't expect to be adding headcount throughout the year. And of course, we'll stay disciplined with all this. But -- and from a retention perspective, right now, our attrition rates are at their lowest levels that I can ever -- that maybe we've ever seen at Dropbox. And part of it is because we've -- I think people are very much bought into this Virtual First strategy. So we've been able to secure talent and great spots throughout the country. They're happy with us. And so -- but again, we'll have to balance what's the level of return we're getting to that, and that's what we'll make decisions accordingly.

And maybe related to that attrition level, how have you seen Dropbox's culture evolve over time? And how do you sort of think about maintaining it? What do you say the good things about Dropbox that make you say?

Yes. Well, I think it's a culture that's obviously stemmed a lot from Drew, where he -- our #1 value is be worthy of trust, right? So it's a high-integrity culture. People have to trust Dropbox to store their content with us and if they can't do that, then it's a really -- it would be impactful to our brands. So that high levels of trust, the high level of integrity that people bring, I think is paramount, and I think that's something that stems from Drew. There's, I think, high bar, high expectations, high levels of ownership. Those are also core values that we have. So -- but I think it's balanced with a culture that's thoughtful and tries to treat its employees with respect and with care. And I think all of that is what lends to the great culture that we have.

Awesome. I think that's a great place to end. Thank you so much, Tim. Really appreciate it.

Awesome, Joey, Thanks, everybody.

Thank you, everyone.