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

Okay. Hello, everyone, and welcome to the UBS IT and AI Conference. So in this session, we have Dropbox's CFO, Tim. Tim thanks so much for joining us today.

You bet, Taylor. Happy to be here.

Awesome. Perfect. And for those in the audience that don't know me, my name is Taylor McGinnis, and I cover the application and SaaS base here at UBS. So with that, before I dive in, if anyone has a question in the audience, there is a QR code in front of you. You can just tap that, and I'll make sure to read off any of those at the end.

Perfect. Awesome. Well, let's dive in. Tim, maybe a good place to start would just be at a high level thoughts on what you're seeing in the demand environment. It sounds like based on some of the comments that you gave last quarter that top-of-funnel activity remains really strong, but you're still seeing possibly some rightsizing and optimization amongst some of your larger customers. So can you comment on that? And any signs of green shoots or is it still challenging out there?

Yes. Good question. I'd say, the demand environment has been relatively consistent being stable, similar signs as we've been seeing in the past couple of quarters. So I think through some of the positives on the individual side of our business across our Plus and essential SKUs, still seeing some growth in those SKUs. We've done some work to improve the mobile experience in particular, and that's where we're seeing a lot of our new customers come through is on the mobile side of things. So seeing some uplift on the individual side of the house. On the Team SKUs, we are seeing some green shoots when it comes to the top of funnel, seeing some improvements when it comes to sign-ups and trials and activations. We've flown through some improvements on the sharing experience and the activation flows. So that's translating to green shoots on the Team side of things on top of funnel. Now on the other hand, we're seeing some pressure, particularly on the Team side as far as price sensitivity. We're seeing a lack of team expansion, we're seeing some downsell pressure. Some of this we introduced at the price increase back in 2022. We've seen some price sensitivity really since that point in time on the Team side. And so that's offsetting some of the green shoots that we are seeing on Teams. And so that's netting out. And so that's factored into some of the color we gave on 2024 in 2025. I think these Teams customers are doing what we're doing ourselves as far as trying to get more efficient with their spend. And so that's part of what's driving some of these headwinds.

Perfect. And then in terms of the visibility you have into when we could start to see some of those headwinds abate, so you talked about the price sensitivity. You talked about these contractions and optimization. Is it as simple as once you get through some of these tougher renewal cohorts, or once we start to lap those pricing changes that were made, then that's when we could start to see that abate? I guess how should we think about when that could occur?

Yes. Good question. So our business is a little challenging to predict because 90% of our revenue comes from the self-serve channel. And so they don't exactly give us a heads up as far as when they're going to renew or churn or downsell. So -- and so less of a dialogue when it comes to that self-serve channel. Those customers also tend to be on monthly or annual plans. So they have to make that renewal decision every year. And so we can't quite say that we're through any renewal pressure. Most of our dialogue does occur with the managed sales motion. So our outbound sales team is able to have an active dialogue with our customers. And so that's where we have more of a signal that a churn or a downsell is coming. So this is where in the third quarter, fourth quarter, we knew about some of our larger teams downselling. So we were able to factor that into our paying user color that we gave and our guidance that we gave. So overall, I can't quite say if we're through any renewal challenges. What we do is always factor in the latest trends in our forecast. I never assume that things are going to improve on us. And so that's what's factored into the '24 numbers and the '25. And so we'll clearly give more color as we have it.

Perfect. And then maybe on the '25 outlook. So you talked about maybe a little bit more visibility for these larger customers. I guess what is the channel saying on that, right? And maybe there's continued appetite to still work through some contractions and optimization is the partner channel saying that we're largely through it at least for these larger customers and how are you embedding that in the 2025 guide? And in terms of as a second part of this question, what the driver of that is? Is it just as simple as there was layoff activities, now you have to optimize for the seats that you have today? And is there any -- are you seeing this in any particular vertical? Or is there any trend there?

Yes, some of the key drivers of folks that downsell or churn, the strongest correlation is these companies that have gone through layoffs themselves, right? And so we see a company that's gone through a layoff and they come around to the renewal cycle, we have a strong sense that we may be impacted as far as customers churning. Price to value is a new -- it's not new, but it's one of the key reasons for churn or downsell, customers flagging, hey, the prices isn't worth the value that we're receiving, episodic use cases, right? So a customer may be using it for a project and once they roll off a project, they may downsell from a paid state to a free state. Another is they may end up in the wrong SKU, whereas they should have been in an individual SKU. They're in a team SKU or vice versa. So those tend to be the main reasons for a churn or downsell. As far as the verticals that we tend to see in the churn and downsell, or seeing it primarily in the tech manufacturing and retail verticals tend to be the hardest hit. And then as far as -- there's a lot we're doing to focus on retention. We have a $2.5 billion ARR base, 18 million paid customers, 575,000 paying teams. So it's critical for us to focus on retention. So this is the #1 strategic initiative for our core team next year is to focus on retention. So there are several things we can do on that front. And number one is engagement. And a customer that's actively using our product is much more likely to retain. And so we find that certain key features and functionality are strongly correlated to retention. And its basic functionality, things like sharing or team creation or editing or uploading files. And so part of the thinking is, let's focus on that core set of features and functionality as opposed to inundating our customers with too many bells and whistles. Let's get that core features and functionality right, drive up engagement, drive up adoption and that tends to translate into retention, strengthening and simplifying the platform, making sure that it's extremely reliable, the usability is seamless. These sorts of things tend to translate to retention. And then there's things we can do as far as, call it, the voluntary churn flow as a customer is going through a churn or downsell offering them a discount or offering them, hey, what about the lower price SKU, doing these certain activities to retain customers. And then there's even work we can do on the involuntary churn side of things as far as, hey, your credit card is about to expire, please update it or extending rebuild windows to give people more of a chance to renew. So there's a lot of work that we're going to be focused on, on retention. Retention is clearly critical, again, with the sizable base we have. And we need a healthy user base that we can cross-sell Dash into. And so we want to make sure we have a strong foundation for our future as far as our growth.

Yes. All that commentary on the retention efforts is super interesting. So in terms of where you guys are in that journey, is this something that you guys have been working on the last couple of quarters, such that once you get into 2025, you could start to see the fruits of that? Are a lot of these initiatives still in the early phases, and it might be more second half, right, where those start to come into play? What does that look like?

It's a mix. Some of these we've been working on for years. So again, 90% of our revenue comes from self-serve. So we are constantly iterating on our self-serve engine, making sure that, that engine is as seamless and intuitive as possible because we don't have that active dialogue with customers. So they have to find things on their own. So we're constantly iterating on our self-serve engine. So that's a journey that we're always embarking on. Some of the voluntary churn flows, involuntary flows, those are on the road map. And so we're working through those. Some of that will be coming. And then additional things we're doing, focused on churn as far as, for example, introducing Dash to our file sync and share user base. That's also on the road map. So it's still coming. So it's a mix of things that are in flight, things we've been working on for years and things that will be coming.

Perfect. All really helpful. And then when we think about the file sync and share business, I know at the time of the RIF, there were some comments made by Dropbox in some of the remarks about that part of the business reaching some level of maturity. So I would love if you could just elaborate a little bit more on what was meant by that because I think you're still talking about bright spots in upsells, right, and some of the top of funnel activity. So is that within certain customer segments where maybe it feels a little bit more penetrated? I know you don't share tons on customer segment today and what the mix looks like. But any even high-level color you could give folks to help them think through what some of that meant?

Well, I think it's an acknowledgment that file sync and share is 15 years old. And it's in a mature competitive environment and maybe the days of high growth rates are passed. And so we've got to be responsible and prudent with how we allocate our capital and make sure that we invest towards the highest areas of growth. And so this is where, as you alluded to, we did a RIF towards the end of October and part of the intention there was just to get more efficient within our file sync and share business. It is in that mature category. So let's free up some of our resourcing and devoted towards the areas of higher growth, which we consider Dash to be. So that's the strategy behind what we're doing is really getting more efficient within our core housing and share business and rotating investment towards Dash. That's the highest level. Now we still are investing a fair amount in file sync and share. Because we do see these green shoots, and we need to translate those green shoots over to growth and as I alluded to, we need a healthy user base on file, sync and share to serve as this launch pad for Dash -- to serve as the first cross-sell point for Dash. So certainly not giving up on file sync and share by any means. But I think it's more about matching the investments we're making towards the growth opportunity we see and constantly having that discipline as a management team to rotate investments towards the highest areas of potential growth.

Perfect. Let's talk about Dash. So I know it was just launched. So it's very new. But just in terms of any insights that you can share from customer momentum and the feedback that you've seen today. So do you think that Dash could start to serve as an offset to some of the pressures that you've seen? Or do you feel like that might take some time?

Yes. So maybe I'll first describe what Dash is trying to do. And so Drew does talk about Dash as being the Dropbox that he would build for today's environment. As far as solving the challenge, it used to be 100 files across your desktop. Now it's 100 browser tabs across your browser and it can be across different tools and applications. So really solving for that fragmentation of tools and content. And so what does Dash do? One of the key features is universal search. So I can have us one search box across all my tools. So I can search in one search box across Dropbox and Microsoft or Google or Notion or HubSpot. A lot of the tools are used to find content that I want and need. And so certainly, that keeps me productive in my day as opposed to bugging Peter for what was that file we were working on a week or two ago or what's the name of that [indiscernible] my team as much as I had done in the past. So that's, call it, the kernel functionality that Dash offers. Answers is another piece of functionality. So for example, I was looking at our second quarter Board deck which is 180-page PDF file. And I just wanted some quick answers as I was preparing for the conference and I said, "Hey, what did we do well in second quarter?" And it gave me a nice 10 bullet summary. And what did we do poorly? What do we need to work on? And that's another 10 bullet summary and it did a really nice job of synthesizing 180-page PDF doc. I could also say, all right, write me an e-mail that I could send to my team about this board deck, and it can do that. So it's almost a personalized chat GPT centered around your content and your company's content. That's another key feature that it has. Stacks is another feature where I can aggregate both files and URLs because it's not just filed anymore, it's cloud content. So around each earnings cycle, I create an aggregated stack around my Q2 or Q3 or Q4 earnings includes my word docs, my excel docs, my PDFs, my Google slides, and I can share that with my team. So we stay -- it keeps our team organized around a particular project or event. And then one of the more interesting and aha features that we're offering to customers, particularly for IT decision-makers, because security is very important with IT tools and particularly for IT decision makers, that's what they're very focused on. So we've introduced this protect and control functionality. It effectively is a dashboard that allows an IT decision maker to see what content has been shared internally and externally and to manage that content more central and from a more centralized basis whereas in the past, if somebody wanted to know, hey, how is a piece of content shared, they have to search in e-mails or find different docs and really go through a laborious process. Now they can do this essentially with Dash and through this protect and control feature. So appealing to IT decision makers has been very important. . I'll get to your question on momentum now. We've been using Dash internally for several months now, and Dropbox employees are tough customers. If we don't like something, we won't use it, even if it's our own product. And so we've been using it. It's getting strong daily, active use getting strong weekly, monthly active use. So that's very encouraging. I use it literally every day. So I'm excited about it. And so we launched this in mid-October, strong early reaction from customers. We've landed our first set of paying users. They're getting onboarded. From a market potential perspective, [indiscernible] has described it as $8 billion TAM tripling over the next 4 years. So strong market potential as well with so much execution in front of us, so much we need to do to drive this through to our customer base. And so -- and again, relative to a $2.5 billion ARR base, it's going to take a while for it to move the needle. But we're very optimistic about the long-term potential here and excited to see what we can do with it.

Perfect. Awesome. And now that it is live, anything you can offer in terms of monetization and how it's being priced. I know you've talked about that being accretive to ARPU in 2025. But any sense of the magnitude that we could see? Is this something more incremental? Could it be 50 basis points of expansion, 75? Any just high-level color you could offer there? What might be embedded in the guide?

Sure. Very early days. So again, we're sorting this out. This will be in negotiation given that we're starting with this managed sales motion. So it would be a conversation with customers. So very early innings. We're getting some good early signals on it. We're clearly aware of how other companies have priced their AI product. So that gives us a bit of an anchor point to use in these conversations. As you alluded to, this will be accretive to ARPU. We're confident in that. As far as the potential to drive basis points across our full user base, it's going to take a while, again, with $2.5 billion to move that needle. So we'll be monitoring this. These are sort of some of the things that we'll be learning over the next months and quarters is the the sales cycle times, the price points that we get. And so we'll be factoring this into our guide in our commentary as we give these proof points to to the Street on how things are going. As far as what we factored into '24 and '25, not much factored into '24, and we're trying to be prudent about what we factor into '25. So factored in some degree of uplift but nominal relative to our total base.

Perfect. And just because we're on the topic of Dash, I'll turn to a question from the audience, which is, what are you looking for with respect to traction for Dash that would cause you to be comfortable leaning in to spending meaningfully on advertising and marketing dollars to promote it?

Sure. So the approach with Dash will be trying to roll this through to our 575,000 installed base across our teams and focused on SMBs, focused on mid-market customers, primarily domestic, eventually rolling through to international, but starting there and having these conversations with IT decision-makers. So the traction that we'll be looking towards is the pace at which we are landing deals, how fast these sales cycles are, what price point we're landing. And that's what will educate whether we continue to add more sellers to that sales motion. So pace of adoption. The level of engagement will also be important, right? Because engagement tells us about retention because if we're seeing low use of the product, maybe they're not going to retain. But if we're seeing high levels of engagement, that will give us confidence in the potential future retention. And then eventually, we'll get -- renewals will come up and how many customers are renewing. So as we're seeing the adoption, as we're seeing actual landing of deals and as we're seeing the tension, that will give us confidence as far as adding more R&D, adding more marketing. Now a lot of that is already embedded within next year's commentary that we've already given. So I think we are investing a healthy amount around Dash. Another thing that is on the horizon for us is launching a self-serve motion, right? And so this is Dropbox's bread and butter when it comes to file sync and share. That's where most of our revenue comes from. And so as we introduce that self-serve motion, what will be really interesting is the adoption curve for self-serve for customers that need to sort more of this out on their own. And again, the adoption, the usage, all of this will give us a sense of ramping up marketing and investment in headcount.

Perfect. And then as we think about putting all of this together, so we've talked about some of the optimization activities, we've talked about top of funnel, we've talked about Dash. When we think about how all of this contributes to your flat revenue guide for 2025, I guess can you talk maybe a little bit further about what some of the assumptions are embedded in that guide? So if we look at the 4Q guide, that assumes that paying users are going to be down sequentially. So what are some of the risks that we could see that persist right, into next year? I know you talked about the possibility of growth actually declining. But what are you seeing, I guess, that's giving you that comfort to at least start with flat year-over-year?

Yes. So we did share that we expect '25 -- provide firm and official guidance in February. But in the November call, we shared that we expect '25 revenue to be roughly flat on a constant currency basis relative to '24. So what's going into that? Well, we're exiting Q4 for file sync and share in our Document Workflow businesses at sub 1% growth and we just did a RIF. So taking away some headcount, taking away some marketing. So I don't expect that to help the growth rate for file sync and share and our Document Workflow businesses. And so if I just calculate the trajectory of our file sync and share business, there is a degree of headwind there. We talked about the pressure points as far as downsell and lack of CD expansion, but not expecting that to improve at all. So we've got this downward trajectory line on our core business, and Dash is just getting started. And so I definitely expect an upward trajectory line there, but we're bringing a sense of pricing, the sales cycles, all these sorts of things we've been talking about. And I don't know the pace of that just yet. So we've got one line coming down, one line going up roughly, flat expectation given those trajectory lines. Now we could see things dip down if the Team's business continues to struggle against these downsell and lack of upsell headwinds or if Dash -- the pace of Dash ticking off is slower than we had hoped. So there could be even further pressure on that growth rate. Or conversely, we could see it turn around and move north if our team is green shoots, if those actually translate into ARR growth or if Dash takes off at a faster clip than we had hoped. And so clearly, these are sorts of things I'm monitoring very, very closely, and I'll share updates each quarter with the Street. But those are the lines we're paying very close attention to. And at this point, the best estimate is that roughly flat.

Perfect. Super helpful color. Maybe shifting to margins. So you announced the RIF that impacted approximately 20% of the workforce. So can you quantify how that's being factored into the 150 basis points of margin expansion in 2025? What level of savings are being realized? How much is being reinvested back into the business?

Sure. So end of October, we let go of about 500 employees, 20% of our workforce. And so some of the color we gave on our November call was that we expect roughly 150 basis points of margin expansion. Next year going -- so we end this year roughly 36% operating margin. So clearly, that infers about 37.5% operating margins next year. Now next year, a few headwinds will put some pressure on that. Number one, every year, we do an annual merit increase for our employees. So our employees will get a merit increase. So that will put some pressure on that. We are going to reinvest some of the head count back into Dash, and we had some performance management actions as part of the 500 heads, so there will be some backfills for that. So that will be factored in as far as the offset to margins. And then 2024 had about 120 basis point uplift due to the extension of the useful life of our hardware equipment. And so we won't see that tailwind again, so that is offsetting some of the margin expansion. But so that gives some color as far as the operating margin leverage we expect going into next year.

That's super helpful. And how predicated is the 150 basis points of expansion on revenue growth, right? So let's say, there is a scenario where we see a decline in revenue growth. Are you still able to show that 150 basis points or more of improvement? Is there areas if you need to pull more cost saving or operating efficiency levers that's still to be had in the business?

Yes. Good question. I think we always anchor on the principle of growth and profitability in finding that right balance. And so these are the conversations that Drew and I have, that the Board has with us and making sure that we're mindful of that balance, and that's part of the thinking beyond behind the RIF as hey, we were seeing the file sync and share growth rate come down, let's be mindful of the spend we have there, and let's drive some incremental profitability. So that will be the anchoring principle. And if we're seeing growth coming down, we'll find ways to drive more profitability. And ways we can do that is continuing to assess our R&D spend or are we getting a sufficient ROI on our R&D spend and if we're not, let's curtail it. Our marketing spend, are we driving a sufficient LTV to CAC on the marketing spend, and if not, let's pull back. Other levers we have, low-cost locations. It'd say we're still in the reining when it comes to low-cost locations. We did introduce hiring in Poland a few years ago, that's still relatively small relative to our R&D base, and so we can continue to leverage low-cost locations. Automation, another thing we can leverage. AI tools and other things to get more efficient, more productive with our time. So there's definitely ways we can drive more leverage across this business. And that's very much something that Drew and I and the management team will be monitoring to make sure that we're delivering sufficient returns for our Vestasinvestors and shareholders.

Perfect. Really helpful. And then maybe translating this to what this all means for cash flow. When we think about the 150 basis points on EBIT expansion, I know on the cash flow side, you have 2 headwinds as it relates to 1Q, the restructuring charge being one of those. But I guess how do we think about that? Is it that the cash flow improvement should be in line, then if you take out some of those onetime headwinds, is there potentially more cash flow leverage, so they actually should try to align with each other. Any help that you can give us there for 2025?

Yes. So for 2025, early signaling we gave in November was we expect free cash flow to be at or above $950 million. Now you alluded to a few of these onetime headwinds. We have a $36 million payout to a San Francisco lease buyout that we did a couple of years ago. So that lands in the first quarter of next year. And then about $10 million of severance related to the RIF for international employees, that will land in the first quarter of next year. So those are a couple of the headwinds that we'll be facing. We've talked about the revenue expectations. Clearly, that's factored in. We've talked about a margin, the fact that we're reinvesting back in certain roles, that's factored in. Then there's higher cash taxes. Unfortunately, as we become more profitable, we have to pay a bit more in taxes. So that's factored in. So -- now again, we're very committed to driving higher levels of free cash flow and with our share repurchase program taking out more of our share count. And so Drew and I are north star, if you will, as far as what we're trying to achieve and what we're trying to drive for shareholders is free cash flow per share. And I think you've seen us drive that pretty strong free cash flow per share growth over the past couple of years, and we intend to keep that pace up.

Perfect. So just to be clear, so the headwinds that we talk to are embedded in that [indiscernible]. Okay. Perfect. And then last question for you in the last 2 minutes or so. Pricing and packaging is always a hot topic. So I guess where does that stand today? Are there opportunities to take price, is it still more about finding the right bundles? What's the strategy?

Yes. I think on price, we'll be cautious with price. We raised prices on teams a few years ago, and so we saw a lot of price sensitivity when we did that. So I'd say, we'll be quite cautious when it comes to raising prices on teams. We did introduce a Dropbox Simple SKU, which is a mobile international SKU. So there's a lower price, lower cost SKU in certain geographies. These are the sorts of things we'll test constantly with our customer base. And that got some good initial traction. And so we'll continue to test that and determine whether to roll this out across different geographies. So that's one way, we'll play with pricing if you will, is by testing different price points and different SKU types. But you alluded to pricing and packaging. So the bundling strategy is definitely something that we will be contemplating. We did introduce bundles towards the end of last year, where we introduced some lightweight functionality across our e-signature and DocSend business lines. I got some muted market reception. And so we're moving away from, call it, the Document Workflow bundles. But bundling Dash or bundling some of the security functionality that I alluded to, the protect and control, those are some of the ways we can also take advantage of pricing and packaging and drive up retention, drive up that utility across our customer base because the more value that customers are getting out of Dropbox are definitely more likely to retain. And so finding the right set of bundles, finding the right packaging and right pricing, that's something we're very, very mindful of.

Perfect. Well, we're out of time. So Tim, thank you so much for joining us. This has been incredibly insightful and thanks to everyone in the audience as well, too. Let's give Tim a round of applause.