Dropbox, Inc. (NASDAQ:DBX) Q1 2024 Earnings Call Transcript

Dropbox, Inc. (NASDAQ:DBX) Q1 2024 Earnings Call Transcript May 9, 2024

Dropbox, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to the Q1 2024 Dropboxs’ Earnings Conference Call. [Operator Instructions]. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker Peter Stabler, Head of Investor Relations. Please go ahead.

Peter Stabler: Thank you. Good afternoon, and welcome to Dropbox’s First Quarter 2024 Earnings Call. Before we get started, I’d like to remind you that our remarks today will include forward-looking statements, such as our financial guidance and expectations, including our long-term objectives and forecast for our second quarter and fiscal year 2024 and our expectations regarding our revenue growth, profitability, operating margin and free cash flow as well as our expectations regarding our business, assets, products, strategies, technology, employees, users in the macroeconomic environment. These statements are subject to risks and uncertainties that could cause actual results to differ materially. They are also based on assumptions as of today, and we undertake no obligation to update them as a result of new information or future events.

Factors and risks that could cause our actual results to differ materially from these forward-looking statements are set forth in today’s earnings release and in our quarterly report on Form 10-Q filed with the SEC. We’ll also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors.dropbox.com. I’ll now turn the call over to Dropboxs’ Co-Founder and CEO, Drew Houston. Drew?

Andrew Houston: Thanks, Peter, and good afternoon, everyone. Welcome to our Q1 2024 earnings conference call. Joining me today is Tim Regan, our Chief Financial Officer. I’ll first provide an overview of recent business and product highlights, and then Tim will review the details of our Q1 financial results and update our outlook for the remainder of the year. Revenue for the quarter was in line with our expectations. However, we still have work to do to return our core FSS business to a growth rate that’s more representative of the opportunity we see. As our teams work on initiatives to achieve that, and I’ll share more about those efforts in a moment, we continue to manage our expenses carefully and we’re pleased to have delivered better-than-anticipated profitability in the quarter.

On another positive note, after a challenging fourth quarter, paying users returned to sequential growth with 35,000 net new additions in the quarter. We are encouraged by this return to paid user growth, but we’re still facing macroeconomic challenges and an uncertain demand environment. Within our core FSS business, we continue to see pressure across our self-serving division [indiscernible] Digital and Teams offerings while in the quarter we saw a better than anticipated performance across our Document Workflow group comprised of Form Swift, Sign and DocSend. I’ll now share more specifics on our core FSS business, starting with Teams. Improving our Team’s offering is a focal point for us this year. Our Team’s plans feature higher net revenue retention rates and an opportunity for license expansion.

In Q1, we focused on reducing friction in the onboarding process, improving the Team admin workflow and streamlining the sharing experience. We’re pleased that the changes we made led to solid top of funnel improvement during Q1 with trial starts, team invitations and weekly active usage, all posting year-over-year increases. These are positive indicators that customers are trying and using our products, and the next step is for us to convert and retain these potential new paying users. And as we mentioned on our last call, late in Q4, we implemented tests and experiments for individual plans that didn’t produce the expected results. In particular our emphasis on higher-priced SKUs in our mobile channel ended up negatively impacting our top of funnel metrics, including trial starts for new individual plan users.

Over the course of Q1, we continued our work on our go-to-market motion for our individual plans. And while our mobile channel hasn’t yet fully recovered, we’ve seen some recent improvement in top funnel, and we’re confident we can further improve the efficiency of the mobile acquisition channel going forward. Moving on to a quick update on Bundles. As a reminder, we created bundled SKUs to offer multiproduct capabilities to new customers at a higher price point, reflecting the additional value we were adding to the plans. These SKUs include FSS as well as limited or introductory functionality across products such as Dropbox Sign, DocSend and Replay. On our last earnings call, we noted that while we saw improved ARPU and higher multiproduct adoption rates for the introduction of these plans, we are also seeing reduced top-of-funnel demand and conversion challenges.

Based on our learnings, in late Q1, we elected to roll back the pricing of our bundled SKUs to prelaunch levels to counteract the potential price sensitivity that these plans introduced. We’re currently assessing the customer response to these reduced prices, while we also work to optimize the features included with these bundles as well as the underlying product experience. We’ll continue to iterate and drive towards an intuitive lineup of offerings for our customers, and we’ll have more to share on our progress here in the coming quarters. Customer feedback is a critical input into our product development. Our April ’24 release is a great example of our teams acting on this feedback as we release the collection of product updates designed to make it even easier for Dropbox users to secure organize and share their work across different devices, locations and platforms.

To help our users secure their content, we released new Advanced Data Protection features, including Advanced Key Management and full end-to-end encryption offering our FSS users complete control over how their data is secured. The kernel of this end-to-end encryption capability stems from our acquisition of BoxCryptor in late 2022. And as we were seeing our customers purchase this functionality separately from Dropbox. Now our users can take advantage of this capability natively within Dropbox, providing additional protection for both our end users and their administrators, who are key influencers and purchasing group decisions. We also consistently hear from our users that they want more help organizing and sharing their content efficiently across distributed teams.

For example, our users have sought ways to improve collaboration across Microsoft applications. That’s why we’re excited to announce real-time Co-Authoring integrations with Microsoft 365. Dropbox Teams users can now edit Microsoft Office files on the desktop simultaneously and save natively within Dropbox without conflicting copies. With real-time editing, they can be confident they’re working off the latest version. We also launched a Microsoft Copilot Integration, giving users the ability to query their Dropbox files directly from within Microsoft Teams. Our April release also featured the launch of DocSend Advanced Data Rooms. Users are now able to securely share multiple files with a single link while maintaining complete control of viewing with group permissions, visitor verification and built-in NDAs. With an easy-to-use virtual data room solution, DocSend is now even better positioned as an attractively priced full-featured solution to address the middle market deal flow opportunity.

Sharing quickly and easily across teams is especially important for projects with large video files, which is the fastest-growing content type on the Dropbox platform with over 1.5 billion videos uploaded each year. To support video-based projects, we’ve continued to invest in Dropbox Replay, our rich media review and approval tool. Since Replay’s general release, active users have been growing on average 15% quarter-over-quarter. And further, with our new integration, replay users who work in added Pro Tools can now review files directly within their Avid application. I’ll now shift gears and share an update on Dash, our stand-alone universal search product that leverages AI and machine learning to help organize all of your cloud content. Last quarter, we shared that we were prioritizing collecting input from our beta users and focusing on maximizing the utility and virality of the Dash product and we’ve been making significant progress in Q1.

For example, we’ve recently seen double-digit percent increases in search success for existing and new users, and we’ve reduced average search latency by over 50%. We’re conducting near daily user sessions and the feedback has been valuable. As we better align Dashs’ key features with user needs and achieve stronger product market fit, we’re eager to leverage our platform’s user base, and distribution to address this growing market opportunity for cloud-based universal search. We’re also working on reducing onboarding hurdles. For example, early on, we prioritized Dash development for Chrome, and while this allowed us to move faster, we create unnecessary friction for Safari and Firefox users. We’ve now eliminated this gap. And as a result, we’ve seen improvements in onboarding success rates and app connections.

Early engagement trends are moving in the right direction as well, up over 70%. Our newly redesigned Dash Start Page also enables users to get shortcuts to their recent work projects and view stacks which are smart, shareable collections for any kind of cloud or file content. In each quarter, we’re adding more integrations with the most widely used workplace tools and apps. In closing, we had a good start to 2024. While not without challenges, we delivered against our key business objectives of enhancing the product experience for our core FSS users while investing in our next-generation AI-enabled product experiences. Given the ongoing uncertainty in the macro landscape, we’ll stay disciplined in our operations, seeking efficiencies and remaining committed to judicious capital allocation.

I’m excited about our road map for the remainder of 2024 and I’d like to thank all of our Dropboxers for their continued focus on delivering a more enlightened way of working for our customers. And with that, I’ll turn the call over to Tim to share a recap of our first quarter financial performance as well as our expectations for the remainder of the year. Tim?

Timothy Regan: Thank you, Drew. I’ll cover our financial highlights from Q1, provide guidance for Q2 and offer some updated thoughts on our full year 2024 outlook. Starting with our results for the first quarter. Total revenue for Q1 increased 3.3% year-over-year, to $631 million, slightly ahead of the high end of our guidance range. As expected, foreign exchange rates had a minimal impact on revenue for the quarter, amounting to a 10 basis point tailwind and a 3.2% year-over-year constant currency growth rate. Total ARR grew to a total of $2.556 billion, up 3.6% year-over-year. On a constant currency basis, we added $16 million sequentially and 2.8% year-over-year. We exited the quarter with 18.16 million users, adding approximately 35,000 net new paying users on a sequential basis.

Average revenue per paying user was $139.59. Before we continue with further discussion of our P&L, I would like to note that unless otherwise indicated, all income statement figures mentioned are non-GAAP and exclude stock-based compensation, amortization of purchased intangibles and certain acquisition-related expenses. Our non-GAAP net income also includes the income tax effect of the aforementioned adjustments. With that, let’s continue with the first quarter P&L. Gross margin was 84.6% for the quarter. As mentioned previously, the primary driver of the year-over-year increase in gross margin was the increase in useful life of our servers from 4 to 5 years effective January 1 of this year. This change resulted in approximately $10 million of benefit to gross margin in the first quarter.

The impact of this change is weighted towards the first half of this year, where we expect the full year benefit to be roughly $30 million. Operating expenses were $303 million, down approximately 8% year-over-year. Operating margin was 36.5%, ahead of our guidance of 33% and up roughly 800 basis points from the year ago period. A substantial portion of our better-than-anticipated results was timing related as we delayed spending behind certain projects and marketing efforts. Much of this delayed spend will be allocated across subsequent quarters of this year. Net income for the first quarter was $197 million, up 35% year-over-year. Diluted EPS for the first quarter was $0.58 based on 341 million diluted weighted average shares outstanding.

This compares to $0.42 per share and 349 million diluted weighted average shares outstanding for Q1 2023. Moving on to our cash balance and cash flow. We ended the quarter with cash and short-term investments of $1.2 billion. First quarter cash flow from operations was $176 million, an increase of 25% versus the year ago period. Capital expenditures in the quarter totaled $9 million. This resulted in quarterly free cash flow of $166 million compared to $138 million in Q1 of 2023. In the quarter, we also added $27 million to our finance leases for data center equipment. While this figure represents a material step down from finance lease additions in Q4, we continue to anticipate full year 2024 addition to approximate 7% of total revenue. As related to our share repurchase program, in Q1, we repurchased just over 11 million shares.

Spending $279 million. As of the end of the first quarter, we had approximately $1.1 billion remaining under our current repurchase authorization. Our philosophy on share repurchases has not changed. We remain committed to returning a significant portion of our free cash flow to shareholders in the form of share repurchases with the intention of reducing our share count over time, that are related to 10b5-1 grid structured to buy more shares at lower price points. I’d now like to share our 2024 second quarter and updated full year guidance, where I will also provide some context on the [indiscernible] behind this guidance. For the second quarter of 2024, we expect revenue to be in the range of $628 million to $631 million. We expect a roughly $1 million positive impact from FX this quarter.

We expect non-GAAP operating margin to be approximately 33%. Finally, we expect diluted weighted average shares outstanding to be in the range of 327 million to 332 million shares based on our trailing 30-day average share price. For the full year, we are maintaining our previous guidance for reported revenue to be in the range of $2.535 to $2.550 billion. Our constant currency revenue guidance range is also unchanged at $2.532 to $2.547 billion despite FX rates worsening in Q1. Changes in FX have a more immediate effect on billings than on revenue and thus, the impact to revenue this year is not significant. As with prior guidance, we expect gross margin to be in the range of 83% to 83.5%. For non-GAAP operating margin, we now expect to land between 32.5% and 33% for the full year, up from our prior guidance of 32% to 32.5% representing an increase of $13 million of operating income at the midpoint.

As mentioned previously, roughly half of our outperformance in Q1 was driven by delayed spend that we expect to incur over the remainder of the year. Our expectation for free cash flow is unchanged at $910 million to $950 million. We continue to expect $20 million to $30 million in capital expenditures, and our outlook for finance lease additions is unchanged at approximately 7% of revenue for the full year. Finally, we expect our diluted weighted average shares outstanding to be in the range of 326 million to 331 million shares based on our trailing 30-day average share price. This represents a reduction of 10 million shares for each end of the range when compared to our previous guidance of 336 million to 341 million shares. I’ll now share some additional context on the thinking behind our guidance.

Consistent with our historical approach, our guidance reflects what we have a high degree of visibility into today. As a result, we are maintaining our revenue guidance for the year given the challenging state of the macroeconomic environment, particularly within the SMB space, as well as the work and progress status of a number of our initiatives for our core FileSync & Share business and Dash. We are also monitoring the recent security incident with our Sign business which represents a low single-digit percentage of our total revenue. And while we do not anticipate a material impact to our revenue, this could lead to incremental customer churn. Regarding paying users, our comments offered last quarter still apply. We still expect paying user growth for the full year, and we project adding users in the second quarter as well.

That said, we want to remind everyone that our quarterly performance could vary should we experience any large Team churn, key changes in the macroeconomic environment, or experienced incremental churn due to our recent security event with our Dropbox Sign product. As related to non-GAAP operating margin, we are raising our outlook by 50 basis points as we remain focused on being disciplined with our spend. We are maintaining our free cash flow guidance for the year. While we are maintaining our revenue guidance and increasing our operating margin guidance, we also saw FX rates worsen during this past quarter, where FX movements have a more immediate impact on billings and cash. Therefore, the improvement we are driving on operating income is roughly being offset by deterioration in FX.

Finally, as related to our share count, we are reducing our expected share count range to reflect our increased pace of repurchases in accordance with our 10b5-1 grid. In conclusion, we continue to focus on efficiently operating our core business as we seek to drive revenue growth, margin expansion and share count reduction. Concurrently, we continue to invest in new AI-enabled experiences that have a large opportunity to serve new and existing customers. We are making progress across these dimensions, and believe that these efforts will culminate in creating long-term value for our shareholders. With that, operator, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions]. And our first question will come from Steve Enders of Citi.

Steven Enders: I guess maybe just to start out on, I guess, maybe the early feedback you’re seeing from some of the AI products in Dash now that it’s out there live. I guess what is the feedback so far? And — what is — I guess, how was this kind of maybe changing how you’re viewing the opportunity and the monetization potential of those products?

Andrew Houston: Sure. Thanks for the question. So the early feedback, I’d say a few themes. So first is I mean the first thing I look for is we do — my leadership — the Dash leadership team and I sit every week with customers virtually and — talking — to interview them. Walk them through the product. And the first thing is that this — I think we feel quite validated this is a universal problem. Virtually all the prospects and users are like, yes, I’m drowning in tabs and content and my stuff scattered everywhere. So that’s good, good validation. Second is validation as far as the overlap with FSS, which is important. So we find that paying Dropbox File Signature users adopt and retain on Dash at higher rates. I mean our hypothesis was that this would be the case.

And we think we believe it’s a natural evolution to go from organizing your files to organizing all your cloud stuff. But to see that in the numbers is encouraging. And then the feedback as part of the product is really just continuing to improve the fit and finish of the experience. So watching engagement and onboarding success, retention different performance characteristics on that front. In Q1, we cut search latency in half. We’ve been improving the search success rate, tens of percentage points last quarter, onboarding success, connector success, that kind of thing is improving. And these are some of the indicators we look for in the March from beta to . So we’re pretty — it’s still early. There’s still a lot of work to do, but we’re encouraged by some of the early signal.

Steven Enders: Okay. Great. The helpful context on that side. And I guess maybe to the packaging and tweaks that you’ve made historically on top of funnel, it sounds like maybe it’s seen a little bit of improvement versus last quarter, but I guess, can you give a little bit more detail on what exactly you’ve changed? And maybe where the potential green shoots are coming from what you’ve tweaked so far?

Andrew Houston: Yes. So yes, for context, in Q4, we did our first kind of first rev of a bundled SKU. And we had mixed results, and so some lessons there that we’ve unpacked. So one, is some of the positive things we expected or that ARPU did go up and it was a higher price points, multiproduct attach went up. But on the negative side, we also saw that the top of the funnel conversions were down partly due to — there was already some price sensitivity or we’ve already been seeing — I mean, due to the macro environment and what a lot of other folks are seeing just more price sensitivity out there, so the higher price was not helping that. And then secondly, we found that promoting — or having all these different products — trying to introduce them all at once, created some extra friction in onboarding.

So some of the indicators around onboarding success declined slightly. But I think more broadly, we changed a lot of variables at once. And so one thing we’ve basically been stepping back and we’re layering these changes on and sort of validating them one at a time or in a more kind of considered fashion. So I think just being careful to not change too many variables at once is a lesson. I mean another lesson is similar to what I was saying with Dash is that there are really big opportunities here, like the $1 billion scale opportunities here are really with things like Dash. And we’re relatively more focused going forward on optimizing our Teams business on Dash, on that evolution from organizing all your files, organizing all your cloud stuff.

So we — it’s still true that awareness is actually still the biggest gap among our customers, and we have a lot of happy customers who want more from Dropbox, but we hear over and over again that they didn’t know we do more than File Sync and share. So we’re doing a lot on the kind of promotional front or finding ways to close that gap. And then with bundling, still a big opportunity. But I’d say we’re relatively more focused on the bigger — the longer-term bundling opportunity between FSS and Dash versus FSS and some of the document workflow products, which still have some incremental returns, but aren’t transformative with the way that some of the other things in the portfolio are.

Operator: And our next question will be coming from Rich Hilliker of UBS.

Richard Hilliker: I just wanted to hit on the overall demand environment right now. You hinted and maybe more than hinted at just the overall macro I don’t think that’s anything new, but you called on SMB. So I’m wondering if maybe from your perspective, what are you hearing in SMB about the health of SMBs? And I guess I’m curious, how much is the health of the SMB impacting the top funnel relative to some of the things that you can control and have shared with us that you’re working on?

Andrew Houston: Sure. So I mean I don’t think there is — there’s been any real change in the kind of — I think a lot of the trends we’re seeing today are just extensions of prior trends we’ve been seeing in the macro environment. I also don’t know how much I can extrapolate to the state of SMBs like in the world or something. But what we’re seeing with SMBs is pretty similar to what we’re seeing with customers of all sizes that folks are more price-sensitive, cost-sensitive after a downturn or a more difficult economic environment. And so that does impact our top of funnel, but we also see there’s offsetting opportunities where when we just look at the mechanics of the — of how you sign up — referred to — sign up as a new SMB on Dropbox.

When we watch that experience, when we watch customers go through it, when we look at some of the metrics on trial conversion and onboarding success. There’s a lot of friction we want to take out of — that we’re taking out of that experience. So just making it easier to get content in your Dropbox, get people properly set up. I mean these things sound pretty basic, but when we look at some of our metrics versus peer benchmarks. There are certain — there are some pretty big gaps in certain areas that represent upside just from getting people properly set up. Because we sort of lose more people through friction in the experience than is necessary. As far as how all that nets out, that’s reflected in our guidance, but we still see a lot of opportunities to improve the experience.