Dropbox, Inc.
Q1 2020 Earnings Call Transcript

Published: 7 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2020 Dropbox Earnings Conference Call. It is now my pleasure to introduce, Head of Investor Relations, Darren Yip.

[Darren Yip:]

Thank you. Good afternoon and welcome to Dropbox's first quarter 2020 earnings call. Today Dropbox will discuss the quarterly financial results that were distributed earlier. Statements on this call include forward-looking statements, including the potential impact of the COVID-19 pandemic and related public health responses on our business, financial results and the economy, statements relating to the expected performance of our business, future financial results, including expectations regarding future profitability and our ability to generate and sustain positive free cash flow, our ability to extend our platform by developing new products or features, our strategy as well as the ability of our key employees to execute on our strategy, long-term growth and overall future prospects.

[Drew Houston:]

Thanks Darren. Good afternoon everyone and welcome to our Q1 earnings call. Thank you for taking the time to join us today, especially under the current circumstances. On the call with me is Ajay Vashee, our Chief Financial Officer. Olivia Nottebohm, our Chief Operating Officer will also join us during Q&A. The three of us are dialing in remotely from our homes, so please forgive us for any sound quality issues or background noise over the next hour. Today I'll provide an update on the top of funnel and engagement trends we're seeing as a result of COVID-19 and talk to business and product highlights from the last quarter. Ajay will review our Q1 financial results, touch on our go-to-market strategy and provide guidance for Q2 and fiscal 2020. First I want to provide some perspective on how the team here at Dropbox is responding to COVID-19. I'm really proud of how quickly our employees have adapted to working effectively in this challenging environment. We continue to hold regular our company-wide town hall meetings across our global offices and productivity has remained high, even if the vast majority of us have shifted to work remotely while reorienting our product road map to adapt to emerging customer demand. In addition, our infrastructure teams have been hard at work to ensure we continue to operate without any service interruptions or issues and are able to support higher utilization during this time. I want to thank the team for staying focused on serving our customers and to continuing to provide them with the tools they need to get work done. In times like these, the ability for teams to easily access and work together on content takes on an even greater significance.

[Ajay Vashee:]

Thank you, Drew. Our Q1 results demonstrate our strong execution and focus on delivering a healthy balance of topline growth and profitability. Total revenue for the quarter was up 18% year-over-year, to $455 million. On a constant currency basis year-over-year growth would have been 19%. ARR for the quarter was $1.864 billion, up 16% from the year ago period. On a constant currency basis, ARR grew $53 million quarter-over-quarter and 17% year-over-year. I note that in Q1 of every year we update the FX rates used to calculate ARR. We ended Q1 with 14.6 million paying users and ARPU was $126.30 in the period. There are reflects our strategy to methodically convert our highest value users to drive sustainable monetization and retention.

[Drew Houston:]

Thank you, Ajay. In conclusion, I'm proud of our execution in what's been a challenging environment. We're in a solid position with a sweeter products that facilitate remote and distributed work, a profitable self-serve business model and a healthy balance sheet. On behalf of our management team, I'd like to take a moment to thank our customers, partners and the entire Dropbox team. With that I'd like to open up the call for Q&A. Operator?

[Operator:]

And our first question comes from the line of Alex Zukin with RBC Capital Markets.

[Alex Zukin:]

Maybe just the first one around the benefits of the tailwinds that you're seeing from work from home. You mentioned the top of funnel. Yeah, I'd love to hear anecdotally what you're seeing from existing customers expanding seat counts and ultimately what have you seen maybe its thus far in Q2 in the month of April with respect to those conversion rates and then I got one quick follow-up.

[Drew Houston:]

This is Drew. So we've certainly seen higher demand at the top of the funnel engagement is up, and as I mentioned, our new desktop app, the engagements - uniquely acting are up 60% in the last couple of months. And then conversions and held up so far in churn has been stable. So far that said for monitoring everything pretty closely, given the macroeconomic environment and unpredictability that the second half may bring. But more broadly, we think this is a huge opportunity because right now, it's been all for us to work from home in the most like unplanned and dramatic way possible. And I think there's a lot of room for improvement and experience and Dropbox has always helped people to work from wherever they are and right now everyone needs that. But we've been very focused on how do we do more for our users - how do you define that experience really great and we've certainly seen a lot of elements or strategy with our Slack and Zoom integrations, presume Zoom integration engagement thing of 2000% for example as being good validation that strategy. But really, just making sure that our roadmap is as aligned as possible to get out of the opportunity is our biggest focus.

[Alex Zukin:]

Perfect. And then maybe just that you mentioned Drew churn and maybe just also for Ajay. Just can you talk about what you're seeing in terms of churn or net retention trends by the various cohorts. Where you expect them to maybe and end up trough often and then how should we think about just exposure to either SMB trends or maybe troubled industries?

[Ajay Vashee:]

Sure, this is Ajay, happy to jump in there and then Drew feel free to add any context that you'd like to. As Drew mentioned, our business has been very resilient to date. Churn was stable for us from Q4 of '19, one of '20 and that continues to be the case today. And this is really because the majority of our subscribers are knowledge workers and we play a really important role in managing business critical content for them. That being said, we'll be keeping a close eye on retention in newer cohorts where we're seeing elevated trial volumes, still very early for us on that dimension, because a lot of these cohorts Alex, that you can imagine have signed up over the past months, I'm just a little bit beyond that. And so, it's still pretty early there. And we do need to keep an eye like every other company on the potential impact from broader macroeconomic trends on existing subscribers but we are being proactive about where we're investing. As Drew said we've been adapting our product roadmap for the year to really support this accelerated shift to distributed work. And so for example, we're proactively investing in leverage to improve and mitigate churn rates across the second half of the year into the future. We're implementing new more flexible cancellation flows to facilitate higher rates retention. So where we're investing if we're going to make sense for us to right now. But so far things have been stable for us across both individuals and teams.

[Alex Zukin:]

Perfect. Thank you. guys.

[Drew Houston:]

And just building on that, we're really focused on helping our customers adapt to the remote work environment. And I'm sure they're getting the most out of the platform. And then as I just said, we're taking other measures to proactively address churn and offering support and selected financial release to ensure that customers can manage. But overall we find that our customer base, even an SMBs like knowledge workers have been - who can work on and must have disrupted then than average and Dropbox is often essential to their business operations as supposed to discretionary. These are all businesses, our people we need to collaborate around content especially and that's, and that continues to be true when you're working from home.

[Operator:]

And our next question comes from the line of Jason Ader with William Blair.

[Jason Ader:]

Thanks for the greater detail on the top of funnel metrics. It's definitely helpful to get some of that and issues to hear your thoughts on kind of historical analytics around that, but my question is probably the question I get most from investors, hope the market is there for Dropbox spaces long term given the dominance of Microsoft teams that's emerging and the fact that they've got a lot of the same smart workspace features and bundle the app in Office 365.

[Drew Houston:]

Sure. So we see a big opportunity for us because and when you look at our customer's workflows, they need to collaborate on our content and then that's usually a parallel if there are complementary experience to the messaging tool. So when people are using something like teams and Slack, often what they're talking about is content that Dropbox. These are complementary - tend to be complementary experiences. And I think with the proliferation of all the different apps, more and more customers are turning to Dropbox for a platform agnostic solution that pulls it all together because the bundled offerings tend to favor the tools within the suite and our customers may be using something like Office but they're often also using G Suite and they're using tools like Slack and Zoom and so on. And more and more we need a way to tie it all together. So the opportunity for Dropbox basis is, really every knowledge or every business, every team is a collaborator on content and I think more and more we're going to need to organize our work in a way that's a bit of a different and complementary experience to messaging. The channel for chat is just one part of the experience and we see the content workflows has really been our strength

[Jason Ader:]

But don't you think the teams is trying to - has a similar vision in terms of smart workspace, in terms of not just chat and messaging.

[Drew Houston:]

Yes. Although, I think there are, there are challenges of that model. As with the kind of synchronous messaging and chat model at a scale. I don't think in five years we'll look back and saying, okay, the secret to productivity is putting people in my 50 different chat room simultaneously all day. I think it becomes very noisy and distracting environment at scale. By all means chat will be - chat remains and will always be a use it like important ingredient, but I think the challenges like if you go on vacation for a couple of days, you come back answer read hundreds of pages of Transcript to figure out what's going on. And so I think there is going to be - there is already and will continue to be an increasing need to organize work and have a more focused place to go that can pull together all the different tools you're using. And I don't see teams or the messaging apps doing that.

[Ajay Vashee:]

And just to bring some of the way - alright. Yeah, I think those are fantastic question and just Jason to bring this back to the metrics for us. We are seeing higher and higher levels of adoption and engagement around that, that's not application as Drew mentioned earlier. Now the majority of our business teams over 350,000 of our 450,000 plus business teams are engaging with that application. And we've seen that 60% increase in activity over the past couple of months.

[Operator:]

And our next question comes from the line of Mark Murphy with JPMorgan.

[Mark Murphy:]

Congrats on the great resilience that showing in the business model. Drew you mentioned solid uplift in the top of funnel metrics since mid-March and I'm interested in how much of that activity do you think will look back on and say that it was one-time surge versus ongoing usage where they'll continue and take it into the workplace over time and then Ajay, I wanted to ask you that your fiscal year guidance, it seems to be adjusting for FX and interest rates, and I was wondering if you could clarify what the assumption is for COVID-19 impact or is it just like you see the tailwind and as offsetting?

[Drew Houston:]

Sure I'll start. I think it's a little too early to tell how to what extent this surge versus a permanent uplift, certainly a huge percentage of the world is being forced into a remote work state for the first time. But I think the effects of it will persist much are well beyond when we physically go back in the office. And I think one of the things that immediately by missing when you're working from home is being able to have that kind of contact of the people around you and suddenly things that we're relatively straightforward like what everybody up to, what important things happened now my team today become pretty challenging when you're only window into work is like video conference or messaging tool. So we see a big opportunity to help. The kinds of things we're working on or thinking about, how do I get a sense everyone around me. How do I make it easier to figure out what's happening on my team without having to wade through hundreds of pages of chat messages of email. And even after we physically go back to work, this shift to distribute or as we distributed work is going to be permanent and I think that's the silver lining to that which is we're all going to have more flexibility because even if you're primarily on the office but if you have a lot of you being able to work from home be equally productive, that would be a big benefit to a lot of people, but the tools aren't really designed for that right now. So that's really the big opportunity for us to expand what we do in terms of helping people distributed work.

[Ajay Vashee:]

And to answer the second part of your question on the guidance philosophy there, I would reiterate a couple of points, Mark. So one given the resilience of the core business, to your point, we are largely maintaining our annual guidance, net of currency and interest rate movements introduced like COVID-19 and we are seeing some encouraging top of funnel trends. It is still early on that front. We want to monitor this cohorts for both conversion and retention information data and we do remain mindful of the broader macroeconomic risks the second half of the year may bring. And so there is certainly more that we will learn in the coming months and will share an updated view of the second half of the year on our August call on that will incorporate more granular perspective on top of funnel trends subscriber mix, some of those retention rates that existing and new cohorts as well as some more information on that realignment of our product roadmap to focus on really accelerating and enabling this with the distributor work for a customer.

[Operator:]

And our next question comes from the line of Rishi Jaluria with DA Davidson.

[Rishi Jaluria:]

Thanks so much for taking my questions. First I wanted to ask, how should we be thinking about the consumer side of the business. I know 80% of your customers are or business users are using Dropbox at work. But if that remaining 20% that's consumer, especially with unemployment up, but I think 33 million or higher last night check. What are you seeing out of that. How are you thinking about that and then I've got a follow-up well,

[Drew Houston:]

I'd say we're as you pointed out, we certainly have a large audience and we certainly have an audience who used Dropbox only or - who use primarily use Dropbox primarily for personal use cases. But the vast majority over time, share around 80% of our users Dropbox both for work use cases or blended home and work use case. And so the big opportunity we see there, we're less focused on the pure consumer use cases. Because I think given a lot of the dynamics, you mentioned I think it's a little more challenging. That said, I think there is - I think there is this blurred line between home and work think that we're all particularly experiencing right now that we're working literally at a home. We see Dropbox is having a particular strength in that boundary where you can go between your personal and work life seamlessly in a way that other tools don't offer because they only focus on personal or are the only focus on work. And so a number of the things we're working on in terms of our personal launches have a use case in our work context as well. Then that's been true of Dropbox historically. So we prioritize features that have both the personal and work use case. Certainly, our primary focus is on work, but I think when going after the pure consumer market is tougher from a business model perspective, and that's really not a big segment for us.

[Rishi Jaluria:]

Okay, got it. That's helpful. And then wanted to ask, what are you seeing in terms of buying behavior from customers, any things like extended payment or contract renegotiations and maybe alongside that. What are you seeing in terms of deal duration, because as I know, I believe, as a couple of quarters ago, you did mention, say you were seeing more customers opting for monthly over annual. Just wanted to understand what are you seeing in terms of those trends? Thanks.

[Olivia Nottebohm:]

Hi Rishi, this is Olivia and I'll take that question. So we have had selective asks from certain customers and we've considered each one thoughtfully really gauging the moment of need for our customers and trying to make them successful and we're doing targeted extension of net payment terms and we're changing our invoice frequency as well in certain situations. These are all neutral mechanisms that we're doing to help assist our customers in this crisis. And we also see the flip side of it. So we also see situations where customers are moving quickly to respond and immediately need to be provisioned extra seats and licenses and we do that instantaneously and then we wait for the paper work on the contracting to catch up. So Hospital in Boston that needed an extra 100 additional seats to manage bed inventory, we spun that up immediately and then we'll be catching it on the renewal cycle in a month when they do a true up.

[Ajay Vashee:]

Yes. And I would just - Ajay-- I would just add that on some of that really appreciate it. It's been offered. It's really a small number of customers, so a relatively immaterial impact on our business there. And as it relates to your question on duration to annual versus monthly and that's more pertinent to the self-serve business and primarily to our individual subscribers and there where we have seen some of this surge in demand. This increase in volumes over the past few months. A lot of that it has been monthly as people kind of rapidly acclimate to a remote work in distributed work environment. So we're keeping a close eye on that that It does change week to week.

[Operator:]

And our next question comes from the line of Heather Bellini with Goldman Sachs.

[Heather Bellini:]

I just want to follow up. You mentioned some of those encouraging top of funnel trends, which is great to see. Ajay, I just wanted to go back, it was probably two quarters ago and then you reiterated it again last quarter that that you expected these what we're net sub adds the roughly 70,000, you've added this quarter and the prior quarter and you had talked about it. The primary reason was just given the anniversary of the pricing increase. Is this something that we should assume is largely behind us at this point. And so when you're thinking about your guidance, you're thinking that some number influx a little bit higher or should we assume it stays the same and I guess the flip side would be just kind of any commentary around ARPU trends for 2Q? Thank you.

[Ajay Vashee:]

Sure. I will say like to start as it relates to some of the increase in top of funnel demand that is still very early in that a lot of those users are still on a trial phase. So, they haven't yet converted into paying user and so there is more that we'll learn more than our share there in future months and quarters. But as you noted on our Q3 '19 Earnings call, we did note that paying user growth will be slightly lower in subsequent quarters as a result of our Plus repricing and repackaging initiative and that's consistent with our expectations when we launched it and that initiative overall continues to be a tailwind to revenue and I would also note that profitably growing our total ARR base versus optimizing for a specific and that you can user number is our priority and where you will see us focus resourcing and commentary going forward. That being said, historically, the primary driver of revenue growth for us has been conversion volume. I mean the secondary driver has been ARPU expansion and that balance will persist for us going forward across this year and into the future. I think probably one data point I can share to give you a little bit more context and I shared a little bit about this last quarter, is that the output of our conversion engine continues to be very consistent that gross new conversion engine at a 1 million gross, you said users per quarter and those trends were consistent in Q1 as well.

[Operator:]

And our next question comes from the line of Sarah Hindlian with Macquarie.

[Sarah Hindlian:]

Thank you so much, Drew and Ajay. I just wanted to follow up on Alex's question at the start of the call. I think one of the things that I'm grappling with and I think others are as well is trying to just get a gauge as to how exposed you are to some of the major industry verticals that are particularly just shattered from COVID-19 right now and we're trying to just balance how much demand you're seeing from work from home and school from home, that's helping to offset that. So maybe a little bit more color on specific vertical exposure you have and then I have a follow-up for you. I think this one is really better for Drew, just thinking about the incredible conversion you're seeing with the desktop app. It's really impressive. And so what are you guys doing to drive the number of teams user is you're seeing up on the desktop apps so quickly?

[Drew Houston:]

Sure, I can speak of both. Yeah, I can speak to both very high level and Olivia please add to specific verticals. I mean, the first thing I'd say is we have a very - customers of all sizes are very diversified customer base, which I think is a strength for us and as I said before, a lot of sectors that are hardest hit are ones where you can't go back to work or were these demand command selling operated and especially and segments. I guess and knowledge workers and looks like to kind of a sweet spot. A lot of those folks can continue working and for them Dropbox continues to be an essential tool. So I think we're relatively less impacted than the typical company although given the macro environment. This is something we're be monitoring closely and we've shared what, what we see so far. And then the second, how we're driving conversion. We're helping people - migrate people from kind of the classic use of Dropbox and now getting in the file system to showing them that they can have much richer experience in the desktop and that would include both the Dropbox tray where we've got a lot of machine intelligence features, make a lot easier to access content that much - refine the content that you are looking for and then bringing a lot of the collaborative features into the core experience. So that historically when we were kind of just in the operating system, if I commented the file - you can commented on a file, you couldn't necessarily see that because that interfaces provided by the operating system and our new experience all of that is really built into the experience and if you want to - and more. So if you want to share something via Slack or use any number of our integrations, you can do that directly from the experience and the fact that we have a desktop app installed, we can upgrade that way, makes it a pretty seamless process and so we're always tuning how we introduce people on that experience, but we're happy with the progress of the rollout.

[Operator:]

And our next question comes from the line of Pat Walravens with JMP Securities.

[Dennis Mark:]

I am Dennis Mark for Pat. Thank you so much for taking my questions. So, you guys mentioned a little bit about the HelloSign strengths. I was wondering if you can give us little more whether the strength is coming from SMB or enterprise and would you expect the streams continue after COVID? Thank you.

[Drew Houston:]

I can start to high level and others chime in. Certainly - when you think about having to work from home, then you can see how you signature, the demand for e-signature goes up and we've seen, for example, number of signature request is up three times across HelloSign products so that and we've seen a spike - a similar spike in new trial starts for HelloSign as we have a core Dropbox products. And so we think it's very helpful for them of e-signature in general and then and I talked about the end user product also particle HelloWorks which is a document workflow product that for example lot of delivery services used onboard their drivers and delivery services. I guess you probably have been using HelloWorks for a long time, we had just started another major delivery platform and we've seen a bunch of COVID related use cases. So as I said, the lenders using HelloSign to help people process release out or loan applications. So I'd say it's been more on the and you decide, but we are actually seeing in the pipeline or we've been building pipeline thus.

[Olivia Nottebohm:]

Yes, just to add to that, we see increase in trials across customer segments. It's pretty consistent across the board, not surprisingly, obviously, given the new world that we're in, but it's nice to see the consistency of it.

[Operator:]

And we have time for one more question and that comes from the line of Zane Chrane with Bernstein Research.

[Zane Chrane:]

I commend you guys on really great transparency in your 10-K, you had some really helpful data on the quarterly ARR over the past couple of years and when I look at how much incremental ARR you added this quarter relative to the paid user adds, it seems to suggest you had a pretty substantial increase year-over-year in the effective average ARPU of the paid users you're adding. So it seems like there is couple of ways to interpret that. On one hand maybe you bringing in a lot more business customers at much higher prices and that's driving up the effective average ARPU of those about. On the other hand, you could have attrition of the lower value consumers coming out that's driving it up to the mix shift. How should we think about what's driving that and the relative difference between those two factors or is there something else, maybe I am missing that could be driving that effective ARPU higher on the about?

[Ajay Vashee:]

Yes, this is Ajay. It's a great question and observation. I think, reflective of our strategy of the company and that's to focus on the high-value conversion to drive profitable ARR growth and you're seeing that reflected in the metrics and in the numbers today. I think what you're alluding to is something that we disclosed at IPO called gross new ASP, which is effectively the ARPU for a new paying users, and we pretty methodically increased gross new ASP over the past two years and it was the highest that it's ever been in this past quarter and add meaningfully lead blended average ARPU. And so the new paying users that we're converting are tend to convert higher and higher rate every period to one of our premium plans. So it's one of our team, plans or to our premium individual plan, Dropbox Professional and sort of the tax rates increase for us every period. And then there's also a tailwind from some of the pricing and packaging changes that we've made over the past few quarters and years.

[Zane Chrane:]

Very helpful, very helpful. And just to follow up on that. Go ahead.

[Drew Houston:]

I was just going to add and I think both trends you - both of your hypotheses are true. I mean we're less focused on pure consumer use cases for less focused on legacy use cases like cloud storage, we're more focused on high-value use case. So that's a good measure of adding higher value customers and that's why we've been proportionately more focused on ARR in aggregate because we're trying to drive that mix shift intentionally.

[Zane Chrane:]

That's helpful. Just a quick follow-up. So should I interpret that to maybe mean that as the consumers come up smaller portion of the mix. You'll have enough new business customers coming in a higher prices that the year-over-year growth in net new ARR turns positive again?

[Drew Houston:]

So we don't guide to ARR. I would look to our revenue growth for our revenue guidance for a sense of the growth that we expect but certainly we're focused on driving some of those structural improvements to conversion volumes and the tailwinds that you see to ARPU are ones that we see persisting, both across the near and medium term. just given how much of how much headroom we have there between gross new ASP and ARPU and how much higher those new paying users are coming in on an ASP perspective.

[Operator:]

Thank you. I will now turn the call back over to CEO, Drew Houston for any further remarks.

[Drew Houston:]

All right, well thank you everyone for joining us. And I want to thank my team one more time for their heroic efforts in continuing to run the business under some pretty extreme conditions and taking care of our customers and we're really proud of the progress we've been making. And so we hope and for all of you we hope you're all hanging in there and staying safe and we'll see you next quarter. Thanks.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may now disconnect.