Dropbox, Inc.
Q2 2020 Earnings Call Transcript

Published: 6 Aug 2020

[Operator:]

Good day, ladies and gentlemen. Thank you for joining Dropbox's Second Quarter 2020 Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox's website following this call. I will now hand the call over Lev Finkelstein, Dropbox's VP of Corporate Finance and Strategy. Please go ahead.

[Lev Finkelstein:]

Thank you. Good afternoon and welcome to Dropbox's second 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 and offering new product and features, our strategy as well as the ability of our key employees to execute our strategy, long-term growth and overall future prospects.

[Drew Houston:]

Thanks, Lev, and good afternoon, everyone. Welcome to our Q2 earnings call. On the call with me is Ajay Vashee, our Chief Financial Officer; and Olivia Nottebhom, our Chief Operating Officer, will also join us during Q&A. Similar to last quarter, 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. I'd like to start by thanking Ajay for all he has contributed to Dropbox over the last eight years. As you've likely seen, we've announced that he'll be leaving us this fall to spend more time with the family and then transition to a career in venture capital. When Ajay started Dropbox, the cloud collaboration market was still nascent and we were just getting started, and we had 100 employees. During his tenure, he has helped scale a new public company with a resilient profitable business model and nearly 3,000 employees all over the world. We're grateful for the strong foundation and incredible team he has established and we couldn't have gotten here without him. Ajay's leadership and investment in this team makes this a relatively seamless transition. On that note, I'm excited to welcome Tim Regan, our Chief Accounting Officer as our new CFO. In his last three years at the company, Tim has demonstrated exceptional leadership with the operational skill and discipline needed for his new role. Tim brings over two decades of experience at Dropbox.

[Ajay Vashee:]

Drew, thank you for all of your support and partnership over the past eight years. It's been an absolute pleasure working alongside you and the Dropbox team, and I'm going to miss every one of the company as I move on to my next endeavor. I'd also like to convey how excited I am to pass the reins to Tim. Tim was my first hire as CFO and couldn't be more prepared to help lead Dropbox through its next phase. Turning to the numbers, our Q2 results continue to demonstrate our strong execution and focus on delivering a healthy balance of top-line growth and profitability. Total revenue for the quarter was up 16% year-over-year to $467 million. On a constant currency basis, year-over-year growth would have been 18%. ARR for the quarter was $1.931 billion, an increase of $67 million quarter-over-quarter and an increase of 17% year-over-year. On a constant currency basis year-over-year ARR growth would have been 18%. We ended Q2 with 15 million paying users and ARPU with $126.88 in the period. Our continued growth in ARR reflects our strategy to methodically convert our highest value users to drive sustainable monetization and retention. We've also been focused on supporting our customers as they manage the transition to remote work and learning from small and large businesses to global universities. With that, let's touch on some of the go-to-market strategies, we implemented this past quarter. Over the last few months, our data science team has been experimenting with the HelloSign up-sell model that identifies which Dropbox customers are most likely to convert to a paying HelloSign subscriber. Based on file types, shared folder activity and certain engagement characteristics, the machine learning model aggregates a list of Dropbox users, who would benefit from HelloSign's e-signature capabilities. Armed with this context, our growth team surface the series of in-apps targeting prompts and notifications promoting HelloSign and its feature set. The initial experimentation period has been promising. Users identified by the model signed up for a HelloSign trial at a 50% higher rate relative to a control group. And with the recent HelloSign and Dropbox deep integration that Drew mentioned earlier, we are excited about the opportunity for us to continue cross selling HelloSign into our install base of over 600 million registered users.

[Drew Houston:]

Thank you, Ajay. At Dropbox, we're committed to helping our users do their best work during these unprecedented times and with our profitable self-serve business model and continued product innovation, we believe we're well positioned to tackle the opportunity. 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:]

Our first question comes from Alex Zukin with RBC Capital Markets. Your line is open.

[Alex Zukin:]

Thanks for taking my questions. And Ajay, it's been a pleasure working with you on these calls, you'll be missed.

[Ajay Vashee:]

Thank you, Alex.

[Alex Zukin:]

So maybe just two quick ones for me. Drew, when you think about the combination of headwinds and tailwinds brought from COVID on the business with respect to the SMB market, given the net add number, this quarter was the strongest you've had in some time. Is it fair to say that the - that has - that the tailwinds around the increasing need of your business and a strategic value proposition like - is it fair for us to think that that - you're now kind of starting to see an actual tailwind that could be durable? And I've got a quick follow-up.

[Drew Houston:]

Sure. Thanks, Alex. Yeah, as you saw measures like trial volumes continue to be elevated. I mean, some of the surge is tapered off since Q1, but in SMB certainly we see that our Dropboxers as has been turning to Dropbox for distributed work since the beginning of it continue to do that since COVID and we've seen elevated demand. And more broadly, we see big opportunities to improve the distributed work experience in general, we're addressing a universal need every knowledge worker needs and organize place for their content that works with all platforms. And even with the shift to COVID, I mean, Dropbox is like an essential part of business operation. So we've seen continued strength and resilience post COVID and we see a lot of opportunities to re-imagine distributed work experience going forward.

[Alex Zukin:]

Okay. And then maybe, just the quick follow-up is, how would you assess the health of the SMB market, maybe for Drew or Ajay? And then, last quarter you talked about seeing early signals in your kind of pipelines that were very positive, but you weren't ready to make the call whether that elevated pipeline is actually driving more deals or conversions. So now after a few months in COVID talked to both of those two things?

[Drew Houston:]

Sure. Well, I can start and Ajay can chime in. Well, I think, again, with SMBs we're mindful of the broader macroeconomic environment and what might happen in the second half. But in general, businesses that employee knowledge workers that can from home have been less receptive and again, Dropbox tends to be critical to - in SMBs operations, so it's not really a discretionary purchase. So we feel good on that front.

[Ajay Vashee:]

Yes, this is Ajay, just to jump in and maybe provide a little bit of commentary around some business metrics and trends, Alex, to help answer your question. The business has been resilient, our churn rate remain relatively stable from Q1 to Q2, that was the case last quarter as well as we noted on that call. And net revenue retention improved for us quarter-to-quarter and this is really because the majority of our subscribers or knowledge workers and we play an important role in managing the business-critical content for them, really more so now than ever. And as it relates to some of those tailwinds that we saw in Q2 to ARR and to paying users higher top of funnel demand, the demand that Drew talked to trial volumes did result in higher level of conversions to our paid plans. And then to the question you had on pipeline, we also closed some large outbound deals and university deployments in the period as well. And all that being said, just one note I would make on as we provide commentary on paying users. Our focus is on profitably growing our total ARR base, certainly versus optimizing for a specific number there quarter-to-quarter and so that will remain our priority going forward.

[Operator:]

Our next question comes from Mark Murphy with JPMorgan. Your line is open.

[Mark Murphy:]

Ajay, it's been great working with you and I wanted to wish you all the best in your...

[Ajay Vashee:]

Thank you.

[Mark Murphy:]

Future role. Yeah, absolutely. And congrats on a very nice quarter and strong guidance. I wanted to hone in on the ARR growth of 18% in constant currency. Again, nice to see the health and actually acceleration in the ARR growth. I know you touched on a couple of this, but I was curious if you could help us understand just to what extent - when we see that acceleration to what extent, could we tie it to the conversion of the remote works driven trials that Alex had asked you about, kind of, to what extent, were any of those outbound large deals kind of chunky that might have move that? And then, to what extent, could we maybe look at it and say that there's adoption of the new desktop app maybe factoring in?

[Ajay Vashee:]

Sure. It's really a combination of all of the above, Mark is answer and I can kind of break it apart for you. Starting with some of those COVID tailwinds and the work from home tailwinds. Drew mentioned across Q2 those trial volumes to both, our individual and team plans were up on average about 20% relative to pre-COVID levels and we began to see some of those conversions come through in Q2 and those conversion rates remained consistent with historical levels. And so that was part of the tailwind there. And then as it relates to HelloSign, usage of their e-signature products both their API product as well as our core e-signature solution were also up about 25%, Q2 to Q1. So that was also, this is tailwind, those were two of the tailwinds that helped us deliver at $67 million of sequential net UARR this past quarter. And we also had a number of growth initiatives and we're always working on cultivating that growth initiative pipeline, there's - there are things we launch every quarter. A handful of those initiatives were also successful and a tailwind to the business and our outbound team has reoriented really successfully from a team that was traveling more actively and one that's really been leveraging telesales and demand for our products has been strong. So they were able to convert a number of those opportunities. So it was a combination really, of all those factors that allowed us to accelerate that net UARR our growth on a year-over-year basis quarter-to-quarter.

[Mark Murphy:]

And Ajay, just since you mentioned that some of the new initiatives, I wanted to ask Drew, how are you thinking about maybe sizing the opportunity for Dropbox Passwords? And just how you're thinking about the ability to ring fence an encrypted data set that presumably, is pretty sensitive high value information and potentially it's something that would be targeted?

[Drew Houston:]

Sure. While we see Passwords as playing to a lot of our strengths around user trust and security and a lot of a huge investments we have made and continue to make there and it's a natural fit. And for things like Dropbox Vault, Dropbox Passwords, these are pretty universal workflows that our customers have and a lot what motivated us to build more focused solutions around them we're seeing that, one, a lot of customers were requesting Dropbox to do more in these areas. And then secondly, people are already kind of using Dropbox or storing this information in Dropbox and we see it - saw an opportunity to provide a more focused experience and then add value to our higher-tier plans. And so we think that these areas again play to our strengths and customers also want the ability to do this in a platform-agnostic across platform way. A lot of the other alternatives they might be using might be tied to one device one platform, but a lot of customers want to be at work on - work across their iPhone and their Windows PC. So it's another big strength of ours. And then I'd say more broadly when you look at these used cases and you look at post-COVID where the lines between home and work have blurred even more or about blurred as much as possible since we're literally working from home, we see one of the Dropbox's core strengths is supporting both work and personal used cases in a platform-agnostic way. And then while both of these features were introduced for your personal lives and the feature things like securing documents, managing passwords is also highly relevant at work. So we look at our personnel and work product portfolios and road maps is reinforcing one another.

[Operator:]

Our next question comes from Rishi Jaluria with DA Davidson. Your line is open.

[Rishi Jaluria:]

Ajay I'll echo my appears and thanks, been a pleasure working with you and best wishes for the next year again. Also wanted to extend my congratulations to Tim on the new role. I wanted to start first by talking about the Michigan deal, I mean, really impressive land. I wonder if you can give a little bit more color on that deal, especially because you are replacing a cloud competitor not in on-premise but to cloud motion presumably Michigan chose you over Microsoft and Google even though they've got long-standing relationships with both vendors. So maybe a little bit more color on that? And broadly, how are you thinking about the higher end opportunity, especially with so many universities going virtual this coming semester? And then I've got a follow-up.

[Olivia Nottebohm:]

Hi, Rishi. This is Olivia Nottebohm. I'll actually take this question and thank you for the question. We were excited to partner with the University of Michigan. It was cross campus deployment, meaning that it was both for their students as well as their faculty and for us that's something we're very proud of and we're partnering with them closely to build out what they need for remote education. And this is an area of focus for us. In fact, I hosted a education CIO forum this morning with a number of education CIOs and they are very much on their front foot, thinking about how does technology lead education going forward and it's nice to see that they're bringing us into the conversation and very much think of ourselves as a partner to them. Other education wins we've had was - were North Western, and University of Pennsylvania and Arizona State just to name a few. I think the other exciting part about this is that as the graduating classes of these educational institutions leave and graduate, they then take that Dropbox love with them. So it's an evergreen model where a quarter of the population is graduating and then, of course, being refilled as they come in. So we're excited about this business opportunity overall.

[Rishi Jaluria:]

And then, I guess, Ajay, I wanted to go a little bit more detail on the guidance for next quarter, specifically on the operating margin side. I mean, you're talking about operating margins declining sequentially pretty meaningfully. Just wanted to get a little more color on why it would be declining from Q2 to Q3 and what factors are driving that? Thanks.

[Ajay Vashee:]

Sure. It's a great question, it's really driven by timing of spend. And we made the decision to shift some marketing spend from Q2 to Q3. And I'll turn things over to Olivia in just a moment to provide a little bit more context on that and some campaign that we're going to be launching in the fall. But generally speaking, I will say, Rishi, that we are expecting to generate more efficiency this year. So this is the driver of us are raising our FY '20 operating margin guidance to 18% to 18.5%, that being up from the 17.5% to 18% last quarter. So structurally we are getting more and more efficient as a business. And I think, you can see, based on the results that we delivered in Q2, we've now executed to well within our prior long-term target range before we raised those targets earlier in this year. And so definitely, feel good about the profitability trajectory that we're on as a business. And I'll turn it over to Olivia to give a little bit more context on some of that marketing spend.

[Olivia Nottebohm:]

Right. So we ended up moving some marketing spend out into the early fall. We're going to be launching an awareness campaign to really drive knowledge about the Dropbox solutions for business and specifically for remote work. We're really excited for that, it will be both, a top of funnel awareness campaign, but then also, pulling those through, so that we are ensuring that we have conversion off of the investment that we're putting at the top of the funnel.

[Operator:]

Our next question comes from Heather Bellini with Goldman Sachs. Your line is open.

[Heather Bellini:]

And Ajay, best wishes. You will be missed. Thanks for everything over the years. I just wanted to ask a little bit about any trend you're seeing that are noteworthy in terms of quarterly versus annual pay?

[Ajay Vashee:]

Sure. This is Ajay. I can start and then Drew, feel free to chime in with any context that you have. I think for some of these larger more elevated cohorts that we've seen post-COVID as the world has shifted to a remote work and a remote learning mode, there has been higher demand for our monthly plans in those cohorts. And so that drove some of the variance that you might have seen quarter-to-quarter, the things like billings, absolute dollars of billings and billings growth rate. So there has been a mix shift there on it from a gross new paying user perspective. On an aggregate basis across our 15 million paying users, it takes a lot to move that. Overall ratio between annual and monthly, and so that hasn't changed a whole lot. But from a gross new paying user perspective quarter-to-quarter, we've seen a slightly higher uptake on kind of monthly relative to annual. That being said, we have seen a lot of stability with respect to retention. And as I mentioned earlier that churn for us was pretty stable from Q1 to Q2. Net revenue to group retention improved quarter-to-quarter. Again, that being because the vast majority of our paying users are knowledge workers and we're playing pretty important both for them in managing their content.

[Operator:]

Our next question comes from Brent Thill with Jefferies. Your line is open.

[Unidentified Analyst:]

This is in on for Brent Thill. First of all, Ajay best wishes to you. I had a couple of questions. One was on the HelloSign opportunity. I know you guys mentioned that you're cross-selling more have assign deals to Dropbox users. So, wanted to maybe, get some color on what the cross-sell opportunity is? How many - maybe, how many Dropbox users currently have HelloSign and what's the opportunity there? And then I'll have a follow-up as well.

[Drew Houston:]

Okay. I can start and Olivia, please chime in. But, yeah, as you noted, we continue to see strong demand for HelloSign and given COVID and the shift to remote work, obviously, a lot of elevated demand for e-signature. And we're really excited that HelloSign is now been fully integrated into Dropbox. So in Q2, we launched brand or improved experience where HelloSign is now natively embedded into the Dropbox product, so our users can easily send and sign and safely store their most important agreements in one seamless workflow without ever having to leave - without ever having to leave Dropbox. And it's one of our fastest growing businesses. So, definitely seeing elevated demand and a big opportunity there.

[Olivia Nottebohm:]

And then on the outbound side, we closed more than 20 deals where we had at least one of HelloSign's products bundled into the customer's Dropbox deployment. So, more and more we're seeing a demand for Combined Solutions on that front. I would also say, our model is very much organic, where we - the self-serve motion begins and kicks us off. And I'm really, really excited that every single Dropbox user right now can have three free e-signature is on HelloSign, right? So they can get that experience and enjoy that experience and then they have the opportunity to become a paid user. So there is part of this element that's great, because we don't even have to actively do the cross-sell, it's there for our own existing customers to see and use for themselves.

[Unidentified Analyst:]

Got it.

[Drew Houston:]

And even in Q2. I was just going to say even in Q2 usage of the e-signature solution and Hellosign API products increased by more than 25% versus Q1. So it's been good to see the sell-in that.

[Unidentified Analyst:]

And maybe, one quick follow-up on - it sounds like you guys are seeing some great tailwinds from work from home. I guess, as you look to 2021 and into the future, do you believe that these growth rates are sustainable going forward? And that's it from me. Thank you.

[Drew Houston:]

Sure. Well, for me, the big opportunity is again that we're addressing this universal need, right? The every knowledge worker needs an organized place for their content that works with all other platforms. And it's an is even bigger need now that we're working from home, post-COVID, because so many of us have office docs and Google docs and air tables scattered across a number of platforms and we don't see any of our competitors solving this problem. So in looking to 2020 or 2021, that's a big opportunity for us. And we're building Dropbox into an organizing layer for all your content that's platform agnostic and brings it all together. And second, moving higher in the stack and handling more of the workflows around your content and things like Passwords and what we've done with HelloSign are good examples of that. And I think, the shift to distributed work is a transformative opportunity, and as I said in my opening remarks, not unlike the shift to mobile or shift to the cloud. And we're in the first inning of that transformation. None of the tools, we are using our purpose-built for this environment. So - and I think we designed things pretty differently for the new world. So that's what we've been doing. We've reoriented our product roadmap around this and we'll have a bigger update in the second half, about our smart-work space.

[Ajay Vashee:]

And I would just add on that. And I think, it's a fantastic answer Drew, just add on a related note, we absolutely remain on a trajectory to achieve a long-term target that we outlined earlier this year. And so, we continue to be on a trajectory that deliver over $1 billion in annual free cash flow by 2024 and certainly, as it relates to next year, we'll have more to share when we issue guidance on our call in February.

[Operator:]

And our next question comes from with Citi. Your line is open.

[Unidentified Analyst:]

Hi, Dropbox team, thank you and I'm in for Walter Pritchard. A question on usage intensity. And it's really through the financial angle, because as I'm looking on - at the revenues year-over-year, you've increased your revenues call it, $66 million. And while you were keeping your cost of revenue were essentially flat year-over-year. So it doesn't really looks like you're rushing to install new servers or procure AWS capacity. So what can you tell us about your average engagement per user during COVID?

[Drew Houston:]

I can speak to engagement and Ajay can speak to financials. As I shared earlier, we've seen broad adoption across the board both the things like HelloSign and our new desktop app. So progress we made there. Adoption of the new desktop app and 450,000 Dropbox business teams that was up from 350,000 in the prior quarter and again weekly actives are up 50% quarter-to-quarter as well. So those are some of the measures we look at. And the new desktop apps also a new foundation for us to drive adoption of all of our new products across the board. And so, having the seamless experiences or having more surfaces allows us to have seamless integrations with HelloSign and all of our partnered products.

[Ajay Vashee:]

And I would just add to that on the gross margin front, we're always focused on bringing down our unit cost and driving incremental efficiency and we've done a good job of that over the past few quarters and the past few years. The things like our rollout of SMR technology as well as our new cold storage tier we're always innovating on that infrastructure layer both as it relates to the unit cost of storage, as well as compute and so that's helping us drive a lot of that year-over-year efficiency as utilization increases.

[Drew Houston:]

Actually, I would say, just engagement is important to us because we see customers who engage more or retail better have higher lifetime value and same thing for collaborative users, same thing for folks that use our integrations. So we are focused both on driving direct monetization by selling more high value plans and then indirect monetization just increasing retention and lifetime value.

[Unidentified Analyst:]

And then on the ARPU sequential increase, it was a little bit less than in prior quarters, to what extent did the trial convergence have an effect on that mix? And what can you tell us about how that is going to evolve going forward?

[Ajay Vashee:]

Sure, this is Ajay. I can take that question. I would say it was really higher demand for our products resulted in the acceleration of some larger scale deployments and conversions. It's a point that you just made. And so we talked about University of Michigan. There were other larger scale EDU departments that Olivia mentioned. And so certainly while all of those are a benefit to revenue, ARR and paying user growth and they underscore the value users are getting from our platform. Those were a modest headwind to ARPU for the period, will be a modest headwind ARPU for the year. And so it's really that outperformance on the paying user front that's driving that and the organic tailwind to ARPU continue to be very strong, so that those attach rates of new paying users to our premium and team plans that mix shift from individual to team over time and gross new ASP for us which is effectively the ARPU for new paying users that continues to meaningfully lead our blended average ARPU. So that runway for expansion remains.

[Operator:]

Our next question comes from Jason Ader with William Blair. Your line is open.

[Billy Fitzsimmons:]

This is Billy Fitzsimmons on for Jason Ader. One of the key data points you guys provided last quarter was around increased trials compared to pre-COVID levels and that's something that obviously continued into this quarter as well. And I start with that because one of the interesting announcements last quarter was around changes your mobile on-boarding flow to targeting users who more likely to convert. And you mentioned last - you mentioned this quarter that you're making changes to your loan that conversion engine as well. So I understand, it might be in the early side to provide any initial takeaways from some of those changes here mobile data driven conversion engine, but any first kind of kind of details or first thoughts that you've seen in the past couple of months and are there shifts in mobile customer close rates or customer feedback since implementing those changes? And I asked because though it's early I'd imagine changes in aggregate mobile conversions are good for future outlooks on conversions. Thank you.

[Ajay Vashee:]

Yes, I mean, we're focused on, certainly improving the mobile experience. And then just making the overall experience across all our surfaces more seamless. And the majority - I mean I'm one way we look at the opportunity is the majority of our users that work are still either free users or on individual subscriptions and so that represents a lot of that embedded value and is one of our biggest upsell opportunities. And other examples of streamlining and simplifying experiences are we want to help folks get into Dropbox business teams. So streamline we've made a lot of progress are things like streamlining the invitation process and onboarding process. And we've also continue to optimize our conversion engines - conversion engine to match users to higher value plans and so on. So we make steady progress on the number dimensions on that front.

[Operator:]

And our last question comes from Zane Chrane with Bernstein Research. Your line is open.

[Zane Chrane:]

Hi, team. Thanks for fitting me in. I just wanted to dig into that net dollar retention rate. The expansion quarter-over-quarter, is that primarily a function of the mix shift to more business customers with business customers growing faster than those on consumer plans? Or is the mix holding relatively steady and the increase was driven by kind of consistent renewal among your consumer plans with the expansion with your business users? Thanks.

[Ajay Vashee:]

Yes it's a great question, this is Ajay. Overall, we've seen those churn rate to gross retention rates remain relatively stable across the business and the expansion we've been able to drive their in net revenue retention twofold you touched on both of the factors. One is us continuing to drive expansion of existing Dropbox business teams, to teams adding more licenses their deployment. And we're also always driving a mix shift towards team. So every period we're converting more and more gross new licenses, as team deployments relative to individual. And so that mix shift over time is changing.

[Zane Chrane:]

And when should we expect the net dollar retention rate to across into the triple digit? It seem like that's really the inflection point where you could stabilize revenue growth and really accelerate the margin expansion.

[Ajay Vashee:]

Yes, we don't - so we don't provide formal guidance or report formally against net retention so we'll continue to provide color commentary, but certainly we've been pleased with the trajectory and trend that that metric has been on since our IPO and it has been improving pretty steadily. And so to the extent we have some milestones that we hit that it makes sense for us to share publicly, that's something that we'll certainly consider.

[Operator:]

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

[Drew Houston:]

Alright. Well, thanks again everyone for joining us this afternoon. We hope you are staying safe and healthy. And we look forward to speaking with you again next quarter.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.