Dropbox, Inc.
Q3 2020 Earnings Call Transcript

Published: 5 Nov 2020

[Operator:]

Good afternoon, ladies and gentlemen, and thank you for joining Dropbox's Third Quarter 2020 Earnings Conference Call. . 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 turn the call over to Rob Bradley, Head of Investor Relations for Dropbox. Mr. Bradley, please go ahead.

[Rob Bradley:]

Thank you, and good afternoon, and welcome to Dropbox's Third 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 our expectations regarding anticipated benefits to our business and the impact to our financial results and business operations, including estimated impairment charges and subleasing income as a result of our shift to a Virtual First work model; our expectations regarding remote work trends, related market opportunities and our ability to capitalize on those opportunities; operational efficiencies we may achieve as a result of changes to our organizational structure; expected performance of our business; our capital allocation plans, including expected timing and volume of share repurchases; future M&A opportunities and other investments; future financial results, including our goals and expectations regarding future revenue growth, profitability and our ability to generate and sustain positive free cash flow; our ability to extend our platform by developing and offering new products or features and through strategic partnerships; our strategy as well as the ability of our key employees to execute our strategy; and overall future prospects.

[Andrew Houston:]

Thanks, Rob. Good afternoon, everyone, and welcome to our Q3 2020 earnings call. Joining me today is Tim Regan, our long-time Chief Accounting Officer and newly appointed Chief Financial Officer. I'm excited to have Tim in this critical role and to have him join me today. I'll start by walking through some of the key elements of the third quarter, and then Tim will share the details of our financial performance and update our outlook for the remainder of the year. Before jumping into the quarter, I'd like to quickly reflect on 2020 as we approach the end of the year. In many ways, this was a critical year for Dropbox. And when I spoke to all of you on our earnings call in February, neither I nor anyone else could have imagined how the world would be upended by the pandemic. 2020 has certainly had its challenges. But we also believe that the shift to distributed work means that our opportunity has never been bigger. This year, our customers relied on us more than ever to help them with the transition to distributed work, and we were fortunate to have the building blocks in place to be resilient in the current environment. We continue to be focused on the commitments we made in February towards our long-term model, driving operational efficiency and generating value for our shareholders. This quarter, I'm happy to share some of the progress we've made.

[Timothy Regan:]

Thank you, Drew. I'm excited to join today with this being my first earnings call as the CFO of Dropbox. As many of you know, I've been with the company for many years, formerly as Chief Accounting Officer, and have helped scale the finance organization as we develop the longer-term financial targets that we shared during our earnings call in February. In particular, our objectives of aiming to deliver operating margins between 28% to 30% and annual free cash flow of $1 billion in 2024, these long-term targets exemplify some of the core tenets of our investment thesis, which I would summarize as follows

[Andrew Houston:]

Thank you, Tim, and thank you all for joining us today. We're all really excited about the road ahead and believe we're uniquely suited to help our users thrive during the transition to distributed work. So 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 the line of Rishi Jaluria with D.A. Davidson.

[Philip Rigby:]

This is Philip Rigby on for Rishi. I wanted to start with deeper integrations with Canvas that you announced back in August. Now that, that's had a couple of months to settle in universities, curious if you have any insights you can share from usage of Dropbox by schools on Canvas? Or just even more broadly, what you've seen in terms of user adoption within education in the fall term?

[Timothy Regan:]

Sure. This is Tim. I can start on that. So to your point, we did add an integration with Canvas. We also added one with Blackboard recently, and we've seen great traction with our EDU space, adding The University of Michigan last quarter and a few other universities in the past. So I think EDU is definitely part of our strategy and one of our long-term initiatives to keep driving ARR in the right direction.

[Philip Rigby:]

Great. And then on R&D declining sequentially in the quarter, can you talk a little bit more about the drivers there? And just how you're thinking about hiring in R&D in the near term?

[Timothy Regan:]

Sure. So we continue to see strong efficiency in R&D and really across all of our OpEx categories. And I think that's where you see our operating income continued to be strong. We did increase operating income 100% year-over-year, ending the quarter with 23% operating margin, up 10 points year-over-year and expect to deliver 20% margin for the year. Within R&D, we're seeing efficiency as far as our personnel spend, and we continue to expect that throughout the rest of the year.

[Operator:]

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

[Pinjalim Bora:]

This is Pinjalim sitting in for Mark. Drew, one product question for you. I mean, content is obviously in the center of majority of the business processes. While we have seen some workflow capabilities in HelloSign and some inside of Paper, we have not seen a general-purpose workflow engine from Dropbox that could go into automating business processes around content. Do you think that's an area that Dropbox might venture into at some point?

[Andrew Houston:]

Sure. Yes. So certainly, we've done a lot more moving into workflows in general. And the way we focus on that is really from an end user self-serve perspective and just thinking about what those key workflows are around content and expanding into them. So HelloSign is a great example. There are a number of others, Dropbox Transfer for sending content. And so initially, we're focused on just addressing these workflows directly that are adjacent to the content. But you're right. I think more broadly, content -- or there's all kinds of workflows that revolve around content. We address those through our ecosystem integrations. We partner with a lot of the horizontal workflow automation tools to drive the ability to get content in and out of Dropbox is generally well supported by the workflow automation tools. And more broadly, just expanding into a lot of our customers' key workflows around content continues to be a big focus for us.

[Pinjalim Bora:]

Understood. And on to -- Tim, one question for you. Thanks for reiterating the long-term goals, that's pretty exciting. But I think in the past, you have mentioned that you would like to maintain kind of a double-digit revenue growth rate as you progress towards the long-term target. Is that still applicable? And how are you thinking of that growth coming from ARPU versus user growth? Do you think it will be more weighted towards ARPU versus user growth or more balanced?

[Timothy Regan:]

Sure. Great question. We will have more to share on our February call, when we issue 2021 guidance as far as long-term growth. I can say that we are investing for double-digit revenue growth. And perhaps more on the profitability front, even with conservative revenue growth rates, we have confidence in our long-term margin trajectory of 28% to 30%, and our cash flow target of $1 billion in 2024, compounding -- free cash flow at a 20% CAGR over that time horizon. So we are extremely focused on executing against that long-term model. As far as the split between paying users and ARPU, we don't formally guide to either paying users or ARPU. I'd look to our revenue guidance for the best reference point for our expectations and profitably. Growing our total ARR base is our goal as opposed to optimizing for paying users or ARPU. Historically, paying users has been the largest contributor to that growth. And I guess, I wouldn't see that changing materially into the future.

[Operator:]

Our next question comes from the line of Brent Thill with Jefferies.

[Luv Sodha:]

This is Luv Sodha on for Brent Thill. I had a couple questions. One was around, obviously, the new product initiatives, especially the two add-ons that you mentioned, Creative Tools and Data Migration. Wanted to sort of see what kind of revenue opportunity this would provide. Are these add-ons that you're planning to monetize? Or any additional details there would be helpful.

[Andrew Houston:]

Yes. So both of these add-ons are really about making the experience better for our larger customers. So Migration, obviously, is easing the onboarding process, making easier to get up and running on Dropbox. And the Creative Tools focusing on the creative segment. So Dropbox is really differentiated among users that -- or you think about the creative audience, they work with a lot of large files, a lot of the creative suites and the fact that we handle large files well is really important to them, and we see a lot of opportunities to simplify their workflows. So yes, we are -- these are add-ons that we're monetizing directly. They're certainly good examples of our focus on really making the creative community successful, and we've done other things in that area recently. We got a partnership with Adobe and other -- and similar partnerships elsewhere. So we're definitely focused on these kinds of communities where Dropbox is really differentiated, and we see a lot of opportunities more broadly to have other add-ons and cross-sell opportunities.

[Luv Sodha:]

Got it. And maybe one quick one on the operating margin side. Obviously, historic margins, but I guess, could you contextualize how much of the benefit you saw was like onetime versus how much is sustainable going forward? And any indication on like what sales and marketing spend will be for next quarter?

[Timothy Regan:]

Sure. So again, we're extremely focused on executing against our long-term model, which targets 28% to 30% operating margin. And as noted, operating margin increased to 100% year-over-year. As far as the drivers in the third quarter, key drivers were higher revenue; increasing our operational efficiency with respect to headcount costs; being prudent with our spend, particularly in light of COVID; and improvement in our FX rates. I wouldn't necessarily call out any onetime items. One matter that I did mention in my remarks was our brand campaign shifted to the fourth quarter, so a bit of a delta relative to the guidance we gave last quarter as far as what drove some of that beat. And so some of that is shifting into the fourth quarter, but that's all factored into our guidance.

[Operator:]

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

[Mark Chen:]

This is Mark on for Pat. So I have two quick ones, if I may. So one is just could you give us an update on HelloSign this quarter. And two, how are you thinking about M&A to add additional functionalities to take advantage of the work-from-home trend?

[Andrew Houston:]

Yes. Thanks for the question. So first, on HelloSign, we continue to see strong demand. I mean, trial volumes in Q3 continued to be 45% above pre-COVID levels. We've recently integrated HelloSign more fully into the Core Dropbox product as well as our go-to-market efforts. And then on the product itself, for example, in Q3, we made HelloSign available in 21 additional languages for broader reach. So this could -- so HelloSign continues to be a big opportunity for us. It's one of our fastest-growing businesses. We think it's still early innings for HelloSign. And then more broadly, with M&A, we're always on the lookout for great opportunities there. I mean M&A has been a really important building block as we've grown the company. And so we're always looking for opportunities to accelerate innovation by adding to our team or product portfolio. And our strong balance sheet, free cash flow, we got the firepower to pursue these opportunities with a big user base and platform to help drive distribution. So certainly, on look out for opportunities, and we'll be disciplined with these investments.

[Operator:]

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

[Heather Bellini:]

Great. Most of mine have been answered, Drew, but I just wanted to ask a little bit about what you're seeing in terms of the funnel. You guys talked a lot about kind of top-of-funnel enhancement during the pandemic as a result of everyone switching to working remotely. So I was wondering if you could just give us an update on kind of how those conversions are progressing versus your plans. And then also, obviously, just given the environment and kind of significant job losses everywhere, how are you -- how is gross churn trending versus what you would have been seeing, call it, pre the COVID levels? And is it starting to show signs, but it's actually -- that gross churn might be coming down a little bit?

[Timothy Regan:]

Sure. This is Tim. The COVID demand surge that we experienced was largely constrained to the second quarter, and we're pleased to have converted and retained those users at levels consistent with historical trends. This has all been factored into our guidance and is part of what's driving our raise. In the third quarter, trial starts were closer to our historical norms. And we do continue to see elevated trial starts in some of our premium SKUs and new products. Just to give a few examples. Professional is actually up 25% from pre-COVID levels, and HelloSign is actually up 45%, from pre-COVID levels. And we're seeing steady conversion and retention relative to historical levels. And then, I guess, maybe to add a little bit on the churn front, not metrics that we're updating quarterly. But to give you some color, across the business, churn continues to be stable, and retention is within historical levels.

[Andrew Houston:]

Yes. And just building on that, particularly with the SMBs that we have on our platform, I mean, Dropbox is often essential to their business operations as opposed to discretionary because all businesses need to collaborate around content, and knowledge workers -- and these kind of knowledge workers can generally work from home and they've been less disruptive.

[Operator:]

There are no further questions. I would now like to turn the call back to your CEO, Drew Houston, for closing remarks.

[Andrew Houston:]

All right. Well, want to thank everyone for joining us, really appreciate your support, and stay safe, and we'll talk to you next quarter.

[Operator:]

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