Dropbox, Inc.
Q3 2019 Earnings Call Transcript

Published: 7 Nov 2019

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for joining Dropbox’s Third Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. 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 to Darren Yip, Dropbox's Head of Investor Relations. Please go ahead.

[Darren Yip:]

Thank you. Good afternoon and welcome to Dropbox's third quarter 2019 earnings call. Today Dropbox will discuss the quarterly financial results that were distributed earlier. Statements on this call include forward-looking statements, including statements relating to the expected performance of our business, future financial results, strategy, long-term growth and overall future prospects. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those projected or implied during this call, in particular, those described in our risk factors included in our Form 10-Q for the quarter ended June 30, 2019 and the risk factors that will be included in our Form 10-Q for the quarter ended September 30, 2019. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today and we undertake no obligation to update them except as required by law. Our discussion today will include non-GAAP financial measures. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and may also be found in the supplemental investor materials posted on our Investor Relations website at investors.dropbox.com. I would now like to turn the call over to Dropbox's Co-Founder and Chief Executive Officer. Drew Houston. Drew?

[Drew Houston:]

Good afternoon, everyone, and welcome to our earnings call. On the call with me is Ajay Vashee, our Chief Financial Officer. And Yamini Rangan, our Chief Customer Officer, will also join us during Q&A. Today, I'll talk about our business and product highlights and the continued expansion of our ecosystem. Ajay will review our Q3 financial results, touch on our go-to-market strategy, and provide guidance for Q4. In Q3, we delivered strong results across our business. Revenue grew 19% year-over-year, driven by increases in both paying users and ARPU. We also drove robust margin expansion, despite some non-recurring expense headwinds as we continue to deliver a balance of growth and profitability. These results further demonstrate the strength of our global collaboration platform, our efficient go-to-market strategy, and our operational discipline. So, let's start with our product update where we continue to make a number of exciting announcements. As you may recall, in June, we unveiled the new Dropbox, a unified workspace to organize users content, connecting to their tools and bring everyone together wherever they are. This included in all-new desktop app that offers our users a foreground experience they never had with Dropbox before. And at our user conference in September, we took things a step further with the introduction of our new product category, the smart workspace and the launch of Dropbox Spaces. Dropbox Spaces transforms the traditional shared folder experience into connected workspace for all of your cloud content. It also uses machine intelligence to surface the work that's important to you when you need it, because we believe technology should be helping you focus, not distracting you. With Dropbox Spaces, users have new ways to access everything they need and stay organized in one place. Users can have all their cloud content including files in one place, so your Google Docs, Paper docs can live next to your PowerPoints and Photoshop files.

[Ajay Vashee:]

Thank you, Drew. Our Q3 results demonstrate our strong execution and focus on delivering a healthy balance of top-line growth and profitability. Total revenue for the quarter was up 19% year-over-year to $428 million, driven by an increase in total paying users and ARPU expansion. On a constant currency basis relative to the average rates across Q3 of 2018, year-over-year growth would have been 20%. We ended Q3 with 14 million paying users. ARPU was $123.15 in Q3, up 4% from $118.60 a year ago. The year-over-year ARPU expansion was primarily driven by strong adoption of our Premium, Professional and Advanced plans by new paying users as well as the repricing and repackaging of our Plus SKU. We remain focused on driving revenue growth by converting our highest value users to drive sustainable monetization and retention. Let me highlight a few ways we've been executing on this strategy. Last quarter we made improvements to our individual plans to help users work more efficiently. We announced a number of new product features across our Plus and Professional plans, and with the additions we made to our Plus plan, we raised the price of that SKU by approximately 20%. We're happy to announce that those enhancements are being well-received by our customers. Not only have we continued to drive healthy conversion volumes to our Plus plan, we've also managed to levels of retention above our expectations. While we do anticipate some impact to net new paying users over the next couple of quarters from this repricing and repackaging initiative, we expect it to be a strong tailwind to revenue.

[Drew Houston:]

Thank you, Ajay. We're creating work environment that helps people focus on what matters. Building the smart workspace is step one and there will be many more. I'm proud of our team's progress thus far with the launch of the new Dropbox and Dropbox Spaces and I'm excited about the early response from both customers and partners. On behalf of our management team, I'd like to take a moment to thank our customers, partners and the entire Dropbox team. We have a huge opportunity in front of us, and I'm really excited about the future. And with that, I'd like to invite Yamini, our Chief Customer Officer to join Ajay and me for Q&A. Operator?

[Operator:]

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

[Alex Zukin:]

Hey, guys. Congrats on a really strong quarter, and thanks for taking my questions. Maybe just first one for Ajay. Can you maybe talk about the ARR number for Q3, something you guys mentioned in Q2 at the Analyst Day? I was hoping to see if you can provide an update. And then, I've got a quick follow-up.

[Ajay Vashee:]

Sure. Thanks for the question, Alex. So, ARR as well as net revenue retention, our metrics that we are continuing to evaluate for ongoing disclosure. But, I can share that ARR grew to about $1.77 billion in Q3, that's up from $1.65 billion in Q2, as we disclosed at our Analyst Day, and then that growth being driven by similar trends to revenue, namely strength in paying user growth and ARPU expansion. And, at our Analyst Day in September, we also noted that net revenue retention had improved to the mid ‘90s, and that's also consistent with what we saw in Q3.

[Alex Zukin:]

And then, you guys -- I think, you mentioned a couple of items where you were able to raise prices, you're very happy with the dynamics around both user adds and revenue retention. And you made a comment around, you could see some maybe impact to user adds over the next few quarters, but also a tailwind to revenue. I was hoping to see if there was any quantification you can provide around that in terms of just from a modeling perspective how we should think about it going forward.

[Ajay Vashee:]

Sure. So, at a high level from a modeling perspective, I would kind of -- I would look to our revenue guidance for a sense of the growth that we expect to deliver in some of the implications for net new paying users, and for ARPU over the next quarter and for the year. But, to give a bit more color commentary on the repricing and repackaging initiative, more generally, as a quick reminder and as I mentioned during prepared remarks, earlier this year we announced a number of new product features really across our subscription plans with the additions we made to Plus, raised the price of SKU by about 20%. Overall, those changes are being received really well. And so, the features of our Plus plan are upgraded in June, existing subs began renewing at the higher price point in July, and that process will continue for the next few quarters really based on the annual cycle. The cycle, sorry, of our annual subscribers. But, overall, as you mentioned, Alex, initiative has been a very strong tailwind to revenue, and that's reflected in our revised guidance for the year. As it relates to paying users, we're seeing stable net retention across the business. So, our annualized net revenue retention has remained in the mid '90s, like I mentioned earlier and as we disclosed at our Analyst Day in September. Churn continues to trend lower than our expectations when we launched the initiative as we’ve really been able to manage the healthy retention rates. And then, we do expect slightly lower NMPU growth over the next couple of quarters as a result of that repricing and repackaging, consistent with our expectations when we launched the initiative. But overall, I would say strength across the board in terms of how our teams have executed against that opportunity.

[Operator:]

Thank you. Our next question comes from Mark Murphy with JP Morgan. Your line is now open.

[Mark Murphy:]

Thank you. Congrats on the upside and acceleration. A question for Drew or maybe Yamini, when you look at the user data that you have thus far for the new product Dropbox Spaces, do you see them engaging in the ways that you want to see it in order to increase your confidence that you'd be able to evolve from a background service to a foreground service? And if so, just what are you seeing in terms of that engagement?

[Drew Houston:]

Yes. Thanks for the question. So, we're really happy with how the launch has gone so far. So, we're about six weeks in post to making the new Dropbox and Dropbox Spaces generally available. and things are broadly in line with our expectations. So, millions of people have engaged with the new desktop app. And we are seeing increases in engagement with collaborative features, which are a big focus of our product changes. And so, that's something we're paying attention to, and continuing to drive. And then, as we've seen with other products or others of our products as we drive engagement, and particularly collaborative engagement then that helps drive monetization with -- a couple of examples. So, as a people link ecosystem apps or if they use Paper, they retain and up-sell at higher rates. So, we expect similar patterns with the new Dropbox.

[Mark Murphy:]

And as a quick follow-up, it is kind of remarkable that a good chunk of your users are starting to pay 20% more for Dropbox and yet you still added about 400,000 net paying users in the quarter, which is very consistent with prior. So, it doesn't appear that you saw incremental churn. Do you think that's telling us that the product is still actually under priced, or is it showing us that users are seeing value from the new desktop app and some of the other functionality you’ve added?

[Ajay Vashee:]

So, this is Ajay. I'm happy to answer that question. I think, at a high level, it shows that we're delivering a lot of value to our users, and it’s value that's resonating with them. And so, when we deliver value, we're able to generate value. I will say as it relates to churn, I made a comment earlier, certainly trending lower than our expectations when we launched the initiative, as we've been able to manage some really healthy retention rates. We do expect slightly lower paying user growth over the next couple of quarters as we work through that repricing and repackaging initiative. But at a high level, I think the value proposition that we brought to the market and brought to our users is resonating really well.

[Operator:]

Thank you. Our next question comes from Richard Davis with Canaccord. Your line is now open.

[Richard Davis:]

Hey, thanks. Maybe piggybacking on Mark’s question. I just wanted to drill down on this, because I’m pushing all of my companies on this topic. But, when you say driving engagement, how are you building out -- I mean, do you have a customer success team, are you hiring in that area, is it organic? Basically, I'm leaning on all my companies, do this say look, that's a really good way to generate incremental margins because it's super high margins. And if you can help people get most out of your software, because you've done a great job on that. What's your strategy on that side of the equation? Thanks.

[Drew Houston:]

Sure. Well, at a high level, it starts with our customers and the challenges they have. And when you think about the motivation for the new Dropbox to begin with, it came from seeing that our customers are certainly collaborating around files, but they are also collaborate around Google Docs and Dropbox Paper docs and all kinds of different cloud tools. And knowledge workers spend a lot of their day toggling back and forth between all these different things and it's really fragmented and distracting experience. And so, when it comes to driving engagement we give -- the purpose of the new Dropbox and Dropbox Spaces is to give people one workspace, one smart workspace where they can pull all these tools together and collaborate instead of having this shift across a bunch of different tools. So, being a more useful place, being more organized place to get work done, -- it creates opportunities for Dropbox to have just more of your share of attention at work and be open all day long and for people to be able to communicate, collaborate and coordinate their activities in a way that you just couldn’t do, when we were limited to the operating system. So, I think just the use case we've selected is one that all knowledge workers have. And so that's where that's kind of the foundation for the engagement. And then, the fact that we have this foreground experience means that we can -- there is a lot -- Dropboxes are more useful. And so, and we're certainly paying attention to making sure that we're doing everything -- we are really excited about the progress we made in terms of driving collaborative engagement and then as I said before, many of the other things that we want, including driving adoption, driving monetization follow from that.

[Operator:]

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

[Heather Bellini:]

Great. Thank you very much. I just had a couple of questions. One, I think you commented a few minutes ago, and my apologies if I didn't hear it correctly, that you expected slightly lower paid user growth over the next few quarters. I'm just wondering if you could share with us what's driving this, and what's the magnitude that you're thinking. I'm wondering about the anniversary of kind of the increase in monthly sub signings that you experienced in the March quarter last year. But, any color you could give us on that, the magnitude and why, would be helpful. And then, the other question would be related to 2020 top-line, and I know you're not giving guidance for 2020. But, in the past you guys have talked about being able to see the deceleration kind of stop and exiting being confident that you thought 2020 could be roughly in line with where you saw Q4 ‘19. I'm just wondering if you still feel that way. Thank you.

[Ajay Vashee:]

Sure. I'm happy to answer those questions, Heather. It's Ajay. I would say, as it relates to the Plus repricing and repackaging, I can reiterate a couple of the points that I made earlier. So, overall, initiative has been a very strong tailwind to revenue, reflected in our revised guidance for the year. As it relates to retention of churn, we're seeing stable net retention across the business, and our annualized net revenue retention rate and ARR has remained in the mid ‘90s. We gave that update at our Analyst Day in September and a lot of consistency against that rate today. And churn continues to trend lower than our expectations when we launched the initiative. There is always a modest uptake whenever you launch a repricing and repackaging initiative like this, like we saw with our grandfathering exercise a couple of years ago, but overall have been able to manage a very healthy retention rate higher than expectations. And so, we do expect slightly lower NMPU growth over the next couple of quarters. We don't formally guide to that metric, as a result of that Plus repricing and repackaging but a strong tailwind from revenue. But overall, a lot of consistency with the expectations we had when we launched the initiative and some upside that we're starting to see now that it's out there live with our customers. And as it relates to 2020 revenue, our thesis there, we have a very large opportunity ahead of us. We're doing a lot to unlock more and more of it through our investments in the new Dropbox and other products, our ecosystem, and then we continue to make data science investments in our conversion engine as well as through M&A like our acquisition of HelloSign earlier this year. Longer term, what I can say now ahead of February is that we will continue to be focused on delivering a healthy balance of growth and profitability, in line with the framework that we shared at our Analyst Day in September. So, we shared framework back then to kind of set expectations longer term, and we'll certainly have more detail to share when we issue formal guidance on our earnings call in a few months.

[Operator:]

Thank you. Our next question comes from Chris Eberle with Nomura Securities. Your line is now open.

[Charlie Rogers:]

Hey, everyone Charlie Rogers here on for Chris. In regards to billings, we showed a pretty nice acceleration this quarter along with revenue. Could you provide a little bit more color on the mix shift of annual versus monthly customers, given the price increases? Was this perhaps due to more user shifting to annual subs or just broad strength in the quarter?

[Ajay Vashee:]

Sure. This is Ajay. Great question. I would say more broadly speaking, it strengthened the quarter and success with our execution against the Plus repricing and repackaging initiative. We are seeing some customers elect to move to an annual billing cycle from a monthly billing cycle, but we're actually seeing slightly less of our overall customer and installed base electing that option right now, which is a tailwind to revenue actually. And so, that's driving a lot of the strength you're seeing in our guidance there. One thing I would kind of reiterate and something that we've said previously is that while billings are related to revenue growth for us and are not consistently predictive revenue for us, and so there can be various items in the quarter that can drive that billings growth rate higher or lower, but don't always correlate to revenue, and so things like the mix between monthly and annual, as you noted, as well as FX. So I just continue to look to our revenue guidance for a sense of the growth that we expect based on current visibility. And the last point and a quantification I can share on billings is that normalized for FX billings growth in Q3 would have been about 1 percentage point higher.

[Operator:]

Thank you. Our next question comes from Rishi Jaluria with D.A. Davidson. Your line is now open.

[Hannah Rudoff:]

Hi, guys. This is actually Hannah on for Rishi. Thank you for taking my questions. Just first one, I was wondering if you could talk about if you're noticing any difficulty in presenting the value proposition of the new Dropbox to customers who say already use Slack as their central hub for work. I know you mentioned Trivago as the company that already had Slack which has new Dropbox desktop app. But is there any broad feedback or pushback you've been seeing some customers?

[Drew Houston:]

No, not at all. In fact, these are complementary use cases in many ways, the fact that you can Slack someone from within the new Dropbox makes that whole experience more seamless. And importantly, we’re solving a complementary problem just -- which is that people, our customers need help organizing their working lives and organizing the content across all the different places where it lifts. And Dropbox is the only place that lets you work across both the Microsoft ecosystem and the G Suite ecosystem and all of these best of breed tools, which is a pretty different value prop and pretty even problem than Slack solves.

[Hannah Rudoff:]

And then, second question, could you just talk about what you're seeing in the macro environment, and if there's anything that's potentially worrisome to you, and is there any regions of particular strength you saw this quarter?

[Yamini Rangan:]

Yes. Thank you, Hannah, for the question. This is the Yamini. I'll take that. Yes. In terms of the macro climate, it is pretty consistent. We're not seeing any major shifts in the macro environment from an outbound sales as well as channel perspective. We are executing consistently across the multiple quarters, as well as in North America, EMEA and APJ. So, pretty consistent and no significant shifts that we are seeing from a macro perspective.

[Operator:]

Thank you. Our next question comes from Pat Walravens with JMP Securities. Your line is now open.

[Joey Marincek:]

Hi. This is Joey on for Pat. Thank you for taking our questions. So, first off, we are wondering how do you plan to navigate this space when these other collaboration tools like Slack, Quip and Microsoft teams all have a goal of being the place where work gets done.

[Drew Houston:]

Well, we're starting again from a different use case and customer need. Certainly, there are all kinds of different messaging apps and that those will be an important part of the collaborative experience, and users have a lot of choices there and we integrate with most of them. But, what our customers are turning to Dropbox for and they'll turn to us more and more over time is really to help organize your working life and organize your content. The new Dropbox is one of the biggest changes we ever made in product and until we launched it Dropbox only handled your files, but now we handle all cloud content and we have a much more engaging and collaborative experience. And we bring these communication tools closer to your content. And we don't see anyone -- even when you look at our traditional competitors like OneDrive or Google Drive, a lot of them are still operating off of the older model where you just have content and it's not as an engaging an experience.

[Joey Marincek:]

And then my follow-up question is, how the transition to selling HelloSign going? Thank you.

[Yamini Rangan:]

Yes. Ii has been -- I can take this part of the question. So, it has been six months since we started the acquisition and integration process. The integration process is going really smoothly. In Q3, we have all of our account executives in international locations, trained and selling HelloSign. So, now all of our account executives are qualifying positioning and closing. In fact, in the quarter, we saw some good wins in EMEA and we're beginning to see traction for HelloSign within our Dropbox customer base. From self-serve perspective, we have continued to drive a more frictionless buying experience for our common customers. So, if you are now a Dropbox customer and you use your credentials for billing, then you can use the same thing for purchasing HelloSign. We are also leveraging our data science teams to be able to identify high propensity users within our customer base that will eventually buy HelloSign, and that is also going well. Overall, also in the quarter, we made some pretty good product enhancements from a much better IT admin console as well as a deeper sales force integration. So, from an outbound execution, self-serve execution and product debt perspective, the integration is really going well. And we are pretty excited about this going forward.

[Operator:]

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

[Jason Ader:]

Yes. Thank you. I just want to make sure I understand your net paying users guidance. Churn from the repricing is better than your expectations. Do you expect to get it worse over the next couple of quarters, given your MPU guidance? And if so, why?

[Ajay Vashee:]

Yes. This is Ajay. Happy to take that question. Certainly not. We've been able to manage to healthy and stable our retention rates as part of our work on the Plus repricing and repackaging initiative. And we've seen really consistent trends since we went live with the initiative. We did close some larger deals this past quarter in Q3, which contributed to higher paying user growth in the period, and we're just guiding to what we have current visibility into with respect to that qualitative guidance for Q4 and Q1.

[Jason Ader:]

Got you. So, to be clear, you are not expecting churn to deteriorate over the next couple of quarters.

[Ajay Vashee:]

No. We've been very pleasantly surprised and successfully managed to high rates of retention as part of that initiative and that's continued since we went live.

[Operator:]

Thank you. Our next question comes from Justin Post with Bank of America Merrill Lynch. Your line is now open.

[Justin Post:]

A couple of questions, first, deferred revenues was up I think $23 million quarter-over-quarter, was that aided by some of the larger deals that you signed in the quarter. And second, Drew, just on bigger picture, the new Dropbox and Spaces, can you just help us understand how that's going to open up new sales opportunities over the next couple of years? Thank you.

[Ajay Vashee:]

Sure. I'll take the first part of the question. This is Ajay. So, I the growth in deferred revenue are partially aided by a larger deals that we closed in the quarter, which is a contributor to deferred revenue growth for us, period-to-period. But, a big driver there as well, a lot of the annual Plus subscribers working through their renewal process as part of that Plus repricing and repackaging.

[Drew Houston:]

And turning to the sales opportunities for the new Dropbox. I mean, the first thing is, we see this as a big expansion of our opportunity and ultimately our TAM, because our whole business today has been around, collaborating around files, but of course many, if not most teams today use a lot more tools than that. Right? Their content lives in all kinds of cloud tools. And the fact that the new Dropbox is the only solution that supports the Office ecosystem, G Suite and all the best of breed tools, is a big differentiator and we think is going to be a big long-term advantage for us because it's pretty hard to do that. And some of our traditional competitors as I said before, like OneDrive, they only allow you to interact with files, which we think over time will be a big limitation. So, we see it as a big driver of differentiation and we see the fact that way this foreground experience and this dedicated desktop app, means that we can -- we have all kinds of opportunities to increase engagement, increase collaborative engagement and then drive adopt -- drive viral adoption and monetization because we have so many more ways to show you all the Dropbox can do for you in context. So I mean there are all kinds of examples of this. But, even just the basics of getting set up in a team lot easier for us to make that a streamlined and smooth experience when we're not limited to the operating system or just a list of files or if I save on a contract. Now, we have a button that says send out for signature with HelloSign, these are promotional opportunities that just weren't available before. So, we think we have a lot of potential across all the major drivers of engagement and monetization.

[Operator:]

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Drew Houston for any further remarks.

[Drew Houston:]

Great. Well, thank you everyone for joining us today. We really appreciate your support and look forward to speaking with you again next quarter.

[Operator:]

This concludes our call. Thank you for joining us. You may now disconnect.