Dropbox, Inc. (DBX) Presents at 45th NASDAQ Investor Conference (Transcript)

Dropbox, Inc. (NASDAQ:DBX) 45th NASDAQ Investor Conference Call December 2, 2021 12:30 PM ET

Company Participants

Tim Regan - CFO

Conference Call Participants

Joshua Baer - Morgan Stanley

Joshua Baer

Hi. I'm Josh Beer, a Software Research Analyst at Morgan Stanley. I'm pleased to host the CFO of Dropbox, Tim Regan today.

Before we get started, for important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. Also for investors, if you submit questions, I'll receive them through e-mail. And if we have a few minutes at the end, we'll try to address those.

But Tim, welcome, and thank you for joining us today.

Tim Regan

Thanks, Josh. Great to be here.

Question-and-Answer Session

Q - Joshua Baer

Awesome. So I want to start high level. I mean, I think everyone's familiar with Dropbox. But perhaps not completely up to speed on some of how the company has evolved over the years from -- starting in 2007 more as a file sync and share to where we are today. So if you could help us kind of walk through how the company got to today and also touch on the vision for the future. That would be a great starting point.

Tim Regan

Sure. Happy to do that. And as a reminder, we went public in 2018. And today, we have over $2 billion in ARR and over 700 million registered users. And over time, we've evolved from a place to keep your files in sync to a place to keep teams in sync.

And in the past couple of years, we've made a number of steps to position ourselves for long-term success. So maybe I'll cover this by briefly touching on our product, people and financial strategy. And our vision is to create one organized place for all your content and the workflows around it.

So this starts with being a trusted home for content, where Dropbox stores over 550 billion pieces of content for our users. And this core content capability is foundational for us. And we continue to evolve and improve this file, sync and share experience for our customers. And now we are layering in additional workflows or more verbs for how users can engage with their content.

So again, we started with store, sync and share. And we've added password protect and watermark and scan. And we've added transfer, where you can transfer large files up to 100 gigabytes. And we just recently introduced very early-stage capabilities, such as capture, which is a video communication tool that helps users share their work in ideas; replay, which is a lightweight video editing tool; and shop, a platform that enables creators to share and monetize digital content and store it on Dropbox. So again, we're offering more verbs for how users can engage with their content.

And then we're also investing in additional workflows through acquisitions like HelloSign, which is an e-signature company; and DocSend, which is a secure document sharing and analytics product to help expand on our offerings. And all of these capabilities give our users more ways to use and engage with their content. So that's a bit on the product side.

Now turning to our people strategy. Last year, we reorganized our teams under a president structure led by Timothy Young, and that brings together our engineering, product, design and go-to-market teams all under his leadership. And this has really helped increase our product release velocity and driven a lot more alignment across those teams.

And then we've shifted to a virtual-first work model, where our employees would do individual work remotely, and collaboration work will be done in our offices. So this has allowed us to hire outside our main hubs, outside of the Bay Area, New York, Seattle, really accelerating our shift to lower-cost locations.

And then finally, on our financial strategy. We continue to focus on balancing growth and profitability in a thoughtful, disciplined way. We've beaten and raised our guidance throughout the year, and we now expect more than 12% revenue growth year-over-year. That's up from 10%, which is where we started the year. And we're committed to our long-term goals of $1 billion in free cash flow annually by 2024 and our operating margin targets of 28% to 30%.

Remember, allocating a significant portion of our annual free cash flow towards share repurchases with the goal of reducing our share count. So hopefully, this gives a bit of a sense of where we're heading across our product, people and financial strategies, but obviously, happy to elaborate.

Joshua Baer

Excellent. That was great and a lot to unpack that we'll cover in this discussion, I wanted to stick high level and ask one on just COVID and some of the changes that we've seen as far as shifts across the world and within technology and thinking about hybrid work, distributed work. How does Dropbox fit into this new world?

Tim Regan

Yeah. It's a great question. We believe the pandemic fundamentally changed the way we work, and one thing Drew likes to say is that we've moved from working primarily out of physical offices to working primarily in digital screens. And we think Dropbox is well positioned to help people stay organized and get work done in this new environment.

And specifically, the pandemic accelerated a few areas of our business that were already in place. And we've seen a rise in solopreneurs and freelancers starting their own businesses, where our professional SKU has been growing 30% year-over-year. And this SKU gives these users the tools they need to run their small businesses.

And then our eSignature solution, HelloSign, also saw us spike in growth as people shift away from signing documents using pen and paper and now using electronic signatures. And we're seeing new ways that customers are behaving, where we've pivoted our product road map to adapt to these new trends. So for example, we've seen an explosion in the creation and sharing of rich media and videos, and over 3.4 billion videos were added by customers to Dropbox in the first half of 2021. And video is now our most shared content type, and so this is where we've introduced new products, such as capture and replay, to give our users capabilities that allow them to do more with that video content.

Joshua Baer

That's great. And with all these changes in mind in the world, how has that changed the competitive environment over the last 18 months?

Tim Regan

Sure. Dropbox has always operated in a competitive landscape. And we continue to win because users value our ease of use, our reliable performance, our open ecosystem and our collaboration capabilities.

And in particular, we're a neutral platform that supports integrations with virtually any tool that users want to use while other companies may take more of a walled garden approach.

So we've been successful within this competitive environment as evidenced by our large and growing user base. And then compared to some of the newer productivity apps, one advantage we have is our scale and our ability to leverage data science to see what customers are doing now, which allows us to add functionality they need.

And so this is where I touched on people starting their own businesses and where we continue to see this translate to success with our Pro SKU. And we also just launched Shop, Dropbox Shop, to help people monetize the digital content they may be creating with their new businesses.

So we think that companies that are large enough to glean trends from their customers and that are nimble enough to pivot their product road maps to adapt to these trends are certainly going to have an advantage.

Joshua Baer

Great. You touched on some of this sort of creator type of customer. Just wanted some broader context around business mix, the customers that you serve. How should investors think about personal use versus professional and SMB versus enterprise and the go-to-markets for those?

Tim Regan

Sure. Let me try to break down the various cuts of our business, so maybe I'll start with self-serve versus our outbound or sales rep motion. So we have a very efficient go-to-market motion with 90% of our revenue coming from our self-serve business. So these customers come directly to Dropbox, sign up to a monthly or annual plan, primarily at our list price with minimal sales involvement. And the remaining 10% represents our managed sales motion, our outbound team, which consists of our sales reps that are focused on new business and renewals as well as our channel partners.

And our outbound team applies the traditional land-and-expand approach, where they monitor pockets of usage of Dropbox within a given organization and then work with an IT decision maker to really expand that deployment. So that's a bit on our self-serve versus our outbound motion.

And then I'll talk a little bit about our customer mix as far as SMBs versus enterprises, where we do have customers of all sizes, but Dropbox has traditionally seen strength in the lower mid-market and with solo peers, particularly freelancers and creatives. And we do serve enterprise customers, but that's not our primary focus. Again, we go back to that land-and-expand motion.

And then our user mix. The mix between the individuals and teams has remained fairly consistent with the majority of our users still being individuals, although growth in teams continues to trend well, and we have over 550,000 paying teams now on the platform.

And maybe one last point I'll make is the use case for Dropbox, where many of our users tend to start with Dropbox in their personal lines and then they bring that familiarity of our products into their work life, where today 80% of our users actually use Dropbox for work. So Dropbox is a bit unique actually in that people use Dropbox both for personal and for work use cases, and we continue to offer products that meet both personal and work use functionality.

Joshua Baer

That makes sense. And so with that in mind, the background on the customer mix and some of the use cases, I think revenue growth is a big debate on the stock. And so where is the growth coming from? And what is the growth outlook looking forward? And what kind of investments do you need to make to achieve that level of growth?

Tim Regan

Sure. It's a great question. When we are getting quite a bit, and I think it's the right question to be asking. And we're certainly encouraged with the execution we've seen this year. And as a reminder, we've now raised our 2021 revenue guidance to more than 12% year-over-year growth, which is more than 2 points above the guidance that we gave at the beginning of the year. And we remain focused on investing for sustainable long-term growth.

So we're investing in hiring and marketing to drive that future revenue growth, and we'll continue to explore inorganic opportunities as well. And when thinking about growth, it's important to think about the different aspects of our business. We have a large core business that we continue to invest in to make our products easy and intuitive to use.

So for example, mobile where over half of our free users are now coming from. So we're working on improving the user experience, which is driving better conversion and retention of these customers. Then on teams, we're making it easier to invite team members to our standard and advanced plans, which is helping to drive team expansion. Professionals to you, I touched on a little bit. That continues to outperform, still up 30% year-over-year.

And we launched -- last year in November, we launched our family plan, which is also doing well. And we have our growth businesses, such as HelloSign and DocSend, which do represent our fastest-growing businesses and where we continue to integrate them more and more into our core platform. And then we have these nascent bets, like our new product experiences, which we just launched, such as Shop, Capture and Replay and Command E, which we just acquired, where these are early-stage initiatives and have longer-term horizons.

So overall, we're building out this diverse product portfolio and set of initiatives to drive growth, but we aren't overly reliant on any one particular initiative. We certainly plan to be disciplined with these investments, making sure we add more capital to what's working and also pull back where we're not seeing the right early signals so we can redeploy as needed. So we will certainly share much more when we give 2022 guidance in February.

Joshua Baer

Excellent. I wanted to follow up on 2 areas that you mentioned just to see if there's anything else to add. On the large free user base, I think you touched on some strategies for monetization. Just wanted to see if there's any additional commentary on the strategies for monetization there. And then on the professional SKU and all the traction that the team has been talking about, just wondering what are the key features or the key use cases that are really driving that level of conversion.

Tim Regan

Sure. So let me start on the free user base. So we have over 700 million registered users, of which about 16.5 million are paying users. And our scale is a huge advantage for us, and we see it as a big opportunity to drive upsell and conversion. And we've got many paths to monetization, whether it's through additional features and functionality, new SKUs or through traditional pay walls.

Let me go a little deeper on one of these angles. One of them is mobile, where one way we're improving the platform is by just simply improving the mobile experience. And so using data insights, we know that most of our mobile users say that their primary reason for downloading Dropbox is for sharing content, and so we really worked to make the sharing experience as easy and intuitive as possible.

And so now when you're in Dropbox, you'll see a blue sharing button on nearly every screen on our mobile app. And in Q3, we continue to iterate on this, reducing the number of steps for non-Dropbox users to view and download content, and this drove an increase in sharing and engagement and more sign-ups of more of our mobile basic users. And this is driving conversion, this is driving retention. So mobile is a key focal point for us.

And then we also have, as far as monetization of our fee-based pay walls is another big lever that we have. So on that traditional pay wall front, we recently did redesign our upgrade pages to now highlight our family plan to users as they approach their storage pay walls. So now rather than just showing them Plus, we also offer them our family plan to help users land in the SKU that may best serve their needs. So as a result, we saw an uplift in the family plan conversions.

And then again, we're building out this diverse product portfolio, where we can cross-sell and upsell new products to our customer base, for instance, HelloSign and DocSend. So all of those can be leveraged to drive monetization, and we'll continue to optimize those levers.

And then I know you asked about our Pro SKU, where we're certainly seeing continued momentum in that SKU, which in some ways does get back to that macro trend that we talked about a little bit as far as people are starting their own businesses during the pandemic, where a majority of our Pro users are in the design, service and education industries

. In many cases, they're running their own businesses or these freelancers selling creative services to our outside clients, and so they're enjoying certain features within this SKU that really help them collaborate and share and send work. They upload and share larger files and folders at a higher frequency than our Plus users, where our Pro SKU provides the ability to transfer large files up to 100 gigabytes per transfer. It provides more storage, gives security features like password protections, which is important to these very small businesses.

And it provides additional analytical insights into the content that we shared so I can understand who is viewing what content for how much time. So again, those insights are helpful.

And then another thing that we're also doing is really simplifying the onboarding experience and getting customers into our Pro SKU to really understand how the product can serve them. And so we've now made the Pro plan much more prominent on our website and easier to use for our new customers. So when a user is considering purchasing a Pro plan, we do this multiple choice quiz that identifies the primary tasks needed to be done so we can better match them with Pro's most relevant functionality.

And this has led to improved trial conversions as we're doing a better job showing these users the most pertinent functionality based on their primary needs as they onboard. So this helps them quickly become more familiar with the product right when they start using it, and that helps with conversion, and that ultimately also helps with retention.

Joshua Baer

Great. Wanted to ask another on retention, which you just mentioned, like it's something that we've been hearing a lot about the last few quarters, improving retention and reduced churn. And so just wondering if there's more levers to pull to continue driving churn lower.

Tim Regan

Sure. It's a key focus area for us. It's a big potential driver of our growth and our long-term health of our business. And we do have a very large and growing ARR base, where a stable churn rate does mean a larger and larger absolute dollar amount in churn to overcome. So again, a big opportunity in focal point for us to improve our retention dynamics, where this last quarter, we did see churn improve both sequentially and year-over-year.

And in particular, we've enhanced this mobile functionality, which we've talked about a little bit, where we've made key user engagement actions such as sharing more simple and intuitive. And we've improved things like upload speeds, which also have led to higher app store ratings and customer satisfaction. And all of that is translating to our mobile users retaining at higher rates.

And then we saw improvements in retention with our larger customers through changes we did make to our outbound sales team, where we've now more than doubled the number of sales reps that are specifically focused on team's renewals. And again, this is where it's easier to keep an existing customer than attract a new one. And so we've pivoted and shifted our outbound team to place this higher level of emphasis on our existing customers to make sure they understand how the product can best serve their needs, stay in touch with them as they're coming up on their renewal cycle and make sure they decide to continue to choose Dropbox. And so all these changes are certainly helping to drive improvements in retention.

Joshua Baer

Great. Definitely a lot of vectors of growth. And do want to ask about one more before shifting on to M&A and margins and capital allocation, and that's pricing, inflation, definitely a big theme this year. And so hoping you can give some color just around Dropbox's pricing strategy. And with all of these new features and functionality that you've introduced into the platform, is raising prices an option for you?

Tim Regan

Sure, sure. So pricing is not baked into our 2021 guidance, but it is a tool in our toolkit, which we've used in the past. And exactly to your point, we tend to only raise prices when we've added sufficient functionality to warrant a price increase. We're -- of course, we're mindful of also of competition and potential retention implications.

So in our last significant price increase was on our individual Plus plan back in 2019, where we actually were very pleased that the vast majority of users stayed with us despite the prior increase. And conversely, we have not done a team's pricing increase in a long time, so that's something we are mindful of in considering as a potential option for us.

But we do realize that we have a very loyal user base, and we plan to build pricing power over time by doing exactly what we talked about, by driving more value to these users with more functionality around their most important workflows.

Maybe one last consideration is the potential packaging of our solutions into bundles or offering products as potential add-ons where we will continue to experiment to find the optimal pricing and packaging approach, right? So as we're building out this diverse product portfolio and as we can potentially offer Dropbox, plus HelloSign, plus DocSend, plus Capture or plus Replay, all these diverse product portfolio offerings, how do we price and package them as bundles or as different packages, I think that's something that's certainly in our opportunity set.

Joshua Baer

Great. That's interesting and very clear. You mentioned HelloSign a few times, an acquisition from a couple of years ago; and DocSend; and more recently, Command E. I wanted to ask on M&A and these assets, how we should think about the opportunity for some of these businesses, how do they fit into Dropbox. And more broadly, if you could touch on the M&A strategy.

Tim Regan

Yeah, sure. So DocSend and HelloSign, these are certainly good examples of the types of businesses we're interested in. We certainly look for companies that are complementary to our core product offering as far as having a natural adjacency. So really what is our strength, which is our strength in content, having that 550 billion pieces of content. So we look for compliments to that strength, first and foremost.

And then we look for go-to-market fits as having -- as far as having a similar self-serve nature and those that can be used by a number of small businesses and individuals.

And then cultural and financial fit, obviously, is important as well, and both DocSend and HelloSign are businesses that are growing fast and certainly excited about integrating them further into our business.

And we also did just purchase a small universal search company called Command E, which is a small tuck-in deal. And these are the types of deals that will help us accelerate our product road map towards our long-term vision of creating that one organized place for your content and the workflows around it.

So M&A will continue to be an important part of our growth strategy. We do have a strong balance sheet that enables us to pursue M&A, but we will remain disciplined as it relates to valuations. We know valuations are challenging in this environment right now, so we will remain disciplined on the M&A front.

Joshua Baer

Got it. Another theme currently around supply chain. And so I just wanted to ask, given your large technology infrastructure, has the supply chain been an issue for you? And if you could talk to that in the context of CapEx and data centers and your strategy there.

Tim Regan

Sure, sure. Good question. This has not had a material impact on us to date. And to your point, as a reminder, we do have our own internal storage infrastructure, where our infrastructure team has done a great job of staying ahead of these issues and has been proactive in ensuring minimal disruption to our operations.

And we've got great relationships with our external partners who continue to prioritize our needs. And where necessary, we have implemented advanced purchase strategies for certain components, and we'll continue to keep a close eye on the supply chain pressures to be sure we do remain ahead.

As far as our overall strategy, we typically lease our infrastructure equipment, and we expect our additions to finance lease line this year to be approximately 6% of revenue. And then our cash CapEx does tend to relate to our office equipment and build-outs, so this spend has certainly declined in recent times just given the shift to virtual first that I touched on earlier. And we expect roughly $35 million or so in cash CapEx this year.

Joshua Baer

Thinking about the data center and CapEx and your own technology infrastructure, are there areas that you're driving efficiency? If you could just kind of touch on gross margins in the context of margin framework and if there's leverage on that line.

Tim Regan

Sure. And again, the team has done a fantastic job on this front. We're eclipsing 80% gross margins, so it's actually a bit north of our long-term target. And some of the ways that they're doing this is by really being on the forefront of adopting newer technologies. One of them is this shingled magnetic recording technology, which reduces data storage density, and we're about 80-plus percent of the rollout of that technology throughout our storage infrastructure. So that's been a catalyst behind our growth and gross margins.

We've also introduced a cold storage layer, where data or content that is accessed less frequently by our users. We shift down to this cold storage layer, which requires less storage cost to support.

And then we're also shifting to lower cost locations, where our data centers primarily were in the Bay Area in the past, and we're shifting that out to lower cost locations, which obviously also helps with gross margins. So the team's done a great job of driving gross margins in the right direction, and we'll continue to strive to carry that forward.

Joshua Baer

Great. And thinking more broadly on your long-term margins and your free cash flow targets, you definitely demonstrated significant progress towards those. How should investors be thinking about the targets today?

Tim Regan

Sure. So we've made great progress on profitability this year, where we're now guiding to approximately 29.5% operating margins for 2021, and that's up 8 points year-over-year. But we don't expect profitability growth of this magnitude every year, particularly as we aim to drive that sustainable revenue growth.

So we are maintaining our long-term operating margin target of 28% to 30%. And we plan to invest in sustainable growth, including hiring to support product and R&D initiatives and specifically growth areas, such as DocSend and HelloSign.

We've also been investing in some marketing campaigns to drive brand and product awareness. And then as a reminder, we did have some tailwinds this year around T&E and certain facilities costs. And once we're through the pandemic, these costs may pick up a bit.

And then perhaps on the free cash flow side, we did generate $221 million in free cash flow in the third quarter, and that was a record for us, and we're guiding to $715 million in free cash flow this year. That's more than a $200 million increase over last year, certainly demonstrates again the strength of our business model. And so certainly pleased with the progress we've made.

But here as well, we have some work left to do to get to our $1 billion target by 2024, and that's where I go back to we're going to need to invest in growth initiatives. We're working through some post-pandemic cost headwinds, and we need to continue to execute against this virtual-first subleasing strategy that we talked about a little bit at the start. So certainly too early for us to increase our long-term targets right now, but we will look at these at least annually and update necessary.

Joshua Baer

Great. We have a couple of minutes, I want to round it out with a couple of questions on capital allocation. First, just listening to -- you mentioned R&D investments and then we also had the conversation on M&A, just wondering how you think about the buy versus build decision as far as some of the innovation and investments.

Tim Regan

Sure. I think this is where we continue to have a strong balance sheet that gives us the opportunity to do both. So we have the opportunity to do organic investment and inorganic investment. And this is where it's quite a partnership with Timothy and his team to understand what are those inorganic opportunities that could complement our product roadmap; that could be a go-to-market fit.

And then our fairly valued in the market given the valuations today, and is that the right path? Or can we get there with organic investment. And it's a consistent balance between understanding where we're going with our product road map and what is the right approach between organic and inorganic, and so that's something we'll continue to monitor and make the right capital allocation decision.

Joshua Baer

Okay. Great. And the last question, speaking of valuations, just wondering some of the color on your share buyback program. And at today's levels, would you consider being more aggressive with the buybacks?

Tim Regan

Sure. So for context, in February this year, our Board authorized a $1 billion share repurchase program. And as of the end of the third quarter, we still have $640 million or so remaining on this authorization. So our buyback is governed by a 10b5-1 plan, which is set to buy more at lower levels.

So under the plan's governance, we actually are buying more at today's levels than a few months ago as the plan allows just given where our stock is trading today. So we will continue to allocate a significant portion of our annual free cash flow towards share repurchases, and our goal is to reduce our total share count as we execute against this plan. So this is certainly another way we're leveraging the strength of our business model to generate value for our shareholders.

Joshua Baer

Great. We're out of time. Tim, thank you so much for the insights. This was a great conversation. Really appreciate it.

Tim Regan

I appreciate it, Josh and NASDAQ. And thanks, everybody for attending.