Q3 2020 Dropbox Inc Earnings Call
Ladies and gentlemen, today's composite scheduled to begin shortly please continue to standby. Thank you for your patience.
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Good afternoon, ladies and gentlemen, and thank you for joining Dropbox is third quarter, 20th 20 earnings Conference call. All participants will be in a listen only mode <unk>.
Should you need assistance. Please signal accomplished specialist that person to star T followed by zero.
After today's presentation there'll be an opportunity to ask questions.
Prospects.
Spoke to all of you on earnings call in February neither I, nor anyone else could imagine how the world would be up ended by the pandemic.
2020th certainly had its challenges.
But we also believe that the shifted distributed work means that our opportunity has never been bigger.
This year, our customers who relied on this 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.
For our employees the vast majority embraced this new reality and they've said that they didn't want to return to the way things were before they don't want to lose the flexibility and focus they've gained they don't want to go back to long commute.
But we also know that things aren't perfect I think we're all adjusting to sitting on zoom meetings, all day, getting bombarded with emails and notifications and we missed being in the office and bonding and collaborating with her coworkers.
David and team building for distributed teams.
I'm really excited about the shift for us and look forward to sharing more about how this will play out in our product strategy in the coming quarters.
I'm also happy to share our recent news that Timothy young our SVP and GM of core Dropbox has been promoted to president.
And he'll continue to report to me as part of my executive team.
At home and work.
Yeah.
As you May recall, we announced a number of new features in June, including Dropbox passwords vault and backup.
We also rolled out our new family plan.
Yeah.
As well as being ranked number one for each of adoption.
I'm working remotely adds to that challenge, creating roadblocks to efficient output.
The new creative tools add on makes large file transfer is secure and easy.
It uses workflows.
The new Dropbox App Center launched in Q2 is the place where our users can discover learn about install and connect apps, they're dropbox accounts.
Helping to create a more engaging and streamlined experience with our platform.
Users can find apps categorized by use cases, including communications marketing and design and project management and we're continuing to expand the number of available apps and simplifying the process for developers to connect their apps to dropbox.
We've also been focused on expanding and deepening our collaboration with our ecosystem of trusted partners.
And part of the strategy is to continue to improve integrations with apps used frequently together with dropbox such as him.
As part of zooms recent launches apps, we were excited to preview a deeper product integration that allows users to prepare for meetings and Warner in one organized place.
Our objectives of aiming to deliver operating margins between 28% to 30% an annual free cash flow of $1 billion in 2024.
These long term targets exemplifies some of the core tenants of our investment thesis, which I would summarize as follows.
As an organization, we are committed to and focused on consistently executing against the guidance that we give while also investing for continued revenue growth.
Driving annual improvements in operating margins.
Doubling free cash flow to $1 billion in 2024, representing a caterer of roughly 20% over this time horizon.
And thoughtfully allocating capital to organic initiatives M&A opportunities as exemplified by Hello sign a returning capital to shareholders through share repurchases.
As we work to achieve our stated long term targets, we plan to leverage our ability to generate cash by allocating a significant portion of our annual free cash flow to share repurchases on an ongoing basis with the intention of maintaining a spend levels that will at least offset solution.
And potentially reduce sure counts.
By our data team to best predict which paid offerings, where the best fit for existing basic users.
The model is used to segment hundreds of millions of users into various categories based on their likelihood to upgrade to either plus or business plans.
These initiatives have had encouraging early signs by improving trial conversion rates through specific prompts.
I want to now move onto some customer wins within our outbound go to market motion, where the team drove wins in a variety of sectors, including software telecom and retail among others.
We are excited to announce that TV Asahi, a leading Japanese media company and now a dropbox enterprise customer.
TV Asahi is migrating from an existing solution based on Dropbox is collaborative strengths excellent product and security performance.
Hundreds of their employees and production sales and business planning, we'll use dropbox enterprise as they prepare for the broadcast of the 2021 Olympic games.
We also continued to see strength in the education space as a globally ranked top research University in the UK is now a dropbox enterprise customer.
We partnered with this research leader to address their top initiatives to improve innovation amongst researchers and staff transform to a cloud first approach and consolidate legacy hardware solutions and costs.
Already identified by the university's researchers and industry peers as their research platform of choice drop.
Dropbox was evaluated and determined to be the best strategic partner to enable collaboration.
And finally, we expanded our relationship with a leading video game company.
The developer currently relies on Dropbox as part of their game development and due to the sheer size of the files. They are working on Dropbox was the best solution that provided away for 1500 developers to sink and access their content in a timely manner.
With that I'll now review the rest of the PNM, but before I do I want to note that unless otherwise indicated.
All income statement measures that follow our non-GAAP and excludes stock based compensation.
Amortization of purchased intangibles and certain expenses related to the acquisition of the low side.
Our non-GAAP net income also excludes net gains and losses on equity investments and includes the income tax effect of the aforementioned adjustments.
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 in the supplemental investor materials posted on our Investor Relations website.
Gross margin for the for the quarter was 80%, which was an increase of three percentage points compared to Q3 2019.
This improvement was driven by unit cost efficiency gains with our infrastructure hardware, including.
Including lower depreciation as a share of revenue.
Mm targets.
Net income for the quarter.
It was $110 million up from $56 million a year ago.
Diluted EPS was 26 cents per share based on 420 million diluted weighted average shares outstanding up from 13 per share in the third quarter of 2019.
Turning to our cash balance and cash flow. We ended Q3 with cash and short term investments of 122 $6 billion.
Cash flow from operations was $201 million in the quarter.
Capital expenditures were $14 million, yielding free cash flow of $187 million or 38% of revenue.
Excluding the headquarters spend net of taas of $3 million and the payout of Hello signed deal consideration hold back a $4 million.
Free cash flow would have been $194 million or 40% of revenue.
And Q3, we also added $42 million to our finance leased lines for data center equipment.
We expect additions to our finance leased lines can be approximately 8% of revenue in 2020.
Now, let's turn to guidance.
For the fourth quarter of 2021.
We expect revenue to be in the range of $497 million to $499 million.
On a constant currency basis, we estimate that revenue would be approximately $2 million lower.
Non-GAAP operating margin to be in the range of 22.
22, 5%.
And diluted weighted average shares outstanding to be in the range of 417 to 422 million shares.
Just on a trailing 30 day average share price.
For the full year 2020, we're raising our revenue guidance range, which was previously 1891 to 190 $1 billion too.
Two one 907.
Will depend on the outcome of negotiations with potential subtenant.
We estimate that this strategy may generate in excess of $800 million.
In cash flows over the course of these agreements.
Which predominantly range and duration between 13 and 15 years.
This enhances our ability to invest in growth initiatives reach.
Return capital to shareholders and achieve our long term targets.
This said as we do not expect to recover the full value of our lease obligations.
We will record a gap impairment charge and the range of $400 million to $450 million related to our right of us and other lease related assets.
The vast majority of this impairment charge will be recorded in the fourth quarter of 2020.
Though a portion may be incurred during the first half of 2021.
I would also note that we plan to exclude this impairment charge from our non-GAAP operating income and as such these charges have not been included in our operating margin guidance.
Next I wanted to highlight our approach to managing our capital.
Looking forward as we work to achieve our long term goals, we intend to allocated significant portion of our annual free cash flow to share repurchases on an ongoing basis.
With the intention of maintaining a spend level that will at least offset dilution and potentially reduce chair count.
In addition in the near term, we intend to increase the pace at which we we repurchase shares under our existing repurchase authorization.
With the potential to exhaust our current share repurchase authorization by the end of the first quarter of next year.
We believe that utilizing our capital in this way as efficient and we will ensure that we put the strength of our ability to generate cash to work.
Collectively our financial results and these future plans steps demonstrate our commitment to an execution against our investment thesis.
We will continue to invest in revenue growth improve our operating margins aim to deliver $1 billion, a free cash flow and 2024 and allocate capital to high ROI initiatives.
While it is early in the journey, we made good progress on these goals in this most recent quarter and we remain on the path of delivering against our long term targets.
With that I will turn it back to drew for his concluding thoughts.
Thank you Tim and thank you all for joining US today, we're all really excited about the road ahead and believe we're we're uniquely suited to help our users thrived during the transition to distribute to work.
So on behalf of our management team I'd like to just take a moment to think our customers partners and the entire drop box team.
With that I'd like to open up the call for Q&A.
Copper later.
Thank you to ask a question you would need to pass Dad, then one on your telephone to withdraw your question. Please pass the pound key.
Our first question comes from the line of Reecey Julia with da Davidson. Your line is now open.
Hi, This is Phillip Rigby on for Rishi, Thanks for taking the question.
Wanted to start with deep the deeper integrations with Kansas emails back in August now that's had a couple of months to settle in universities curious if you have any insights you can share from usage of Dropbox My school's on campus or just even more broadly what you've seen in terms of user adoption within education the full term.
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's space setting the University of Michigan.
Last quarter and a few other universities in the past. So I think <unk> is definitely part of our strategy and one of our long.
Long term initiatives to keep driving <unk> in the right direction.
Great. Thanks, and then.
[noise] R&D declining sequentially in the quarter can you talk a little bit more about the drivers there and just how are you thinking about hiring R&D in the near term.
Sure. So we continue to see strong efficiency in R&D and really across all of our opex categories I think thats.
Where you see are operating income continue to be strong.
We did increase operating income of 100% year over year.
Pending the quarter with 23% operating margins up 10 points your year unexpected delivered 20% not 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.
Great. Thank you so much.
Thank you. Our next question comes from the line of Mark Murphy, What J P. Morgan Your line is not open.
Oh. Thank you. This is a pendulum sedan for mark Thanks for being a question.
Uhm one on one product question for you I mean content is obviously in the center of the majority of the business processes. When you see some workflow capabilities and Hello sign in and some inside of paper, we have not seen a general purpose work for Jim from drop box that could go into automating business processes around content do you.
Think that's an area that drop box might venturing to at some point.
Sure Yeah. So certainly we've done a lot more moving into workflows in general.
And the way we focused 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 hello signs a great example.
There are a number of others dropbox transfer for.
For sending content and.
And so initially were 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 work flow automation tools, so the ability to get content in and out and drop boxes generally well supported by the work flow 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.
Understood.
And.
Tim one question for you.
Thanks for training the the long term goals, that's pretty exciting.
I think in the past you had mentioned.
Like to maintain kind of a double digit revenue growth rate as you progress towards.
Target is that is that still applicable and how are you thinking of that.
Coming from our voices user.
Do you think it will be more weighted towards.
Oh, that's horrible balanced.
Sure Great question, we will have more to share on our February call with me issue 2021 guidance as far as long term growth I can't 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 longterm margin trajectory of 28% to 30% and our cash flow target of 1 billion in 2024, compounding a free cash flow at a 20% CAGR over that time horizon. So we are extremely focused on <unk>.
<unk> against that long term model as far as the split between paying users.
<unk> <unk>, we don't formerly guide to either paying users or <unk>.
I I would look to our revenue guidance for the best reference point for our expectations and profitably growing our total IRR bases our goal.
As opposed to optimizing for paying users.
Or are historically.
Historically paying users heads has been the largest contributor to that growth and I guess I wouldn't see that changing materially.
Into the future.
Understood. Thank you so much.
Thank you. Our next question comes on the line of Brent sale with Jeffries. Your line is now open.
Hi, This is love soda on for Brentsville. Thank you again for the update.
I had a couple of questions one was around obviously, the new product initiatives.
Especially the to add on that you mentioned creative tools and data migration wanted to sort of see what kind of revenue opportunity. This would provide are are these.
Add ons that you're planning to monetize or any any additional details that would be helpful.
Yes. So it's both are these add ons are really about making the experience better for our larger customers. So migration, obviously, just using the onboarding process make it easier to get up and running on Dropbox.
And the creative tools focusing on.
The creative segments, So drop box is really <unk>.
Differentiated among users that.
Think about the creative audience, they use that 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 to simplify their workflows. So yes. We are plant. We these are add ons that were monetizing directly.
There certainly good.
Good examples our focus on really making the creative community successful and we've done other things in that area recently got a partnership with Adobe.
And and and.
And similar partnerships elsewhere so.
We are definitely focused on these kinds of communities, where dropbox is really differentiate it and we see a lot of opportunities more broadly to.
To have other add ons and cross sell opportunities.
Got it and maybe one quick one on the operating margins side, obviously is tour margins, but I guess could you contextualize how much of the benefit you solved with like one time versus how much a sustainable going forward.
And any indication on like what sales and marketing span will be for next quarter. Thank you.
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 increase 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 her head count costs being prudent with our spend particularly in light of Covid and improvement in our FX rates.
I wouldn't necessarily call call out any one time items, one matter that I did mentioned in my remarks was our brand campaign shifted to the fourth quarter. So a bit of a delta relative to the guidance, we gave lapsed last quarter as far as what drove some of that beat and so some of that is shifting into the fourth quarter.
Sure, but that's all factored into our guidance.
Perfect. Thank you.
Thank you. Our next question comes from the line of Pat Walraven Smith JMP Securities. Your line is now open.
Hi, This is mark on Pat. Thank you so much for taking my question. So I have two quick one if I may.
So one is just could you give us an update on Ah handle sign this quarter.
And to how are you thinking about uhm and then to add additional assumption that he used to take advantage of that work from home Chen.
Yep.
Yeah. Thanks for the question. So first Unhealth sign we continue to see strong demand I mean trial volumes in Q3 continued.
To be 45% above pre covid levels.
We've recently integrated Hello, <unk> more fully into the core dropbox product as well as I go to market efforts.
And then on the product itself for example in Q3, we made made Hello sign available and 21 additional languages for broader reach so the school so health and continues to be a big opportunity for us it's one of our fastest growing businesses.
We think it's still early innings.
For Hello, son, 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.
Building block as we've.
Grown the company and so.
We're always looking for.
Opportunities to accelerate innovation by adding to our team of product portfolio.
And are strong balance sheet free cashflow, we've got the firepower to pursue these opportunities.
With big user base in platform to help drive distribution.
So certainly on lookout for opportunities and will be disciplined with these investments.
Got it thank you so much.
Yep.
Thank you. Our next question comes from the line of Heather Bellini with Goldman Sachs. Your line is now open.
Great. Thanks, so much for taking the question most of mine have been answered true, but I I just wanted to ask a little bit about what you're seeing in terms of the funnel you guys talked a lot about you know kind of top top a funnel enhancement during the pandemic as a result of everyone switching to.
<unk> 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 just given the environment and kind of significant job losses everywhere. How are you how is gross churn trending versus.
Versus what you you would've been seeing call it pre pre the covid levels Nathan it's starting to show signs that it's actually get that first turn might be coming down a little bit. Thank you.
Sure it's a 10.
Covid demand surge that we experience was largely constrained to the second quarter.
And we're pleased to have converted and retained those users at levels consistent with historical trends.
There's all been factored into our guidance and as part of what's driving or raise.
In the third quarter trial starts we're closer to our historical norms.
And we do continue to see elevated trial starts in some of our premium skews and new products just to give a few examples professional is actually up 25% from pre covid levels as low sign is actually up 45% from pre covid levels, and we're seeing steady conversion and retention relative to historical.
Levels.
Uhm.
And then I guess, maybe to add a little bit on the churn front.
Not not metrics that we're updating quarterly but but to give you some color across the business turn continues to be stable and retention is within historical levels.
Yeah, <unk>, yeah, and I've just building on that.
Particularly with the Smbs that we have on our platform Dropbox is often essential to their business operations as opposed to discretionary because all businesses need to collaborate around content.
And knowledge workers in these kinds of knowledge workers can generally work from home and have been less disruptive.
Great. Thank you.
Thank you there are no further questions I would now like tend to call back to your C. E. L Drew house now for closing remarks.
Alright, well, we want to thank everyone for joining us.
I really appreciate your support and stay safe and we will talk to you next quarter.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.
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