Q3 2021 Dropbox Inc Earnings Call
Good afternoon, ladies and gentlemen, and thank you for joining Dropbox. His third quarter of 2021 earnings Conference call. All participants are in a listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero after today's presentation there'll be an opportunity.
D 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 website. Following the call I will now turn it over to.
Kern co poor Dropbox as head of Investor Relations Mister co poor. Please go ahead.
Thank you and good afternoon, and welcome to drop box in the third quarter of 2021 earnings call.
They drop box will discuss quarterly financial results that were distributed earlier statements.
Statements on this call include forward looking statements, including future financial results, including your goals and expectations regarding future revenue growth profitability, and our ability to generate and sustain positive free cash flow.
Our expectations regarding remote work trends related market opportunities and our ability to capitalize on those opportunities our expectations regarding anticipated impact to Ah transfer results, including estimated impairment charges and sub leasing income as a result of our ship to virtual first work model or capital allocation plans, including X.
Correct, the timing and volume of share repurchases Petra, how many opportunities and other investments the potential.
[noise] amendment to our San Francisco lease and potential, resulting financial impact as well as the potential closing of her previously announced acquisition our ability to drive user growth upgrades and retention by enhancing our products developing in offering new products or features and through acquisitions and our strategy overall future performance and prospects and ability.
D to achieve our business schools and generate shareholder value.
Saturday of evolving the core dropbox experience to meet the growing needs of freelancers small teams and mobile users while investing in adjacent workflows to help our customers do Martha contact.
We're well on our way to achieving our long term vision of creating one organized place for your content and all the work plus around it.
Before I walked through highlights from the quarter I Wanna share some context around why we believe this vision matters in today's world.
As we share before the pandemic accelerated many trends already in play for us like digital transformation and the rise of the creator economy.
But at the highest level when the most consequential changes was that 2020th was the year, where knowledge workers globally and probably most of US on this call moved from working primarily in physical offices to working primarily and digital screens and we believe this is a permanent shift.
And justice, we're relying on them. The most these digital screens have become even more chaotic and overwhelming.
Over the last several years work is extended into the browser and across the sea of web based productivity apps.
What used to be 100 icons on your desktop are now 100 tabs in your browser.
The shifter remote work shine a spotlight on this problem and it's clear that we need a solution that organizes everything more than ever.
Drop box has long been the place where so many of our customers, whether they're creative teams or freelancers and small businesses do their most important work.
Helping them organize their digital lives has always been a focus area for us.
So it's natural that now we're focused on solving the 2021 version of the problem. We saw it back in 2007.
As we iterate on our product roadmap and execute against the current strategy. We're also building a foundation for this long term vision and I'm excited to share more about our progress here.
Now turning to the quarter.
As a reminder, our first strategic priority from earlier this year was to evolve the core dropbox offering and strengthen our foundation for long term growth.
We've been executing against us priority in two ways first by focusing on her most passionate customers that use dropbox for work such as freelancers, So openers and small business teams.
And second by improving the mobile experience, where nearly half of new users begin their dropbox journey.
For all these users whether basic or paid we're focused on delivering more intuitive experiences and driving optimizations around sharing onboarding and reliability.
As for sharing so we're confident these enhancements will continue to be a driver of higher conversion and retention among our users who subscribe to the mobile channel.
All of these improvements in the core Dropbox offerings serve as an important foundation for our product roadmap and vision of building one organized place for your content and all the workflows around it.
Next I'd like to highlight the new product experiences we introduced in Q3 to better address decision.
For the majority of our customers they use dropbox for work a common completely here as they have trouble finding and accessing the information they need to do their work.
And while people can store their content in a growing number of different cloud platforms. What they need most is one place that keeps their content organized so they can spend more time on their work.
We view advanced organization functionality as a competitive advantage in delivering this to users will help drive both retention and conversion.
This week, we introduced a number of new features for teams around helping users automatically organize our content and we also acquired a universal cloud search company, which I'll cover later on.
Simple easy to use functionality has always been core to our product philosophy. So we focused on adding automation capabilities that our users can easily implement to better organize their uploaded content and find it quickly.
We pared human input with machine learning capabilities. So that our users are always in control.
With our new automated folders users can customize automated tests around their files, such as converting categorizing sorting our tagging.
Multi file organized allows users to categorize it in multiple files at the same time based on dates keywords or other criteria.
And with a user defined naming conventions dropbox saves users time by automatically updating filenames and format types.
Organizing files and folders as a critical first step to helping our customers do more with our content.
And then the last year, we've seen this work involved beyond the traditional office docs as there's been an explosion in the creation of rich media like videos and pdfs on our platform.
These are the fastest growing types of content on dropbox with videos being the most common type of file shared on the platform followed by Pdfs.
Nearly 50 billion pdfs were added or modified on dropbox over the last year alone.
To address these growing workflows, we've been investing in complementary workflows, such as DOCSIS, <unk>, which remain our fastest growing businesses.
Send out for outperformed our expectations for the second straight quarter and we're focused on building on this from mentioned by.
By investing in improving the user experience and adding new functionality into adjacent workflows beyond fundraising docks and continues to see the increases in both usage and retention.
It's simple you I and how it streamlines existing workflows since their video files are already on drop box.
Replays also integrated with the number of video editing solutions like Adobe premiere Pro and we're excited to build out replace feature set towards G E and 2022.
We also introduced Dropbox capture which enables distributed teams to continue to create communicate synchronously too short video clips, reducing the need for meetings and long emails and Dropbox shop, which offers freelancers and creators of seamless way to sell the digital content already stored and drop box.
Well. These are all in very early stages, we're really excited about our ability to introduce new capabilities to help our customers do more of a concept.
And just last week, we took another important step towards our long term vision as we entered into a definitive agreement to acquire command D. A universal search and productivity company.
As I shared my opening remarks, the content and information we need to do our work is distributed across files folders apps and other productivity tools, making it even harder for teams to stay organized.
And that's the browser and web based apps become even more central to Knowledgeware. We believe our recent acquisition of command D will be a competitive differentiator come.
<unk> has built powerful functionality that makes everything you need in the cloud across your desktop and the browser immediately accessible from one universal search bar.
And the product and team or a great fit for Dropbox, we share a user focus design philosophy and the belief in maintaining an open ecosystem. So users can easily access all the tools they need to do their work.
We expect to be able to close in queue for and not to have any material impact on on 20 toilet guidance.
And while it will take some time to integrate come into your into Dropbox. This acquisition is an important step towards that vision upgrading one organize place for your content and workflows around it.
It is also a great a great example of our ability to leverage our healthy balance sheet. So identify early stage technology that can ultimately bring more longterm value to our customers.
And finally, we remain focused on driving operational excellence by being thoughtful and disciplined with how we grow our business.
On the technology side, we continue to increase our adoption of SM, our infrastructure bit of advantage of storage efficiency, particularly at a time when there are shortages in the supply chain.
Net new paying users in the quarter.
Given by strength in teams and the continued self serve adoption of our family plan.
Average revenue per paying user was $133.79 in Q3.
Before I turn to the P&L I'd like to highlight some of our go to market progress in the quarter.
As a reminder, our go to market strategies involve both our self serve motion as well as our outbound sales motion.
As Joe discussed we saw better than expected expansion in our self serve teams skus as.
As a result of making it more seamless for teams to invite additional members.
We prompted users with suggested invites right after the shared content with a potential team member.
Driving an increase in invites and net licenses for team.
We also saw improved retention and our outbound business as a result of the change in strategy. We made earlier this year.
Where are we more than doubled the number of sales reps that are fully dedicated to customer renewals.
And once again, we saw momentum in our pro SKU that's drew highlighted.
Professional grew by about 30% year over year, driven by the ongoing adoption by freelancers and creators.
We continue to help our pro users understand those are the solutions that we offer by enhancing our on boarding pass to match their most common use cases with pros most pertinent functionality.
As a result, we saw improved trial conversion as our users developed a stronger appreciation of how pro users helped them get their work done.
Finally, we continue to see a healthy contribution to our net new paying users from our family plan.
During the quarter, we redesigned our upgrade pages to better highlight our family plan to basic users that were near or above their storage quotas.
Thus driving an uplift in conversion.
Before we continue with further discussion of our P&L I would like to note.
That unless otherwise indicated all income statement measures mentioned our non-GAAP.
And exclude stock based compensation amortization of purchased intangibles.
Certain acquisition related expenses.
Impairments of our real estate assets and expenses related to a reduction in force.
Our non-GAAP net income also excludes net gains and losses on equity investments.
And includes the income tax effect of the aforementioned adjustments.
I'd also like to provide a brief update on our real estate strategy.
Where we are taking steps to D cost, our real estate portfolio as part of our transition to a virtual first model.
We continue to make progress against our goals executing sub leases in Austin.
Seattle and Ireland this past quarter.
As a result, we incurred no additional impairment and our previous expectations.
Of up to $450 million in total impairment charges remain unchanged.
In addition, we are in discussions with our San Francisco landlord to pay roughly $32 million to buy out a portion of our lease where we have an existing subtenant.
If executed this would generate a long term financial gain as we expect our savings on future rent payments avoided it would exceed the amounts we would otherwise generate from the sublease by roughly $50 million.
Thus this would be an efficient use of our capital and this would aid our ability to achieve our $1 billion of free cash flow target by 2024.
In addition, executing this buyout would free us from the operational obligation to service this space.
We expect to execute this arrangement in the fourth quarter. This year and therefore factored this into our guidance, which I'll touch on shortly.
In the future we may enter into similar buyouts with their landlords should the economics makes sense for us.
So there are no other pending deals at this time.
With that let's continue with the P&L.
Operating margin of 29% or six percentage point improvement compared to the third quarter of 2020.
Net income for the third quarter, it was $147 million, which is a 33% improvement over the third quarter of 2020.
Diluted EPS with 37 cents per share based on 398 million diluted weighted average shares outstanding up from 26 cents per share.
For the third quarter of 2020.
Moving on to a cash balance in cash flow.
We ended the quarter with cash and short term investments of $1.929 billion.
Cash flow from operations was $231 million in the third quarter and capital expenditures with $10 million during the quarter.
This resulted in record quarterly free cash flow of $221 billion.
Compared to $187 billion in Q3 of 2020.
And the third quarter, we also added $44 million to our finance leases for data center equipment.
Let's turn to our share repurchase activity.
As I previously mentioned, we intend to leverage our share repurchase program to not only returned capital to our shareholders, but to also reduce our share count.
$730 million.
To be approximately $715 million.
This includes cash outflows comprised of 30 $32 million for the lease buyout.
$16 million for the <unk> 2021 installments of deal consideration holdback related to our acquisition of the low side.
And one time severance payments of approximately $14 million related to a reduction in force, which occurred in the first quarter.
We now expect capital expenditures for 2020, one to be approximately $35 million net of tenant improvement allowances as we complete our investments in our lease space in order to optimize their potential sublease income.
We we continue to expect additions to our finance lease lines to be approximately 6% of revenue in 2021.
Finally, we are maintaining our expectation for 2021 diluted weighted average shares outstanding to be in the range of 397 to 402 million shares.
Lastly, let me share some thoughts on our long term operating margin and free cash flow targets were.
We are on track to take a sizable step forward this year unprofitability outperforming our expectations.
Okay today.
I'm incredibly proud of our third quarter results and excited about the opportunity to ahead of us.
I believe dropbox as well positioned as our customers continue to look for technologies that help them adapt to the rapidly evolving work environment.
We remain focused on executing against of 2021 strategic priorities are longterm financial goals and further solidifying our position as to Goto solution for distributed work and.
And with that I'd like to open up the call for Q&A.
<unk>.
Thank you if you would like to ask a question press star one on your telephone to withdraw your question press. The pound key our first question comes from Richy each of Lauria with our B C. Your line is open.
Wonderful. Thank thank you guys for for taking my question is nice to see can can you solid resolved at first I wanted to touch with your I'm on a comment you made in your prepared remarks, which is <unk> regarding supply chain issue. So no I understand obviously you have much more efficient infrastructure apartment with with S. M I'll, probably get some of the other investments you.
Made so maybe a little bit more insulated, but can you talk a little bit about you know how does this impact some of your future Capex plans and and at what point does the supply chain issues out there start to become a worry and then I've got a follow up.
Sure well I can start and thanks for she and Tim feel free to add on so I mean, as you'd imagine where we were obviously keeping an eye a close eye on shortages and the type of supply chain. It's something our team has been out in front of her and for instructor team has done an excellent job in securing the supply we need this year you know we don't.
See a reason why that would change we've always had great relationships with our vendors and partners.
And in today at our teams have been pretty proactive about it I mean, obviously, you never say never and things.
The environment is somewhat unpredictable, but today, we've it's we feel good about how we've been able to keep on top of this.
Alright, thanks that bedroom, that's really helpful. And then I want to maybe I think are a little philosophically about the virtual first model. So you know it. It feels like you guys were were very much early in this and you know as a delta has pushed the office reopenings out.
It seems like more and more companies are are adopting that kind of virtual first model that to a certain extent you guys pioneered you know however, you shaved your your view and in what that virtual first model looks like since you announced it and as things have been pushed out and and maybe more importantly, how do you think.
We'll have kind of spread out so I think that for most companies they find even anti remote companies in the old World are now finding themselves on their way to having a double digit percentage of their population and places well outside of commuting distance of their former office and in a number of others and they're hiring more remote workers outside of.
Commuting distance and so that's why that matters is in these hybrid models. If you have even one person on a given team who is remote then suddenly the whole meeting has to happen on zoom and then youre in this massively dysfunctional situation, where you're paying for all this office space, you're getting people to commute multiple hours and in many cases further than they were before to them.
Being the office without like back on zoom without your snacks or your dog or your setup in the noisy environment. You know so we sort of envision that there was going to be the circle of Hell with the default model that we did not want to inhabit we learned a lot from other I'm really proud of the work the team did researching a lot of the.
Models that other companies have have come up with in and we've tried to build on that and open source. What we've found so everything that we've done I'm talking about here, we've we've posted online and our spiritual first tool kit. So you know.
Basically I'm happy with where we are we're going to continue to iterate on this so I'm looking forward to reintroducing the in person experience.
And.
And and I'm, where I'm excited for next year I think we'll continue to tune. This we've got a lot of ideas on how we can iterate further.
Alright, great. That's really helpful. Thank you so much.
Thank you. Our next question comes from Brent Thill with Jefferies. Your line is open.
Oh, Hey, guys.
So Don from Brent So I wanted to echo the congrats as well on another solid quarter.
Maybe the first question would be for drew.
It sounds like you have a lot of different.
Levers if you will on the innovation front.
The creator economy teams.
Hello find docs and could you maybe talk to us about like here.
Two or three levers that you think will help you sustain the current growth momentum.
So dynamics like so that the these are kind of huge problems hidden in plain sight that dropbox is really well positioned to solve.
So when my team I talking about Hey, we're solving the 2021 version.
Of the problem, we have of the we solve back in 2007 and maybe back then he was thinking files across your devices or was 100 icons or 100 files on your desktop now that's 100 tabs in your browser and so there's this we're we're transforming our core business in ways that if you think about it a lot of our customers today pay for Dropbox surround file oriented work flow.
But we all have.
Side or are you still committed more to investing on the self serve motion. Thank you.
Sure. So while self serve does remain the vast majority of our go to market motion certainly encouraged by your outbound team's execution and the team continues to execute well against the strategy that we adopted at the beginning of the year and specifically we more than doubled the number of reps focused on renewals.
So this is driving improvements in our team retention are also cross selling add ons and newer products like close on a dachshund.
And we're investing more in that channel, which is also gaining traction. So overall certainly pleased with how the team is performing and with the higher levels of efficiency that we're seeing in or outbound side yeah.
And building on that we also see these as one integrated motion or one customer journey, so often folks started dropbox.
Tony.
Yeah.
Great actually.
The last last two quarters I mean last quarter, you mentioned an improvement in overall retention rates. We're hearing it again tonight, both from the self serve side and on the strategic side you touched on it a little bit with respect to adding more than a doubling the reps focused on renewals I guess with respect to the self serve side can you can you kind of give us an update on what's driving that retention rate.
And kind of how we should be thinking about the durability and levers of that and if you could level set us on kind of maybe where we are now versus where we are last year and where we are at the time of the IPO or any kind of directional color would be great. Thank you.
Sure I can start and Tim can add so.
It really start retention starts with just the quality of experience right and so figuring out and as there's been a mix shift as people have as mobile becomes more or as I spend more time on our phones. In addition to our laptops or desktops.
That becomes a more important part of the experience and something like half of our top of funnel a half of new sign ups coming from mobile. So a lot of is just getting back to basics and making sure that experience is as simple and fast and streamlined and it just works.
That's always been kind of our product philosophy, and and removing friction from sign up or from sharing or different things pays dividends. So we've seen Oh. This example, but we've seen like record app store ratings or big improvements.
As it stands now and then how you expect that to trend going forward.
Sure I mean, I can speak to it at a high level and then Tim can add on.
I mean, the family plan is a good example of how are you now while on the one hand, most of most dropbox subscribers use dropbox for work are the vast majority of our many also use it for personal use and the family plan is in is something that was like commonly requested and it's been pretty popular and doing well.
I bring that up because one of the things that was clear.
After the pandemic is that the physical boundaries between home and work like fully dissolved for many of US and the same thing is true of of the virtual boundary between home and work like we're all managing personal stuff and work stuff off and on the same machine and that can be a big hassle and dropbox has always been or our customers.
I appreciate it that we handle both your personal and working life together. So we'll continue to make investments like that and.
And Tim can speak to more of the growth momentum yeah, maybe just to quickly add on so in the third quarter, we did enhance or upgrade pages for those approaching their storage quarters, where we did offer them. The family plan for the first time, so that helped drive incremental traffic and conversion and maybe one place you do see that is a net new paying users where in the quarter we added.
350000, net new paying users. So family plan that was a contributor to that as was the strength in teams as well as the strength in professional.
Awesome. Thanks, so much.
Thank you and we have a question from Steve Enders with Keybanc. Your line is open.
Okay, great. Thanks for thanks for taking the questions.
Paired remarks like there is a quite a lot of content around the broader ambitions around content workflow and how how dropbox I'm thinking about that but just kind of wondering.
The kind of product roadmap and what happens here longer term how does the product set evolved to match that vision that you were lane.
Sure well I mean at the highest level in the core business.
It's that evolution from sinking files to organizing all your cloud content and so big part of that is search command is a great example of pretty important building block there with like Universal search and being able to index all of your different cloud tools and services and and have one search box instead of like one fully working search box instead of 10 kind of fragmented search box.
<unk>.
And then organization like how do you help people build us how do you get people one view of their stuff regardless of wherever it may reside instead of having to visit 10 different 10 different places. So organization navigation search those are all certainly pillars of the future experience where that those those are I'm really like say.
About our roadmaps and each of those areas and then.
Then second is all the workflows around content as I mentioned, so they're our document workflows with with our products like Hell of a sign of docs and I'm really excited about the opportunity to build a more end to end solution with each of those.
But encompasses all those components, so bringing docks and Hello science Dropbox together. So that you know when you say the contract in Dropbox send it out for feedback and docs and get it signed in Palestine and have the completed that have the completed contract in Dropbox.
There's a lot more that we can do to tie those products together and then finally, a lot of the creative workflows rich media workflows, so things like Dropbox capture a visual communication tool a Starbucks replay a video collaboration tool.
And shop, where we find we have a lot of demand from our customers to help monetize their digital goods or monetize the content, they havent dropbox without having to stitch together.
Five different things so there's.
Theres, a pretty big portfolio.
Of of products and and potential growth levers.
Okay, Great. That's helpful and I know you mentioned, you know capture replay and shopping there and you've come out with passwords in the past year, but how do you think about that.
The ability to kind of incrementally monetize these new solutions are rolling out and how does that kind of play out over the next the next next couple of years and how would we see that develop yeah. I mean, I think it's gonna be portfolio in each of these investments.
Is gonna have a different magnitudes over different time scale. So I mean, the core business is obviously the biggest.
Lever and we have and I've talked about kind of the range of more incremental improvements to more transformative changes or more incremental improvements that happened kind of week by week month by month to this broader transformation that will take where be measured more in years.
And then even and then in our portfolio of workflows and similar kinds of thing got Hello, signing docs, and which our party at meaningful scale and in our fastest growing businesses and then we will always have a portfolio of green shoots where we'll double down on what works and keep it or anything but it won't be material to the business for you know in 'twenty two.
Okay perfect I really appreciate you taking the questions here.
Yep.
Thank you and there are no further questions in the queue I'd like to call back to drew Houston for any further remarks.
Alright, well. Thank you everyone for joining today, we really appreciate your continued support and look forward to speaking with you again next quarter.
This concludes today's conference call. Thank you for participating you may now disconnect.
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