Q4 2022 Dropbox Inc Earnings Call
The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.
[music].
Okay.
Good afternoon, ladies and gentlemen, thank you for joining Dropbox as fourth quarter 2022 earnings conference call.
All participants will be in listen only mode.
After todays presentation, there will be an opportunity to ask questions to ask a question. During the session you will need to press star one one on your telephone.
As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox as website. Following this call.
I will now turn it over to Karen Gabor head of Investor Relations for Dropbox. Mr. Gabor. Please go ahead.
Okay.
Thank you good afternoon, and welcome to Dropbox as fourth quarter of 2022 earnings call.
Before we get started I'd like to remind you that our remarks today will include forward looking statements such as our financial guidance and expectations, including our long term objectives and forecasts for our first quarter and fiscal year 2023, and our expectations regarding our revenue growth profitability operating margin and free cash flow as long as our expectations regarding our business.
Assets products strategies technology employees users demand and the macroeconomic environment.
These statements are subject to risks and uncertainties that could cause actual results to differ materially.
There also are based on assumptions as of today and we undertake no obligation to update them as a result of new information or future events.
Factors and risks that could cause our actual results to differ materially from these forward looking statements are set forth in todays earnings release and in our quarterly report on Form 10-Q filed with the SEC. We'll also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles.
A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors Dropbox Dotcom.
I would now like to turn the call over to Dropbox as co founder and Chief Executive Officer Drew Houston drew.
Thanks, Brian and good afternoon, everyone. Welcome to our Q4 2022 earnings call. Joining me today is Jim Reagan, our Chief Financial Officer, and I'll start with a recap of 2022 and provide an overview of our strategy for 2023, then Tim will go over our financials for Q4 and fiscal year 2020 to give guidance for Q1 and full year.
Our 2023 and provide an update on our long term targets.
So let's get started.
<unk> saw a more challenging macroeconomic backdrop and we saw some elevated headwinds in Q4, which Tim will discuss in more detail I am pleased with how our business performed for the year.
We ended the year with over $2 5 billion and there are we want to once again increase profitability and free cash flow and repurchased nearly $800 million of our stock.
We also rolled out new plans for our teams customers with expanded security and data protection capabilities made progress improving revenue retention and closed acquisitions, such as forklifts and box script or which I'll touch on shortly.
Before we dive in as you know last month, we shared that Timothy young is stepping down from his role as president.
I really appreciate everything that <unk> done for Dropbox over the past few years and wish him all the best.
I've also enjoyed digging in with our senior leaders to continue leveling up our execution and to pursue all the opportunities. We have ahead of us.
And over the last year, we've been focused on three strategic objectives to help us realize our long term vision.
Our first objective has been to evolve our core FSS product driving retention gains and monetization efforts through better conversion of our free users and through pricing and packaging.
Our second objective has been to expand workflows beyond core FSS around documents videos.
And our third objective has been to drive operational excellence and improve efficiency.
And this year, we've added the four strategic objectives.
Which is to move beyond files and organize all cloud content for our customers.
This has been a critical step in our product vision for some time and recent advancements in AI and machine learning have a huge role to play in accelerating our plans, particularly in building out our universal search and other capabilities I'll discuss this opportunity in more detail shortly.
We are already executing against these strategic objectives with a strong sense of urgency.
Q4 showed us that we're not immune to a slowing economy and thats why and focus on our speed of execution in 2023 and on areas, where we can improve efficiency.
For more details on how we plan to do that but first let me discuss some observations of <unk>.
'twenty two.
Starting with our first strategic objective around evolving our core FSS business.
Our focus over the last few years has been on improving the user experience, particularly on mobile and this is where in a growing number of basic users sign up for Dropbox.
We've also been focused on adding more capabilities to better serve small businesses and freelancers, who represent a passionate user base for dropbox.
Regarding mobile we observed that the uptick in churn from plus individuals that we witnessed in Q3 continued in Q4, largely due to recent mobile operating system changes.
Increased transparency around subscriptions.
From the macro pressures impacting consumer behavior, we've identified areas, where we can make the world mobile workflow, a more seamless and reliable.
And to drive higher basic user activity, we're focused on improving the onboarding experience.
This quarter, we're rolling out Google once App, which will help streamline the sign up flow for mobile and web users.
Many of our customers such as small business teams and freelancers rely on dropbox to ship to store and share videos and other rich media.
To better serve them, we've made improvements to the sharing experience of large files, particularly reducing the time and uploading and large files, which would you expect to drive improvements in customer satisfaction and reduce churn.
And as we continue to see the growth in video related content stored and shared on Dropbox, particularly among creative professionals. We've made progress with our video preview capabilities by increasing size and limits and adding editing functionality.
By improving slightly but valuable functionality, we are seeing increases in active video users and time spent per user.
Last quarter, we discussed our first full quarter as progress enrolling out new plans for our standard and advanced teams customers with a focus on security and data protection.
While we continue to see a net benefit to <unk> from these changes we saw incremental headwinds in Q4 from some of our larger teams customers reducing licenses.
We recognize that as our customers experiences experienced challenges in their businesses and evaluate their budgets has added pressure to reduce software spend.
But we see an opportunity to mitigate some of this pressure through more high touch account management for these customers, who traditionally came through the self serve channel.
We're actively working to strengthen the alignment between our business units and our go to market teams and see opportunities to improve renewal activity as we increased customer awareness of the added functionality, we're adding for teams.
We're also continuing to invest in our security roadmap to strengthen our offering for business users.
In Q4, we acquired assets from box script or a provider of end to end zero knowledge encryption for cloud storage services.
And over time, we plan to embed these encryption capabilities natively within Dropbox for our business users providing them an additional layer of security by encrypting files locally on their devices prior to taking their contents of dropbox.
We know that security is a top priority for our customers and at the time of consolidating spend will continue to identify opportunities to bundle more value for our paying users.
As we think about funding additional value into our different paid plans will continue to evaluate the best pricing and packaging strategy diverse best serves our customers.
Moving onto our second objective, which is to expand our workflows beyond FSS, particularly around documents and videos.
I will first share an update on <unk> and sign in 2022, and where we see opportunity to scale. These businesses in 2023.
As we've noted throughout the last year, we've seen both dark tenant sign growth moderate as headwinds in their respective markets continue.
Dr. <unk> core market, which is venture backed fundraising has seen activity pulled back materially from 2021 levels.
As a resulted in customers being more price sensitive.
This year, we're focused on diversifying the customer base, introducing it to new geographies and extending beyond venture capital and other professional services such as consulting.
<unk> also seen challenges amidst an overall slowdown in the esignature market.
And competition.
While we saw strength in our API offering.
There is opportunity to stabilize signs overall growth as we leverage it under the Dropbox brand and drive more sales led growth targeting small businesses.
For both Simon Docs and are focused on 2023 is around deeper integration with core dropbox, while we can.
Made progress integrating certain capabilities into the core Dropbox experience for example, <unk> analytics within an individual user sharing flow and signs native San for signature entry point, and Pdfs and Dropbox. There are still challenges for the end user experience due to multiple systems that need to be unified.
For example customers have been required to re logged into the different application access multiple in terms of service and checkout flows and different user interfaces overall.
We're quickly youre working to remove the friction and the user experience to make it easier for customers to try buy and use these products, which is a critical step in unlocking our platform strategy.
And up until now we've mostly talked about the auction and drawbacks sign as key pillars to our document workflow strategy and today I'm excited to discuss an important new piece to this business with our acquisition of farm Swift.
<unk> is a cloud based service that helps customers create complete edit and save critical business forms and agreements.
With farm, so SaaS library of tablets individuals and small businesses are able to access hundreds of forms rather than spending resources drafting them from scratch.
Whether it's a lease agreement or an employment contract forklifts cloud based offering makes it simple for customers to complete their agreement workflows.
So this is complementary to dropbox with a similar target customer a robust self serve go to market engine and capabilities that allow customers to do more with their digital content.
We plan to integrate points swept under the Dropbox brand this year and overtime combine its content library with our sign a document capabilities, providing a comprehensive end to end agreement workflow.
And with millions visiting parks US website, we see a natural opportunity to drive more top of funnel activity to dropbox and our suite of products.
Outside of the documents the other adjacent workflows beyond the assessed is around video.
We see significant usage on our platform.
This year, we plan to continue our focus on video workflows building on the recent public launch of Dropbox capture video communication tool for distributed teams as well as our continued progress with replay which allows teams to collaborate and edit videos all within Dropbox.
This launch and capture to all Dropbox users in October we've seen this usage grow significantly.
We see an opportunity for replay to follow a similar path.
General General availability as its adoption and retention continued to improve with the creative community.
By continuously iterating on these experiences we're excited to build a best in class platform for creative to manage their video content.
And as I mentioned earlier, our newest strategic pillar in 2023 is to organize all cloud content centered around AI and machine learning.
We're entering a new era of augmented knowledge work, where human and machine intelligence combined you unlock unprecedented levels of productivity.
We've been working towards our mission of designing a more enlightened way of working for years as a proliferation of cloud tools and the shift to remote work with less people with a more chaotic working environment than ever before.
Instead of once our Sparks, we all have it doesn't search boxes across all of our productivity tools and apps and Theres never been a better time to help our customers organize and simplify their working lives.
And with the recent developments in natural language processing and large language models machines can now take on more complex tasks than ever before and they are providing us the building blocks needed to augment knowledge work every presentation.
AI and machine learning is an area, where we've been investing for a long time.
We've used machine learning to improve content suggestions and retrieval and help users that our search and organize their video content, but theres a lot more we can do.
One of the biggest opportunities we see as in tackling content fragmentation and universal search and I'm looking forward to sharing more about what we'll be launching in the coming quarters.
I believe we're operating from a position of strength given our scale our platform neutrality and the millions of people and businesses that already use dropbox for work and entrust us to store their most valuable content on <unk>.
Working very closely with our product teams on our roadmap and I couldnt be more excited about what dropbox can do to leverage all these new technologies to unlock significant levels of productivity for millions of our customers and ultimately designed more in line.
In closing 2022 was a solid year, despite an increasing challenges from the macro environment.
We're making important changes within our business to better position us for the long term, we continue to focus on improving our execution as we navigate what is likely to be another difficult year for our customers.
The challenging times can be transformative for any business.
We launched Dropbox during the great financial crisis, and I've learned that operating under more difficult environments and resulted in producing our best work.
While we're not immune to a worsening economy, we are well positioned given our scale, our trusted brand our healthy financial profile and our strong balance sheet.
We remain focused on operational excellence identifying areas of efficiency and capitalizing on emerging growth opportunities to invest in our future.
And with that I'll hand, it over to Tim to walk through our financial results.
Thank you drew.
Before turning to our quarterly results.
Like to start with a reminder of our financial strategy.
We are continuing to pursue sustained growth and profitability.
In a disciplined and thoughtful manner, while remaining committed to our longer term financial targets.
We also remain focused on allocating capital to growth initiatives that we believe will drive future revenue, both organically and through acquisitions.
While also returning a significant portion of our free cash flow to shareholders in the form of share repurchases.
As Joe highlighted we are seeing more signs of macro related weakness impacting our business.
And today I'll walk through our guidance for 2023, which takes the current environment into consideration.
I'll also provide an update on our financial targets for 2024.
But first let me discuss our fourth quarter and full year 2022 results.
Total revenue for the fourth quarter increased five 9% year over year.
The $599 million.
Beating our guidance range of $592 million to $595 million.
Foreign exchange rates provide.
And approximately $19 million.
Headwind to growth in.
In line with our previous guidance.
On a constant currency basis revenue grew nine 2% year over year.
I will note that our Q4 revenue was inclusive of a partial month of revenue from our acquisition of form Swift, which we closed on December 15th.
Total <unk> for the quarter grew 11, 2% year over year.
For a total of 251 4 billion.
On a constant currency basis, <unk> grew by $83 million sequentially.
And 11, 8% year over year.
More than $50 million of this error was driven by the acquisition of form Swift.
With an additional contribution from our pricing and packaging changes to our team plans that we announced in June .
As a reminder, we include the error related to acquired companies and our total error in the period of the acquisition.
We exited the quarter with $17 $7 7 million paying users and added approximately 230000 net new paying users in the fourth quarter.
With over 200000 of these paying users stemming from our acquisition of form Swift.
As with <unk>. We include all paying users of an acquired company within our total paying users in the period of the acquisition.
Excluding form swift additions to paying users fell below our expectations driven by two main factors.
First was the churn of a large education customer where I'd note that these customers have a very low <unk> and hence an immaterial impact to our total <unk> base.
The second factor was softness around our plus and teams plans as we continued to see increasing macroeconomic headwinds as drew mentioned.
Specifically, we continued to see softness in our plus SKU, particularly on mobile and we began to see increased price sensitivity to our teams plans.
Average revenue per paying user for Q4 was $134 53.
Up slightly compared to Q3.
With the benefit from our team's pricing initiatives, partially offset by FX headwinds.
And the continued mix shift towards family plan, which is comprised of six seats and therefore carries a lower RPC profile.
We also saw an RP headwinds from the acquisition of form Swift as we recognize the entire paying user count.
But only half a month of revenue.
Before we continue with further discussion of our P&L I would like to note that unless otherwise indicated all income statement figures mentioned, our non-GAAP and exclude stock based compensation amortization of purchased intangibles certain acquisition related expenses and <unk>.
<unk> of our real estate assets and net gains on equity investments.
Our non-GAAP net income also excludes the income tax benefit from the release of a valuation allowance on deferred tax assets.
And includes the income tax effect of the aforementioned adjustments.
I'll now provide a brief update on our real estate strategy, where we have been taking steps to D costs, our real estate portfolio as a result of our transition to a virtual first model.
We made progress against our sub leasing goals in 2022, and the vast majority of our space outside of San Francisco headquarters has now been sublease.
However, while we continue to actively seek sub leases and consider buyouts of our San Francisco headquarters.
<unk> downsizing and reductions in corporate needs throughout the San Francisco real estate market have resulted in a more challenging sub leasing environment than we had originally anticipated.
Given the current corporate real estate market, we are no longer assuming that we enter into additional sub leases in San Francisco in the next few years.
As a result, we've revised our sub leasing assumptions, resulting in an additional write down of our facilities and other related assets of $162 million in the fourth quarter.
This brings our cumulative impairment charge to $604 million.
This revised sub leasing assumption also reduces our expected cash flow benefit over the next few years.
Additionally, in Q4, our GAAP net income was favorably impacted by a $420 million.
One time income tax benefit from the release of a valuation allowance on our U S deferred tax assets.
This is a result of our improved profitability in the U S leading us to conclude that our evaluation allowance on these deferred tax assets is no longer necessary.
I would also note that there is no cash impact associated with this onetime benefit.
And it is excluded from our non-GAAP net income.
With that let's continue with the fourth quarter P&L.
Gross margin was 82% for the quarter, representing an increase of one percentage point on a year over year basis.
The improvement in gross margin was primarily driven by ongoing efficiencies in our data center infrastructure.
Fourth quarter, R&D expense was $174 million or 29% of revenue.
The increase compared to 26% of revenue in the fourth quarter of 2021.
We've seen our R&D expense as a percent of revenue rise over this past year as we have been investing in key initiatives across our core file sync and share Dropbox sine and <unk> businesses.
While also investing in our universal search and AI roadmap that drew discussed.
This has coincided with attrition rates falling to record lows, which has resulted in the increased levels of R&D spend relative to 2021.
Fourth quarter sales and marketing expense was $96 million or 16% of revenue, which decreased compared to 17% of revenue in the fourth quarter of 2021.
Fourth quarter, G&A expense was $43 million or 7% of revenue, which decreased compared to 8% of revenue in the fourth quarter of 2021.
In total we earned an operating profit of $179 million in the fourth quarter, representing an operating margin of 30% in line with the fourth quarter of 2021.
Net income for the fourth quarter was $141 million, which is a 12% decrease versus the fourth quarter of 2021.
This decrease in net income is driven by the substantial increase in our tax expense in 2022.
Due to the impact of the R&D capitalization and tax legislation the effective in 2022 and.
And given that we have now fully utilized our Nols for non-GAAP tax purposes.
Diluted EPS was <unk> 40 per share based on 354 million diluted weighted average shares outstanding.
In line with 41 per share based on 386 million diluted weighted average shares outstanding for the fourth quarter of 2021.
Moving on to our cash balance and cash flow.
We ended the quarter with cash and short term investments of $1 3 billion.
Cash flow from operations was $195 million in the fourth quarter.
I will note that as part of our acquisition to form Swift and box Clipper in Q4.
We paid a total of $33 million of key employee retention hold back to escrow.
Which decreased our cash flow from operations.
Capital expenditures were $13 million during the quarter.
This resulted in quarterly free cash flow of $182 million compared.
Compared to $161 million in Q4 of 2021.
As we had guided on our last call. We had planned for this significant step up in Q4 in leases as part of the build out of a new data center going into service in Q1 of 2023.
Let's turn to our share repurchase activity.
Q4, we continued executing against the $1 $2 billion authorization that was approved earlier in 2022.
Repurchasing 8 million shares.
Spending approximately $174 million.
As of the ended the fourth quarter, we have approximately $748 million remaining under the current authorization.
Now, let's turn to our full year 2022 results.
Total revenue for 2022, with two $3 billion to $5 billion.
Representing seven 7% year over year growth, beating our guidance range of $2 318 billion.
The two $3 billion to $1 billion.
On a constant currency basis relative to the average rates across 2021 year over year growth was nine 4%.
Gross margin was 82% for the year up one five percentage points from 2021.
Operating margin was 31% for 2022, which was up one percentage point from 2021.
Net income was $574 million for the year, which is a 6% decrease from 2021.
Driven by the substantial increase in our tax expense in 2022 as I've mentioned previously.
Diluted EPS.
It was $1 58 per share.
Based on 363 million diluted weighted average shares outstanding.
Up from $1 54 per share for the full year 2021 based on 396 million diluted weighted average shares outstanding.
Cash flow from operations for 2022.
It was $797 million.
Capital expenditures for the full year totaled $34 million, which resulted in free cash flow.
$764 million or 33% of revenue.
Our free cash flow for 2022 came in slightly below our guidance of $770 million to $790 million due to the $33 million in form Swift and Fox script or acquisition related to hold backs that we paid to escrow in Q4.
We do not anticipate additional payments related to these hold backs performed swift and box character.
These amounts will be expense over time as they are earned by the respected key employees.
In 2022, and we also added $106 million to our finance lease lines for data center equipment.
Nearly 5% of revenue.
Net of repayments, our finance lease balance decreased by $22 million.
Finally, we repurchased approximately 36 million shares.
Spending $795 million in 2022.
I'd now like to share our 2023 first quarter and full year guidance, where I will also provide some context on the thinking behind this guidance.
For the first quarter of 2023, we expect revenue to be in the range.
600 <unk>.
$103 million.
On a constant currency revenue basis, we expect revenue to be in the range of 616 $619 million.
We are assuming a currency headwind of approximately $16 million in the first quarter.
Which translates to nearly a 300 basis point headwind to growth.
And as a reminder, there are two fewer subscription base in the first quarter of 2023 as compared to the fourth quarter of 2022.
We expect non-GAAP operating margin to be approximately 26, 5%.
As a reminder, there is some seasonality with first quarter operating margins as payroll taxes reset at the start of each year.
This also includes roughly 100 basis points of headwind from FX, and 60 basis points of headwind from form Swift.
Finally, we expect diluted weighted average shares outstanding to be in the range of 351 million to 356 million shares based on our trailing 30 day average share price.
For the full year 2023, and we expect revenue to be in the range of $2 $4 75.
To two four at $901 billion.
On a constant currency revenue basis, we expect revenue to be in the range.
Of 2510.
The 252 5 billion.
Approximately 150 basis points headwind to growth.
With the FX headwinds moderating each quarter as we lap the headwinds of last year.
We also expect forms swift to contribute approximately two five points of growth.
We expect gross margin to be approximately 81% to 82%.
As a reminder, we made infrastructure investments related to our new data Center, which just went live this quarter, resulting in slightly lower full year gross margin in 2022.
We expect non-GAAP operating margin to be approximately 30%.
This is inclusive of an approximately 50 basis point headwind from FX.
As well as a 50 basis point headwind.
Smith acquisition.
We expect free cash flow to be in the range of $825 million to $855 million.
This includes approximately $23 million in cash outflows for the 2023 installments of acquisition related deal consideration holdback.
Dachshund income Andy.
Additionally, our free cash flow guidance is inclusive of an approximate $50 million headwind as a result of the R&D tax legislation, which I will elaborate on shortly.
As it related to our capital expenditures, we expect our addition to finance leases to be approximately 5% of revenue.
And we expect cash capex to be in the range of $25 million to $35 million in 2023.
We expect 2023 diluted weighted average shares outstanding to be in the range of 346.
To 351 million shares.
To share some additional context on this guidance as it related to revenue.
Saw incremental headwinds from the deteriorating macro environment across all lines of our business in the fourth quarter.
We continue to see our mobile plus users turn at higher levels.
And we saw our teams users carefully evaluate their license counts.
In addition, while we are still seeing a net positive impact from our pricing and packaging changes to our standard and advanced teams plan.
We did see elevated churn relative to Q3.
While we have seen the majority of teams customers come up for renewal under the higher price point.
Now expecting a lower incremental contribution from the pricing change over the next two quarters, but those that have not yet seen the pricing change in light of these recent trends.
In addition to the softness that we're seeing within our file sync and share core business.
Also continued to see incremental macro headwinds across our sign and <unk> businesses.
We are factoring all of these recent trends into our revenue guidance for the year.
As it related to operating margin, we are expecting operating margins of approximately 30% slightly below our 2022 margins.
We expect Q1 to represent the trough of the year as a combination of factors, including the resetting of payroll taxes, FX and the acquisition of forms with our pressuring operating margins below our recent trend.
For the full year, we expect FX and the acquisition of form Swift to represent roughly a 100 basis point headwind to margins.
Additionally, our guidance contemplates the annulus station of the hiring we did in the second half of 2022, particularly within R&D.
We are closely monitoring the efficiency of this spend to ensure that we're being prudent.
And expect our R&D as a percentage of revenue to trend lower through the through the year following Q1.
As it related to full year free cash flow.
Guidance includes a $50 million cash tax headwind.
As a result of a law that now requires R&D cost to be capitalized for tax purposes.
While there is a possibility that the current legislation may be amended or repealed.
Including this impact in our guidance until such time that it is repeal.
Which brings me to our long term financial targets of delivering gross margins of 80% to 82%.
Operating margins of 30% to 32%.
And $1 billion of annual free cash flow by 2024.
We continue to operate within our long term margin range and we have made significant progress growing free cash flow since we introduced our target three years ago.
However, changes to R&D tax legislation and deteriorating FX rates.
Relative to the rates, we used when initially issuing our free cash flow target currently represents a combined headwind of over $75 million in 2024.
While these and other factors have introduced pressure on our ability to achieve our $1 billion free cash flow target by 2024.
We continue to have multiple ways to achieve this target.
Thus, while the path has become more challenging.
It is too early to make any changes to our long term financial targets at this time.
In conclusion, despite the macro headwinds we observed in the fourth quarter.
We remain optimistic about our strategy and the opportunities in front of us, including our multi product efforts, our recent acquisitions and our plans to organize our user's cloud content.
We will remain focused on our customers'.
Operating the business efficiently and driving long term value for our shareholders.
With that I'll now turn it over to the operator for Q&A.
As a reminder to ask a question you will need to press star one one on your telephone again Thats Star one one on your telephone to ask a question. Please standby, while we compile the Q&A roster.
Our first question comes from the line of Rishi <unk> of RBC capital markets. Your question. Please re queue.
Alright wonderful thanks, so much for taking my questions guys.
I wanted to maybe think about <unk> and what is the customer overlap within that customer base look like so in other words not only what is the cross sell potential for you to cells form stuff to the existing dropbox customer base.
The asset, but maybe are there net new customers.
You have the ability to sell dropbox, the core dropbox into an.
And your rates and then I've got a quick follow up.
Sure. So thanks for the question and I'd say short answer is yes to all of the above I mean, I think thats first.
Lot of it.
Overlap of complementary fit between <unk> thrift in Dropbox in terms of a similar target customer.
Similar self serve go to market.
And.
And addressing the content lifecycle, and then theres fit in the other direction. So every.
Contracts are often contracts that you send out for signature originate in the form of a template where if you think about getting an NDA, Don or some office lease or something.
That might start with a Google searching for Atlanta on a site like forms we have to find the template so complementary in both directions.
And for us it.
It has its own audience of millions of visitors every year that are potential dropbox customers. So we see a lot of synergies in all directions.
Alright wonderful that's that's really helpful. And then Tim when you were talking about.
Kind of the elevated churn that you're seeing maybe can you give us a little bit of color in terms of what youre seeing on the churn are these customers just.
Going out of business or shutting down at the low end are they going to maybe larger platforms, where they're consolidating their spend be it with that with the Microsoft or Google and maybe alongside that what's happening on the consumer side of the business, which last night that you disclosed is about 20% of total paying customers. Thank you.
Sure. So we did see our churn rates increase this past quarter largely due to the deterioration in the macro economy.
And we continue to see churn from our plus customers, particularly on mobile devices and.
And we also saw heightened price sensitivity amongst our team customers where in particular, we saw a greater degree of churn from customers subject to our team's pricing and packaging changes than we saw in the third quarter now that all said our overall churn rate is currently in the low teens and that's an improvement from where it was just a couple.
Years ago, so improving retention continues to be a focus for us.
Of course, our revenue guidance factors in all of these latest trends and as far as what's happening on the consumer side of the business I wouldn't say, there's been any material deviation in those trends as far as the 80 20 split that you referred to.
Thank you.
Our next question.
It comes from the line.
Michael Funk of Bank of America. Your question. Please Michael.
Yeah, Hey, guys. Thank you for the question.
So just.
A couple of more if I could so on the.
It <unk> change you mentioned a few different factors there.
Family for one obviously the change in pricing has also been.
<unk> been a factor and then forms Swift can you can deconstruct the change in RFP for us based on those different factors.
Sure. So we ended Q4 with <unk> at $134 53, which was down about 25 cents year over year so acute.
Two key factors there. So FX was a $4 in 'twenty headwind and continued headwinds from a mix shift to family plan are also a factor. There now this was offset by benefits from our team's pricing initiative.
Which we launched in June and then forms with represented a small headwind.
Roughly 25 cents, because we recognize all forms of users, but only a half a month of revenue now looking forward. We don't formally guide to <unk>, but again there are some factors that will impact our trends next year again, the team's pricing change that will be a tailwind to <unk>.
Forum's Swift, we expect swift to be a tailwind to ARPA as well next year as its monthly plan is roughly $40 per seat FX, we expect that to be a headwind.
But that to moderate throughout 2023, assuming current rates hold and then again family plan.
As a reminder, that SKU is a headwind to our Apio is this plan includes six licenses for friends and family.
Got it and then and then also on the call you mentioned some incremental revenue headwinds baked into the 'twenty three guidance you gave us a few different things China mobile.
User count elevated churn.
I'll attempt to <unk>, what you are experiencing there.
Can you just break this down for us as well I already talked about <unk>, but in terms of gross add expectations versus churn expectations that are part of incremental headwind are you also expecting to have fewer gross additions or is the majority of the change on the churn side.
Sure I'll give you some context on our net new paying user additions. So again, we added 230000 net new paying user in the fourth quarter majority of that did come from form Swift and then excluding form swift additions to paying users did fall below our expectations as I touched on now there were a few factors to.
That first was the churn of a large university, which did carry a low <unk>. This had an immaterial impact on <unk> and then second was the softness across our plus and teams plans as we continue to see increasing macro headwinds now as far as what we expect going forward from a net new paying user perspective.
I would expect that our net new paying users going forward to be a bit lower than the run rate that it was in the first half of 2022.
And while we don't guide to net new paying users just as we navigate the pricing and packaging changes and the current macro environment I'd expect something in the neighborhood of roughly 100000, net new paying users per quarter with RP expansion being more pronounced next year.
That's really helpful in thinking about the the piece parts of trying to model out the growth for the year is about 100000.
New per quarter, and just one more quick one if I could just on the impairment related to to real estate specifically.
San Francisco did you explore other options.
Such.
Early exit from the lease.
Simply negotiating maybe.
Yeah.
Stronger position with the landlords or I'm, assuming you're probably export all options here.
Robin simply taken that off of the expectation for sub leasing.
Good for sublease, which has pushed out our anticipated time to lease and so we originally anticipated we would suddenly San Francisco in mid 2023, now we expect we won't begin subleasing until mid 'twenty five we've also lowered the rates we expect to receive so we've certainly been active and we continue to be active in partnering with our landlord and searching.
For sub leases, but at this point in time. This is our revised assumption just given what we're facing at this moment understand thank you so much for the questions.
You bet.
Thank you.
Our next question comes from the line of.
Steve Enders of Citi. Your question please Steve.
Alright, great. Thanks, Rob Thanks for taking the questions here I guess, maybe just to start.
I think lumpy a little bit more detail on how youre thinking about kind of future.
Peter packaging and pricing.
Leverage to potentially pull in and how you see.
Form Swift come in.
Coming into the rest of the portfolio and how you think about kind of future monetization and pricing that the.
Taking a bank to meet there going forward.
Sure.
Sure.
<unk> is a good example, it's complementary to a lot of other use cases, and we've been building towards supporting document.
Document workflows end to end throughout the whole.
Lifecycle. So for example.
Sure.
Okay that originated the template now we can we have the top of the funnel covered and then as you send out a draft.
For review or iteration, you might use docs and and then send it out for signature and sign and then have the signed version archived in Dropbox.
So we've been building towards this on our road map for a long time, and there's a lot of as far as pricing and packaging as you'd imagine building that more integrated experience bundling these experiences together.
Having a broader portfolio of products all all these things contribute to monetization and with then zooming out from document workflows. Our philosophy in general has been to add more value to add new features to our core products.
So last year as a lessor examples include a lot of new security features.
And then as we add.
Beyond a sufficient.
Shoulder value increased prices and so you saw US do this last year with her 20% price increase for teams customers.
So that philosophy will stats.
That will still hold.
That said as as we're all as we're all monitoring the macro environment and every company is looking to looking at budgets and consolidating spend.
You have to we have to be mindful of what customers are going through and what they want and so.
Price increase it might be less around just straight price increases and more around bundling.
Forward looking at our customer share.
Sure customers.
Talking to them about if theyre using some separate.
Key signature tool to buy a bundle that includes sign.
And FSS instead, so I'd say what customers are interested is shifting and we have to be mindful of the balance.
To increase monetization and <unk>, while also being.
<unk>.
Monitoring churn and what our customers want.
Okay got you.
That's helpful context.
And I guess, maybe for the outlook here I guess, particularly as we think about the.
24.
Just wondering for outlook on free cash flow I understand there is the $75 million headwind headwind there, but I know you mentioned that theres. Some further levers that you could.
Sensually Paul.
I guess, how are you thinking about what the potential.
Areas are to potentially hurt eventually pull there and how are you thinking about I guess, the general kind of hiring environment and outlook as you think about it.
As you think about trying to drive that free cash flow target.
Sure. So we continue to have multiple ways to achieve our target we have several organic initiatives, including improving our file sync and share business.
Expanding our multi product capabilities and organizing cloud content that can drive revenue growth. We also have inorganic opportunities, we can pursue which can contribute.
We're also actively looking at ways, we can drive more efficiency in the business.
And of course, it's possible that exaggerates factors, such as R&D capitalization and FX can turn in our favor.
While the path has certainly become more challenging it's too early to make any changes to our long term targets at this time.
And then as related to hiring.
We.
We are aware that many other companies are facing hiring challenges.
And taking restructuring measures in the industry right now we did see an elevated impact of the macro economy on our business in the fourth quarter. So we're not immune to those pressures were closely reviewing the efficiency of our spend to ensure that we are seeing a sufficient level of return and we will remain thoughtful and disciplined and making appropriate decisions.
For the long term health of our business.
Okay perfect I appreciate you taking the questions.
Thank you.
Our next question comes from the line.
Joey Marin check of JMP Securities. Your line is open Joey.
Hey, Tim Thanks, so much for the questions. Gary you mentioned increasing competition the esignature market. So I'm curious how do you think sign stacks up relative to the competition and what assumptions are baked into the guide on overall demand for sign in 2023.
Sure. So I mean, I think in the competitive environment, we're seeing.
Certainly lots of different <unk>.
Activities, where we're different products or adding esignature are different new kind of pricing and packaging approaches from different folks.
So in general we see.
Sign is having a very complementary motion to dropbox. So we're self serve somewhat more SMB focused we think that segment is relatively less address than any enterprise or with with higher end customers.
Certainly one of our big advantages as our existing audience of tens of millions of Dropbox FSS subscribers. So we.
We're doing a lot too.
Better integrate sign in docks and in our products.
So as to that list.
Attaching it to our base and I'd say, we're pretty early in terms of our pricing and packaging and bundling optimizations. There and then when you sort of zoom out from just esignature to just the whole end to end workflow as I said.
We have a lot of different parts that were stitching together and I think that our ability to provide a seamless and integrated.
And to end experience starting from again that Google search to find the template.
With forms left all the way down to signature and archival.
We are at it is that as an advantage being able to have all those pieces of puzzle.
As with a lot of the competing point solutions, you have to like log that log in and log out there's a lot of friction.
That isn't that overall experience. So as you can see we've been building a big source of differentiation is building the end to end experience and we're relatively early innings in terms of driving adoption among our base and beyond.
That's super helpful and can you give us some more details around Timothy supplier sure. How are you thinking about replacing and do you feel like you have the bench already or would you potentially look outside the company any thoughts there would be helpful. Thank you so much.
Sure Yes.
So just for color Timothy or last month, we announced that Timothy.
Stepping down he sold the company will be here through March.
And he contributed a lot. So I really appreciate everything he has done for us.
As far as the go forward leadership structure, nothing like pre announce here, we'll keep everybody posted but.
It's been great for me to get closer to our operating leaders.
Given all the opportunities we have in front of us.
And to focus on continuing to improve our execution.
Thanks, so much.
Thank you.
Our next question comes from the line.
Brent Thill of Jefferies. Your line is open Brent.
Okay.
Hi, this is not soda on for Brent Thill.
Thanks drew and thanks for taking my question, maybe one for you too.
Yes.
As you view.
That's a long term growth potential of this business.
How should we think of the long term growth potential.
What are the main levers.
You have to drive growth, both organically and Inorganically.
Sure.
So many growth levers I mean, starting with just organic levers so continuing to optimize our core business.
<unk>, which is at scale.
And optimizations, there, there's still a lot of returns to those.
Second we've been brought building out our broader portfolio of growth stage businesses like sign and docs and and.
And we also have a pipeline of newer products.
Capture and replay and backup and.
And then there's M&A, we've done in the past surround things like <unk> and Universal search.
And then looking ahead as I shared on the call and in previous calls I'm really excited about the opportunity to move beyond files and organize all of our customers' customers cloud content.
Because if you look over the last <unk>.
Decade, or so a lot of workloads have shifted from files to cloud tools, but there is a missing organizational air there and Theres a lot of the customer pain points.
Search is one that is kind of obviously what used to be one search box in kind of the file and PC era is now dozens of search boxes in the cloud era.
And we see dropbox as very well positioned.
To help address.
Pain points like these in acquisitions like commodity bring.
Bringing in a company that was already working on some of these problems and investing more behind it.
Has been a big initiative for us.
So theres a lot on the organic front I think this is this will ultimately be a bigger market than FSS I think everybody. There no. One is solving these challenges around organizing cloud content and there's a whole lot of.
I'm from <unk>.
And that experience.
And we're investing very heavily there and it also dovetails with a lot of.
A lot of the recent advances in AI and machine learning so that.
We're very excited about the prospect of having a self organizing dropbox or to be able to bring natural language and the experience.
For search or workflow or other areas and these are areas, we've been investing for a long time and we're doubling down here. Even further so there's a lot on the organic front and were continuing also there are a number of growth levers on the M&A front and even just the last quarter.
<unk>.
Got it and a quick follow up for Tim If I may.
Just Ken just wanted to be.
I wanted to dig deeper into the revenue guide for next year could you just walk through your assumptions are you think.
Embedding a worsening macro are you expecting macro.
Just any color in terms of churn in both the macro environment and then you mentioned R&D efficiency.
How should we think of that as the lever, especially as you look at your medium term margin outlook.
30% to 32% thank you.
Sure Good question so.
So we are baking in I would say at an appropriate level of conservatism given the evolving macro landscape.
And we have assumed that key trends such as the increased levels of price sensitivity that we saw in the fourth quarter will continue throughout 2023, and so we are factoring in the latest signals and not assuming a turnaround in the economy in our guidance for 2023 now consistent with our historical approach, we do factor in growth initiatives, when we have sufficient signal.
On their performance and as we see additional data over the course of the year, we will revise our guidance as needed and then as far as the R&D efficiencies that lever just given our medium term margin guide of 22, or sorry, 30% to 32%, we certainly will be looking at our R&D efficiency and.
Closely reviewing the output that we're getting relative to an investment and we will continue to manage this business business with discipline.
As we make our decisions going forward.
Perfect. Thank you.
Thank you our last question comes from the line of.
Mark Mark Mark Murphy of Jpmorgan. Your question. Please mark.
Hi, This is <unk> on for Mark Murphy. Thank you for taking my question first I just wanted to ask if you could walk us through any changes that youre seeing in the competitive landscape for Dropbox, given dropbox, a scale and reputation Im curious if theres been an opportunity to kind of gain share given some of the macro pressures may be weighing on smaller vendors.
With less runway.
Sure I'd say, our competitive dynamics have been pretty stable.
And I think you can see this in a while there were a macro headwinds in Q4 than broadly.
Retention has been pretty stable margins have been pretty stable and so on we haven't seen major changes in the environment I'd say, they're the.
Dynamics, so maybe a little bit by business by business or.
<unk> and docs and have some different factors than the core business are in fundraising comes down that affects docks and disproportionately things like that but I'd say overall, it's been pretty stable and then as we.
We look ahead, especially as you think about organizing all cloud content.
Especially as you think about things like AI and machine learning and having a new generation of smart tools and products.
We feel we're well positioned given our scale and our brand around trust and privacy and our platform neutrality.
And we've already been investing a lot.
In machine learning and AI for a long time, so compared to startups a lot of our accumulated advantages.
<unk>.
Leave us well positioned so pretty stable, but we're obviously continuing to monitor the environment.
Great. Thank you that's very helpful. A quick follow up I just wanted to ask around some of the changes and enhancements you've made with your Doc document workflow oriented products are there any early indications on the attach rates or initial proof points for some of these specific features that you've added that seem to be resonating more deeply with customers.
I don't have any additional stats to share right now, but we have been making increased progress in cross selling.
Sign and docs and to our base and things like that or rebrand from Hello Science to Dropbox signed have been helpful. And then we've made I would continue to.
Make progress in building tighter integration points between.
File sync and share our core dropbox product and the <unk>.
Broader portfolio.
So we see a lot more upside there both in terms of better integration and then continued iteration on pricing and packaging and bundling.
Awesome. Thank you very much.
Thank you. This concludes today's conference call.
Please disconnect your lines at this time and have a wonderful day.
Yeah.
Okay.
Yeah.
The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.
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Okay.
Okay.
Yes.
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Thank you.
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