Q2 2023 Dropbox Inc Earnings Call

[music].

Good afternoon, ladies and gentlemen, thank you for joining Dropbox second quarter 2023 earnings conference call.

All participants will be in a listen only mode.

After today's presentation there'll be an opportunity to ask questions.

Just a question during the session you will need to press star one one on your telephone.

During this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox website. Following this call.

I will now turn the call over to Karen <unk> head of Investor Relations. One Dropbox is a good park. Please go ahead.

Thank you good afternoon, and welcome to Dropbox, a second quarter 2023 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 third quarter and fiscal year 2023, and our expectations regarding our revenue growth profitability operating margin and free cash flow as well as expectations regard.

Our business assets product strategies technology employees users demand industry trends and the macroeconomic environment.

These statements are subject to risks and uncertainties that could cause actual results to differ materially. They are also based on assumptions as of today and we undertake no obligation to update them as a result of new information or future events factors.

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.

Reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors Dropbox Dotcom.

I'd now like to turn the call over to Dropbox as co founder and Chief Executive Officer Drew Houston drew.

Thanks, Karen and good afternoon, everyone. Welcome to our Q2 2023 earnings call. Joining me today are Tim <unk>, our Chief Financial Officer.

I will first share our business and product highlights from the quarter and then Tim will review, our Q2 financial results and provide guidance for the rest of the year.

I am pleased to report that we had a solid quarter once again, beating our guidance across all metrics led by revenue outperformance and phosphate.

And so the recovery within our individuals' skus as the progress we saw in late Q1 continued into Q2.

However, we're still navigating a difficult macro environment that continues to impact our teams customers and pressures for us and our docks and in time businesses.

Before I walk through the highlights from the quarter in more detail I want to quickly remind you of our primary business objectives that I outlined last quarter.

The first objective is around building AI powered product experiences to help our customers organize their working lives.

Our company mission that Dropbox is to design, a more enlightened way of working and I'm proud that we've accelerated our road map here with Dropbox Dash and our progress in AI, which I'll discuss in a minute.

Our second objective is continuing to evolve the core file sync and share experience to specifically address customers' workflows around documents and videos.

Much of the work here, it's been foundational focusing on driving retention and conversion and I'll share more about the progress we made during the quarter.

So with that backdrop I'll touch on what we're working on to drive these objectives, starting with our first objective of building AI powered product experiences to improve knowledge work.

As we discussed on our last call. We took some important actions in Q2 to better align our investment strategy with our long term growth initiatives and to drive product velocity against our AI roadmap.

While dropbox has been investing in AI and machine learning technology for many years, we're all witnessing an unprecedented wave of innovation around generative AI and large language models and.

And seemingly overnight, we now live in a world where machines can read and write talk to us and answer our questions and natural.

Switch.

But while there's a lot that these AI chatbot can do there are a lot of questions. These chatbot can answer when it comes to the questions about you or your content or your company because they arent personalized.

And it's clear that customers need more personalized AI that can answer questions and provide insights on their own content the company's content to help them find what they need at work.

And with hundreds of billions of pieces of content already start on Dropbox and as a service that's trusted by hundreds of millions of users. We see ourselves is uniquely positioned to build personalized AI at scale.

That's why in June I was really excited to introduce our first generation of AI powered product experiences to help our customers organize their working lives.

I'll start with Dropbox Dash Dash is our AI powered universal search product that connects all of your cloud tools and apps and content to a single search bar that searches everything.

With more of our work spread it costs 100 tabs in the browser a common pain point for knowledge workers is that they spend too much time looking for their work and having to navigate between apps.

Dash connect the major platforms and tools like workspace, Microsoft outlook on it.

Notion many others. It allows users to quickly find everything from one place.

And because dash is powered by machine learning it evolves and gets smarter the more you use it.

We've talked about universal search over the last couple of years since our acquisition of command D and our teams are working hard to build on top of that functionality.

We rolled out to additional features within dash beyond Universal search the first the stacks, which are smart collections for all the cloud docs in your browser.

And similar to how files have folders and songs playlists stacks give you and easily shareable organizational layer for Urls. So that you can seamlessly share multiple things at a time.

Its taxis and machine learning to offer smart suggestions and organized links for you saving you from the process of having to manually save all your links.

The other feature within dash at the start page, which is a single dashboard that lets you access that is universal search via your stacks integrated calendars to start meetings from there and get shortcut through recent work.

So these are closed their browser and restart the computer at the start page picks up where they left off letting users get back to their most important work.

That is currently in closed beta and we've been carefully rolling it out to more users over the summer.

Feedback has been positive and we're seeing healthy activation rates and retention rates.

While we are leveraging our self serve go to market to acquire users. We're also working with our managed sales force to identify SMB customers that can test and used ash as early teens customers.

We're excited to continue scaling dash and iterating on the product based on customer feedback.

Over time, we plan to release more advanced use cases, such as dash answers, where users can ask any question or is it a specific answer about a piece of content instead of having to click through lots of search results or dig through specific files and folders.

I'm looking forward to getting dash in the hands of many more customers over the coming months.

Along with Dropbox Dash in Q2, we also advanced our core product roadmap with the launch of Dropbox AI.

Now Dropbox professional and Dropbox teams users can leverage <unk> AI on the previous page to summarize our content with a single click.

It's 100 page document or even along video.

Users can also ask a question for Dropbox AI to answer based on content within a file and over time, we plan to apply the functionality of the folders and eventually to either his entire dropbox.

We're encouraged by the early engagement from users who have tried dropbox AI for their files and as we increase discovery ability for this new functionality for more users. We're excited to see how dropbox AI can ultimately increase customers' productivity.

We will continue to evaluate the performance on these new AI powered product experiences as well as other in house capabilities, we're building within Dropbox.

And we're not doing this alone.

Last month, we were featured as a global partner for Meadows Lama to launch and we also announced Dropbox ventures to support the next generation of AI start ups.

And as we stay on the forefront of this new AI wave continuing to use AI responsibly, while protecting our customers' privacy is more important than ever.

So in June we publish our AI principles, which guide our teams as we develop AI products and features in the years to come.

Moving to our second objective, which is evolving the existing dropbox file sync and share user experience to seamlessly address customers' workflows around documents and videos.

In Q2, we made progress on a number of areas to improve churn with individuals and drive higher top of funnel activity for our work users.

We also continue driving our companywide effort to deliver a multi product solution integrating a number of our workflow businesses beyond FSS.

First I'll touch on improved churn with individuals.

As we discussed on the past several calls and at the macro environment has become more challenging we saw an uptick in churn amongst our individual users, notably our mobile plus customers.

Some of this was driven by recent mobile operating system changes, which increased transparency around subscriptions and.

It was also due to some areas of Athens stability.

To address the latter issue our team made significant progress in enhancing our tooling and instrumentation to detect and address reliability issues, which helped reverse the sequential declines in mobile churn that we had seen over the prior quarters.

We also made some optimizations, our payment processing to make it easier for customers to keep their wallet up to date, which also drove some modest improvements to individuals' churn.

In addition to these behind the scenes upgrades for our customers, we improve the UX experience and the performance of file uploads.

This led to improvement in upload success in our internal testing has showed that we've regained the number one position for upload speeds for large files.

We also made an improvement to the speed of our camera loads on iOS that increases the speed of our most common upload size by up to 40%.

I'm proud of the team's work here and quickly addressing areas to drive performance and reliability and ultimately deliver a better experience for our customers.

We also remain focused on driving our top of funnel and in Q2, we made a more concerted effort to surface teams and professional plans, resulting in an increase in teams trial starts as well as pro conversions through this more targeted effort.

And while it's important to focus on top of funnel. We also made improvements in driving engagement for teams admin, starting a trial, which are necessary leading indicators in our efforts to increase conversion of these users and ultimately team expansion.

In Q2, we launched a new activation homepage for admins to easily set up the team and learn about the product.

Over time. This homepage will also serve as a jumping off point for dropbox to introduce higher value capabilities, including our document and video workflows and our new AI powered features.

During this environment, where we've seen continue to see contraction tomorrow larger teams customers, who face challenges within their own businesses I am encouraged to see our increased focus on how we can better serve professionals and small teams.

I've talked before about our investments in workflows around videos and documents and the efforts we have made in integrating a number of our businesses and at the core dropbox experience to make it more seamless for customers.

In Q2, we began rolling out an integrated bundle, including FSS docks and sign and PDF editing for the first time to some of our professional users.

Previously, we had sold standalone offerings, such as our pro FSS and E sign as a bundle, but the user experience was disjointed for customers as the two products werent tightly integrated.

I am excited to see our deeper integration efforts provide a more frictionless experience for customers and we'll have more to share next quarter about our multi product strategy.

And while driving multi product attach rates across the dropbox users as a long term opportunity.

To also see some momentum in our Standalone businesses, such as farms left which we acquired late last year and our in house video editing tool replay, which just launched <unk> in April .

As a reminder, <unk> provides an online library of forms and templates for small businesses and individuals.

We saw outperformance in farm Swiss business for the second straight quarter, driven by improved retention and increased account creation through Google Simon.

While forms so it benefits from some seasonality earlier in the year around tax planning, we see opportunities to further leverage <unk> performance marketing engine, and we're continuing to make progress towards rebranding and deeper integration of form so us within Dropbox this year.

And in our video workflows replay has shown a solid start in its first couple of months since we launched it to a wider audience.

We're already seeing some beta customers subscribing to the premium add on and customer satisfaction scores remain high across our user base of creative professionals.

We see a greater opportunity to drive replay adoption as we advance towards our multi product suite offerings and I look forward to sharing more next quarter as part of our multi product update.

In closing, we delivered a solid quarter and introduced some exciting AI powered product experiences to our customers.

While we recognize the macro environment remains uncertain, we are focused on improving the product experience within core dropbox and attaching more value across workflows and AI driven capabilities.

I remain focused on working closely with our product and engineering teams to strengthen our foundation, while innovating for our next act.

And we look forward to sharing more of what we've been building at our upcoming customer conference in October in New York.

It'll be our first major in person customer events since the pandemic and I'm excited for more of you to see our product enhancements up close.

We'll be sharing more details in the coming weeks and I hope to see many of you in person soon.

And with that I'll pass it on to Tim.

Thank you drew.

I'll walk through some financial highlights for Q2 and provide an outlook for Q3.

In 2023, as well as an update on our financial targets for 2024.

Let's start with our second quarter results.

Total revenue in Q2 increased eight 7% year over year to.

Two $622 million, beating our guidance range of 612 $615 million.

Foreign exchange rates provided an approximate $14 million headwind to growth.

On a constant currency basis revenue grew 11, 2% year over year.

The upside to our revenue guidance was driven by outperformance from form Swift as well as the improvement we saw.

Across our individual plans that you mentioned.

Total <unk> for the quarter grew seven 2% year over year.

For a total of $2 5 billion.

On a constant currency basis, <unk> grew 10, 9% year over year.

Primarily driven by form Swift and her team's price increase.

<unk> grew $33 million sequentially, driven by the retention improvements within our individual's plans.

We exited the quarter with 18 million paying users and added approximately 140000.

Net new paying users sequentially, a modest improvement from Q1, driven by some improvement in individuals' churn as compared to the trend in prior quarters as well as an uptick in professional users from our more targeted top of funnel efforts.

Average revenue per paying user for Q2 was $138 94.

Which is flat compared to the first quarter of 2023 as the benefit we saw from a pricing initiative was largely offset by FX headwinds and the continued adoption of our family plan.

<unk> increased by over $5 year over year, driven by the team's pricing increase form swift and a shift to premium plans.

Before we continue with further discussion of our P&L I'd like to note that unless otherwise indicated all income statement figures that mentioned, our non-GAAP and.

And exclude stock based compensation amortization of purchased intangibles certain acquisition related expenses.

Impairments of our real estate assets expenses related to a reduction in force and net gains on equity investments.

Our non-GAAP net income.

It also includes the income tax effects of the aforementioned adjustments.

Moving to our real estate strategy, where we have been taking steps to <unk>, our real estate portfolio as a result of our transition to a virtual first model.

This quarter, we incurred a nominal impairment charge of $2 million due to a small sublease, we executed outside of San Francisco.

Overall, our assumptions regarding our real estate portfolio remain consistent and that we continue to anticipate a softer real estate market over the next couple of years.

We also continue to actively seek steadily since they are considered buyout of the remaining space available within our San Francisco headquarters.

With that let's continue with the second quarter P&L.

Gross margin.

It was approximately 83% for the quarter roughly flat as compared to the second quarter of 2022.

Operating margin was approximately 34% up roughly 200 basis points year over year.

We beat our operating margin guidance by over 250 basis points, mainly due to delayed marketing and project spend.

Following a reduction in force in April as well as our revenue outperformance.

Operating expenses were $302 million up about 3% year over year.

While we did see a partial quarter of cost savings in Q2 from a reduction enforced announced in late April .

This was offset by our annual Merit increases and continued investment in talent supporting our AI efforts as.

As well as marketing spend performs swift.

Net income for the second quarter was $174 million of.

26% versus the second quarter of 2022.

Driven by operating income growth and higher interest income.

Diluted EPS was <unk> 51 per share based on 344 million diluted weighted average shares outstanding.

Up from 38 per share based on 366 million diluted weighted average shares outstanding for the second quarter of 2022.

Moving on to our cash balance and cash flow.

We ended the quarter with cash and short term investments of $1 2 billion.

Cash flow from operations was $188 million in the second quarter down from $210 million in the second quarter.

2022, mostly driven by $34 million in severance payments related to a reduction in force.

Capital expenditures were $3 million during the quarter.

This resulted in quarterly free cash flow of $185 million compared.

Compared to $206 million in Q2 of 2022.

In the quarter, we also added $33 million to our finance leases for data center equipment.

Let's turn to our share repurchase activity.

Q2, we continued to execute against the $1 $2 billion authorization that was approved in 2022 by repurchasing 7 billion shares.

Approximately $154 million.

At the end of the second quarter, we had approximately $419 million remaining under the current authorization.

Additionally, as I will discuss in greater detail shortly we're.

We're pleased to announce today that our board has authorized an additional $1 $2 billion share repurchase program.

I'd now like to share our guidance for the third quarter and provide an update to our full year 2023 guidance.

I will also provide some context on the thinking behind this guidance.

But the third quarter of 2023, we expect revenue to be in the range of 626.

$629 million.

On a constant currency revenue basis, we expect revenue to be in the range of 634.

$637 million.

We are assuming a currency headwind of approximately $8 million in the third quarter.

Which translates to a 130 basis point headwind to year over year growth.

We expect non-GAAP operating margin to be approximately 33%.

This includes roughly a 130 basis point headwind from FX and form Swift.

Finally, we expect diluted weighted average shares outstanding to be in the range of 347 to 352 million shares.

Based on our trailing 30 day average share price.

For the full year 2023.

We are raising the midpoint of our as reported revenue guidance up by $14 $5 million.

Two to $4 87.

The $2 $4 97 billion.

From a previous range of $2 $4 seven zero.

The $2 $4 85 billion.

On a constant.

Currency revenue basis, we are raising by $12 5 million at the midpoint.

To 2525.

To 253 5 billion.

Up from the prior range of 2510.

252 5 billion.

We estimate our full year 2023 currency headwind of approximately $38 million.

Or approximately 160 basis point headwind to growth with a minimal FX impact in Q4.

We now expect foreign Swift to contribute closer to 300 basis points of growth.

Up from our prior forecast of approximately 250 basis points of growth.

We expect gross margin to be approximately 82% up from our prior guidance of $81, 5% to 82%.

We expect non-GAAP operating margin.

Approximately 32% up from our prior guidance.

Of 31% to 32%.

This is inclusive of an approximately 100 basis point headwind from FX and form slips.

We are maintaining our free cash flow guidance of $820 million to $840 million.

This includes cash outflows of approximately $23 million in cash outflows for the 2023 installments of acquisition related deal consideration holdback.

For docs and Mandy.

One time severance payments of approximately $40 million related to a reduction in force.

And consistent with our initial guidance. This includes an approximately $50 million headwind as a result of R&D tax legislation.

As it related to our capital expenditures and additions to finance leases, we are increasing our prior guidance.

In recent years, we have seen users uploading increasing levels of high density files, such as videos and images to our platform.

To address these usage and storage needs, we're adding some extra capacity and upgrading some of our existing infrastructure. This year, which is reflected in our revised guidance.

We now expect our additions to finance leases to be approximately five 5% of revenue.

Up from our prior guidance of approximately 5%.

And we are increasing our cash capex range by $5 million to now expect $30 million.

$40 million in cash Capex in 2023.

Finally, we expect 2023 diluted weighted average shares outstanding to be in the range of 345 to 350 million shares.

Up from our previous guidance range of 340 to 345 million shares.

To share some additional context on this guidance as it relates to revenue we are raising our revenue guidance for 2023, driven by outperformance in Q2 from forms with an improved trends across our individuals plants.

These positive trends are outweighing macro headwinds on our team's plans as well as both docks ensign.

Additionally, and as a reminder, we will be lapping the benefit of our team's price increase in the second half of this year, which is reflected in our guidance.

As it related to operating margins, we are raising our operating margin guidance to approximately 32% up 50 basis points as compared to the midpoint of our prior guidance driven mostly by our revenue outperformance.

As a reminder, we expect to invest some of the savings from a reduction in force towards long term growth initiatives and.

In particular hiring talent skilled in AI and early stage product development.

We also have shifted some project in marketing spend from Q2 into the second half of 2023.

And as a result, we expect that our Q2 operating margins will represent the high mark for the year.

As it related to full year free cash flow, we are maintaining our free cash flow guidance range of $820 million to $840 million.

While we are raising our revenue and operating margin guidance, we are maintaining our free cash flow range due to the higher levels of capex needed to support our recent infrastructure capacity needs.

Additionally, and as a reminder, we still foresee a potential impact to billings later in the year as a result of our reduced levels of head count and marketing investments stemming from our restructuring.

As it related to our share count and plans to return capital to shareholders in the form of share repurchases.

As of the end of Q2, we had approximately $419 million remaining on our existing $1 $2 billion share buyback authorization.

We remain committed to allocating a significant portion of our annual free cash flow to share repurchases.

Insistent with this strategy, we are pleased to announce that our board has authorized an additional $1 2 billion in.

And share repurchases.

This brings our total current capacity under our share repurchase program to approximately $1 6 billion.

As a reminder, our buyback our buyback program is structured to buy more shares at lower price points.

And as a result of our recent share price performance, we have adjusted our full year share count guidance Accordingly.

Lastly, as it related 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.

As you can see we are operating at or above these margin levels. This year driven by efficiencies in our data center infrastructure and savings from a reduction in force.

While we are not offering more specific 2020 for guidance at this time.

We expect to remain at the high end of these ranges next year.

Consistent with what we shared last quarter, we expect to invest a portion of our savings from our recent workforce reduction.

Towards our long term initiatives, including Dropbox Dash and Dropbox AI.

As we rollout these products to a broader audience of users and gain clarity on the customer response, we will assess the appropriate levels of investment to support their momentum.

And therefore, we are maintaining our range at this time.

As it related to our $1 billion of annual free cash flow by 2024.

We're maintaining our target at this time.

While we exceeded our revenue and operating margin guidance in the second quarter, we continued to face significant headwinds from exogenous factors such as R&D tax legislation, which came to light. After we initially developed our long term targets.

We are also keeping in mind that the potential for further investment that I just mentioned where.

We intend to ensure that we're appropriately funding our long term growth.

In short we remain focused on achieving our $1 billion target. However, we still have work to do.

In conclusion, we continue to drive foundational improvements to our core business, while carefully investing towards new AI powered products that we're excited to roll out to more customers.

While the macro environment remains uncertain, we will stay 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.

Thank you, ladies and gentlemen to ask a question you will need to press star one on your telephone and wait planning to be announced to withdraw your question Press Star One again, please standby, while we compile the Q&A roster.

And our first question coming from the line of.

Mr <unk> with RBC capital markets. Your line is open.

Wonderful thanks, guys. So much for taking my questions.

Two I wanted to first start maybe true if you could go a little bit deeper into your strategy around dash and particularly you had mentioned dash answers.

An area you want to get into later can you talk a little bit about kind of some of the use cases and maybe more importantly.

The use case, you're trying to solve or at least the way it sounds to us seems like a big pain point for a lot of customers I know the idea of search has been important to your per year. So this isn't brand new work coming out of nowhere, but how do you think about positioning yourself to your customers as the center of gravity for solving that problem and driving that.

Adoption of these solutions.

I think especially just given maybe some of the learnings out of out of the new Dropbox in the past and then I've got a quick follow up.

Great. Thanks.

Thanks Rajiv.

So we're really excited about dash and I see it as a natural evolution for Dropbox to go from organizing all your files to organizing everything Oregon, including your cloud content.

And so the origin.

Right.

Alright.

Think about customer problem I think within the company.

I experienced these problems I think we all do words.

You know you were looking at a documented a day ago and you know its there, but you can't find it.

And the problem is really similar to the one I started with which is like my stuff is scattered across all these myself the scattered everywhere and back then back when we started it was my files are scattered across all these different devices and operating systems.

And today those are 100 files on your desktop have become a hunter tabs in your browser, so and Theres really is missing organizing layer for your cloud content.

And that search is broken right, we have like instead, where we used to have one search box now we got 10 is with all the different apps and platforms that we use that <unk> 10 search boxes that each search 10% of your of your stuff.

And and Theres, a missing organizing later than that.

There is no persistence and there's no there's no kind of concept of like collections for links.

Could go on about the pain points, but we see this as kind of another opportunity hidden in plain sight, that's very reminiscent of where dropbox started which is.

That theirs is missing organizing layer in a better way of doing things and we see it as a universal customer need.

In many ways that the challenges that people have with with organizing their cloud content are much greater than the challenge that they have with file sync and share. So we see it is.

So much bigger.

A huge Tam.

On a much greater unmet need now.

And then the building onto as we've been working in this direction for a long time, but then the emergence of large language models and generative AI adds another layer on top of that which is.

The ability to interact and in natural language, so and to change the paradigm of search entirely so.

As people as we've all used chat GPT, it's pretty amazing what these regenerative AI can do but there's a lot of questions that can answer if you think about it so because not personalized or things I chat GBT you can't really tell you. What if you have a question like what's my passport number or is that presentation I did last year on last year's product lines or things like that.

CECI beauty can answer that because it's not connected to your information. So we see a big opportunity for dropbox more broadly to provide personalized AI.

We have this audience of millions of users who have already entrusted us with a lot of their most important information.

We've been in June in our launch we launched.

We also introduced Dropbox AI, which is allows you to just summarize large documents or even large videos ask questions and natural language provided that kind of personalized chatbot AI experience. In addition to dash, where we're doing the same thing with dash answers for all of your content.

So we're very excited about this.

Right about having the launch it's in closed beta right now and where.

Continuing to iterate on the experience and gets better every week and.

I look forward to getting in more people's hands.

And I think thanks for that position.

Yes.

So is that what's different I think there are a couple of other aspects like what's the positioning or how do we.

You'd be kind of center of gravity I think it's a natural because we have that trusted relationship with our customers and we have distribution we have scale.

In many cases, our customers are already putting their most important files and Dropbox I think it's a pretty natural evolution for existing file sync and share users to adopt dash and then but then when you look at the market of a 1 billion knowledge workers and none of them have a solution to their challenges around organizing cloud content. So we think this is a significant.

The opportunity to make our our Tam many multiples of what it is now.

And as far as positioning it again that I think it's a natural evolution in elastic.

We've incorporated a lot of lessons from.

Past product efforts, but I'd say one thing that's really different this time is the emergence of AI.

And we can build products that we wanted to build for a long time, but didnt have the technical building blocks or what sort of the missing piece of the large language model.

<unk> is a big deal and then I'd say with dash.

It's a very focused experience reduce search we do smart collections.

Start page for work concept.

And we've had a much more iterative approach.

We're we've been working with our customers and Dash is also.

A key ingredient of that was an acquisition of <unk>, which we did a few years ago. So.

We continue to iterate and and.

And drawn the lessons from past experiences and we were really excited about getting dash in the rest of our portfolio in more people's hands.

Very thorough I guess, just a quick follow up as we think about generative AI I know, it's too early to give prices around monetization, but I want to better understand your monetization strategy is this something that you maybe gateway all behind the higher tier skus and use that uses.

Incentive to drive upgrades are there certain modules that you might consider monetizing discretely is this more about driving value and therefore, youre going to get more new customers and better gross retention just.

It really just to understand your philosophy around monetization without having to put numbers around it.

Sure. So I mean, there's gonna be a portfolio of applications of AI and I think the way I think about it's pretty similar to you could sort of replace some machine learning and there's a lot of applications. The machine learning even before launch language models and some are just table Stakes features of the product.

Some are available only in higher tier plans and then some are explicit add ons and we expect that to be true for AI and that's already the case to some extent, so dropbox AI, which is an add on.

To the right, which is part of the Dropbox files sync and share product is only available to to pay customers. It's an alpha right now so we're continuing to iterate on it.

And then.

Products like Dropbox Dash.

Or or when you look at the more broadly at other companies some theres a lot of different approaches from.

Integrating AI AI functionality in paid skus or higher tier plans or you see what Microsoft like having an add on.

For AI capabilities.

It's a little too soon for us to share exactly what we're doing but we're certainly thinking about it as a portfolio and making sure that we're both creating the right amount of value for most users and then making sure that we design, our pricing and packaging to best capture the value that we create.

And real brief.

<unk>. This is Tim so our focus this year, particularly on dash is on bringing a quality product to market and driving customer adoption. So that said, we expect it will take several quarters before we start seeing a contribution to revenue from dash.

Alright wonderful that's really helpful. Thanks drew and Ken.

Yeah.

Thank you and our next question coming from the line of Mark Murphy with Jpmorgan. Your line is open.

Great. Thank you for taking the question. This is <unk> on for Mark Murphy with Jpmorgan Kim Other TMT conference. This year you shared some color around our customer survey, indicating about I think 8% of existing customer awareness for dropbox side could.

Could you please provide us with some additional context on the progress Dropbox is making in terms of spreading that awareness of the full capabilities of the platform and how that might be driving incremental cross sell or upsell opportunities.

Sure. Good question. So we have been working towards bundles for a while where we're excited to roll those out soon and to exactly to your point. We did recently run a survey where roughly half of our users want capabilities, such as esignature, but less than 10% of our users now we offer it.

So we do have an opportunity to solve these problems for our customers and we've addressed some foundational items such as rolling out a single legal in terms of service and a unified customer identity and we're now testing a bundle that does include file sync and share sign and dachshund for professional users where early signals on conversion are positive.

And then we're working on our team's version of these bundles.

We will have more to share on that soon so excited that we are making progress on this dimension.

Great. Thank you Tim and then maybe a quick follow up is just in terms of the macro I'm curious.

We havent say relative to Q1, if the macro is fairly consistent or would you say that there's pockets of incremental improvement or worsening just any color that you can provide on kind of how the macro is trended sequentially.

Sure so as far as what we're seeing today I would say the macro trends are roughly consistent with what we've observed over the past couple of quarters.

On one hand, we continue to see elevated price sensitivity and downhole pressure from our teams customers, particularly those that have had layoffs themselves.

And then sign and docs and are also continuing to face macro related headwinds on the other hand, we are seeing some positive trends around your individual skus.

Particularly on retention, though our sense is that this is largely due to actions that we have taken as opposed to a change in macro dynamics and we're also seeing continued improvement in sign up trends as a result of our rollout of Google one tap and other streamline on boarding processes, where our guidance factors in these latest trends.

Yeah.

Great. Thank you and congrats on the results.

Thank you.

Thank you and our next question coming from the line of Steve Enders with Citi. Your line is now open.

Yeah.

Oh, great. Thanks for thanks for taking the questions here.

I guess I wanted to follow on.

Last quarter and now there's a bigger push on the hiring side too to higher AI.

And help kind of diversifying.

The employee base I guess, how are you finding the hiring environment today for.

Some days with with expertise there.

I guess, how should we view those incremental hiring kind of like layering into the out layer into the model through the rest of the year.

Sure I can start.

We're finding it a pretty fertile environment and having a lot of success hiring in.

We find.

Well, it's been helpful to have things like dash announced and be able to talk about these things more broadly.

And all the other factors like our virtual first model of being able to hire.

More flexibly outside of the major tech hubs is another big advantage.

And so we've been building out a lot of leadership teams.

For these AI.

Skill sets and then.

We'll have a blend of both hiring experienced.

Hi folks from industry, but then also when you think about other shifts to the internet or mobile or the cloud.

A lot of the best mobile engineers our.

Engineers are or pick your favorite example started out as great journalist engineers before that so we were also trading up the company, there's a lot of enthusiasm.

And interest in <unk>.

Turning Oliver and making all of our engineers.

Sure.

And skilled so well.

We will do both and we're seeing good progress.

And maybe just from a model perspective, so for this year, we're setting our operating margin guidance to be approximately 32%.

And that's up 50 basis points from the midpoint of our prior guidance of 31% to 32% driven by the revenue outperformance.

And we still do expect to invest some of the savings from our reduction in force towards longer term growth initiatives, including this hiring and talent skilled in AI and early stage product development.

And then we also have shifted some project in marketing spend into the second half. So as a result, we do expect that our Q2 operating margins will be the high mark for the year.

Okay.

That's helpful.

And then maybe on farms left I mean, good to see continued.

Our performance here in the quarter I guess two questions.

On that I guess, firstly I guess what is it thats helping.

Drive the performance above your expectations and secondly.

On the updated guide it looks like.

Is that is coming from Alex on the topline is coming from.

The form Swift.

Performance here I guess is that the right way to be thinking about that and secondarily.

Guess what.

What are the implications for how the rest of the business is executing versus your expectations.

Sure. So we're raising the midpoint of our constant currency guidance range up by about $12 5 million for the full year I would say, that's mostly driven by the Q2 outperformance as well as some better trends in individuals'.

Conversely, as we know we continue to see macro headwinds weighing on our teams customers as well as both docks ensign.

We're not assuming an improvement in those trends now again, Forbes Swift did outperform our expectations for the second quarter in a row. So certainly pleased with their progress.

Are seeing better than expected retention on their side, where the team implemented some UI and product enhancements and then the association with a Dropbox brand also seems to be helping.

Okay perfect. Thanks for thanks for taking the questions.

Yeah.

Thank you.

And our next question coming from the line of Michael Funk with Bank of America. Your line is now open.

Yes. Thank you for the question guys.

I appreciate it.

Digging a bit more on the on the churn improvement sequentially. During the quarter. I think previously you mentioned <unk> implemented some new customer retention initiatives. So love to get some more color around that and then also our expectation for how much more churn could improve from here as we anniversary the price increase.

Last year.

Yes, sure Tim I can start to feel free to jump in so we saw our churn rates remain roughly consistent with last quarter with ongoing macro pressure on our teams customers offset by some improvement with individuals we continue to see heightened churn amongst our teams customers, particularly those that have gone through layoffs themselves.

Now on the positive side, we did see turn stabilize for individual plans, where the team worked on making the product easier to use improving upload speeds and reducing upload delays. They also introduced payment processing alerts to help users keep their credit card information up to date.

So overall, our churn rate does remain in the low teens.

Okay, and then and then the impact on our <unk> from the retention efforts.

How should we think about I know I know it was flat quarter over quarter, but how should we think about the impact on the RFP from retention.

Sure maybe just to walk through some of the <unk> dynamics, we saw in the quarter. So on a year over year basis, <unk> was up about $5 landing at about $139, Let's say that was driven by a few different factors so benefits from our pricing initiative, which continues to flow through.

As well as the shift to higher priced plans that was about $7 contribution.

The acquisition of forms with that's about a $2 contribution. This is partially offset by FX and the continued growth in our family plan.

Okay, and then really quickly on the on our repurchase and a great incremental $1 2 billion. So about one six total my math about 18%.

Of the cap.

Any any commentary on the adjustment to the year end share count barrel.

And how we should think about.

The pace of share of share repurchase and then kind of the signaling.

Of the new repurchase program.

Sure. Good question. So our buyback program is structured to buy more shares at lower price points and as a result of our recent share price performance. We've adjusted our full year share count guidance. Accordingly, we do continue to repurchase shares as part of our <unk>, one plan, where our updated share count guidance gives the.

Our best sense of our future repurchase expectations.

We do of course continue to expect to allocate a significant portion of our annual free cash flow to share repurchases.

On an ongoing basis with the intention of reducing our share count and the new authorization is just a continuation of that.

It reflects our commitment to that program.

Great. Thank you all for the time Tonight.

Yes.

Okay.

Thank you and our next question coming from the line of Brent Thill with Jefferies. Your line is open.

Hello.

This is elan liana <unk> on for Brent and Bill Thanks for taking my question too.

Two things on my end.

Sure.

What do you think about the sustainable growth rate of the business and how do you break that out between core FSS and the other assets and secondly, given that you raised the full year guide by more than the beat in the quarter are you factor in getting a greater sense of optimism in terms of macro for the.

Back half of the year or is this if you could talk through the factors that went into the full year guide that would be great.

Okay.

Sure maybe on guidance philosophy, I would say, we're being consistent with our historical approach or a macro view is largely the same as it was last quarter not assuming an improvement in the economy in our guidance. We are assuming that the same trends. We saw in Q2, we will continue including positive trends from our individual Skus, where again we took.

Direct action to improve those plans of course this is somewhat offset by sluggish demand within our team Skus and we do also remain mindful of our reduction in force and the potential impact. This could have on our billings given our reduced levels of investment in head count and marketing for all of these considerations are factored into guidance now as far as your <unk>.

Earlier part of your question on our long term thinking not providing any revenue guidance beyond 'twenty three at this time, certainly keeping a close eye on the evolving macro environment as we navigate our path forward. We are also launching several new product experiences later this fall such as Dropbox dash and bundles.

Well, we will have a better idea of their revenue contribution after we gain initial customer signals, where ultimately we're very focused on driving a healthy balance of growth and profitability as we pursue our financial targets.

Yeah.

Thank you.

Sure.

Thank you and our next question coming from the line of Jacob Stifel with Goldman Sachs. Your line is now open.

Hi, This is Jacob Stifel on for Kash Rangan. Thanks for taking the question a couple of questions from me.

So dropbox has expanded the product portfolio recently.

Dash Dropbox AI docs on replay.

Can you touch on how those offerings might be doing relative to the core FSS offering dropbox.

Dropbox was founded on and then additionally.

How are you thinking through.

Hiring in the near term, specifically quota carrying reps and can you touch on maybe how the self service channel has fared.

<unk> on a sequential and on a year over year basis.

Sure.

So we are really pleased with the progress we've been making in broadening the portfolio as you kind of touched on so I mean, we started with FSS, but we saw that our customers had a bunch of workflow needs around the content in dropbox and so that's how that's why you've seen us.

Expand into.

The document workflows with things like form Swift and docks and in <unk>.

And increasingly we're doing more with video with replay and capture as we've seen.

Folks it up initially adopted dropbox for those use cases are kind of duck tape something together and then we found we could build a more targeted product for that.

For that use case, and then Youre seeing is as our customers are as many work workflows have shifted from files and desktop apps to cloud tools in the browser.

And you need to organize all your cloud content and fix problems with search and an organization and then.

And then bring intelligence into the work experience. So that's kind of the motivation behind it and.

And as far as how those products are doing I think probably don't have much to add from the from beyond the comments we've already made.

But we're very excited about the potential, especially for things like dash and Dropbox AI.

And I wouldn't say, there's much of a shift in how we're thinking about hiring quota carrying reps I mean, as a reminder, 90% of our business is self serve.

And then we have a targeted outbound unmanaged motion to help grow those.

To grow those accounts once they reach a certain threshold.

And.

And we're thinking about how do we continue to scale the go to market and get the best of both of those worlds from a go to market standpoint.

And get ready to be scaling a lot of our new products.

And then briefly I think you asked about the performance of self serve I think it largely mirrors the.

The trends that drew and I have been talking about where on the team side, we're seeing price sensitivity on the individual side, we saw some improvement in retention that we've touched on.

Awesome. Thank you so much.

Okay.

Thank you.

And I see we have no further questions at this time.

Ladies and gentlemen. This concludes today's conference call. You may disconnect at this time and have a wonderful day.

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Good afternoon, ladies and gentlemen, thank you for joining Dropbox second quarter 2023 earnings conference call.

All participants will be in a listen only mode.

After today's presentation there'll 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 website. Following this call.

I'll now turn the call over to Connie <unk> head of Investor Relations. One Dropbox is the Cooper. Please go ahead.

Yeah.

Thank you good afternoon, and welcome to Dropbox, the second quarter 2023 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 third quarter and fiscal year 2023, and our expectations regarding our revenue growth profitability operating margin and free cash flow as well as our expectations regarding our.

Business assets product strategies technology employees users' demand industry trends and the macroeconomic environment.

These statements are subject to risks and uncertainties that could cause actual results to differ materially. They are also 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 today's earnings.

And in our quarterly report on Form 10-Q filed with the SEC.

We will 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 Dot Com I would now like to turn the call over to Dropbox as co founder and Chief Executive Officer Drew Houston.

No.

Thanks, Karen and good afternoon, everyone. Welcome to our Q2 2023 earnings call. Joining me today is Tim <unk>, our Chief Financial Officer.

And I'll first share our business and product highlights from the quarter and then Tim will review, our Q2 financial results and provide guidance for the rest of the year.

I am pleased to report that we had a solid quarter once again, beating our guidance across all metrics led by revenue outperformance in <unk> and so the recovery within our individuals' skus as the progress we saw in late Q1 continued into Q2.

However, we're still navigating a difficult macro environment that continues to impact our teams customers and pressures for us in our docks and assign businesses.

Before I walk through the highlights from the quarter in more detail I want to quickly remind you of our primary business objectives that I outlined last quarter.

The first objective is around building AI powered product experiences to help our customers organize their working lives.

Our company mission that Dropbox is to design, a more enlightened way of working and I'm proud that we've accelerated our road map here with Dropbox Dash and our progress in AI, which I'll discuss in a minute.

Our second objective is continuing to evolve the core file sync and share experience to specifically address customers' workflows around documents and videos.

Much of the work here, it's been foundational focusing on driving retention and conversion and I'll share more about the progress we made during the quarter.

So with that backdrop I'll touch on what we're working on to drive these objectives, starting with our first objective of building AI powered product experiences to improve knowledge work.

As we discussed on our last call. We took some important actions in Q2 to better align our investment strategy with our long term growth initiatives and to drive product velocity against our AI roadmap.

While dropbox has been investing in AI and machine learning technology for many years, we're all witnessing an unprecedented wave of innovation around generative AI and large language models.

And seemingly overnight, we now live in a world where machines can read and write talk to us and answer our questions and natural language.

But while there is a lot that these AI chat bots can do there are a lot of questions. These chat bots can't answer when it comes to the questions about you or your content or your company because they arent personalized.

And it's clear that customers need more personalized AI that can answer questions and provide insights on their own content their company's content to help them find what they need at work.

And with hundreds of billions of pieces of content already stored on Dropbox and as a service that is trusted by hundreds of millions of users. We see ourselves is uniquely positioned to build personalized AI at scale.

That's why in June I was really excited to introduce our first generation of AI powered product experiences to help our customers organize their working lives.

I'll start with Dropbox Dash dash.

<unk> is our AI powered universal search product that connects all of your cloud tools and apps and content to a single search bar that searches everything.

With more of our work spread it costs 100 tabs in the browser a common pain point for knowledge workers is that they spend too much time looking for their work and having to navigate between apps.

Dash connect to major platforms and tools like Google workspace in Microsoft outlook on a notion many others. It allows users to quickly find everything from one place.

And because dash is powered by machine learning it evolves and gets smarter the more you use it.

We've talked about universal search over the last couple of years since our acquisition of command.

And our teams are working hard to build on top of that functionality.

We rolled out to additional features within dash beyond Universal search the first the stacks, which are smart collections for all the cloud docs and your browser and.

And similar to how files have folders and Fox have platelets stacks give you and easily shareable organizational layer for your Urls. So that you can.

And seamlessly share multiple things at a time.

And sexy and machine learning to offer smart suggestions and organized links for you saving you from the process of having to manually save all your links.

The other feature within dash at the start page, which is a single dashboard that lets you access that is universal search due to your stacks integrated calendars to start meetings from there and get shortcuts to recent work.

So these are closed their browser and restart the computer at the start page picks up where they left off letting users get back to their most important work.

Dash is currently in closed beta and we've been carefully rolling it out to more users over the summer.

Early feedback has been positive and we're seeing healthy activation rates and retention rates.

While we are leveraging our self serve go to market to acquire users. We're also working with our managed sales force to identify SMB customers that can test and use dash as early teams customers.

We're excited to continue scaling dash and iterating on the product based on customer feedback.

Over time, we plan to release more advanced use cases, such as dash answers, where users can ask any question or is it a specific answer about a piece of content instead of having to click through lots of search results or dig through specific files and folders.

I'm looking forward to getting dash in the hands of many more customers over the coming months.

Along with Dropbox Dash in Q2, we also advance our core product roadmap with the launch of Dropbox AI now.

Now Dropbox professional and Dropbox teams users can leverage Dropbox AI on the previous page to summarize our content with a single click whether its a 100 page document or even along video.

Users can also ask a question for Dropbox AI to answer based on constant within a file and over time, we plan to apply this functionality the folders and eventually the users' entire dropbox.

We're encouraged by the early engagement from users who have tried dropbox AI for their files and as we increased discovery ability for this new functionality for more users. We're excited to see how dropbox AI can ultimately increase customer productivity.

We will continue to evaluate the performance on these new AI powered product experiences as well as other in house capabilities, we're building within Dropbox.

And we're not doing this alone.

Monthly were featured as a global partner for Meadows Lama to launch and we also announced Dropbox ventures to support the next generation of AI startups.

And as we stay on the forefront of this new AI wave continuing to use AI responsibly, while protecting our customers' privacy is more important than ever.

So in June we publish our AI principles, which guide our teams as we develop AI products and features in the years to come.

Moving to our second objective, which is evolving that existing dropbox file sync and share user experience to seamlessly address customers' workflows around documents and videos.

In Q2, we made progress on a number of areas to improve churn with individuals and drive higher top of funnel activity for our work users.

We also continue driving our company wide effort to deliver a multi product solution integrating a number of our workflow businesses beyond FSS.

First I will touch on improved churn with individuals.

As we discussed on the past several calls and as the macro environment has become more challenging we saw an uptick in churn amongst our individual users, notably our mobile plus customers.

Some of this was driven by recent mobile operating system changes, which increased transparency around subscriptions and.

Some was also due to some areas of App and stability.

To address the latter issue our team made significant progress in enhancing our tooling and instrumentation to detect and address reliability issues, which helped reverse the sequential declines in mobile churn that we had seen over the prior quarters.

We also made some optimizations are on payment processing to make it easier for customers to keep their wallet up to date, which also drove some modest improvements to individuals' churn.

In addition to these behind the scenes upgrades for our customers, we improved the UX experience and the performance of file uploads.

This led to improvement in upload success in our internal testing has showed that we've regained the number one position for upload speeds for large files.

We also made an improvement to the speed of our camera uploads on iOS that increases the speed of our most common upload size by up to 40%.

I am proud of the team's work here and quickly addressing areas to drive performance and reliability and ultimately deliver a better experience for our customers.

We also remain focused on driving our top of funnel and in Q2, we made a more concerted effort to surface teams and professional plans, resulting in an increase in teams trial starts as well as pro conversions through this more targeted effort.

And while it's important to focus on top of funnel. We also made improvements in driving engagement for teams admin, starting a trial, which are necessary leading indicators in our efforts to increase conversion of these users and ultimately team expansion.

In Q2, we launched a new activation homepage for admins to easily set up the team and learn about the product.

Over time. This homepage will also serve as a jumping off point for dropbox to introduce higher value capabilities, including our document and video workflows and our new AI powered features.

During this environment, where we've seen continue to see contraction tomorrow larger teams customers, who face challenges within their own businesses I'm encouraged to see our increased focus on how we can better serve professionals and small teams.

I've talked before about our investments in workflows around videos and documents and the efforts we've made in integrating a number of our businesses into the core dropbox experience to make it more seamless for customers.

In Q2, we began rolling out an integrated bundle, including FSS docks and sign and PDF editing for the first time to some of our professional users.

Previously, we had sold standalone offerings, such as our pro FSS and E sign as a bundle, but these are experience was disjointed for customers at the two products Werent tightly integrated.

I'm excited to see our deeper integration efforts provide a more frictionless experience for customers and we'll have more to share next quarter about our multi product strategy.

And while driving multi product attach rates across the dropbox users as a long term opportunity.

To also see some momentum in our Standalone businesses, such as <unk>, which we acquired late last year and our in house video editing tool replay, which just launched <unk> in April .

As a reminder, <unk> provides an online library of forms and templates for small businesses and individuals.

We saw outperformance in farm Swiss business for the second straight quarter, driven by improved retention and increased account creation through Google sign it.

While forms so it benefits from some seasonality earlier in the year around tax planning, we see opportunities to further leverage <unk> performance marketing engine, and we're continuing to make progress towards rebranding and deeper in the integration of form so us within Dropbox this year.

And in our video workflows replay has shown a solid start in its first couple of months since we launched it to a wider audience.

We're already seeing some beta customers subscribing to the premium add ons and customer satisfaction scores remain high across our user base of creative professionals.

We see a greater opportunity to drive replay adoption as we advance towards our multi product suite offerings that I look forward to sharing more next quarter as part of our multi product update.

In closing, we delivered a solid quarter and introduce some exciting AI powered product experiences to our customers.

While we recognize the macro environment remains uncertain, we are focused on improving the product experience within core dropbox and attaching more value across workflows and AI driven capabilities.

We remain focused on working closely with our product and engineering teams to strengthen our foundation, while innovating for our next act.

And we look forward to sharing more of what we've been building at our upcoming customer conference in October in New York.

It'll be our first major in person customer events since the pandemic and I am excited for more of you to see our product enhancements up close.

We will be sharing more details in the coming weeks and I hope to see many of you in person soon.

And with that I'll pass it on to Tim.

Thank you drew.

I'll walk through some financial highlights for Q2 and provide an outlook for Q3 and 2023 as well as an update on our financial targets for 2024.

Let's start with our second quarter results.

Total revenue in Q2 increased eight 7% year over year.

$622 million, beating our guidance range of 612 $615 million.

Foreign exchange rates provided an approximate $14 million headwind to growth.

On a constant currency basis revenue grew 11, 2% year over year.

The upside to our revenue guidance was driven by outperformance from form Swift as well as the improvement we saw.

Across our individual plans that drew mentioned.

Total <unk> for the quarter grew seven 2% year over year.

For a total of $2 5 billion.

On a constant currency basis, <unk> grew 10, 9% year over year.

Similarly, driven by form Swift and her team's price increase.

<unk> grew $33 million sequentially, driven by the retention improvements within our individuals' plants.

We exited the quarter with 18 million paying users and added approximately 140000 net new paying users sequentially a modest improvement from Q1, driven by some improvement in individuals' churn as compared to the trend in prior quarters as well as an uptick in professional users.

From a more targeted top of funnel efforts.

Average revenue per paying user for Q2 was $138 94.

Which is flat compared to the first quarter of 2023 as the benefit we saw from a pricing initiative was largely offset by FX headwinds and the continued adoption of our family plan.

<unk> increased by over $5 year over year, driven by the team's pricing increase form swift and a shift to premium plans.

Before we continue with further discussion of our P&L I'd like to note that unless otherwise indicated all income statement figures I've mentioned, our non-GAAP and.

And exclude stock based compensation amortization of purchased intangibles certain acquisition related expenses.

Impairments of our real estate assets expenses related to a reduction in force and net gains on equity investments.

non-GAAP net income.

<unk> also includes the income tax effects of the aforementioned adjustments.

Moving to our real estate strategy, where we have been taking steps to <unk>, our real estate portfolio as a result of our transition to a virtual first model.

This quarter, we incurred a nominal impairment charge of $2 million due to a small sub lease we executed outside of San Francisco.

Overall, our assumptions regarding our real estate portfolio remain consistent and that we continue to anticipate a softer real estate market over the next couple of years.

We also continue to actively seek sublicense and consider buyout of the remaining space available within our San Francisco headquarters.

With that let's continue with the second quarter P&L.

Gross margin.

It was approximately 83% for the quarter roughly flat as compared to the second quarter of 2022.

Operating margin was approximately 34% up roughly 200 basis points year over year.

We beat our operating margin guidance by over 250 basis points, mainly due to delayed marketing and project spend.

Following a reduction in force in April as well as our revenue outperformance.

Operating expenses were $302 million up about 3% year over year.

While we did see a partial quarter of cost savings in Q2 from a reduction enforced announced in late April This was offset by our annual merit increases and continued investment in talent supporting our AI efforts.

As well as marketing spend performs swift.

Net income for the second quarter was $174 million up 26% versus the second quarter of 2022.

Driven by operating income growth and higher interest income.

Diluted EPS was <unk> 51 per share based on 344 million diluted weighted average shares outstanding.

Up from 38 per share based on 366 million diluted weighted average shares outstanding for the second quarter of 2022.

Moving on to our cash balance and cash flow.

We ended the quarter with cash and short term investments of $1 2 billion.

Cash flow from operations was $188 million in the second quarter down from $210 million in the second quarter.

Of 2022, mostly driven by $34 million severance payments related to a reduction in force.

Capital expenditures were $3 million during the quarter.

This resulted in quarterly free cash flow of $185 million.

Compared to $206 million in Q2 of 2022.

In the quarter, we also added $33 million to our finance leases for data center equipment.

Let's turn to our share repurchase activity.

In Q2, we continue to execute against the $1 $2 billion authorization that was approved in 2022 by repurchasing 7 billion shares.

Spending approximately $154 million.

At the end of the second quarter, we had approximately $419 million remaining under the current authorization.

Additionally, as I will discuss in greater detail shortly.

Pleased to announce today that our board has authorized an additional $1 2 billion.

Share repurchase program.

I would now like to share our guidance for the third quarter and provide an update to our full year 2023 guidance.

I will also provide some context on the thinking behind this guidance.

But the third quarter of 2023, we expect revenue to be in the range of 626.

$629 million.

On a constant currency revenue basis, we expect revenue to be in the range of 634 to.

$637 million.

We are assuming a currency headwind of approximately $8 million in the third quarter, which translates to a 130 basis point headwind to year over year growth.

We expect non-GAAP operating margin to be approximately 33%.

This includes roughly a 130 basis point headwind from FX and form Swift.

Finally, we expect diluted weighted average shares outstanding debate in the range of 347 to 352 million shares.

Based on our trailing 30 day average share price.

For the full year 2023.

We are raising the midpoint of our as reported revenue guidance up by $14 $5 million.

2% to 487% the.

Two $4 97 billion.

From a previous range of $2 $4 seven zero.

The $2 $4 85 billion.

On a constant currency revenue basis, we are raising by $12 $5 million at the midpoint.

To 25252.

To 253 5 billion.

Up from the prior range of $2 510.

252 5 billion.

We estimate our full year 2023 currency headwind of approximately $38 million.

Or approximately 160 basis point headwind to growth with a minimal FX impact in Q4.

We now expect foreign Swift to contribute closer to 300 basis points of growth.

From our prior forecast of approximately 250 basis points of growth.

We expect gross margin to be approximately 82% up from our prior guidance of 81, 5% to 82%.

We expect non-GAAP operating margin to be approximately 32% up from our prior guidance.

Of 31% to 32%.

This is inclusive of an approximately 100 basis point headwind from FX and inform swift.

We are maintaining our free cash flow guidance of $820 million to $840 million.

This includes cash outflows of approximately $23 million in cash outflows for the 2023 installments of acquisition related deal consideration holdback.

For <unk> and <unk>.

One time severance payments of approximately $40 million related to a reduction in force.

And consistent with our initial guidance. This includes an approximately $50 million headwind as a result of R&D tax legislation.

As it related to our capital expenditures and additions could finance leases, we are increasing our prior guidance.

In recent years, we have seen users uploading increasing levels of high density files, such as videos and images to our platform.

To address these usage and storage needs, we're adding some extra capacity and upgrading some of our existing infrastructure. This year, which is reflected in our revised guidance.

We now expect our additions to finance leases to be approximately five 5% of revenue.

Up from our prior guidance of approximately 5%.

And we're increasing our cash capex range by $5 million to now expect $30 million 40.

$40 million in cash Capex in 2023.

Finally, we expect 2023 diluted weighted average shares outstanding to be in the range of 345 to 350 million shares.

Our previous guidance range of 340 to 345 million shares.

To share some additional context on this guidance as it relates to revenue we are raising our revenue guidance for 2023, driven by outperformance in Q2 from former Swift and improved trends across our individuals' plants.

These positive trends are outweighing macro headwinds on our team's plans as well as both <unk> and <unk>.

Additionally, and as a reminder, we will be lapping the benefit of our team's price increase in the second half of this year, which is reflected in our guidance.

As it related to operating margins, we are raising our operating margin guidance to approximately 32% up 50 basis points.

As compared to the midpoint of our prior guidance driven mostly by our revenue outperformance.

As a reminder, we expect to invest some of the savings from a reduction in force towards long term growth initiatives.

In particular hiring talent skilled in AI and early stage product development.

We also have shifted some project in marketing spend from Q2 into the second half of 2023.

And as a result, we expect that our Q2 operating margins will represent the high mark for the year.

As it related to full year free cash flow, we are maintaining our free cash flow guidance range of $820 million to $840 million.

While we are raising our revenue and operating margin guidance, we are maintaining our free cash flow range due to the higher levels of capex needed to support our recent infrastructure capacity needs.

Additionally, and as a reminder, we still foresee a potential impact to billings later in the year as a result of our reduced levels of head count and marketing investments stemming from our restructuring.

As it related to our share count and plans to return capital to shareholders in the form of share repurchases.

As of the end of Q2, we had approximately $419 million remaining on our existing $1 $2 billion share buyback authorization.

We remain committed to allocating a significant portion of our annual free cash flow to share repurchases.

And consistent with this strategy. We are pleased to announce that our board has authorized an additional $1 2 billion.

And share repurchases.

This brings our total current capacity under our share repurchase program to approximately $1 6 billion.

As a reminder, our buyback our buyback program is structured to buy more shares at lower price points.

And as a result of our recent share price performance, we have adjusted our full year share count guidance Accordingly.

Lastly, as it related 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.

As you can see we are operating at or above these margin levels. This year driven by efficiencies in our data center infrastructure and savings from a reduction in force.

While we are not offering more specific 2020 for guidance at this time we.

We expect to remain at the high end of these ranges next year.

Consistent with what we shared last quarter, we expect to invest a portion of our savings from our recent workforce reduction.

Towards our long term initiatives, including Dropbox Dash and Dropbox AI.

As we rollout these products to a broader audience of users and gain clarity on the customer response, we will assess the appropriate levels of investment to support their momentum.

Therefore, we are maintaining our range at this time.

As it related to our $1 billion of annual free cash flow by 2024, we are maintaining our target at this time.

While we exceeded our revenue and operating margin guidance in the second quarter, we continued to face significant headwinds from exogenous factors such as R&D tax legislation, which came to light. After we initially developed our long term targets.

We are also keeping in mind that the potential for further investment that I just mentioned where.

Where we intend to ensure that we're appropriately funding our long term growth.

In short we remain focused on achieving our $1 billion target. However, we still have work to do.

In conclusion, we continue to drive foundational improvements to our core business, while carefully investing towards new AI powered products that we're excited to rollout to more customers.

While the macro environment remains uncertain, we will stay 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.

Thank you, ladies and gentlemen to ask a question you will need to press star one on your telephone and wait planning to be announce to withdraw your question Press Star One again, please standby, while we compile the Q&A roster.

And our first question coming from the lineup.

We've seen <unk> with RBC capital markets. Your line is now open.

Wonderful thanks, guys. So much for taking my questions.

Two I wanted to first start maybe true if you could go a little bit deeper into your strategy around das and particularly you had mentioned dash answers.

As an area you want to get into later can you talk a little bit about kind of some of the use cases and maybe more importantly.

The use case, you're trying to solve or at least the way it sounds to us seems like a big pain point for a lot of customers I know the idea of search has been important to you for years. So this isn't brand new or coming out of nowhere, but how do you think about positioning yourself to your customers as the center of gravity for solving that problem in driving that.

Adoption of these solutions I think, especially just given maybe some of the learnings out of out of the new Dropbox in the past and then I've got a quick follow up.

Great Yeah. Thanks Rishi.

So we're really excited about dash and I see it as a natural evolution for Dropbox to go from organizing all your files to organizing everything including your cloud content.

And so the origin.

Alright, I think about a customer problem I think we will.

Within the company.

I experienced these problems I think we all do words.

You know you were looking at a documented a day ago and you know its there, but you can't find it.

And the problem is really similar to the one I started with which is like my stuff is scattered across all these myself the scattered everywhere and back then back when we started it was my files are scattered across all these different devices and operating systems.

And today those are 100 files on your desktop have become 100 tabs in your browser, so and that's what really is missing organizing layer for your cloud content.

And that search is broken right, we have like instead, where we used to have one search box now we've got 10 as with all the different apps and platforms that we use that.

<unk> boxes that each search 10% of your of your stuff.

And and Theres, a missing organizing later than that.

There is no persistence and Theres no theres no kind of concept of like collections for Lynx and I could go on about the pain points, but we see this as kind of another opportunity hidden in plain sight, that's very reminiscent of where dropbox started which is.

That theirs is missing organizing layer in a better way of doing things and we see it as a universal customer need.

In many ways that the challenges that people have with with organizing their cloud content are much greater than the challenges they have with file sync and share. So we see it is.

So much bigger.

A huge Tam.

And a much greater unmet need now.

And then the building onto as we've been working in this direction for a long time, but then the emergence of large language models and generative AI adds another layer on top of that which is.

The ability to interact and in natural language, so and to change the paradigm of search entirely so.

As people as we've all used chat GPT, it's pretty amazing what these regenerative AI can do but there's a lot of questions I can't answer if you think about it so because of that personalize, our or things I chat GBT. It can't really tell you. What if you have a question like what's my passport number whereas that presentation I did last year on last year's product launch or things like that.

CECI beauty can answer that because it's not connected to your information. So we see a big opportunity for dropbox more broadly to provide personalized AI.

We have this audience of millions of users who are already entrusted us with a lot of their most important information.

We've been in June in our launch we launched.

We also introduced Dropbox AI, which is allows you just summarized large documents or even large videos ask questions and natural language provided that kind of personalized chatbot AI experience. In addition to dash, where we're doing the same thing with dash answers for all of your content.

So we're very excited about this.

Cited about having the launch it's in closed beta right now and where.

Continuing to iterate on the experience gets better every week and.

I look forward to getting into more people's hands.

And I think thanks for that position.

Yes.

So is that what's different I think there are a couple of other aspects like what's the positioning or how do we.

You'd be kind of center of gravity I think it's a natural because we have that trust relationship with our customers and we have distribution we have scale.

In many cases, our customers are already putting their most important files and Dropbox, we think it's a pretty natural evolution for existing file sync and share users to adopt ash and then but then when you look at the market of 1 billion knowledge workers and none of them have a solution to their challenges around organizing cloud content. So we think this is a significant.

The opportunity to make our our.

Tim you know many multiples of what it is now.

And as far as positioning it again that I think it's a natural evolution and then lastly.

We've incorporated a lot of lessons from <unk>.

Past product efforts, but I'd say one thing that's really different this time is the emergence of AI.

And we can build products that we wanted to build for a long time, but didnt have the technical building blocks, where were sort of the missing piece of the large language model.

<unk> is a big deal and then I'd say with dash.

It's a very focused experience reduced search we do smart collections we'd.

We'd start page for work concept.

But and we've had a much more iterative approach.

We're we've been working with our customers and Dash is also.

A key ingredient of that was an acquisition of community, which we did a few years ago. So.

We continue to iterate and and.

And drawn the lessons from past experiences and we were really excited about getting dash <unk> and the rest of our portfolio in more people's hands.

Thanks, very thorough I guess, just a quick follow up as we think about generative I know, it's too early to give prices around monetization, but I want to better understand your monetization strategy is this something that you maybe gateway all behind the higher tier skus and use that use visas.

To drive upgrades are there certain modules that you might consider monetizing discretely is this more about driving value and therefore, youre going to get more new customers and better gross retention.

Just want to understand your philosophy around monetization without having to put numbers around it.

Sure. So I mean, theres going be a portfolio of applications of AI and you know I think the way I think about it's pretty similar to you could sort of replace a machine learning and there's a lot different applications of machine learning for large language models and some are just table Stakes features of the product.

Some are available only in higher tier plans and then some are explicit add ons and we expect that to be true for AI and that's already the case to some extent, so dropbox AI, which is an add on.

To the right, which is part of the Dropbox files sync and share product is only available to to paid customers. It's an alpha right now so we're continuing to iterate on it.

And then.

Products like Dropbox Dash.

Or or when you look at the more broadly at other companies some theres a lot of different approaches from.

Integrating AI AI functionality in paid skus or higher tier plans or you see with Microsoft like having an add on.

For AI capabilities.

It's a little too soon for us to share exactly what we're doing but we're certainly thinking about it as a portfolio and making sure that we're both creating the right amount of value for most users and then making sure that we designed our pricing and packaging to best capture the value that we create.

And real brief.

<unk>. This is Tim so our focus this year, particularly on dash is on bringing a quality product to market and driving customer adoption. So that said, we expect it will take several quarters before we start seeing a contribution to revenue from dash.

Alright wonderful that's really helpful. Thanks drew and Ken.

Yeah.

Thank you and our next question coming from the line of Mark Murphy with Jpmorgan. Your line is open.

Great. Thank you for taking the question. This is <unk> on for Mark Murphy with Jpmorgan.

Tim either TMT conference. This year, you shared some color around our customer survey, indicating about I think 8% of existing customer awareness for dropbox side could.

Could you please provide us with some additional context on the progress Dropbox is making in terms of spreading that awareness of the full capabilities of the platform and how that might be driving incremental cross sell or upsell opportunities.

Sure. Good question. So we have been working towards bundles for awhile, where we're excited to roll those out soon and to exactly to your point. We did recently run a survey where roughly half of our users want capabilities, such as E signature, but less than 10% of our users no we offer it.

So we do have an opportunity to solve these problems for our customers and we've addressed some foundational items such as rolling out a single legal in terms of service and a unified customer identity and we're now testing a bundle that does include file sync and share sign and dachshund for professional users where early signals on conversion are positive.

And then we're working on our team's version of these bundles.

We will have more to share on that soon so excited that we are making progress on this dimension.

Great. Thank you Tim and then maybe a quick follow up is just in terms of the macro I'm curious.

We haven't seen relative to Q1, if the macro is fairly consistent or would you say that there's pockets of incremental improvement or worsening just any color that you can provide on kind of how the macro is trended sequentially.

Sure so as far as what we're seeing today I would say the macro trends are roughly consistent with what we've observed over the past couple of quarters.

On one hand, we continue to see elevated price sensitivity and downhole pressure from our teams customers, particularly those that have had layoffs themselves.

And then Simon Docs and are also continuing to face macro related headwinds on the other hand, we are seeing some positive trends around your individual skus.

Particularly on retention, though our sense is that this is largely due to actions that we have taken as opposed to a change in macro dynamics and we're also seeing continued improvement in sign up trends as a result of our rollout of Google one tap and other streamline on boarding processes, where our guidance factors in these latest trends.

Yeah.

Great. Thank you and congrats on the results.

Thank you.

Thank you and our next question coming from the line of Steve Enders with Citi. Your line is now open.

Yeah.

Oh, great. Thanks for thanks for taking the questions here.

I guess I wanted to follow on.

Last quarter and now there's a bigger question on the hiring side due to higher AI talent and help kind of diversified.

<unk> I guess, how are you finding the hiring environment today for.

10 days with with expertise there.

I guess, how should we view that as incremental hiring kind of like layering into the layer into the model through the rest of the year.

Sure I can start.

We're finding it a pretty fertile environment and having a lot of success hiring.

We find a.

Well, it's been helpful to have things like dash announced and be able to talk about these things more broadly.

Other factors like our virtual first model being a little higher.

More flexibly outside of the major tech hubs is another big advantage.

And so we've been building out a lot of leadership teams.

These AI.

Skill sets and then.

Well, we will have a blend of both hiring experienced.

Hey, I folks from industry, but then also.

When you think about other shifts to the internet or mobile or the cloud.

A lot of the best Mobile engineers are.

Engineers are or pick your favorite example started out as a great journalist engineers before that so we were also training up the company, there's a lot of enthusiasm.

And interest in <unk> and.

Turning all of our and just making all of our engineers are AI aware hence.

And skilled so.

We'll do both and we're seeing good progress.

And maybe just from a model perspective, so for this year, we're setting our operating margin guidance to be approximately 32%.

And that's up 50 basis points from the midpoint of our prior guidance of 31% to 32% driven by the revenue outperformance.

And we still do expect to invest some of the savings from our reduction in force towards longer term growth initiatives, including this hiring and talent skilled in AI and early stage product development.

Then we also have shifted some project in marketing spend into the second half. So as a result, we do expect that our Q2 operating margins will be the high mark for the year.

Okay.

Helpful.

Then maybe on farms left I mean, good to see continued.

Performance here.

The quarter I guess two questions.

On that I guess, firstly I guess what is it thats helping.

Drive.

<unk> above your expectations.

Secondly.

On the updated guide it looks like.

Is that it is coming from at least on the topline is coming from.

The form Swift outperformance here I guess is that the right way to be thinking about that and secondarily.

I guess what are you now.

What are the implications for how the rest of the business is executing versus your expectations.

Sure. So we're raising the midpoint of our constant currency guidance range up by about $12 5 million for the full year I would say, that's mostly driven by the Q2 outperformance as well as some better trends in individuals.

Conversely, as we know we continue to see macro headwinds.

On our teams customers as well as both docks ensign.

We're not assuming an improvement in those trends now again form Swift did outperform our expectations for the second quarter in a row. So certainly pleased with their progress.

We're seeing better than expected retention on their side, where the team implemented some UI and product enhancements and then the association with the Dropbox brand also seems to be helping.

Okay perfect. Thanks for thanks for taking the questions.

Yeah.

Thank you.

And our next question coming from the line of Michael Funk with Bank of America. Your line is now open.

Yes. Thank you for the question guys.

I appreciate it.

Digging a bit more on the on net churn improvement sequentially. During the quarter. I think previously you mentioned that you implemented some new customer retention initiatives. So love to get some more color around that and also our expectation for how much more churn can improve from here if we anniversary the price increase.

Last year.

Yes, sure Tim I can start to feel free to jump in so we saw our churn rates remain roughly consistent with last quarter with ongoing macro pressure on our teams customers offset by some improvement with individuals we continue to see heightened churn amongst our teams customers, particularly those that have gone through layoffs themselves.

Now on the positive side, we did see churn stabilized for individual plans, where the team worked on making the product easier to use improving upload speeds and reducing upload delays. They also introduced payment processing alerts to help users keep their credit card information up to date.

So overall, our churn rate does remain in the low teens.

Okay, and then and then the impact on our appeal from the retention efforts.

How should we think like I know, it's I know it's.

Quarter over quarter, but how should we think about the impact on RPM from retention.

Sure maybe just to walk through some of the <unk> dynamics, we saw in the quarter. So on a year over year basis, <unk> was up about $5 landing at about $139 let's.

And I'd say that was driven by a few different factors so benefits from our pricing initiative, which continues to flow through as well as a shift to higher priced plans that was about a $7 contribution.

The acquisition of forms with it was about a $2 contribution this is partially offset.

Offset by FX and the continued growth in.

In our family plan.

Okay, and then really quickly on the on our repurchase and a great incremental $1 2 billion. It's about one six total.

My math about 18%.

All of the cap.

Any commentary on the adjustment to the year end share count barrel.

And how we should think about the.

The pace of share of share repurchase and then kind of a signaling of.

The new repurchase program.

Sure. Good question. So our buyback program is structured to buy more shares at lower price points and as a result of our recent share price performance. We've adjusted our full year share count guidance. Accordingly, we do continue to repurchase shares as part of our <unk> five one plan, where our updated share count guidance gives.

The best sense of our future repurchase expectations.

We do of course continue to expect to allocate a significant portion of our annual free cash flow to share repurchases on an ongoing basis with the intention of reducing our share count and the new authorization is just a continuation of that.

It reflects our commitment to that program.

Great. Thank you all the time.

Okay.

Okay.

Thank you and our next question coming from the line of Brent Thill with Jefferies. Your line is open.

Hello.

As Elan Liana <unk> on for Brent.

Thanks for taking my question.

Two things on my end.

Sure.

What do you think about the sustainable growth rate of the business and how do you break that out between core FSS and the other assets and secondly.

Given that you raised the full year guide by more than the beat in the quarter are you factor in getting a greater sense of optimism in terms of macro for the back half of the year or is this if you can talk through the factors that went into the full year guide that would be great.

Thanks.

Okay.

Sure maybe on guidance philosophy, I'd say, we're being consistent with our historical approach our macro view is largely the same as it was last quarter not assuming an improvement in the economy in our guidance. We are assuming that the same trends. We saw in Q2, we will continue including positive trends from our individual skus, where again we.

Took direct action to improve those plans.

Of course, this is somewhat offset by sluggish demand within our team Skus and we do also remain mindful of our reduction in force and the potential impact. This could have on our billings given our reduced levels of investment in head count and marketing where all of these considerations are factored into guidance.

Now as far as your earlier part of your question on our long term thinking not providing any revenue guidance beyond 'twenty three at this time, certainly keeping a close eye on the evolving macro environment as we navigate our path forward. We are also launching several new product experiences later this fall such as Dropbox dash and bundles.

We will have a better idea of the revenue contribution after we gain an initial customer signals.

Ultimately, we're very focused on driving a healthy balance of growth and profitability as we pursue our financial targets.

Thank you.

Sure.

Thank you.

Our next question coming from the line of Jacob Snaffle with Goldman Sachs. Your line is now open.

Hi, This is Jacob thoughtful on for Kash Rangan. Thanks for taking the question a couple of questions for me.

So dropouts has expanded the product portfolio recently.

With dash Dropbox, AI docks and replay.

Can you touch on how those offerings might be doing relative to the core FSS offering.

Dropbox was founded on and then additionally.

How are you thinking through.

Hiring in the near term, specifically quota carrying reps and can you touch on maybe how the self service channel has fared.

<unk> on a sequential and on a year over year basis.

Sure.

So we are really pleased with the progress we've been making in broadening the portfolio as you kind of touched on so I mean, we started with FSS, but we saw that our customers had a bunch of workflow needs around the content in dropbox and so that's how that's why you've seen us expand into.

The document workflows with things like form Swift and docks and in Hello sign.

And increasingly we're doing more with video with replay and capture as we've seen.

The folks at up or they initially adopted dropbox for those use cases are kind of duct tapes them together and then we found we could build a more targeted product for that.

Or for that use case and then you are seeing is as our customers are as many work workflows have shifted from files and desktop apps to cloud tools in the browser.

And you need to organize all your cloud content and fix problems with search and an organization and then.

And then bringing intelligence into the work experience. So that's kind of the motivation behind it and and.

And as far as how those products are doing I think probably don't have much to add from the from beyond the comments we've already made.

We're very excited about the potential, especially for things like dash and Dropbox AI.

And I wouldn't say, there's much of a shift in how we're thinking about hiring quota carrying reps I mean, as a reminder, 90% of our business is self serve.

And then we have a targeted outbound and manage motion to help grow those.

To grow those accounts once they reach a certain threshold.

And.

And we're thinking about how do we continue to scale the go to market and get the best of both of those worlds from a go to market standpoint, and get ready to be scaling a lot of our new products.

And then briefly I think you asked about the performance of self serve I think it largely mirrors.

The trends that drew and I have been talking about where on the team side, we're seeing price sensitivity on the individual side, we saw some improvement in retention that we've touched on.

Awesome. Thank you so much.

Yes.

Thank you.

I see we have no further questions at this time.

Ladies and gentlemen. This concludes today's conference call. You may disconnect at this time and have a wonderful day.