Q3 2023 Dropbox Inc Earnings Call

November 2, 2023

[music].

Good afternoon, ladies and gentlemen, thank you for joining Dropbox as third quarter 2020 earnings conference call. All participants will be in a listen only mode. After today's presentation there'll be an opportunity you asked the question to ask a question during the session need to press star one on your telephone as a reminder, this conference call is being recorded and will be available for replay.

<unk> from the Investor Relations section of Dropbox as website. Following this call I will now turn the call over to current Kapoor head of Investor Relations for Dropbox. Mr. Kapoor. Please go ahead.

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

Stations regarding our business assets products 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.

Also based on assumptions as of today.

Undertakes no obligation to update them as a result of new information or future events.

Factors and risks that could cause our actual results to differ materially from these forward looking statements are set forth in todays earnings release and in our quarterly report on Form 10-Q filed with the SEC.

We 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 Chief Financial Officer, Tim Regan Tim.

Thanks, Karen and good afternoon.

Before I begin I wanted to let everyone know that I'll be filling in for Joe today.

He and his wife, Erin just welcomed their first child, Charlie This week.

So big congratulations and well wishes to drew and his family.

I'll first provide an update on our company strategy and share some recent product highlights before moving onto our Q3 results and guidance for the rest of the year.

I'll also offer some commentary to help you think about our 2020 for outlook.

While we continue to navigate an uncertain economic climate, we beat our revenue guidance driven by strength within our individual skus for the second straight quarter.

And we again drove better than expected profitability.

However, we continue to see pressure across our teams customers and document workflow businesses.

<unk> seasonal softness with informed Swift.

As we approach the end of 2023 I want to quickly provide an update on our company strategy.

As you recall earlier in the year, we simplified our focus around two main business objectives.

The first is building AI powered product experiences centered around organizing all cloud content star.

Starting with the introduction of Dropbox Dash Standalone, Universal search product, leveraging AI and machine learning.

And the second objective is continuing to evolve our core file sync and share offering integrating AI and other improvements in order to provide a more seamless product experience for customers workflows.

We first discussed this refocused strategy. After we took actions in Q2 to realign our workforce in order to run a more efficient core business.

While investing more towards longer term AI product initiatives.

We're pleased with how our teams have taken these changes its stride and how as a company.

To look ahead with a unified product vision, while staying focused on responsible resource allocation.

Now moving on to some of the recent progress we've made building our AI product portfolio.

As a reminder, in June we introduced our first generation of products, including Dropbox Dash and Dropbox AI.

I'll focus on Dropbox Dash that this represents our first major product launch within our next generation of AI powered products.

We see this opening a new market opportunity of Universal search.

<unk> talked for a while about the growing challenge of fragmented content in this new world of distributed work.

Last month, we met with hundreds of customers in New York and many echoed the same pain points around organizing their work.

And we believe we're in a good position to solve these new problems with our scale and platform neutrality.

We also see the shift from files and folders along with recent advancements in AI, giving way to new market opportunities in particular, the search and knowledge discovery software market.

IDT sides of this as a $7 billion market today that's it.

Expected to triple over the next four years.

And we believe we are well positioned to take part in this secular wave with Dropbox dash.

As a reminder, dropbox dash leverages AI, while connecting your cloud tools apps and content into a single search bar.

It allows users to quickly find everything in one place whether that content is pulled from Microsoft outlook or Google workspace horizontal.

And because dash is powered by machine learning it learns about you and your priorities the more you use it.

Since introducing dash into closed beta over the summer we've carefully rolled out the product to a select group of users in order to observe customer engagement and test our scaling capabilities.

And the first few months, we've learned valuable insights from users and Iterating on the product in a number of ways to address their top pain points.

For example, we noticed users experiencing friction during the Onboarding process and many were not initially establishing connected apps to work with <unk>.

We rolled out our new web based on boarding experience, reducing the number of steps in the sign up process.

And made it easier to add connected apps.

Since revamping this onboarding flow, we've seen a significant increase in the number of users who adopt at least one connected app versus before.

Also seeing an improvement in overall user retention.

We've also significantly improved our service quality.

We're currently rolling out semantic search functionality, which processes intent and context behind the search query.

More relevant results.

Early feedback from this rollout has been positive as users previously hadn't relied more on using exact wording to find the right piece of content.

And lastly, we're continuing to make stacks more intuitive for users to create and share.

As a reminder, stacks or smart collections for links that offer a quick way to safe organized and retrieve urls.

It's just like platelets organize songs stacks organize urls in a way that's easy to group by topic, you can share with colleagues.

Adding more adoption of stacks is an important part of our strategy with dash as.

As we found that users who add more links to a stack have higher retention profile.

They don't.

As we continue to evolve Dropbox dash will be investing more in sales and marketing to drive user education and distribution.

I mean also see an opportunity to sell bashed, the team's customers who are grappling with even more information overload and complexity.

This is where we're also making sure we build dash with security and transparency at night.

We recognized in the rapidly evolving world of AI customers are looking for tools that can trust to keep their content space.

This is why we are building in the right controls admin and compliance features to customers can feel safe deploying dash.

A small team or a large organization.

We're encouraged by the early progress with Dash, which is now in open beta we're seeing growth in the number of weekly engaged users since we removed the waitlist last month.

And we continue to observe healthy activation and retention rates with roughly half of the users returning to use the product within one to two weeks of first activating.

Our near term focus is continuing to improve the product and growing the user base before we plan to launch dash into Georgia.

Earlier part of 2024.

We believe our value proposition is resonating with customers and we're excited for the long term potential Pradesh.

Moving onto our second objective evolving the existing Dropbox files sync and share user experience seamlessly address customer workflows around documents and videos.

For years, we've been adding functionality within dropbox through organic and acquired assets. So that our users can do more with their content beyond storage.

Whether it's signing documents are creating and editing videos.

These capabilities are even more important in today's era of distributed work with.

We've often heard from our customers that they were unaware of everything we offered.

Or they had a difficult time, discovering new functionality within dropbox.

It was clear we needed to modernize and simplify the web experience.

That's why at our customer event last month, we announced an entirely new and intuitive web experience that helps users stay productive.

Whether its editing a PDF recording a video message for team are tracking your proposal center clients.

Redesigned makes it easier for users to access the right tools at the right time.

With an adaptive interface.

New changes based on what users are working on.

As a dedicated tab focused on E signatures.

And with a number of these capabilities integrated more seamlessly users can avoid having to switch between apps.

With our web redesign and we also saw an opportunity to refresh our business plans, making it easier for customers to discover all the value Dropbox can provide to them directly from our plans page.

Previously we sold some of our additional capabilities with select plans like our E signature and professional plan package.

But it's two separate products and user experience with disjointed and difficult to navigate.

It was also confusing for self serve customers looking for more than just storage to discover how they could purchase the right plan for them.

I'm excited to announce that we've rolled out the first generation of our fully integrated bundled offerings for new customers.

And we've updated pricing and packaging to reflect the added value, including capabilities, such as E signature tracking analytics and PDF editing.

These new offerings are dropbox is essential for solar professionals Dropbox business for small teams.

And Dropbox business plus for larger teams.

More details of each plan can be found on our website as well as in our investor presentation.

New customers can purchase these plans today and we're currently migrating existing customers to the new plans at their existing plan price.

We see an opportunity for these bundles to provided <unk> lift overtime from new user adoption as well as retention improvements as we've seen the customers who use multiple products retained at significantly higher rates.

I'll now move onto our financial highlights from Q3 and update guidance for the rest of this year along with offering some commentary on how to think about our 2024 targets.

And growth outlook.

Starting with our third quarter results.

Total revenue in Q3 increased seven 1% year over year to $633 million.

Beating our guidance range of $626 million to $629 million.

Foreign exchange rates provided an approximately $7 million headwind to growth.

On a constant currency basis revenue grew eight 3% year over year.

The revenue outperformance was driven by strength across our individuals' plans.

Which were once again, partially offset by headwinds we continue to see across our teams and document workflow businesses.

Total <unk> for the quarter grew three 8% year over year for a total of $2 $5 5 billion.

On a constant currency basis, <unk> grew $25 billion sequentially and seven 5% year over year, primarily driven by individuals.

I would note that in Q3 with largely lap the pricing and packaging changes we made to our teams plans last June.

And hence added less quarterly net new <unk> relative to the first half of 2023.

We exited the quarter with $18 2 million paying users and added approximately 130000 net new paying users sequentially.

Average revenue per paying user for Q3 was $138 71.

Down slightly on a sequential basis, but up over $4 year over year, driven by the team's pricing increase form swift as well as the shift to premium plans.

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

And excludes stock based compensation amortization of purchased intangibles certain acquisition related expenses impairments of our real estate assets and expenses related to a reduction in force.

Our non-GAAP net income also includes the income tax effect of the aforementioned adjustments.

Moving to our real estate strategy, where we have been actively seeking sub leases and buyouts of our vacant real estate space. The majority of which is in San Francisco.

In October we exited a buyout with our landlords of approximately 40% of our remaining sublease space in San Francisco.

For $79 million to be paid over three years, beginning with an approximate $28 million payment in the fourth quarter of this year.

This payment was not previously factored into our 2023 free cash flow guidance.

And I will provide an update on this when we share our latest view for the year.

Overall, we expect this buyout to drive significant savings in the long term.

As we will be avoiding over $220 million in aggregate rent payments and common area maintenance fees.

The remaining 10 year lease duration.

We will continue to actively seek sub leases and pursue additional buyouts, where we see favorable returns.

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

Gross margin was approximately 83% for the quarter roughly flat compared to the third quarter of 2022.

Operating margin was 36% up roughly 400 basis points year over year.

We beat our operating margin guidance by 300 basis points, primarily driven by delayed marketing and professional services spend.

We expect to incur in Q4.

We are also being prudent with the pace of hiring as we remain focused on cost discipline.

Net income for the third quarter was $194 million up 27% versus the third quarter of 2022.

Driven by operating income growth.

Diluted EPS was <unk> 56 per share base.

Based on $346 billion diluted weighted average shares outstanding up from 43 per share based on $360 million diluted weighted average shares outstanding.

For the third quarter of 2022.

Moving onto our cash balance and cash flow.

We ended the quarter with cash and short term investments of $1 3 billion.

Cash flow from operations was $256 million in the third quarter.

Capital expenditures were $9 million during the quarter.

This resulted in quarterly free cash flow of $247 million compared to $245 million in Q3 of 2022.

In the quarter, we also added $26 million to our finance leases for data center equipment.

Moving on to our share repurchase activity in.

In Q3, we repurchased 4 million shares spending approximately $104 million.

As of the end of the third quarter, we have approximately $1 5 billion remaining under our current repurchase authorizations.

As a reminder, we remain committed to allocating a significant portion of our annual free cash flow to share repurchases.

I would now like to share our guidance for Q4 and in turn.

Full year 2023.

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

For the fourth quarter of 2023, we expect revenue to be in the range of 602000 $9 million to $632 million.

We are assuming a currency headwind of approximately $2 million in the fourth quarter.

Thus on a constant currency revenue basis, we expect revenue to be in the range of 631.

$634 million.

We expect non-GAAP operating margins to be approximately 31, 5%.

This includes a roughly 90 basis point headwind from FX and form slips.

Finally, we expect diluted weighted average shares outstanding to be in the range of 345 to 350 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 range by roughly $5 million.

Two $4 96 to.

The $2 $4 99 billion.

Versus our previous range of $2 $4 87.

Two to $4 97 billion.

On a constant currency basis, we are raising the midpoint by roughly $7 million to a range of $2 $5 36.

To two five to $3 9 billion.

We now estimate our full year 2023 currency headwind of approximately $40 million.

Or an approximately 170 basis point headwind to growth.

We continue to expect foreign Swift to contribute nearly 300 basis points of growth.

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

We expect non-GAAP operating margin to be approximately 32, 5%.

Up from our prior guidance of approximately 32%.

This is inclusive of an approximately 75 basis point headwind from FX and form switch.

We are reducing our free cash flow guidance by $50 million at the midpoint and.

And narrowing the range to $775 million to $785 million relative to our previous guidance range of $820 million to $840 million, which I will elaborate on shortly.

As it relates to capital expenditures, we now expect capex to be approximately $30 million.

The low end of our prior guidance range.

In addition, the finance lease lines to be approximately 6% of revenue up from our prior expectations of five 5%.

Finally, we are maintaining our 2023 diluted weighted average shares outstanding guidance range of.

345 million to 350 million shares.

To share some additional context on this guidance.

As it related to revenue we are raising our revenue guidance for 2023, driven by better than expected performance across our individual plans.

This is outweighed macroeconomic headwinds on our team's plans as well as both docks and ensign.

I will also note that I expect lower net new paying user additions in Q4.

Alongside the uncertain macro economic environment.

Q4 is a seasonally slower quarter for net new paying users.

Additionally, as part of our recent bundles launch and plans page changes, we have minimized the family plan Skus prominence on our plans page.

While this skew is still available to existing customers.

We found the business users were using it as a loophole to obtain licenses at a lower cost.

As a result of these factors, we expect net new paying users to trend lower relative to our historical run rates.

As it related to operating margins for 2023, we are raising our operating margin guidance to approximately 32, 5%.

50 basis points as compared to our prior guidance.

This increase is driven both by our revenue outperformance as well as our disciplined approach to hiring subsequent to our risk which is translating to savings.

As it relates to finance leases as a reminder, in recent years, we have seen users uploading increasing levels of high density pilots such as videos.

And images to our platform, particularly within our advanced teams plan, which allows for customers to use as much storage as needed.

We also discovered that some customers were using the storage benefit for purposes that did not meet the spirit of the plans design.

To address this in Q3, we sunset it or as much space as you need policy.

And transitions to a metered model.

We accompany this with an extended grandfathering window for the vast majority of impacted customers to support them with the transition.

While this will ultimately translate to a more profitable advanced planned SKU in the long term.

Will lead to incremental storage costs in the short term as indicated by the uptick in finance leases to support the grandfathering window.

We also expect a modest headwind to IRR from this change as we expect some degree of refunds and incremental churn for those customers seeking storage solutions that we no longer offer.

As it related to full year free cash flow, we are reducing our free cash flow guidance range.

There are a few factors driving this decrease.

First is the aforementioned buyout of a portion of our San Francisco lease, which was not factored into our previous guidance.

The first tranche of about $28 million and is due in the fourth quarter.

Second we now expect to receive our December installment payment from an App store partner of roughly $14 million in January of 2024.

Thus, we now only expect to receive 11 monthly payments in 2023.

Looking ahead, we still expect to receive 12 payments in 2024.

Lastly, we are also expecting a reduced level of billings in the fourth quarter due to two factors.

First is FX given the recent strengthening of the U S dollar, which has a more immediate impact on billings.

And second we are seeing incremental softness pressuring our teams and document workflow businesses.

Which we attribute to the macro environment as well as the reduced head count and marketing investments in these businesses subsequent to our risks.

This free cash flow guidance range also continues to include several unique cash outflows that I have mentioned on prior calls.

Including approximately $23 million for the 2023 installments of acquisition related deal consideration holdback reduction in commodity.

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

And an approximately $50 million headwind as a result of R&D tax legislation.

This brings me to 2024, where I wanted to share some early thinking on our revenue growth expectations.

And our 2020 for operating margin and free cash flow targets.

And we will not offer specific 2020 for revenue guidance at this time however.

However, I would point to our Q4 'twenty three constant currency revenue growth expectations.

Excluding forms swift as a fair proxy for our underlying organic growth rate next year.

As we also lapped the benefit of the team's price increase.

As a reminder, the strategy behind our risks earlier this year was to rotate investments away from our legacy file sync and share and document workflow businesses to become more efficient in those areas and to use those savings to fund investments in areas of higher growth potential over the long term.

This along with continued macroeconomic headwinds is translating to a slowdown in billings and these legacy business lines.

Separately, while we're making early progress on our new longer term investments in dash bundles and video products.

These products are either only recently being introduced to the market or will not be going to <unk> until 2024.

Thus, we expect that these initiatives will not be meaningful contributors to our growth until later in 2024 and beyond.

This brings me to our 2020 for operating margin and free cash flow targets.

We have made significant progress on these targets since introducing them over three years ago.

Made a commitment to driving higher levels of profitability and free cash flow.

I'm proud of our progress against these targets and we will continue to operate the business in a disciplined manner.

And while we remain at or above our margin targets, we continued to face challenges to free cash flow.

Including factors, such as FX, which has grown as a headwind since last quarter.

As well as the partial buyout of our San Francisco lease that will also serve as a headwind to a free cash flow next year.

In addition, we are now planning as though the R&D tax legislation, which came to light. After we initially developed our targets will not be repealed.

To overcome these mounting headwinds we could withhold investments in our long term initiatives such as dash.

However, we believe that this would be a short sighted approach.

As such we are lowering our $1 billion free cash flow target.

To adjust for the R&D tax legislation now expected to be approximately $36 million in 2024.

In other words, we are resetting the 'twenty 'twenty four free cash flow target.

To be 1 billion minus the ultimate R&D tax legislation amount.

We will also continue to monitor exogenous factors such as FX.

And its potential impact to our 2020 for free cash flow expectations.

When we will provide official guidance on 2024 and February.

In conclusion, we've been focused on investing towards our longer term product roadmap, while finding opportunities to run our legacy businesses more efficiently.

While we continue to navigate macro headwinds, we believe we have been making the necessary changes this year to better position dropbox for the long term.

We continue to see opportunities to leverage our scale and brand as we enter new market opportunities centered around the future of work.

With Dropbox dash, representing an important first step in our next generation of AI powered products.

We will remain focused on our customers, while allocating capital efficiently.

And driving long term value for our shareholders.

And with that I'll turn it to the operator for Q&A.

Thank you ladies and gentlemen, if you have a question or a comment at this time. Please press star one on your telephone. If your question has been answered you were seeing with yourself from the queue. Please press star one again, we will pause for a moment, while we compile the Q&A roster.

Our first question comes from Matt <unk> with Bank of America. Your line is open.

Hi, Thanks, Congrats that drew I'm on for Mike.

Really nice operating margin this quarter nice beat can you provide any commentary on the pace of R&D.

Head count that you've mentioned a few quarters ago. Following the <unk> is that progressing on pace.

And then more broadly any commentary on customer behavior, whether its churn or price sensitivity quarter over quarter. Thank you.

Sure Matt Good question.

With respect to hiring we remained disciplined with our head count investments, where our hiring will be focused on growth areas, such as dash and our multi product initiatives.

And with respect to AI, we have been adding AI talent over the past few years.

We will be adding more as we drive towards our dash gea timing and we've been able to attract strong talent from top tech companies.

They see the opportunity to solve a big problem for our customers.

And then as far as what we're seeing with customer behaviors recently.

I would say the macro trends remained roughly consistent with what we've observed over the past couple of quarters.

On one hand, we continue to see elevated price sensitivity in down sell pressure from our teams customers largely those that have had layoffs themselves. We've.

We've seen this particularly impact customers and the technology and construction verticals.

And we are also seeing reduce top of funnel across our team as planned subsequent to the price increase last year.

<unk> also continued to face macro related headwinds.

Now on the other hand, we haven't seen some positive trends around our individual skus, particularly on retention and sign ups. So our sense is that this largely relates to actions that we've taken as opposed to a change in the environment.

I think that our guidance does factor in these latest trends.

Excellent. Thank you.

One moment for our next question.

Okay.

Our next question comes from Mark Murphy with Jpmorgan. Your line is open.

Great. This is <unk> on for Mark Murphy, Thanks for taking the question and Echo the congrats to true Tim.

Tim given that you've now lapped the price increase you had implemented back in June of 'twenty. Two I'm, just curious how youre thinking about pricing going forward do you see the potential to continue to use price as a meaningful lever for growth given some of these additional capabilities you're building out into the platform and then have a quick follow up.

Yes, I would say that we are seeing increasing levels of price sensitivity in this macro environment, where we're mindful of this as we assess our future pricing and packaging plans were for now we're focused on our bundling strategy as opposed to price increases just given that price sensitivity and this is where again in <unk>.

Early October we did launch bundled offering where the idea of what these bundles is to drive adoption of our non storage products for our customers have been asking us to provide these capabilities. They just.

Often don't know that we already do and so.

These these new plans to integrate additional functionality such as esignature docs since tracking analytics PDF editing and video recording in a seamless way and we accompany this with a refreshed web redesign that makes it easy to find and use this additional functionality and we've seen that customers that leveraged more than one product from us convert.

And retain at higher rates.

We will be migrating existing users at their current price points over the next couple of quarters.

This bundling strategy as the priority right now as opposed to price increases.

Great. Thanks, Tim and then I know the <unk> is one of the larger remaining leases are there any other relatively larger leases that we should be mindful of remaining or is it fair to assume that the major sub leases have now been absolutely right sized.

San Francisco's.

The.

The largest portion of our remaining space to be sublease.

Basically sublease to the vast majority of our remaining space and this is again, where we just did a buyout this past quarter.

Approximately 40% of that remaining sublease space for $79 million to be paid over three years.

We do expect that that will drive significant savings over the long term avoiding over $220 million in rent payments in common area of fees over the remaining 10 year lease duration. So we think that was a good decision for the long term health of the company.

Great. Thank you so much.

One moment for our next question.

Okay.

Our next question comes from Steve Enders with Citi. Your line is open.

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

I guess, maybe to start I wanted to ask about the customer event that you held.

Last month in <unk>.

Oregon.

The feedback that you've heard from from customers, there and how they're viewing.

The early data access will be with AI solutions.

Sure. So we gathered with the few 100 customers in New York earlier this month.

As part of the events, we made several product announcements, we launched dash into open beta we released our web redesign of the core file sync and share experience.

We introduced our new fully integrated bundled offerings, which I just touched on and we also use the event to kickoff paid digital campaign to drive awareness and sign ups.

Dash and our new plan lineup.

It was really great to talk with customers and to validate the thesis behind our new products is really resonating with them.

Okay.

That's great that's great to hear.

And then I guess, maybe on on the outlook for.

For next year at least the preliminary view there.

I just want to make sure that I'm thinking about this right I think you said.

FX rate for this year I think it was something like 5% growth that youre guiding to.

And then on the on the free cash flow side.

Yes, it does have that $1 billion intact outside of the R&D tax.

I guess with the building in leaf as well is that being factored in or you sound like outside of that and then some of the other.

Incremental capex that needs to come in here that you would still be able to hit that billion dollars number ex.

R&D tax legislation.

For now we are only lowering our $1 billion of free cash flow target to adjust for the R&D tax legislation now expected to be about $36 million.

If I take a step back we've made significant progress against our free cash flow target over the past few years.

Proud of how far we've come more than doubling our annual free cash flow since we set the target, but we do continue to face headwinds to reaching that target. For example, FX does remain a headwind that's grown since last quarter to your point the biodiesel Francisco will also impact the free cash flow next year and again now planning.

As though the R&D tax legislation, which came to light after we developed our targets will not be repealed.

And we could withhold investments to our long term initiatives such as das to meet that target, but again, we believe that would be shortsighted.

We will continue to monitor exogenous factors, such as FX and its potential impact to our expectations, where again, we will provide official guidance on 'twenty four in February.

Okay perfect. Thanks for taking the questions.

Sure.

Number four our next question.

Okay.

Our next question comes from Rishi <unk> with RBC capital markets. Your line is open.

Hi, This is Richard calling on for Richie Deloria.

Thanks for taking my question and would reiterate my congrats to drew.

First one just in terms of the new bundle how should we interpret the difference between the new docs and an esignature pricing capabilities that are included in the bundle first is what was available in the sand standalone offerings prior.

How long until we expect more of the functionality like form Swift or dash in AI to be included in those five boats as well. Thanks.

Sure. So maybe I'll start with the back end of your question.

Now that we've built these bundles, we will continue to iterate on further capabilities to add to them over time.

So form Swift is one of the areas that we are contemplating as far as.

Future additions to the bundles and we'll have more to share on that in future quarters.

Dash at this point we are.

Navigating towards selling that on a standalone basis.

We're driving towards our GAA in in the early part of 2024, where we are still <unk>.

Identifying our go to market approach and so much more to share on that front as we get closer to that point.

As far as how we've we've been integrated docks and in sign into.

Into these bundles, so maybe I'll just articulate that we are offering dropbox essentials for solo professionals for 2020 or sorry 20.

$22, that's relative to our professional plan, which was $20.

Dropbox business for small teams thats $24, a month relative to standard in 2018, and Dropbox business plus for larger teams $32 a month relative to advanced.

For 30, and so the way we've brought these in and as we've brought in some degree of functionality, but not full functionality from our sign and send capabilities and so that's reflected in the degree of uplift in those the pricing of those plans.

Again, the idea is to drive adoption of these multi product capabilities that we have in these plans.

We've seen increased conversion and retention once users use more than one portion of our functionality. So that's the idea behind the bundles and we're excited to see how this progresses.

Okay, that's very helpful.

And then just a follow up to that I think in previous quarter, you mentioned efforts to improve customer awareness of the document workflow capability as it seems like this kind of.

Jives with that pretty well.

But do you have plans to I guess do any other like marketing campaigns or anything like that to.

Boost awareness of the new pricing plans are maybe trying to shift some of those family customers that.

She would probably be on the team's business plans.

Like that kind of as we look into 2024.

Absolutely, we're looking into many different angles to improve the awareness of our multi product capabilities.

Marketing campaigns as you alluded to and that's part of why our margins are going from 36% in the third quarter.

Down to the guided level in the fourth quarter, that's where we're investing in marketing campaigns to fuel awareness of dash as well as these bundled offerings that we just touched on and then again, we've accompanied the launch of bundles with this refreshed web design that makes it very easy to find and use this additional functionality. So.

Multi pronged approach to try to improve the awareness.

Got it. Thank you that's very helpful.

One moment for our next question.

Our next question comes from Brent Thill with Jefferies. Your line is open.

Hello. This is <unk> on for Brent Thill. Thank you for taking my question.

First you said that the demand environment remained roughly the same versus to Q. When do you expect that sentiment to shift, especially for docs and then Hello sign.

It remained under pressure in the past couple of quarters and second if you can shed some color on the international side that would be helpful as well.

Yes.

It's really hard for me to predict when the macro were changed and when sentiment will shift.

Not something I'm, assuming in our guidance.

So for now certainly assuming consistency in the trends that we have.

As far as international FX headwinds continued to put pressure on our international growth rates.

Our document workflow businesses are also predominantly in the U S and those tend to have faster growth rates.

Of course, driving international growth through improved localization.

Is an opportunity for us.

Maybe just briefly on the middle East, we do have double digit <unk> from customers in Israel and since the beginning of.

The conflict, we have seen some slowdown in activity in that region. However, I don't expect that to have a material impact on our overall numbers.

Thank you.

One of them before the next question.

Our next question comes from patent Wall Ravens with JMP Securities. Your line is open.

Oh, great. Thank you.

Forgive me if this has already been touched on but.

I think with the Adobe firefighters something like 3 billion images that's been created.

And with all the EMS generators. This is.

Yes, we're seeing more and more of it is is it going to drive.

Different storage requirements for you guys and other different.

Sort of functionality and usage.

Yes.

Sorry, Pat are you referring to Adobe Firefly.

Yes, just with <unk>.

Generative AI there is so much more video and images that are going to be created than they've ever been created before and you've got to put them somewhat.

Sure so.

Dropbox has actually been home to many PDF files and use of Adobe.

So I would expect those sorts of trends to continue.

Users continue to find places to store.

His store their content in Dropbox, because one of their favorite homes for that so.

That could be a catalyst for future storage growth for us and we're paying close attention to these sources.

Trends.

Okay, so far not though right.

No material difference or no material delta as it related to Adobe Firefly at this point.

Alright, thank you.

Thank you and I see that we have no further questions in queue. At this time, ladies and gentlemen. This concludes today's conference call. You may now disconnect at this time and have a wonderful day.

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Good afternoon, ladies and gentlemen, thank you for joining Dropbox as third quarter 2023 earnings conference call. All participants will be in a listen only mode. After today's presentation there'll be opportunity to ask a question to ask a question during the session need to press star one on your telephone as a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section.

Dropbox website. Following this call I will now turn the call over to current Kapoor head of Investor Relations for Dropbox. Mr. <unk>. Please go ahead.

Thank you good afternoon, and welcome to Dropbox with third quarter 2023 earnings call.

Before we get started I would 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 fourth quarter and fiscal year 2023, and our expectations regarding our revenue growth profitability operating margin and free cash flow as well as our XP.

Dictations regarding our business assets products 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.

Undertakes no obligation to update them as a result of new information or future events.

We'll also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles.

A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors Dropbox Dot com.

I would now like to turn the call over to Dropbox as Chief Financial Officer, Tim Regan Tim.

Thanks, Karen and good afternoon.

Before I begin I wanted to let everyone know that I'll be filling in for Joe today.

He and his wife, Erin just welcomed their first child, Charlie This week so.

So big congratulations and well wishes to drew and his family.

I'll first provide an update on our company strategy and share some recent product highlights before moving onto our Q3 results.

Guidance for the rest of the year.

I'll also offer some commentary to help you think about our 2020 for outlook.

While we continue to navigate an uncertain economic climate, we beat our revenue guidance driven by strength within our individual skus for the second straight quarter.

And we again drove better than expected profitability.

However, we continue to see pressure across our teams customers and document workflow businesses, including.

Including seasonal softness within form Swift.

As we approach the end of 2023 I want to quickly provide an update on our company strategy.

As you recall earlier in the year, we simplified our focus around two main business objectives.

First is building AI powered product experiences centered around organizing all cloud content.

Starting with the introduction of Dropbox Dash Standalone, Universal search product, leveraging AI and machine learning.

We first discussed this refocused strategy. After we took actions in Q2 to realign our workforce in order to run a more efficient core business.

While investing more towards longer term AI product initiatives.

We're pleased with how our teams have taken these changes its stride and how as a company. We're able to look ahead with a unified product vision, while staying focused on responsible resource allocation.

Now moving on to some of the recent progress we've made building our AI product portfolio.

As a reminder, in June we introduced our first generation of products, including Dropbox Dash and Dropbox AI.

I'll focus on Dropbox Dash is this represents our first major product launch within our next generation of AI powered products.

This opening a new market opportunity of Universal search.

<unk> talked for a while about the growing challenge of fragmented content in this new world of distributed work.

Last month, we met with hundreds of customers in New York and many echoed the same pain points around organizing their work.

And we believe we're in a good position to solve these new problems with our scale and platform neutrality.

We also see the shift from files and folders along with recent advancements in AI, giving way to new market opportunities in particular, the search and knowledge discovery software market.

IDC sizes. This is a $7 billion market today that's it.

Expected to triple over the next four years.

And we believe we are well positioned to take part in this secular wave with Dropbox dash.

As a reminder, dropbox dash leverages AI, while connecting your cloud tools apps and content into a single search box.

It allows users to quickly find everything in one place whether that content is pulled from Microsoft outlook or Google workspace horizontal.

And because dash is powered by machine learning it learns about you and your priorities the more you use it.

Since introducing dash into closed beta over the summer we've carefully rolled out the product to a select group of users in order to observe customer engagement and test our scaling capabilities.

And the first few months, we've learned valuable insights from users and Iterating on the product in a number of ways to address their top pinpoints.

For example, we noticed users experiencing friction during the Onboarding process and many were not initially establishing connected apps to work with <unk>.

We rolled out our new web based onboarding experience, reducing the number of steps in the sign up process and made it easier to add connected apps.

Since revamping this onboarding slow we've seen a significant increase in the number of users who adopt at least one connected to app versus before.

<unk> also seen an improvement in overall user retention.

We've also significantly improved our service quality.

We're currently rolling out semantic search functionality, which processes intent and context behind the search query to deliver more relevant results.

Early feedback from this rollout has been positive as users previously had to rely more on using exact wording to find the right piece of content.

And lastly, we're continuing to make stacks more intuitive for users to create and share.

As a reminder, stacks or smart collections for links that offer a quick way to safe organized and retrieve urls.

Just like platelets organize songs stacks organize urls in a way that's easy to group by topic, you can share with colleagues.

I think more adoption of stacks is an important part of our strategy with dash.

As we found that users who add more links to a stack have higher retention profile.

They don't.

As we continue to evolve Dropbox dash will be investing more in sales and marketing to drive user education and distribution.

I mean also see an opportunity to sell bash the team's customers who are grappling with even more information overload and complexity.

This is where we're also making sure we build dash with security and transparency in mind.

We recognized in the rapidly evolving world of AI customers are looking for tools. They can trust to keep their content safe.

This is why we are building in the right controls admin and compliance features so customers can feel safe deploying dash.

A small team or a large organization.

We're encouraged by the early progress with Dash, which is now in open beta we're seeing growth in the number of weekly engaged users since we removed the waitlist last month.

And we continue to observe healthy activation and retention rates with roughly half of the users returning to use the product within one to two weeks first activating.

Our near term focus is continuing to improve the product and growing the user base before we plan to launch dash into Georgia.

Earlier part of 2024.

We believe our value proposition is resonating with customers and we're excited for the long term potential Pradesh.

Moving onto our second objective evolving the existing dropbox file sync and share user experience to seamlessly address customer workflows around documents and videos.

For years, we've been adding functionality within dropbox through organic and acquired assets. So that our users can do more with their content beyond storage.

Whether it's signing documents are creating and editing videos.

These capabilities are even more important in today's era of distributed work with.

We've often heard from our customers that they were unaware of everything we offered.

Or they had a difficult time, discovering new functionality within dropbox.

It was clear we needed to modernize and simplify the web experience.

That's why at our customer event last month, we announced an entirely new and intuitive web experience that helps users stay productive.

Whether its editing of Pds recording a video message for team are tracking your proposal sent to a client or.

The web redesign makes it easier for users to access the right tools at the right time.

With an adaptive interface the view changes based on what users are working on.

Such as a dedicated tab focused on E signatures.

And with a number of these capabilities integrated more seamlessly users can avoid having to switch between apps.

With our web redesign and we also saw an opportunity to refresh our business plans, making it easier for customers to discover all the value Dropbox can provide to them directly from our plans page.

Previously we sold some of our additional capabilities with select plans like our E signature and professional planned package.

But as two separate products and user experience with disjointed and difficult to navigate.

It was also confusing for self serve customers looking for more than just storage to discover how they could purchase the right plan for them.

I'm excited to announce that we've rolled out the first generation of our fully integrated bundled offerings for new customers.

And we've updated pricing and packaging to reflect the added value, including capabilities, such as E signature tracking analytics and PDF editing.

These new offerings are dropbox is essential for solar professionals Dropbox business for small teams.

And Dropbox business plus for larger teams.

More details of each plan can be found on our website as well as in our investor presentation.

New customers can purchase these plans today and we're currently migrating existing customers to the new plans at their existing plan price.

We see an opportunity for these bundles to provide an RP lift over time from new user adoption as well as retention improvements as we've seen the customers who use multiple products retained at significantly higher rates.

I'll now move onto our financial highlights from Q3 and update guidance for the rest of this year along with offering some commentary on how to think about our 2024 targets.

And growth outlook.

Starting with our third quarter results.

Total revenue in Q3 increased seven 1% year over year to $633 million.

Beating our guidance range of $626 million to $629 million.

Foreign exchange rates provided an approximately $7 million headwind to growth.

On a constant currency basis revenue grew eight 3% year over year.

The revenue outperformance was driven by strength across our individual plans.

Which were once again, partially offset by headwinds we continue to see across our teams and document workflow businesses.

Total <unk> for the quarter grew three 8% year over year for a total of 252 5 billion.

On a constant currency basis, <unk> grew $25 billion sequentially and seven 5% year over year, primarily driven by individuals.

Note that in Q3 with largely lap the pricing and packaging changes we've made to our teams plans last June.

And hence added less quarterly net new <unk> relative to the first half of 2023.

We exited the quarter with $18 2 million paying users and added approximately 130000 net new paying users sequentially.

Average revenue per paying user for Q3 was $138 71.

Down slightly on a sequential basis, but up over $4 year over year, driven by the team's pricing increase form swift as well as the shift to premium plans.

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

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

<unk> of our real estate assets and expenses related to a reduction in force.

Our non-GAAP net income also includes the income tax effect of the aforementioned adjustments.

Moving to our real estate strategy, where we have been actively seeking sub leases and buyouts of our vacant real estate space. The majority of which is in San Francisco.

In October we exited a buyout with our landlord of approximately 40% of our remaining sublease space in San Francisco.

For $79 million to be paid over three years, beginning with an approximate $28 million payment in the fourth quarter of this year.

This payment was not previously factored into our 2023 free cash flow guidance.

And I will provide an update on this when we share our latest view for the year.

Overall, we expect this buyout to drive significant savings in the long term.

As we will be avoiding over $220 million in aggregate rent payments and common area maintenance fees.

The remaining 10 year lease duration.

We will continue to actively seek sub leases and pursue additional buyouts were received favorable returns.

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

Gross margin was approximately 83% for the quarter roughly flat compared to the third quarter of 2022.

Operating margin was 36% up roughly 400 basis points year over year.

We beat our operating margin guidance by 300 basis points, primarily driven by delayed marketing and professional services spend.

We expect to incur in Q4.

We are also being prudent with the pace of hiring as we remain focused on cost discipline.

Net income for the third quarter was $194 million up 27% versus the third quarter of 2022.

Driven by operating income growth.

Diluted EPS was <unk> 56 per share.

Based on 346 billion diluted weighted average shares outstanding up from 43 per share based on 360 million diluted weighted average shares outstanding.

For the third quarter of 2022.

Moving on to our cash balance and cash flow.

We ended the quarter with cash and short term investments of $1 3 billion.

Cash flow from operations was $256 million in the third quarter.

Capital expenditures were $9 million during the quarter.

This resulted in quarterly free cash flow of $247 million compared to $245 million in Q3 of 2022.

In the quarter, we also added $26 million to our finance leases for data center equipment.

Moving on to our share repurchase activity in.

In Q3, we repurchased 4 million shares spending approximately $104 million.

As of the end of the third quarter, we have approximately $1 5 billion remaining under our current repurchase authorizations.

As a reminder, we remain committed to allocating a significant portion of our annual free cash flow to share repurchases.

I'd now like to share our guidance for Q4 and in turn.

Full year 2023.

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

For the fourth quarter of 2023, we expect revenue to be in the range of 602000 $9 million to $632 million.

We are assuming a currency headwind of approximately $2 million in the fourth quarter.

Thus on a constant currency revenue basis, we expect revenue to be in the range of 631 to.

$634 million.

We expect non-GAAP operating margins to be approximately 31, 5%.

This includes a roughly 90 basis point headwind from FX and form slips.

Finally, we expect diluted weighted average shares outstanding to be in the range of 345 to 350 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 range by roughly $5 million.

Two $4 96.

The $2 $4 $99 billion.

Versus our previous range of $2 $4 87 to <unk>.

$2 $4 $97 billion.

On a constant currency basis, we are raising the midpoint by roughly $7 million to a range of $2 $5 36.

To 253 9 billion.

We now estimate our full year 2023 currency headwind of approximately $40 million.

Or an approximately 170 basis point headwind to growth.

We continue to expect form swift to contribute nearly 300 basis points of growth.

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

We expect non-GAAP operating margin to be approximately 32, 5%.

Up from our prior guidance of approximately 32%.

This is inclusive of an approximately 75 basis point headwind from FX and form sweats.

We are reducing our free cash flow guidance by $50 million at the midpoint and.

And narrowing the range to $775 million to $785 million relative to our previous guidance range of $820 million to $840 million, which I will elaborate on shortly.

As it relates to capital expenditures, we now expect capex to be approximately $30 million.

The low end of our prior guidance range.

In addition to finance lease lines to be approximately 6% of revenue up from our prior expectations of five 5%.

Finally, we are maintaining our 2023 diluted weighted average shares outstanding guidance range of.

345 million to 350 million shares.

To share some additional context on this guidance.

As it related to revenue we are raising our revenue guidance for 2023, driven by better than expected performance across our individual plans.

This is outweighed macroeconomic headwinds on our team's plans as well as both docks and inside.

I will also note that I expect lower net new paying user additions in Q4.

Alongside the uncertain macro economic environment.

Q4 is a seasonally slower quarter for net new paying users.

Additionally, as part of our recent bundles launching plans page changes, we have minimized the family plan Skus prominence on our plans page.

While this skew is still available to existing customers we.

We found the business users were using it as a loophole to obtain licenses at a lower cost.

As a result of these factors, we expect net new paying users to trend lower relative to our historical run rates.

As it related to operating margins for 2023, we are raising our operating margin guidance to approximately 32, 5%.

Up 50 basis points as compared to our prior guidance.

This increase is driven both by our revenue outperformance as well as our disciplined approach to hiring subsequent to our risk which is translating to savings.

As it relates to finance leases as a reminder, in recent years, we have seen users uploading increasing levels of high density pilots such as videos.

And images to our platform, particularly within our advanced teams plan, which allows our customers to use as much storage as needed.

We also discovered that some customers were using the storage benefit for purposes that did not meet the spirit of the plans design.

To address this in Q3, we sunset it or as much space as you need policy.

And transitions to a metered model.

However, we accompany this with an extended grandfathering window for the vast majority of impacted customers to support them with the transition.