Dropbox Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2023

There are 8 speakers on the call.

Operator

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 will be an opportunity to ask questions. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox website following this call.

Operator

I will now turn the call over to Karn Kapoor, Head of Investor Relations for Dropbox. Mr. Kapoor, please go ahead.

Speaker 1

Thank you. Good afternoon, and welcome to Dropbox's Q2 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 Q3 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, 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 undertake no obligation to update them a result of new information or future events.

Speaker 1

Factors and risks that could cause our actual results to differ materially from these forward looking statements Are set forth in today's earnings release and in our quarterly report on Form 10 Q filed with the SEC. We'll also discuss non GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non GAAP results is provided in our earnings release and on our website at investors. Dropbox.com. I would now like to turn the call over to Dropbox's Co Founder and Chief Executive Officer, Drew Houston.

Speaker 1

Drew? Thanks, Karen, and good afternoon, everyone. Welcome to our Q2 2023 earnings call. Joining me today is Tim Regan, 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.

Speaker 1

I'm pleased to report that we had a solid quarter, once again beating our guidance across all metrics, Led by revenue outperformance in FormSwift and some 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 team's customers and pressures growth in our DocSend and Science 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 at Dropbox is to design a more enlightened way of working and I'm proud that we've accelerated our roadmap here with Dropbox DASH and our progress in AI, which I'll discuss in a minute.

Speaker 1

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 has 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 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.

Speaker 1

And seemingly overnight, we now live in a world where machines can read and write and talk to us and answer our questions In natural language. But while there's a lot that these AI chatbots can do, there are a lot of questions these chatbots can answer when it comes to questions about you or your content or your company because they aren't personalized. And it's clear that customers need more personalized AI that can questions and provide insights on their own content, their company's content and 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's trusted by 100 of millions of users, we see ourselves as uniquely positioned to build personalized AI at scale. That's why in June, I was really excited to introduce our 1st generation of AI powered product experiences to help our customers organize their working lives.

Speaker 1

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 across 100 tabs in a browser, a common pain point Like Google Workspace, Microsoft Outlook, Asana, 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 of Command E and our teams are working hard to build on top of that functionality.

Speaker 1

We rolled out 2 additional features within DASH beyond universal search. The first is stacks, which are smart collections for all the cloud docs in your browser. And similar to how files have folders and songs have playlists, Stacks give you an easily shareable organizational layer for your URLs, so that you can seamlessly share multiple links at a time. Instax uses machine learning to offer smart suggestions and organize links for you, saving you from the process of having to manually save all your links. The other feature within Dash is the start page, which is a single dashboard that lets you access Dash's universal search, view your stacks, integrate your calendars to start meetings from there, and get shortcuts to recent work.

Speaker 1

So if users close their browser or restart the computer, 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.

Speaker 2

Early feedback has been positive and

Speaker 1

we're seeing healthy activation rates and retention rates. While we're 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 receive 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.

Speaker 1

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 Dropbox on their file previous page to summarize their content with a single click, whether it's a 100 page document or even a long 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 this functionality to folders and eventually to users' entire Dropbox. We're encouraged by the early engagement from the users who have tried Dropbox AI for their files.

Speaker 1

And as we increase discoverability for this new functionality for more users, We're excited to see how Dropbox AI can ultimately increase customers' productivity. We'll 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 Meta's Llama 2 launch And we also announced Dropbox Ventures to support the next generation of AI startups. 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.

Speaker 1

So in June, we published 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 in 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'll touch on improved churn with individuals.

Speaker 1

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 instability. To address the latter issue, our team made significant progress in enhancing our tooling and instrumentation to detect and address reliability issues, which help reverse the sequential declines in mobile churn that we had seen over the prior quarters. We also made some optimizations on 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 improved the UX experience and the performance of file uploads.

Speaker 1

This led to improvement in upload success and our internal testing has showed that we've regained the number one position 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'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 serve Teams and professional plans resulting in an increase in Teams trial starts as well as pro conversions through this more targeted effort. 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 increase conversion of these users and ultimately team expansion.

Speaker 1

In Q2, we launched a new activation homepage for admins to easily set up their 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 continued to see contraction among our 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 and 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, DocSend, sign and PDF editing for the first time to some of our professional users.

Speaker 1

Previously, we had sold standalone offerings such as our Pro FSX and eSign as a bundle, but the user experience was disjointed for customers as the 2 products weren't 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 our Dropbox users is a long term opportunity, I'm pleased to also see some momentum in our standalone businesses such as FormSwift, which we acquired late last year and our in house video editing tool, Replay, which just launched into GA in April. As a reminder, FormSwift provides an online library of forms and templates for small businesses and individuals. We saw outperformance in FormSwift's business for the 2nd straight quarter, driven by improved retention and increased account creation through Google sign in.

Speaker 1

While FormSoa benefits from some seasonality earlier in the year around tax planning, We see opportunities to further leverage FormSwift's performance marketing engine and we're continuing to make progress towards rebranding and deeper integration of FormSwift within Dropbox this year. And in our video workflows, Replay has shown a solid start in its 1st 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 multiproduct suite offerings and I look forward to sharing more next quarter as part of our multiproduct update. In closing, we delivered a solid quarter and introduced some exciting AI powered product experiences to our customers.

Speaker 1

While we recognize the macro environment remains uncertain, we're focused on improving the product experience within core Dropbox and attaching more value across workflows and AI driven 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 will be our 1st major in person customer event 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.

Speaker 2

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 2nd quarter results. Total revenue in Q2 increased 8.7% year over year to $622,000,000 beating our guidance range of $612,000,000 to $615,000,000 Foreign exchange rates provided an approximate $14,000,000 headwind to growth. On a constant basis revenue grew 11.2 percent year over year.

Speaker 2

The upside to our revenue guidance was driven by outperformance from FormSwift as well as the improvement we saw across our individual plans that Drew mentioned. Total ARR for the quarter grew 7.2% year over year for a total of $2,500,000,000 On a constant currency basis, ARR grew 10.9% year over year, primarily driven by FormSwift and our team's price increase. ARR grew $33,000,000 sequentially, driven by the retention improvements within our individuals' plans. We exited the quarter with 18,000,000 paying users and added approximately 140,000 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 Q1 of 2023 As the benefit we saw from our pricing initiatives was largely offset by FX headwinds and the continued adoption of our family plan.

Speaker 2

ARPU increased by over $5 year over year driven by the team's pricing increase, FormSwift and a shift to premium plans. Before we continue with further discussion of our P and L, I'd like to note that unless otherwise indicated, all income statement figures mentioned are non GAAP and exclude stock based compensation, amortization of purchased intangibles, certain acquisition related expenses, Impairments of our real estate assets, expenses related to our reduction in force and net gains on equity investments. Our non GAAP net income Also includes the income tax effects of the aforementioned adjustments. Moving to our real estate strategy, where we have been taking steps to de cost our real estate portfolio as a result of our transition to a virtual first model. This quarter, we incurred a nominal impairment charge of $2,000,000 due to a small sublease we executed outside of San Francisco.

Speaker 2

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 We also continue to actively seek subleases and consider buyouts of the remaining space available within our San Francisco headquarters. With that, let's continue with the Q2 P and L. Gross margin was approximately 83% for the quarter, Roughly flat as compared to the Q2 of 2022. Operating margin was approximately 34%, up roughly 200 basis points year over year. We beat our operating margin guidance by over 2 50 basis points, mainly due to delayed marketing and project spend, following our reduction in force in April, as well as our revenue outperformance.

Speaker 2

Operating expenses were $302,000,000 up about 3% year over year. While we did see a partial quarter of cost savings in Q2 from Enforce 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 for FormSwift. Net income for the Q2 was $174,000,000 of 26% versus the Q2 of 2022, driven by operating income growth and higher interest income. Diluted EPS was $0.51 per share based on $344,000,000 diluted weighted average shares outstanding, Up from $0.38 per share based on $366,000,000 diluted weighted average shares outstanding for the Q2 of 2022.

Speaker 2

Moving on to our cash balance and cash flow. We ended the quarter with cash and short term investments of $1,200,000,000 Cash flow from operations was $188,000,000 in the 2nd quarter, down from $210,000,000 in the 2nd quarter of 2022, mostly driven by $34,000,000 in severance payments related to our reduction in force. Capital expenditures were $3,000,000 during the quarter. This resulted in quarterly free cash flow of $185,000,000 compared to $206,000,000 in Q2 of 2022. In the quarter, we also added $33,000,000 For finance leases for data center equipment.

Speaker 2

Let's turn to our share repurchase activity. In Q2, we continue to execute against the $1,200,000,000 authorization that was approved in 2022 By repurchasing 7,000,000,000 shares, spending approximately $154,000,000 At the end of the second quarter, we had approximately $419,000,000 remaining under the current authorization. Additionally, as I will discuss in greater detail shortly, We're pleased to announce today that our Board has authorized an additional $1,200,000,000 share repurchase program. I'd now like to share our guidance for the Q3 and provide an update to our full year 2023 guidance, where I will also provide some context on the thinking Behind this guidance. For the Q3 of 2023, we expect revenue to be in the range of 626 To $629,000,000 On a constant currency revenue basis, we expect revenue to be in the range of 6.34 $4,000,000 to $637,000,000 We are assuming a currency headwind of Nearly $8,000,000 in the 3rd quarter, which translates to a 130 basis point headwind to year over year growth.

Speaker 2

We expect non GAAP operating margin to be approximately 33%. This includes roughly a 130 basis point headwind from FX And FormSwift. Finally, we expect diluted weighted average shares outstanding to be in the range of 347 The 352,000,000 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 $14,500,000 To $2,487,000,000 to $2,497,000,000 From our previous range of $2,470,000,000 to $2,485,000,000 On a constant currency revenue basis, we are raising by $12,500,000 at the midpoint We estimate a full year 2023 currency headwind of approximately $38,000,000 or approximately 160 basis point headwind to growth With a minimal FX impact in Q4. We now expect Forum Swift to contribute closer to 300 basis points of growth, up from our prior forecast of approximately 250 basis points of growth.

Speaker 2

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 FormSwift. We are maintaining our free cash flow guidance of $820,000,000 to $840,000,000 This includes cash outflows of approximately $23,000,000 in cash outflows for the 2023 installments of acquisition related deal consideration holdbacks For Doxins and Command E, one time severance payments of approximately $40,000,000 related to a reduction in force And consistent with our initial guidance, this includes an approximately $50,000,000 headwind as a result of R and D tax legislation. As related to our capital expenditures and additions to finance leases, we are increasing their prior guidance.

Speaker 2

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 5.5% of revenue, up from our prior guidance of approximately 5%. And we're increasing our cash CapEx range By $5,000,000 to now expect $30,000,000 to $40,000,000 in cash CapEx in 2023. Finally, we expect 2023 diluted weighted average shares outstanding to be in the range of 345,000,000 to 350,000,000 shares, From our previous guidance range of 340,000,000 to 345,000,000 shares.

Speaker 2

To share some additional context on this guidance, as related to revenue, we are raising our revenue guidance for 2023 driven by outperformance in Q2 from Form And improved trends across our individual plans. These positive trends are outweighing macro headwinds on our team's plans as well as both DocSend and Sign. Additionally, and as a reminder, we will be lapping the benefit of our Teams price increase in the second half of this year, which is reflected in our guidance. As 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 our reduction in force We also have shifted some project and marketing spend from Q2 into the second half of twenty twenty three.

Speaker 2

And as a result, we expect that our Q2 operating margins will represent the high mark for the year. As related to full year free cash flow, we are maintaining our free cash flow guidance range of $820,000,000 to $840,000,000 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 Additionally, and as a reminder, we still foresee a potential impact of billings later in the year as a result of our reduced levels of headcount and marketing investments stemming from our restructuring. As 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 $419,000,000 remaining on our existing $1,200,000,000 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 $1,200,000,000 in share repurchases.

Speaker 2

This brings our total current capacity under our share repurchase program to approximately $1,600,000,000 As a reminder, our buyback program is Lastly, as related to our long term financial targets of delivering gross margins of 80% to 82%, Operating margins of 30% to 32% and $1,000,000,000 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 our reduction in force. While we are not offering more specific 2024 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 roll out these products to a broader audience of users Gain clarity on the customer response, we will assess the appropriate levels of investment to support their momentum.

Speaker 2

And therefore, we are maintaining As related to our $1,000,000,000 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 Q2, we continue to face significant headwinds From exogenous factors such as R and D tax legislation, which came to light after we initially developed our long term targets. We are also keeping in mind the potential for further investment that I just mentioned, where we intend to ensure that we are appropriately funding our long term growth. In short, we remain focused on achieving our $1,000,000,000 target. However, we still have work to do.

Speaker 2

In conclusion, we continue to drive foundational improvements to our core business, while carefully investing towards new AI powered products And 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 and A.

Operator

Thank you. And our first question coming from the line of Rishi Jaluria with RBC Capital Markets.

Speaker 3

Wonderful. Thanks guys so much for taking my questions. I had 2. I wanted to first Start, maybe Drew, if you could go a little bit deeper into your strategy around DASH 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 for or at least the way it sounds to us seems like a big pain point for a lot of customers.

Speaker 3

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 a center of gravity for solving that problem and driving adoption of these solutions, I think especially just kind of given maybe some of the learnings Out of the new Dropbox in the past. And then I've got a quick follow-up.

Speaker 1

Great. Yes, 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 I think about the customer problem, I think within the company, I mean, I experienced these problems. I think we all do where it's You know you were looking at a document a day ago and you know it's there, but you can't find it. And the problem is really similar to the one I started with, which is My stuff is 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 100 files on your desktop have become 100 tabs in your browser.

Speaker 1

So and there's really this missing organizing layer For your cloud content, in that search is broken, right? We have like instead of where we used to have 1 search box, now we got 10, as with all the different apps and platforms that we use, That you have 10 search boxes that each search 10% of your stuff. And there's a missing organizing layer in that. There's no persistence and there's no kind of concept of like collections for links and I could go on about So 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 there's this missing organizing layer and a better way of doing things. And we see it as a universal customer need.

Speaker 1

In many ways that the challenges that people have with organizing their cloud content are much greater than the challenges they have With Fouse Against Share. So we see it as a much bigger or a huge TAM and a much greater unmet need. Now, and then building on, 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 in natural language, so and to change the paradigm of search entirely. So As people as we've all used ChatGPT, it's pretty amazing what these, what generative AI can do, but there's a lot of questions that can't answer If you think about it, so because it's not personalized or things like ChatGBT, it can't really tell you what if you have a question like what's my passport number or what is that presentation I did last year On last year's product launch or things like that, ChatrouBT can't answer that because it's not connected to your information. So we see a big opportunity For Dropbox more broadly to provide personalized AI, because we have this audience of millions of users who have already entrusted us With a lot of their most important information and we're we've been in June in our launch, we launched we also introduced Dropbox AI, which is Allows you to summarize large documents or even large videos, ask questions in natural language, provide that kind of personalized Chatbot AI Experience in addition to Dash where we're doing the same thing with Dash Answers for all your content.

Speaker 1

So we're very excited about this. We're excited about having the launch. It's in closed beta right now, and we're continuing to iterate on the experience and Gets better every week and look forward to getting in more people's hands. And I think Yes.

Speaker 2

Go ahead. Yes.

Speaker 1

I was just going to say, so what's different, I think there are a couple of other aspects like what's positioning or how do we become the center of gravity. I think it's 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 in Dropbox, we think Natural evolution for existing file sync and share users to adopt DASH. And then but then when you look at the market of a 1,000,000,000 knowledge workers, none of them have A solution to their challenges around organizing cloud content. So we think this is a significant opportunity to Make our TAM many multiples of what it is now. And as far as positioning it again, I think it's natural evolution.

Speaker 1

And then last, like, 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've wanted to build for a long time, but didn't have the technical building blocks or sort of the missing piece of the large language model It's a big deal and then I'd say with DASH, it's a very focused experience, right? We do search, we do smart collections, We have started page for work concept, but we and we've had a much more iterative approach, where we've been working with our customers and DASH is also A key ingredient of that was an acquisition of Command D, which we did a few years ago. So we continue to iterate And draw on the lessons from past experiences and we're really excited about getting DASH and the rest of our portfolio in more people's

Speaker 3

hands. Awesome. No, thanks. Very thorough. I guess just a quick follow-up.

Speaker 3

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 gate wall behind the higher Tier SKUs and use these as incentive to drive upgrades, are there certain modules that you might consider Monetizing discreetly, is this more about driving value and therefore you're going to get more new customers and better growth retention? Just I really just want to understand your full walkthrough around monetization without having to put numbers around it.

Speaker 1

Sure. So I mean, there's going to be a portfolio of applications of AI and I think it The way I think about it is pretty similar. You could sort of replace machine learning and there's a lot of different applications of machine learning even before 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 or which is part of the Dropbox File Sync and Share product is only available To pay customers, it's in alpha right now, so we're continuing to iterate on it.

Speaker 1

And then products like Dropbox Dash Or when you look at the more broadly at other companies, there's a lot of different approaches from integrating 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 design our pricing and packaging to best capture the value that we create.

Speaker 2

And real brief, Rishi, 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 that it will take several quarters before we start seeing a contribution to revenue from DASH.

Speaker 3

All right. Wonderful. That's really helpful. Thanks Drew and Tim.

Operator

Thank you. And our next

Speaker 4

Great. Thank you for taking the question. This is Sona Kolar on for Martin Murphy at JPMorgan. Kim, at our TMC conference this year, you shared Color around a customer survey indicating about, I think, 8% of existing customer awareness for Dropbox Sign. 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 up sell opportunities?

Speaker 2

Sure. Good question. So we have been working towards Bundles for a while. We're excited to roll those out soon. And 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 know we offer it.

Speaker 2

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 terms of service and a unified customer identity. We're now testing a bundle that does include file sync and share, sign and doc send for professional users where early signals on conversion are positive. And we're working on our Teams version of these bundles where we will have more to share on that soon. So excited that we are making progress on this dimension.

Speaker 4

Great. Thank you, Tim. And then maybe a quick follow-up is just in terms of the macro. I'm curious if We have to say relative to Q1 if the macro is fairly consistent or would you say that there's pockets of incremental improvement or worsening? Any color that you can provide on kind of how the macro has trended sequentially?

Speaker 2

Sure. So as far as what we're seeing today, I'd 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 down sell pressure from Teams customers, particularly those that have had layoffs themselves. And then Sign and DocSend are also continuing to face macro related headwinds. On the other hand, we are seeing some positive trends around our 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 streamlined onboarding processes, where our guidance factors in these latest trends.

Speaker 4

Great. Thank you and congrats on the results.

Speaker 2

Thank you.

Operator

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

Speaker 5

Great. Thanks for taking the questions here.

Speaker 2

I guess I want to

Speaker 5

start on, it seems like Last quarter, now there was a bigger push on the hiring side to hire AI talent and help kind of The employee base here, I guess, how are you finding the hiring environment today for those with expertise there? And I guess how should we view those incremental hires kind of like layering into the model through the rest of the year?

Speaker 1

Sure, I can start. We're finding it a pretty fertile environment and having a lot of success hiring and We find, well, it's been helpful to have things like DASH announced and be able to talk about these things more broadly, and Other factors like our Virtual First model 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 AI folks from industry, but then also When you think about other shifts to the Internet or to mobile or the cloud, a lot of the best mobile engineers or web engineers Pick your favorite example, started out as great generalist engineers before that. So we were also training up the company.

Speaker 1

There's a lot of enthusiasm And interest in turning all of our making all of our engineers AI aware and skilled. So we'll do both and we're seeing good progress.

Speaker 2

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 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 and 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.

Speaker 5

Okay. That's helpful. And then maybe on Farms Lift, I mean, good to see continued Outperformance here in the quarter, I guess two questions on that. I guess, firstly, I guess, what is it that's helping Drive the performance above your expectations. And secondly, on the updated guide, it looks like most Is that a is coming from at least on the top line is coming from the FormSwift outperformance here.

Speaker 5

I guess, Is that the right way to be thinking about that? And secondarily, I guess, what are the implications for how rest of the business is executing versus your expectations?

Speaker 2

Sure. So we're raising the midpoint of our constant currency guidance range up By about $12,500,000 for the full year. I'd 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 DocSend and Sign, We're not assuming an improvement in those trends. Now again, FormSwift did outperform our expectations for the Q2 in a row, so certainly pleased with their progress.

Speaker 2

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.

Speaker 5

Okay, perfect. Thanks for taking the questions.

Operator

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

Speaker 6

Yes. Thank you for the question, guys. I really appreciate it. To dig in a bit more on the churn improvement sequentially during the quarter, I think previously you mentioned that you'd implemented some new customer retention initiatives. So love to get some more Color around that and also expectation for how much more churn could improve from here as we anniversary the price increase from last year?

Speaker 2

Yes, sure. This is Tim. I can start. Drew, feel free to jump in. So we saw our churn rates remain roughly consistent with last quarter with ongoing Macro pressure on our team's customers offset by some improvement with individuals.

Speaker 2

We continue to see heightened churn amongst our team's customers, 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 Okay.

Speaker 6

And then the impact on ARPU from the retention efforts. How should we think about I know it's flat quarter over quarter, but how should we think about the impact on ARPU from retention?

Speaker 2

Sure. Maybe just to walk through some of the ARPU dynamics we saw in the quarter. So on a year over year basis, ARPU was up about $5 Landing at about $139 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 FormSwift is about a $2 contribution.

Speaker 2

This is partially offset by FX and the continued growth In our family plan.

Speaker 6

Okay. And then really quickly on the repurchase and a great incremental $1,200,000,000 so about 1.6 Total, my math about 18% of the cap. Any Commentary on the adjustment to the year end share count though, and how we should think about The pace of share repurchase and then kind of the signaling of the new repurchase program?

Speaker 2

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 We've adjusted our full year share count guidance accordingly. We do continue to repurchase shares as part of our 10b5-1 plan, where our updated share count guidance gives the best sense of our future repurchase expectations.

Speaker 2

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's our it reflects our commitment to that program.

Speaker 6

Great. Thank you all for the time tonight.

Operator

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

Speaker 2

Hello. This is Eilon Liani on for Brent Thill. Thanks for taking my question. Two things on my end. First, What do you think about the sustainable growth rate of the business?

Speaker 2

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 factoring in a greater sense of optimism in terms of Grow for the back half of the year or just if you can talk through the factors that went into the full year guide, that would be great. Thanks. Sure. Maybe on guidance philosophy, I'd say we're being consistent with our historical approach.

Speaker 2

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 will continue, including positive trends from our individual SKUs, 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 headcount and marketing, 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 23 at this time, certainly keeping a close eye on the evolving macro environment as we navigate our path forward.

Speaker 2

We are also launching several new product experiences later this fall, such as Dropbox Dash and bundles, where we will have a better idea of their revenue After we gain initial customer signals, we're ultimately, we're very focused on driving a healthy balance of growth and profitability as we pursue our financial targets. Thank you.

Speaker 1

Sure.

Operator

Thank you. And our next question coming from the line of Jacob Staple with Goldman Sachs. Your line is open.

Speaker 7

Hi, this is Jacob Staphyl on for Kash Rangan. Thanks for taking the question. A couple of questions from me. So Dropbox has Expanded the product portfolio recently. We see that with Dash, Dropbox AI, DocSend, Replay.

Speaker 7

Can you touch on how those offerings might be doing relative to Core FSS offering that 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 in 2Q on a sequential and on a year over year basis?

Speaker 1

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 Document workflows with things like FormSwift and DocSend and HelloSign, and increasingly we're doing more with video with replay and capture as we've seen Folks adopt everything. Initially dropped Dropbox for those use cases or kind of duct taped something together and then we found we could build a more Targeted product for that use case and then you're seeing as our customers or as many workflows have shifted from Files and desktop apps to cloud tools and the browser, a new need to organize all your cloud content and fix problems with search and And organization and then bring intelligence into the work experience. So that's kind of the motivation behind it.

Speaker 1

And as far as how those products are doing, I think we probably don't have much to add 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 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 managed motion to help grow those accounts once they reach a certain threshold.

Speaker 1

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.

Speaker 2

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

Speaker 7

Awesome. Thank you so much.

Operator

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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Earnings Conference Call
Dropbox Q2 2023
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