Good afternoon, ladies and gentlemen, thank you for joining Dropbox's Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox's website following this call. I will now turn it over to Ishaan Gupta with Dropbox's Investor Relations Team.

Thank you. Good afternoon, and welcome to Dropbox's fourth 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 forecast for first quarter and fiscal year 2024, and our expectations regarding revenue growth, profitability, operating margin, and free-cash flow, as well as our expectations regarding our business, assets, products, strategies, technology employees, users, demand and the macroeconomic environment. These statements are subject to risks and uncertainties, that could cause actual results to differ materially. They are also based on assumptions as of today, and we undertake no obligation to update them as a result of new information or future events. Factors and risks that could cause our actual results to differ materially from those 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 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.com. I will now turn the call over to Dropbox's Co-Founder and Chief Executive Officer, Drew Houston.

Thank you, Ishaan, and good afternoon, everyone. Welcome to our Q4 2023 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I'll first provide a recap of 2023, share a perspective on our fourth quarter, and then close with an overview of our strategy for 2024. Tim will then go over our financial results for Q4 and fiscal year 2023, as well as provide guidance for Q1 and fiscal 2024. Let's get started. In 2023, we had two main business objectives. The first was to build AI-powered product experiences centered around organizing all your cloud content. The second was to continue evolving our core FSS offering to provide a seamless product experience for our customers workflows. I'm proud of the work our team accomplished on both of these fronts. Starting with building AI-powered product experiences. In 2023, we introduced the first iteration of Dropbox Dash, a standalone universal search product, leveraging AI and machine-learning. With more of our work spread across hundreds of tabs in a browser, knowledge workers are spending far too much time, just finding what they need to do their work, particularly in this new world of distributed work. Dash connects all of your apps, tools, and content in a single search bar, so it's easy to find everything you need in one place, regardless of where it lives. And because Dash is powered by machine-learning, it learns about you and your priorities, the more you use it. In 2023, Dash moved from closed-beta to open-beta and represents our first major AI-powered product experience. While still very early, we are gaining valuable insights into the types of customers that are engaging with this product and the features that are generating the most interest. For example, we're seeing that are more engaged in existing users…

Thank you, Drew. I'll cover our financial highlights from Q4 and share guidance for Q1 and fiscal 2024. I will then offer some context on the considerations underlying our guidance. Starting with the fourth quarter of 2023, total revenue for the fourth quarter increased 6% year-over-year to $635 million, beating our guidance range of $629 million to $632 million. Foreign-exchange rates provided an approximately $1 million headwind to growth. On a constant currency basis, revenue grew 6.2% year-over-year. Total ARR grew to a total of $2.523 billion, up 3.8% year-over-year on a constant currency basis. However, on a constant currency basis, ARR declined by $2 million sequentially. As Drew mentioned, the sequential decline in ARR was driven by a few factors, including business decisions we intentionally made such as eliminating unlimited storage for advanced plan users, which resulted in incremental churn and softness in our top of funnel, a continued challenging macro-economy and the typical seasonality we see in our business in Q4. We exited the quarter with 18.12 million paying users, which reflects a sequential decline of roughly 50,000 paying users. A number of factors led to this decline, including our decision to reduce the prominence of the family plan on our plans page, macro headwinds facing our Teams SKUs, experiments that underperformed impacting our individual SKUs and finally, Q4 tends to be a seasonally low quarter for File Sync and Share and FormSwift in particular. Collectively, these factors served as headwinds to paying user growth in Q4, where I'll speak to our paying user expectations for 2024 shortly. Finally, average revenue per paying user for Q4 was $138.83, up slightly compared to Q3. Before we continue with further discussion on our P&L, I would like to note that, unless otherwise indicated, all income statement figures mentioned are non-GAAP…

Thank you. [Operator Instructions] And our first question will come from Rishi Jaluria from RBC Capital Markets. Your line is open.

Oh, wonderful. Thanks guys for taking my questions. I wanted to start out, Drew, in the past, you've talked about there is maybe some appetite for M&A, especially transformational M&A. Given this kind of road map of wanting to develop new products and capabilities, especially around generative AI, how are you viewing the potential for M&A to just accelerate your road map in kind of broadening the platform and going from the EFSS to kind of a more Gen AI-enabled company? And then I've got a quick follow-up.

Sure. So still see a big opportunity for M&A to accelerate our road map. And actually, Dash - Dropbox Dash is a great example of - it was seeded by an acquisition of a company called Command E We did. And another benefit is that unlike the first few years after we were public, when valuations were really frothy, as the external environment has moderated, we've certainly seen that moderation happened in public company SaaS. And I think we've been slowly seeing that translate to private company valuations, too. So we think it's a door that keeps opening. But our philosophy is - and so, I think we are certainly opportunistic on the lookout for good companies to buy. But at the same time, our philosophy is pretty consistent. We want to be disciplined because - I mean another thing is even in the AI realm, there's a little bit of a bubble around AI start-up funding. And I don't think it's everywhere, but I think you have to be careful. But yes, M&A certainly continues to be a big opportunity for us.

All right. Wonderful. That's really helpful. And then turning to Dash. I know it's still early. And this year is going to be kind of the big proof point of the year before we can start talking about monetization. But how are you internally measuring the success of Dash, both from a technology perspective, as well as customer adoption, right? Because it sounds like it's solving, a real problem that customers have. But I think a lot of times over the years, we've learned customers may not use it, even if they should be. So what - how are you measuring that success? And what can you do to drive user adoption of Dash to begin with? Thanks.

Yes, yes. So measuring it qualitatively and quantitatively. So really great news and something we pay a lot of attention to, is when we watch customers or talk to customers, everybody's got this problem. Everybody struggles with information overload, fragmentation of using all these different apps. And so, when we explain the value prop, the most common response is, yes, yes, I totally have this problem. And then it's - the question is more like can you really solve it for me? So we start with like, is there a real job to be done in market here and we are seeing really encouraging validation from our customers on that. And then when we look at in terms of success or leading indicators are, how is the quality of the Dash experience? And so, we've spent a lot of time and effort and made a lot of progress in improving things like search ranking and quality. We look at how do we - I mean this is a new category. So similarly to Dropbox 1.0, we spend a lot of time focusing on what the onboarding experience look like, do people understand the concepts. There's a lot of new things like connecting Dash to your different apps. And so how do we make that as seamless and streamline of an experience as possible. And so, we still minimize time to value, things like that. So product quality, onboarding success, engagement generally, retention and then monetization. And these kind of go - we work on all of them in parallel, but I think you kind of clear you go through them a little bit in sequence. So first, you have a great product - you get the product experience is great, then you sand down rough edges in the onboarding. Then you drive engagement, then monetization - or engagement retention, then monetization and virality. So, we're still in the early innings of that, so I think making progress on all fronts. And yes, this year, we'll continue to open the doors wider and wider to Dash as we scale it up.

Really helpful, thank you so much.

Thank you. Our next question will come from Steve Enders from Citi. Your line is open.

Hi, great. Thanks for taking the questions here. I guess maybe just to start, I think it'd be getting a little more clarity on the packaging, and pricing changes that you were - have been working on, and trying to convert over the base. I guess, what were the learnings coming out of that? And I guess as you think about changes moving forward, and trying to build on those learnings, like what does that, I guess, kind of look like through calendar '24 here?

Sure. So some of the lessons from last year, we did a big launch in October where we wanted to address one of the biggest gaps in our funnel, which is that we have all these products that customers. The majority of our customers are not aware that we do more than storage. And we believe a big reason for that is that, in many cases, we haven't promoted the products to our users or integrated those experiences as seamlessly as we could. And because when you look at Sign and DocSend, those started as acquisition of companies and we brought them in via acquisition, and we are fully - we're doing the rest of the work to integrate them. So in October, we launched a redesigned website, where we could start a lot of these document workflows from the new experience. We made -- we launched new bundles that include the workflow products as well as FSS. And then what we found is we made a lot of changes and then a lot of metrics changed. And it was a little difficult to isolate some of the variables. And a lot of the changes are favorable. So for example, we saw more or like a significantly elevated attachment to multiple products, but some changes were negative. So for example, as the default SKUs were more expensive, we saw a decrease in new subscriptions on our team's SKUs. And so - and then there were some other optimizations we were doing around onboarding, where we - for example, some people - we stopped promoting the desktop client as heavily to reduce a number of steps, but then that had a negative impact on engagement in, as customers who are going, into their second through six months or things like that. So it's affecting retention curves. So part of what we're doing is backing up a little, and it testing and iterating our way back into making a lot of the same changes, but making sure that we know exactly, where the deltas are coming from. So, we're taking a little bit more of a - stepping back and taking more iterative approach, to preserve as many of the good changes as we can and edit out the ones that were less promising. So - but for sure, we continue to focus on building awareness and driving adoption of multiple products, whether that's our document workflow products or newer products like Dropbox Replay, which is around video collaboration and Dropbox Dash, which is around AI-powered universal search.

All right. Perfect. I appreciate the context around some of those changes on. And then maybe just on the macro side of it. It seems like most of the challenges were more related to the business on the team side. I guess I just want to clarify if there is kind of any impact more on the consumer front as well? And then, for the public funnel activity, seemed like that slowed down a little bit. How has that kind of trended so far in '24 in the first half of the quarter here?

Sure. I mean I'd say, overall, it's been pretty stable, I think. I don't think the headwinds we saw in Q4 are of a different kind than we were seeing in prior quarters. It's broadly things when you look at the teams business, it's mostly driven by customers becoming more price-sensitive in general, or something we see often is, where we saw last year was as companies or especially tech companies made headcount reductions of their own. Then that means fewer SaaS licenses and so Dropbox is affected by that. And then we've seen more broadly with our Document Workflow businesses, you look like the eSignature category or things like DocSend. There's a big acceleration during COVID and then a bit of a pullback. So things like eSignature were sector wide. And then DocSend has - focuses on the fundraising and kind of start-up part of the ecosystem. And in a world where VCs are doing a lot less investing, or there's less IPO activity, things like that, then DocSend's business has been impacted by that. So there's a lot we're doing in response. Again, like integrating the experiences to be - make it a lot easier to get up and running on these other products via Dropbox or - via the Dropbox UI and through things like the redesign we did in October help. And then with DocSend expanding to new audiences and use cases. So for example, we've been working towards - we've had a lot of good early signal on our virtual data room offering in DocSend, and we'll be rolling that out to GA later this year. So I'd say there wasn't a lot of change in the shape of the curves. It's more of the carrying forward of similar trends. And then we also see in Q4 that there tends to be seasonality in both - or tends to be a lighter quarter for both FSS and some of - and doc workflow products, especially FormSwift for different reasons.

And then Steve, real quick. This is Tim. I believe you asked about top of funnel activity in the first part of this year. So far, have not seen any material changes. So that's all in line with our guidance. So that's all been factored in.

And we see less of the seasonality effect in Q1.

Okay, perfect, I appreciate the commentary there. So I'll turn it back to you.

Thank you. And our next question will come from Michael Funk from Bank of America. Your line is open.

Yes, thank you for the questions. A couple if I could. So on the call, you mentioned seat rationalization is one of the factors that you've been seeing in the last 12 months or so, specifically software companies. We did see a notable increase in rest across software since the beginning of the year. So can you comment on how much the most recent reductions back into your forecast for the year? And if we don't draw a direct correlation between those reductions customers and the seat rationalization?

Sure. So we do factor in what we're seeing across the industry, particularly in that tech vertical, as far as layoffs that we're seeing there into our guidance. So that's certainly been contemplated. And maybe just, to provide a bit more color. We don't formally guide to paying users, but I do expect that we will still add paying users in 2024. I do expect our total additions this year to be less than last year. Again, largely due to the de-emphasis of our family plan. And there may be some quarters where we lose paying users, depending on things like the state of the economy, potential turn of larger customers and the timing of our initiatives. But again, we still expect to add paying users this year.

Okay. And then just on the share repurchase plan, and the guidance for the share count for the year, trying to some back envelope math here. Does that roughly imply a similar cadence, to share repurchase in '24, to what we saw in 2023 absolute dollars?

Yes, I'd say no changes in our philosophy as far as share repurchase program, still remain very dedicated to that. We continue to expect, to allocate a significant portion of our annual free cash flow to share repurchases, with the intention of reducing our share count. And maybe to provide some color on how it is structured, our buyback program buys more shares, at lower price points and less shares at higher price points. Again, all reflected in our full year share count guidance.

Great, thank you so much for the questions.

Thank you. And our next question will come from Pat Walravens from Citizens JMP. Your line is open.

Oh, great, thank you. I mean, Drew, very big picture, how happy were you with how this business executed in Q4?

So I mean, I was happy to get things like Dash to open beta, and I was happy with the improvement to a lot of the customer experience and product quality with things like our web redesign. And I was unhappy with the overall results and the fact that some of the upside we had been projecting didn't fully materialize. And we have to kind of go back and take a more iterative approach. To making sure all the new ingredients or changes we're making that we're doubling down on the additive ones and filtering out the ones that aren't working. And I think there were so many variables that got kind of conflated with making so many changes to the ones. I think that was a lesson. And then some of the lessons around, yes, a more difficult macro environment. A lot of our customers are more price sensitive. And so, when I say we're iterating on pricing and packaging, we want to make sure that as our customers used to be able to - many SaaS companies would just be on a regular clip of price increases and customers are fine with that, now in a world where things are more difficult, or there's more budget pressure, different value props are more compelling. So the idea of like, well, I can consolidate spend by. In addition, if I can have not just files we can share, but also be able to have eSignature with Dropbox, or I can do video collaboration or I can do AI-powered universal search and get that all as part of one subscription. So bundling and things like that. So this is the kind of iteration that we need to do. So overall, I mean, I'm not happy with the headline result. But I think we've got - we took away some clear lessons and we'll be making targeted improvements in response.

Okay. Thank you. And then, Tim, is there - did I miss it? Is there a sort of a new $1 billion free cash flow target?

Yes. Let me walk you through that, Pat. So as a reminder, last quarter, we did adjust our free cash flow target by the amount of the R&D tax legislation, which we now estimate to be $30 million, effectively taking our $1 billion target to a revised target of $970 million. Our guidance of 910 to 950 falls below that target, and that's primarily driven by slower billings growth, incremental FX since we first set the target and our investments in Dash. Now while we could withhold investments in our long-term initiatives to meet the target, that would be a shortsighted approach. So that's where this guidance reflects our continued investment in the long-term health of the business. And again, we still have time to outperform that guidance throughout the year and via product execution or identifying efficiencies within the business.

Okay. Thank you.

Thank you. [Operator Instructions] And one moment for our next question. And our next question will come from Richard Hilliker from UBS. Your line is open.

Hi guys, thanks for taking my question. My question is on the R&D line. So I appreciate the exciting opportunity ahead, particularly with Dash and AI. But I guess what I'm wondering is, can you help me understand why we couldn't potentially see more leverage on this R&D line, while still investing in AI and these other exciting opportunities? And then I have a follow-up? Thanks.

Sure. I'll start, Drew. Obviously, feel free to jump in. So R&D increased slightly to 25% of revenue. That's primarily due to hiring for our longer-term growth initiatives such as Dash on that side. These engineers with an AI background typically, do command premium compensation and are located in higher-cost locations, such as the Bay Area and Seattle. So certainly, we want to make sure that we're focused on investing in these long-term initiatives and that we're funding them at a proper rate. So certainly contemplates an investment on that front. And then maybe just to provide some more color on our overall operating margins, that's between 32% and 32.5%. At the highest level, what we're doing across the business? We will be driving increased efficiencies within our core file sync and share and document workflow businesses, again, while concurrently investing in long-term growth initiatives such as Dash. We're also going to be investing in marketing, to drive product and brand awareness, including our partnership with McLaren Formula 1 racing that Drew alluded to. And the guidance does preserve some flexibility to invest across the business, to drive long-term growth.

Yes. And I would just add that it's a balancing act. I mean we certainly care about margins, we certainly care about efficiency. And we also don't want to miss, these like once a decade, or once a generation platform shifts. I mean you look at the move to mobile and cloud made Dropbox 1.0 possible to begin with, and all the emergence of AI, is going to make Dropbox 2.0 possible. And ultimately, I think it's going to be a much larger opportunity, so we don't want to miss that. But that's like the tension, we're navigating. I mean, fortunately, we're able to do a lot of these investments within the general envelope that we've provided. So I don't expect there to be like massively different shaped curves. And I think another thing is we're also been reallocating our resources away from less efficient or less promising areas and more towards things like AI and Dash. So that's a little bit harder to see was just the aggregate R&D line.

Okay. Thanks. And then, Tim, maybe one last one for you here. I was curious - I think you mentioned that finance lease would jump up to about 7% of revenue. And I think that's from right around 5%. It seems like kind of a big jump. Maybe wondering if you could give us any other color to help us understand that change? Thanks so much.

Yes. Sure. Good question. So, we are seeing an increase in our finance lease additions this year that's, due to two reasons. First, we are nearing a hardware refresh cycle for equipment that's reaching the end of its life, where we did have a similar refresh in 2019, 2020. And then additionally, we are supporting one-time quota grants to customers on our advanced plan who are using an excess amount of storage. So, we've grandfathered some of these customers in. And so, we need to support those customers. So that's partly what's driving that additions.

Thank you. Our next question will come from Mark Murphy from JPMorgan. Your line is open.

Thank you. Do you notice much of a difference in the signals you're seeing from the very, very smallest businesses, which are more sensitive to interest rates, and banks extending credit if you compare that to your relatively midsized, and larger customers within the mix?

Yes. Hi Mark, I think this is all part of what we're seeing on the macro side, where, as you know, most of our teams plans are in the SMB space, where we do continue to see a challenging demand environment there. Again, as Drew has talked about, some of that is due to heightened price sensitivity, and we've seen that since our price increase in 2022. And again, as Drew has also touched on, some of that also pertinent to SMBs seeing down sell pressure as teams trim their license counts, following whether that's layoffs, or budget cuts, those sorts of things. So our guidance factors in a continuation of these trends.

And I wanted to ask as well, you described this as a unique period. What do you think has to happen through the course of the year? If we're going to look back on it as kind of a troughing out period for growth, there's no real price increase as a driver. You're taking some intentional actions, which are minor headwinds. And you had foreshadowed a lot of this coming off the Q3 call. The new products haven't ramped yet. We still have tech companies that are out there doing incremental layoffs. Is it a bit of a perfect storm this year where that kind of alignment of all these factors might be marking a troughing out period?

Yes. So with last year, we had to make some difficult decisions with layoff of our own and then kind of weaning ourselves off of things that I didn't find sustainable like price increases or inefficient sources of growth, or inefficient marketing spend or sort of over investments in areas that weren't going to bear as much fruit and then reallocating a lot of resources towards the future and things like AI and Dash. So, I'm hopeful there are like a lot of more difficult decisions are behind us and winning this year would look like finishing the swing on that, rotating away from things like price and monetization experiments, to areas of the funnel, especially on our teams business where that have been overlooked. So I mentioned a few of them in my prepared remarks, but things like - we see a lot of opportunity to improve the team onboarding experience. There's a lot of friction. A lot of friction, I would see is unnecessary, like too many steps or things that are confusing to customers, when you actually sit down with customers and watch them go through that process. We've identified plenty of things that we continue to make that better, and make some more improvements to the ones we've made on the individual side of the business, where over the years, we've been able to really chip away a churn. And as we've improved the user experience on things like sharing, we see more engagement, more sharing, more viral sign-ups and just more - focusing more on the fundamental levers of engagement and virality more so than monetization. So, I think stabilizing the core business and like - and getting after some of those levers where we've been underinvesting around team onboarding, team expansion, sharing in general. And then the other main goal is getting Dash to true product market fit. So getting it to be a great product experience, great retention, smooth onboarding and bridging from individual use cases like search and organizing your stuff to sharing. And a lot of this is the playbook that, made Dropbox 1.0 successful, and we're doubling down on a lot of those things.

Thank you.

Thank you. And our last question will come from Brent Thill from Jefferies. Your line is open.

This is Eylon Liani on for Brent Thill. Thanks for taking my question. My first question is just at a high level. Was the demand environment better, worse, or in line with what you saw in 3Q? And I have a follow-up after.

Yes, great question. I'd say it was in line. I have not seen an improvement in macro trends. We've talked a bit about, what we saw in our teams business, which stayed rather consistent. We talked about FormSwift, which sees a seasonal low point in the fourth quarter, and then tends to rebound in the first quarter as we enter tax season. And then we saw consistent pressure across DocSend and our eSignature categories. DocSend, in particular, continue to see headwinds in the fundraising space. So a lot of consistency in what we have been seeing. And that has all been extrapolated into our guidance, for next year as far as a continuation of those trends.

Super helpful. And then the second part of my question is just in terms of the monetization of Dropbox Dash. I know it's still early days. But should we expect it to be embedded in the more premium SKUs of the platform? Or would they be priced as a separate SKU? Just like a high level, how should we think about it?

Yes, it will be both. So Dash will be available as a stand-alone subscription and then there will also be different add-on and bundle options over time. So - and we're still pretty early in terms of signal on monetization, we're focusing on finding on driving adoption right now.

Thanks, super helpful.

Thank you. And this does conclude today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.