Dropbox, Inc. (DBX) Q4 2021 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for joining Dropbox's Fourth Quarter 2021 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 Kern Kapoor, Head of Investor Relations for Dropbox. Mr. Kapoor. Please go ahead.

Thank you. Good afternoon, and welcome to Dropbox's Fourth Quarter 2021 Earnings Call. Today, Dropbox will discuss the quarterly financial results that were distributed earlier. Statements on this call include forward-looking statements, including future financial results, including our goals and expectations regarding future revenue growth, profitability and our ability to generate and sustain positive free cash flow; our expectations regarding anticipated benefits to our business and the impact to our financial results, including estimated impairment charges as a result of our shift to a Virtual First work model; our expectations regarding the future performance of our business; operational efficiencies we may achieve as a result of changes to our organizational structure; our expectations regarding remote work trends, related market opportunities and our ability to capitalize on those opportunities; our capital allocation plans, including expected timing and volume of share repurchases, future M&A opportunities and other investments; our ability to drive user growth and retention by enhancing our products, developing and offering new products or features and through strategic partnerships; our strategy as well as the ability of our key employees to execute our strategy and our overall future prospects and ability to generate shareholder value. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those projected or implied during this call, in particular, those described in the risk factors included in our Form 10-Q for the quarter ended September 30, 2021, and the risk factors that will be included in our Form 10-K for the year ended December 31, 2021. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them, except as required by law. Our discussion today will include non-GAAP financial measures. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and may also be found in the supplemental investor materials posted on our Investor Relations website at investors.dropbox.com. I would now like to turn the call over to Dropbox' Co-Founder and Chief Executive Officer, Drew Houston. Drew?

Thanks, Kern, and good afternoon, everyone. Welcome to our Q4 2021 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I'll start with a recap of 2021 and provide an overview of our strategy for 2022. Then Tim will go over for our results for Q4 and fiscal year 2021, give guidance for Q1 and full year 2022 and provide an update on our long-term financial targets. So let's get started. To recap, 2021 was a strong year for Dropbox. We ended with over $2.2 billion in ARR, significantly increased our profitability, grew free cash flow by over 40% and reached approximately 600,000 paid teams. And throughout the year, we've stayed focused on our three strategic objectives and delivered even more value to our customers as we work towards our long-term vision to organize all your cloud content and the workflows around it. Our first objective for 2021 was to evolve the Dropbox core offering. We made investments to simplify and remove friction from the experience to drive customer satisfaction and gains in long-term retention while also improving high-value actions like sharing content and previews and mobile and team onboarding flows. I'm pleased to see these investments pay-off. We've seen retention improve with churn coming down each quarter in 2021. And our rebuild of the mobile experience, which we began in 2020 and continued in 2021 was one of the biggest drivers of churn improvements. Last year, we also made improvements to quality, performance and sharing to drive mobile user acquisition and retention at the basic level. And these are crucial investments because nearly half of our basic sign-ups come from mobile and over 40% of mobile sign-ups come from users receiving shared content. We also reduced the friction in the onboarding experience for mobile and self-serve teams users. We made it easier for basic users with a corporate domain to find a team after signing up, which drove a 15% increase in the request-to-join rate. And we also saw a nearly 20% increase in the invite center team by encouraging existing team users to invite their collaborators to the team within the sharing flow. Our second objective for 2021 was to invest in our product pipeline beyond the core experience. In early 2021, we acquired DocSend, a secured sharing and document analytics company. With DocSend, we added to our suite of document workflow capabilities, and I'm pleased to say it has outperformed our expectations each quarter. We're excited about DocSend's strength and our plans to further integrate it into Dropbox along with HelloSign. We also launched our newest products into beta, Capture, Replay and Shop, which are designed to better support creative workflows and distributed teams. And lastly, in Q4, we closed our acquisition of Command E, a universal search company, that we believe will help bring our vision to life as we work to make it easier to find and organize all your cloud content. I'm really excited for our plans to build universal search into our road map and offer this capability to our users, which I'll share a bit more on later. Our last objective of 2021 was driving operational excellence and executing against our long-term financial targets. I'm proud of our progress here as we expanded our non-GAAP operating margins nearly 9 points year-over-year, consistent with our improvements in 2020. And we increased free cash flow by over $200 million while delivering significant capital back to shareholders in the form of share repurchases, which Tim will discuss in more detail. And finally, we completed a full year in our Virtual First operating model. And though we're still early in the transition, we're already realizing some of the benefits. Employees report that they value the flexibility that our model offers, are more productive, and we're also seeing positive trends in attracting and hiring diverse and distributed talent. I'm excited to build on all the great work from 2021 this year. As I've shared before, there's never been a better time in history to be building software to improve the experience of modern work, and Dropbox is uniquely positioned to support our customers as they transition to new ways of working. To help frame our strategy, I want to reiterate some of the key macro trends we continue to see in this environment. First, over the last year, we've continued to see companies accelerate their shift to the cloud as they adapt to more flexible or hybrid working models. We also see the ongoing growth of the creator economy as new tools and platforms offer more seamless ways to create, publish and monetize content. And more broadly, it's clear to us that the shift from working primarily in physical offices to working primarily in digital screens is a permanent one. We continue to see a huge opportunity to improve that experience and help organize the digital lives of our customers. So with these themes in mind, this year, we remain focused on three important pieces of our strategy, much of which is consistent with the work we began in 2021. First, we'll continue to evolve our core FSS business to improve retention and drive monetization. Second, we're expanding workflows beyond FSS around documents, with HelloSign and DocSend, while also investing in rich media workflows to better serve creators. Finally, we'll stay focused on operational excellence as we continue to balance growth and profitability. I'll go deeper into each piece of that strategy starting with evolving our core business. In order to drive monetization, we're focused on improving retention, strengthening the top of our funnel and leveraging pricing and packaging. Let's start with retention. While we steadily reduce our churn rate over the past year, there's still more room for improvement in usability and speed in our mobile and sharing capabilities. Investments we're making here include updating our web architecture, which enables much faster web loading, improving mobile videos when browsing and organizing and enhancing our search capabilities, so users can find their content faster. Virality and network effects are another key driver of retention as users who share tend to retain at higher rates. We've simplified the sharing experience, so it's easier for mobile users to access shared content. And we're also making it easier for work users whether professionals or small teams to quickly share and receive content across all of our surfaces. Teams will be easily able to see who has access to the content they've shared and any actions taken by recipients. Finally, we're enhancing the recipient experience for teams, making it more efficient for them to immediately engage with shared content, to re-share it, add more content to a shared folder or begin a related workflow like e-signature. And while reducing churn is one component of improving monetization, we're also focused on our top of funnel and on conversion. We've increased our marketing investments to drive product awareness of the new value that we provide beyond FSS. And we're making improvements to our web surfaces and our CRM to deliver more personalized and relevant product experiences, along with building a more seamless onboarding process overall. These investments also support our efforts to convert basic users, particularly on mobile, where we can easily surface some more of our high-value mobile features such as camera uploads and scanning and use mobile prompts and promotions to surface the right plan to users at the right time. Building on conversions, we're also experimenting with up-sell opportunities through self-serve add-ons to drive more value from existing users. For example, in Q4, we rolled out our extended version history add-on to Plus users to allow them to extend deleted file recovery in version history from 30 days to a year. We'll continue iterating on this approach with adjacent products in the pipeline, and I'll have more to share on that in the coming quarters. In the past, we've also had success leveraging effective pricing and packaging to drive growth. And it's always been tied to high-value capabilities that we see demand flow from our customers. In two areas we're especially focused on this year are security and automation. As more and more companies shift their workloads to the cloud, we continue to see security rank as a top spending priority for IT decision-makers of every kind from CIOs down to solo professionals. And this year, we plan to expand our offerings to include both lightweight capabilities like advanced alerts, and insights and controls as well as more robust protection against today's most critical threats. like ransomware and phishing. We'll also be building on our existing functionality like passwords to provide easy access to identity monitoring and manage shared accounts for teams and freelancers. And most recently, we updated passwords into our browser-first product and enabled password sharing, and we'll continue to iterate on this experience. In addition, we're committed to investing in automation and machine intelligence to help our users organize their content and search and discover content more easily. We've learned from our most passionate creative customers that they need more than folders to collect and organize their content, which tends to be large format and rich media. And they're used to targeted search to find what they're looking for, and they don't want to waste time browsing, potentially since most of them live in a hybrid world of traditional media and cloud content. So this year, we plan to improve the ways that users can view and manage their content through better suggestions and surfacing assisted and automated controls in search and performance. As always, we improve our products. We add new functionality like security and automation and we increase the value for our customers. As we do that, we'll also iterate on pricing and packaging that best reflects that value. Now onto the second pillar of our strategy which is expanding into adjacent workflows beyond FSS. In 2021, we saw the number of PDF files shared on Dropbox grow by nearly 40%, and the number of videos shared grew by over 25%. This kind of demand is why we're committed to driving workflows around documents with HelloSign and DocSend and around rich media like videos to better serve creatives and teams. HelloSign and DocSend were our fastest-growing businesses in 2021, and we're excited about the opportunity to expand their customer reach. An important part of this is bringing these products under the Dropbox umbrella, both through our back-end technology and brand. In this month, we relaunched DocSend as a Dropbox product with Dropbox DocSend and went live with an updated marketing website and more consistent user experience. In addition, we went to market with our first Dropbox and DocSend bundle, where we applied key learnings from our e-signature and Pro bundle, which has also seen increasing adoption. We continue to integrate HelloSign and DocSend to enable a true multiproduct experience that makes it easier for our customers to build the best plans for them in one checkout across both web and mobile. And we see more opportunity to further integrate these workflows into our core functionality so that users can see e-signature and analytics, for example, side-by-side with their FSS solution. And in late Q3 and Q4, we also took our newest product experiences, Dropbox Capture, Shop and Replay to market to support creative professionals and teams around rich media. We've seen strong adoption and engagement for beta users who appreciate the ease of use of Shop and the time savings from Capture and Replay. Supporting creative professionals is an important part of our growth strategy as these are passionate and expanding base who are looking for more seamless ways to share digital content with their collaborators and their customers. For example, Dropbox was integral to the Sundance Film Festival's ability to seamlessly go virtual in 2021 and 2022. Sundance's team used Dropbox to request and share video content, throughout the festival and collect, organize and share all the new assets that they needed to create a dynamic and more accessible experience for the filmmakers and the attendees. And then finally, we'll continue to focus on operational excellence. Our technology infrastructure team has done a great job strengthening our supply chain relationships to stay ahead of any constraints. We'll also roll out Kubernetes this year to improve our infrastructure utilization, which we expect to drive efficiency and reduce costs while allowing us to maintain a more flexible footprint between public and private cloud. This is a great example of our increasing efficiency and making progress towards our long-term financial goals, which Tim will outline. And I'm really grateful to our employees who keep our business running and bring our cultural life. I'm pleased to share that once again, Dropbox has been included on the Forbes Best Employers List for 2022. And for the seventh year in a row, Dropbox received a perfect score on the Corporate Equality Index. We're proud to stand alongside many of our peers as we support diversity, equity and inclusion across all industries. We'll also continue to expand our geographic footprint and diversify our talent pool to Virtual First. To close, I'm really excited about our strategy and our opportunity this year. And I'm really proud of all the progress we made in 2021 to lay the groundwork for the important work we have ahead. As I think about the future, what I'm most motivated by is a universal problem that we're solving for our customers in helping to organize their working lives in the new remote and hybrid world. As I shared earlier, we see the shift from physical offices to digital screens as a permanent one. And we see a lot of room for improvement in the chaotic and overwhelming experience of those screens today. Most knowledge workers are caught between the file and browser-based world, juggling a sea of web-based productivity apps. The 100 files we used to see on our desktops are now 100 tabs in our browsers. So in many ways, we're solving today's version of the same problem we saw back in 2007. Our foundational work in 2021 was an important step towards our long-term vision of building one organized place for your cloud content and all the workflows around it, and I'm looking forward to tear ahead. With that, I'll hand it over to Tim to walk through our financial results.

Thank you, Drew. On today's call, I'll walk through our fourth quarter and full year 2021 results, our 2022 guidance along with some context underlying this guidance, and then I will close with an update on our long-term targets. Starting with our fourth quarter and full year 2021 results, total revenue for the fourth quarter increased 12.2% year-over-year to $565 million, beating our guidance range of $556 million to $559 million. Our revenue outperformance was driven by strength in our higher ASP offerings, such as our professional SKU, our teams’ plans and DocSend. Foreign exchange rates provided approximately a 150 basis point tailwind to growth. Total ARR for the quarter grew 11.8% year-over-year for a total of $2.261 billion. On a constant currency basis, ARR grew by $43 million sequentially and 10.2% year-over-year. As Drew highlighted, our continued growth in ARR reflects our efforts to attract new users to our premium SKUs and to drive better retention by improving the user experience with a specific emphasis on mobile, work and teams users. We exited the quarter with 16.79 million paying users and added approximately 300,000 net new paying users in the fourth quarter driven by strength in our teams plans and the continued adoption of our family plan. Average revenue per paying user was $134.78 in Q4. Before we continue with further discussion of our P&L, I would 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 our lease termination. Our non-GAAP net income also excludes net gains and losses on equity investments, the income tax benefit from the release of a valuation allowance on deferred tax assets and includes the income tax effect of the aforementioned adjustments. I'll now provide a brief update on our real estate strategy, where we are taking steps to de-cost our real estate portfolio as part of our transition to a Virtual First model. We continue to make progress against our goals, executing subleases in Seattle and Ireland in the fourth quarter. As we anticipated during our previous earnings call, in the fourth quarter, we also successfully reached an agreement with our landlord to buy out a portion of our San Francisco lease where we had an existing subtenant in Q4. This resulted in a onetime payment of $32 million, which is reflected within our cash flow from operations and a $14 million gain on lease termination, which is reflected within our GAAP results. As a reminder, this lease termination agreement will drive significant savings as the amount of rent payments avoided exceeds the amounts we otherwise would have generated from our previous sublease. In the future, we may enter into similar buyouts with our landlords, should the economics make sense for us, though there are no other pending deals at this time. Separately, during the fourth quarter, we incurred impairment charges of $14 million on our remaining facilities footprint as continued pandemic restrictions translated to slower-than-expected subleasing. This brings our cumulative impairment incurred to-date to $430 million. We continue to estimate that our total impairment charges will be up to $450 million. Additionally, in Q4, our GAAP net income was favorably impacted by a $38 million onetime income tax benefit from the release of a valuation allowance on Irish deferred tax assets. This event is a result of our improved profitability, leading us to conclude that our valuation allowance on these deferred tax assets is no longer necessary. I would also note that there is no cash impact associated with this onetime benefit. With that, let's continue with the P&L. I'd note that all expense categories continue to benefit from lower facilities-related costs driven by pandemic restrictions and a reduction in depreciation as a result of the write-down in our real estate assets stemming from the aforementioned impairment. Gross margin was 81% for the quarter, representing an increase of 1 percentage point on a year-over-year basis. The improvement in our gross margin is primarily a result of the continued rollout of hardware efficiencies across our internally managed storage and data infrastructure. Fourth quarter R&D expense was $148 million or 26% of revenue, which is slightly increased as a percent of revenue compared to the fourth quarter of 2020. Sales and marketing expense was $99 million or 17% of revenue, which decreased compared to 20% of revenue in the fourth quarter of 2020. G&A expense was $43 million or 8% of revenue, which decreased compared to 9% of revenue in the fourth quarter of 2020. In total, we earned an operating profit of $168 million in the fourth quarter, which represents an operating margin of 30% or a 4 percentage point improvement compared to the fourth quarter of 2020. Net income for the fourth quarter was $160 million, which is a 36% improvement over the fourth quarter of 2020. Diluted EPS was a record $0.41 per share based on 386 million diluted weighted average shares outstanding, up from $0.28 per share based on 416 million diluted weighted average shares outstanding for the fourth quarter of 2020. Moving on to our cash balance and cash flow, we ended the quarter with cash and short-term investments of $1.718 billion. Cash flow from operations was $163 million in the fourth quarter and includes the impact of the aforementioned lease buyout of our headquarters in San Francisco. Capital expenditures were $1 million during the quarter. This resulted in quarterly free cash flow of $161 million compared to $158 million in Q4 of 2020. In the fourth quarter, we added $16 million to our finance leases for data center equipment. Let's turn to our share repurchase activity. In Q4, we repurchased 11.2 million shares, spending approximately $295 million, nearly doubling the number of shares purchased from Q3. As a reminder, our buyback program is structured to buy more shares at lower price points. At the end of Q4, we had approximately $344 million remaining on our $1 billion share repurchase authorization. Additionally, as we will discuss in greater detail later on this call, we're pleased to announce that earlier this month, our Board authorized an additional $1.2 billion share repurchase program. Now let's turn to our full year 2021 results. Total revenue for 2021 was $2.158 billion, representing 12.7% year-over-year growth, beating our updated guidance range. On a constant currency basis, relative to the average rates across 2020, year-over-year growth would have been 11.1%. Reflecting on this for a moment, our 2021 total revenue beat our initial constant currency revenue guidance of approximately 8% by over 300 basis points as we executed against our strategic pillars and outperformed throughout the year. Gross margin was 81% for the year, which was up 1 percentage point from 2020. Operating margin was 30% for 2021, which was up 9 percentage points from 2020. This significant year-over-year improvement demonstrates our continued commitment to and ability to execute against our long-term financial targets. Net income was $609 million for the year a 56% improvement over last year. Diluted EPS was $1.54 per share based on 396 million diluted weighted average shares outstanding, up from $0.93 per share for the full year 2020. Cash flow from operations for 2021 was $730 million. Capital expenditures for the full year totaled $22 million, which resulted in free cash flow of $708 million or 33% of revenue. Free cash flow grew by over 40% year-over-year. In 2021, we also added $127 million to our finance lease lines for data center equipment. Net off repayments, our finance lease balance increased by $17 million. Finally, we repurchased approximately 41 million shares, spending over $1 billion in 2021. I'd now like to share our 2022 first quarter and full year guidance, where I will also provide some context on the thinking behind this guidance. For the first quarter, we expect revenue to be in the range of $557 million to $560 million. We are assuming a minimal currency tailwind of approximately $1 million in the first quarter. Additionally, and as a reminder, there are fewer subscription days in the first quarter of each year. We expect non-GAAP operating margin to be in the range of 27.5% to 28%. As a reminder, there is some seasonality with first quarter operating margins as payroll taxes reset at the start of each year. Finally, we expect diluted weighted average shares outstanding to be in the range of 375 million to 380 million shares based on our trailing 30-day average share price. For the full year, we expect revenue to be in the range of $2.320 billion to $2.330 billion. This range is inclusive of an approximate $16 million currency headwind. We expect gross margin to be approximately 81%. We expect non-GAAP operating margin to be approximately 29%. We expect free cash flow to be in the range of $760 million to $790 million. This includes $17 million in cash outflows for the 2022 installments of acquisition-related deal consideration holdbacks. Additionally, our free cash flow guidance is inclusive of an estimated $30 million headwind as a result of pending R&D tax legislation, which I will elaborate on shortly. As related to capital expenditures, we expect our addition to finance leases to be approximately 5% of revenue, and we expect cash CapEx to be in the range of $25 million to $35 million in 2022. We expect 2022 diluted weighted average shares outstanding to be in the range of 368 million to 373 million shares. In addition to this formal guidance, I wanted to share some further context behind our expectations for 2022. As related to revenue, and as Drew shared, we've been investing across the business as we grow our product portfolio. Specifically, we have increased our investment in R&D and marketing initiatives in recent quarters in a targeted way to address key opportunities, including efforts aimed towards improving our retention trends, feeling growth areas such as DocSend and HelloSign through both product innovation and foundational improvements that help us capture the synergies inherent in these deals and launching new features and capabilities aimed at improving conversion. We also continue to invest in ensuring a seamless experience for our customers as we adapt our desktop client to operating system updates and changes, most recently related to a new version of Mac OS. And we're also building out our capabilities in security and automation to address customer demand in an increasingly complex environment. As we continue to add value with these features and other investments in the user experience this year, we envision updates to our pricing and packaging approach for a subset of our customers to reflect this value. We expect the cumulative impact of these efforts to translate to monetization momentum, culminating and accelerating revenue growth in the back half of the year. Any changes we are considering on pricing and packaging in the second half of the year have been factored into this guidance. As related to operating margins, we are facing a few exogenous headwinds this year that are playing a role in our guidance. In 2021, we benefited from an approximate two-point FX tailwind, whereas in 2022, we are currently expecting roughly a 50 basis point headwind. We also expect to incur incremental T&E, event and overhead expenses in 2022 as pandemic restrictions soften and company travel and employee gatherings resume. Additionally, we will continue to invest in R&D and sales and marketing initiatives that carry a compelling ROI. As related to free cash flow, our guidance includes a $30 million cash tax headwind as a result of pending tax legislation that would defer recently effective laws that now require R&D costs to be capitalized for tax purposes. There is a possibility that the current legislation may be amended or repealed. However, until such time, we are including this impact in our guidance. Furthermore, I'll now share an update on our long-term targets, which we plan to achieve by 2024. Our infrastructure team continues to drive innovation and efficiency as we manage our storage footprint. As a result, we are now above the top end of our previous long-term gross margin target range, and we continue to see incremental room to drive efficiencies. As such, we are raising our long-term gross margin target to a range of 80% to 82%, up from our previous range of 78% to 80%. As related to operating margins and despite the exogenous headwinds mentioned earlier, we are confident in our ability to drive leverage in our business. As a result, we are increasing our long-term operating margin target to a range of 30% to 32%, up from our previous range of 28% to 30%. It is important to note that even with raising our operating margin targets, we've maintained flexibility to invest in high ROI initiatives as top line growth remains a key priority for us. Additionally, despite the aforementioned cash tax headwinds, we are reiterating our goal of annual free cash flow of $1 billion by 2024. Lastly, I want to share an update on our plan to return capital to shareholders in the form of share repurchases. We plan to exhaust our previously authorized $1 billion share repurchase program in the first half of this year. Furthermore, as previously mentioned, our Board has authorized an additional $1.2 billion share repurchase program, consistent with our strategy to allocate a significant portion of our annual free cash flow to share repurchases with the goal of reducing our share count. In conclusion, our financial objectives remain intact. We continue to focus on balancing growth and profitability in a thoughtful, disciplined way. And we continue to allocate capital to initiatives that carry a compelling return while also returning cash to shareholders in the form of share repurchases. This strong rule of 40 financial profile enables us to invest in the biggest opportunities that we may see to enhance the value of our product offerings to drive long-term sustainable top line growth and to create shareholder value. We will continue to assess these opportunities, which could range from additional strategies to monetize our free user base, inorganic opportunities to enter into product adjacencies or organic initiatives as we aim to solve the challenges that our customers are facing. In short, we continue to have many opportunities to win, and we are very excited about the road ahead. With that, I'll now turn it over to the operator for Q&A.

Thank you. [Operator Instructions] Our first question comes from Mark Murphy with JPMorgan. You may proceed with your question.

Yes, thank you very much and congrats on all the progress that you're making. Drew, I had a question regarding Dropbox capture and Replay products. What is it that's underpinning this move that you seem to have into video creation and targeting creatives. Just wondering if there's more to come on this video road map. And as well, can you just touch on the margin profile for maybe storing some of those larger video-type files?

Sure. I can start. So we're following customer demand, and we've been seeing an explosion in engagement with video on the platform over the last couple of years. And this is – this dovetails with the rise of the creator economy, both with having more creative professionals on Dropbox and then a broader audience of more kind of casual creatives or creators. And Dropbox resonates with these audiences because their workflows revolve around large files, rich media, and so we've gotten a lot of demand from these customers to better support video and their new workflows. So Capture and Replay are an example of that is where you can communicate over video and help produce video in a distributed way. Dropbox Shop is another one where you – where we're helping our customers monetize their digital content. So we see that these customers are – that Dropbox really resonates with these customers. They need more than what they get with the bundled solutions in their office suites. So we think it's going to be an exciting expansion opportunity for us.

And then, Mark, this is Tim. Maybe I'll just add to that. As far as Capture, Replay and Shop, these are lean internal teams where these were not material contributors to our results in 2021 and not expected to materially contribute in the near term. These are certainly longer-term bets where we will be monitoring adoption and adjusting our resourcing accordingly. And as related to margins, you can see they're not having a material impact on our margins as indicated by the raise in our long-term targets to 80% to 82% for gross margins.

Yes. And so Tim, thank you for clarifying that. It kind of bridges right into my other question, which is on the increase in the long-term margin framework. Obviously, it's nice to see. I think I'm just wondering what is the delta that's creating the uplift there? For instance, maybe it's the real estate footprint coming down or maybe it's storage costs, maybe it's user acquisition costs or something else. Can you just help us bridge to that increase there?

Sure. So as you know, we are raising our long-term operating margin target to 30% to 32%, up from 28% to 30%. We do have some headwinds this year such as FX and post-pandemic costs such as additional T&E and other costs. But despite this, we do see the opportunity to drive leverage within the business, really starting with our infrastructure team as they continue to find ways to be more efficient with our storage costs. Then additionally, we see other ways to drive efficiencies such as the shift to lower-cost locations. And as a result, we do see the opportunity to raise these longer-term targets. But that said, we still have room to invest in growth opportunities, and we remain focused on driving sustainable top line growth.

Excellent. Thank you very much.

Thank you. Our next question comes from Brent Thill with Jefferies. You may proceed with your question.

Drew, there's been a lot of talk about the great pull forward during the pandemic. And I'm curious your thoughts about – is there a digestion phase on the way? Or do you feel from what you're seeing in the signals that your clients are continuing to move forward at the same pace you saw over the last couple of years. Curious just to get your thoughts on the overall shape of demand and what you're seeing?

Sure. I think, I mean, maybe different shapes across the different businesses. I mean I'd say on the core business, it's been pretty stable. I mean we found a lot of our customers needed Dropbox before the pandemic, needed during the pandemic, needed after the pandemic. And then you have our businesses like HelloSign and DocSend where there were – as these are like new habits like shifting from pen and paper-based workflows to adopting e-signature, for example. So there's a surge in demand during the pandemic, but that's moderated somewhat. And then another thing that we see is that as people are working out of screens more than offices going forward. There's a lot of room for improvement in that experience. And we find when we talk to customers that their content is all over the place. It's scattered in a lot of different places. They're using tons of different apps, 100 tabs open in their browser. And so we see a big opportunity for Dropbox to help organize your cloud content the same way that we help you organize your files. So there's an expansion opportunity where this is more acute for this challenge of fragmentation and my content being scattered and using all these different tools being more acute after the pandemic. So there's certainly a pull forward in terms of that complexity and this fragmentation becoming a bigger problem. So those are some of the dynamics that we see. And overall, we think the shift to distributed work will only create more demand for our tools.

And just on the capital allocation, great to see the buyback, but some will ask why not plow that into more innovation and M&A? What's driving conviction to keep driving that? Are you leaving enough room for M&A going forward? Can you just walk through that decision?

Sure. I can start. Tim, feel free to add on. I mean, our business is really efficient. We're able to invest in a lot of growth areas, and we're always thinking about having a balance of growth and profitability. Unfortunately, we can afford to both fully fund our core business and some of the transformation we're working on there. We have our growth stage businesses with HelloSign and DocSend that are fully funded, and then we have a longer tail of newer products that we think are big long-term opportunities. So we feel good about our ability to invest organically while also continuing to expand margins, and we're pretty unconstrained in terms of capital. I'm also excited to the extent the market corrects that M&A can become more efficient. And so we're on the lookout for those kinds of opportunities opening up more, but at the same time, we'll still be disciplined. So over the last few years, we've really gotten a lot more disciplined and intentional about our capital allocation.

And maybe just to quickly add to that. We do, as Drew alluded to, have a very strong balance sheet and an efficient business model that does generate a lot of cash. And that gives us great flexibility to pursue share repurchases, M&A and organic investments. And as related to share repurchases, we do intend 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. To Drew's point, as related to M&A, certainly, we'll look for businesses that complement our vision and product road map similar to HelloSign and DocSend. And as related to organic investments, we'll continue to invest in R&D to cultivate a diverse product portfolio and to drive revenue growth. And ultimately, Drew, Timothy and I will continue to assess the best use of our capital according to where we believe we can generate the best returns.

Thank you.

Thank you. Our next question comes from Steve Enders with KeyBanc. You may proceed with your question.

Okay. Great. Thanks for taking the question. I appreciate all the extra context on the guide. I guess I want to get a little better sense for how you're thinking about kind of the levers that you could potentially pull as you think about the revenue opportunity for the year. It seems like there's some things coming both on the pricing and packaging side, but what are – are there other income areas we either invest or optimize some of the experiences to drive better conversion rates?

Yes, I can start. So the growth – there's a lot of growth levers. I mean, the ones we're focused on include continued optimizations to our core FSS business. So we see lot of opportunities to continue the deposit momentum we've had on reducing churn, just improving engagement and simplifying the experience, improving top of funnel. And then we have our growth stage businesses with HelloSign and DocSend, which are still some of our fastest-growing businesses and a lot of headroom there, still pretty early innings for them. There's an opportunity for a broader transformation in our core business, so evolving beyond, syncing files to organizing all your cloud content, which I talked about a little bit earlier and then the longer tail of the earlier stage products like Capture and Replay and future M&A. So these are all levers were investing into different degrees, and we feel good about where the portfolio is right now.

I mean it sounds like the – some of the new pricing and packaging is coming later this year, but I guess, is there kind of a – I guess what are kind of the areas that you're looking to kind of augment if there's kind of any early preview for at least how you're thinking about what some of the changes would be there.

Sure. This is Tim. I'll take that one. We're always thoughtful about our pricing and packaging approach to ensure it best reflects the value that we're delivering for our customers. And as we improve our products, provide new capabilities and deliver even more value for our customers later this year, we'll iterate on the right pricing and packaging approach. And we're also building out new capabilities such as security and automation features to address customer demand in an increasingly complex environment. And our 2022 guidance is inclusive of updates to our pricing and packaging approach. We'll have more detail to share in future quarters.

Okay, great. Thanks for taking the questions.

Thank you. Our next question comes from Kash Rangan with Goldman Sachs. You may proceed with your question.

Hi, thank you very much. Drew, I wanted to get your thoughts on the value proposition in the product and technology is almost very different and more enhanced certainly from the days of the IPO. How is the marketing and go-to-market changing as a result to accommodate the new workflows that you're building into the product? And also what does this mean for the pricing power of the company and what we all know to be a very inflationary environment? Thank you so much.

Sure. Hey Kash. Well, I'd say we're – some of the changes since the IPO that you've alluded to, we've just had a lot of strength among creators, whether that's creative professionals or solopreneurs, SMBs, freelancers, gig economy. These are segments where we've had strength and where there's a lot of natural adjacencies. So as creators work on content, they need to do a variety of different things with it, whether that's on more on the video side and things like video production or monetizing digital content or on the document side, having richer sharing capabilities or e-signature. So we've certainly seen new kinds of demand or elevated demand on those fronts. As far as our marketing go-to-market, I think, at a high level, our philosophy is pretty similar where we focus on building a great end user experience. We focus on customers where they self-serve and organically adopt new tools. And these viral motions we're sharing, if I share – if I use HelloSign or Dropbox and I share with you or send something to you for signature, in many cases, you become a new user or you certainly become exposed to our products. So it's an incredibly efficient motion, as you can see from just the fundamentals. And so the self-survival motion is really efficient. We've embraced that. I'd say one thing that is changing is as we become a truly multi-product multi-business company that we're investing a lot in helping make sure that when we buy a HelloSign or DocSend, we can quickly drive adoption through our existing base. And that's a huge source – or our customer base is a huge source of option value and potential customers for all of our products. So we're investing a lot in our multiproduct foundation having more consistent branding, exposing our customers thoughtfully to all the different products. And then on the pricing packaging front, we've had some early success with bundling and having new SKUs. So for example, we have our professional e-signature bundle with HelloSign. We have a similar thing with DocSend, and we're always tuning pricing and packaging. And then the last, I think, as we've touched on, obviously, we're monitoring inflation. And as – and we always try to create a virtuous cycle of adding significant new value to our products and then iterating on our pricing or leveraging pricing as we feel like we've added enough value to justify it. So we expect that cycle will continue this year.

Wonderful. Thank you so much.

Thank you. Our next question comes from Rishi Jaluria with RBC. You may proceed with your question.

Wonderful. Thanks so much for taking my question guys. Two here. First, I wanted to go back to the long-term operating model. Look, I appreciate you're raising the margin target. I guess I want to push back a little bit on your R&D target, right? You're talking about still spending 23% to 25% of revenue, which great that you're a product-led growth company and self-service. But I have to wonder, is that the right level when you're talking about 7.5% growth around there for 2022? You're talking about negative sequential growth for Q1. Maybe just remind us how you're thinking about your R&D expense in the context of your growth and where all that spending is going at this point, just given that that's a very high level for a software company at your growth rates? And then I've got a follow-up.

Sure. So we are investing for growth. And lately, we've been adding R&D head count where it does take some time for these investments to translate to net new ARR and to flow through to revenue. And we've been investing in what we see is our highest return initiatives where I would broadly break them into a few high-level buckets. And first, retention, where particularly as related to our mobile and teams customers, we continue to see room for improvement, security and automation features, we're keeping content safe and easily accessible are key challenges that our customers are facing, enabling our multiproduct strategy as far as introducing our customers to our products, SKUs and add-ons in a seamless, intuitive way, investing in workflows, for example, adjacencies such as HelloSign and DocSend. And finally, ensuring a seamless experience for our customers as we adapt our desktop client to operating system updates and changes as regionally related to new versions of Mac OS, where these are all foundational investments that can have a long-term impact, and we see these contributing to our longer-term revenue growth rates.

Got it. That's helpful. And then one figure, in terms of – like on maybe take a high-level view, you were probably one of the first companies out there during the pandemic to go down this Virtual First strategy, and we're seeing more and more companies adopt that, which is great to see. From your experience, would love to hear, how are you thinking about the potential impact of that on employee retention, especially as we start to hear some really big tech companies talk about return to office as soon as the end of this month and definitely beyond that? How do you see that shaking out? And how you plan to drive employee retention and maybe alongside that, preserve Dropbox culture, while at the same time, keeping to this Virtual First approach? Thanks.

Sure. Well, on balance, Virtual First has been really positive for us. I mean, last year, we saw a 126% increase in offer accepts that's nearly double the number – and then also nearly double the number of candidates for op enroll and even an uptick in what we call Boomerang candidates like folks that might leave the company and then come back within a year. So we're finding that from a hiring perspective, it's really resonating and unlocking new pools of talent. And I think more broadly, what you're seeing is that employees once they have the flexibility or when companies like ours offer this flexibility, they then – employees demand it. So we think it positions us really well, and we think I'm really happy with the decisions that we started making back in, I think, October 2020 when we first rolled this out publicly. That said, I mean, I think every company is still figuring out how do you maintain culture in a distributed environment. We are trying to get – importantly, we're not remote only. We're Virtual First, meaning that the in-person experience is really critical. That's always been true, and we don't see a substitute for that. So we're also excited to – hopefully, there – we're able to return to office as it looks like we'll be able to do in the next few months after some false starts in the last several months. But we're really excited about being able to reintroduce the in-person experience. And our team has done a great job of thinking through how do we get the best of both of those worlds, get the best of the in-person experience, have really great retreats or just convening opportunities, but then give people flexibility to work from home day to day.

All right. Got it. Awesome. Thank you so much.

Thank you. [Operator Instructions] Our next question comes from Pat Walravens with JMP Securities. You may proceed with your question.

Great. Thank you so much. It's Joey Marincek on for Pat. Just one from our end. On HelloSign, can you give us an update on the competitive set there? How often are you going head-to-head? And then how penetrated do you think that market opportunity is? Thank you so much.

Sure. I can start. I mean things are going well with HelloSign, continues to be one of our fastest-growing businesses. And we've seen increasing adoption of our pro – our professional and e-signature bundle, which allows customers to buy both Dropbox and HelloSign at a slight discount. And we're investing heavily here. So there's – our customers have – appreciate how we added SharePoint support, so you can send and sign documents natively within SharePoint. We launched a new mobile app last quarter. So we're always improving the experience. And more broadly, we see a pretty stable competitive environment. I mean I think our advantage is that HelloSign is focused on the same kind of product-led growth motion that Dropbox has been. I think there are similar dynamics where we're less reliance on – or it's just a really efficient and scalable model. So it continues to be a big opportunity. I mean it's moderated somewhat after the big surge in the pandemic, but still we think it's early innings.

Thank you so much.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Drew Houston for any further remarks.

All right, everyone. Well, thanks again for joining us today. We appreciate your continued support and look forward to speaking with you again next quarter.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.