Good afternoon, ladies and gentlemen, and thank you for joining Drug Box's First 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 the call over to Karan Kapoor, Head of Investor Relations for Dropbox. Mr. Kapoor, please go ahead.

Thank you. Good afternoon, and welcome to Dropbox's first quarter 2023 earnings call. Before we get started, I'd like to remind you that our remarks today will include forward-looking statements, such as our financial guidance and expectations including our long-term objectives and forecast for our second quarter and fiscal year 2023 and our expectations regarding our revenue growth, profitability, operating margin and free cash flow, as well as our expectations regarding our business, assets, 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 as a result of new information or future events. Factors and risks that could cause our actual results to differ materially from these forward-looking statements are set forth in today's earnings release and in our annual report on Form 10-K 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. Drew?

Thanks, Karan, and good afternoon, everyone. Welcome to our Q1 2023 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I'll first share our business and product highlights from the quarter, and then Tim will review our Q1 financial results, provide guidance for the second quarter and update our outlook for the remainder of the year. I recognize our announcement last week to reduce our workforce. It's top of mind for many, and I plan to discuss that in a moment. But as far as our financial results, overall, I'm pleased with how we performed in Q1 during a challenging environment. We beat our guidance across all metrics, led by revenue outperformance in FormSwift, which we acquired in late Q4 and some better performance around individual sign-ups exiting the quarter. On the flip side, we saw continued weakness across our team's plans as our customers face pressure in their own businesses. And we also saw a continued moderation in our DocSend and Dropbox Sign businesses due to ongoing softness in their respective markets. Over the last several months, we've noted that we're not immune to the increasing macro headwinds that our customers are also facing. And during this period, we've carefully evaluated our different business units and recognize that some investments which showed promise before the downturn have less potential today. Part of this is accepting some normalization following demand acceleration during the pandemic as well as the natural maturation of our existing FSS business. And yet at the same time, we see a huge opportunity for building new AI-powered products for our customers to improve the technology and tools that are used to get our work done, which I'll discuss in more detail shortly. I'm determined to ensure that Dropbox is at the forefront of innovating…

Thank you, Drew. Today, I'll walk through some financial highlights for Q1 and provide an outlook for Q2 as well as an update on our 2023 guidance and our financial targets for 2024, all within the context of the current macro environment and last week's restructuring, which Drew discussed. I'll start with our first quarter results. Total revenue for the first quarter increased 8.7% year-over-year to $611 million, beating our guidance range of $600 million to $603 million. Foreign exchange rates provided an approximate $16 million headwind to growth, in line with our previous guidance. On a constant currency basis, revenue grew 11.6% year-over-year. The upside to our revenue guidance was driven by an outperformance from FormSwift as well as some improving trends in our individual plans exiting this quarter. Total ARR for the quarter grew 7.8% year-over-year, for a total of $2.468 billion. On a constant currency basis, ARR grew by $37 million sequentially and 11.6% year-over-year, primarily driven by FormSwift and pricing and packaging changes to our teams plans that we announced last June. We exited the quarter with 17.9 million paying users and added approximately 120,000 net new paying users sequentially. Average revenue per paying user for Q1 was $138.97, an increase of over $4 compared to Q4 2022. The driven by another quarter of Teams customers renewing at higher prices, which we announced last June as well as a full quarter of FormSwift revenue. 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 and certain acquisition-related expenses. Our non-GAAP net income also includes the income tax effect of the aforementioned adjustments. Moving to our real estate strategy, where we have been taking…

[Operator Instructions] And our first question comes from Rishi Jaluria with RBC Capital Markets. Please proceed.

Hi. This is Richard Poland on for Rishi. Thanks for taking my question. So the first one is, you talked a little bit about some of the investments that might have less potential today -- outside of, I guess, some of the core FSS, is there anything in particular that you identified that maybe wasn't working too well and you want to shift away from. Thanks.

Sure. So I can start. So we're continuing to invest. I'd say a business that have been affected beyond the core business would include Sign and DocSend. And they're still promising businesses, but as we see each of their categories affected in different ways, then if the prospective returns are coming down, then we've trimmed some of our investment in those areas, mostly to free up resources to invest in some of our future growth levers. But we're certainly not stopping investment in those areas and in a lot of ways where you take something like DocSend in response to -- may be true that the fundraising environment is -- there's less fund raising going on, which means lower demand for DocSend in the fundraising context. But the underlying use case of sharing with analytics and extra security features and a lot of what DocSend does, has brought applicability to a lot of professional services. So we're diversifying in DocSend and we're investing in DocSend to both support other verticals and other geographies. So that's a little bit of the context behind some of the shifts in investment, but we continue to be confident in the potential of these businesses.

And then this is Tim. Just to briefly add on to that. We did take a hard look across the company where we took this opportunity to consolidate or eliminate some roles and also to address lower performers. . And we also looked at where we had too many layers that we could streamline which were slowing down execution and decision-making. And ultimately, the vast majority of the cuts were across R&D with additional cuts in sales and marketing and more minor cuts in G&A.

Got it. That's super helpful. And then just as a follow-up, impressive to see the good performance out of FormSwift and really a good acquisition on that side. With the strong balance sheet and the continued free cash flow generation are there any other areas that you'd think about maybe investing more on the inorganic side? And maybe it's AI, but just anything you could talk to just around the inorganic strategy from here?

Yes. So we're -- we've certainly had a lot of success with our acquisitions or happy with a lot of the acquisitions we made. And I would say there's like a change in approach. We've had successful acquisitions kind of a different scale, so that's bringing great teams or great products or great businesses, and that will continue. And as you pointed out, we have a strong balance sheet, cash flow, so we can -- so we have a lot of optionality there. So yes. And then certainly, in the AI space, there's a lot of interesting early-stage start-ups where we see opportunity and are spending a lot of time. There's a greater supply of AI start-ups because there's a lot of interest and then we're certainly interested in adding there. But at the same time, we'll continue to be disciplined and we've got a lot of good places to put capital.

Got it. Thank you.

Thank you. One moment for our next question please. And it comes from the line of Mark Murphy with JPMorgan. Please proceed.

Thank you very much. So I think it's a surprisingly solid quarter considering the environment. You have the 12% ARR growth, margin upside, solid free cash flow number. We might have expected more just as well given the recent headcount actions. And so I'm wondering if you can expand on that a bit. How much of that reduction might flow through to margins maybe next year versus how much is earmarked for incremental AI investments? Because typically, if we see a 16% type of reduction, it's going to yield a little more margin than that. So I'm just trying to understand that particular equation, and then I have a follow-up.

Yes. I'd look to our 2023 margin guidance, which is up 150 basis points from our prior guidance at the midpoint, it's an indication of the net savings we expect this year. And then note that we will continue to see some of the benefits carry forward into 2024 as the savings annualized. And we're not giving 2024 guidance right now, but I did indicate that I expect our margins to be at or above these 2023 levels. And this is where we are increasing our investments around AI and early-stage product development, which will partially offset those savings. And then we also did take the opportunity to address some performance management with this risk where in some of these cases, we'll be adding backfills for those positions as part of this action.

And so could we maybe think of the 150 basis points is a little more in the half year if you're doing -- I don't know exactly when the when the cost and expenses there kind of roll off the books. But is that one way to think about it like more like a 300 basis points annualized type of effect perhaps?

Yes. I don't think I'm going to elaborate much more on '24 just yet. I think there's many factors that will go into our thinking for our guidance next year. I think I just fall back on what I previously stated as far as I expect our margins to be at or above these 2023 levels.

Okay. Fair enough. And then, Drew, is it possible to provide an example of -- what is -- what you're picturing in your mind as you build out an AI product. You mentioned search, you mentioned personalization. I'm just trying to envision what the product would be or maybe how the user experience would feel, right, as you start steering relatively more investments into your AI road map.

Sure. So we'll have more specifics to share with the forthcoming launches. But I think at a high level, there's with new products that we're creating. And then there's also applications of AI across our existing product portfolio and sort of -- and the opportunities to reimagine those experiences. But I think one of the most straightforward is really when you look at everyone who use tools like ChatGPT, they're not really personalized to you. So if you ask you a question like -- if you want to ask you a question, like, what's my passport number again? Or who in my company is working on this thing? Or why did we make a certain decision? It is now possible we have the technical foundation to actually build an experience where you can use natural language and basically have the silicon brain that knows about you and your staff and your company, sort of a personalized ChatGPT. We find ourselves very well positioned to build that kind of capability, and we've been building towards that for many years. So that's been -- I mean, there are other examples because there's a lot of other exciting applications beyond text or pretty much all the different multimodal capabilities. There's like been breakthroughs in how you can -- the things you can do with images, the things you can do with videos, things you can do with audio. So there's a lot of different potential applications that we're working on and we'll have more sharing in the coming months.

Okay. I like that branding around silicon brain. Maybe that's something we'll see from you in the future, and rolls off the tongue pretty well. Thanks a lot. Congrats on all the success.

Thank you.

Thank you. One moment please. And our next question comes from the line of Steve Enders with Citi. Please proceed.

Okay. Great. Thanks for taking the question. I guess maybe following up on the AI to question a little bit. Universal Search is just kind of being rolled out there and tested. But I guess what's kind of been the early feedback from the customers that are trialing it? And I guess, how are you kind of thinking about what that could mean from like a monetization lever and how you're thinking about packaging around that down the line?

Sure. So we're just -- it's just reaching outside customers literally two days ago. So I want to let some of the feedback roll in a little more before having a more comprehensive response. We're certainly using internally, and that's been a really helpful tool for us to kind of battle test the product and make sure it's really great before rolling out to customers. So we've been some milestones like that closed beta, we're really excited about. As far as pricing packaging, I mean, we certainly believe it will be incremental revenue. We believe this will unlock new categories of customer who might not otherwise be buying FSS or might not be either current or future FSS customers. So we think it's a big unlock on that front. But as far as -- we'll have more to share around the specific pricing and packaging in -- at the actual launches.

And then maybe just briefly from a financial perspective, we certainly plan to stay disciplined and closely monitor customer adoption and feedback as we consider further investment on this side. Our focus this year is on bringing quality product to market and driving adoption and we do expect it will take several quarters before we start seeing any contribution to revenue from these products.

Okay. That's helpful context on that front. I guess maybe dig in a little bit more on just the ARR upside in the quarter. I guess, how do we think about some of the moving parts around there for the FormSwift outperformance, individual plans sounds like they were relatively strong versus maybe some of the headwinds that you're seeing in other aspects of it? Like any kind of further kind of breakdown for the strength there?

Sure. So FormSwift did outperform our expectations. We continue to expect that it will contribute about 2.5 points to our growth this year, and we're excited about the progress we're making on the integration front with FormSwift. I think we're also seeing improving sign-up trends as a result of our rollout of Google One Tap, which reduces friction in the sign-up and onboarding process. We also did see churn improve across our individual plans, particularly as we exited the quarter. And then, of course, we continue to see a contribution from the pricing and packaging changes that we announced in June on our teens plants.

Okay. Perfect. Appreciate taking questions here.

Thank you. One moment for our next question please. Our next question comes from the line of Brent Thill with Jefferies. Please proceed.

Hi. This is Alan on for Brent Thill. Thanks for taking my question. First, what are you seeing out there in the market? And what considerations are factored into your guide? What are you seeing in terms of churn? Thanks.

See, as far as the macro trends, I'd say that we're seeing trends that are roughly consistent with what we saw in the fourth quarter, we continue to see elevated price sensitivity and downsell pressure from our teams, customers, particularly those that had layoffs themselves. And then Sign and DocSend also continue to face macro-related headwinds. DocSend, in particular, is exposed to the fundraising community, where the recent banking events are adding some volatility to that vertical. And we continue to see elevated levels of churn from our individual SKUs, though again, we did see those trends improve exiting the quarter. We also saw incremental FX headwinds in Q1, and we expect a similar impact in Q2. From maybe a guidance philosophy perspective, we do remain prudent and continue to factor in an appropriate level of conservatism given the challenging macro landscape. We've assumed that key trends such as a degree of elevated churn and customer price sensitivity will continue throughout 2023. So certainly factoring in these latest signals and not assuming any level of improvement in the economy and our guidance and certainly also mindful of our reduction in force and the potential effect that this could happen in our billings given our reduced levels of investment in headcount and marketing. So again, all of these considerations are factored into our guidance.

Thanks. Super helpful color. And lastly, how should we be thinking about the mix of paid user growth and ARPU to drive future growth?

Sure. So from a paid user perspective, we added about 120,000 paid users in the first quarter. Family plan was a significant contributor to that. FormSwift also added to paying users in Q1, particularly as this business does have a seasonal increase due to tax season. As far as forward-looking expectations, we don't formally guide to debt new paying users and particularly as we navigate our pricing and packaging changes in the current macro environment, I'd continue to expect something in the neighborhood of roughly 100,000 net new paying users per quarter with ARPU expansion being more pronounced this year as we saw in the first quarter.

Thanks. Super helpful.

Thank you so much. [Operator Instructions] And it comes from the line of Matt Bullock with Bank of America. Please proceed.

Hi, thanks for the question. I wanted to double tap on the Command E opportunity here. Is there anything you can give us in terms of the competitive environment for Universal Search or who you expect to compete most directly with?

Sure. So I mean at a high level I'd say it's very early for the category. I think there are startups that are going to pursue ideas in this in the space. And we believe that we're well positioned there because of our scale, our distribution, our ability to make significant technical infrastructure investments and the fact that we already have the trust relationship with customers and that they're already trusting the most important information in Dropbox. So when you think about Universal Search and Content, we think we have big advantages versus start-ups. And then, of course, the platform companies, folks that provide office suites to various kinds they will certainly do things in this area as well. But I think the fact that we're platform agnostic and then also aspects of our trust and privacy brand the fact that we're a subscription business and not advertising, our track record with privacy and trust. I think those are big advantages against the larger incumbents as well.

Excellent. Thank you. And then just quickly, was there anything to call out in terms of the ARPU this quarter. It was a nice beat relative to expectations. Is that just the FormSwift tailwinds or anything else?

Sure. So ARPU increased just over $4 sequentially and maybe breaking down some of the components of that increase was primarily driven by benefits from our pricing initiatives. So I'd say that's about $2.50. And our acquisition of FormSwift, that contributed about $2, and this was partially offset by the continued growth in our family plan.

Excellent. Thank you very much.

Thank you. And I'm not showing any further questions in the queue team.

Thank you, everyone, for dialing in for your support, and we'll see you next quarter.

And with that, we thank you for participating in today's conference. You may now disconnect.