Good afternoon, ladies and gentlemen. Thank you for joining Dropbox Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] As a reminder, this conference call is being recorded, and will be available for replay from the Investor Relations section of Dropbox website following this call. 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 second quarter 2023 earnings call. Before we get started, I'd like to remind you that our remarks today will include forward-looking statements such as our financial guidance and expectations, including our long-term objectives and forecasts for our third 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 quarterly report on Form 10-Q filed with the SEC. We'll also discuss non-GAAP financial measures, which are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors.dropbox.com. I would now like to turn the call over to Dropbox's Co-Founder and Chief Executive Officer, Drew Houston. Drew?

Thanks, Karan, and good afternoon, everyone. Welcome to our Q2 2023 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. And I'll first share our business and product highlights from the quarter, and then Tim will review our Q2 financial results and provide guidance for the rest of the year. I'm pleased to report that we had a solid quarter, once again beating our guidance across all metrics, led by revenue outperformance in FormSwift and some recovery within our Individuals SKUs as the progress we saw in late Q1 continued into Q2. However, we are still navigating a difficult macroenvironment that continues to impact our Teams customers and pressures growth in our DocSend and Sign businesses. Before, I walk through the highlights from the quarter in more detail, I want to quickly remind you of our primary business objectives that I outlined last quarter. The first objective is around building AI-powered product experiences to help our customers organize their working lives. Our company mission at Dropbox is to design a more enlightened way of working and I'm proud that we've accelerated our roadmap here with Dropbox Dash and our progress in AI, which I'll discuss in a minute. Our second objective is continuing to evolve the core file sync and share experience to specifically address customers' workflows around documents and videos. Much of the work here has been foundational, focusing on driving retention and conversion, and I'll share more about the progress we made during the quarter. So, with that backdrop, I'll touch on what we're working on to drive these objectives, starting with our first objective of building AI-powered product experiences to improve knowledge work. As we discussed on our last call, we took some important actions in Q2 to better align our investment strategy with…

Thank you, Drew. I'll walk through some financial highlights for Q2 and provide an outlook for Q3 and 2023, as well as an update on our financial targets for 2024. Let's start with our second quarter results. Total revenue in Q2 increased 8.7% year-over-year to $622 million, beating our guidance range of $612 million to $615 million. Foreign exchange rates provided an approximate $14 million headwind to growth. On a constant currency basis, revenue grew 11.2% year-over-year. The upside to our revenue guidance was driven by outperformance from FormSwift as well as the improvement we saw across our Individuals plan that Drew mentioned. Total ARR for the quarter grew 7.2% year-over-year for a total of $2.5 billion. On a constant currency basis, ARR grew 10.9% year-over-year, primarily driven by FormSwift and our Teams price increase. ARR grew $33 million sequentially, driven by the retention improvements within our Individuals plans. We exited the quarter with 18 million paying users and added approximately 140,000 net new paying users sequentially, a modest improvement from Q1, driven by some improvement in Individuals churn as compared to the trend in prior quarters, as well as an uptick in professional users from our more targeted top-of-funnel efforts. Average revenue per paying user for Q2 was $138.94, which is flat compared to the first quarter of 2023 as the benefit we saw from our pricing initiatives was largely offset by FX headwinds and the continued adoption of our Family plan. ARPU increased by over $5 year-over-year, driven by the Teams pricing increase, FormSwift, and a shift to premium plans. Before we continue with further discussion of our P&L, I'd like to note that unless otherwise indicated, all income statement figures mentioned are non-GAAP and exclude stock-based compensation, amortization of purchased intangibles, certain acquisition-related expenses, impairments of our…

Thank you. [Operator Instructions] And our first question coming from the line of Rishi Jaluria with RBC Capital Markets. Your line is open.

Wonderful. Thanks, guys, so much for taking my questions. I had two. I wanted to first start, maybe, Drew, if you could go a little bit deeper into your strategy around Dash and particularly you had mentioned Dash Answers as an area you want to get into later. Can you talk a little bit about kind of some of the use cases? And maybe more importantly the use case you're trying to solve for, at least the way it sounds to us, it seems like a big pain point for a lot of customers. I know the idea of search has been important to you for years, so this isn't a brand new or coming out of nowhere. But how do you think about positioning yourself to your customers as the center of gravity for solving that problem and driving adoption of these solutions, I think, especially just kind of given maybe some of the learnings out of the new Dropbox in the past? And then, I've got a quick follow-up.

Great. Yeah, thanks, Rishi. So, we're really excited about Dash, and I see it as a natural evolution for Dropbox to go from organizing all your files to organizing everything, including your cloud content. And this is the origin -- I think about the customer problem, I think within the company, I mean I experienced these problems, I think we all do, or -- you know you were looking at a document a day ago, and you know it's there, but you can't find it. And the problem is really similar to the one I started with, which is like my stuff is scattered across all these -- my stuff is scattered everywhere. And back then, back when we started, it was -- my files were scattered across all these different devices and operating systems, and today those 100 files on your desktop have become 100 tabs in your browser. So -- and there's really this missing organizing layer for your cloud content, in that search is broken, right? We have like instead where we used to have one search box, now we got 10, as with all the different apps and platforms that we use. 10 search boxes that each search 10% of your stuff, and there is a missing organizing layer in that. There's no persistence and there's no kind of concept of like collections for links, and I could go on about the pain points. But we see this is kind of another opportunity hidden in plain sight that's very reminiscent of where Dropbox started, which is that there is a missing organizing layer in a better way of doing things and we see it as a universal customer need in many ways that the challenges that people have with organizing their cloud content are much greater…

Yes, go ahead.

Yeah, I was just going to say, so what's different -- I think there are a couple other aspects like what's positioning or how do we become a center of gravity. I think it's natural because we have that trust relationship with our customers and we have distribution, we have scale, in many cases, our customers are already putting their most important files in Dropbox. We think it's a pretty natural evolution for existing file sync and share users to adopt Dash. And then -- but then when you look at the market of 1 billion knowledge workers and none of them have a solution to their challenges around organizing cloud content. So, we think this is a significant opportunity to make our TAM many multiples of what it is now. And far as positioning, again, I think it's natural evolution. And then last, like, we've incorporated a lot of lessons from past product efforts, but I'd say one thing that's really different this time is the emergence of AI. And we can build products that we've wanted to build for a long time, but didn't have the technical building blocks, so where sort of the missing piece of the large language model is a big deal. And then I'd say with Dash, it's a very focused experience, right? We do search. We do smart collections. We have a start page for work concept. But we -- and we've had a much more iterative approach where we've been working with our customers, and Dash is also -- a key ingredient of that was an acquisition of Command E, which we did a few years ago. So, we continue to iterate and draw on the lessons from past experiences and we're really excited about getting Dash and the rest of our portfolio in more people's hands.

Awesome. No, thanks. Very thorough. I guess just a quick follow-up. As we think about generative AI, I know it's too early to give prices around monetization. But I want to better understand your monetization strategy. Is this something that you maybe [gate wall] (ph) behind the higher-tier SKUs and use that to use these as incentive to drive upgrades? Are there certain modules that you might consider monetizing discreetly? Is this more about driving value, and therefore, you're going to get more new customers and better gross retention? Just I really just want to understand your philosophy around monetization without having to put numbers around it.

Sure. So, I mean, there's going to be a portfolio of applications of AI and I think -- the way I think about it is pretty similar. You could sort of replace machine learning and there's a lot of different applications of machine learning even before large language models. And some are just table stakes features of the product, some are available only in higher-tier plans, and then some are explicit add-ons. And we expect that to be true for AI. And that's already the case, to some extent. So, Dropbox AI, which is an add-on to the -- which is part of the Dropbox file sync and share product is only available to paid customers. It's an alpha right now. So, we're continuing to iterate on it. And then, products like Dropbox Dash -- when you look at more broadly at other companies, there's a lot of different approaches from integrating AI functionality in paid SKUs or higher-tier plans, or you see it with Microsoft like having an add-on for AI capabilities. So it's a little too soon for us to share exactly what we're doing, but we're certainly thinking about it as a portfolio and making sure that we're both creating the right amount of value for most users and then making sure that we design our pricing and packaging to best capture the value that we create.

And real brief, Rishi, this is Tim. So, our focus this year, particularly on Dash is on bringing a quality product to market and driving customer adoption. So that said, we expect that it will take several quarters before we start seeing a contribution to revenue from Dash.

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

Thank you. And our next question coming from the line of Mark Murphy with JPMorgan. Your line is open.

Great. Thank you for taking the question. This is Sonak Kolar on for Mark Murphy at JPMorgan. Tim, at our TMC conference this year, you shared some color around a customer survey indicating about, I think, 8% of existing customer awareness for Dropbox Sign. Could you please provide us with some additional context on the progress Dropbox is making in terms of spreading that awareness of the full capabilities of the platform? And how that might be driving incremental cross-sell or up-sell opportunities?

Sure. Good questions. So, we have been working towards bundles for a while, where we're excited to roll those out soon. And to exactly to your point, we did recently run a survey where roughly half of our users want capabilities, such as e-signature, but less than 10% of our users know we offer it. So, we do have an opportunity to solve these problems for our customers. And we've addressed some foundational items such as rolling out a single legal terms of service and a unified customer identity. And we're now testing a bundle that does include file sync and share, Sign and DocSend for professional users where early signals on conversion are positive. And then, we're working on our Teams version of these bundles where we will have more to share on that soon. So, excited that we are making progress on this dimension.

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

Sure. So, as far as what we're seeing today, I'd say the macro trends are roughly consistent with what we've observed over the past couple of quarters. On one hand, we continue to see elevated price sensitivity and down sell pressure from our Teams customers, particularly those that have had layoffs themselves. And then Sign and DocSend are also continuing to face macro-related headwinds. On the other hand, we are seeing some positive trends around our individual SKUs, particularly on retention, though our sense is that this is largely due to actions that we have taken as opposed to a change in macro dynamics. And we're also seeing continued improvement in sign up trends as a result of our rollout of Google One Tap and other streamline onboarding processes, where our guidance factors in these latest trends.

Great. Thank you, and congrats on the results.

Thank you.

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

Great. Thanks for taking the questions here. I guess I want to start on, it seems like last quarter and now there's a bigger push on the hiring side to hire AI talent and help kind of diversify the employee base here. I guess, how are you finding the hiring environment today for those with expertise there? And, I guess, how should we view those incremental hires kind of like layering into the model through the rest of the year?

Sure. I can start. We're finding it a pretty fertile environment and having a lot of success hiring. And, we find -- of course it's been helpful to have things like Dash announced and be able to talk about these things more broadly. And other factors like our virtual-first model being able to hire more flexibly outside of the major tech hubs is another big advantage. And so, we've been building out a lot of leadership teams for these AI skill sets. And then, we'll have a blend of both hiring experienced AI folks from industry, but then also when you think about other shifts to the internet or to mobile or the cloud. A lot of the best mobile engineers or web engineers or pick your favorite example started out as great generalist engineers before that. So, we were also training up the company. There's a lot of enthusiasm, and interest in turning all of our -- making all of our engineers AI aware and skilled. So, we'll do both and we're seeing good progress.

And maybe just from a model perspective, so for this year, we're setting our operating margin guidance to be approximately 32%, and that's up 50 basis points from the midpoint of prior guidance of 31% to 32%, driven by the revenue outperformance. And we still do expect to invest some of the savings from our reduction in force towards longer-term growth initiatives, including this hiring and talent skilled in AI and early-stage product development. And then we also have shifted some project and marketing spend into the second half. So as a result, we do expect that our Q2 operating margins will be the high mark for the year.

Okay. That's helpful. And then, maybe on FormSwift, I mean, good to see continued outperformance here in the quarter. I guess two questions on that. I guess, firstly, I guess, what is it that's helping drive the performance above your expectations? And secondly, on the updated guide, it looks like most of that is coming from, at least on the top-line, is coming from the FormSwift outperformance here. I guess, a, is that the right way to be thinking about that? And, secondarily, I guess, what are the implications for how the rest of the business is executing versus your expectations?

Sure. So, we're raising the midpoint of our constant currency guidance range up by about $12.5 million for the full year. I'd say that's mostly driven by the Q2 outperformance as well as some better trends in Individuals. Conversely, as we know, we continue to see macro headwinds weighing on our Teams customers as well as both DocSend and Sign where we're not assuming an improvement in those trends. Now again, FormSwift did outperform our expectations for the second quarter in a row, so certainly pleased with their progress. We're seeing better-than-expected retention on their side, where the team implemented some UI and product enhancements, and then the association with the Dropbox brand also seems to be helping.

Okay. Perfect. Thanks for taking the questions.

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

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

Yeah, sure. This is Tim. I can start. Drew, feel free to jump in. So, we saw our churn rate remained roughly consistent with last quarter with ongoing macro pressure on our Teams customers, offset by some improvement with Individuals. We continue to see heightened churn amongst our Teams customers, particularly those that have gone through layoffs themselves. Now on the positive side, we did see churn stabilize for our individual plans. where the team worked on making the product easier to use, improving upload speeds, and reducing upload delays. They also introduced payment processing alerts to help users keep their credit card information up to date. So, overall, our churn rate does remain in the low teens.

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

Sure. Maybe just to walk through some of the ARPU dynamics that we saw in the quarter. So, on a year-over-year basis, ARPU was up about $5, landing at about $139. And I'd say that was driven by a few different factors. So, benefits from our pricing initiative, which continues to flow through, as well as a shift to higher-priced plans, that was about a $7 contribution. The acquisition of FormSwift, that's about a $2 contribution. This is partially offset by FX and the continued growth in our Family plan.

Okay. And then really quickly on the repurchase. Great to see incremental $1.2 billion, so it's about $1.6 billion total; my math, about 18% of the cap. Any commentary on the adjustment to the year-end share count though? And how we should think about the pace of share repurchase, and then, kind of the signaling of the new repurchase program?

Sure. Good question. So, our buyback program is structured to buy more shares at lower price points. And as a result of our recent share price performance, we've adjusted our full year share count guidance accordingly. We do continue to repurchase shares as part of our 10b5-1 plan, where our updated share count guidance gives the best sense of our future repurchase expectations. We do, of course, continue to expect to allocate a significant portion of our annual free cash flow to share repurchases on an ongoing basis with the intention of reducing our share count. And the new authorization is just a continuation of that. It reflects our commitment to that program.

Great. Thank you all for the time.

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

Hello. This is Eylon Liani on for Brent Thill. Thanks for taking my question. Two things on my end. First, what do you think about the sustainable growth rate of the business and how do you break that out between core FSS and the other assets? And secondly, given that you raised the full year guide by more than the beat in the quarter, are you factoring in a greater sense of optimism in terms of macro for the back half of the year? Or just if you can talk through the factors that went into the full year guide, that would be great. Thanks.

Sure. Maybe on guidance philosophy, I'd say we're being consistent with our historical approach. Our macro view is largely the same as it was last quarter, not assuming an improvement in the economy and our guidance. We are assuming that the same trends we saw in Q2 will continue, including positive trends from our individual SKUs. Again, we took direct action to improve those plans. Of course, this is somewhat offset by sluggish demand within our Teams SKUs. And we do also remain mindful of our reduction in force and the potential impact this could have on our billings given our reduced levels of investment in headcount and marketing, where all of these considerations are factored into guidance. Now, as far as your earlier part of your question on our long-term thinking, not providing any revenue guidance beyond '23 at this time, certainly keeping a close eye on the evolving macro environment as we navigate our path forward. We are also launching several new product experiences later this fall, such as Dropbox Dash and Bundles, where we will have a better idea of the revenue contribution after we gain initial customer signals, where ultimately we're very focused on driving a healthy balance of growth and profitability as we pursue our financial targets.

Thank you.

Sure.

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

Hi, this is Jacob Staffel on for Kash Rangan. Thanks for taking the question. A couple of questions from me. So, Dropbox has expanded the product portfolio recently. We see that with Dash, Dropbox AI, DocSend and Replay. Can you touch on how those offerings might be doing relative to the core FSS offering that Dropbox was founded on? And then, additionally, how are you thinking through hiring in the near term, specifically quota carrying reps? And can you touch on maybe how the self-service channel has fared in 2Q on a sequential and on a year-over-year basis?

Sure. So, we are really pleased with the progress. We've been making and broadening the portfolio as you kind of touched on. So, I mean, we started with FSS, but we saw that our customers had a bunch of workflow needs around the content in Dropbox. And so that's how -- that's why you've seen us expand into document workflows with things like FormSwift and DocSend and HelloSign, and increasingly, we're doing more with video with Replay and Capture. As we've seen folks adopt everything -- initially adopted Dropbox for those use cases are kind of duct tape something together, and then we found we could build a more targeted product for that use case. And then you're seeing as, as our customers are as many workflows have shifted from files and desktop apps to cloud tools and the browser, a new need to organize all your cloud content and fix problems with search and organization, and then bring intelligence into the work experience. So that's kind of the motivation behind it. And as far as how those products are doing, I think probably I don't have much to add from the -- beyond the comments we've already made. But we're very excited about the potential, especially for things like, Dash and Dropbox AI. And I wouldn't say there's much of a shift in how we're thinking about hiring quota carrying reps. I mean, as a reminder, 90% of our business is self-serve. And then, we have a targeted outbound and managed motion to help grow those -- to grow those accounts once they reach a certain threshold. And we're thinking about how do we continue to scale the go-to-market [indiscernible] get the best of both of those worlds from a go-to-market standpoint and get ready to be scaling a lot of our new products.

And then briefly, I think you asked about the performance of self-serve, I think it largely mirrors the trends that Drew and I have been talking about, where on the Teams side, we're seeing price sensitivity, on the Individuals side, we saw some improvement in retention that we've touched on.

Awesome. Thank you so much.

Thank you. And I see we have no further questions at this time. Ladies and gentlemen, this concludes today's conference call. You may disconnect at this time, and have a wonderful day.