Okay, hello everyone, and welcome to the UBS IT and AI conference. So in this session, we have Dropbox's CFO, Tim. Tim, thanks so much for joining us today.
You bet, Taylor. Happy to be here.
Awesome, perfect. And for those in the audience that don't know me, my name's Taylor McGinnis, and I cover the application and SaaS space here at UBS. So with that, before I dive in, if anyone has a question in the audience, there is a QR code in front of you. You can just tap that, and I'll make sure to read off any of those at the end. Perfect. Awesome, well, let's dive in. Tim, maybe a good place to start would just be at a high level, thoughts on what you're seeing in the demand environment? It sounds like, based on some of the comments that you gave last quarter, that top-of-funnel activity remains really strong, but you're still seeing possibly some right-sizing and optimizations among some of your larger customers.
So can you comment on that, and any signs of green shoots, or is it still challenging out there?
Yeah, good question. I'd say the demand environment has been relatively consistent, seeing stable, similar signs as we've been seeing the past couple of quarters. I think through some of the positives on the individual side of our business, across our Plus and Essential SKUs, still seeing some growth in those SKUs. We've done some work to improve the mobile experience in particular, and that's where we're seeing a lot of our new customers come through, is on the mobile side of things. So seeing some uplift on the individual side of the house. On the team SKUs, we are seeing some green shoots when it comes to the top-of-funnel, seeing some improvements when it comes to sign-ups and trials and activations. We've flown through some improvements on the sharing experience and the activation flows. So that's translating to green shoots on the team side of things, on top-of-funnel.
Now, on the other hand, we're seeing some pressure, particularly on the team side, as far as price sensitivity. We're seeing a lack of team expansion. We're seeing some downsell pressure. Some of this, we introduced a price increase back in 2022. We've seen some price sensitivity really since that point in time on the team side. And so that's offsetting some of the green shoots that we are seeing on teams. And so that's netting out. And so that's factored into some of the color we gave on 2024 and 2025. I think these team customers are doing what we're doing ourselves as far as trying to get more efficient with their spend. And so that's part of what's driving some of these headwinds.
Perfect. And then in terms of the visibility you have into when we could start to see some of those headwinds abate, so you talked about the price sensitivity, you talked about these contractions and optimizations. Is it as simple as once you get through some of these tougher renewal cohorts, or once we start to lap those pricing changes that were made, then that's when we could start to see that abate? I guess, how should we think about when that could occur?
Yeah, good question. So our business is a little challenging to predict because 90% of our revenue comes from the self-serve channel. And so they don't exactly give us a heads-up as far as when they're going to renew or churn or downsell. And so less of a dialogue when it comes to that self-serve channel. Those customers also tend to be on monthly or annual plans, so they have to make that renewal decision every year. And so we can't quite say that we're through any renewal pressure. Most of our dialogue does occur with the managed sales motion. So our outbound sales team is able to have an active dialogue with our customers. And so that's where we have more of a signal that a churn or a downsell is coming.
So this is where in the third quarter, fourth quarter, we knew about some of our larger teams downselling, so we were able to factor that into our paying user color that we gave and our guidance that we gave, so overall, I can't quite say if we're through any renewal challenges. What we do is always factor in the latest trends in our forecast. I never assume that things are going to improve on us, and so that's what's factored into the 2024 numbers and the 2025, and so we'll clearly give more color as we have it.
Perfect. And then maybe on the 2025 outlook, so you talked about maybe a little bit more visibility for these larger customers. I guess, what is the channel saying on that, right, and maybe this continued appetite to still work through some contractions and optimizations? Is the partner channel saying that we're largely through it, at least for these larger customers, and how are you embedding that in the 2025 guide? And in terms of, as a second part of this question, what the driver of that is, is it just as simple as there was layoff activities, now you have to optimize for the seats that you have today, and are you seeing this in any particular vertical, or is there any trend there?
Yeah. Some of the key drivers of folks that downsell or churn. The strongest correlation is companies that have gone through layoffs themselves, right, and so we see a company that's gone through a layoff, and they come around to their renewal cycle. We have a strong sense that we may be impacted as far as customers churning. Price to value is a new, or is not a new, but is one of the key reasons for churn or downsell. Customers flagging, hey, the price isn't worth the value that we're receiving. Episodic use cases, right? So a customer may be using it for a project. Once they roll off a project, they may downsell from a paid state to a free state. Another is they may end up in the wrong SKU, whereas they should have been in an individual SKU. They're in a team SKU or vice versa.
So those tend to be the main reasons for a churn or downsell. As far as the verticals that we're tending to see the churn and downsell in, we're seeing it primarily in the tech, manufacturing, and retail verticals tend to be the hardest hit. And then, as far as, there's a lot we're doing to focus on retention, where we have a $2.5 billion ARR base, 18 million paid customers, 575,000 paying teams. So it's critical for us to focus on retention. So this is the number one strategic initiative for our core team next year, is to focus on retention. So there's several things we can do on that front. And number one is engagement. And a customer that's actively using your product is much more likely to retain. And so we find that certain key features and functionality are strongly correlated to retention.
And it's basic functionality, things like sharing or team creation or editing or uploading files. And so part of the thinking is let's focus on that core set of features and functionality, as opposed to inundating our customers with too many bells and whistles. Let's get that core features and functionality right, drive up engagement, drive up adoption. And that tends to translate to retention. Strengthening and simplifying the platform, making sure that it's extremely reliable, the usability is seamless. These sorts of things tend to translate to retention. And then there's things we can do as far as the, call it the voluntary churn flow, as a customer is going through a churn or downsell, offering them a discount, or offering them, hey, what about the lower price SKU? Doing these certain activities to retain customers.
And then there's even work we can do on the involuntary churn side of things, as far as, hey, your credit card's about to expire, please update it. Or extending rebill windows to give people more of a chance to renew. So there's a lot of work that we're going to be focused on, on retention. Retention's clearly critical, again, with the sizable base we have. And we need a healthy user base that we can cross-sell Dash into. And so we want to make sure we have a strong foundation for our future as far as our growth.
Yeah. All that commentary on the retention efforts is super interesting, so in terms of where you guys are in that journey, is this something that you guys have been working on the last couple of quarters, such that once you get into 2025, you could start to see the fruits of that? Are a lot of these initiatives still in the early phases, and it might be more second half, right, where those start to come into play? What does that look like?
It's a mix. Some of these we've been working on for years, so again, 90% of our revenue comes from self-serve. So we are constantly iterating on our self-serve engine, making sure that that engine is as seamless and intuitive as possible because we don't have that active dialogue with customers, so they have to find things on their own. So we're constantly iterating on our self-serve engine, so that's a journey that we're always embarking on. Some of the voluntary churn flows, involuntary flows, those are on the roadmap, and so we're working through those, so some of that will be coming, and then additional things we're doing focused on churn, as far as, for example, introducing Dash to our file sync and share user base, that's also on the roadmap, so still coming.
So it's a mix of things that are in flight, things we've been working on for years, and things that will be coming.
Perfect. All really helpful, and then when we think about the file sync and share business, I know at the time of the RIF, there were some comments made by Dropbox in some of the remarks about that part of the business reaching some level of maturity. So I would love if you could just elaborate a little bit more on what was meant by that, because I think you're still talking about bright spots in upsells, right, and some of the top-of-funnel activity. So is that within certain customer segments where maybe it feels a little bit more penetrated? I know you don't share tons on customer segment today and what the mix looks like, but any even high-level color you could give folks to help them think through what some of that meant.
Yeah. Well, I think it's an acknowledgment that file sync and share is 15 years old, and it's in a mature, competitive environment, and maybe the days of high growth rates are past. And so we've got to be responsible and prudent with how we allocate our capital and make sure that we invest towards the highest areas of growth. And so this is where, again, as you alluded to, we did a RIF towards the end of October, and part of the intention there was just to get more efficient within our file sync and share business. It is in that mature category, so let's free up some of our resourcing and devote it towards the areas of higher growth, which we consider Dash to be.
So that's the strategy behind what we're doing, is really getting more efficient within our core file sync and share business and rotating investment towards Dash. That's the highest level. Now, we still are investing a fair amount in file sync and share because we do see these green shoots, and we need to translate those green shoots over to growth, and as I alluded to, we need a healthy user base on file sync and share to serve as this launchpad for Dash, to serve as the first cross-sell point for Dash, so certainly not giving up on file sync and share by any means, but I think it's more about matching the investments we're making towards the growth opportunity we see and constantly having that discipline as a management team to rotate investments towards the highest areas of potential growth.
Perfect. Let's talk about Dash. So I know it just launched, so it's very new, but just in terms of any insights that you can share from customer momentum and the feedback that you've seen today, so do you think that Dash could start to serve as an offset to some of the pressures that you've seen, or do you feel like that might take some time?
Yeah. So maybe I'll first describe what Dash is trying to do. And so Drew does talk about Dash as being the Dropbox that he would build for today's environment. As far as solving the challenge of it used to be 100 files across your desktop, now it's 100 browser tabs across your browser, and it can be across different tools and applications. So really solving for that fragmentation of tools and content. And so what does Dash do? One of the key features is universal search. So I can have one search box across all my tools. So I can search in one search box across Dropbox or Microsoft or Google or Notion or HubSpot. A lot of the tools I use to find content that I want and need.
And so certainly that keeps me productive in my day, as opposed to bugging Peter for, what was that file we were working on a week or two ago, or what's the name of that thing? Now I can find what I want much faster and don't have to annoy my team as much as I had done in the past. So that's the, call it the kernel functionality that Dash offers. Answers is another piece of functionality. So for example, I was looking at our second quarter board deck, which is a 180-page PDF file. And I just wanted some quick answers as I was preparing for the conference. And I said, hey, what did we do well in the second quarter? And it gave me a nice 10-bullet summary. And what did we do poorly? What do we need to work on? And that's another 10-bullet summary.
And it did a really nice job of synthesizing a 180-page PDF doc. I could also say, all right, write me an email that I could send to my team about this board deck, and it can do that. So it's almost a personalized ChatGPT centered around your content and your company's content. That's another key feature that it has. Stacks is another feature where I can aggregate both files and URLs, because it's not just files anymore, it's cloud content. So around each earnings cycle, I create an aggregated stack around my Q2 or Q3 or Q4 earnings. It includes my Word docs, my Excel docs, my PDFs, my Google Slides. And I can share that with my team. So it keeps our team organized around a particular project or event.
Then one of the more interesting and Aha features that we're offering to customers, particularly for IT decision-makers, because security is very important with IT tools, and particularly for IT decision-makers, that's what they're very focused on. We've introduced this Protect and Control functionality, which effectively is a dashboard that allows an IT decision-maker to see what content has been shared internally and externally and to manage that content more centrally from a more centralized basis. Whereas in the past, if somebody wanted to know, hey, how is a piece of content shared, they have to search in emails or find different docs and really go through a laborious process. Now they can do this centrally, essentially with Dash and through this Protect and Control feature. Appealing to IT decision-makers has been very important. I'll get to your question on momentum now.
We've been using Dash internally for several months now, and Dropbox employees are tough customers. If we don't like something, we won't use it, even if it's our own product, and so we've been using it. It's getting strong daily active use, getting strong weekly, monthly active use, so that's very encouraging. I use it literally every day, so I'm excited about it, and so we launched this in mid-October. Strong early reaction from customers. We've landed our first set of paying users. They're getting onboarded. From a market potential perspective, IDC has described it as an $8 billion TAM tripling over the next four years, so strong market potential as well, but so much execution in front of us, so much we need to do to drive this through to our customer base.
And again, relative to a $2.5 billion ARR base, it's going to take a while for it to move the needle. But we're very optimistic about the long-term potential here and excited to see what we can do with it.
Perfect. Awesome, and now that it is live, anything you can offer in terms of monetization and how it's being priced? I know you've talked about that being accretive to ARPU in 2025, but any sense of the magnitude that we could see? Is this something more incremental? Could it be 50 basis points of expansion, 75? Any just high-level color you could offer there? What might be embedded in the guide?
Sure. Very early days. So again, we're sorting this out. This will be in negotiation, given that we're starting with this managed sales motion. So it'll be a conversation with customers. So very early innings, we're getting some good early signals on it. We're clearly aware of how other companies have priced their AI products. So that gives us a bit of an anchor point to use in these conversations. As you alluded to, this will be accretive to ARPU. We're confident in that. As far as the potential to drive basis points across our full user base, it's going to take a while, again, with $2.5 billion to move that needle. So we'll be monitoring this. These are some of the things that we'll be learning over the next months and quarters: the sales cycle times, the price points that we get.
And so we'll be factoring this into our guide and our commentary as we give these proof points to the street on how things are going. As far as what we factored into 2024 and 2025, not much factored into 2024. And we're trying to be prudent about what we factor into 2025. So factored in some degree of uplift, but nominal relative to our total base.
Perfect. And just because we're on the topic of Dash, I'll turn to a question from the audience, which is, what are you looking for with respect to traction for Dash that would cause you to be comfortable leaning in to spending meaningfully on advertising and marketing dollars to promote it?
Sure. So the approach with Dash will be trying to roll this through to our 575,000 installed base across our teams and focused on SMBs, focused on mid-market customers, primarily domestic, eventually rolling through to international, but starting there, and having these conversations with IT decision-makers. So the traction that we'll be looking towards is the pace at which we are landing deals, how fast these sales cycles are, what price point we're landing. And that's what will educate whether we continue to add more sellers to that sales motion. So pace of adoption, the level of engagement will also be important, right? Because engagement tells us about retention, because if we're seeing low use of the product, then maybe they're not going to retain. But if we're seeing high levels of engagement, that'll give us confidence in the potential future retention.
And then eventually we'll get renewals will come up and how many customers are renewing. So as we're seeing the adoption, as we're seeing actual landing of deals, and as we're seeing the retention, that'll give us confidence as far as adding more R&D, adding more marketing. Now, a lot of that is already embedded within next year's commentary that we've already given. So I think we are investing a healthy amount around Dash. Another thing that is on the horizon for us is launching a self-serve motion, right? And so this is Dropbox's bread and butter when it comes to file sync and share. That's where most of our revenue comes from. And so as we introduce that self-serve motion, what'll be really interesting is the adoption curve for self-serve for customers that need to sort more of this out on their own.
Again, the adoption, the usage, all of this will give us a sense of ramping up marketing and investment and headcount.
Perfect. And then as we think about putting all of this together, so we've talked about some of the optimization activity. We've talked about top-of-funnel. We've talked about Dash. So when we think about how all of this contributes to your flat revenue guide for 2025, I guess, can you talk maybe a little bit further about what some of the assumptions are embedded in that guide? So if we look at the four key guide, that assumes that paying users are going to be down sequentially. So what are some of the risks that we could see that persist, right, into next year? I know you talked about the possibility of growth actually declining, but what are you seeing, I guess, that's giving you that comfort to at least start with flat year over year?
Yeah. So we did share that we expect 2025. We'll provide firm and official guidance in February. But in the November call, we shared that we expect 2025 revenue to be roughly flat on a constant currency basis relative to 2024. So what's going into that? Well, we're exiting Q4 for file sync and share in our document workflow businesses at sub 1% growth. And we just did a RIF. So taking away some headcount, taking away some marketing. So I don't expect that to help the growth rate for file sync and share in our document workflow businesses. And so if I just calculate the trajectory of our file sync and share business, there is a degree of headwind there. We talked about the pressure points as far as downsell and lack of seed expansion. So not expecting that to improve at all.
So we've got this downward trajectory line on our core business. And Dash is just getting started. And so I definitely expect an upward trajectory line there. But we're getting a sense of pricing, the sales cycles, all these sorts of things we've been talking about. And I don't know the pace of that just yet. And so we've got one line coming down, one line going up, roughly flat expectation given those trajectory lines. Now, we could see things dip down if the team's business continues to struggle against these downsell and lack of upsell headwinds, or if Dash, the pace of Dash ticking off, is lower than we had hoped. So there could be even further pressure on that growth rate.
Or conversely, we could see it turn around and move north if our team's green shoots, if those actually translate into ARR growth, or if Dash takes off at a faster clip than we had hoped. And so clearly, these are the sorts of things I'm monitoring very, very closely. And I'll share updates each quarter with the street. But those are the lines we're paying very close attention to. And at this point, the best estimate is that roughly flat line.
Perfect. That's super, super helpful, Caller. Maybe shifting to margin. So you announced the RIF that impacted approximately 20% of the workforce. So can you quantify how that's being factored into the 150 basis points of margin expansion in 2025? What level of savings are being realized? How much is being reinvested back into the business?
Sure. So end of October, we let go of about 500 employees, 20% of our workforce. And so some of the color we gave on our November call was that we expect roughly 150 basis points of margin expansion next year. So we end this year roughly 36% operating margins. So clearly, that infers about 37.5% operating margins next year. Now, next year, a few headwinds will put some pressure on that. Number one, every year we do an annual merit increase for our employees. So our employees will get a merit increase. So that'll put some pressure on that. We are going to reinvest some of the headcount back into Dash. And we had some performance management actions as part of the 500 heads. So there'll be some backfills for that. So that'll be factored in as far as the offset to margins.
And then 2024 had about 120 basis points uplift due to the extension of a useful life of our hardware equipment. And so we won't see that tailwind again. So that is offsetting some of the margin expansion. So that gives some color as far as the operating margin leverage we expect going into next year.
That's super helpful. And how predicated is the 150 basis points of the expansion on revenue growth, right? So let's say there is a scenario where we see a decline in revenue growth. Are you still able to show that 150 basis points are more of improvement? Is there areas if you need to pull more cost saving or operating efficiency levers? That's still to be had in the business.
Yeah. Good question. I think we always anchor on the principle of growth and profitability and finding that right balance. And so these are the conversations that Drew and I have, that the board has with us, and making sure that we're mindful of that balance. And that's part of the thinking behind the RIF is, hey, we were seeing file sync and share growth rate come down. Let's be mindful of the spend we have there, and let's drive some incremental profitability. So that'll be the anchoring principle. And if we're seeing growth coming down, we'll find ways to drive more profitability. And ways we can do that is continue to assess our R&D spend. Are we getting a sufficient ROI on our R&D spend? And if we're not, let's curtail it. Our marketing spend, are we driving a sufficient LTV to CAC on the marketing spend?
If we're not, let's pull back. Other levers we have, low-cost locations. I'd say we're still in the early innings when it comes to low-cost locations. We did introduce hiring in Poland a few years ago, but it's still relatively small relative to our R&D base. And so we can continue to leverage low-cost locations. Automation, another thing we can leverage, AI tools and other things to get more efficient, more productive with our time. So there's definitely ways we can drive more leverage across this business. And that's very much something that Drew and I and the management team will be monitoring to make sure that we're delivering sufficient returns for our investors and shareholders.
Perfect. Really helpful. And then maybe translating this to what this all means for cash flow. So when we think about the 150 basis points on EBIT expansion, I know on the cash flow side, you have two headwinds as it relates to 1 Q, the restructuring charge being one of those. But I guess, how do we think about that? Is it that the cash flow improvement should be aligned? Then if you take out some of those one-time headwinds, is there potentially more cash flow leverage? So they actually should try to align with each other. Any help that you can give us there for 2025?
Yeah. So for 2025, early signaling we gave in November was we expect free cash flow to be at or above $950 million. Now, you alluded to a few of these one-time headwinds. We have a $36 million payout to a San Francisco lease buyout that we did a couple of years ago. So that lands in the first quarter of next year. And then about $10 million of severance related to the RIF for international employees. That'll land in the first quarter of next year. So those are a couple of the headwinds that we'll be facing. We've talked about the revenue expectations. Clearly, that's factored in. We talked about the margin, the fact that we're reinvesting back in certain roles. That's factored in. Then there's higher cash taxes. Unfortunately, as we become more profitable, we have to pay a bit more in taxes. So that's factored in.
So now, again, we're very committed to driving higher levels of free cash flow and with our share repurchase program, taking out more of our share count. And so Drew and I are our North Star, if you will, as far as what we're trying to achieve and what we're trying to drive for shareholders is free cash flow per share. And I think you've seen us drive that pretty strong free cash flow per share growth over the past couple of years. And we intend to keep that pace up.
Perfect. So just to be clear, so the headwinds that we talked to are embedded in that preliminary guide. Okay.
Correct.
Perfect. And then last question for you in the last two minutes or so. Pricing and packaging is always a hot topic. So I guess, where does that stand today? Are there opportunities to take price? Is it still more about finding the right bundles? What's the strategy?
Yeah. I think on price, we'll be cautious with price. We raised prices on Teams a few years ago. And so we saw a lot of price sensitivity when we did that. So I'd say we'll be quite cautious when it comes to raising prices on Teams. We did introduce a Dropbox Simple SKU, which is a mobile international SKU. So it's a lower price, lower cost SKU in certain geographies. These are the sorts of things we'll test constantly with our customer base. And that got some good initial traction. And so we'll continue to test that and determine whether to roll this out across different geographies. So that's one way we'll play with pricing, if you will, is by testing different price points and different SKU types. But you alluded to pricing and packaging. So the bundling strategy is definitely something that we will be contemplating.
We did introduce bundles towards the end of last year where we introduced some lightweight functionality across our e-signature and DocSend business lines. That got some muted market reception. And so we're moving away from, call it the document workflow bundles, but bundling Dash or bundling some of the security functionality that I alluded to, the Protect and Control. Those are some of the ways we can also take advantage of pricing and packaging and drive up retention, drive up that utility across our customer base. Because the more value that customers are getting out of Dropbox, they're definitely more likely to retain. And so finding the right set of bundles, finding the right packaging and right pricing, that's something we're very, very mindful of.
Perfect. Well, we're at time. So Tim, thank you so much for joining us. This has been incredibly insightful. And thanks to everyone in the audience as well, too. Let's give Tim a round of applause.