Dropbox Inc (DBX) 2018 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for joining Dropbox's first-quarter 2018 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 hand the call over to Darren Yip from Dropbox's Investor Relations team.

Please go ahead.

Thank you.

Good afternoon and welcome to Dropbox's first-quarter 2018 earnings call.

Today Dropbox will discuss the quarterly financial results that were distributed earlier.

Statements on this call include forward-looking statements, including statements relating to the expected performance of our business, future financial results, strategy, long-term growth and overall future prospects.

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 our risk factors included in our final prospectus for our initial public offering filed with the SEC on March 23, 2018, and the risk factors included in our Form 10-Q that will be filed by May 15, 2018.

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 applicable 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 is furnished with our Form 8-K filed today with the SEC and may also be found on our Investor Relations website at Investors.

Dropbox.com.

I would now like to turn the conference call over to Dropbox's Co-founder and Chief Executive Officer, Drew Houston.

Drew?

Good afternoon, everyone, and welcome again to our earnings call.

On the call with me are Dennis Woodside, our Chief Operating Officer, and Ajay Vashee, our Chief Financial Officer.

I'll touch on our business and product highlights and then Dennis will talk about our go-to-market approach and ecosystem and Ajay will review our Q1 financial results and provide guidance for Q2 and fiscal year 2018.

To kick things off, since this is our first earnings call as a public Company, I wanted to share some context on our history.

We started Dropbox back in 2007 with the idea that life would be better if all of your most important information lived in the cloud.

Our products spread virally and globally and, as Dropbox reached hundreds of millions of people, our users brought Dropbox into millions of businesses.

Along the way we realized that what our customers really valued about Dropbox wasn't just the storage, but the sharing and collaboration.

So a few years ago we decided to tackle an even bigger challenge: keeping teams in sync and connecting people to their most important information at work.

And today we're one of the most widely adopted business software platforms in the world.

We have over 500 million registered users and Dropbox is the place where millions of people and teams get their work done; a place where people come together and ideas come to life.

Of our 11.5 million paying users, we estimate that approximately 80% use Dropbox for work.

Our consumer roots have helped us pioneer a unique business model that combines the virality and scale of a consumer Internet business with the predictability and cash generation of a SaaS business.

As a result, we were the fastest SaaS company to a $1 billion revenue run rate and we believe we have a long runway for growth.

Today we're focused on addressing the constant collaboration market, a $50 billion plus opportunity according to IDC estimates, and we're really excited about the road ahead.

And we made great progress tapping into that opportunity in Q1.

It was a strong quarter for us with revenue growth of 28% year-over-year and meaningful free cash flow generation.

And one of the drivers of our revenue growth this quarter was our success in increasing adoption of our premium plans.

A year ago we launched Dropbox Advanced, which is a premium business plan built specifically for teams seeking more sophisticated administrative, security and device management functionality.

Advanced is offered at a higher price point relative to our standard business plan.

And late last year we also introduced Dropbox Professional, which is a premium individual plan that features extended file recovery, advanced sharing control features and a new product called Dropbox Showcase.

Showcase lets users present their work to clients and business partners through a customizable, professionally branded webpage.

And Professional is also offered at a higher price point relative to our Plus individual plan.

These new plans increase the value we deliver to our users, creating a richer sharing and collaboration experience and more people are subscribing to them.

And as a result, we saw an increase in average revenue per user in Q1.

In addition to premium subscription plans, enhancing products like Dropbox Paper is an important focus for us.

Launched in early 2017 to GA, Paper is a collaborative workspace for teams and it's off to a great start.

Dropbox users have created millions of Paper docs in more than 20 languages around the world.

We view Paper has an important part of our platform that drives higher engagement and retention.

We recently rolled out several updates to Paper, including a completely redesigned Paper mobile app, and our revamped Paper mobile editor makes key editing features easier to discover and use on the go.

In addition, the mobile app facilitates task creation, including assigning to-dos and sitting due dates.

We also completely redesigned the Paper iPad app for a more optimized experience.

Updates like these have helped Paper drive improvements in monetization for Dropbox business team trials.

In particular, teams with at least one Paper user convert to a paid subscription at approximately twice the rate of those without Paper usage, and those teams also have a 25% higher net retention rate.

We're constantly working to add new tools and functionality to Dropbox Paper and Dropbox more broadly so our users can get their best work done.

So we'll continue to innovate to improve our platform and deliver more and more value to our users.

And now to talk to our go-to-market approach and ecosystem, I'd like to turn the call over to Dennis, our COO.

Thanks, Drew.

As Drew mentioned earlier, Dropbox has a unique go-to-market approach.

Underlying this approach is a robust self-serve engine that helps us efficiently land inside an organization.

In fact, 90% of our revenue comes from self-serve users who may never talk to a salesperson.

Our large user base provides us access to hundreds of millions of actively connected devices and proprietary messaging services and we leverage machine learning and data science to determine what messages to deliver to which prospects in order to drive conversion.

We complement our self-serve engine with a targeted outbound sales motion that drives expansion within organizations.

Before we make a single sales call we may see a number of basic accounts, many individual subscribers and several paid teams deployed within an organization.

We prioritize which accounts to target by utilizing aPriori, our machine learning tool, that notifies a sales rep to reach out to a prospect based on signals such as free and paid usage and sharing frequency.

Our sales cycles are short and predictable and we don't need to rip and replace as we can often tap into departmental budgets which makes decision-making easier and faster.

In Q1 we continued to make improvements to our data science models to further optimize our growth engine.

For example, by applying analytics to certain segments of users who chose to churn or down sell, we were able to deploy customized promotions to win them back.

In addition, by analyzing multiple factors related to reseller performance, we were able to build a predictive model to determine reseller success rates in selling to new customers.

With this model we can optimize the reseller channel by better targeting new partners.

An example of our efficient land and expand approach from Q1 is WeWork.

The shared office space provider has grown its Dropbox deployment 200% since Q3 of 2017, recently expanding its subscription to our platform by an additional 500 users.

Since starting as a 30-user self-serve account within the company's digital team in 2015, Dropbox usage at WeWork has expanded alongside the rapidly growing company to groups like brand marketing, design and real estate services -- teams that all consider Dropbox critical to important collaboration workflows.

WeWork has also adopted Paper within its design, digital and IT teams.

Another example of a customer that's followed a similar land and expand approach is 2U.

A rapidly growing EdTech company, 2U partners with top-tier universities to power their online graduate degree programs and short courses.

They've been using Dropbox since 2011 when they started as a small, self-serve team and have consistently scaled their account as they've grown.

So far this year they have increased their deployment to nearly 2,000 total licenses.

Dropbox is a key part of 2U's technology stack, integrating seamlessly with its existing tools and serving as the primary tool for FSS and collaboration, particularly for users in design and sales.

We've also seen success in expanding international deployments, including at one of the world's largest advertising agencies based in Japan.

Beginning with 15 users in 2012, this customer has steadily grown its Dropbox business deployment and surpassed 6,000 paying users in Q1.

The company uses Dropbox to securely share files and collaborate with colleagues and clients around the world and has achieved significant time and cost savings and increased productivity with Dropbox.

In Q1, we also continued to expand our open ecosystem.

We find that many of our customers struggle with content and application fragmentation and the resulting challenge in stitching everything together.

Dropbox integrates with just about any tool a team might be using, which is critical to our vision of becoming a single unified home for team content and the collaboration around it.

As of the end of 2017, we have more than 500,000 developers on our platform and we are receiving over 50 billion API calls per month.

And in Q1 we kept that momentum going with some key partnership announcements.

First, we announced a strategic partnership with Salesforce that connects the number one CRM platform with Dropbox, enabling businesses of all types to collaborate and more deeply connect with their customers across sales, service, marketing, commerce and more.

The partnership will include an integration with Salesforce's Commerce Cloud and Marketing Cloud to allow users to users to create branded, customized Dropbox folders that can be accessed by both internal teams and external partners.

With two-way workflows, content will stay relevant and up-to-date whether a user is working in Dropbox or Salesforce.

In addition, an integration with Quip will allow users to access Dropbox contest directly within Quip.

Dropbox will also add support for Quip documents, allowing joint users to work on Quip files that live in Dropbox, furthering Dropbox's effort to build a unified home for work.

Additionally, we announced a partnership with Google Cloud.

Working with Google, we plan to develop a series of cross platform integrations that connect G Suite cloud productivity tools and content with our global collaboration platform.

As a result, users will be able to more easily organize, create, open and edit Google Docs, Sheets and Slides from within Dropbox and Dropbox business administrators will be able to more easily manage these files.

In Q1 we also announced that we were expanding our partnership with Adobe.

Together we're introducing a new Adobe Creative Cloud integration that allows users to share and preview XD files from Dropbox, streamlining design collaboration without disrupting users' workflows.

Finally, while we have universal appeal for companies of all sizes and in all industries, we're also focused on advancing industry specific integrations across a number of key verticals.

Last year teams working in the architecture, engineering and construction industries created and saved more than 0.25 billion files in Dropbox.

That translates to roughly 25 million files per month or 800,000 files per day.

To better support these teams and their end-to-end workflows, we announced a number of integrations in Q1 with companies like Aconex, BulldozAIR, Fieldwire and PlanGrid.

In summary, we're really pleased with the progress we're making and our recent customer wins and partnership announcements help validate that Dropbox is becoming the preferred platform for collaboration across companies of all sizes and industries.

With paying Dropbox business teams in over 50% of the Fortune 500 and paying users in over 90%, we believe we have universal appeal and a long runway to keep expanding our footprint.

We look forward to keeping you posted on our progress in 2018 and I will now turn it over to Ajay, our CFO, to walk through our financial results.

Thank you, Dennis.

Our Q1 results continue to demonstrate our strong execution and focus on delivering top-line growth and free cash flow generation.

Total revenue for the quarter was up 28% year-over-year to $316 million, driven by an increase in total paying users and average revenue per paying user.

We ended Q1 with 11.5 million paying users with the majority of growth primarily driven through our self-serve channels.

We also saw healthy uptake of our premium Professional and Advanced plans, which helped increase ARPU to $114.30.

Looking ahead, while we're focused on continuing to deliver more value to our users and on increasing adoption of our premium plans, there may be some quarterly variation in ARPU from a variety of factors such as monthly annual subscriber mix, plan mix, negotiated pricing and changes in FX rates.

Before I move on, I want to note that unless otherwise indicated, all income statement measures that follow are non-GAAP and exclude stock-based compensation and employer-related taxes on the release of our two-tier RSUs at IPO, which I'll discuss shortly.

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 on our Investor Relations website.

Gross margin for the quarter was 74%, an increase of 11 percentage points compared to the first quarter of 2017.

Gross margin expanded due to a continued focus on unit costs and utilization efficiencies, as well as a change in the useful life of certain hardware.

Since migrating to our own infrastructure, we've implemented a number of software improvements that have allowed us to extend the useful life of certain equipment from three to four years.

As a result, our cost of revenue included a $6 million benefit in Q1.

With the majority of the full-year benefit expected to be realized in the first half of 2018, we expect gross margins to be roughly consistent with Q1 for the remainder of the year.

Moving to operating expenses, first-quarter R&D expense was $87 million or 28% of revenue compared to 27% in Q1 a year ago.

The increase as a percentage of revenue was primarily driven by higher headcount as we continue to invest in new products experiences to broaden the value of our platform.

S&M expense was $82 million in the first quarter or 26% of revenue compared to 24% in Q1 a year ago.

The year-over-year increase was primarily driven by a new brand campaign that was launched in late 2017 and continued into Q1.

The goal for the campaign is to extend Dropbox's appeal to a wider target audience and position Dropbox as a platform that helps teams find focus, stay in their flow and unleash their creative energy.

G&A expense was $30 million or 10% of revenue and consistent with the prior year, as headcount and other expenses grew in line with revenue.

Taken together, we earned $34 million in operating profit in the first quarter.

This translates to an 11% operating margin, which is a 9 percentage point improvement from Q1 of 2017.

Net income for the quarter was $31 million, up from $5 million a year ago.

Diluted EPS was $0.08 per share, up from $0.02 per share in Q1 2017 based on 373 million diluted weighted average shares outstanding as of Q1.

This share count reflects the reverse stock split at the time of our IPO, shares issued in our IPO, time weighting of preferred stock across the duration of the quarter, and treasury stock method calculations.

I want to spend a moment covering the major items excluded from our non-GAAP financials as a result of our IPO in the quarter.

In Q1, we incurred $487 million in stock-based compensation expense and $14 million in employer payroll tax expenses, which were excluded from our non-GAAP results.

Between 2011 and 2015, we granted two-tier RSUs to employees.

These awards have both a service-based vesting condition and a liquidity event-related performance condition.

The liquidity event-related performance condition was met upon our IPO.

We therefore recognized $419 million in previously unrecognized stock-based compensation expense for two-tier RSUs for which the service-based vesting condition was already satisfied in the first quarter of 2018.

This $419 million and a separate $10 million charge for modifying our RSUs to enable vesting once per quarter are included in our total stock-based compensation expense of $487 million.

In addition, we released 27 million shares of common stock underlying the vested two-tier RSUs during the quarter and, as a result, recorded $14 million in employer payroll tax expenses associated with these same awards.

Moving on to cash balance and cash flow, we ended Q1 with cash and short-term investments of $846 million, which includes the net proceeds from our IPO but excludes the $108 million of net proceeds from the exercise of our underwriter overallotment option which was completed in April.

Cash flow from operations was $62 million in the quarter.

Capital expenditures were $10 million, yielding free cash flow of $52 million or 16% of revenue.

Q1 is typically a seasonal low point for free cash flow as it includes our annual cash bonus payments.

In addition, the employer tax payment related to the two-tier RSU release I previously mentioned was $14 million in the quarter.

CapEx in Q1 included $600,000 of spend on our new headquarters net of tenant improvement allowances received.

As a reminder, at the end of 2017, we entered into a lease to move to our new San Francisco headquarters which will be completed over approximately the next two years.

We expect total CapEx related to the buildout of our new headquarters, net of tenant improvement allowances received, to be approximately $35 million to $40 million in 2018.

In Q1 we had $26 million of additions to our capital lease lines for data center equipment.

We generally expect additions to capital lease lines to be high single digits as a percentage of revenue this year.

Turning to our guidance, for the second quarter of 2018, we expect revenue to be in the range of $328 million to $331 million, non-GAAP operating margin to be in the range of 9% to 10% and diluted weighted average shares outstanding to be in the range of 422 million to 427 million based on our trailing 30-day average share price.

For the full year 2018, we expect revenue to be in the range of $1.343 billion to $1.355 billion, non-GAAP operating margin to be in the range of 9% to 10%, and free cash flow to be in the range of $340 million to $350 million.

This figure includes one-time spend related to the buildout of our new corporate headquarters.

We expect 2018 fully diluted weighted average shares outstanding to be in the range of 410 million to 415 million shares based on our trailing 30-day average share price.

I'll now turn it back to Drew for closing remarks.

All right.

Thank you, Ajay.

In closing, we had a great quarter.

Our results continue to demonstrate the strength of our platform, our efficient go-to-market strategy and our financial discipline.

We're operating in a scale that few SaaS companies have been able to achieve and we're delivering a healthy balance of growth and free cash flow generation, and we feel we've built something really unique.

We are pioneering a new model for business software and we're incredibly well-positioned in a large and growing market.

So, on behalf of our management team, I'd like to take a moment to thank our customers, partners and the entire Dropbox team for getting us to where we are today.

So with that, I'd like it to open up for questions.

Operator?

(Operator Instructions).

Mark Murphy, JPMorgan.

Congrats on a great start to the year.

Ajay, I wanted to ask you about the billings growth which accelerated, and I believe it was above any of their prior four quarters.

What was it that might have driven the strength in the deferred revenue growth and therefore the billings growth?

For instance, was there any material impact from billing terms, contract terms, FX or anything else that we should be aware of?

Yes, Mark.

It's great to hear from you and thank you for the question.

I would say at a high level billings for us are related to revenue growth but not as predictive of revenue as one might think.

And so, in Q1 our billings benefited from a prepayment from one of our partner resellers as well as a bit of an FX tailwind as billings are more sensitive to movements in FX relative to revenue given how our business model works.

And in a given quarter there can be various items that can drive billings growth higher or lower that don't consistently correlate to revenue.

For example, additions to our deferred revenue balance are highly sensitive to the mix between monthly and annual subscribers.

And small changes in mix shift in a given period can skew deferred revenue, resulting in deviations between billings and revenue.

So I'd say our revenue guidance reflects the growth that we expect based on current visibility.

Okay.

And as a quick follow-up for Drew, Dropbox is one of the very few exabyte-scale cloud platforms that we're aware of.

Wondering if you can walk us through what you're doing -- and/or maybe Dennis could comment on this -- to leverage that amount of data that you have as you are applying the data science.

And trying to understand the user behaviors, identify trends and developing new products, can you just walk us through maybe what you're working on to try to leverage it?

Yes, thanks for the question.

So, we think our focus on content is a big strength when we think about the collaboration category.

And so, when it comes to how do we use that content or leverage it, our ecosystem is a great example of that.

Because we see that so many workflows in a company revolve around content, so it's a way for us to drive engagement through some of the most important workflows in a business.

And so, there's a lot we do on that front and some of our partnerships are a good example of that.

Now, AI game machine learning are another really promising area and an area where we're investing, and some of which -- or some of the investments you can see in the product today.

Whether that's -- our doc scanner is an example, where you can take a picture of a piece of paper and get a searchable PDF.

And deep learning and a lot of the machine vision technology is an important part of that.

More broadly, we see a big opportunity to help people find the information that's really important to them.

And I think verbs like finding what you're looking for or tasks like that, or help me organize stuff, or help me cut through the clutter and see only the things that are important -- machine intelligence is going to be pivotal to making that happen.

And some of our early efforts in search and ranking and relevance and so on and ranking on our activity feeds are an early example of that.

But I think we're going to be able to go much deeper here.

And the fact that people have put an exabyte of content, or over 400 billion files and other pieces of content in Dropbox, is a huge advantage for us.

Thank you.

Heather Bellini, Goldman Sachs.

Congratulations on your inaugural quarter.

I had two questions.

One, Drew, I was wondering, how do you see the collaboration market evolving?

And from an R&D pipeline perspective, how do we think about your priorities to expand into apps that leverage your core Dropbox infrastructure?

And then I just had a follow-up.

Sure.

So we start with our users, and when we look at the overall experience of using technology at work, maybe putting it nicely, there's a lot of room for improvement.

And so, for example, there's still a ton of friction that arises because people -- we have all these new tools that are coming along, but the old tools are also still here, so there's this fragmentation of the experience.

And so, often we find that they are customers turn to us to try to -- as the cloud to keep their clouds or their ecosystems in sync.

And so, that's kind of a new problem and we think we are uniquely positioned to do that really well, and our partnerships are an important part of that with folks like Microsoft and Google and hundreds of thousands of developers on our platform.

So we see a big need to tie all these things together, given that proliferation of tools.

And then we see an opportunity to do things a little bit differently.

So, a lot of the office suites were really designed a generation ago, and we can take advantage of that and the fact that we're designing for 2018.

And so, what does that mean?

Well, Dropbox Paper is an example of this because we think that a lot of the friction that arises from having all these different tools could be fixed if you build a more integrated experience.

And so, we see that there are -- we watch as our users toggle between all these different apps to get work done.

So, if you are working on a PowerPoint in one place and you want to talk about it in Slack or an email and you want to respond to a ticket or a task, you're constantly toggling between different apps.

And so we looked at that and we thought here's an opportunity to bring the content -- with Dropbox Paper, to bring all the content into one place, all the conversations around it in one place, and increasingly things like coordination and task management, the ability to manage a project from one place within Paper.

But when you look at it, we're kind of drawing outside the conventional boundaries of these categories and integrating things that have been separate.

So there's a lot more I could say on either of those fronts, but we certainly see an opportunity to make -- to rein in some of the chaos that's resulted from this proliferation of cloud tools.

Okay, great.

And then just the follow-up would be, you had mentioned some data points on Paper and Showcase adoption, and I've been wondering, have you been able to measure how this might be impacting -- how adoption of those products might be impacting churn, as well as the potential that you've seen for this to actually help you with seat expansion at existing accounts?

For sure.

So, products like Paper and Showcase are relatively new, so our primary focus is on getting the experience right.

And we want to do that, and so we want to scale up gently and make sure that -- certainly our scale is a big asset when it comes to driving distribution of our new products, but we want to drive sustainable, retained growth.

And there are some early promising signs.

So one thing we shared is that among Dropbox business team trials, folks that use Paper both convert at twice the rate and they also retain 25% higher.

So for sure, as we add functionality to the product people are more engaged with it.

In many ways that by definition reduces churn because we're increasing retention and engagement.

So we take a blended approach to that.

Great.

Thank you very much.

John DiFucci, Jefferies.

I express my congrats, too, on your first quarter out of the blocks here.

I think my question is probably for Dennis or maybe Drew.

I think ARPU growth of about 3%, at least that we calculate, looks good.

It's near -- I think you saw somewhere in the 2% to 4% last year.

You mentioned the price uplift, I think Drew did, as a positive influence to ARPU in your prepared remarks.

I was wondering if you can give us any specific or even subjective commentary on user behavior when they are renewing at this point.

Anything like the portion that are choosing the higher function, higher-priced SKUs over going back to the more standard SKUs.

Yes, so I can start and Dennis can share more about the specific adoption of some of our higher tier plans.

But we certainly see the biggest levers to drive monetization as growing the subscriber base and then driving ARPU uplift.

And so, that happens in a couple of -- as far as ARPU uplift, that happens in a couple ways.

So first is people moving from individual subscriptions at work to having the business version of Dropbox.

That's a higher priced plan, so the mix shift is something that we focus on and getting people set up properly in teams in adopting the business version of Dropbox, as opposed to just a mix of free and paid use.

And then for sure one of the more recent levers -- or again, promising early signs but it takes a while for it to fully flow-through -- is the introduction of our higher tier plans both on the individual front and business front.

And so we see some early uplift there, too.

Yes.

Hi, it's Dennis.

Thanks for the question.

So just a little bit of context on our plans.

We introduced our Advanced plan a little over a year ago and we introduced our Professional plan just in Q4 of last year, so both plans are relatively new in market.

And remember, we gave our users of our business plans a year to experience the benefits of the Advanced plan before they had to make a decision as to whether to stay with the Advanced plan or move to standard plan.

And the Advanced plan is at a 60% price premium to our standard plan.

We're seeing very good conversion to, or maintenance of, the Advanced plan among those users.

We're happy with where that is, although we're not releasing any specific numbers.

And the features that are in the Advanced plan -- things like audit logs and tiered admin control single sign-on, those are appropriate for really any meaningful team deployment.

Because most teams that are using Dropbox as a business tool are going to want to use those sorts of integrations.

So, we're seeing good take rates.

You see that reflected in the overall ARPU numbers and we're pretty happy with how that's going so far.

That's great.

That's really helpful.

And if I might, just for clarification, Dennis, was it the beginning of this year when the Advanced users had to make that decision once they start renewing?

Is that -- (multiple speakers) was the cutoff January 1?

It was a little bit later than that.

It was in Q1.

Okay.

Around February, beginning of February, yes.

Okay, great.

That's really helpful, thank you.

Alex Zukin, Piper Jaffray.

Again, echoing the congratulations mentioned earlier in the call.

You talked about some very interesting new partnerships with Salesforce and Adobe, and I wanted to ask how you're thinking about partner-influenced sales or any other metric that you're tracking to assess the impacts of these types of programs.

(multiple speakers)

I can start and -- yes.

I can start and Dennis can add to it, and thanks, Alex.

So, some of these -- you look at the Salesforce and Google partnerships, both were in Q1, so still pretty early days.

But they are examples of -- with the Salesforce relationship, that's an example of looking at our customer base and realizing that we and Salesforce share a large number of customers.

And workflows like CRM revolve around content when you think about salespeople sharing collaterals, prospects and so on.

And so, when you look at -- there are a lot of different potential dimensions of that partnership and things that we're excited about.

We are focused first on building a great product experience, so for people that use both Dropbox and Salesforce, making sure that those integrations are really good.

And then there's a ton of opportunity in other areas, so joint go-to-market, and you look at the -- Salesforce's customer base and you look at Dropbox's customer base, they are complementary in a number of ways.

And so, that's something that will happen over time, but that's one of the -- that's an example of the kind of opportunity in these partnerships that we're excited about.

Yes, it's Dennis.

Thanks, Alex, for the question.

So with respect to partner-influence sales, the way we're thinking about things now is that we know that teams that use at least one integration renew at higher rates and expand at higher rates, simply because they're getting more value out of Dropbox and we're more deeply embedded into the workflow.

So, the kinds of things that we look at when we're trying to surface integrations, we want to be managing the number of teams that use at least one integration with a partner like Slack or Splunk or Salesforce.

We look at the number of teams that have more than one integration and then we look at the integrations with applications that are most correlated with retention and upsell.

So some applications have a very high correlation with retention and upsell.

And then we are now starting to be more aggressive about surfacing those integrations to our teams so that, if a given partner happens to be driving value for a certain segment of our users, we want more users to know about that.

So we're not, for the most part, focused on directly selling; we're focused more on adding value to the user base and indirectly monetizing that way.

Got it.

Thank you, guys.

And then maybe just as a point of clarification for Ajay, any comment with respect to trends around ARPU growth from a seasonality perspective?

You mentioned some of the comments in the call, but just anything that would help us for modeling purposes?

Yes.

Thanks for the question, Alex.

I think at a high level our strategy is to continue to drive revenue growth both through paying user growth and conversion as well as ARPU expansion.

And I would think of that really in any given quarter one of these levers may outpace the other, depending on the initiatives that we're deploying in that period.

And there are some factors that can influence ARPU in the short term, and so these are things like monthly and annual subscriber mix, depending on the experimentation and the initiatives that we're working on, plan mix and pricing on larger deals, as well as FX.

But I would say over the long-term, Alex, we are focused on driving ARPU expansion and expect to drive more expansion over time.

Great.

Thank you, guys.

Karl Keirstead, Deutsche Bank.

So maybe two for Ajay.

Ajay, the 9% to 10% operating margin guide for 2Q and for the full year 2018 are higher than we were modeling.

I just want to clarify, is that due entirely to this change in useful life of the hardware and maybe as well due to the revenue upside?

And then I've got a follow-up.

Thanks.

Yes.

Great to hear from you, Karl, and thank you for the question.

And yes, you're right.

So the primary driver of the raise on operating margins, or the guidance, rather, that we're giving on operating margin as a percentage of revenue is driven by the expansion of gross margins.

And that gross margin expansion, I'll just reiterate for one moment, was driven partially by a change in useful life.

And that change in useful life was a result of us getting more and more efficient with our infrastructure efforts.

And partially by a reduction in unit costs for certain hardware and higher utilization efficiencies.

So just overall higher efficiency at the cost of sales level and then higher revenue growth, and that was the flow through down to operating income.

Yes, understood.

That's helpful.

And then maybe, Ajay, a second one.

Just a nit here, but just in terms of FX impacts, you did flag out earlier that maybe billings got a bit of an FX tailwind.

I'm wondering if you could quantify what the FX tailwind was for both billings and assuming revenues as well, what it was there.

Yes.

Thanks for the question.

So for revenue in any given period, so quarter over quarter, FX has a relatively modest marginal impact on revenue, and that's really because we enter any given period with a whole lot of deferred revenue on our books that we recognize in that period.

And that deferred revenue is generated over the prior 12 months or so.

And when it -- as it pertains to billings, there was a bit of a tailwind in Q1 from FX, and that flows through to operating cash flow.

And that was, again, not a really meaningful number but in the single digits millions.

Got it, okay.

Wonderful.

Thank you very much.

Justin Post, Merrill Lynch.

I know one of the initiatives of the Company is to move up to team sales.

Just wondering how you are thinking about enterprise sales force and whether you might accelerate hiring there.

And then on the CapEx versus the capital leases, maybe talk about why you choose to use capital leases, what are the advantages to the Company and how you think about the cash flow around those?

Thank you.

Hi, it's Dennis.

Maybe I'll take the first part on enterprise.

So remember, 90% of our revenue comes from self-serve customers, customers who already -- for the most part are already basic users and they are responding to a product prompt or to an email or to in-product messaging to learn more about our paid plans, and then decide to pay us.

So, those sales do not involve a traditional sales force, and that's why our sales and marketing efficiency is considerably higher than many of our peers and others in SaaS.

Nearly all of our outbound sales are made to organizations that already have meaningful paid deployment.

We have a mix of teams.

If you recall the example from the Japanese advertising company, there were 16 seats purchased a couple years ago, completely self-serve.

And organizations typically will self-serve up to as many as 100 or a couple hundred seats before we will have a salesperson call into the account.

And then we use -- as I was saying in my remarks, the machine learning and data science to really target that sales force on the highest potential prospects.

And as well as the people within the organization who have buying authority, which might be in IT but it might not.

So, you think of our outbound sales force, they are not in every case going for the 10,000 seat deal right off of the bat.

They are typically getting small bites of usage within larger organizations over a period of time.

We have accounts that have gone from 20 seats to 30,000 seats over a period of 18 months, but they did that in many, many transactions.

So, we will continue to expand the outbound sales team, but that sales team -- the leads are fed primarily from the self-serve business and we see opportunity on both sides.

Yes, I just want to echo some of what Dennis said.

It's just -- highlight some of the unique elements of our model.

So success for us is not about, or not just about hiring a huge enterprise sales force, which would be the conventional approach.

Because of our self-serve model, which has (inaudible) is not a great example of that, but on top of that, we also have this viral and freemium element which drives scale and efficiency and is pretty unique.

And then, as Dennis said, we are able to have a targeted sales force that -- what we like to say -- they start that enterprise sales cycle marathon on mile 20 because there's already adoption in the company and the sales force is a lot more leveraged.

So add it all up and it's a much more efficient and scalable model.

This is Ajay.

I'll jump in on the question on capital leases and thank you for the question.

So the high level update there is that in the last quarter we added $25.5 million to our capital lease lines, and we made close to $30 million in payments against our capital lease obligations.

And as a result, our ending capital lease balance was $170 million in Q1, and that was down about $4.3 million from Q4.

And at a high level, while there may be some variances within a given quarter and between quarters, we expect to generally maintain our outstanding capital lease balance over the long-term, as capital lease repayments will roughly offset capital lease additions.

And to your question on how we choose to buy equipment versus leverage a capital lease, we receive favorable financing terms on our capital leases.

And we believe that for a portion of our infrastructure hardware, that they better match our capital investments with our cash inflows, and so that's why we leverage them.

And we of course continue to evaluate our capital allocation strategy on an ongoing basis.

Great.

Thanks, Ajay.

Thanks, Drew, and thanks, Dennis.

Thank you.

Mark Mahaney, RBC Capital Markets.

Two questions, please.

You added about 500,000 net new paying customers in the quarter.

Any color on where they came from?

Did they come from -- are they similar to the previous -- the net customer adds, net paid customer adds?

And secondly, you did start this brand advertising campaign in the March quarter.

Can you talk about learnings from that?

And do you plan to continue it, scale it up or scale it down?

Thank you.

Yes.

I can start with the question on paying users and then I'll pass it over to Dennis.

But yes, Mark, to answer your question, the mix was relatively similar.

And so, the primary driver of that paying user growth was conversions to both our individual and team plans.

And then we continue to drive growth with team expansion as well, but that was a secondary driver in the quarter.

I'll turn it over to Dennis.

Thanks for the question.

On brand, so we launched our brand campaign in Q4 of last year and that continued into Q1.

And what we're trying to do, many people know Dropbox as an individual user.

They may not be familiar with the value that we can bring in a business setting.

So the campaign was all about how we can unleash creative energy, particularly in organizations that are doing amazing things.

We are trying to drive awareness, consideration and intent for a couple of select audiences, particularly organizations that have large marketing, design and sales teams.

And we're seeing pretty good uplift from that.

We expect to continue to invest in our brand over time.

We think our brand is actually one of our key strengths, so expect to see more brand work from us over the course of the rest of the year.

Okay.

Thank you, Drew, thank you, Ajay.

Greg McDowell, JMP Securities.

One for Drew and one for Dennis.

Drew, I first wanted to specifically ask about the Dropbox custom-built global infrastructure.

Certainly moats have been a theme on some recent high profile earnings calls.

I just wanted to ask you what that infrastructure has done for the business in the past, what we should expect in the short term and how this helps Dropbox in the long-term, having your own global infrastructure?

And then one quick follow-up for Dennis.

Sure.

So thanks, Greg.

So we're really proud of our infrastructure; it's been a huge investment that's paid off for us in many ways.

And the most obvious place -- the most obvious return has been in the financials, right.

The margin expansion we've driven over the last couple years has -- a big part of that has been due to the efficiency we've been able to drive by operating and building our own infrastructure.

And so, there's certainly a sustained cost advantage that we continue to drive because -- both because we're able to ride the cost curves down directly, but then also we are able to tune our infrastructure for our specific workload.

So an example of that is most of the time when you're using Dropbox you're looking at some -- a document from the last couple days, not something from five years ago.

So being able to separate hot and cold storage is an example of something that we can do, or we can tune to a much greater degree than you can do with the public cloud, although they give you some tuning to that effect as well.

But when you look at it more on a 10-year timeline, we see big opportunities to improve the experience, the core product experience, and drive improvements in performance.

And as compute becomes more of our -- a bigger part of our workload and as machine intelligence becomes a more important part of our workload, then having that flexibility to control every layer of the stack is a big advantage.

And we think it's similar to what other tech companies have done.

Apple obsesses over vertical integration and getting -- and benefits a lot by being able to customize every element or every ingredient of that experience.

I don't know if I would draw that comparison that directly, but that's certainly some -- that flexibility and performance and ability to customize to our workload is something that we see as a bigger and bigger asset over time.

That's helpful, thank you.

And Dennis, one quick one for you.

I don't think we've talked too much about the international expansion opportunity yet, so I was just hoping you could give a little color.

I know you guys already have a very large international business, but anything you are seeing there or any new initiatives there to target international and companies that have a propensity to buy in international markets?

Thanks.

Yes.

Thanks, Greg.

So, yes, international is a big opportunity for us.

We already have close to half of our revenue coming from outside the United States, and we see significant growth in the markets that you would expect are starting to really come on strong in cloud.

So think about Western Europe, the UK, the Nordics in particular, Germany.

We're seeing quite a bit of strength in Japan and Australia as well.

I'm actually heading to Japan next week.

And we have over the last couple of years put teams on the ground in all those places except for the Nordics.

But we can serve all of Europe from our hub in Dublin, because most of our revenue still comes through that self-serve motion.

We don't need to have people in every country.

We do invest in teams where we see an outbound opportunity and we're starting to see significant traction in those markets that I described.

And it's really the benefits of this viral approach to growth where we have hundreds of millions of users who are familiar with Dropbox, they're bringing us into the workplace all around the world.

That's a global trend that's really just getting started in some parts of the world, so we think that that will be a source of growth for us for a long time to come.

Thank you.

Richard Davis, Canaccord.

So one of the questions that I wonder is how far away are we from Dropbox deploying -- and you kind of a little bit touched on it -- but deploying AI to deliver relevant content to users either proactively or at least on demand?

So basically what I'm thinking is to what extent could Dropbox actually enable organizations to realize the promise that you probably remember never arrived from those knowledge management systems back in the early 2000s?

So it feels like you could do that, so that's what that question is.

Thanks.

For sure.

So thanks, Richard.

We're really excited about machine intelligence, and we see that capability growing and growing over time.

And so, today that's already an area where we invest, as I mentioned.

Things like search, there are a lot of different signals that go into relevance.

And we have a great team tuning that and helping people find what they're looking for.

And over time, again, the way I think about it is just like think about the verbs or the tasks that we all have to do.

And instead of in a world where today you have to do a lot of filing things away or get inundated by stuff you don't want and then struggle to find the stuff that you do want, machine learning is going to be the antidote to that.

And so, I mentioned search, but then as we have added more activity feeds to our -- to the Dropbox experience and made that more part of our core home experience, helping surface what's relevant, we get a lot of benefit both from the data we have in Dropbox, as I said, but then also just the scale of our user base.

So that feedback loop, it tightens a lot faster and more effectively because of the scale we're operating.

But we want to get to a world where you open up your laptop or your phone and only the important stuff shows up.

And so, we think a lot about how do we design a calmer and more organized and much more effective working environment and how do we make the experience of using technology at work a lot more seamless.

Can you peer into the documents yet, or is that too hard to do?

In other words to tag the stuff inside the document, [or] look at just the title?

Well, for sure in search we have full tech search and there's a lot of possibility to auto-organize things for people.

And so, in new products like Dropbox Paper, all of that content lives in Dropbox and is indexed just as the files are.

And so, for sure we can -- we use not just the metadata, but when people are actively searching for something we can look in the file contents as well.

Got it.

Thank you very much.

Sarah Hindlian, Macquarie.

I'll add my congratulations on your inaugural quarter.

A question first for you, Drew, and then I have a follow-up for Dennis as well.

And I apologize if you hit on any of these.

Maybe we can go into them in a little bit more detail, but free cash flow was really strong this period and the balance sheet looks like it's in outstanding shape.

So one thing I'd love to hear from you, Drew, is how you are thinking about your strategic priorities and what you're really ranking in terms of areas you are particularly interested in on the platform today.

Sure.

Thanks, Sarah.

As you alluded to, some of the good news is that we have been cash flow positive for a long time.

And so, we didn't need to go public to raise money.

And so, we certainly think it's a good thing to have a healthy balance sheet, but we can be opportunistic.

And so, we'll use the proceeds to continue investing in growth and in the product portfolio generally against some of the dimensions I talked about, both -- or all of improving the core product experience, moving into adjacent categories and doing more for our users, tuning our product driven conversion engine and machine learning in our infrastructure.

All right, terrific.

And just a follow-up for you, Dennis.

I know you've talked a little bit today in particular on all the efforts going on on the business side, and I think it's really astonishing to us -- as we do more work around the Company, we generally think of a competitor of yours as somebody that really specializes in some regulated industries like healthcare or finance.

But we're astonished by the number of individual -- let's say, for example, medical professionals that are using Dropbox.

So Dennis, I guess as I look out at the landscape, I'm wondering when and if and where you feel the need, or if you even do, feel the need to focus on any sort of vertical specific strategy as you reverse mine these users into the team product?

Or if you are just still a ways away from that.

Today we have Dropbox business deployments in about half of the Fortune 500, so we have a pretty broad footprint already.

And we have paying users in over 90% of them.

So we already have a foothold in most major industries.

The industries that we do well -- SKU well in today include media, technology, manufacturing, construction -- any industry where there's a large sales force, a remote workforce or people managing design files.

Now, that said, the regulated industries, like you said, we see plenty of doctors, people in financial institutions, that are choosing to use Dropbox because the tools that they are being provided just simply don't work for what they're trying to do.

And often physicians or researchers in particular are collaborating around very, very large files.

So we have a number of very large research institutions, one medium-sized one that we referred to on our roadshow is Gladstone Industries that use Dropbox as their system of record.

And Dropbox is fully integrated into how they're doing research.

We have organizations in financial services, in insurance who are using Dropbox to help process auto claims, for example, by taking records on site of auto accidents and so forth.

So, it's not -- we don't purposely set out to go after those industries, but where we see a signal, where we have usage, where we have paid usage, we certainly will have a sales rep call.

And most of that usage actually is just coming to us through our self-serve engine.

All right, thank you very much.

Appreciate it.

Very helpful, and congratulations.

Rob Owens, KeyBanc Capital Markets.

I guess my question really revolves around the total base of users.

And I don't know if you disclosed it or not, but given some of the brand campaigns and the marketing awareness that you're spending on and generating, was the strength in paid users a function of incremental increased conversion rates?

Or are you seeing roughly the same conversion rates on a larger base at this point?

Hey, Rob, thanks.

So we continue to grow the top of the funnel even though we don't fixate on our registered user number, but we certainly want everybody to have an understanding of the scale where we're operating.

And so, for sure we get conversions both from those -- from folks that joined in the last year or who have joined recently, but we also spend a lot of time thinking about the hundreds of millions of monetizable users that we already have.

Because we already have -- we see ourselves as already having reached or registered a meaningful portion of the knowledge workers or our target audience, or knowledge workers on the planet, really.

And so, we are -- we focus on -- certainly top of funnel is part of it, but we also think about how do we take more of those users and bring them along the journey faster and more effectively from free use to maybe an individual plan to a business plan to -- or a self-serve business plan than a wall-to-wall deployment.

Yes, and I would just add to that, Rob, briefly -- it's really reflective of growth across our revenue channels, as Drew mentioned.

So conversions, upgrades, expansions within companies, also business trials, direct-to-paid and outbound.

Right.

But more of the revenue growth at this point is coming from incremental paid users than it is from ARPU.

Yes.

So, is there a pivot point that it's going to be more ARPU driven?

Is that what I'm to understand?

Or more of the same moving forward based on your commentary?

So both levers will be important to us moving forward, both paying user growth and ARPU growth.

But I would view paying user growth as continuing to be the primary driver of revenue growth for the Company.

Great, thanks.

All right.

So (technical difficulty) again, everyone, for joining us today.

We really appreciate your support and look forward to speaking with you again next quarter.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect and have a wonderful day.