Dropbox Inc (DBX) 2018 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for joining Dropbox' Fourth Quarter and Fiscal 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' website following this call.

I will now hand the call over to Darren Yip from Dropbox' Investor Relations team.

Please go ahead.

Thank you.

Good afternoon, and welcome to Dropbox' Fourth Quarter and Fiscal 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 Form 10-Q for the quarter ended September 30, 2018, as well as the risk factors that will be included in our Form 10-K for the year ended December 31, 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 law.

Our discussion today will include non-GAAP financial measures.

These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results.

A reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and may also be found in the supplemental investor materials posted on our Investor Relations website at investors.dropbox.com.

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

Drew?

Thanks, Darren.

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

On the call with me is Ajay Vashee, our Chief Financial Officer; and Yamini Rangan, our Chief Customer Officer, will also join us during Q&A.

Today, I'll recap our achievements and performance in 2018 and highlight the momentum we have going into 2019.

I'll then cover our business and product announcements from Q4 and provide you with an update on our ecosystem and partnerships.

Ajay will review our financial results and provide guidance for Q1 and fiscal 2019.

2018 was a strong year for Dropbox.

We generated $1.4 billion in revenue and ended the year with 12.7 million paying users and over 400,000 Dropbox Business teams.

Our continued innovation and partner integrations also helped drive the adoption of our premium plans and increased ARPU.

Last year, we continued to enhance the Dropbox experience for our users, teams and admins.

We launched new mobile apps for Dropbox and Paper and revamped the user interface for Showcase to facilitate a more seamless sharing and collaboration experience for our users.

We introduced machine intelligence capabilities to our platform through our DBXi initiative, improving our search engine architecture and making images searchable within Dropbox using our new optical character recognition technology.

We also expanded our open ecosystem and deepened our partnerships with Microsoft, Google, Salesforce, Adobe and Zoom.

In addition, we continue to optimize our conversion and upsell growth engines by leveraging our advanced data science models.

We were also one of the first companies to deploy SMR technology at scale and grew our extensive network of points of presence around the world.

Our go-to-market efficiencies and infrastructure investments allowed us to expand gross margins to new highs and deliver record free cash flow.

In our first fiscal year as a public company, our results reflect the strength of our global collaboration platform, our efficient business model and our operational discipline.

We're operating at a scale that few SaaS companies have achieved, and we're delivering a healthy balance of growth and profitability.

We're focused on building a platform for people to come together to collaborate on their content.

And in 2019, we're already off to a great start with our acquisition of HelloSign a few weeks ago.

HelloSign has built a thriving business focused on eSignature and document workflow with over 80,000 customers.

Millions of people already use Dropbox as a place to collaborate on their most important content.

Together, we can deliver an even better experience to Dropbox users, simplify their workflows and expand the markets we serve.

Signing documents and completing forms are an important part of everyday life from opening an investment account or buying an apartment to signing a major new customer or hiring a new employee.

But even today, millions of people still rely on legacy pen and paper to complete these tasks, resulting in an inefficient and fragmented experience.

HelloSign offers user-friendly eSignature and online fax products through HelloSign and HelloFax as well as fully customizable document workflow solutions through HelloWorks and HelloSign API, improving business processes while also helping reduce time and cost to get things done.

We're excited to welcome the HelloSign team to Dropbox.

Joseph and Neal, HelloSign's CEO and CTO, got their start at Y Combinator just like we did.

And with their COO, who joined in early 2016 after serving as the SVP of Marketing and GM of Enterprise at Box, we can't wait to begin working together.

Turning to Q4.

We continue to deliver a number of innovations that make the Dropbox experience even better for our users, teams and admins.

First is video commenting.

We observed that teams collaborating on video files needed a better way to provide actionable feedback.

Previously, users were forced to manually log timestamps for each of their comments, which interrupted their flow as they toggled back and forth between videos and their notes.

To address this pain point, we launched time-coded video commenting, which offers a seamless way for users to provide input on video files without leaving the Dropbox platform.

Comments and annotations are surfaced at a specific point in time, allowing viewers to clearly interpret feedback.

Next is the admin experience.

We're kicking off an initiative to provide customers with a new layer of visibility, control and flexibility in managing their Dropbox deployments, and we're excited to announce multi-team admin, our first step in this process.

Multi-team admin enables IT to more easily manage multiple Dropbox Business accounts within their organization while allowing individual teams to retain personalized settings.

We're making a concerted effort to offer admins the capabilities they need to securely manage and grow their Dropbox employments while enabling users to work with flexibility and autonomy.

By making it easier for customers to onboard new employees, multi-team admin is an important step in reducing the friction in account expansion.

Now let's move onto the infrastructure that powers our platform.

We're always innovating across our hardware and software infrastructure stack to improve the customer experience and reduce costs.

After analyzing usage patterns, we recently developed a new storage tier that allows us to store less frequently accessed data at lower cost.

By modifying how we separate content into storage blocks and optimizing how it's replicated, this new storage tier reduces cost while maintaining the high levels of reliability and durability our customers have come to expect from Dropbox.

Moreover, this offer-based innovation doesn't require us to deploy incremental infrastructure as it runs on the same internal network and SMR drives as our primary storage system.

We expect this new storage tier to reduce our storage costs by 10% to 15%, which we plan to reinvest into international expansion and compute infrastructure.

Switching gears to our ecosystem.

We continue to forge partnerships that position Dropbox at the center of our users' workflows.

We're firm believers in the power of integrations, and one of our most important differentiators is that we're a uniquely open and interoperable platform.

Last quarter, we launched Dropbox Extensions so users can initiate and manage workflow with category-leading partner applications from within Dropbox.

Since then, our customers have started using them to sign, edit, annotate and fax business-critical documents, and we're already starting to curate our next set of categories and partners for new extensions.

This quarter, we also announced new partnerships with education software tools that power collaboration for the institutions that use Dropbox today.

These customers use Dropbox to keep their work secure and fuel research and innovation across faculty and students worldwide.

To better support our edu community, we announced a number of integrations over the past few months with partners like Turnitin, Pronto and WeVideo.

The edu vertical is important because it gives us the opportunity to evangelize our product with the next generation of knowledge workers.

Each year, students graduate from universities and bring Dropbox with them into the workforce, while a new class of incoming students is introduced to our platform.

In summary, Q4 was another strong quarter that capped off a great 2018.

We launched new platform features like video commenting and multi-team admin to enhance the experience for our users, teams and admins and strengthen the efficiency of our core infrastructure.

And our partnerships with education software tools are seeding future growth.

I'll now turn it over to Ajay, our CFO, to walk through our financial results.

Thank you, Drew.

Our Q4 results continue to demonstrate our strong execution and focus on delivering a healthy balance of top line growth and free cash flow generation.

Total revenue for the quarter was up 23% year-over-year to $376 million, driven by an increase in total paying users and ARPU expansion.

We ended Q4 with 12.7 million paying users, up from 12.3 million at the end of Q3.

ARPU was $119.61 in the quarter, up 5% from $113.39 a year ago.

The year-over-year ARPU expansion was primarily driven by strong adoption of our premium Professional and Advanced plans by new paying users.

We also continued to see some tailwinds from teams choosing to remain on our Advanced plan following the expiration of their grandfathering period.

As a reminder, our strategy is to drive revenue growth through a combination of paying user conversion and ARPU expansion.

Our continued growth in ARPU reflects our strategy to methodically convert our highest value users to drive sustainable monetization and retention.

In Q4, we had a number of wins across a range of verticals, including transportation, insurance and health care.

For example, we're excited to announce a new enterprise deployment with Cabify, the leading Spanish ride-hailing service.

Cabify has operations in 11 countries and is rapidly growing its presence in the LatAm market.

Their team has grown quickly over the past year, and the company needed a platform that would allow them to securely collaborate with external partners.

Cabify selected Dropbox due to our best-in-breed collaboration tools, seamless sharing capabilities and strong organic adoption of our platform within their product teams.

One of the largest automobile services and insurance organizations in the country also chose Dropbox in Q4.

The customer will roll out our Enterprise plan after evaluating a number of tools to improve internal and external collaboration on large files.

Dropbox was chosen as the preferred vendor due to ease of use and our open APIs, which will enable integrations into the organization's workflows.

Within the claims team, Dropbox will replace email for the exchange of large files between agents and the organization's members.

In addition, Nationwide Children's Hospital recently expanded its team deployment after first adopting Dropbox in 2016.

Our ability to provide a secure HIPAA-compliant workflow solution was key to Nationwide's continued partnership with Dropbox.

Before I move on to the P&L, I want to note that, unless otherwise indicated, all income statement measures that follow are non-GAAP and excludes stock-based compensation.

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 in the supplemental investor materials posted on our Investor Relations website.

Gross margin for the quarter was 76%, an increase of 5 percentage points compared to the fourth quarter of 2017.

The increase in gross margin was driven by unit cost efficiency gains with our infrastructure hardware, including lower depreciation as a share of revenue, which was partially offset by higher headcount-related expenses.

Moving to operating expenses.

Fourth quarter R&D expense was $108 million or 29% of revenue compared to 25% in Q4 a year ago.

The increase as a percentage of revenue was primarily driven by higher headcount and investments in new product development and testing.

In addition, you may recall that in June of 2018, we took possession of our new corporate headquarters and began recognizing rent expense associated with that property.

Until we occupy the new property later this year, we will incur rent expense for both our existing and new headquarters.

This overlapping rent impacts each of our expense categories, but since the highest proportion of our headcount is in R&D, it carries the largest percentage of allocated overhead.

S&M expense was $94 million in the fourth quarter or 25% of revenue compared to 30% in Q4 a year ago.

The decreased spend was due to lower marketing expenses relative to Q4 of 2017 when we initiated our global brand campaign.

G&A expense was $41 million or 11% of revenue and 1 point lower than our G&A expense as a percentage of revenue in the prior year.

The decrease was the result of lower nonincome-based taxes partially offset by nominally higher outside services spend.

Taken together, we earned $42 million in operating profit in the fourth quarter.

This translates to an 11% operating margin, which is an 8 percentage point improvement from Q4 of 2017.

This operating margin expansion was driven by continued gross margin improvement paired with lower S&M spend in the period.

Net income for the quarter was $42 million, up from $11 million a year ago.

Diluted EPS was $0.10 per share, up from $0.03 per share in Q4 of 2017 based on 416 million diluted weighted average shares outstanding as of Q4.

Moving on to cash balance and cash flow.

We ended Q4 with cash and short-term investments of nearly $1.1 billion.

Cash flow from operations was $124 million in the quarter.

Capital expenditures were $35 million, yielding free cash flow of $88 million or 23% of revenue.

CapEx in Q4 included $28 million of spend on our new headquarters.

Excluding this spend, free cash flow would have been $116 million or 30% of revenue.

We did not receive any tenant improvement allowance reimbursements for our new headquarters from our landlord during the quarter.

In Q4, we also had $26 million of additions to our capital lease lines for data center equipment.

We continue to expect additions to capital lease lines to be high single digits as a percentage of revenue going forward.

Let's move on to our full year results.

Total revenue for 2018 was $1.392 billion, representing 26% year-over-year growth.

Gross margin was 75%, up 7 percentage points from the prior year, and our operating margin was 12%, also up 7 percentage points from 2017.

Cash flow from operations was $425 million in 2018.

Capital expenditures were $63 million, yielding free cash flow of $362 million or 26% of revenue.

CapEx in 2018 included $33 million of spend on our new headquarters.

Excluding this spend, free cash flow would have been $395 million or 28% of revenue.

We did not receive any tenant improvement allowance reimbursements for our new headquarters from our landlord during 2018.

In 2018, we also had $99 million of additions to our capital lease lines for data center equipment.

Before I walk through our guidance for 2019, I'd like to reiterate how excited we are to welcome the HelloSign team to Dropbox.

Given that we closed our acquisition of HelloSign a few weeks ago, our guidance will include their projected business contribution for Q1 and the year.

I want to share some details about HelloSign's financial performance to help provide context on how they'll contribute to our results.

In calendar 2018, HelloSign's revenue was approximately $20 million.

In 2019, we don't expect HelloSign's contribution to Dropbox' top line to be material because, as part of purchase accounting guidelines, we will write down a significant portion of HelloSign's deferred revenue.

This write-down will reduce the amount of revenue we recognize from the business throughout the year.

In addition, based on when we closed the acquisition, we expect our financials to reflect a partial year of HelloSign's 2019 revenue.

Longer term, we're excited about the opportunity we have to drive revenue synergies together.

On a go-forward basis, we are not planning to provide explicit disclosures around HelloSign's business performance.

We intend to report our financial results and key metrics as a combined entity.

Now let's turn to our guidance.

Please note that our non-GAAP operating margins for the upcoming quarter and year exclude the impact of stock-based compensation as well as certain expenses related to the acquisition of HelloSign.

Additional detail may be found in the supplemental investor materials posted on our Investor Relations website.

With that in mind, for the first quarter of 2019, we expect revenue to be in the range of $379 million to $382 million, non-GAAP operating margin to be in the range of 7% to 8% and diluted weighted average shares outstanding to be in the range of 418 million to 423 million based on our trailing 30-day average share price.

I would like to remind everyone that in the first quarter of each year, there is seasonality to revenue because there are fewer days in the quarter as well as seasonality to operating margins and free cash flow due to the reset of payroll taxes and the payout of year-end bonuses.

Our operating margin guidance also incorporates integration and synergy investments related to HelloSign.

Turning to the full year 2019.

We expect revenue to be in the range of $1.627 billion to $1.642 billion, fiscal 2019 gross margin to be consistent with 2018 though slightly lower through the first 2 quarters of the year as we open a new data center to support continued growth, non-GAAP operating margin to be in a range of 10.5% to 11.5% and free cash flow to be in the range of $375 million to $385 million.

This range includes onetime spend related to the build-out of our new corporate headquarters.

Excluding this spend, free cash flow would be $445 million to $465 million.

Finally, we expect 2019 fully diluted weighted average shares outstanding to be in the range of 420 million to 425 million based on our trailing 30-day average share price.

In conclusion, I want to reiterate our ongoing commitment to balancing growth and profitability.

We're excited about the opportunities ahead with HelloSign, and while we will be investing in the business this year to unlock those synergies, we remain on track to achieve our long-term margin targets.

On this note, we expect the impact from HelloSign-related investments as well as our onetime headquarter spend to decrease in the second half of the year and to resume our trajectory of year-over-year operating margin expansion by the end of 2019.

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

Thank you, Ajay.

We're focused on continuing to expand our platform by bringing together content and all the communication and coordination around it.

Our team is committed to developing products our users love, and we continue to expand our open ecosystem to reduce the friction between the tools people use to work.

We're really pleased with the progress we're making, and our results help validate that Dropbox is becoming the preferred collaboration platform for organizations of all sizes across all industries.

On behalf of our management team, I'd like to take a moment to thank our users, partners and the entire Dropbox team for making 2018 such an incredible year.

I couldn't be more proud of everything we've accomplished, and I'm looking forward to another great year ahead in 2019.

With that, I'd like to invite Yamini, our Chief Customer Officer, to join Ajay and me for Q&A.

As a reminder, Yamini oversees our customer and partner focus functions, including sales, marketing and business development.

Operator?

(Operator Instructions) And our first question comes from the line of John DiFucci with Jefferies.

I guess, the first question is for Ajay, and then I have a follow-up for Drew.

So Ajay, you just gave the guidance for 2019 margins, and they're -- we get there's a lot of give and takes here, a lower margin due to HelloSign integration, but you also get some economies of scale that would, I would think, would offset that.

But you're guiding to margins being lower for the year.

And I just want to know, is there something else in there?

Are you increasing investment beyond the economies of scale in sales and marketing?

Or is there something else happening in that?

Sure.

This is Ajay.

Happy to take that part of the question.

And to talk at a high level about our margin philosophy for the year, I'd reiterate a couple of points that we made earlier on.

One, our Q1 operating margin is seasonally lower each year, and that's really due to higher employee-related costs like the reset of payroll taxes.

This is something that we see every year and we've seen every year historically.

And at their current run rate, HelloSign would be roughly 1 point dilutive to operating income for us.

We're also reserving some flexibility in our guidance to make integration and synergy investments over the course of the year.

I will say, looking ahead, we expect the impact from HelloSign-related investments as well as the overlapping rent expense that I talked to for our existing and new corporate headquarters to decrease in the second half of the year and for us to resume our trajectory of year-over-year operating margin expansion as we exit 2019.

Okay.

So it sounds like that rent overlap is having an effect, too, here, on the year-over-year impact.

Okay.

Yes, yes.

Okay.

And then, Drew, a question on HelloSign.

So we've heard you talk along the way, and Dropbox has evolved as a company from sort of like file, sync and share to collaboration to incremental functionality for your customers.

And this one actually sort of pulls in the workflow in a very meaningful way.

Certainly, eSignature, too, and workflow.

But I'm just trying to wonder, is there something eSignature and workflow stands on its own?

It can stand on its own.

But as part of Dropbox, it's -- can we be thinking about this as it becomes even greater than just that simple functionality once it's firmly integrated with Dropbox?

And then the second part to that question is do you plan to charge this separately or will it be included in some SKUs or both?

Thanks.

And I think you're alluding to and highlighting some of the reasons why we're excited.

And so we see a lot of opportunity with HelloSign, both in their existing business and products and where this can go in the future.

And we felt that by -- we had a great opportunity to combine their product and business with our scale and our platform and our distribution and all the content that already exists in Dropbox and add a lot of value and certainly a lot more value beyond the basics of storing or access or sharing.

So we have a lot of surface area in our product where there's opportunities to integrate.

It's still pretty early.

The transaction closed a couple of weeks ago, but we certainly see ourselves moving up the stack in meaningful ways and our customers turning to us for more and more over time in -- both with our core product functionality and through products that we buy like HelloSign companies and our partnerships.

So those are a lot of the reasons why we're excited about the opportunity here, and you'll hear more about that in the coming quarters.

And the second part is do we plan to charge separately.

The short answer is yes.

We -- and more broadly, our intention is for HelloSign to remain a stand-alone business.

We think there are a lot of benefits to that.

And as we think about our strategy to expand ARPU overall, sometimes it will be separate SKUs like HelloSign or like this HelloSign functionality, and sometimes, it'll be features like Showcase or Paper or Smart Sync that go in our higher -- or, well, Showcase and Smart Sync are examples of features that go in our higher tier plans in our business plan.

So both levers are important for ARPU growth.

And our next question comes from the line of Mark Murphy with JPMorgan.

Drew, when you consider the scale of the opportunity here with 12.7 million paying users representing only a pretty small fraction of the 300 million high-value targets, which are using the free version of Dropbox.

What do you think is the gating factor to growing that paid user base a little faster than this 15% trajectory if you wanted to do that?

And Ajay, along that thought line, if the product strategy is with HelloSign and Extensions and Paper, et cetera, if all of this continues to succeed, do you think it would enable you to step up the cadence of the paying user adds above this 400,000 per quarter level?

Or do you think that's more likely to help you kind of sustain this level?

Okay.

Well, thanks, Mark.

So the -- we certainly believe there's a ton of opportunity in front of us.

And for us, it starts with -- we're solving universal and growing problem, and we think that we're in the early innings of -- as far as adoption.

And we continue to see a ton of expansion opportunity, both in terms of growing subscriber base and driving adoption of higher-value plans and in terms of expanding our TAM by addressing new use cases, and HelloSign's a good example of that.

Yes.

And to answer the second part of your question, Mark, we don't formally guide to paying users but certainly happy to provide some context.

Our strategy is to drive revenue growth through a combination of paying user conversion and ARPU expansion.

And as I've mentioned in the past, in any given quarter, one of these levers may outpace the other.

Really depends on the initiatives that we're deploying in that period.

So I wouldn't necessarily index to a run rate on either dimension.

Looking ahead, I think you'll see us continue to focus on driving high-value conversions.

We want to convert users with the best LTV profile, and we've been successful with this strategy, and that will be reflected in continued strength and conversion volume as well as growing ARPU.

And to answer perhaps your question a bit more directly, our philosophy is that as we do more for our users, we think our platform will be valuable to more and more people over time.

Okay.

Lastly, just as a quick follow-up with respect to the delays in deferred revenue numbers, is it possible to normalize that for this quarter at all for FX and duration impacts if either of those were material?

Sure, that's a great question.

And I'll give a little bit of context and background there for those on the call.

And as I've mentioned previously, while billings are related to revenue growth for us, they're not consistently predictive of revenue for us.

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

And an example is that additions to our deferred revenue balance are highly sensitive to the mix between monthly and annual subscribers.

So small changes in mix shift in a given period can skew deferred revenue, and that can result in deviations between billings and revenue.

We've certainly seen this in prior periods as well as the last one, and FX can also impact billings in a meaningful way as billings are more sensitive to FX movements relative to revenue.

So to answer your question, Mark, normalized for FX, our billings growth in Q4 would have been actually very consistent with Q3.

And our next question comes from the line of Richard Davis with Canaccord.

Great.

Maybe a product question.

So one of the things I hear from salespeople, and you guys have kind of touched on this a little bit, but for salespeople, it's kind of a pain to find the right content at the right time, right?

So could Dropbox help people, sales or otherwise, kind of get that content at the right time?

I mean it's -- maybe it's intelligence.

Maybe it's something like that.

Is that something that makes sense for you guys?

Absolutely.

And I would say there's all kinds of things that people want to do with their content or that even salespeople want to do with their content, and certainly, search and access is an important part of that.

We've talked about some of the investments we've been making in machine intelligence over the last couple quarters.

And certainly helping surface what's most relevant to you, helping you navigate large quantities of content, we're incredibly well positioned to address those use cases.

And I think some of what we've also talked about this quarter with HelloSign and some of the improvements we've made with Showcase are examples of doing even more with content.

And you think about what salespeople need to do as far as getting contracts signed or being able to present a proposal in a branded way, we're -- over the years, we've done more and more to help with all different kinds of use cases around content.

We expect to expand into adjacencies, both with first-party products and through our partners.

Got it.

And just real quickly.

You've done a lot of architecture changes and improvements, et cetera, and you've talked about it on the call.

So is it logical for us to think of this as kind of a continuing kind of improvement on that front?

There shouldn't -- we're not like running out of runway there in terms of cost savings, right?

This is Ajay.

I can answer that at a high level.

I think we have a very strong infrastructure team, and investing in infrastructure has been important to us and will continue to be important to us.

So certainly, we're focused on delivering the next wave of innovation across that hardware and software stack.

Things like SMR, things like our new storage tier are good examples of that, but that's -- it's a priority area for us in 2019 and beyond.

And then I'd say we're investing both in cost and efficiency and we're investing in -- or we're making the kinds of foundational investments you need in compute and machine learning to be -- to get ready for the whole next generation of innovation.

And our next question comes from the line of Mark Mahaney with RBC Capital Markets.

It's Zachary Schwartzman on for Mark.

Drew, Yamini, which feature this year gained the most traction amongst your customers in 2018?

Was it Paper, Showcase, video commenting or perhaps something else?

Just trying to have a better idea of how the product improvements have resonated with your customers and specifically, which products gained the strongest incremental adoption through the year.

Well -- so yes, we look at this from a couple different lenses.

So I'd say from a conversion standpoint, the adoption of our Advanced SKU has been great and the higher tier plans, and that's been pivotal in the ARPU growth that you've seen.

And then from a more strategic standpoint and from an engagement standpoint, we're really proud of the progress we've been making with our integrations and our ecosystem.

So last year, we announced partnerships with Google and Salesforce and Zoom.

We're really excited about the road maps for all those and some programmatic things like Dropbox Extensions, where we have a whole open-partner ecosystem.

And so when we look at this problem that our customers have around how do they tie together all the world's different office suites and SaaS tools and the kind of mayhem that they're experiencing, they're turning to Dropbox more and more as the company and the product to tie all that together.

So those are -- that's thematically a huge area of investment for us and a big differentiator against the incumbents.

And our next question comes from the line of Heather Bellini with Goldman Sachs.

Apologize for the background noise.

I had a couple of questions.

The first, I was wondering if you could talk about kind of churn at the Enterprise level, if you noticed any changes there this quarter, even what you could share with us over the course of the year.

And then did you see any changes on the consumer level?

And then I had a follow-up question on Paper.

Sure.

Thanks, Heather.

I can take the question on the churn.

Overall, we are seeing very consistent business metrics, both from retention of revenue perspective as well as the number of subscribers.

We do a number of initiatives at any given quarter to drive the engagement of our users; and with those, we see consistent metrics.

So no change in churn metrics at all.

And then my follow-up question was just about Paper, and I guess maybe this is for Drew.

How are you thinking about, over time, selling Paper as kind of a higher-priced offering for higher-end functionality, right?

As you guys continue to evolve that product, could we see that be a premium SKU?

And kind of what type of functionality do you need to see to be able to do that, right, to be able to kind of then start migrating customers to that additional functionality?

Sure, yes.

Great question.

So we think about -- when I think about ARPU growth and creating more values -- or creating more value for our customers, there are a few different levers.

And so there's -- there are more direct levers like Showcase and Smart Sync, which are only available on our higher-tier plans and so those drive monetization pretty directly because people are paying for higher-priced plans and then indirect monetization and driving lifetime value.

So Paper is an example of the latter, where it's part of the core Dropbox experience, and we think that the engagement that it can drive is strategic.

And we noticed even early on that customers that adopt Paper convert at twice the rate or convert to Dropbox Business at twice the rate and they retain better.

So products like Paper and other products that might be part of the free product or part of lower-tier plans drive engagement, which drives retention, which drives lifetime value.

So we certainly have an eye towards monetization through everything we do, and we want to balance engagement and monetization.

And our next question comes from the line of Justin Post with Merrill Lynch.

Maybe you can just give me a data point on how your headcount has grown over the last year for the sales team, where that is right now and how much changed year-over-year.

And then what are your key go-to-market initiatives as you look out to 2019?

Great.

I can take the question in terms of the headcount as well as the go-to-market initiatives.

So on the headcount, as you know, we have a very unique go-to-market strategy where we start with viral adoption, land with self-serve and then continue to use the outbound team as a very targeted team.

So the areas where we are growing from a sales and marketing perspective are very targeted where we see deployments growing and therefore leveraging.

So we're investing in sales headcount in very specific countries as well as expanding for customer success.

Going back to the point that Drew was making, one of the key things for us is really driving engagement, so we invest in those areas from a sales perspective.

As far as go-to-market initiatives are concerned, well, the first one is around the conversion engine.

We have one of the largest conversion engines at scale, which is productized, so we continue to make investments on the conversion side.

The second area of investment is around team expansion.

For us, as you probably heard, we went to 400,000 teams in the last year, and that is a big opportunity for us.

So we'll continue to invest in acquiring new teams as well as expanding within the current teams.

And then the final area, of course, that we'll continue to make investment is HelloSign integration and getting the product in the hands of our outbound sales teams.

And our next question comes from the line of Sarah Hindlian with Macquarie.

Drew, I want to start with you.

When you look at the partnership agreements that you have coming online this year, Zoom, a number of others, how do you think about those either between drivers of higher-priced plans or ARPU or as a way to drive better paid user conversion?

And then I had a quick follow-up for Yamini.

Yamini, when you're looking at your initiatives on paid conversion, in particular, how do you feel about the shape of how you're going after the enterprise market in particular, as you're starting to see more team plan adoption?

Great.

So I'll start with just our partnerships and ecosystem.

We see this, our ecosystem, as a really valuable asset, and it contributes both to differentiating the product experience and to engagement and lifetime value for reasons that are similar to some of the other products that I mentioned.

But we see that our status of having an open ecosystem is a big advantage and differentiator from the office suites or the bundles because our users love having choice, and the deep integrations that we have create a more seamless and integrated experience overall, which both drives engagement, so people are interacting more at Dropbox because there's a lot more that they can do from within the surfaces of our product, and then we find that it drives retention, so -- in a number of ways.

So one is just when we look at -- with 75% of Dropbox Business teams have linked to a third-party application and those teams retain at higher rates.

And second, the integrations themselves can be a differentiated thing, where it's something that's kind of hard to migrate or it's a reason for teams to stay on our platform.

So we think that it's both -- it both drives near-term business metrics largely through lifetime value, and it's a big strategic advantage in the long run.

And Sarah, on the second part of your question on paid conversion for GDM, the way we think about this is really taking our customers on a journey.

They start as a free user.

We use the conversion engine to get them exposed to higher-value features and products, and from there on, we are able to get them to use us in businesses.

And that is the starting point, so that's where you begin to see the team acquisition.

And then what happens from there is that we leverage onboarding education and prompts to really help our users share and collaborate much more, and that drives through more conversion of paid users.

And as we've talked before, one of the unique ways in which we actually approach the conversion is also leveraging data science algorithms.

We are able to really look at where the deployments are growing and therefore, have outbound sales teams approach those particular deployments and continue that expansion.

So the whole customer journey from basic to self-serve land to very data-driven expansion is working, and we'll continue to use that model to scale forward.

And our next question comes from the line of Karl Keirstead with Deutsche Bank.

Two for Ajay.

First, Ajay, back to FX, you've said on the call in the past that FX hits to DR and billings today translates to a revenue hit tomorrow as DR amortizes into the reported revenue line.

So when I look at your 2019 revenue guide of 17%, 18%, I'm just wondering whether there's an FX hit to that that's worth calling out.

Sure, a great question, Karl.

I would say our guidance for revenue reflects the current FX rate environment.

So certainly, the trends that we're seeing materialize in billings and deferred revenue are trends that you're seeing in the revenue guidance that we've issued, and we'll continue to update that guidance over the course of the year.

Quarter-to-quarter, as I mentioned in the past and you know, movements in FX rates have a smaller impact on revenue for us just given how that revenue recognition model works.

And just a note on our guidance as well, the 17% to 18% for the year I mentioned earlier, that contribution from HelloSign is likely to be relatively immaterial just due to purchase accounting guidelines.

We'll write down a significant portion of their deferred revenue as we integrate them, and then we're also recognizing a partial year revenue from HelloSign based on when we close that acquisition.

A little more color there that I think would be helpful, as a result, we expect them to contribute just over 1 point of revenue growth this year.

And longer term, certainly, very excited about the opportunity we have to drive revenue synergies together, and we're structuring our business for consistent and compounding growth as we exit 2019 into 2020 and beyond.

And then my second question, if we can just go back to your 2019 gross margin guidance, if I heard you correctly, you said flat with 2018 after, I think, a 700-plus basis point increase in gross margins in 2018.

It seems that you still got a lot of room left on the unit cost efficiency gains rolling out the next-gen storage tech.

So obviously, there are some offsetting areas of investment.

I think Drew mentioned in his comments international and some more data center investments.

But could you elaborate a little bit?

One would think you'd be getting an uplift in gross margins in 2019 as well.

Sure, I can just reiterate a bit of what Drew said, then provide some more color.

So this new storage tier that we have rolled out is really a pretty exciting example of the continued innovation that we continue to deliver across our hardware and software infrastructure stack, certainly, one of the many benefits we get from managing that stack ourselves, and that new storage tier is going to allow us to reduce unit cost for less frequently accessed data by roughly 10% to 15%.

Those savings are ones that we plan to reinvest into international expansion and compute infrastructure.

And these changes, along with our rollout of other innovations like SMR, have been factored into our view of gross margin for the year and longer term.

And then to come back to what I had mentioned earlier about margins being slightly lower through the first 2 quarters of the year, that's relative to what we delivered in Q4.

You can think about that being roughly 1 point lower than what we delivered in Q4 through Q1 and Q2.

But then certainly, margins, Karl, are starting to ramp up again and expand beyond what we've delivered in the past in the back half of the year.

And our next question comes from the line of Alex Zukin with Piper Jaffray.

This is Scott Wilson on for Alex.

Maybe my first question, I think this is probably just another way of asking what some other people have gotten at.

But you added 1.7 million net paid users for the year, which is down from 2.2 million, 2.3 million the last couple of years.

I'm curious how you view those results, if there might be any headwinds worth explaining, maybe increased churn related to un-grandfathering or anything and if there's the potential to kind of reaccelerate that going into 2019.

Yes, this is Ajay.

I can perhaps touch on a few of the comments that I made earlier and then answer any follow-up questions that you have.

Our strategy is to drive revenue growth through that combination of paying user conversion and ARPU expansion.

Depending on the initiatives that we're launching in a given quarter or that we've launched over a given year, one of those levers can outpace the other.

I think looking ahead, one theme that I would index you on is this theme of high-value conversion, it's something that we've been very successful with that's how we're gearing up the many elements of our product strategy and our M&A strategy to help feed.

And we really want to convert users with the best LTV profile.

We've been successful with that strategy, and I think you'll see that reflected in continued strength in conversion volume as well as growing ARPU.

And I will say, as we continue to extend the capabilities and breadth of our platform, we want to play more and more jobs for our users and do more and more for them over time.

As we deliver that value, we think it'll be something that will be more valuable to more users and eventually, more customers.

And I would just add that -- I was just going to add -- this is Drew.

I was just going to add, as we really focus on work use cases, we become more focused on our go-to-market, so really, and as Ajay was saying, going after teams, going after business users in a more focused way than just going after the general public.

And those users convert at a much higher ARPU.

Drew, maybe unrelated.

I know it's early, 3 to 4 months after the Zoom partnership announced that we talked about last quarter.

Where do we stand from a product and integration perspective?

And any kind of early anecdotes you might be able to comment on with regard to go-to-market benefit that you're seeing?

Well, as you mentioned, it's pretty early in the partnership.

And step one is really to get the basics of being able to present Dropbox content within a Zoom meeting and being able to initiate Zoom communication from within Dropbox.

And so those are the most basic integrations, and we're excited about those because those are very common use cases that our customers have.

And over time, we have a road map to go deeper and to do more creative and interesting things.

And so I would say both Zoom -- with all of Zoom and Google and Salesforce, we've got product road maps we're really excited about that you're going to hear more about, and you'll see a drumbeat pretty similar to what we've done with Salesforce, where we'll find more and more surface area over time and build more and more integrations.

And our next question comes from the line of Rob Owens with KeyBanc Capital Markets.

Since most have been answered, just curious around the margin hit to 2019 guidance as a function of the double rent expense and when that rent expense would end.

Sure, I would think about the quantum there as being roughly 2 percentage points.

And as we move into that space and we vacate our current headquarters in the second half of this year, that's when you'll see that dual rent expense start to abate.

And the thought process around incremental marketing spend for HelloSign given you've got a dominant player in that eSignature space?

Yes, certainly, I could take that question.

So as you think about our customer base, we have the 12.7 million paid users but also a lot of basic users, and our thought process is really to get to awareness-building, right?

So a lot of the initial couple of quarters of spend is around awareness building campaigns, identifying the right friction areas from not just an eSig but also from a workflow perspective and driving those campaigns to the users.

We're planning on that, and we are going to start executing on that fairly quickly.

Yes.

And then I'd say the most effective levers we're going to have for driving distribution are surfaces within our product, and so those are kind of house adds or they don't -- we don't have incremental marketing spend for that.

And our next question comes from the line of Rishi Jaluria with D.A. Davidson.

Let me just start with you, Ajay.

I want to go back to a couple of different comments you made.

So it sounds like the dual rent expense is about a 2% drag on margins for '19.

HelloSign, inclusive of deferred revenue write-down, is about a 1% drag on margins.

So if I square those both together, that tells me that in the absence of these kind of onetime-ish factors, you'd be at about 14% operating margins in '19, which would actually be above what you've done so far this year.

Am I thinking about this correctly?

Or is there something I'm missing?

Yes, you're thinking about that correctly at a high level.

I think the one component I'd even add into that is the synergy and the integration investments that we're making in HelloSign this year.

So we are reserving some flexibility to make those investments in the guidance that we provided, but your math certainly adds up.

That's helpful.

And then for either Drew or Yamini, seeing Business grow from 300k at the time of IPO to 400k now, just would like to get a sense for what's driving this growth.

And is it existing Dropbox users that you're converting from maybe individual plans to business, net new, a combination?

How should we directionally think about that?

I think it's a testament to some of the investments we've been making that Yamini spoke to.

So first is our fundamental model is really scaled -- or our fundamental go-to-market model with self-serve and viral adoption is fundamentally efficient.

So we're able -- people start using Dropbox as -- at home.

They bring it into work.

They start working on a team, and then the team becomes a department, becomes a company.

So that's a very -- we think of that as one user journey.

And the efficiencies -- or the increase you mentioned is really due to a lot of the investments we've been making in that product-driven conversion engine to remove friction from each phase of that user journey and move people along it faster and more effectively.

And that's an area where we're going to continue to invest.

And we have time for one last question, and that comes from Chris Eberle with Nomura Securities.

Can you give us some idea of what percentage of revenue is currently tied to Enterprise spend?

In other words, how does that 400,000 Business teams number translate to revenue?

And does HelloSign give you more consumer exposure?

Or does it help more on the Enterprise side?

Sure, this is Ajay.

I can take the first part of your question.

If you look at our 12.7 million paying users, the majority of those users are individuals, so they're paying for one of our individual subscription plans.

However, on a period-to-period basis, we're seeing a larger and larger mix shift from gross new subscribers into our team's products.

We're getting better and better at landing users in the right product for them on day 1, the right SKU for them on day 1. We're also getting better at migrating individuals into team plans over time, and so we're really focused on this philosophy of managing the customer journey and if someone's using Dropbox at work as an individual, encouraging them to adopt one of our team plans and then drive account expansion over time.

So certainly, a mix shift towards teams is what we're seeing.

But I'll turn it over to Yamini for the second part of your question.

Yes.

I can add a little bit color in terms of what happens with the HelloSign acquisition.

One of the reasons why we are really excited about the HelloSign acquisition is because there's a lot of similarities in terms of the go-to-market motion.

They have a self-serve engine that is complemented by a sales-assisted engine.

But more importantly, from a customer base perspective, we're very similar.

Their 80,000 paying customers are in businesses of all sizes, so it's really not a shift one way or the other.

It's a lot more synergy and similarly, from a vertical perspective, very synergistic to our model.

So while we are very excited about getting the HelloSign family of products built into our go-to-market, it doesn't really shift the makeup of our go-to-market.

Thank you.

And with that, I would like to turn the conference back over to Drew for closing remarks.

All right.

Well, thank you all for joining us today.

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

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

This does conclude the program, and you may all disconnect.

Everyone, have a wonderful day.