Dropbox delivers growth, but records $162 million real estate loss - CEO cautious about the year ahead

Dropbox has this week released its Q4 and full year earnings report, which highlights the mixed environment within which enterprise technology vendors are operating at the moment. On the one hand the company delivered consistent growth, as buyers continue to shift to distributed cloud-based work. Whilst on the other, Dropbox is also seeing hesitation amongst its customer base and it had to suffer a significant real estate loss, as it too moves away from office-based work. 

The company’s analyst call this week felt like a lesson in managing expectations, as Co-Founder and CEO Drew Houston highlighted a number of challenges that will persist across the buyer environment in 2023. However, the overall performance was still positive. Houston said: 

While 2022 saw a more challenging macroeconomic backdrop, and we saw some elevated headwinds in Q4, I'm pleased with how our business performed for the year. We ended the year with over $2.5 billion in ARR. We once again increased profitability and free cash flow, and repurchased nearly $800 million of our stock.

The key numbers released this week include: 

• Total revenue was $598.8 million, an increase of 5.9% from the same period last year. On a constant currency basis, year-over-year growth would have been 9.2%.

• Total ARR ended at $2.514 billion, an increase of $82.8 million quarter-over-quarter and an increase of 11.2% year-over-year. On a constant currency basis, year-over-year growth would have been 11.8%.

• Paying users ended at 17.77 million, as compared to 16.79 million for the same period last year. Average revenue per paying user was $134.53, as compared to $134.78 for the same period last year.

• GAAP gross margin was 80.7%, as compared to 79.5% in the same period last year. Non-GAAP gross margin was 82.0%, as compared to 80.9% in the same period last year.

Houston said that Dropbox is focused on executing against four strategic pillars, which include: 

Our first objective has been to evolve our core FSS [File, sync and share] product, driving retention gains and monetization efforts through better conversion of our free users and through pricing and packaging. 

Our second objective has been to expand workflows beyond core FSS around documents and videos. Our third objective has been to drive operational excellence and improve efficiency. 

And this year, we've added a fourth strategic objective, which is to move beyond files and organize all cloud content for our customers. This has been a critical step in our product vision for some time, and recent advancements in AI and machine learning have a huge role to play in accelerating our plans, particularly in building out our universal search and other capabilities.

Houston added that Dropbox is executing against these objectives with a “strong sense of urgency”, given that Q4 highlighted that the vendor is “not immune to a slowing economy”. 

The company also said that in Q4 it would be taking a financial hit, as a result of it's real estate strategy. Dropbox signed a lead on an office in San Francisco in 2017, but has since had to readjust its property portfolio given the fallout from COVID-19. CFO Tim Regan said: 

We have been taking steps to de-cost our real estate portfolio as a result of our transition to a virtual-first model. We made progress against our subleasing goals in 2022, and a vast majority of our space outside of San Francisco headquarters has now been subleased. 

However, while we continue to actively seek subleases and consider buyouts of our San Francisco headquarters, recent downsizing and reductions in corporate needs throughout the San Francisco real estate market have resulted in a more challenging subleasing environment than we had originally anticipated. Given the current corporate real estate market, we are no longer assuming that we enter into additional subleases in San Francisco in the next few years. 

As a result, we have revised our subleasing assumptions, resulting in an additional write-down of our facilities and other related assets of $162 million in the fourth quarter. This brings our cumulative impairment charge to $604 million. This revised subleasing assumption also reduces our expected cash flow benefit over the next few years.

Buyer trends

Elsewhere, Houston added some color to the behaviors Dropbox is seeing in the market from its buyers. For example, he highlighted how this year the vendor had rolled out new plans for its standard and advanced Team customers - where he said these did benefit ARR, but also resulted in incremental headwinds in Q4 from some of its larger customers reducing licenses. Houston said: 

We recognize that as our customers experienced challenges in their businesses, and evaluated their budgets, there's added pressure to reduce software spend. But we see an opportunity to mitigate some of this pressure through more high-touch account management for these customers, which traditionally came through the self-serve channel.

We're actively working to strengthen the alignment between our business units and our go-to-market teams and see opportunities to improve renewal activity as we increase customer awareness of the added functionality we're adding for Teams.

Houston said that Dropbox will continue to evaluate the best pricing and packaging strategy over the coming year. 

The company also saw headwinds across its DocSend and Sign products, with Houston saying: 

As we've noted throughout the last year, we've seen both DocSend and Sign growth moderate as headwinds in their respective markets continue. DocSend's core market, which is venture back fundraising, has seen activity pull back materially from 2021 levels, which has resulted in customers being more price sensitive. This year, we're focused on diversifying DocSend customer base, introducing its new geographies and extending beyond venture capital and other professional services such as consulting.

Sign has also seen challenges amidst an overall slowdown in the eSignature market and increasing competition. While we saw strength in our Sign API offering, there's opportunity to stabilize Sign's overall growth as we leverage it under the Dropbox brand and drive more sales-led growth targeting small businesses.

For both Sign and DocSend, our focus in 2023 is around deeper integration with core Dropbox. While we've made progress integrating certain capabilities into the core Dropbox experience, for example, DocSend's analytics within an individual user sharing flow and Sign's native send for signature entry point and PDF in Dropbox, there are still challenges for the end user experience due to multiple systems that need to be unified.

But a big focus for the coming year will be utilizing AI and machine learning across the Dropbox portfolio, Houston said: 

We're entering a new era of augmented knowledge work where human and machine intelligence combined to unlock unprecedented levels of productivity. We've been working towards a mission of designing a more light way of working for years as a proliferation of cloud tools and the shift to remote work have left people with a more chaotic working environment than ever before. 

Instead of one search box, we all have a dozen search boxes across all of our productivity tools and apps, and there's never been a better time to help our customers organize and simplify their working lives.

And with the recent developments in natural language processing and large language models, Teams can now take on more complex tasks than ever before, and they're providing us the building blocks needed to augment knowledge work as we first envisioned.

AI and machine learning is an area where we've been investing for a long time. We view machine learning to improve content suggestions and retrieval and help users better search and organize their video content, but there's a lot more we can do. Where the biggest opportunities we see is in tackling content fragmentation and universal search, and I'm looking forward to sharing more about what we'll be launching in the coming quarters.

My take

Dropbox is performing well, but it’s clear that there are some challenges that are front of mind for the company - challenges which are clearly emanating directly from its customers. However, Houston, whilst being upfront about the concerns, was still optimistic about the opportunity. He finished by saying: 

Challenging times can be transformative for any business. We launched Dropbox during the great financial crisis, and I've learned that operating under more difficult environments can result in producing our best work. While we're not immune to a worsening economy, we're well positioned given our scale, our trusted brand, our healthy financial profile and our strong balance sheet. We remain focused on operational excellence, identifying areas of efficiency and capitalizing on emerging growth opportunities to invest in our future.