Dropbox, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Amounts are in U.S. dollars; financial figures are in millions unless noted. Dropbox operates a global collaboration and subscription platform, reporting as one segment.
Financial performance and operating metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $428.2 | $360.3 | $1,215.3 | $1,015.8 |
| Gross profit / margin | $323.4 / 76% | $270.1 / 75% | $909.2 / 75% | $715.5 / 70% |
| Operating loss | $(18.6) | $(8.9) | $(73.9) | $(482.0) |
| Net loss | $(17.0) | $(5.8) | $(46.1) | $(475.4) |
| Net loss per share, diluted | $(0.04) | $(0.01) | $(0.11) | $(1.39) |
- Q3 revenue grew 19% year over year; nine-month revenue grew 20%. Management attributed growth principally to a 14% increase in paying users and higher average revenue per user (ARPU), reflecting plan mix and pricing changes.
- Paying users reached 14.0 million at September 30, up from 12.3 million a year earlier. ARPU was $123.15 for Q3 versus $118.60, and $121.75 for the nine-month period versus $116.94.
- Q3 operating expenses were $342.0 million, up from $279.0 million. Research and development rose 30% to $172.8 million, largely on employee and facility costs. Nine-month operating expenses fell to $983.1 million from $1,197.5 million, mainly because 2018 included substantial IPO-related stock-based compensation (SBC).
- Gross margin improved year over year in both comparisons as revenue growth exceeded cost-of-revenue growth. Q3 operating loss widened despite higher gross profit, reflecting increased operating expenses.
Cash flow, liquidity and obligations
- For the first nine months, operating cash flow was $341.7 million versus $301.7 million. Capital expenditures were $110.6 million versus $27.6 million; company-defined free cash flow was $231.1 million versus $274.1 million. Management cited office and datacenter build-outs and bonus payments as factors in the FCF decline.
- Investing cash outflow was $278.8 million, including $171.6 million net cash paid for HelloSign and $110.6 million in capital expenditures. Financing cash outflow was $137.3 million, principally finance-lease principal and tax withholding on released equity awards.
- At September 30, cash and cash equivalents were $443.2 million and short-term investments were $587.7 million, totaling approximately $1.031 billion. Cash and equivalents had declined from $519.3 million at December 31, 2018.
- No borrowings were outstanding under the $725 million revolving credit facility; $60 million of letters of credit left $665 million available. Dropbox reported covenant compliance. Finance lease obligations totaled $198.9 million, while operating lease liabilities totaled $702.2 million; these lease commitments are not conventional funded debt.
- Current assets were $1,133.6 million and current liabilities $948.3 million. Deferred revenue was $541.1 million, up from $485.0 million at year-end.
Material changes, outlook and risks
- Pricing and growth: A repackaged Dropbox Plus plan with higher pricing took effect for new and renewing users beginning in Q2 2019. Higher-priced plan mix and renewals at increased prices also supported ARPU.
- HelloSign: Acquired in February 2019 for preliminary purchase consideration of $177.9 million. The acquisition added $133.0 million of goodwill and $44.6 million of identifiable intangible assets. Up to $48.5 million in future payments to key personnel are service-conditioned compensation, to be expensed over three years.
- Investment and costs: Management expects infrastructure, research and development, sales and marketing, and administrative expenses to rise in absolute dollars. It expects free cash flow to fluctuate and potentially decline as a percentage of revenue due to infrastructure and office investment. No specific revenue, earnings, or full-year numerical guidance is provided in the supplied filing text.
- Liquidity outlook: Management believes cash, investments, operating cash flow, and available revolver capacity will meet needs for the foreseeable future. Future requirements depend on growth, renewals, infrastructure, office investment, and other factors.
- Leases and headquarters: Dropbox adopted ASC 842 on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. The company relocated to its new San Francisco headquarters in Q3; it disclosed $220.2 million of operating leases not yet commenced and substantial long-term headquarters commitments.
- Legal matters: Six putative securities class actions filed in 2019 allege misleading statements or omissions in the IPO registration statement. The company does not currently expect a material adverse impact, but notes litigation outcomes are uncertain. A separate Synchronoss patent case was resolved in Dropbox’s favor at summary judgment and is on appeal.
- Key risks: Retaining and converting users, slowing growth, competition and pricing pressure, security or service disruptions, privacy and regulatory compliance, foreign-exchange exposure, and execution/integration of acquisitions. Dropbox had over 600 million registered users but 14.0 million paying users; it noted that many registered users may never convert. The company reported no foreign-currency hedging program.
- Other items: Nine-month results benefited from a lower SBC burden than in 2018, when $418.7 million of cumulative compensation was recognized upon IPO-related vesting. The nine-month 2019 tax benefit included a $6.9 million HelloSign-related benefit. Disclosure controls were assessed as effective at a reasonable assurance level.
Important facts for investors to verify
- Whether paying-user growth, renewals, plan upgrades, and pricing changes continue to support revenue and ARPU growth.
- Whether higher operating costs and investment spending can be managed while improving operating profitability and sustaining free cash flow.
- The cash-flow and integration effects of HelloSign, including service-conditioned compensation and acquired goodwill/intangibles.
- The full scale and timing of lease, headquarters, datacenter, and finance-lease commitments, including leases not yet commenced.
- Developments and potential financial exposure from the IPO securities litigation and other legal or regulatory matters.
- The effect of SBC and other unusual or noncash items when comparing current results with 2018, and the limits of the company-defined FCF measure.