Dropbox, Inc (DBX) Q1 2023 Earnings Call Transcript

Dropbox, Inc (NASDAQ: DBX) Q1 2023 Earnings Call dated May. 04, 2023

Corporate Participants:

Kern Kapoor — Head of Investor Relations

Drew Houston — Co-Founder and Chief Executive Officer

Tim Regan — Chief Financial Officer

Analysts:

Rishi Jaluria — RBC Capital Markets — Analyst

Mark Murphy — JPMorgan — Analyst

Steve Enders — Citi — Analyst

Alan — Jefferies — Analyst

Matt Book — Bank of America — Analyst

Presentation:

Operator

Good afternoon, ladies and gentlemen, and thank you for joining Dropbox’s First Quarter 2023 Earnings Conference Call. [Operator Instructions] and will be available for replay from the Investor Relations section of Dropbox’s website following this call.

I will now turn the call over to Kern Kapoor, Head of Investor Relations for Dropbox. Mr. Kapoor, please go ahead.

Kern Kapoor — Head of Investor Relations

Thank you. Good afternoon, and welcome to Dropbox’s first quarter 2023 earnings call. Before we get started, I’d like to remind you that our remarks today will include forward-looking statements, such as our financial guidance and expectations including our long-term objectives and forecast for our second quarter and fiscal year 2023 and our expectations regarding our revenue growth, profitability, operating margin and free cash flow as well as our expectations regarding our business, assets, products, strategies, technology, employees, users, demand, industry trends and the macroeconomic environment. These statements are subject to risks and uncertainties that could cause actual results to differ materially.

They are also based on assumptions as of today, and we undertake no obligation to update them as a result of new information or future events. Factors and risks that could cause our actual results to differ materially from these forward-looking statements are set forth in today’s earnings release and in our annual report on Form 10-K filed with the SEC. We’ll also discuss non-GAAP financial measures, which are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP and non-GAAP results is provided in our earnings release and on our website at investors.dropbox.com.

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

Drew Houston — Co-Founder and Chief Executive Officer

Thanks, Kern, and good afternoon, everyone. Welcome to our Q1 2023 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I’ll first share our business and product highlights from the quarter, and then Tim will review our Q1 financial results, provide guidance for the second quarter and update our outlook for the remainder of the year. I recognize our announcement last week to reduce our workforce. It’s top of mind for many, and I plan to discuss that in a moment. But as far as our financial results, overall, I’m pleased with how we performed in Q1 during a challenging environment. We beat our guidance across all metrics, led by revenue outperformance in FormSwift, which we acquired in late Q4 and some better performance around individual sign-ups exiting the quarter.

On the flip side, we saw continued weakness across our team’s plans as our customers face pressure in their own businesses. And we also saw a continued moderation in our DocSend and Dropbox Sign businesses due to ongoing softness in their respective markets. Over the last several months, we’ve noted that we’re not immune to the increasing macro headwinds that our customers are also facing. And during this period, we’ve carefully evaluated our different business units and recognize that some investments which showed promise before the downturn have less potential today. Part of this is accepting some normalization following demand acceleration during the pandemic as well as the natural maturation of our existing FSS business.

And yet at the same time, we see a huge opportunity for building new AI-powered products for our customers to improve the technology and tools that are used to get our work done, which I’ll discuss in more detail shortly. I’m determined to ensure that Dropbox is at the forefront of innovating for this new AI era, just as we are at the forefront of the shift to mobile and the cloud. And while we’ve added talent over the last couple of years that bring AI and early stage product development skill sets to Dropbox, we need to free up resources to better align our investments with these long-term growth initiatives. And so unfortunately, these shifts required us to reduce our workforce by approximately 16%.

This was a really tough decision, but necessary to the long-term health of our company. And while it’s painful to say goodbye to many of our colleagues, I’m grateful for all their contributions to Dropbox. In conjunction with this announcement, we’ve also updated and streamlined our strategic objectives. The first objective is around building AI-powered product experiences centered on organizing cloud content. We believe for many years and the potential for AI to completely transform and knowledge work and we’ve been investing in automation and machine intelligence features to help our users organize their cloud content and search and discover more easily. And with recent advancements in AI, we’re able to accelerate our vision. I’m excited to share some progress we’ve made here and what to expect over the next few months.

Second, we’re evolving our core FSS experience to specifically address customers’ workflows around documents and videos. And with this shift, we consolidated our DocSend, FormSwift and Dropbox Sign businesses together with our core team, which we believe will drive a more integrated and seamless product experience for our customers. And lastly, as a foundational objective, we remain focused on driving operational excellence by improving our efficiency, our execution and the product velocity. So with that backdrop, I’ll share some updates for this past quarter and touch on what we’re working on for each of our first two objectives. Starting with investing in AI capabilities to organize all cloud content and improving our customers’ working lives.

You’ve heard me talk on previous calls about the evolution of workloads, moving from files and folders to the browser and web-based apps. What used to be 100 icons on your desktop have now become 100 tabs on your browser. And what used to be one hard drive to search for all your content is now 10 fragmented search boxes. We believe a large audience and knowledge workers face growing challenges when searching, organizing and using content across multiple cloud repositories and platforms to start their workflows and see a huge opportunity here. That’s why we’ve been working on an AI and ML powered solution that offers one universal search bar for all your cloud content.

Our acquisition of Command E in 2021 was an important first step in building this functionality, and I’m excited to share that just this week, we began testing our first AI-powered universal search product with a select group of customers and can’t wait to share more in the coming months. Universal search is just one application of how AI and ML can improve the way our customers work. We’ve all seen how generative AI tools like ChatGPT and others have captured people’s imaginations and open their eyes over the last few months to a lot of new possibilities. One thing that becomes clear when using these tools is the need for personalization.

We all want an AI that knows about us, that knows about our content, know about our company that you can interact with using natural language and of course, you can’t build personalized AI without access to your data and building personalized AI at scale is a lot easier when you have millions of people already storing their most important information on your servers. So we strongly believe that users of existing Dropbox products stand to benefit from AI-enabled experiences like this, and they want a service that they can trust that will use AI responsibly. The market for these types of products and capabilities is growing faster than anyone could have imagined, and I believe Dropbox is uniquely positioned to lead here.

For years, we’ve invested in AI and ML technologies to improve our infrastructure, improve our search functionality, image recognition and many others. And now we can apply the same principles and techniques to organizing our customers’ working lives. And our customers can rely on us as a trusted brand that integrates seamlessly with all of their work tools, and we’re committed to ensuring the privacy and security of our customers’ content and using AI responsibly. And we’ll leverage our foundational strengths as we build out additional AI-powered capabilities and lean into this new era of computing.

And just as we’re increasing our product velocity with the launch of our new AI-powered universal search product, we’re also increasing the level of urgency around our second objective, which is evolving the existing Dropbox FSS user experience to seamlessly address customers’ workflows around documents and videos. There are a number of important foundational steps that we’re taking here, ultimately to make the Dropbox family of products, easier to try, buy and use. Last quarter, I talked about our rollout of Google One Tap to reduce friction in the onboarding process. And in Q1, we had tangible results with sign-ups and sign-ins exceeding our expectations.

And we continue to take steps to improve user retention by improving the reliability and usability of our product. We’ve identified customer pain points around the many forms of sharing and made improvements to provide a more consistent experience across mobile, web and desktop, making it easier for users to manage who can access their shared content. We also made some enhancements around mobile upload performance and the reliability of the Dropbox app, which drove improvement in mobile, plus retention exiting the quarter.

We’re also making changes to address the increased down-sell pressure we’ve observed with our Teams customers. And while difficult employment trends and cost-cutting initiatives among many of our Teams customers weigh on our user counts, we’ve identified an opportunity to drive higher retention for our self-serve Teams customers by leveraging outsourced sales support. We’re optimistic that this higher touch, sales-assisted motion will be an efficient way to mitigate some of the retention pressures we’ve seen with some of our self-serve Teams customers.

Moving to our workflow businesses, which now operate within our core vision to improve execution and increase alignment across our teams in order to deliver a more holistic experience for our customers. DocSend continues to see its growth moderate and its ongoing challenges in the fundraising environment, and we’re actively working on diversifying into new verticals, such as sales and professional services, as well as internationally. We’re also making progress in removing friction for our DocSend users on Dropbox. For example, we eliminated multiple terms of service gates, and we’ve seen encouraging results with a healthy increase in trial starts for DocSend among Dropbox users. Dropbox Sign growth also continues to moderate against the challenging backdrop in e-signature.

Despite that, we’ve continued to see higher win rates with our Dropbox Sign API offering, with customers setting a better developer experience in a more customizable platform than our competitors. And as we right-size many areas of our business to align with our growth outlook, we’re shifting investment towards the Dropbox Sign API and towards deeper integration with the core Dropbox products. We also see synergy potential of Dropbox Sign and our PDF editing capabilities, which continue to gain traction among core FSS users, as well as our recent acquisition of FormSwift, which provides an online library of forms and tablets for small businesses and individuals.

And FormSwift, in its first full quarter as part of Dropbox, exceeded our expectations on users and ASP. And the teams are already working quickly on integration, taking learnings from our past acquisitions. We’ve already launched Dropbox branded SEM pages and associated marketing campaigns to drive traffic to the FormSwift with encouraging early results. I’m pleased to see this integration off to a strong start and we’ll continue to push for rebranding efforts and deeper product integrations later this year. And finally, moving to our video workflow products, starting with Replay, which allows video production teams to edit and collaborate on video projects simultaneously wherever they are. In this era of distributed work, Replay has helped many creative professionals stay connected with their teams and deliver media projects faster and more efficiently by avoiding time switching between editing and review tools.

I’m excited to announce that last week, we launched Dropbox Replay to all users, with premium features made available for an add-on subscription. We see a natural fit for Replay that connect with the core Dropbox experience, as it caters to many of the highly engaged creators who use Dropbox FSS for work. This is now the second video collaboration tool that we’ve created in-house and launched into general availability after we made Dropbox Capture available to all users last fall. Dropbox Capture is a video communication tools that helps teams stay in sync while avoiding meetings and long e-mails to present material and offer educational and training content. In Q1, we saw Dropbox Capture users grow significantly again quarter-over-quarter, and we’re excited to see its viral adoption continue driving both retention benefits and network effects across existing and prospective Dropbox users.

In closing, we’ve been making a number of changes to set up Dropbox for long-term success. And while I know these transitions are never easy and the macro environment remains challenging, I believe our best days are ahead of us. The AI era of computing has finally arrived, and I personally haven’t been this excited about what we’re building since I started the company. It’s been really rewarding to be so hands on in developing a product road map alongside our leadership team. We’re strengthening our foundation while innovating on our next act. We have a strong brand with hundreds of millions of users recognizing Dropbox as a platform they can trust with their most secure content, and I’m excited about our path forward as we work to transform the way customers organize all their cloud content and ultimately organize their working lives.

And with that, I’ll pass it on to Tim.

Tim Regan — Chief Financial Officer

Thank you, Drew. Today, I’ll walk through some financial highlights for Q1 and provide an outlook for Q2 as well as an update on our 2023 guidance and our financial targets for 2024, all within the context of the current macro environment and last week’s restructuring, which Drew discussed. I’ll start with our first quarter results. Total revenue for the first quarter increased 8.7% year-over-year to $611 million, beating our guidance range of $600 million to $603 million. Foreign exchange rates provided an approximate $16 million headwind to growth, in line with our previous guidance. On a constant currency basis, revenue grew 11.6% year-over-year. The upside to our revenue guidance was driven by an outperformance from FormSwift as well as some improving trends in our individual plans exiting this quarter.

Total ARR for the quarter grew 7.8% year-over-year, for a total of $2.468 billion. On a constant currency basis, ARR grew by $37 million sequentially and 11.6% year-over-year, primarily driven by FormSwift and pricing and packaging changes to our teams plans that we announced last June. We exited the quarter with 17.9 million paying users and added approximately 120,000 net new paying users sequentially. Average revenue per paying user for Q1 was $138.97, an increase of over $4 compared to Q4 2022 driven by another quarter of Teams customers renewing at higher prices, which we announced last June as well as a full quarter of FormSwift revenue.

Before we continue with further discussion of our P&L, I would like to note that unless otherwise indicated, all income statement figures mentioned are non-GAAP and exclude stock-based compensation, amortization of purchased intangibles and certain acquisition-related expenses. Our non-GAAP net income also includes the income tax effect of the aforementioned adjustments. Moving to our real estate strategy, where we have been taking steps to de-cost our real estate portfolio as a result of our transition to a virtual-first model. In the first quarter, we continued to actively seek subleases and considered buyouts of our San Francisco headquarters. We did not incur any additional impairment charges in the quarter with our cumulative impairment incurred to date remaining at $604 million. Given the current corporate real estate market, we have maintained our assumption that we will not enter into additional subleases in San Francisco in the next few years.

Let’s continue with the first quarter P&L. Gross margin was 82% for the quarter, representing an increase of one percentage point on a year-over-year basis. The improvement in our gross margin was primarily driven by a greater mix of higher density storage that can store more data within the same physical space, which resulted in lower depreciation as a percentage of revenue. Operating margin was 28.6%, down nearly two percentage points year-over-year, mostly driven by an approximate 80 basis point headwind from FX and a 50 basis point headwind from FormSwift. We exceeded our operating margin guidance by approximately two points mainly due to our revenue outperformance and lower-than-expected workforce costs.

Operating expenses were $329 million, up about 15% year-over-year driven by increased R&D hiring in 2022. As Drew mentioned, we’ve been adding engineers in early-stage product leaders as we invest in our longer-term growth initiatives around organizing all cloud content, leveraging artificial intelligence and machine learning. In addition, our operating expenses increased year-over-year due to higher advertising expenses associated with FormSwift. Net income for the first quarter was $146 million, up 3% versus the first quarter of 2022 as higher operating expenses offset most of the revenue increase. Diluted EPS was $0.42 per share based on 349 million diluted weighted average shares outstanding, up from $0.38 per share based on 373 million diluted weighted average shares outstanding for the first quarter of 2022.

Moving on to our cash balance and cash flow. We ended the quarter with cash and short-term investments of $1.3 billion. Cash flow from operations was $140 million in the first quarter. Capital expenditures were $2 million during the quarter. This resulted in quarterly free cash flow of $138 million compared to $131 million in Q1 of 2022. In the quarter, we also added $35 million to our finance leases for data center equipment. Let’s turn to our share repurchase activity. In Q1, we continued executing against a $1.2 billion authorization that was approved in 2022 by repurchasing 8 million shares, spending approximately $175 million. As of the end of the first quarter, we have approximately $573 million remaining under the current authorization.

I’d like to now share our guidance for the second quarter and provide an update to our full year 2023 guidance, where I will also provide some context on the thinking behind this guidance. For the second quarter of 2023, we expect revenue to be in the range of $612 million to $615 million. On a constant currency revenue basis, we expect revenue to be in the range of $627 million to $630 million. We are assuming a currency headwind of approximately $15 million in the second quarter, which translates to over a 250 basis point headwind to growth. We expect non-GAAP operating margin to be approximately 31.5%. This margin guidance excludes approximately $40 million related to the severance and benefits we expect to pay to employees impacted by a reduction in force in Q2. This also includes a roughly 130 basis points of headwind from FX and 50 basis points of headwind from FormSwift.

Finally, we expect diluted weighted average shares outstanding to be in the range of 343 million to 348 million shares based on our trailing 30-day average share price. For the full year 2023, due to the strengthening of the US dollar since our last update, we are revising our as-reported revenue guidance range down by $5 million to $2.470 billion to $2.485 billion from our previous range of $2.475 billion to $2.490 billion. However, on a constant currency revenue basis, we are maintaining our prior guidance range of $2.510 billion to $2.525 billion. Now estimated full year 2023 currency headwinds of approximately $40 million or approximately 170 basis point headwind to growth with the FX headwinds moderating significantly in the second half. We expect gross margin to be approximately 81.5% to 82%, which is up from our prior guidance of 81% to 82%.

We expect non-GAAP operating margin to be between 31% to 32%, up from our prior guidance of approximately 30%. This also excludes the aforementioned severance and benefits we expect to pay in Q2. This is inclusive of an approximately 80 basis point headwind from FX, as well as an approximate 50 basis point headwind from our FormSwift acquisition. We are revising the midpoint of our free cash flow guidance down by $10 million and narrowing the range to $820 million to $840 million from our previous guidance range of $825 million to $855 million. This includes cash outflows of approximately $23 million in cash outflows for the 2023 installments of acquisition related deal consideration holdback for DocSend and Command E. One-time severance payments of approximately $40 million related to our reduction in force, and consistent with our initial guidance, this includes an approximate $50 million headwind as a result of R&D tax legislation.

As related to our capital expenditures, we are maintaining our prior guidance. We continue to expect our additions to finance leases to be approximately 5% of revenue and for cash capex to be in the range of $25 million to $35 million in 2023. Finally, we expect 2023 diluted weighted average shares outstanding to be in the range of 340 million to 345 million shares down from our previous guidance range of 346 million to 351 million shares. This reduction in our share count reflects our commitment to an anticipated impact of our share repurchase program. Here’s some additional context on this guidance. Let me first elaborate on our restructuring decisions, where our intent is to identify and address areas of inefficient spend and then to rotate our investments towards areas of higher future potential growth.

The reductions were thus largely targeted towards R&D and sales and marketing teams supporting our mature file sync and share category as well as some reductions against business lines that are facing distinct macroeconomic and competitive pressures. We also intend to be more efficient with our marketing spend across these same areas. In light of these changes and as related to revenue, we are maintaining our constant currency revenue guidance for 2023. We saw outperformance in Q1 largely stemming from FormSwift as well as some improving trends in our individual plans exiting the quarter. Conversely, we continue to see macro headwinds weighing on our teams customers as well as both DocSend and Sign.

These opposing trends, combined with the potential impact of billings as a result of our reduced levels of headcount and marketing investments, stemming from our restructuring, are leading us to maintain our full year guidance despite the first quarter outperformance. As related to operating margins, we are raising our operating margin guidance to approximately 31% to 32%, up over 150 basis points at the midpoint as compared to our prior guidance, driven by net savings from our reduction in stores. As Drew mentioned, while we are restructuring our existing business lines to increase their efficiency, we will also be investing in long-term growth initiatives around organizing all cloud content. Thus, some of the savings will be offset by hiring talent skilled in AI and early-stage product development, which has been factored into this guidance.

As related to full year free cash flow, we are lowering our free cash flow expectations by $10 million at the midpoint. There are a few factors leading to this reduced estimate. While we will derive cash savings from our restructuring events over time, the benefit in 2023 is largely offset by severance payments and the timing of bonus payment savings, which will be a benefit next year. Additionally, as mentioned above, we may see an impact to our billings in the second half of 2023 as a result of our reduced levels of headcount and marketing investments, given our restructuring, which would have a more pronounced impact on cash as opposed to revenue this year.

Lastly, this guidance incorporates an approximately $8 million deterioration in foreign exchange rates since our initial guidance, which brings me to our long-term financial targets of delivering gross margins of 80% to 82%, operating margins of 30% to 32% and $1 billion of annual free cash flow by 2024. We continue to operate within our long-term margin ranges where our recent restructuring activities are pushing us to the top end of these ranges. While we are not offering more specific 2024 guidance at this time, we expect to see continued net savings in 2024, and for our operating margins to be at or above the 2023 levels. As related to our $1 billion of annual free cash flow by 2024 target, we are maintaining our $1 billion target at this time.

Our restructuring activities will increase our efficiency and will be a benefit to free cash flow in 2024. However, we still have work to do to achieve our target. We need to closely monitor the impact of our restructuring decisions and any corresponding impact on billings to ensure that we maintain an appropriate pace of growth across our existing business lines. Additionally, we need to monitor our investments in organizing cloud content and AI to ensure that we are remaining disciplined with our spend and to validate that our new products are gaining an appropriate level of customer traction.

Lastly, we need to — we continue to need to navigate numerous exogenous factors such as R&D tax legislation, a softer subleasing environment and deteriorating FX rates that continue to serve as headwinds. Thus, while we are taking actions that bring us closer to our targets, we need to execute well and remain disciplined with our spend amidst these varying dynamics. In conclusion, as Drew mentioned, we’ve been making a number of changes to set up Dropbox for long-term success. We are mindful of the difficult macro environment and the inherent challenges that come with businesses and transition, and we remain optimistic about our strategy as we improve our execution while investing towards our future in this new AI era. We will remain focused on our customers, operating the business efficiently and driving long-term value for our shareholders.

With that, I’ll now turn it over to the operator for Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question comes from Rishi Jaluria with RBC Capital Markets. Please proceed.

Rishi Jaluria — RBC Capital Markets — Analyst

Hi. This is Richard calling on for Rishi. Thanks for taking my question. So the first one is, you talked a little bit about some of the investments that might have less potential today — outside of, I guess, some of the core FSS, is there anything in particular that you identified that maybe wasn’t working too well and you want to shift away from? Thanks.

Drew Houston — Co-Founder and Chief Executive Officer

Sure. So I can start. So we’re continuing to invest. I’d say a business that have been affected beyond the core business would include Sign and DocSend. And they’re still promising businesses, but as we see each of their categories affected in different ways, then if the prospective returns are coming down, then we’ve trimmed some of our investment in those areas, mostly to free up resources to invest in some of our future growth levers. But we’re certainly not stopping investment in those areas and in a lot of ways where you take something like DocSend in response to — may be true that the fundraising environment is — there’s less fund raising going on, which means lower demand for DocSend in the fundraising context.

But the underlying use case of sharing with analytics and extra security features and a lot of what DocSend does, has brought applicability to a lot of professional services. So we’re diversifying in DocSend and we’re investing in DocSend to both support other verticals and other geographies. So that’s a little bit of the context behind some of the shifts in investment, but we continue to be confident in the potential of these businesses.

Tim Regan — Chief Financial Officer

And then this is Tim. Just to briefly add on to that. We did take a hard look across the company where we took this opportunity to consolidate or eliminate some roles and also to address lower performers. And we also looked at where we had too many layers that we could streamline which were slowing down execution and decision-making. And ultimately, the vast majority of the cuts were across R&D with additional cuts in sales and marketing and more minor cuts in G&A.

Rishi Jaluria — RBC Capital Markets — Analyst

Got it. That’s super helpful. And then just as a follow-up, impressive to see the good performance out of FormSwift and really a good acquisition on that side. With the strong balance sheet and the continued free cash flow generation are there any other areas that you’d think about maybe investing more on the inorganic side? And maybe it’s AI, but just anything you could talk to just around the inorganic strategy from here?

Drew Houston — Co-Founder and Chief Executive Officer

Yeah. So we’re — we’ve certainly had a lot of success with our acquisitions or happy with a lot of the acquisitions we made. And I would say there’s like a change in approach. We’ve had successful acquisitions kind of a different scale, so that’s bringing great teams or great products or great businesses, and that will continue. And as you pointed out, we have a strong balance sheet, cash flow, so we can — so we have a lot of optionality there.

So yes. And then certainly, in the AI space, there’s a lot of interesting early-stage start-ups where we see opportunity and are spending a lot of time. There’s a greater supply of AI start-ups because there’s a lot of interest and then we’re certainly interested in adding there. But at the same time, we’ll continue to be disciplined and we’ve got a lot of good places to put capital.

Rishi Jaluria — RBC Capital Markets — Analyst

Got it. Thank you.

Operator

Thank you. One moment for our next question please. And it comes from the line of Mark Murphy with JPMorgan. Please proceed.

Mark Murphy — JPMorgan — Analyst

Thank you very much. So I think it’s a surprisingly solid quarter considering the environment. You have the 12% ARR growth, margin upside, solid free cash flow number. We might have expected more just as well given the recent headcount actions. And so I’m wondering if you can expand on that a bit. How much of that reduction might flow through to margins maybe next year versus how much is earmarked for incremental AI investments? Because typically, if we see a 16% type of reduction, it’s going to yield a little more margin than that. So I’m just trying to understand that particular equation, and then I have a follow-up.

Tim Regan — Chief Financial Officer

Yeah. I’d look to our 2023 margin guidance, which is up 150 basis points from our prior guidance at the midpoint, it’s an indication of the net savings we expect this year. And then note that we will continue to see some of the benefits carry forward into 2024 as the savings annualized. And we’re not giving 2024 guidance right now, but I did indicate that I expect our margins to be at or above these 2023 levels. And this is where we are increasing our investments around AI and early-stage product development, which will partially offset those savings. And then we also did take the opportunity to address some performance management with this risk where in some of these cases, we’ll be adding backfills for those positions as part of this action.

Mark Murphy — JPMorgan — Analyst

And so could we maybe think of the 150 basis points is a little more in the half year if you’re doing — I don’t know exactly when the cost and expenses there kind of roll off the books. But is that one way to think about it like more like a 300 basis points annualized type of effect perhaps?

Tim Regan — Chief Financial Officer

Yes. I don’t think I’m going to elaborate much more on 2024 just yet. I think there’s many factors that will go into our thinking for our guidance next year. I think I just fall back on what I previously stated as far as I expect our margins to be at or above these 2023 levels.

Mark Murphy — JPMorgan — Analyst

Okay. Fair enough. And then, Drew is it possible to provide an example of — what is — what you’re picturing in your mind as you build out an AI product. You mentioned search, you mentioned personalization. I’m just trying to envision what the product would be or maybe how the user experience would feel, right, as you start steering relatively more investments into your AI road map.

Drew Houston — Co-Founder and Chief Executive Officer

Sure. So we’ll have more specifics to share with the forthcoming launches. But I think at a high level, there’s with new products that we’re creating. And then there’s also applications of AI across our existing product portfolio and sort of — and the opportunities to reimagine those experiences. But I think one of the most straightforward is really when you look at everyone who use tools like ChatGPT, they’re not really personalized to you. So if you ask you a question like — if you want to ask you a question, like, what’s my passport number again? Or who in my company is working on this thing?

Or why did we make a certain decision? It is now possible we have the technical foundation to actually build an experience where you can use natural language and basically have the silicon brain that knows about you and your staff and your company, sort of, a personalized ChatGPT. We find ourselves very well-positioned to build that kind of capability, and we’ve been building towards that for many years.

So that’s been — I mean, there are other examples because there’s a lot of other exciting applications beyond text or pretty much all the different multimodal capabilities. There’s like been breakthroughs in how you can — the things you can do with images, the things you can do with videos, things you can do with audio. So there’s a lot of different potential applications that we’re working on and we’ll have more sharing in the coming months.

Mark Murphy — JPMorgan — Analyst

Okay. I like that branding around silicon brain. Maybe that’s something we’ll see from you in the future, and rolls off the tongue pretty well. Congrats on all the success.

Drew Houston — Co-Founder and Chief Executive Officer

Thank you.

Operator

Thank you. One moment please. And our next question comes from the line of Steve Enders with Citi. Please proceed.

Steve Enders — Citi — Analyst

Okay. Great. Thanks for taking my question. I guess maybe following up on the AI to question a little bit. Universal Search is just kind of being rolled out there and tested. But I guess what’s kind of been the early feedback from the customers that are trialing it? And I guess, how are you kind of thinking about what that could mean from like a monetization lever and how you’re thinking about packaging around that down the line?

Drew Houston — Co-Founder and Chief Executive Officer

Sure. So we’re just — it’s just reaching outside customers literally two days ago. So I want to let some of the feedback roll in a little more before having a more comprehensive response. We’re certainly using internally, and that’s been a really helpful tool for us to kind of battle test the product and make sure it’s really great before rolling out to customers. So we’ve been some milestones like that closed beta, we’re really excited about.

As far as pricing packaging, I mean, we certainly believe it will be incremental revenue. We believe this will unlock new categories of customer who might not otherwise be buying FSS or might not be either current or future FSS customers. So we think it’s a big unlock on that front. But as far as — we’ll have more to share around the specific pricing and packaging in — at the actual launches.

Tim Regan — Chief Financial Officer

And then maybe just briefly from a financial perspective, we certainly plan to stay disciplined and closely monitor customer adoption and feedback as we consider further investment on this side. Our focus this year is on bringing quality product to market and driving adoption and we do expect it will take several quarters before we start seeing any contribution to revenue from these products.

Steve Enders — Citi — Analyst

Okay. That’s helpful context on that front. I guess maybe dig in a little bit more on just the ARR upside in the quarter. I guess, how do we think about some of the moving parts around there for the FormSwift outperformance, individual plans sounds like they were relatively strong versus maybe some of the headwinds that you’re seeing in other aspects of it? Like any kind of further kind of breakdown for the strength there?

Tim Regan — Chief Financial Officer

Sure. So FormSwift did outperform our expectations. We continue to expect that it will contribute about 2.5 points to our growth this year, and we’re excited about the progress we’re making on the integration front with FormSwift. I think we’re also seeing improving sign-up trends as a result of our rollout of Google One Tap, which reduces friction in the sign-up and onboarding process. We also did see churn improve across our individual plans, particularly as we exited the quarter. And then, of course, we continue to see a contribution from the pricing and packaging changes that we announced in June on our teens plants.

Steve Enders — Citi — Analyst

Okay. Perfect. Appreciate the opportunity taking the questions here.

Operator

Thank you. One moment for our next question please. All right, and our next question comes from the line of Brent Thill with Jefferies. Please proceed.

Alan — Jefferies — Analyst

Hey. This is Alan [Phonetic] on for Brent Thill. Thank you for taking my question. First, what are you seeing out there in the market? And what considerations are factored into your guide? What are you seeing in terms of churn? Thanks.

Tim Regan — Chief Financial Officer

See, as far as the macro trends, I’d say that we’re seeing trends that are roughly consistent with what we saw in the fourth quarter, we continue to see elevated price sensitivity and down-sell pressure from our teams, customers, particularly those that had layoffs themselves. And then Sign and DocSend also continue to face macro-related headwinds. DocSend, in particular, is exposed to the fundraising community, where the recent banking events are adding some volatility to that vertical. And we continue to see elevated levels of churn from our individual SKUs, though again, we did see those trends improve exiting the quarter. We also saw incremental FX headwinds in Q1, and we expect a similar impact in Q2.

From maybe a guidance philosophy perspective, we do remain prudent and continue to factor in an appropriate level of conservatism given the challenging macro landscape. We’ve assumed that key trends such as a degree of elevated churn and customer price sensitivity will continue throughout 2023. So certainly factoring in these latest signals and not assuming any level of improvement in the economy and our guidance and certainly also mindful of our reduction in force and the potential effect that this could happen in our billings given our reduced levels of investment in headcount and marketing. So again, all of these considerations are factored into our guidance.

Alan — Jefferies — Analyst

Thanks. Super helpful color. And lastly, how should we be thinking about the mix of paid user growth and ARPU to drive future growth?

Tim Regan — Chief Financial Officer

Sure. So from a paid user perspective, we added about 120,000 paid users in the first quarter. Family plan was a significant contributor to that. FormSwift also added to paying users in Q1, particularly as this business does have a seasonal increase due to tax season. As far as forward-looking expectations, we don’t formally guide to debt new paying users and particularly as we navigate our pricing and packaging changes in the current macro environment, I’d continue to expect something in the neighborhood of roughly 100,000 net new paying users per quarter with ARPU expansion being more pronounced this year as we saw in the first quarter.

Alan — Jefferies — Analyst

Thanks. Super helpful.

Operator

Thank you so much. [Operator Instructions] And it comes from the line of Matt Book with Bank of America. Please proceed.

Matt Book — Bank of America — Analyst

Hi. Thanks for the questions. I wanted to double tap on the Command E opportunity here. Is there anything you can give us in terms of the competitive environment for universal search or who you expect to compete most directly with?

Drew Houston — Co-Founder and Chief Executive Officer

Sure. So I mean at a high level I’d say it’s very early for the category. I think there are startups that are going to pursue ideas in this in the space. And we believe that we’re well positioned there because of our scale, our distribution, are able — our ability to make significant technical infrastructure investments and the fact that we already have the trust relationship with customers and that they’re already trusting the most important information in Dropbox.

So when you think about Universal Search and Content we think we have big advantages versus start-ups. And then, of course, the platform companies, folks that provide office suites to various kinds they will certainly do things in this area as well. But I think the fact that we’re platform agnostic and then also aspects of our trust and privacy brand the fact that we’re a subscription business and not advertising, our track record with privacy and trust. I think those are big advantages against the larger incumbents as well.

Matt Book — Bank of America — Analyst

Excellent. Thank you. And then just quickly, was there anything to call out in terms of the ARPU this quarter. It was a nice beat relative to expectations. Is that just the FormSwift tailwinds or anything else?

Drew Houston — Co-Founder and Chief Executive Officer

Sure. So ARPU increased just over $4 sequentially and maybe breaking down some of the components of that increase was primarily driven by benefits from our pricing initiatives. So I’d say that’s about $2.50. And our acquisition of FormSwift, that contributed about $2, and this was partially offset by the continued growth in our family plan.

Matt Book — Bank of America — Analyst

Excellent. Thank you very much.

Operator

Thank you. And I’m not showing any further questions in the queue, team.

Drew Houston — Co-Founder and Chief Executive Officer

Thank you, everyone, for dialing in for your support, and we’ll see you next quarter.

Operator

[Operator Closing Remarks]