Earnings Call Transcript - DBX Q4 2021

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for joining Dropbox's Fourth Quarter 2021 Earnings Conference Call. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox's website following this call. I will now turn it 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 Fourth Quarter 2021 Earnings Call. Today, Dropbox will discuss the quarterly financial results that were distributed earlier. Statements on this call include forward-looking statements, including future financial results, including our goals and expectations regarding future revenue growth, profitability and our ability to generate and sustain positive free cash flow; our expectations regarding anticipated benefits to our business and the impact to our financial results, including estimated impairment charges as a result of our shift to a Virtual First work model; our expectations regarding the future performance of our business; operational efficiencies we may achieve as a result of changes to our organizational structure; our expectations regarding remote work trends, related market opportunities and our ability to capitalize on those opportunities; our capital allocation plans, including expected timing and volume of share repurchases, future M&A opportunities and other investments; our ability to drive user growth and retention by enhancing our products, developing and offering new products or features and through strategic partnerships; our strategy as well as the ability of our key employees to execute our strategy and our overall future prospects and ability to generate shareholder value. 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 the risk factors included in our Form 10-Q for the quarter ended September 30, 2021, and the risk factors that will be included in our Form 10-K for the year ended December 31, 2021. 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's Co-Founder and Chief Executive Officer, Drew Houston. Drew?

Drew Houston, CEO

Thanks, Kern, and good afternoon, everyone. Welcome to our Q4 2021 earnings call. Joining me today is Tim Regan, our Chief Financial Officer. I'll start with a recap of 2021 and provide an overview of our strategy for 2022. Then Tim will go over our results for Q4 and the fiscal year 2021, give guidance for Q1 and the full year 2022, and provide an update on our long-term financial targets. So let's get started. To recap, 2021 was a strong year for Dropbox. We ended with over $2.2 billion in ARR, significantly increased our profitability, grew free cash flow by over 40%, and reached approximately 600,000 paid teams. Throughout the year, we've stayed focused on our three strategic objectives and delivered even more value to our customers as we worked towards our long-term vision to organize all your cloud content and the workflows around it. Our first objective for 2021 was to evolve the Dropbox core offering. We made investments to simplify and remove friction from the experience to drive customer satisfaction and gains in long-term retention while also improving high-value actions like sharing content, previews, and mobile and team onboarding flows. I'm pleased to see these investments pay off. We've seen retention improve with churn coming down each quarter in 2021. Our rebuild of the mobile experience, which we began in 2020 and continued in 2021, was one of the biggest drivers of churn improvements. Last year, we also made improvements to quality, performance, and sharing to drive mobile user acquisition and retention at the basic level. These are crucial investments because nearly half of our basic sign-ups come from mobile, and over 40% of mobile sign-ups come from users receiving shared content. We also reduced the friction in the onboarding experience for mobile and self-serve teams users. We made it easier for basic users with a corporate domain to find a team after signing up, which drove a 15% increase in the request-to-join rate. We saw a nearly 20% increase in the invite center team by encouraging existing team users to invite their collaborators to the team within the sharing flow. Our second objective for 2021 was to invest in our product pipeline beyond the core experience. In early 2021, we acquired DocSend, a secured sharing and document analytics company. With DocSend, we added to our suite of document workflow capabilities, and I'm pleased to say it has outperformed our expectations each quarter. We're excited about DocSend's strength and our plans to further integrate it into Dropbox along with HelloSign. We also launched our newest products into beta, Capture, Replay, and Shop, designed to better support creative workflows and distributed teams. Lastly, in Q4, we closed our acquisition of Command E, a universal search company, which we believe will help bring our vision to life as we work to make it easier to find and organize all your cloud content. I'm really excited for our plans to build universal search into our roadmap and offer this capability to our users, which I'll share a bit more on later. Our last objective of 2021 was driving operational excellence and executing against our long-term financial targets. I'm proud of our progress here as we expanded our non-GAAP operating margins nearly 9 points year-over-year, consistent with our improvements in 2020. We increased free cash flow by over $200 million while delivering significant capital back to shareholders in the form of share repurchases, which Tim will discuss in more detail. We completed a full year in our Virtual First operating model. Though we're still early in the transition, we're already realizing some of the benefits. Employees report that they value the flexibility that our model offers, are more productive, and we're also seeing positive trends in attracting and hiring diverse and distributed talent. I'm excited to build on all the great work from 2021 this year. As I've shared before, there's never been a better time in history to be building software to improve the experience of modern work, and Dropbox is uniquely positioned to support our customers as they transition to new ways of working. To help frame our strategy, I want to reiterate some of the key macro trends we continue to see in this environment. First, over the last year, we've continued to see companies accelerate their shift to the cloud as they adapt to more flexible or hybrid working models. We see the ongoing growth of the creator economy as new tools and platforms offer more seamless ways to create, publish, and monetize content. More broadly, it's clear to us that the shift from working primarily in physical offices to working primarily in digital screens is a permanent one. We continue to see a huge opportunity to improve that experience and help organize the digital lives of our customers. With these themes in mind, this year, we remain focused on three important pieces of our strategy, much of which is consistent with the work we began in 2021. First, we'll continue to evolve our core FSS business to improve retention and drive monetization. Second, we're expanding workflows beyond FSS around documents, with HelloSign and DocSend, while also investing in rich media workflows to better serve creators. Finally, we'll stay focused on operational excellence as we continue to balance growth and profitability. I'll go deeper into each piece of that strategy, starting with evolving our core business. To drive monetization, we're focused on improving retention, strengthening the top of our funnel, and leveraging pricing and packaging. Let's start with retention. While we steadily reduce our churn rate over the past year, there's still room for improvement in usability and speed in our mobile and sharing capabilities. Investments we're making here include updating our web architecture, which enables faster web loading, improving mobile videos when browsing and organizing, and enhancing our search capabilities, so users can find their content faster. Virality and network effects are another key driver of retention as users who share tend to retain at higher rates. We've simplified the sharing experience, making it easier for mobile users to access shared content. We're also making it easier for work users, whether professionals or small teams, to quickly share and receive content across all of our surfaces. Teams will be easily able to see who has access to the content they've shared and any actions taken by recipients. Finally, we're enhancing the recipient experience for teams, making it more efficient for them to immediately engage with shared content, re-share it, add more content to a shared folder, or begin a related workflow like e-signature. While reducing churn is one component of improving monetization, we're also focused on our top of funnel and conversion. We've increased our marketing investments to drive product awareness of the new value that we provide beyond FSS. We're making improvements to our web surfaces and CRM to deliver more personalized and relevant product experiences, along with building a more seamless onboarding process overall. These investments also support our efforts to convert basic users, particularly on mobile, where we can easily surface some more of our high-value mobile features such as camera uploads and scanning and use mobile prompts and promotions to surface the right plan to users at the right time. Building on conversions, we're also experimenting with upsell opportunities through self-serve add-ons to drive more value from existing users. For example, in Q4, we rolled out our extended version history add-on to Plus users, allowing them to extend deleted file recovery in version history from 30 days to a year. We'll continue iterating on this approach with adjacent products in the pipeline, and I'll have more to share on that in the coming quarters. In the past, we've also had success leveraging effective pricing and packaging to drive growth, always tied to high-value capabilities that we see demand flow from our customers. This year, we're especially focused on security and automation. As more companies shift their workloads to the cloud, we continue to see security rank as a top spending priority for IT decision-makers from CIOs to solo professionals. This year, we plan to expand our offerings to include both lightweight capabilities like advanced alerts, insights, and controls as well as more robust protection against today's most critical threats like ransomware and phishing. We'll also build on our existing functionality like passwords to provide easy access to identity monitoring and manage shared accounts for teams and freelancers. Most recently, we updated passwords into our browser-first product and enabled password sharing, and we'll continue to iterate on this experience. We're also committed to investing in automation and machine intelligence to help our users organize their content and search and discover it more easily. We've learned from our most passionate creative customers that they need more than folders to collect and organize their content, which tends to be large format and rich media. They're used to targeted search to find what they're looking for and do not want to waste time browsing, especially since most of them live in a hybrid world of traditional media and cloud content. This year, we plan to improve the ways that users can view and manage their content through better suggestions and surfacing assisted and automated controls in search and performance. As always, we improve our products, add new functionality like security and automation, and increase the value for our customers. As we do that, we'll also iterate on pricing and packaging that best reflects that value. Now onto the second pillar of our strategy, which is expanding into adjacent workflows beyond FSS. In 2021, we saw the number of PDF files shared on Dropbox grow by nearly 40%, and the number of videos shared grew by over 25%. This kind of demand is why we're committed to driving workflows around documents with HelloSign and DocSend and around rich media like videos to better serve creatives and teams. HelloSign and DocSend were our fastest-growing businesses in 2021, and we're excited about the opportunity to expand their customer reach. An important part of this is bringing these products under the Dropbox umbrella, both through our back-end technology and brand. This month, we relaunched DocSend as a Dropbox product with Dropbox DocSend and went live with an updated marketing website and a more consistent user experience. In addition, we went to market with our first Dropbox and DocSend bundle, where we applied key learnings from our e-signature and Pro bundle, which has also seen increasing adoption. We continue to integrate HelloSign and DocSend to enable a true multiproduct experience that makes it easier for our customers to build the best plans for them in one checkout across both web and mobile. We see more opportunities to further integrate these workflows into our core functionality so that users can see e-signature and analytics, for example, side-by-side with their FSS solution. In late Q3 and Q4, we also took our newest product experiences, Dropbox Capture, Shop, and Replay to market to support creative professionals and teams around rich media. We've seen strong adoption and engagement from beta users who appreciate the ease of use of Shop and the time savings from Capture and Replay. Supporting creative professionals is an important part of our growth strategy as these are passionate and expanding base who are looking for more seamless ways to share digital content with their collaborators and customers. For example, Dropbox was integral to the Sundance Film Festival's ability to seamlessly go virtual in 2021 and 2022. The Sundance team used Dropbox to request and share video content throughout the festival and collect, organize, and share all the new assets they needed to create a dynamic and more accessible experience for the filmmakers and the attendees. Finally, we'll continue to focus on operational excellence. Our technology infrastructure team has done a great job strengthening our supply chain relationships to stay ahead of any constraints. We'll roll out Kubernetes this year to improve our infrastructure utilization, which we expect to drive efficiency and reduce costs while allowing us to maintain a more flexible footprint between public and private cloud. This is a great example of our increasing efficiency and making progress towards our long-term financial goals, which Tim will outline. I'm grateful to our employees who keep our business running and bring our culture to life. I'm pleased to share that once again, Dropbox has been included on the Forbes Best Employers List for 2022. For the seventh year in a row, Dropbox received a perfect score on the Corporate Equality Index. We're proud to stand alongside many of our peers as we support diversity, equity, and inclusion across all industries. We'll also continue to expand our geographic footprint and diversify our talent pool to support our Virtual First model. To close, I'm really excited about our strategy and our opportunity this year. I'm proud of all the progress we made in 2021 to lay the groundwork for the important work we have ahead. As I think about the future, what motivates me most is the universal problem that we're solving for our customers in helping to organize their working lives in the new remote and hybrid world. We see the shift from physical offices to digital screens as a permanent one, and there is a lot of room for improvement in the chaotic and overwhelming experience of those screens today. Most knowledge workers are caught between the file and browser-based world, juggling many web-based productivity apps. The 100 files we used to see on our desktops are now 100 tabs in our browsers. In many ways, we're solving today's version of the same problem we saw back in 2007. Our foundational work in 2021 was an important step towards our long-term vision of building one organized place for your cloud content and all the workflows around it. I'm looking forward to the year ahead. With that, I'll hand it over to Tim to walk through our financial results.

Tim Regan, CFO

Thank you, Drew. On today's call, I'll walk through our Fourth Quarter and full-year 2021 results, our 2022 guidance along with some context underlying this guidance, and then I will close with an update on our long-term targets. Starting with our Fourth Quarter and full-year 2021 results, total revenue for the Fourth Quarter increased 12.2% year-over-year to $565 million, beating our guidance range of $556 million to $559 million. Our revenue outperformance was driven by strength in our higher ASP offerings, such as our professional SKU, our teams’ plans, and DocSend. Foreign exchange rates provided approximately a 150 basis point tailwind to growth. Total ARR for the quarter grew 11.8% year-over-year for a total of $2.261 billion. On a constant currency basis, ARR grew by $43 million sequentially and 10.2% year-over-year. As Drew highlighted, our continued growth in ARR reflects our efforts to attract new users to our premium SKUs and to drive better retention by improving the user experience with a specific emphasis on mobile, work, and teams users. We exited the quarter with 16.79 million paying users and added approximately 300,000 net new paying users in the fourth quarter driven by strength in our team plans and continued adoption of our family plan. Average revenue per paying user was $134.78 in Q4. 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, certain acquisition-related expenses, impairments of our real estate assets, expenses related to our reduction in force, and net gains on our lease termination. Our non-GAAP net income also excludes net gains and losses on equity investments, the income tax benefit from the release of a valuation allowance on deferred tax assets, and includes the income tax effect of the aforementioned adjustments. I'll now provide a brief update on our real estate strategy, where we are taking steps to de-cost our real estate portfolio as part of our transition to a Virtual First model. We continue to make progress against our goals, executing subleases in Seattle and Ireland in the fourth quarter. As we anticipated during our previous earnings call, in the fourth quarter, we also successfully reached an agreement with our landlord to buy out a portion of our San Francisco lease, where we had an existing subtenant in Q4. This resulted in a one-time payment of $32 million, which is reflected within our cash flow from operations, and a $14 million gain on lease termination, which is reflected within our GAAP results. As a reminder, this lease termination agreement will drive significant savings as the amount of rent payments avoided exceeds the amounts we otherwise would have generated from our previous sublease. In the future, we may enter into similar buyouts with our landlords, should the economics make sense for us, though there are no other pending deals at this time. Separately, during the fourth quarter, we incurred impairment charges of $14 million on our remaining facilities footprint as continued pandemic restrictions translated to slower-than-expected subleasing. This brings our cumulative impairment incurred to-date to $430 million. We continue to estimate that our total impairment charges will be up to $450 million. Additionally, in Q4, our GAAP net income was favorably impacted by a $38 million one-time income tax benefit from the release of a valuation allowance on Irish deferred tax assets. This event is a result of our improved profitability, leading us to conclude that our valuation allowance on these deferred tax assets is no longer necessary. I would also note that there is no cash impact associated with this one-time benefit. With that, let's continue with the P&L. I'd note that all expense categories continue to benefit from lower facilities-related costs driven by pandemic restrictions and a reduction in depreciation as a result of the write-down in our real estate assets stemming from the aforementioned impairment. Gross margin was 81% for the quarter, representing an increase of 1 percentage point on a year-over-year basis. The improvement in our gross margin is primarily a result of the continued rollout of hardware efficiencies across our internally managed storage and data infrastructure. Fourth quarter R&D expense was $148 million or 26% of revenue, which is slightly increased as a percent of revenue compared to the fourth quarter of 2020. Sales and marketing expense was $99 million or 17% of revenue, which decreased compared to 20% of revenue in the fourth quarter of 2020. G&A expense was $43 million or 8% of revenue, which decreased compared to 9% of revenue in the fourth quarter of 2020. In total, we earned an operating profit of $168 million in the fourth quarter, which represents an operating margin of 30%, or a 4 percentage point improvement compared to the fourth quarter of 2020. Net income for the fourth quarter was $160 million, which is a 36% improvement over the fourth quarter of 2020. Diluted EPS was a record $0.41 per share based on 386 million diluted weighted average shares outstanding, up from $0.28 per share based on 416 million diluted weighted average shares outstanding for the fourth quarter of 2020. Moving on to our cash balance and cash flow, we ended the quarter with cash and short-term investments of $1.718 billion. Cash flow from operations was $163 million in the fourth quarter and includes the impact of the aforementioned lease buyout of our headquarters in San Francisco. Capital expenditures were $1 million during the quarter. This resulted in quarterly free cash flow of $161 million compared to $158 million in Q4 of 2020. In the fourth quarter, we added $16 million to our finance leases for data center equipment. Let's turn to our share repurchase activity. In Q4, we repurchased 11.2 million shares, spending approximately $295 million, nearly doubling the number of shares purchased from Q3. Our buyback program is structured to buy more shares at lower price points. At the end of Q4, we had approximately $344 million remaining on our $1 billion share repurchase authorization. Additionally, earlier this month, our Board authorized an additional $1.2 billion share repurchase program. Now let's turn to our full year 2021 results. Total revenue for 2021 was $2.158 billion, representing 12.7% year-over-year growth, beating our updated guidance range. On a constant currency basis, relative to the average rates across 2020, year-over-year growth would have been 11.1%. Reflecting on this for a moment, our 2021 total revenue beat our initial constant currency revenue guidance of approximately 8% by over 300 basis points as we executed against our strategic pillars and outperformed throughout the year. Gross margin was 81% for the year, which was up 1 percentage point from 2020. Operating margin was 30% for 2021, which was up 9 percentage points from 2020. This significant year-over-year improvement demonstrates our continued commitment to and ability to execute against our long-term financial targets. Net income was $609 million for the year, a 56% improvement over last year. Diluted EPS was $1.54 per share based on 396 million diluted weighted average shares outstanding, up from $0.93 per share for the full year 2020. Cash flow from operations for 2021 was $730 million. Capital expenditures for the full year totaled $22 million, resulting in free cash flow of $708 million, or 33% of revenue. Free cash flow grew by over 40% year-over-year. In 2021, we also added $127 million to our finance lease lines for data center equipment. Net of repayments, our finance lease balance increased by $17 million. Finally, we repurchased approximately 41 million shares, spending over $1 billion in 2021. I'd now like to share our 2022 first quarter and full year guidance, where I will also provide some context on the thinking behind this guidance. For the first quarter, we expect revenue to be in the range of $557 million to $560 million. We are assuming a minimal currency tailwind of approximately $1 million in the first quarter. Additionally, and as a reminder, there are fewer subscription days in the first quarter of each year. We expect non-GAAP operating margin to be in the range of 27.5% to 28%. As a reminder, there is some seasonality with first-quarter operating margins as payroll taxes reset at the start of each year. Finally, we expect diluted weighted average shares outstanding to be in the range of 375 million to 380 million shares based on our trailing 30-day average share price. For the full year, we expect revenue to be in the range of $2.320 billion to $2.330 billion. This range is inclusive of an approximate $16 million currency headwind. We expect gross margin to be approximately 81%. We expect non-GAAP operating margin to be approximately 29%. We expect free cash flow to be in the range of $760 million to $790 million. This includes $17 million in cash outflows for the 2022 installments of acquisition-related deal consideration holdbacks. Additionally, our free cash flow guidance is inclusive of an estimated $30 million headwind as a result of pending R&D tax legislation. As related to capital expenditures, we expect our addition to finance leases to be approximately 5% of revenue, and we expect cash CapEx to be in the range of $25 million to $35 million in 2022. We expect 2022 diluted weighted average shares outstanding to be in the range of 368 million to 373 million shares. In addition to this formal guidance, I wanted to share some further context behind our expectations for 2022. As related to revenue, and as Drew shared, we've been investing across the business as we grow our product portfolio. Specifically, we have increased our investment in R&D and marketing initiatives in recent quarters in a targeted way to address key opportunities, including efforts aimed towards improving our retention trends, fueling growth areas such as DocSend and HelloSign through both product innovation and foundational improvements that help us capture the synergies inherent in these deals, and launching new features and capabilities aimed at improving conversion. We continue to invest in ensuring a seamless experience for our customers as we adapt our desktop client to operating system updates and changes, most recently related to a new version of Mac OS. We're also building out our capabilities in security and automation to address customer demand in an increasingly complex environment. As we continue to add value with these features and other investments in the user experience this year, we envision updates to our pricing and packaging approach for a subset of our customers to reflect this value. We expect the cumulative impact of these efforts to translate to monetization momentum, culminating in accelerating revenue growth in the back half of the year. Any changes we are considering on pricing and packaging in the second half of the year have been factored into this guidance. As related to operating margins, we are facing a few exogenous headwinds this year that are playing a role in our guidance. In 2021, we benefited from an approximate two-point FX tailwind, whereas in 2022, we are currently expecting roughly a 50 basis point headwind. We also expect to incur incremental T&E, event and overhead expenses in 2022 as pandemic restrictions soften and company travel and employee gatherings resume. Additionally, we will continue to invest in R&D and sales and marketing initiatives that carry a compelling ROI. Regarding free cash flow, our guidance includes a $30 million cash tax headwind as a result of pending tax legislation that would defer recently effective laws that now require R&D costs to be capitalized for tax purposes. There is a possibility that the current legislation may be amended or repealed; however, until such time, we are including this impact in our guidance. Furthermore, I'll now share an update on our long-term targets, which we plan to achieve by 2024. Our infrastructure team continues to drive innovation and efficiency as we manage our storage footprint. As a result, we are now above the top end of our previous long-term gross margin target range, and we continue to see incremental room to drive efficiencies. As such, we are raising our long-term gross margin target to a range of 80% to 82%, up from our previous range of 78% to 80%. As for operating margins, despite the exogenous headwinds mentioned earlier, we are confident in our ability to drive leverage in our business. As a result, we are increasing our long-term operating margin target to a range of 30% to 32%, up from our previous range of 28% to 30%. It is important to note that even with raising our operating margin targets, we've maintained flexibility to invest in high ROI initiatives while top line growth remains a key priority for us. Additionally, despite the aforementioned cash tax headwinds, we are reiterating our goal of annual free cash flow of $1 billion by 2024. Lastly, I want to share an update on our plan to return capital to shareholders in the form of share repurchases. We plan to exhaust our previously authorized $1 billion share repurchase program in the first half of this year. Furthermore, our Board has authorized an additional $1.2 billion share repurchase program, consistent with our strategy to allocate a significant portion of our annual free cash flow to share repurchases with the goal of reducing our share count. In conclusion, our financial objectives remain intact. We continue to focus on balancing growth and profitability in a thoughtful, disciplined way. We continue to allocate capital to initiatives that carry a compelling return while also returning cash to shareholders in the form of share repurchases. This strong rule of 40 financial profile enables us to invest in the biggest opportunities we may see to enhance the value of our product offerings, drive long-term sustainable top line growth, and create shareholder value.

Operator, Operator

Thank you. Our first question comes from Mark Murphy with JPMorgan. You may proceed with your question.

Mark Murphy, Analyst

Yes, thank you very much and congrats on all the progress that you're making. Drew, I had a question regarding Dropbox Capture and Replay products. What is it that's underpinning this move that you seem to have into video creation and targeting creatives? Just wondering if there's more to come on this video roadmap. And as well, can you just touch on the margin profile for maybe storing some of those larger video-type files?

Drew Houston, CEO

Sure. I can start. So we're following customer demand, and we've been seeing an explosion in engagement with video on the platform over the last couple of years. This dovetails with the rise of the creator economy, as we have more creative professionals on Dropbox and a broader audience of casual creatives or creators. Dropbox resonates with these audiences because their workflows revolve around large files and rich media, and we've received a lot of demand from these customers to better support video and their new workflows. Capture and Replay are examples of that, where you can communicate over video and help produce video in a distributed way. Dropbox Shop is another where we're helping our customers monetize their digital content. We see that Dropbox really resonates with these customers. They need more than what they get with the bundled solutions in their office suites. We think it's going to be an exciting expansion opportunity for us.

Tim Regan, CFO

And then, Mark, this is Tim. Maybe I'll just add to that. As far as Capture, Replay, and Shop, these are lean internal teams where these were not material contributors to our results in 2021 and are not expected to materially contribute in the near term. These are certainly longer-term bets where we will be monitoring adoption and adjusting our resourcing accordingly. As related to margins, you can see they're not having a material impact on our margins, as indicated by the raise in our long-term targets to 80% to 82% for gross margins.

Mark Murphy, Analyst

Yes. And so Tim, thank you for clarifying that. It kind of bridges right into my other question, which is on the increase in the long-term margin framework. Obviously, it's nice to see. I think I'm just wondering what is the delta that's creating the uplift there? For instance, maybe it's the real estate footprint coming down, or maybe it's storage costs, maybe it's user acquisition costs, or something else. Can you just help us bridge to that increase there?

Tim Regan, CFO

Sure. So as you know, we are raising our long-term operating margin target to 30% to 32%, up from 28% to 30%. We do have some headwinds this year, such as FX and post-pandemic costs like additional T&E and other costs. Despite this, we see the opportunity to drive leverage within the business, starting with our infrastructure team as they continue to find ways to be more efficient with our storage costs. Additionally, we see other ways to drive efficiencies, such as the shift to lower-cost locations. As a result, we see the opportunity to raise these longer-term targets. That said, we still have room to invest in growth opportunities, and we remain focused on driving sustainable top-line growth.

Brent Thill, Analyst

Drew, there's been a lot of talk about the great pull forward during the pandemic. I'm curious about your thoughts on whether there is a digestion phase on the way, or do you feel from what you're seeing in the signals that your clients are continuing to move forward at the same pace you saw over the last couple of years? I'm curious just to get your thoughts on the overall shape of demand and what you're seeing.

Drew Houston, CEO

Sure. I think, I mean, there may be different shapes across the different businesses. On the core business, it's been pretty stable. We found a lot of our customers needed Dropbox before the pandemic, during the pandemic, and they will continue to need it after the pandemic. Businesses like HelloSign and DocSend experienced a surge in demand during the pandemic, which has moderated somewhat. As people are working more from screens than from offices, we see that there is a significant opportunity for Dropbox to help organize their cloud content—the fragmentation challenge has become more acute post-pandemic. Overall, we think the shift to distributed work will only create more demand for our tools.

Brent Thill, Analyst

And just on the capital allocation, great to see the buyback, but some will ask why not plow that into more innovation and M&A? What's driving conviction to keep driving that? Are you leaving enough room for M&A going forward? Can you just walk through that decision?

Drew Houston, CEO

Sure. I can start. Tim, feel free to add on. Our business is really efficient. We can invest in a lot of growth areas, and we're always thinking about balancing growth and profitability. We can afford to fund our core business and some of the transformation we're working on. We have our growth stage businesses like HelloSign and DocSend, which are fully funded, as well as a longer tail of newer products we believe are big long-term opportunities. We're excited that the market corrects so that M&A can become more efficient, but we will remain disciplined.

Tim Regan, CFO

And maybe just to quickly add to that. We do, as Drew alluded to, have a very strong balance sheet and an efficient business model that generates a lot of cash. That gives us great flexibility to pursue share repurchases, M&A, and organic investments. We intend to allocate a significant portion of our annual free cash flow to share repurchases while still keeping an eye on opportunities for M&A that complement our vision and product roadmap, similar to HelloSign and DocSend. Regarding organic investments, we will continue to invest in R&D to cultivate a diverse product portfolio and drive revenue growth.

Steve Enders, Analyst

Okay. Great. Thanks for taking the question. I appreciate all the extra context on the guide. I guess I want to get a better sense of how you're thinking about the levers that you could potentially pull as you think about the revenue opportunity for the year. It seems like there are some things coming both on the pricing and packaging side, but are there other income areas where you either invest or optimize some of the experiences to drive better conversion rates?

Drew Houston, CEO

Yes, I can start. So, the growth–there are many growth levers we are focused on, including continued optimizations to our core FSS business. We see a lot of opportunities to continue reducing churn, improving engagement, customer experience, and simplifying the experience overall. The growth stage businesses with HelloSign and DocSend have a lot of headroom, and we also see opportunities for a broader transformation of our core business. These are all levers we're investing in at various degrees, and we feel good about our portfolio.

Tim Regan, CFO

We're always thoughtful about our pricing and packaging approach to ensure it accurately reflects the value we're delivering to customers. As we enhance our products and deliver even more value, we will iterate our pricing and packaging approach. Our 2022 guidance includes updates to this pricing and packaging approach, and we'll provide more detail in future quarters.

Rishi Jaluria, Analyst

Wonderful. Thanks so much for taking my question, guys. Two here. First, I wanted to go back to the long-term operating model. I appreciate you're raising the margin target. But I have to wonder, is the R&D target a bit too high? You're talking about still spending 23% to 25% of revenue, which is great as a product-led growth company. But given the 7.5% growth forecast for 2022 and expected negative sequential growth for Q1, how do you see that spending justified in terms of growth? Could you remind us how you're thinking about your R&D expenses in this context?

Tim Regan, CFO

So we are investing for growth. We've been adding R&D headcount, and it takes time for these investments to translate to new ARR and flow through to revenue. We are focusing on our highest return initiatives, such as retention improvements, enhancing security and automation, and enabling our multiproduct strategy. These foundational investments are critical for our long-term growth.

Drew Houston, CEO

On balance, we have found Virtual First to be beneficial. Last year, we saw a 126% increase in offer acceptances. The flexibility offered by our model resonates well, leading to a strong influx in candidates. I believe employees are demanding that flexibility. Every company is figuring out how to maintain culture in a distributed environment while offering this flexibility. I think it positions us well, and we’re excited to reintroduce the in-person experience in the coming months.

Joey Marincek, Analyst

Great. Thank you so much. It's Joey Marincek on for Pat. Just one from our end. On HelloSign, can you give us an update on the competitive set there? How often are you going head-to-head? And how penetrated do you think that market opportunity is? Thank you so much.

Drew Houston, CEO

Sure. Things are going well with HelloSign; it continues to be one of our fastest-growing businesses. We've seen increasing adoption of our professional and e-signature bundle, which allows customers to buy both Dropbox and HelloSign at a slight discount. Our customers appreciate how we've added SharePoint support, and we have launched a new mobile app. Overall, we see a stable competitive environment. Our advantage is that HelloSign focuses on a product-led growth motion that is efficient and scalable. We believe this opportunity is still early.

Operator, Operator

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Drew Houston for any further remarks.

Drew Houston, CEO

All right, everyone. Well, thanks again for joining us today. We appreciate your continued support and look forward to speaking with you again next quarter.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.