10-Q 1 dbx-063018x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018

or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from________to________

Commission File Number 001-38434

 
Dropbox, Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
26-0138832
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
Dropbox, Inc.
333 Brannan Street
San Francisco, California 94107
(415) 857-6800
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
  
Accelerated filer
¨
 
 
 
Non-accelerated filer
x
  
Smaller reporting company
¨
 
 
 
 
 
(Do not check if a smaller reporting company)
 
Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.    ¨

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of July 31, 2018, there were 112,045,238 shares of the registrants’ Class A common stock outstanding (which excludes 14,733,333 shares of Class A common stock subject to restricted stock awards that were granted pursuant to the Co-Founder Grants, and vest upon the satisfaction of a service condition and achievement of certain stock price goals), 290,261,229 shares of the registrant’s Class B common stock outstanding, and no shares of the registrant’s Class C common stock outstanding.





TABLE OF CONTENTS

 
 
Page
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 

2


FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risk and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

our ability to retain and upgrade paying users;

our ability to attract new users or convert registered users to paying users;

our future financial performance, including trends in revenue, costs of revenue, gross profit or gross margin, operating expenses, paying users, and free cash flow;

our ability to achieve or maintain profitability;

the demand for our platform or for content collaboration solutions in general;

possible harm caused by significant disruption of service or loss or unauthorized access to users’ content;

our ability to effectively integrate our platform with others;

our ability to compete successfully in competitive markets;

our ability to respond to rapid technological changes;

our expectations and management of future growth;

our ability to grow due to our lack of a significant outbound sales force;

our ability to attract large organizations as users;

our ability to offer high-quality customer support;

our ability to manage our international expansion;

our ability to attract and retain key personnel and highly qualified personnel;

our ability to protect our brand;

our ability to prevent serious errors or defects in our platform;

our ability to maintain, protect, and enhance our intellectual property; and

our ability to successfully identify, acquire, and integrate companies and assets.
We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.
You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a

3


very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

4


PART I. FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS

DROPBOX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)

As of

June 30, 2018

December 31, 2017
Assets



Current assets:



Cash and cash equivalents
$
504.1


$
430.0

Short-term investments
477.7



Trade and other receivables, net
31.2


29.3

Prepaid expenses and other current assets
86.8


58.8

Total current assets
1,099.8


518.1

Property and equipment, net
330.8


341.9

Intangible assets, net
16.3


17.0

Goodwill
97.8


98.9

Other assets
57.7


44.0

Total assets
$
1,602.4


$
1,019.9

Liabilities and stockholders’ equity



Current liabilities:



Accounts payable
$
24.0


$
31.9

Accrued and other current liabilities
172.3


129.8

Accrued compensation and benefits
45.1


56.1

Capital lease obligation(1)
87.1


102.7

Deferred revenue
464.8


417.9

Total current liabilities
793.3


738.4

Capital lease obligation, non-current(1)
73.1


71.6

Deferred rent, non-current
73.6


69.8

Other non-current liabilities
31.5


37.2

Total liabilities
971.5


917.0

Commitments and contingencies (Note 7)



Stockholders’ equity:



Convertible preferred stock

 
615.3

Preferred stock



Common stock



Additional paid-in capital
2,248.4


533.1

Accumulated deficit
(1,619.4
)

(1,049.7
)
Accumulated other comprehensive income
1.9


4.2

Total stockholders’ equity
630.9


102.9

Total liabilities and stockholders’ equity
$
1,602.4


$
1,019.9


(1) Includes amounts attributable to related party transactions. See Note 12 for further details.

See accompanying Notes to Condensed Consolidated Financial Statements.

5


DROPBOX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
(Unaudited)

Three Months Ended
June 30,
 
Six Months Ended
June 30,

2018

2017
 
2018
 
2017
Revenue
$
339.2


$
266.7

 
$
655.5

 
$
514.6

Cost of revenue(1)
89.5


92.2

 
210.1

 
185.7

Gross profit
249.7


174.5

 
445.4

 
328.9

Operating expenses(1):



 

 

Research and development
119.7


89.8

 
498.2

 
179.1

Sales and marketing
87.4


69.2

 
244.4

 
136.4

General and administrative(2)
49.8


42.2

 
175.9

 
73.5

Total operating expenses
256.9


201.2

 
918.5

 
389.0

Loss from operations
(7.2
)

(26.7
)
 
(473.1
)
 
(60.1
)
Interest income (expense), net
2.0


(3.0
)
 
0.8

 
(7.2
)
Other income, net
2.2


3.3

 
5.6

 
8.1

Loss before income taxes
(3.0
)

(26.4
)
 
(466.7
)
 
(59.2
)
Provision for income taxes
(1.1
)

(0.4
)
 
(2.9
)
 
(0.7
)
Net loss
$
(4.1
)

$
(26.8
)
 
$
(469.6
)
 
$
(59.9
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.01
)

$
(0.14
)
 
$
(1.51
)
 
$
(0.31
)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted
401.3


195.4

 
310.5

 
194.5

(1) 
Includes stock-based compensation as follows (in millions):

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenue
$
2.9

 
$
3.3

 
$
40.7

 
$
6.4

Research and development
27.9

 
21.7

 
310.8

 
43.5

Sales and marketing
7.9

 
7.7

 
80.3

 
15.4

General and administrative
16.4

 
6.0

 
109.8

 
12.2


(2) 
General and administrative expense for the three and six months ended June 30, 2017 includes $9.4 million related to a non-cash charitable contribution of common stock to the Dropbox Charitable Foundation, which is a related party of the Company. The Company made additional cash contributions to the Foundation of $0.2 million and $0.4 million during the three and six months ended June 30, 2017, respectively. See Note 12 for further details.

See accompanying Notes to Condensed Consolidated Financial Statements.

6


DROPBOX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In millions)
(Unaudited)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(4.1
)
 
$
(26.8
)
 
$
(469.6
)
 
$
(59.9
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in foreign currency translation adjustments
(3.6
)
 
1.1

 
(2.1
)
 
3.6

Change in net unrealized losses on short-term investments
(0.1
)
 

 
(0.2
)
 

Total other comprehensive income (loss), net of tax
$
(3.7
)
 
$
1.1

 
$
(2.3
)
 
$
3.6

Comprehensive loss
$
(7.8
)
 
$
(25.7
)
 
$
(471.9
)
 
$
(56.3
)

See accompanying Notes to Condensed Consolidated Financial Statements.

7


DROPBOX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
Six months ended June 30,
 
2018
 
2017
Cash flow from operating activities
 
 
 
Net loss
$
(469.6
)
 
$
(59.9
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
75.9

 
94.4

Stock-based compensation
541.6

 
77.5

Amortization of deferred commissions
5.3

 
2.6

Donation of common stock to charitable foundation

 
9.4

Other
(1.1
)
 
(0.9
)
Changes in operating assets and liabilities:
 
 
 
Trade and other receivables, net
(1.9
)
 
(9.1
)
Prepaid expenses and other current assets
(33.9
)
 
2.4

Other assets
(17.5
)
 
(2.1
)
Accounts payable
(8.5
)
 
2.6

Accrued and other current liabilities
44.5

 
11.8

Accrued compensation and benefits
(10.9
)
 
(6.6
)
Deferred revenue
46.4

 
32.2

Non-current liabilities
3.4

 
(6.6
)
Net cash provided by operating activities
173.7

 
147.7

Cash flow from investing activities
 
 
 
Capital expenditures
(19.6
)
 
(8.8
)
Purchases of intangible assets
(2.5
)
 
(0.8
)
Cash received from equipment rebates
0.9

 
1.9

Purchases of short-term investments
(495.9
)
 

Proceeds from maturities of short-term investments
16.4

 

Proceeds from sales of short-term investments
3.1

 

Net cash used in investing activities
(497.6
)
 
(7.7
)
Cash flow from financing activities
 
 
 
Proceeds from initial public offering and private placement, net of underwriters' discounts and commissions
746.6

 

Payments of deferred offering costs
(3.4
)
 

Shares repurchased for tax withholdings on release of restricted stock
(282.4
)
 
(24.0
)
Principal payments against capital lease obligations(1)
(58.3
)
 
(69.3
)
Other
(3.1
)
 
(5.1
)
Net cash provided by (used in) financing activities
399.4

 
(98.4
)
Effect of exchange rate changes on cash and cash equivalents
(1.4
)
 
1.4

Change in cash and cash equivalents
74.1

 
43.0

Cash and cash equivalents—beginning of period
430.0

 
352.7

Cash and cash equivalents—end of period
$
504.1

 
$
395.7

 
 
 
 
Supplemental cash flow data:
 
 
 
Property and equipment acquired under capital leases
$
44.2

 
$
15.4

(1) 
Includes amounts attributable to related party transactions. See Note 12 for further details.

See accompanying Notes to Condensed Consolidated Financial Statements.

8

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)



Note 1.
Description of the Business and Summary of Significant Accounting Policies

Business
Dropbox, Inc. (the “Company” or “Dropbox”) is a global collaboration platform. Dropbox was incorporated in May 2007 as Evenflow, Inc., a Delaware corporation, and changed its name to Dropbox, Inc. in October 2009. The Company is headquartered in San Francisco, California.

Basis of presentation and consolidation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the United States of America generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. The accompanying unaudited condensed consolidated financial statements include the accounts of Dropbox and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The condensed consolidated balance sheet as of December 31, 2017 included herein was derived from the audited financial statements as of that date. The unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the balance sheets, statements of operations, statements of comprehensive loss and the statements of cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full fiscal year ended December 31, 2018 or any future period.

The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto as of and for the year ended December 31, 2017, included in the Company's prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on March 23, 2018, referred to as the Prospectus.

Initial public offering and private placement
On March 27, 2018, the Company closed its initial public offering ("IPO"), in which the Company issued and sold 26,822,409 shares of Class A common stock at $21.00 per share. The Company received aggregate proceeds of $538.2 million, net of underwriters' discounts and commissions, before deducting offering costs of $6.9 million, net of reimbursements.

Immediately prior to the closing of the Company’s IPO, 147,310,563 shares of convertible preferred stock outstanding converted into an equivalent number of shares of Class B common stock. Further, pursuant to transfer agreements with certain of the Company’s stockholders, 258,620 shares of the Company’s convertible preferred stock and 2,609,951 shares of the Company’s Class B common stock automatically converted into an equivalent number of shares of Class A common stock. 

Immediately subsequent to the closing of the Company's IPO, Salesforce Ventures LLC purchased 4,761,905 shares of Class A common stock from the Company at $21.00 per share. The Company received aggregate proceeds of $100.0 million and did not pay any underwriting discounts or commissions with respect to the shares that were sold in the private placement.

On March 28, 2018, the underwriters exercised their option to purchase an additional 5,400,000 shares of the Company's Class A common stock at $21.00 per share. This transaction closed on April 3, 2018, resulting in additional proceeds of $108.4 million, net of underwriters' discounts and commissions.

The Company’s net proceeds from the IPO, the concurrent private placement, and underwriters' option totaled $746.6 million, before deducting offering costs of $6.9 million, net of reimbursements.

Upon the effectiveness of the registration statement for the Company's IPO, which was March 22, 2018, the liquidity event-related performance vesting condition, referred to as the Performance Vesting Condition, associated with the Company's two-tier RSUs was satisfied. As a result, the Company recognized the cumulative unrecognized stock-based compensation related to its two-tier restricted stock units ("RSUs") using the accelerated attribution method of $418.7 million attributable to service prior to such effective date. As of June 30, 2018, the remaining unamortized stock-based compensation related to the

9

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


two-tier RSUs was $1.2 million, which will be recognized if the requisite service is provided over a weighted average period of 0.4 years.

During the first quarter of 2018, the Company's Board of Directors approved the acceleration of the Performance Vesting Condition for which the service condition was satisfied, to occur upon the effectiveness of the registration statement for the Company's IPO, rather than six months following an IPO. As a result, the Company released 26.8 million shares of common stock underlying the two-tier RSUs for which the Performance Vesting Condition was satisfied, and recorded $13.9 million in employer related payroll tax expenses associated with these same awards. See “—Stock-Based Compensation” for further discussion regarding the Company's two-tier RSUs.

Stock Split
On March 7, 2018, the Company effected a 1-for-1.5 reverse stock split of its capital stock. All of the share and per share information referenced throughout the condensed consolidated financial statements and notes to the condensed consolidated financial statements have been retroactively adjusted to reflect this reverse stock split.

Use of estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the Company’s condensed consolidated financial statements and accompanying notes. These estimates are based on information available as of the date of the condensed consolidated financial statements. Management evaluates these estimates and assumptions on a regular basis. Actual results may differ materially from these estimates.

The Company’s most significant estimates and judgments involve recognition of revenue, the measurement of the Company’s stock-based compensation, including the estimation of the underlying deemed fair value of common stock in periods prior to the date of the Company's IPO, the estimation of the fair value of market-based awards, and the valuation of acquired intangible assets and goodwill from business combinations.

Financial information about segments and geographic areas
The Company manages its operations and allocates resources as a single operating segment. Further, the Company manages, monitors, and reports its financials as a single reporting segment. The Company’s chief operating decision-maker is its Chief Executive Officer, who reviews financial information presented on a consolidated basis for purposes of making operating decisions, assessing financial performance, and allocating resources. For information regarding the Company’s long-lived assets and revenue by geographic area, see Note 13.

Foreign currency transactions
The assets and liabilities of the Company’s foreign subsidiaries are translated from their respective functional currencies into U.S. dollars at the exchange rates in effect at the balance sheet date. Revenue and expense amounts are translated at the average exchange rate for the period. Foreign currency translation gains and losses are recorded in other comprehensive income (loss).

Gains and losses realized from foreign currency transactions (those transactions denominated in currencies other than the foreign subsidiaries’ functional currency) are included in other income (expense), net. Monetary assets and liabilities are remeasured using foreign currency exchange rates at the end of the period, and non-monetary assets are remeasured based on historical exchange rates. The Company recorded net foreign currency transaction losses of $1.1 million and $0.4 million during the three and six months ended June 30, 2018, respectively, and net foreign currency transaction gains of $1.3 million and $4.0 million during the three and six months ended June 30, 2017, respectively.

Revenue recognition
The Company derives its revenue from subscription fees from customers for access to its platform. The Company’s policy is to exclude sales and other indirect taxes when measuring the transaction price of its subscription agreements. The Company accounts for revenue contracts with customers through the following steps:
Identification of the contract, or contracts, with a customer

10

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations in the contract
Recognition of revenue when, or as, the Company satisfies a performance obligation

The Company’s subscription agreements generally have monthly or annual contractual terms and a small percentage have multi-year contractual terms. Revenue is recognized ratably over the related contractual term beginning on the date that the platform is made available to a customer. Access to the platform represents a series of distinct services as the Company continually provides access to, and fulfills its obligation to the end customer over the subscription term. The series of distinct services represents a single performance obligation that is satisfied over time. The Company recognizes revenue ratably because the customer receives and consumes the benefits of the platform throughout the contract period. The Company’s contracts are generally non-cancelable.

The Company bills in advance for monthly contracts and typically bills annually in advance for contracts with terms of one year or longer. The Company also recognizes an immaterial amount of contract assets, or unbilled receivables, primarily relating to rights to consideration for services completed but not billed at the reporting date. Unbilled receivables are classified as receivables when the Company has the right to invoice the customer.

The Company records contract liabilities when cash payments are received or due in advance of performance to deferred revenue. Deferred revenue primarily relates to the advance consideration received from the customer.

The price of subscriptions is generally fixed at contract inception and therefore, the Company’s contracts do not contain a significant amount of variable consideration. As a result, the amount of revenue recognized in the periods presented from performance obligations satisfied (or partially satisfied) in previous periods was not material.

The Company recognized $208.7 million and $313.0 million of revenue during the three and six months ended June 30, 2018, respectively, and recognized $166.6 million and $254.4 million of revenue during the three and six months ended June 30, 2017, respectively, that was included in the deferred revenue balances at the beginning of their respective periods.

As of June 30, 2018, future estimated revenue related to performance obligations that were unsatisfied or partially unsatisfied was $510.7 million. The substantial majority of the unsatisfied performance obligations will be satisfied over the next twelve months.

Stock-based compensation
The Company has granted RSUs to its employees and members of the Board of Directors under the 2008 Equity Incentive Plan (“2008 Plan”), the 2017 Equity Incentive Plan (“2017 Plan”), and the 2018 Equity Incentive Plan ("2018 Plan"). The Company had two types of RSUs outstanding as of June 30, 2018:

One-tier RSUs, which have a service-based vesting condition over a four year period. These awards typically have a cliff vesting period of one year and continue to vest quarterly thereafter. The Company began granting one-tier RSUs under its 2008 Plan in August 2015 and it continues to grant one-tier RSUs under its 2018 Plan. The Company recognizes compensation expense associated with one-tier RSUs ratably on a straight-line basis over the requisite service period and accounts for forfeitures in the period in which they occur.

Two-tier RSUs, which have both a service-based vesting condition and a Performance Vesting Condition. The service-based vesting period for these awards is typically four years with a cliff vesting period of one year and continue to vest monthly thereafter. Upon satisfaction of the Performance Vesting Condition, these awards vest quarterly. The Performance Vesting Condition is satisfied on the earlier of (i) an acquisition or change in control of the Company or (ii) the earlier of (a) six months after the Company’s initial public offering or (b) March 15 of the year following the Company’s initial public offering. During the first quarter of 2018, the Company's Board of Directors approved the acceleration of the Performance Vesting Condition for which the service condition was satisfied, to occur upon the effectiveness of the registration statement related to the Company's IPO. Prior to August 2015, the Company granted two-tier RSUs under the 2008 Plan. The last grant date for two-tier RSUs was

11

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


in May 2015. The Company recognizes compensation expense associated with two-tier RSUs using the accelerated attribution method over the requisite service period.

The Performance Vesting Condition for the two-tier RSUs was satisfied upon the effectiveness of the registration statement related to the Company's IPO, which was March 22, 2018. On that date, the Company recognized the cumulative unrecognized expense of the two-tier RSUs, using the accelerated attribution method, which is included in the Company's results for the six months ended June 30, 2018. See "—Initial Public Offering and Private Placement” for further discussion. As of June 30, 2018, the remaining unamortized stock-based compensation related to the two-tier RSUs was $1.2 million, which will be recognized if the requisite service is provided over a weighted average period of 0.4 years.

Since August 2015, the Company has granted RSUs as the only stock-based payment awards to its employees, with the exception of awards granted to its co-founders, and has not granted any stock options since then. The fair values of the common stock underlying the RSUs granted in periods prior to the date of the Company's IPO were determined by the Board of Directors, with input from management and contemporaneous third-party valuations, which were performed at least quarterly. For valuations after the Company's IPO, the Board of Directors will determine the fair value of each share of underlying common stock based on the closing price of the Company's Class A common stock as reported on the Nasdaq Global Select Market on the date of the grant.

In December 2017, the Board of Directors approved a grant to the Company’s co-founders of restricted stock awards (“RSAs”) with respect to 14.7 million shares of Class A Common Stock in the aggregate (collectively, the “Co-Founder Grants”), of which 10.3 million RSAs were granted to Mr. Houston, the Company’s co-founder and Chief Executive Officer, and 4.4 million RSAs were granted to Mr. Ferdowsi, the Company’s co-founder and Director. These Co-Founder Grants have service-based, market-based, and performance-based vesting conditions.

The Co-Founder Grants comprise nine tranches that are eligible to vest based on the achievement of stock price goals, or, each, a Stock Price Target. The Company estimated the grant date fair value of the Co-Founder Grants using a model based on multiple stock price paths developed through the use of a Monte Carlo simulation that incorporates into the valuation the possibility that the Stock Price Targets may not be satisfied. The average grant date fair value of each Co-Founder Grant was estimated to be $10.60 per share, and the Company will recognize aggregate stock-based compensation expense of $156.2 million over the requisite service period of each tranche, which ranged from 2.9 to 6.9 years, using the accelerated attribution method. If the Stock Price Targets are met sooner than the derived service period, the Company will adjust its stock-based compensation to reflect the cumulative expense associated with the vested awards. The Company will recognize expense if the requisite service is provided, regardless of whether the market conditions are achieved.

The Co-Founder Grants contain an implied performance-based vesting condition because the Stock Price Targets are based on the trailing 30-day average price of the shares from an established national securities exchange or automated quotation system. Accordingly, no vesting could occur until the completion of the Company’s IPO. The relevant performance-based vesting condition for the Co-Founder Grants was satisfied on the date the Company’s shares of Class A common stock commenced trading on the Nasdaq Global Select Market, in connection with the Company’s IPO, which was March 23, 2018. The Company recognized $8.7 million and $19.3 million in stock-based compensation related to the Co-Founder Grants during the three and six months ended June 30, 2018, respectively.

Cash and cash equivalents
Cash consists primarily of cash on deposit with banks and includes amounts in transit from payment processors for credit and debit card transactions, which typically settle within five days. Cash equivalents include highly liquid investments purchased with an original maturity date of 90 days or less from the date of purchase.

Short-term investments
The Company’s short-term investments are primarily comprised of U.S. treasury securities, corporate notes and obligations, U.S. agency obligations, commercial paper, and certificates of deposits. The Company determines the appropriate classification of its short-term investments at the time of purchase and reevaluates such designation at each balance sheet date. The Company has classified and accounted for its short-term investments as available-for-sale securities as the Company may sell these securities at any time for use in its current operations or for other purposes, even prior to maturity. As a result, the Company classifies its short-term investments, including securities with stated maturities beyond twelve months, within current assets in the condensed consolidated balance sheets.

12

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)



The Company's short-term investments are classified as available-for-sale securities and are recorded at fair value each reporting period. Unrealized gains and losses on these short-term investments are reported as a separate component of accumulated other comprehensive income (loss) in the condensed consolidated balance sheets until realized. Interest income is reported within interest income (expense), net in the condensed consolidated statements of operations. The Company periodically evaluates its short-term investments to assess whether those with unrealized loss positions are other-than-temporarily impaired. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time the investment has been in a loss position, the extent to which the fair value is less than the Company’s cost basis, and the financial condition and near-term prospects of the investee. Realized gains and losses are determined based on the specific identification method and are reported in other income (expense), net in the condensed consolidated statements of operations. If the Company determines that the decline in an investment’s fair value is other-than-temporary, the difference is recognized as an impairment loss in the condensed consolidated statements of operations.

Concentrations of credit risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivable, and short-term investments. The Company places its cash and cash equivalents and short-term investments with well-established financial institutions.

Trade accounts receivables are typically unsecured and are derived from revenue earned from customers located around the world. Two customers accounted for 12% and 32% of total trade and other receivables, net as of June 30, 2018. Two customers accounted for 18% and 27% of total trade and other receivables, net as of December 31, 2017. No customer accounted for more than 10% of the Company’s revenue in the periods presented.

Non-trade receivables
The Company records non-trade receivables to reflect amounts due for activities outside of its subscription agreements. Historically, the Company’s non-trade receivables have related primarily to receivables resulting from tenant improvement allowances. Non-trade receivables totaled $45.4 million and $5.2 million, as of June 30, 2018 and December 31, 2017, respectively, and are classified within prepaid expenses and other current assets and other assets in the accompanying condensed consolidated balance sheets. The Company recognized its initial tenant improvement allowance receivable related to its new corporate headquarters of $40.2 million once it took initial possession of the first phase in June 2018, of which $29.5 million is included in prepaid expenses and other current assets and $10.7 million is included in other assets. See "—Lease obligations” for further discussion on the corresponding recording of the lease incentive obligation.

Deferred commissions, net
Deferred commissions, net is stated as gross deferred commissions less accumulated amortization. Sales commissions earned by the Company’s sales force and third-party resellers, as well as related payroll taxes, are considered to be incremental and recoverable costs of obtaining a contract with a customer. These amounts have been capitalized as deferred commissions within prepaid and other current assets and other assets on the condensed consolidated balance sheet. The Company deferred incremental costs of obtaining a contract of $7.7 million and $17.5 million during the three and six months ended June 30, 2018, respectively, and $5.0 million and $9.7 million during the three and six months ended June 30, 2017, respectively.

Deferred commissions, net included in prepaid and other current assets were $11.4 million and $8.1 million as of June 30, 2018 and December 31, 2017, respectively. Deferred commissions, net included in other assets were $33.7 million and $24.8 million as of June 30, 2018 and December 31, 2017, respectively.

Deferred commissions are amortized over a period of benefit of five years. The period of benefit was estimated by considering factors such as historical customer attrition rates, the useful life of the Company’s technology, and the impact of competition in its industry. Amortized costs were $2.9 million and $5.3 million for the three and six months ended June 30, 2018, respectively, and $1.4 million and $2.6 million for the three and six months ended June 30, 2017, respectively. Amortized costs are included in sales and marketing expense in the accompanying condensed consolidated statements of operations. There was no impairment loss in relation to the deferred costs for any period presented.

Property and equipment, net

13

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful life of the related asset, which is generally three to seven years. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the term of the related lease. In the first quarter of 2018, the Company determined that the useful lives of certain infrastructure equipment, which are depreciated through cost of revenue, should be increased from three to four years. The Company accounted for this as a change in estimate that was applied prospectively, effective as of January 1, 2018. This change in useful life resulted in a reduction in depreciation expense within cost of revenue of $4.7 million and $10.8 million during the three and six months ended June 30, 2018, respectively.

The following table presents the estimated useful lives of property and equipment:

Property and equipment
 
Useful life
Buildings
 
20 to 30 years
Datacenter and other computer equipment
 
3 to 5 years
Office equipment and other
 
3 to 7 years
Leasehold improvements
 
Lesser of estimated useful life or remaining lease term

Lease obligations
The Company leases office space, datacenters, and equipment under non-cancelable capital and operating leases with various expiration dates through 2033. Certain of the Company’s operating lease agreements contain tenant improvement allowances from its landlords. These allowances are accounted for as lease incentive obligations and are amortized as reductions to rent expense over the lease term. In June 2018, the Company took initial possession of the first phase of its new corporate headquarters and recorded a lease incentive obligation in the amount of $40.2 million, recorded in accrued and other current liabilities and non-current deferred rent in the Company's condensed consolidated balance sheet.

In addition, certain of the operating lease agreements contain rent concession, rent escalation, and option to renew provisions. Rent concession and rent escalation provisions are considered in determining the straight-line rent expense to be recorded over the lease term. Lease expense is recognized on a straight-line basis over the lease term commencing on the date the Company has the right to use the leased property. The Company does not assume renewals in its determination of the lease term unless the renewals are deemed to be reasonably assured at lease inception.

The Company leases certain equipment from various third parties, including from a related party, through equipment financing leases under capital leases. See Note 12, “Related Party Transactions” for additional details. These leases either include a bargain purchase option, a full transfer of ownership at the completion of the lease term, or the terms of the leases are at least 75 percent of the useful lives of the assets and are therefore classified as capital leases. These leases are capitalized in property and equipment and the related amortization of assets under capital leases is included in depreciation and amortization expense in the Company’s condensed consolidated statements of operations. Initial asset values and lease obligations are based on the present value of future minimum lease payments.

Long-lived assets, including goodwill and other acquired intangible assets, net
The Company evaluates the recoverability of its property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review determines that the carrying amount of specific property and equipment or intangible assets is not recoverable, the carrying amount of such assets is reduced to its fair value.

The Company reviews goodwill for impairment at least annually in the fourth quarter, or more frequently if events or changes in circumstances would more likely than not reduce the fair value of its single reporting unit below its carrying value.

The Company has not recorded impairment charges on property and equipment, goodwill, or intangible assets for the periods presented in these condensed consolidated financial statements.


14

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Acquired property and equipment and finite-lived intangible assets are amortized over their useful lives. The Company evaluates the estimated remaining useful life of these assets when events or changes in circumstances warrant a revision to the remaining period of amortization. If the Company revises the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life on a prospective basis. See "—Property and Equipment, Net” for further discussion regarding a change in useful life applied during the six months ended June 30, 2018.

Income taxes
Deferred income tax balances reflect the effects of temporary differences between the financial reporting and tax bases of the Company’s assets and liabilities using enacted tax rates expected to apply when taxes are actually paid or recovered. In addition, deferred tax assets are recorded for net operating loss and credit carryforwards.

A valuation allowance is provided against deferred tax assets unless it is more likely than not that they will be realized based on all available positive and negative evidence. Such evidence includes, but is not limited to, recent cumulative earnings or losses, expectations of future taxable income by taxing jurisdiction, and the carry-forward periods available for the utilization of deferred tax assets.

The Company uses a two-step approach to recognizing and measuring uncertain income tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company recognizes interest and penalties related to unrecognized tax benefits as income tax expense.

Although the Company believes that it has adequately reserved for its uncertain tax positions, it can provide no assurance that the final tax outcome of these matters will not be materially different. The Company evaluates its uncertain tax positions on a regular basis and evaluations are based on a number of factors, including changes in facts and circumstances, changes in tax law, such as the 2017 Tax Cuts and Jobs Act ("2017 Tax Reform Act"), correspondence with tax authorities during the course of an audit, and effective settlement of audit issues.

To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on the Company’s financial condition and results of operations.

Fair value measurement
The Company applies fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value measurements for assets and liabilities, the Company considers the principal or most advantageous market in which it would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions, and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3—Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

Recently issued accounting pronouncements not yet adopted
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-02, Leases (Topic 842). Most prominent among the changes in the standard is the recognition of right of use assets and lease liabilities by lessees for

15

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


those leases classified as operating leases under current GAAP. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The Company is required to adopt the standard using the modified retrospective approach and is currently evaluating the use of the optional transition method related to comparative reporting at adoption. The new standard is effective for fiscal years beginning after December 15, 2018. Early adoption by public entities is permitted. The Company is in the process of evaluating changes to its systems, processes, disclosures and controls in order to adopt the new standard on January 1, 2019. The Company anticipates the adoption of this standard will result in a substantial increase in its non-current assets and liabilities recorded on the condensed consolidated balance sheets. The adoption of the standard is not expected to have a material impact on the consolidated statement of operations. While the Company is assessing all potential impacts of the adoption of the standard, it currently expects the most significant impact to be the capitalization of right-of-use assets and lease liabilities for its office space and datacenter operating leases. The Company expects its accounting for capital leases related to infrastructure equipment to remain substantially unchanged under the new standard.

In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. Under existing U.S. GAAP, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense in the period in which the law was enacted. When deferred tax balances related to items originally recorded in accumulated other comprehensive income are adjusted, certain tax effects become stranded in accumulated other comprehensive income. The amendments in ASU No. 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Reform Act. The amendments in ASU No. 2018-02 also require certain disclosures about stranded tax effects. The guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption in any period is permitted. The Company is currently evaluating the timing and impact of adopting ASU No. 2018-02.

In June 2018, the FASB issued ASU No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. Under existing U.S. GAAP, the measurement date for equity awards granted to nonemployees is the earlier of the performance commitment date or the date the performance is complete. The amendments in ASU No. 2018-07 allow for measurement of these awards on the grant date, consistent with equity awards granted to employees. The guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption in any period is permitted. The Company does not expect the impact of adoption to have a material impact on its condensed consolidated financial statements and is currently evaluating the timing of adopting ASU No. 2018-07.

Recently adopted accounting pronouncements
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825), which primarily affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities and financial liabilities is largely unchanged. The Company adopted ASU No. 2016-01 on January 1, 2018. The adoption of the standard did not have a material impact on the Company's condensed consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Intra-Entity Transfers Other than Inventory (Topic 740), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The Company adopted ASU No. 2016-16 on January 1, 2018. The adoption of the guidance did not have a material impact on the Company's condensed consolidated financial statements.

16

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Note 2.
Cash, Cash Equivalents and Short-Term Investments

The amortized cost, unrealized gains and losses and estimated fair value of the Company's cash, cash equivalents and short-term investments as of June 30, 2018 consisted of the following:

As of June 30, 2018

Amortized Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
Cash
$
110.8

 
$

 
$

 
$
110.8

Cash equivalents
 
 

 

 

Money market funds
344.3

 

 

 
344.3

Commercial paper
45.5

 

 

 
45.5

Certificates of deposit
3.5

 

 

 
3.5

Total cash and cash equivalents
$
504.1

 
$

 
$

 
$
504.1

Short-term investments

 

 

 

Corporate notes and obligations
192.2

 

 
(0.2
)
 
192.0

U.S. Treasury securities
165.5

 

 

 
165.5

Certificates of deposit
53.5

 

 

 
53.5

U.S. agency obligations
39.1

 

 

 
39.1

Commercial paper
27.6

 

 

 
27.6

Total short-term investments
477.9

 

 
(0.2
)
 
477.7

Total
$
982.0

 
$

 
$
(0.2
)
 
$
981.8


The Company's cash and cash equivalents at December 31, 2017 consisted of cash of $62.9 million and money market funds of $367.1 million. The Company did not have short-term investments as of December 31, 2017.

Included in cash and cash equivalents is cash in transit from payment processors for credit and debit card transactions of $12.4 million and $13.3 million as of June 30, 2018 and December 31, 2017, respectively.

All short-term investments were designated as available-for-sale securities as of June 30, 2018.

The Company had 138 short-term investments in unrealized loss positions as of June 30, 2018. There were no material gross unrealized losses from available-for-sale securities and no material realized gains or losses from available-for-sale securities that were reclassified out of accumulated other comprehensive income for the three and six months ended June 30, 2018.

For investments in available-for-sale debt securities that have unrealized losses, the Company evaluates whether (i) it has the intention to sell any of these investments and (ii) whether it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis. Based on this evaluation, the Company determined that there were no other-than-temporary impairments associated with short-term investments as of June 30, 2018.

The following table presents the contractual maturities of the Company’s short-term investments as of June 30, 2018:
 
As of June 30, 2018
 
Amortized Cost
 
Estimated Fair Value
Due within one year
$
298.4

 
$
298.3

Due between one to three years
179.5

 
179.4

Total
$
477.9

 
$
477.7


17

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Note 3.
Fair Value Measurements

The Company measures its financial instruments at fair value each reporting period using a fair value hierarchy that prioritizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following table presents information about the Company’s financial instruments that are measured at fair value on a recurring basis using the input categories further discussed in Note 1:   
 
As of June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
344.3

 
$

 
$

 
$
344.3

Commercial paper

 
45.5

 

 
45.5

Certificates of deposit

 
3.5

 

 
3.5

Total cash equivalents
$
344.3

 
$
49.0

 
$

 
$
393.3

Short-term investments
 
 
 
 
 
 
 
Corporate notes and obligations
$

 
$
192.0

 
$

 
$
192.0

U.S. Treasury securities

 
165.5

 

 
165.5

Certificates of deposit

 
53.5

 

 
53.5

U.S. agency obligations

 
39.1

 

 
39.1

Commercial paper

 
27.6

 

 
27.6

Total short-term investments
$

 
$
477.7

 
$

 
$
477.7

Total cash equivalents and short-term investments
$
344.3

 
$
526.7

 
$

 
$
871.0


The total cash equivalents held by the Company as of December 31, 2017 were $367.1 million and were entirely comprised of money market funds classified within Level 1 of the fair value hierarchy.

The Company had no transfers between levels of the fair value hierarchy.

The carrying amounts of certain financial instruments, including cash held in banks, accounts receivable and accounts payable approximate fair value due to their short-term maturities and are excluded from the fair value table above.
Note 4.
Property and Equipment, Net

Property and equipment, net consisted of the following:

 
As of
 
June 30, 2018
 
December 31, 2017
Building
$
36.6

 
$
36.6

Datacenter and other computer equipment
711.7

 
663.1

Furniture and fixtures
25.2

 
21.2

Leasehold improvements
130.1

 
118.6

Construction in process
2.6

 
7.2

Total property and equipment
906.2

 
846.7

Accumulated depreciation and amortization
(575.4
)
 
(504.8
)
Property and equipment, net
$
330.8

 
$
341.9


18

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)



The Company leases certain infrastructure from various third parties, including from a related party, through equipment financing leases that are accounted for as capital leases. See Note 12, “Related Party Transactions” for additional details. Infrastructure assets as of June 30, 2018 and December 31, 2017, respectively included a total of $385.4 million and $417.9 million acquired under capital lease agreements. These leases are capitalized in property and equipment, and the related amortization of assets under capital leases is included in depreciation and amortization expense. The accumulated depreciation of the infrastructure under capital leases totaled $235.7 million and $259.0 million as of June 30, 2018 and December 31, 2017, respectively.

Construction in process includes costs primarily related to construction of leasehold improvements for office buildings and datacenters.

Depreciation expense related to property and equipment was $38.0 million and $72.1 million for the three and six months ended June 30, 2018, respectively, and $43.6 million and $88.1 million for the three and six months ended June 30, 2017, respectively.
Note 5.
Goodwill

Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but tested for impairment on an annual basis. There was no impairment of goodwill as of June 30, 2018 and December 31, 2017. The Company did not complete any business combinations in any of the periods presented.
Note 6.
Revolving Credit Facility

In April 2017, the Company entered into an amended and restated credit and guaranty agreement which provided for a $600.0 million revolving loan facility (the “revolving credit facility”). In conjunction with the revolving credit facility, the Company paid upfront issuance fees of $2.6 million, which are being amortized over the five-year term of the agreement.

In February 2018, the Company amended its revolving credit facility to, among other things, permit the Company to make certain investments, enter into an unsecured standby letter of credit facility and increase its standby letter of credit sublimit to $187.5 million. The Company increased its borrowing capacity under the revolving credit facility from $600.0 million to $725.0 million. The Company may from time to time request increases in its borrowing capacity under the revolving credit facility of up to $275.0 million, provided no event of default has occurred or is continuing or would result from such increase. In conjunction with the amendment, the Company paid upfront issuance fees of $0.4 million, which are being amortized over the remaining term of the agreement.

Pursuant to the terms of the revolving credit facility, the Company may issue letters of credit under the revolving credit facility, which reduce the total amount available for borrowing. Pursuant to the terms of the revolving credit facility, the Company is required to pay an annual commitment fee that accrues at a rate of 0.20% per annum on the unused portion of the borrowing commitments under the revolving credit facility. In addition, the Company is required to pay a fee in connection with letters of credit issued under the revolving credit facility, which accrues at a rate of 1.5% per annum on the amount of such letters of credit outstanding. There is an additional fronting fee of 0.125% per annum multiplied by the average aggregate daily maximum amount available under all letters of credit. Borrowings under the revolving credit facility bear interest, at the Company’s option, at an annual rate based on LIBOR plus a spread of 1.50% or at an alternative base rate plus a spread of 0.50%.

The revolving credit facility contains customary conditions to borrowing, events of default and covenants, including covenants that restrict the Company’s ability to incur indebtedness, grant liens, make distributions to holders of the Company or its subsidiaries’ equity interests, make investments, or engage in transactions with its affiliates. In addition, the revolving credit facility contains financial covenants, including a consolidated leverage ratio covenant and a minimum liquidity balance of $100.0 million, which includes any available borrowing capacity. The Company was in compliance with the covenants of the revolving credit facility as of June 30, 2018 and December 31, 2017, respectively.


19

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


The Company had an aggregate of $73.4 million of letters of credit outstanding under the revolving credit facility as of June 30, 2018, and the Company’s total available borrowing capacity under the revolving credit facility was $651.6 million as of June 30, 2018. The Company’s letters of credit expire between April of 2019 and April of 2022.
Note 7.
Commitments and Contingencies

Leases
The Company has entered into various non-cancelable operating lease agreements for certain offices and datacenters with contractual lease periods expiring at various dates through 2033. The facility lease agreements generally provide for escalating rental payments and for options to renew, which could increase future minimum lease payments if exercised. The Company recognizes rent expense on a straight-line basis over the lease period and accounts for the difference between straight-line rent and actual lease payments as deferred rent.

Gross rent expense was $21.1 million and $43.0 million for the three and six months ended June 30, 2018, respectively, and $16.4 million and $32.4 million for the three and six months ended June 30, 2017, respectively. Sublease income, which is recorded as a reduction of rental expense, was $3.1 million and $6.6 million for the three and six months ended June 30, 2018, respectively, and $1.9 million and $3.8 million for the three and six months ended June 30, 2017, respectively. Sublease income in excess of the Company’s original lease obligation is split with the original lessor per the terms of the sublease agreement, with the Company’s portion recorded to other income (expense), net.

In 2017, the Company entered into a new lease agreement for office space in San Francisco, California, to serve as its new corporate headquarters. The Company took initial possession of the new corporate headquarters in June 2018 and began to recognize rent expense during the three months ended June 30, 2018. The Company expects to start making recurring rental payments under the lease in the third quarter of 2019. Included in the operating lease commitments below are total expected minimum obligations under the lease agreement of $831.5 million, which exclude expected tenant improvement reimbursements from the landlord of approximately $75.0 million and variable operating expenses. The Company’s obligations under the lease are supported by a $34.2 million letter of credit, which reduced the borrowing capacity under the revolving credit facility.

In May 2018, the Company amended its lease agreement for its current corporate headquarters, modifying the original lease termination date from 2027 to 2019. As a result of the amendment, the Company expects to vacate its current corporate headquarters in August 2019, but is obligated to pay rent through February 2020. Accordingly, the Company has removed $192.4 million in future minimum rental payments from the table below.
Other commitments
Other commitments include payments to third-party vendors for services related to the Company’s infrastructure, infrastructure warranty contracts, payments related to the imputed financing obligation for its previous headquarters, asset retirement obligations for office modifications, and a note payable related to financing of infrastructure.

Future minimum payments under the Company’s capital leases, non-cancelable operating leases, and other commitments as of June 30, 2018, are as follows.


20

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


 
Capital
lease
commitments
 
Operating
lease
commitments(1)
 
Other
commitments
Remainder of 2018
$
53.1

 
$
49.1

 
$
37.4

2019
66.9

 
94.3

 
58.5

2020
30.4

 
102.1

 
35.8

2021
15.4

 
94.6

 
1.8

2022
5.2

 
87.8

 

Thereafter
0.4

 
710.6

 
0.3

Future minimum payments
171.4

 
$
1,138.5

 
$
133.8

Less interest and taxes
(11.2
)
 
 
 
 
Less current portion of the present value of minimum lease payments
(87.1
)
 
 
 
 
Capital lease obligations, net of current portion
$
73.1

 
 
 
 
(1) 
Consists of future non-cancelable minimum rental payments under operating leases for the Company’s offices and datacenters, excluding rent payments from the Company’s sub-tenants, variable operating expenses, and tenant improvement reimbursements. Non-cancelable rent payments from the Company’s sub-tenants as of June 30, 2018, are expected to be $57.1 million through 2023.

Legal matters
From time to time, the Company is a party to a variety of claims, lawsuits, and proceedings which arise in the ordinary course of business, including claims of alleged infringement of intellectual property rights. The Company records a liability when it believes that it is probable that a loss will be incurred and the amount of loss or range of loss can be reasonably estimated. In its opinion, resolution of pending matters is not likely to have a material adverse impact on its consolidated results of operations, cash flows, or its financial position. Given the unpredictable nature of legal proceedings, the Company bases its estimate on the information available at the time of the assessment. As additional information becomes available, the Company reassesses the potential liability and may revise the estimate.

Indemnification
The Company’s arrangements generally include certain provisions for indemnifying customers against liabilities if its products or services infringe a third party’s intellectual property rights. It is not possible to determine the maximum potential amount under these indemnification obligations due to the limited history of prior indemnification claims.

21

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Note 8.
Accrued and Other Current Liabilities
Accrued and other current liabilities consisted of the following:
 
As of
 
June 30, 2018
 
December 31, 2017
Non-income taxes payable
$
73.7

 
$
69.7

Deferred rent
50.1

 
14.6

Accrued legal and other external fees
25.2

 
21.3

Financing obligations, current
7.6

 
9.7

Accrued infrastructure costs
5.4

 
2.6

Accrued property and equipment purchases
1.7

 
1.8

Income taxes payable
1.0

 
0.4

Other accrued and current liabilities
7.6

 
9.7

Total accrued and other current liabilities
$
172.3

 
$
129.8

Deferred rent as of June 30, 2018 increased from December 31, 2017 primarily due to the amendment of the lease for the Company's current corporate headquarters and the shortening of its lease term as described further in Note 7. This lease modification resulted in a reclassification of deferred rent from deferred rent, non-current to accrued and other current liabilities, and is included in the deferred rent amount in the table above.
Note 9.
Stockholders’ Equity

Common stock
The Company’s amended and restated certificate of incorporation authorizes the issuance of Class A common stock, Class B common stock, and Class C common stock. Holders of Class A common stock, Class B common stock, and Class C common stock are entitled to dividends on a pro rata basis, when, as, and if declared by the Company’s Board of Directors, subject to the rights of the holders of the Company’s preferred stock. Holders of Class A common stock are entitled to one vote per share, holders of Class B common stock are entitled to 10 votes per share, and holders of Class C common stock are entitled to zero votes per share. During the three months ended June 30, 2018, holders of 40.6 million shares of Class B common stock voluntarily converted into an equivalent number of shares of Class A common stock.

As of June 30, 2018, the Company had authorized 2,400.0 million shares of Class A common stock, 475.0 million shares of Class B common stock, and 800.0 million shares of Class C common stock, each at par value of $0.00001. As of June 30, 2018, 101.0 million shares of Class A common stock, 301.3 million shares of Class B common stock, and no shares of Class C common stock were issued and outstanding. As of December 31, 2017, 8.9 million shares of Class A common stock, 187.9 million shares of Class B common stock, and no shares of Class C common stock were issued and outstanding. Class A shares issued and outstanding as of June 30, 2018 and December 31, 2017 exclude 14.7 million unvested restricted stock awards granted to the Company’s co-founders. See "Co-Founder Grants" section below for further details.

Convertible preferred stock
Immediately prior to the closing of the Company’s IPO, all of the 147.3 million shares of convertible preferred stock converted into an equivalent number of shares of Class B common stock. Further, pursuant to transfer agreements with certain of the Company’s stockholders, 0.3 million shares of the Company’s convertible preferred stock automatically converted into an equivalent number of shares of Class A common stock. 

Preferred stock

The Company's Board of Directors will have the authority, without further action by the Company's stockholders, to issue up to 240.0 million shares of undesignated preferred stock with rights and preferences, including voting rights, designated from time to time by the Board of Directors.

22

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)



Equity incentive plans
Under the 2018 Plan, the Company may grant stock-based awards to purchase or directly issue shares of common stock to employees, directors, and consultants. Options are granted at a price per share equal to the fair market value of the Company's common stock at the date of grant. Options granted are exercisable over a maximum term of 10 years from the date of grant and generally vest over a period of four years. No options have been granted since August of 2015. RSUs and RSAs are also granted under the 2018 Plan. The 2018 Plan will terminate 10 years after the later of (i) its adoption or (ii) the most recent stockholder-approved increase in the number of shares reserved under the 2018 Plan, unless terminated earlier by the Company's Board of Directors. The 2018 Plan was adopted on March 22, 2018 with a reserve of 41.4 million shares of our Class A common stock for future issuance. As of June 30, 2018, there were 35.2 million shares issued and outstanding and 55.4 million available for issuance under the 2008 Equity Incentive Plan, the 2017 Equity Incentive Plan, and the 2018 Plan ("the Plans").

Stock option and restricted stock activity for the Plans was as follows for the six months ended June 30, 2018:

 
 
 
Options outstanding
 
Restricted stock
outstanding
 
Number of
shares
available for
issuance
under the
Plans
 
Number of
shares
outstanding
under the
Plans
 
Weighted-
average
exercise
price
per share
 
Weighted-
average
remaining
contractual
term
(In years)
 
Number of
shares
outstanding under the Plans
 
Weighted-
average
grant date
fair value
per share
Balance at December 31, 2017
9.0

 
5.0

 
$
10.52

 
5.5
 
54.9

 
$
15.60

Reserved for issuance under the 2018 Plan
41.4

 

 

 
 
 

 

Additional shares authorized
1.3

 

 

 
 
 

 

Options exercised and RSUs released

 
(0.2
)
 
6.76

 
 
 
(33.7
)
 
15.07

Options and RSUs canceled
2.4

 

 

 
 
 
(2.4
)
 
17.03

Shares repurchased for tax withholdings on release of restricted stock
12.9

 

 

 
 
 

 

Restricted stock granted
(11.6
)
 

 
 
 
 
 
11.6

 
17.88

Balance at June 30, 2018
55.4

 
4.8

 
$
10.62

 
2.2
 
30.4

 
$
16.98

Vested at June 30, 2018
 
 
4.7

 
$
10.41

 
2.2
 

 
$

Unvested at June 30, 2018
 
 
0.1

 
$
24.76

 
 
 
30.4

 
$
16.98


The following table summarizes information about the pre-tax intrinsic value of options exercised during the three and six months ended June 30, 2018 and 2017:

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Intrinsic value of options exercised
$
0.3

 
$

 
$
2.0

 
$
1.0


As of June 30, 2018, unamortized stock-based compensation related to unvested stock options, restricted stock awards (excluding the Co-Founder Grants), and RSUs was $454.2 million. The weighted-average period over which such compensation expense will be recognized if the requisite service is provided is approximately 2.9 years as of June 30, 2018.

Co-Founder Grants

23

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


In December 2017, the Board of Directors approved a grant to the Company’s co-founders of non-Plan RSAs with respect to 14.7 million shares of Class A Common Stock in the aggregate (collectively, the “Co-Founder Grants”), of which 10.3 million RSAs were granted to Mr. Houston, the Company’s co-founder and Chief Executive Officer, and 4.4 million RSAs were granted to Mr. Ferdowsi, the Company’s co-founder and Director. These Co-Founder Grants have service-based, market-based, and performance-based vesting conditions. The Co-Founder Grants are excluded from Class A common stock issued and outstanding until the satisfaction of these vesting conditions. The Co-Founder Grants also provide the holders with certain stockholder rights, such as the right to vote the shares with the other holders of Class A common stock and a right to cumulative declared dividends. However, the Co-Founder Grants are not considered a participating security for purposes of calculating net loss per share attributable to common stockholders in Note 9 as the right to the cumulative declared dividends is forfeitable if the service condition is not met.

The Co-Founder Grants are eligible to vest over the ten-year period following the date the Company’s shares of Class A common stock commenced trading on the Nasdaq Global Select Market in connection with the Company’s IPO. The Co-Founder Grants comprise nine tranches that are eligible to vest based on the achievement of stock price goals, or, each, a Stock Price Target, measured over a consecutive thirty-day trading period during the Performance Period. The Performance Period will begin on January 1, 2019.

During the first four years of the Performance Period, no more than 20% of the shares subject to each Co-Founder Grant would be eligible to vest in any calendar year. After the first four years, all shares are eligible to vest based on the achievement of the Stock Price Targets.

The Company calculated the grant date fair value of the Co-Founder Grants based on multiple stock price paths developed through the use of a Monte Carlo simulation. A Monte Carlo simulation also calculates a derived service period for each of the nine vesting tranches, which is the measure of the expected time to achieve each Stock Price Target. A Monte Carlo simulation requires the use of various assumptions, including the underlying stock price, volatility, and the risk-free interest rate as of the valuation date, corresponding to the length of time remaining in the performance period, and expected dividend yield. The weighted-average grant date fair value of each Co-Founder Grant was estimated to be $10.60 per share. The weighted-average derived service period of each Co-Founder Grant was estimated to be 5.2 years, and ranged from 2.9 - 6.9 years. The Company will recognize aggregate stock-based compensation expense of $156.2 million over the derived service period of each tranche using the accelerated attribution method as long as the co-founders satisfy their service-based vesting conditions. If the Stock Price Targets are met sooner than the derived service period, the Company will adjust its stock-based compensation to reflect the cumulative expense associated with the vested awards. The Company will recognize expense if the requisite service is provided, regardless of whether the market conditions are achieved.

The Performance Vesting Condition for the Co-Founder Grants was satisfied on the date the Company’s shares of Class A common stock commenced trading on the Nasdaq Global Select Market in connection with the Company’s IPO, which was March 23, 2018. The Company recognized $8.7 million and $19.3 million in stock-based compensation related to the Co-Founder Grants during the three and six months ended June 30, 2018, respectively. As of June 30, 2018, unamortized stock-based compensation expense related to the Co-Founder Grants was $136.9 million.
Note 10.
Net Loss Per Share

The Company computes net loss per share using the two-class method required for multiple classes of common stock and participating securities. The rights, including the liquidation and dividend rights, of the Class A common stock and Class B common stock are substantially identical, other than voting rights. Accordingly, the Class A common stock and Class B common stock share equally in the Company’s net losses. Before the IPO, the Company’s participating securities also included convertible preferred stock. The holders of convertible preferred stock did not have a contractual obligation to share in the Company’s losses, and as a result net losses were not allocated to these participating securities.

24

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)



The following table sets forth the calculation of basic and diluted net loss per share attributable to common stockholders during the periods presented. The shares issued in the IPO and the private placement and the shares of Class A and Class B common stock issued upon conversion of the outstanding shares of convertible preferred stock in the IPO are included in the table below weighted for the period outstanding in the three and six months ended June 30, 2018. Additionally, the voluntary conversions of Class B common stock into Class A common stock are included in the table below weighted for the period outstanding in the three months ended June 30, 2018:

 
Three months ended June 30,
 
2018
 
2017
 
Class A
 
Class B
 
Class A
 
Class B
Numerator:
 
 
 
 
 
 
 
Net loss attributable to common stockholders
$
(0.8
)
 
$
(3.3
)
 
$
(0.8
)
 
$
(26.0
)
Denominator:
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding used in computing basic and diluted net loss per common share
78.6

 
322.7

 
6.0

 
189.4

Net loss per common share, basic and diluted
$
(0.01
)
 
$
(0.01
)
 
$
(0.14
)
 
$
(0.14
)

 
Six months ended June 30,
 
2018
 
2017
 
Class A
 
Class B
 
Class A
 
Class B
Numerator:
 
 
 
 
 
 
 
Net loss attributable to common stockholders
$
(70.6
)
 
$
(399.0
)
 
$
(1.8
)
 
$
(58.1
)
Denominator:
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding used in computing basic and diluted net loss per common share
46.7

 
263.8

 
5.7

 
188.8

Net loss per common share, basic and diluted
$
(1.51
)
 
$
(1.51
)
 
$
(0.31
)
 
$
(0.31
)

Since the Company was in a loss position for all periods presented, basic net loss per share attributable to common stockholders is the same as diluted net loss per share for all periods as the inclusion of all potential common shares outstanding would have been anti-dilutive. The weighted-average impact of potentially dilutive securities that were not included in the diluted per share calculations because they would be anti-dilutive was as follows:
 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Convertible preferred stock

 
147.6

 

 
147.6

Restricted stock units
32.1

 
53.5

 
42.8

 
51.3

Options to purchase shares of common stock
4.8

 
5.1

 
4.9

 
5.2

Co-Founder Grants
14.7

 

 
14.7

 

Shares subject to repurchase from early-exercised options and unvested restricted stock

 
0.2

 

 
0.3

Total
51.6

 
206.4

 
62.4

 
204.4

Note 11.
Income Taxes

The Company computed the year-to-date income tax provision by applying the estimated annual effective tax rate to the year-to-date pre-tax loss and adjusted for discrete tax items in the period. The Company's income tax expense was $1.1 million

25

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


and $2.9 million for the three and six months ended June 30, 2018, respectively and $0.4 million and $0.7 million for the three and six months ended June 30, 2017, respectively.

Income tax expense for the three and six months ended June 30, 2018, was primarily attributable to U.S. state income taxes, foreign taxes, and increases in uncertain tax positions.

For the periods presented, the difference between the U.S. statutory rate and the Company's effective tax rate is primarily due to the full valuation allowance on its U.S. and Irish deferred tax assets. The effective tax rate is also impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate.

The Company periodically evaluates the realizability of its net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is dependent on the Company's ability to generate sufficient future taxable income during periods prior to the expiration of tax attributes to fully utilize these assets. As of June 30, 2018, the Company continues to maintain a full valuation allowance on its deferred tax assets in the U.S. and Ireland. However, the Company has partially benefited from its deferred tax assets due to the recognition of forecasted future income which is more likely than not to be earned in one of its foreign jurisdictions.

The Company is subject to income tax audits in the U.S. and foreign jurisdictions. The Company records liabilities related to uncertain tax positions and believes that it has provided adequate reserves for income tax uncertainties in all open tax years. Unrecognized tax benefits increased by approximately $8.5 million and $16.2 million for the three and six months ended June 30, 2018, of which $0.6 million, if recognized, would affect the Company's effective tax rate.

Impact of the Tax Cuts and Jobs Act ("2017 Tax Reform Act")

The 2017 Tax Reform Act was enacted on December 22, 2017 and provides for significant changes to U.S. tax law. Among other provisions, the 2017 Tax Reform Act reduces the U.S. corporate income tax rate to 21% effective in 2018. The 2017 Tax Reform Act also contains a number of provisions that may impact the Company in future years.

Since ongoing guidance and accounting interpretation is expected in the 12 months following enactment, the Company has made certain provisional accounting estimates, as permitted under Staff Accounting Bulletin No. 118, and continues to analyze its accounting policies in this area. The U.S. Treasury Department, the IRS, and other standard-setting bodies could interpret or issue guidance on how provisions of the 2017 Tax Reform Act will be applied or otherwise administered that is different from the Company’s interpretation. As the Company completes its analysis of the 2017 Tax Reform Act, collects and prepares necessary data, and interprets any additional guidance, the Company may make adjustments to provisional amounts that it has recorded that may materially impact the provision for income taxes in the period in which the adjustments are made. The final accounting analysis will occur no later than one year from the date the 2017 Tax Reform Act was enacted.

As a result of the reduction in the corporate rate, the Company remeasured its U.S. deferred tax assets and liabilities as of December 31, 2017 to reflect the lower rate expected to apply when these temporary differences reverse. The Company provisionally estimated that the remeasurement resulted in a reduction in deferred tax assets of $63.1 million, which was fully offset by a corresponding change to the Company’s valuation allowance. Although the tax rate reduction was known, the Company had not collected the necessary data to complete its analysis of the effect of the 2017 Tax Reform Act on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 were provisional. However, the Company anticipates that any adjustment to provisional amounts recorded would be fully offset by a corresponding change to the Company’s valuation allowance. The Company has not made any additional measurement-period adjustments related to these items during the quarter because the Company is continuing to gather additional information and expects to complete its accounting within the prescribed measurement period.

The Company has also considered and estimated a number of provisions of the 2017 Tax Reform Act effective January 1, 2018 as part of the estimated annual effective tax rate as of March 31, 2018. Due to forecasted tax losses and a full valuation allowance in the U.S., these provisions had no material impact to the income tax provision as of June 30, 2018.

The 2017 Tax Reform Act also repealed the corporate alternative minimum tax (“AMT”) effective beginning in 2018, and permits AMT credit carryforwards to be refunded to the extent unused through 2021. Since the Company does not anticipate the use of these credits to reduce future federal taxes, the Company was able to reasonably estimate the income tax benefit and income tax receivable of $1.4 million during the year ended December 31, 2017. The Company had not collected the necessary

26

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


data to complete its analysis of the classification of the AMT credit as a receivable and as such, the amounts recorded as an income tax receivable as of December 31, 2017 were provisional. There have not been material changes to the provisional amounts as of June 30, 2018.

The 2017 Tax Reform Act also provides for a transition to a new territorial system of taxation and generally requires companies to include certain untaxed foreign earnings of non-U.S. subsidiaries into taxable income in 2017 (“Transition Tax”). As a result of the cumulative deficits in the Company’s foreign subsidiaries, the Company estimated that it has no Transition Tax inclusion. As of June 30, 2018, the Company has made no changes to its estimated Transition Tax inclusion.

The 2017 Tax Reform Act subjects a US shareholder to tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5 Accounting for GILTI, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. Given the complexity of this provision, the Company is still evaluating the effects of the provision on its condensed consolidated financial statements and has not yet determined its accounting policy as of June 30, 2018. The Company has, however, included the estimated impact related to current year operations only in its annual effective tax rate for 2018 and has not provided for additional impact on deferred items. The Company expects to complete its accounting within the prescribed measurement period.
Note 12.
Related Party Transactions

Dropbox Charitable Foundation
During the year ended December 31, 2016, two of the Company’s controlling shareholders formed the Dropbox Charitable Foundation, a Delaware non-stock corporation (the “Foundation”). The primary purpose of the Foundation is to engage in charitable and educational activities within the meaning of Section 501(c)(3) of the Code. The Foundation is governed by a Board of Directors, a majority of which are independent. Both shareholders made contributions to the Foundation during the year ended December 31, 2016, comprised entirely of shares of Dropbox common stock. The Company has not consolidated the Foundation in the accompanying condensed consolidated financial statements, as the Company does not have control of the entity.

During the three and six months ended June 30, 2018, the Company did not make cash contributions to the Foundation. During the three months ended June 30, 2017, the Company donated shares of Class B common stock to initially fund the Foundation and recorded $9.4 million of expense to general and administrative expenses based on the Company’s estimate of the then current fair value of the contributed shares. The Company made additional cash contributions to the Foundation of $0.2 million and $0.4 million during the three and six months ended June 30, 2017, respectively.

Hewlett Packard Enterprise
The Company has engaged in various commercial relationships with Hewlett Packard Enterprise (“HPE”), whose chief executive officer was appointed to the Dropbox Board of Directors in September 2017. The chief executive officer of HPE resigned effective February 1, 2018. The Company's commercial relationships with HPE include infrastructure equipment under capital leases, the purchase of commercial products and other services, and a multi-year subscription agreement for access to the Dropbox platform. During the six months ended June 30, 2018 and through the date of the resignation of the former chief executive officer of HPE, the Company made payments of $5.5 million for infrastructure equipment under capital leases and for commercial products and services provided by HPE.

27

DROPBOX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables are in millions except per share data, or as otherwise noted)


Note 13.
Geographic Areas

Long-lived assets
The following table sets forth long-lived assets by geographic area:

 
As of
 
June 30, 2018
 
December 31, 2017
United States
$
311.8

 
$
323.7

International(1)
19.0

 
18.2

Total property and equipment, net
$
330.8

 
$
341.9

(1) 
No single country other than the United States had a property and equipment balance greater than 10% of total property and equipment, net, as of June 30, 2018 and December 31, 2017.

Revenue
Revenue by geography is generally based on the address of the customer as defined in the Company’s subscription agreement. The following table sets forth revenue by geographic area for the three and six months ended June 30, 2018 and 2017.

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
United States
$
172.4

 
$
141.8

 
$
334.0

 
$
271.7

International(1)
166.8

 
124.9

 
321.5

 
242.9

Total revenue
$
339.2

 
$
266.7

 
$
655.5

 
$
514.6

(1) 
No single country outside of the United States accounted for more than 10% of total revenue during the three and six months ended June 30, 2018 and 2017.

28


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our final prospectus, dated March 22, 2018, and filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”). As discussed in the section titled “Note About Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part II, Item 1A in this Quarterly Report on Form 10-Q and in our prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on March 23, 2018, referred to as the Prospectus. Our fiscal year ends December 31.

Overview
Our modern economy runs on knowledge. Today, knowledge lives in the cloud as digital content, and Dropbox is a global collaboration platform where more and more of this content is created, accessed, and shared with the world. We serve more than 500 million registered users across 180 countries. 

Since our founding in 2007, our market opportunity has grown as we’ve expanded from keeping files in sync to keeping teams in sync. We believe the need for our platform will continue to grow as teams become more fluid and global, and content is increasingly fragmented across incompatible tools and devices. Dropbox breaks down silos by centralizing the flow of information between the products and services our users prefer, even if they’re not our own.

By solving these universal problems, we’ve become invaluable to our users. The popularity of our platform drives viral growth, which has allowed us to scale rapidly and efficiently. We’ve built a thriving global business with 11.9 million paying users.

Our Subscription Plans
We generate revenue from individuals, teams, and organizations by selling subscriptions to our platform, which serve the varying needs of our diverse customer base. Subscribers can purchase individual licenses through our Plus and Professional plans, or purchase multiple licenses through a Standard, Advanced, or Enterprise team plan. Each team represents a separately billed deployment that is managed through a single administrative dashboard. Teams must have a minimum of three users, but can also have more than tens of thousands of users. Customers can choose between an annual or monthly plan, with a small number of large organizations on multi-year plans. A majority of our customers opt for our annual plans. We typically bill our customers at the beginning of their respective terms and recognize revenue ratably over the term of the subscription period. International customers can pay in U.S. dollars or a select number of foreign currencies.

Our premium subscription plans, such as Professional and Advanced, provide more functionality than other subscription plans and have higher per user prices. Our Standard and Advanced subscription plans offer robust capabilities for businesses, and the vast majority of Dropbox Business teams purchase our Standard or Advanced subscription plans. While our Enterprise subscription plan offers more opportunities for customization, companies can subscribe to any of these team plans for their business needs.

Our Customers
Our customer base is highly diversified, and in the period presented, no customer accounted for more than 1% of our revenue. Our customers include individuals, teams, and organizations of all sizes, from freelancers and small businesses to Fortune 100 companies. They work across a wide range of industries, including professional services, technology, media, education, industrials, consumer and retail, and financial services. Within companies, our platform is used by all types of teams and functions, including sales, marketing, product, design, engineering, finance, legal, and human resources.


29


Our Business Model

Drive new signups

We acquire users efficiently and at relatively low costs through word-of-mouth referrals, direct in-product referrals, and sharing of content. Anyone can create a Dropbox account for free through our website or app and be up and running in minutes. These users often share and collaborate with other non-registered users, attracting new signups into our network.

Increase conversion of registered users to our paid subscription plans

We generate over 90% of our revenue from self-serve channels—users who purchase a subscription through our app or website. We actively encourage our registered users to become paying users through in-product prompts and notifications, time-limited free trials of paid subscription plans, email campaigns, and lifecycle marketing.

Upgrade and expand existing customers

We offer a range of paid subscription plans, from Plus and Professional for individuals to Standard, Advanced, and Enterprise for teams. We analyze usage patterns within our network and run hundreds of targeted marketing campaigns to encourage paying users to upgrade their plans. We prompt individual subscribers who collaborate with others on Dropbox to purchase our Standard or Advanced plans for a better team experience, and we also encourage existing Dropbox Business teams to purchase additional licenses or to upgrade to premium subscription plans.

30



Key Business Metrics

We review a number of operating and financial metrics, including the following key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.

Paying users
We define paying users as the number of users who have active paid licenses for access to our platform as of the end of the period. One person would count as multiple paying users if the person had more than one active license. For example, a 50-person Dropbox Business team would count as 50 paying users, and an individual Dropbox Plus user would count as one paying user. If that individual Dropbox Plus user was also part of the 50-person Dropbox Business team, we would count the individual as two paying users.

We have experienced growth in the number of paying users across our products, with the vast majority of paying users for the periods presented coming from our self-serve channels.

The below table sets forth the number of paying users as of June 30, 2018, December 31, 2017, and June 30, 2017.

 
As of
 
As of
 
As of
 
June 30, 2018
 
December 31, 2017
 
June 30, 2017
 
(In millions)
Paying users
11.9

 
11.0

 
9.9


Average revenue per paying user
We define average revenue per paying user, or ARPU, as our revenue for the period presented divided by the average paying users during the same period. For interim periods, we use annualized revenue, which is calculated by dividing the revenue for the particular period by the number of days in that period and multiplying this value by 365 days. Average paying users are calculated based on adding the number of paying users as of the beginning of the period to the number of paying users as of the end of the period, and then dividing by two.

In 2017, we launched our Dropbox Business Advanced plan. At the time of launch, we grandfathered existing Dropbox Business teams into the Dropbox Business Advanced plan at their legacy price. During the second quarter of 2018, a significant portion of those grandfathered teams renewed at a higher price. As a result of these renewals, and combined with an increased mix of sales towards our higher priced subscription plans, we experienced an increase in our average revenue per paying user for the three and six months ended June 30, 2018, compared to the three and six months ended June 30, 2017.

The below table sets forth our ARPU for the three and six months ended June 30, 2018 and 2017.

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
ARPU
$
116.66

 
$
111.19

 
$
115.80

 
$
110.98


31


Non-GAAP Financial Measure

In addition to our results determined in accordance with U.S. generally accepted accounting principles, or GAAP, we believe that free cash flow, or FCF, a non-GAAP financial measure, is useful in evaluating our liquidity.

Free cash flow
We define FCF as GAAP net cash provided by operating activities less capital expenditures. We believe that FCF is a liquidity measure and that it provides useful information regarding cash provided by operating activities and cash used for investments in property and equipment required to maintain and grow our business. FCF is presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance with GAAP. FCF has limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash provided by operating activities. Some of the limitations of FCF are that FCF does not reflect our future contractual commitments, excludes investments made to acquire assets under capital leases, and may be calculated differently by other companies in our industry, limiting its usefulness as a comparative measure.

Our FCF increased for the six months ended June 30, 2018, compared to the six months ended June 30, 2017, primarily due to higher cash provided by operating activities, which was driven by increased subscription sales, as a majority of our paying users are invoiced in advance. These cash inflows were partially offset by an increase in capital expenditures related to our office and datacenter build-outs.

We expect our FCF to fluctuate in future periods as we purchase infrastructure equipment to support our user base and invest in our new and existing office spaces, including our new corporate headquarters, to support our plans for growth. These activities, along with certain increased operating expenses as described below, may result in a decrease in FCF as a percentage of revenue in future periods.

The following is a reconciliation of FCF to the most comparable GAAP measure, net cash provided by operating activities:

 
Six months ended June 30,
 
2018
 
2017
 
(In millions)
Net cash provided by operating activities
$
173.7

 
$
147.7

Capital expenditures
(19.6
)
 
(8.8
)
Free cash flow
$
154.1

 
$
138.9


32


Components of Our Results of Operations

Revenue
We generate revenue from sales of subscriptions to our platform.

Revenue is recognized ratably over the related contractual term generally beginning on the date that our platform is made available to a customer. Our subscription agreements typically have monthly or annual contractual terms, although a small percentage have multi-year contractual terms. Our agreements are generally non-cancelable. We typically bill in advance for monthly contracts and annually in advance for contracts with terms of one year or longer. Amounts that have been billed are initially recorded as deferred revenue until the revenue is recognized.

Our revenue is driven primarily by the number of paying users and the price we charge for access to our platform, which varies based on the type of plan to which a customer subscribes. We generate over 90% of our revenue from self-serve channels. No customer represented more than 1% of our revenue in the periods presented.

Cost of revenue and gross margin
Cost of revenue. Our cost of revenue consists primarily of expenses associated with the storage, delivery, and distribution of our platform for both paying users and free users, also known as Basic users. These costs, which we refer to as infrastructure costs, include depreciation of our servers located in co-location facilities that we lease and operate, rent and facilities expense for those datacenters, network and bandwidth costs, support and maintenance costs for our infrastructure equipment, and payments to third-party datacenter service providers. Cost of revenue also includes costs, such as salaries, bonuses, employer payroll taxes and benefits, travel-related expenses, and stock-based compensation, which we refer to as employee-related costs, for employees whose primary responsibilities relate to supporting our infrastructure and delivering user support. Other non-employee costs included in cost of revenue include credit card fees related to processing customer transactions, and allocated overhead, such as facilities, including rent, utilities, depreciation on leasehold improvements and other equipment shared by all departments, and shared information technology costs. In addition, cost of revenue includes amortization of developed technologies, professional fees related to user support initiatives, and property taxes related to the datacenters.

During the first quarter of 2018, based on considerations including our asset replacement cycle and our ongoing infrastructure optimization efforts, we revisited the useful life estimates of certain infrastructure equipment. These optimization efforts include software efficiencies that allow us to utilize certain infrastructure equipment for longer periods of time. As a result, we determined that the useful lives of the impacted infrastructure equipment, which are depreciated through cost of revenue, should be increased from three to four years. We accounted for this as a change in estimate that was applied prospectively, effective as of January 1, 2018. This change in useful life resulted in a reduction in depreciation expense within cost of revenue of $4.7 million and $10.8 million during the three and six months ended June 30, 2018, respectively.

We plan to continue increasing the capacity and enhancing the capability and reliability of our infrastructure to support user growth and increased use of our platform. We expect that cost of revenue, excluding the impact of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, will increase in absolute dollars in future periods. In addition, as a result of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, our cost of revenue increased significantly in absolute dollars during the six months ended June 30, 2018 due to the completion of our initial public offering.

Gross margin. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin may fluctuate from period to period based on the timing of additional capital expenditures and the related depreciation expense, or other increases in our infrastructure costs, as well as revenue fluctuations. As we continue to increase the utilization of our internal infrastructure, we generally expect our gross margin, excluding the impact of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, to remain relatively constant in the near term and to increase modestly in the long term.

Operating expenses
Research and development. Our research and development expenses consist primarily of employee-related costs for our engineering, product, and design teams, and allocated overhead. Additionally, research and development expenses include internal development-related third-party hosting fees. We have expensed almost all of our research and development costs as they were incurred.


33


We plan to continue to hire employees for our engineering, product, and design teams to support our research and development efforts. We expect that research and development costs will increase in absolute dollars in future periods and, excluding the impact of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, vary from period to period as a percentage of revenue.

Sales and marketing. Our sales and marketing expenses relate to both self-serve and outbound sales activities, and consist primarily of employee-related costs, brand marketing costs, lead generation costs, and allocated overhead. Sales commissions earned by our outbound sales team and the related payroll taxes, as well as commissions earned by third-party resellers that we consider to be incremental and recoverable costs of obtaining a contract with a user, are deferred and amortized over an estimated period of benefit of five years. Additionally, sales and marketing expenses include non-employee costs related to app store fees and fees payable to third-party sales representatives.

We plan to continue to invest in sales and marketing to grow our user base and increase our brand awareness, including marketing efforts to continue to drive our self-serve business model. We expect that sales and marketing expenses will increase in absolute dollars in future periods and, excluding the impact of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, vary from period to period as a percentage of revenue. The trend and timing of sales and marketing expenses will depend in part on the timing of marketing campaigns.

General and administrative. Our general and administrative expenses consist primarily of employee-related costs for our legal, finance, human resources, and other administrative teams, as well as certain executives. In addition, general and administrative expenses include allocated overhead, outside legal, accounting and other professional fees, non-income based taxes, and contributions to the Dropbox Charitable Foundation.

We expect to incur additional general and administrative expenses to support the growth of the Company as well as our transition to being a publicly traded company, which includes the recognition of stock-based compensation expense related to grants of restricted stock made to our co-founders. We expect that general and administrative expenses will increase in absolute dollars in future periods and, excluding the impact of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, vary from period to period as a percentage of revenue.

As a result of certain stock-based compensation charges described in “—Significant Impacts of Stock-Based Compensation”, our research and development, sales and marketing, and general and administrative expenses increased significantly in absolute dollars and as a percentage of revenue during the six months ended June 30, 2018 due to the completion of our initial public offering.

Interest income (expense), net
Interest income (expense), net consists primarily of interest income earned on our money market funds classified as cash and cash equivalents and short-term investments, partially offset by interest expense related to our capital lease obligations for infrastructure and our imputed financing obligation for our obligation to the legal owner of our previous corporate headquarters.

Other income (expense), net
Other income (expense), net consists of other non-operating gains or losses, including those related to ongoing subleases, foreign currency transaction gains and losses, and realized gains and losses related to our short-term investments.

Provision for income taxes
Provision for income taxes consists primarily of U.S. federal and state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. For the periods presented, the difference between the U.S. statutory rate and our effective tax rate is primarily due to the valuation allowance on deferred tax assets. Our effective tax rate is also impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. We maintain a full valuation allowance on our net deferred tax assets for federal, state, and certain foreign jurisdictions as we have concluded that it is not more likely than not that the deferred assets will be realized.

Impact of the Tax Cuts and Jobs Act ("2017 Tax Reform Act")
The 2017 Tax Reform Act was enacted on December 22, 2017 and provides for significant changes to U.S. tax law. Among other provisions, the 2017 Tax Reform Act reduces the U.S. corporate income tax rate to 21% effective in 2018. The 2017 Tax Reform Act also contains a number of provisions that may impact us in future years.

34


Since ongoing guidance and accounting interpretation is expected in the 12 months following enactment, we have made certain provisional accounting estimates, as permitted under Staff Accounting Bulletin No. 118, and continue to analyze our accounting policies in this area. The U.S. Treasury Department, the IRS, and other standard-setting bodies could interpret or issue guidance on how provisions of the 2017 Tax Reform Act will be applied or otherwise administered that is different from our interpretation. As we complete our analysis of the 2017 Tax Reform Act, collect and prepare necessary data, and interpret any additional guidance, we may make adjustments to provisional amounts that we have recorded that may materially impact the provision for income taxes in the period in which the adjustments are made. The final accounting analysis will occur no later than one year from the date the 2017 Tax Reform Act was enacted. Adjustments made for the three and six months ended June 30, 2018, were not material.

35


Results of Operations

The following tables set forth our results of operations for the periods presented:

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In millions)
Revenue
$
339.2

 
$
266.7

 
$
655.5

 
$
514.6

Cost of revenue(1)
89.5

 
92.2

 
210.1

 
185.7

Gross profit
249.7

 
174.5

 
445.4

 
328.9

Operating expenses:(1)
 
 
 
 

 
 
Research and development
119.7

 
89.8

 
498.2

 
179.1

Sales and marketing
87.4

 
69.2

 
244.4

 
136.4

General and administrative(2)
49.8

 
42.2

 
175.9

 
73.5

Total operating expenses
256.9

 
201.2

 
918.5

 
389.0

Loss from operations
(7.2
)
 
(26.7
)
 
(473.1
)
 
(60.1
)
Interest income (expense), net
2.0

 
(3.0
)
 
0.8

 
(7.2
)
Other income, net
2.2

 
3.3

 
5.6

 
8.1

Loss before income taxes
(3.0
)
 
(26.4
)
 
(466.7
)
 
(59.2
)
Provision for income taxes
(1.1
)
 
(0.4
)
 
(2.9
)
 
(0.7
)
Net loss
$
(4.1
)
 
$
(26.8
)
 
$
(469.6
)
 
$
(59.9
)

(1) 
Includes stock-based compensation as follows:

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(In millions)
Cost of revenue
$
2.9

 
$
3.3

 
$
40.7

 
$
6.4

Research and development
27.9

 
21.7

 
310.8

 
43.5

Sales and marketing
7.9

 
7.7

 
80.3

 
15.4

General and administrative
16.4

 
6.0

 
109.8

 
12.2

Total stock-based compensation
$
55.1

 
$
38.7

 
$
541.6

 
$
77.5


(2) 
General and administrative expense for the three and six months ended June 30, 2017 includes $9.4 million related to a non-cash charitable contribution of common stock to the Dropbox Charitable Foundation, which is a related party of the Company. We made additional cash contributions to the Foundation of $0.2 million and $0.4 million during the three and six months ended June 30, 2017, respectively. See Note 12, "Related Party Transactions" to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for further information.


36



The following table sets forth our results of operations for each of the periods presented as a percentage of revenue:
 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(As a % of revenue)
Revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue(1)
26

 
35

 
32

 
36

Gross profit
74

 
65

 
68

 
64

Operating expenses(1):
 
 
 
 

 

Research and development
35

 
34

 
76

 
35

Sales and marketing
26

 
26

 
37

 
27

General and administrative
15

 
16

 
27

 
14

Total operating expenses
76

 
75

 
140

 
76

Loss from operations
(2
)
 
(10
)
 
(72
)
 
(12
)
Interest income (expense), net
1

 
(1
)
 

 
(1
)
Other income, net
1

 
1

 
1

 
2

Loss before income taxes
(1
)
 
(10
)
 
(71
)
 
(12
)
Provision for income taxes

 

 

 

Net loss
(1
)%
 
(10
)%
 
(72
)%
 
(12
)%

(1) 
Includes stock-based compensation as a percentage of revenue as follows:

 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(As a % of revenue)
Cost of revenue
1
%
 
1
%
 
6
%
 
1
%
Research and development
8

 
8

 
47

 
8

Sales and marketing
2

 
3

 
12

 
3

General and administrative
5

 
2

 
17

 
2

Total stock-based compensation
16
%
 
15
%
 
83
%
 
15
%


37


Comparison of the three months ended June 30, 2018 and 2017
Revenue
 
Three months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Revenue
$
339.2

 
$
266.7

 
$
72.5

 
27
%

Revenue increased $72.5 million or 27% during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017. This increase was primarily due to a 20% increase in the number of paying users between periods. The average revenue per paying user also increased between periods primarily due to an increased mix of sales towards our higher priced subscription plans, including renewals of grandfathered teams on our Dropbox Business Advanced Plan at higher prices, as discussed in "—Key Business Metrics".

Cost of revenue, gross profit, and gross margin
 
Three months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Cost of revenue
$
89.5

 
$
92.2

 
$
(2.7
)
 
(3
)%
Gross profit
249.7

 
174.5

 
75.2

 
43
 %
Gross margin
74
%
 
65
%
 
 
 
 

Cost of revenue decreased $2.7 million or 3% during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to a decrease of $6.5 million in our infrastructure costs due to continued infrastructure usage optimization efforts, which resulted in a reduction in depreciation expense due to the change in depreciable useful life of certain of our infrastructure equipment, which was effective on January 1, 2018. These decreases in cost of revenue were partially offset by an increase of $4.6 million in professional fees for user support and credit card transaction fees due to higher sales.
Our gross margin increased 9% during the three months ended June 30, 2018 compared to the three months ended June 30, 2017, primarily due to a 27% increase in our revenue during the period and a decrease in our cost of revenue primarily due to a decrease in infrastructure costs as described above.

Research and development
 
Three months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Research and development
$
119.7

 
$
89.8

 
$
29.9

 
33
%

Research and development expenses increased $29.9 million or 33% during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to an increase of $19.9 million in employee-related expenses, which was due to headcount growth and an increase of $8.3 million in overhead-related costs.

Sales and marketing
 
Three months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Sales and marketing
$
87.4

 
$
69.2

 
$
18.2

 
26
%

38



Sales and marketing expenses increased $18.2 million or 26% during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to an increase of $9.7 million in spend related to brand campaign fees, lead generation fees, and third-party sales representative fees. Further, sales and marketing expenses increased due to $4.3 million in app store fees due to increased sales and $3.0 million in employee-related costs primarily due to salary increases.

General and administrative
 
Three months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
General and administrative
$
49.8

 
$
42.2

 
$
7.6

 
18
%

General and administrative expenses increased $7.6 million or 18% during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to an increase of $10.3 million in stock-based compensation due to the recognition of expense related to the Co-Founder Grants in the three months ended June 30, 2018. In addition, employee-related expenses, excluding stock-based compensation, increased $4.0 million due to headcount growth. Further, general and administrative expenses increased $3.0 million due to legal-related and other expenses related to public company governance. These increases were offset by a decrease of $9.6 million in contributions to the Dropbox Charitable Foundation, of which $9.4 million was a non-cash contribution of Class A common stock for its initial funding, and $0.2 million was related to cash contributions made during the three months ended June 30, 2017.

Interest income (expense), net

Interest income (expense), net increased $5.0 million during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to an increase in interest income from our money market funds and short-term investments of $3.8 million and a decrease of interest expense of $1.2 million due to fewer assets acquired under capital leases.

Other income, net

Other income, net decreased $1.1 million during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily due to an increase of $2.5 million in foreign currency losses primarily related to monetary assets and liabilities denominated in euros and pounds. The decrease in other income, net was partially offset by an increase in sublease income of $0.6 million.

Provision for income taxes

Provision for income taxes increased $0.7 million during the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, primarily as a result of additional income in our profitable foreign entities.


39


Comparison of the six months ended June 30, 2018 and 2017
Revenue
 
Six months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Revenue
$
655.5

 
$
514.6

 
$
140.9

 
27
%

Revenue increased $140.9 million or 27% during the six months ended June 30, 2018, as compared to the six months ended June 30, 2017. This increase was primarily due to a 20% increase in the number of paying users between periods. The average revenue per paying user also increased between periods primarily due to an increased mix of sales towards our higher priced subscription plans, including renewals of grandfathered teams on our Dropbox Business Advanced Plan at higher prices, as discussed in "—Key Business Metrics".

Cost of revenue, gross profit, and gross margin
 
Six months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Cost of revenue
$
210.1

 
$
185.7

 
$
24.4

 
13
%
Gross profit
445.4

 
328.9

 
116.5

 
35
%
Gross margin
68
%
 
64
%
 
 
 
 

Cost of revenue increased $24.4 million or 13% during the six months ended June 30, 2018, as compared to the six months ended June 30, 2017, primarily due to an increase of $34.3 million in stock-based compensation, which included the achievement of the Performance Vesting Condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO. Cost of revenue also increased due to $7.0 million in professional fees for user support and credit card transaction fees due to higher sales. These increases were offset by a decrease of $15.4 million in our infrastructure costs due to continued infrastructure usage optimization efforts, which resulted in a reduction in depreciation expense due to the change in depreciable useful life of certain of our infrastructure equipment, which was effective on January 1, 2018. These increases were further offset by a decrease of $2.5 million in amortization of developed technologies, as certain assets became fully amortized during the six months ended June 30, 2017.
Our gross margin increased from 64% to 68% during the six months ended June 30, 2018 compared to the six months ended June 30, 2017, primarily due to a 27% increase in our revenue during the period and a decrease in our infrastructure costs as described above. The increase in gross margin was partially offset by the increase in stock-based compensation from the achievement of the Performance Vesting Condition related to our two-tier RSUs upon the effectiveness of the registration statement related to our IPO.

Research and development
 
Six months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Research and development
$
498.2

 
$
179.1

 
$
319.1

 
178
%

Research and development expenses increased $319.1 million or 178% during the six months ended June 30, 2018, as compared to the six months ended June 30, 2017, primarily due to an increase of $267.3 million in stock-based compensation, which included the achievement of the Performance Vesting Condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO. Further, the increase in research and development expense was due to an increase of $32.1 million in employee-related expenses, excluding stock-based compensation, which was due to headcount growth and employer payroll taxes related to the release of our two-tier RSUs, and an increase of $16.2 million in overhead-related costs.


40


Sales and marketing
 
Six months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
Sales and marketing
$
244.4

 
$
136.4

 
$
108.0

 
79
%

Sales and marketing expenses increased $108.0 million or 79% during the six months ended June 30, 2018, as compared to the six months ended June 30, 2017, primarily due to an increase of $64.8 million in stock-based compensation, which included the achievement of the Performance Vesting Condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO. Sales and marketing expenses also increased $26.0 million due to brand marketing costs, lead generation costs, and third-party sales representative fees. In addition, the increase in sales and marketing expense was due to an increase of $8.3 million in employee-related expenses, excluding stock-based compensation, which was due to salary increases and employer payroll taxes related to the release of our two-tier RSUs, and an increase of $8.0 million due to app store fees as a result of increased sales.

General and administrative
 
Six months ended
June 30,
 
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
(In millions)
 
 
 
 
General and administrative
$
175.9

 
$
73.5

 
$
102.4