Earnings Call
Dropbox, Inc. (DBX)
Earnings Call Transcript - DBX Q1 2020
Darren Yip, Head of Investor Relations
Thank you. Good afternoon and welcome to Dropbox's first quarter 2020 earnings call. Today, Dropbox will discuss the quarterly financial results that were distributed earlier. Statements on this call include forward-looking statements, including the potential impact of the COVID-19 pandemic and related public health responses on our business, financial results, and the economy, statements relating to the expected performance of our business, future financial results, including expectations regarding future profitability and our ability to generate and sustain positive free cash flow, our ability to extend our platform by developing new products or features, our strategy, as well as the ability of our key employees to execute on our strategy, long-term growth and overall future prospects. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those projected or implied during this call. In particular, those described in our risk factors included in our Form 10-K for the year ended December 31, 2019, and the risk factors that will be included in our Form 10-Q for the quarter ended March 31, 2020. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them except as required by law. Our discussion today will include non-GAAP financial measures. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of our GAAP and non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and may also be found in the supplemental investor materials posted on our Investor Relations website at investors.dropbox.com. I would now like to turn the call over to Dropbox's Co-Founder and Chief Executive Officer, Drew Houston.
Drew Houston, CEO
Thanks Darren. Good afternoon everyone and welcome to our Q1 earnings call. Thank you for taking the time to join us today, especially under the current circumstances. On the call with me is Ajay Vashee, our Chief Financial Officer. Olivia Nottebohm, our Chief Operating Officer will also join us during Q&A. The three of us are dialing in remotely from our homes, so please forgive us for any sound quality issues or background noise over the next hour. Today I'll provide an update on the top of funnel and engagement trends we're seeing as a result of COVID-19 and talk to business and product highlights from the last quarter. Ajay will review our Q1 financial results, touch on our go-to-market strategy, and provide guidance for Q2 and fiscal 2020. First, I want to provide some perspective on how the team here at Dropbox is responding to COVID-19. I'm really proud of how quickly our employees have adapted to working effectively in this challenging environment. We continue to hold regular company-wide town hall meetings across our global offices and productivity has remained high, even if the vast majority of us have shifted to work remotely while reorienting our product roadmap to adapt to emerging customer demand. In addition, our infrastructure teams have been hard at work to ensure we continue to operate without any service interruptions or issues and are able to support higher utilization during this time. I want to thank the team for staying focused on serving our customers and for continuing to provide them with the tools they need to get work done. In times like these, the ability for teams to easily access and work together on content takes on an even greater significance. We launched the new Dropbox last year to address unmet needs around distributed teamwork and collaboration. It's a smart workspace to organize users' content, connect our tools and bring teams together, helping users stay in sync and reducing the friction of working remotely. We believe the accelerated transition to remote work that's underway will have lasting effects that will favor companies like ours in the long run and create added demand for our products, and we're starting to see that in our top of funnel metrics. Over the last few months, we've seen an increase in free trial starts across both our team and individual plans. Since mid-March, daily Dropbox business team trials increased by approximately 40% over pre-COVID levels at the outset of the year with higher levels of engagement and collaborative activity. Similarly, daily trial starts for our Plus individual plan increased over 25% over the same periods. We will be closely monitoring these newer cohorts for conversion trends and business contributions in the coming weeks and months. In addition to the higher demand we've seen in our top of funnel, we've also seen increased adoption of our new desktop app. Now available to all users, early adoption of our new desktop app has grown to over 350,000 of our over 450,000 Dropbox Business teams. Over the past couple of months, weekly active users on the new desktop app have increased by approximately 60%. We've also seen significantly higher usage of HelloSign in recent months, with the number of signature requests tripling from average levels across January and February. HelloWorks, our fully customizable document workflow solution, has seen an uptick in new COVID-19 related use cases. Lenders have leveraged the product and sent out tens of thousands of small business loan relief applications; a New York-based urgent care facility relied on HelloWorks to process nearly 2,000 patient intake forms in April alone. Increased interest in Dropbox has also come from higher-education institutions that have shifted to a remote learning model. Demand for our products from universities is increasing and professors are using Dropbox Paper as a tool to make educational content more accessible and collaborative for students. In Q1, we also launched a program to donate free Dropbox licenses to NGOs battling COVID-19 as well as K-12 teachers, and we're continuing to support our local hospitals and medical professionals on the front lines. We want to do everything we can to help critical efforts like these. Turning to our quarterly results, in Q1 we continued to see strength across our business. Revenue grew 19% year-over-year on a constant currency basis, driven by paying user growth and ARPU expansion. We also achieved record operating margins and reached GAAP profitability for the first time. These results underscore the strength of our global collaboration platform, our efficient go-to-market strategy, and our operational discipline. Let's move on to some of the product highlights from the quarter. We're always focused on building a great experience for our users. This quarter we added notable features to our deep integration with Zoom, allowing users to do even more without ever leaving Dropbox. Now users can record a Zoom meeting and save it, along with the transcript, directly to Dropbox. From there they can securely share the transcript and recording with team members and keep them in the loop when they can't make it to a meeting. Since transcript files are indexed using our full-text search feature, they'll show up when users search for any phrase mentioned during a video conference. Given that many of our collective users are now working remotely, this has proven to be a timely product release. Heading into April, we saw a 20-fold increase in usage of our Zoom integration compared to February levels. This quarter, we also launched a number of improvements to the admin experience. Empowering IT is an important focus area for us as we drive adoption of Dropbox within business teams. In Q1, we introduced an updated insights dashboard. This refreshed dashboard, part of the Dropbox business admin console, enables IT to easily review user activity and take relevant actions as needed. The new dashboard allows admins to see which outside domains the team is sharing with and how often, generate at-a-glance stats on paid license utilization, pending invites, active members, and monitor sharing activity for compliance. In Q1, we also launched new admin and security features into HelloSign enterprise. Customers in this queue can now streamline multi-team management with centralized visibility and delegation controls, providing oversight over documents, templates, branding, and usage. These capabilities empower IT to stay in control as utilization scales. Enterprise features like these have already helped HelloSign land one of its largest deals to date. We're excited to announce that another leading on-demand services platform has joined a growing number of delivery companies, including Instacart, who are leveraging HelloSign. The customer will deploy HelloSign Enterprise Plus to create a faster and more seamless onboarding experience for restaurants and will drive improved e-signature workflows across several business functions. Together, our new Dropbox business insights dashboard and the advanced admin and security features we introduced for HelloSign help streamline the admin experience as teams scale their deployments of Dropbox. In addition to improving our native admin functionality, we've been investing in key partnerships to bring Dropbox Business teams tools to manage and secure a best-of-breed SaaS environment. Our advanced team and content controls add-on, launched in partnership with BetterCloud, empowers IT admins with even greater control over data protection, enhanced visibility and auditability, and automated user lifecycle management. In Q1, we closed nine outbound deals where the advanced team and content control add-on was cited as a key differentiator. This included a Dropbox enterprise win to displace a competitor at a physician group with over 5,000 employees across 200 locations, specializing in emergency medicine and acute care. With our advanced team and content controls add-on, Dropbox addresses the customer's need for a HIPAA-compliant tool to enable collaboration among a highly distributed workforce. To wrap things up, Q1 was a strong quarter for us amidst a rapidly shifting global environment. The record trial volumes and customer engagement trends have been encouraging, but we remain cognizant that there are likely headwinds ahead for the broader economy. At Dropbox, we remain committed to our customers, and we'll continue to focus on enhancing the capabilities of our products to facilitate distributed and remote work. Our efforts to improve the experience for IT admins will help teams efficiently and securely expand their deployments, and our latest integrations and partnerships help our users bring all their different tools together so that they can focus on their work wherever they may be. I'll now turn it over to Ajay, our CFO, to walk through our financial results.
Ajay Vashee, CFO
Thank you, Drew. Our Q1 results demonstrate our strong execution and focus on delivering a healthy balance of topline growth and profitability. Total revenue for the quarter was up 18% year-over-year, to $455 million. On a constant currency basis, year-over-year growth would have been 19%. ARR for the quarter was $1.864 billion, up 16% from the year-ago period. On a constant currency basis, ARR grew $53 million quarter-over-quarter and 17% year-over-year. I note that in Q1 of every year we update the FX rates used to calculate ARR. We ended Q1 with 14.6 million paying users, and ARPU was $126.30 in the period. This reflects our strategy to methodically convert our highest-value users to drive sustainable monetization and retention. Let me highlight a few ways we're executing on that strategy. Over the past several months, we've enhanced our mobile onboarding flows for users who sign up for a Dropbox Plus trial that drive higher levels of engagement and conversion to our platform. Our data science team identified certain actions that mobile users can take in the first few weeks of their trial, such as sharing links to content, which increase their propensity to convert into a paying subscriber. With these insights in mind, our engineering teams have been revamping our onboarding prompts to encourage users on the Plus trial to take these types of actions, thereby helping to drive notable improvements in our mobile trial conversion rate. This is an investment we're particularly excited about in light of the elevated trial volume that Drew spoke to earlier. Let's move on to some of our customer highlights. In Q1, we had a number of wins across a range of verticals, including healthcare, technology, education, and insurance. We're excited to announce that Usborne Publishing is now a Dropbox business customer. Usborne Publishing is a leading U.K.-based publisher of children's books that turned to Dropbox as part of this accelerated shift to a remote work strategy due to COVID-19. With the onset of the virus in the UK, the company needed to enable employees on the production and creative teams, who were dependent on on-premise file servers, to work from home with a tool that they can deploy quickly. In less than a week, Dropbox business was purchased and provisioned to all employees. Usborne has cited that Dropbox's widespread usage in the media industry and key integrations with Adobe products have been critical to their decision to adopt our platform. In addition, we're pleased to announce that the University of Oregon is now a Dropbox customer. Dropbox will be made available to all faculty, staff, and students at Oregon's flagship public university. Our products were already widely adopted across the university's faculty, with particularly high usage among research professors who leverage Dropbox to collaborate with colleagues at other institutions. With this purchase, the University of Oregon will now be able to administer all Dropbox usage centrally using the IT controls available to enterprise customers. Our support of FERPA, HITECH, and HIPAA protocols was key to becoming a trusted partner to the university. Before I move on to the rest of the P&L, I want to note that unless otherwise indicated, all income statement measures that follow are non-GAAP and exclude stock-based compensation, amortization of purchased intangibles, and certain expenses related to the acquisition of HelloSign. Our non-GAAP net income also excludes net gains and losses on equity investments. A reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and in the supplemental investor materials posted on our Investor Relations website. Moving to the P&L, gross margin for the quarter was 78%, an increase of three percentage points compared to the first quarter of 2019. The increase in gross margin was driven by unit cost efficiency gains with our infrastructure hardware, including lower depreciation as a share of revenue. We continue to expect fiscal 2020 gross margin to be approximately 1.5 points higher than 2019. Moving to operating expenses, first quarter R&D expense was $140 million, or 31% of revenue, compared to 30% in Q1 a year ago. The increase as a percentage of revenue was primarily driven by higher headcount as well as investments in new product development and testing. S&M expense was $96 million in the first quarter, or 21% of revenue, compared to 24% in Q1 a year ago. The decrease was due to greater efficiencies in marketing-related spend relative to Q1 of 2019. G&A expense was $47 million, or 10% of revenue, compared to 11% of revenue in Q1 a year ago. The decrease was due to lower non-income-based taxes. Taken together, we earned $73 million in operating profit in the first quarter. This translates to a record 16.1% operating margin, which is a six percentage point improvement from Q1 of 2019. Net income for the quarter was $70 million, up from $42 million a year ago. Diluted EPS was $0.17 per share based on 419 million diluted weighted average shares outstanding, up from $0.10 in Q1 a year ago. As Drew noted earlier, Q1 was also our first quarter of GAAP profitability, an important milestone for us. While we may see some fluctuations quarter-to-quarter based on timing of spend, we expect to be GAAP profitable for the fiscal year. Moving on to cash balance and cash flow, we ended Q1 with cash and short-term investments of $1.101 billion. Cash flow from operations was $53 million in the quarter. Capital expenditures were $28 million, yielding free cash flow of $25 million or 6% of revenue. CapEx in Q1 included $21 million of spend on our new headquarters, of which $8 million was offset by tenant improvement allowances. In Q1, we also incurred the first payout of deal consideration holdback related to our acquisition of HelloSign. Excluding the headquarters spend, net of TIAs of $13 million and payout of HelloSign deal consideration holdback of $16 million, free cash flow would have been $54 million or 12% of revenue. In Q1, we also added $35 million to our finance lease lines for data center equipment. We expect additions to our finance lease line to be approximately 8% of revenue in 2020. Now let's turn to our guidance. Since our IPO two years ago, we've maintained a consistent guidance philosophy that is to guide to what we have a certain degree of visibility into and revise our outlook over time as we build more signal on business trends and initiatives in our pipeline. While our near-term revenue and earnings remain quite predictable given our subscription-based model, COVID-19 introduces some uncertainty across the second half of the year. Our business has been resilient over the past few months, and we believe our product portfolio uniquely positions us to support the global shift to remote work and remote learning that's underway. As Drew mentioned earlier, we're seeing some encouraging top of funnel trends related to both team and individual trial volumes, although it's still early on this front. On the other hand, the weakening of foreign currencies relative to the US dollar, as well as lower interest rates, could negatively impact our revenue and free cash flow for the remainder of the year if they persist at current levels. Like every other SaaS business today, we need to remain mindful of the broader macroeconomic risks and unpredictability that the second half of the year may bring. With that, let's move on. For the second quarter of 2020, we expect revenue to be in the range of $463 million to $466 million. On a constant currency basis, we estimate that revenue would be approximately $5 million higher. We expect non-GAAP operating margin to be in the range of 16.5% to 17.5%, and diluted weighted average shares outstanding to be in the range of $417 million to $420 million based on our trailing 30-day average share price. For the full year 2020, we are revising our revenue guidance range, which was previously $1.890 billion to $1.905 billion, to $1.880 billion to $1.900 billion to account for FX headwinds introduced by COVID-19. On a constant currency basis, we estimate that revenue would be approximately $16 million higher for a range of $1.896 to $1.916 billion which is largely consistent with our guidance on last quarter's earnings call. We continue to expect non-GAAP operating margin to be in the range of 17.5% to 18%. We are revising our free cash flow guidance range which was previously $475 million to $485 million to $460 million to $470 million to account for FX headwinds and lower interest rates as a result of COVID-19. This range includes one-time spending related to the build-out of our new corporate headquarters, as well as the payout of deal consideration holdback related to our acquisition of HelloSign. Excluding these items, free cash flow would be $510 million to $520 million. Net of FX and interest-related adjustments, our free cash flow guidance would have remained consistent with the figures we provided on last quarter's earnings call for approximately $15 million higher. Finally, we expect 2020 diluted weighted average shares outstanding to be in the range of $419 million to $422 million based on our trailing 30-day average share price. Moving forward, we remain focused on supporting our employees and customers during these unprecedented times. We also remain committed to delivering long-term shareholder value. Like every other company, we're closely monitoring the evolving macroeconomic environment. While Dropbox is certainly not immune to external pressures, we do feel that we're uniquely positioned. We're operating an efficient self-serve driven business, which underpins our strong free cash flow generation. This has enabled us to build a healthy balance sheet with over $1 billion in cash and short-term investments. Looking ahead, we will certainly continue investing in our business, but we're also committed to driving efficiencies and higher levels of productivity across the company to execute to the long-term targets we outlined on last quarter's call. We remain focused on generating over $1 billion in annual free cash flow by 2024 and achieving our long-term operating margin target of 28% to 30%. As always, our goal is to deliver a healthy balance of growth and profitability, and we're excited about the opportunity ahead. I'll now turn it back to Drew for closing remarks.
Drew Houston, CEO
Thank you, Ajay. In conclusion, I'm proud of our execution in what's been a challenging environment. We're in a solid position with a suite of products that facilitate remote and distributed work, a profitable self-serve business model, and a healthy balance sheet. On behalf of our management team, I'd like to take a moment to thank our customers, partners, and the entire Dropbox team. With that, I'd like to open up the call for Q&A.
Operator, Operator
And our first question comes from Alex Zukin with RBC Capital Markets.
Alex Zukin, Analyst
Maybe just the first one around the benefits of the tailwinds that you're seeing from work from home. You mentioned the top of funnel. I'd love to hear anecdotally what you're seeing from existing customers expanding seat counts and ultimately what have you seen, maybe thus far in Q2 in the month of April, with respect to those conversion rates, and then I got one quick follow-up.
Drew Houston, CEO
This is Drew. So we've certainly seen higher demand at the top of the funnel. Engagement is up, and as I mentioned, our new desktop app's engagement has uniquely increased by 60% in the last couple of months. And then conversions have held up so far, and churn has been stable. That said, we're monitoring everything pretty closely, given the macroeconomic environment and the unpredictability that the second half may bring. More broadly, we think this is a huge opportunity because right now, it's been an unplanned and dramatic shift towards work from home. I think there's a lot of room for improvement in experience, and Dropbox has always helped people work from wherever they are. We're very focused on how to do more for our users—how we define that experience really great—and we've certainly seen a lot of elements of our strategy, with our Slack and Zoom integrations proving successful, for example, with a 2000% increase in engagement, being good validation for that strategy. But really, making sure our roadmap is aligned to capitalize on this opportunity remains our biggest focus.
Alex Zukin, Analyst
Perfect. And then maybe just that you mentioned Drew churn and maybe just also for Ajay. Can you talk about what you're seeing in terms of churn or net retention trends by the various cohorts? Where you expect them to end up and how should we think about just exposure to either SMB trends or maybe troubled industries?
Ajay Vashee, CFO
Sure, this is Ajay, happy to jump in there, and then Drew feel free to add any context that you'd like to. As Drew mentioned, our business has been very resilient to date. Churn was stable for us from Q4 of '19 into '20 and that continues to be the case today. This is really because the majority of our subscribers are knowledge workers, and we play a really important role in managing business-critical content for them. That being said, we'll be keeping a close eye on retention in newer cohorts where we're seeing elevated trial volumes. Still very early for us on that dimension because a lot of these cohorts, as you can imagine, have signed up over the past month, and we're still understanding their behavior. We do need to keep an eye like every other company on the potential impact from broader macroeconomic trends on existing subscribers, but we're being proactive about where we're investing. As Drew said, we've been adapting our product roadmap to support this accelerated shift to distributed work. An example is proactively investing in leverage to improve and mitigate churn rates across the second half of the year into the future.
Drew Houston, CEO
And just building on that, we're really focused on helping our customers adapt to the remote work environment. We want to ensure they're getting the most out of the platform, and we're taking other measures to proactively address churn, offering support and selected financial relief to ensure that customers can manage. Overall, we find that our customer base, even in SMBs, like knowledge workers who can work and must collaborate around content, are less disrupted than average, and Dropbox is often essential to their business operations as opposed to discretionary. These are all businesses and people that need to collaborate around content, especially when working from home.
Operator, Operator
And our next question comes from the line of Jason Ader with William Blair.
Jason Ader, Analyst
Thanks for the greater detail on the top of funnel metrics. It's definitely helpful to get some of that, and issues to hear your thoughts on kind of historical analytics around that, but my question is probably the question I get most from investors. How do you see the market there for Dropbox spaces in the long term, given the dominance of Microsoft Teams that's emerging and the fact that they've got a lot of the same smart workspace features and bundle the app in Office 365?
Drew Houston, CEO
Sure. We see a big opportunity for us because when you look at our customer's workflows, they need to collaborate on content, and that's usually a parallel complementary experience to messaging tools. When people are using something like Teams or Slack, often what they discuss relates to content in Dropbox. These are complementary experiences. With the proliferation of various apps, more and more customers are turning to Dropbox for a platform-agnostic solution that ties everything together because the bundled offerings tend to favor the tools within their own suite. Our customers may be using something like Office, but they're also using G Suite, Slack, Zoom, and so on. There is an increasing need to organize work in a focused place that pulls together different tools, and I don't see Teams or the messaging apps achieving that.
Ajay Vashee, CFO
With that said, those are fantastic questions, and to bring this back to the metrics for us, we are seeing higher and higher levels of adoption and engagement with that, that's not an application as Drew mentioned earlier. Now the majority of our business teams—over 350,000 of our 450,000-plus business teams—are engaging with that application and learning from the 60% increase in activity over the past couple of months.
Operator, Operator
And our next question comes from the line of Mark Murphy with JPMorgan.
Mark Murphy, Analyst
Congrats on the great resilience that you've shown in the business model. Drew, you mentioned a solid uplift in the top of funnel metrics since mid-March, and I'm interested in how much of that activity you think will look back on and say that it was a one-time surge versus ongoing usage, where they'll continue and take it into the workplace over time. And then Ajay, I wanted to ask you, your fiscal year guidance seems to be adjusting for FX and interest rates, and I was wondering if you could clarify what the assumption is for COVID-19 impact, or is it just like you see the tailwind offsetting?
Drew Houston, CEO
Sure. I'll start. I think it's a little too early to tell to what extent this surge versus a permanent uplift, certainly a huge percentage of the world is being forced into a remote work state for the first time. However, I believe the effects will persist well beyond when we physically go back into the office. One of the immediate realizations when working from home is the desire for contact with those around you. Things that were relatively straightforward, like knowing what everyone is up to, have become quite challenging when your only window into work is through video conferences or messaging tools. We see a big opportunity to help address this. The focus is on ensuring that our tools enable organizations to adapt to a distributed work environment. After we physically return to the office, this shift to a distributed or hybrid work model will be permanent, leading to increased flexibility for employees.
Ajay Vashee, CFO
To answer the second part of your question on the guidance philosophy, I would reiterate a couple of points. Given the resilience of our core business, we are largely maintaining our annual guidance, net of currency and interest rate movements, like COVID-19, and we are observing some encouraging top-of-funnel trends. It's still early in that front. We want to monitor these cohorts for both conversion and retention information and remain mindful of broader macroeconomic risks the second half of the year may bring. There is certainly more that we will learn in the coming months and will share an updated view of the second half of the year on our August call, incorporating more granular perspectives.
Operator, Operator
And our next question comes from the line of Rishi Jaluria with DA Davidson.
Rishi Jaluria, Analyst
Thanks so much for taking my questions. First, I wanted to ask, how should we be thinking about the consumer side of the business? I know 80% of your customers are business users using Dropbox at work. But what about that remaining 20% that is consumer? Especially with unemployment up, reportedly over 33 million last night. What are you seeing from that side?
Drew Houston, CEO
I'd say we're seeing a large audience of consumer users, but the vast majority, around 80% of our users, utilize Dropbox both for work use cases and blended home and work use cases. Therefore, we see less focus on pure consumer cases and are prioritizing features that correspond to both personal and work use cases. Certainly, our primary focus remains on work. Targeting the pure consumer space is tougher from a business model perspective and isn't a significant segment for us.
Rishi Jaluria, Analyst
Okay, got it. That's helpful. And then I wanted to ask, what are you seeing in terms of buying behavior from customers? Any indications of extended payment or contract renegotiations? Additionally, what are you observing in terms of deal duration? A couple of quarters ago, you mentioned that you were seeing more customers opting for monthly versus annual contracts. Just wanted to understand the trends around that?
Olivia Nottebohm, COO
Hi Rishi, this is Olivia, and I'll take that question. We have had selective requests from certain customers, and we've considered each one thoughtfully, gauging the moment of need for our customers to assist them and considering targeted extensions of net payment terms and changing our invoice frequency in some situations. These are all neutral mechanisms we're employing to help assist our customers through this crisis. On the flip side, we see scenarios where customers are quickly activating additional seats and licenses. We expedite that process and then allow the paperwork to catch up later. For example, a hospital in Boston needed an additional 100 seats to manage bed inventory; we spun that up immediately, then will catch it on the renewal cycle in a month during a true-up.
Ajay Vashee, CFO
To add to that, these discussions are relatively immaterial with respect to our overall business impact. Regarding the duration of contracts, it's more relevant to the self-serve business and primarily to our individual subscribers. Here we’ve observed that due to the surge in demand over recent months, many have opted for monthly contracts versus annual ones as they adapt rapidly to remote and distributed work.
Operator, Operator
And our next question comes from the line of Heather Bellini with Goldman Sachs.
Heather Bellini, Analyst
I just want to follow up. You mentioned some of those encouraging top-of-funnel trends, which is great to see. Ajay, I wanted to return to something you discussed a couple of quarters ago that you reiterated last quarter: the expectation of net sub adds being roughly 70,000. Has this dynamic largely changed, or is there something you'd consider to drive that number higher in guidance?
Ajay Vashee, CFO
As it relates to the increase in top-of-funnel demand, it's still early. Many of those users remain in trial phases and have yet to convert to paying users. On our last earnings call, we noted that paying user growth would be slightly lower as a result of our Plus repricing and repackaging initiative, and that continues to align with our expectations. This initiative has maintained momentum for revenue. Historically, our revenue growth has been driven primarily by conversion volume, with ARPU expansion as the secondary driver, and this balance will persist for us moving forward. Our gross new conversions have remained consistent at approximately 1 million gross new users per quarter.
Operator, Operator
And our next question comes from the line of Sarah Hindlian with Macquarie.
Sarah Hindlian, Analyst
Thank you so much, Drew and Ajay. I wanted to follow up on Alex's question regarding exposure to industry verticals that are particularly struggling due to COVID-19. Could you provide a bit more insight into specific vertical exposure? In addition, Drew, regarding the incredible conversion you're seeing with the desktop app, what strategies are being implemented to drive the rapid increase in user engagement?
Drew Houston, CEO
We have a very diversified customer base, which is advantageous for us. Many sectors that are most impacted require a return to physical work environments. However, knowledge workers can continue to operate effectively thanks to our tools, making us less affected than others in the market. We are monitoring the macro environment closely as this is something we take seriously. Regarding user engagement, we help users transition from classic file management systems to a richer experience through the desktop app. This includes new features like the Dropbox tray, which enhances our users' ability to access content and utilize collaborative features more effectively within their daily workflow.
Olivia Nottebohm, COO
To add to that, we're seeing an increase in trials across customer segments. It's consistent across the board, as expected given the environment, but it's great to witness that consistency.
Operator, Operator
And we have time for one more question and that comes from the line of Zane Chrane with Bernstein Research.
Zane Chrane, Analyst
I commend you guys on the great transparency in your 10-K. You had some helpful data on the quarterly ARR over the past couple of years, and when I look at the incremental ARR you added this quarter relative to the paid user adds, it seems to suggest there has been a substantial increase year-over-year in the effective average ARPU of the paid users you're adding. Should I interpret this to mean that you're bringing in a lot of business customers at much higher prices that are lifting the effective average ARPU? Or could it be that the lower-value consumers are being attritioned, thereby driving it higher? What should we consider around this?
Ajay Vashee, CFO
This observation reflects our strategy of focusing on high-value customer conversion to drive profitable ARR growth, which is evident in our metrics. We've methodically increased our gross new ASP over the past two years, leading to the highest rate we’ve ever recorded in this quarter. The new paying users we are converting represent higher-value cases than previous periods, indicating intentional growth through this transition.
Drew Houston, CEO
I would say both trends are accurate. We're continuing to transition toward serving higher-value customers, away from focusing on pure consumer use cases. That strategic shift drives our revenue growth, and we're focused on it for the long-term success of the business.
Operator, Operator
Thank you. I will now turn the call back over to CEO Drew Houston for any further remarks.
Drew Houston, CEO
All right, well thank you everyone for joining us. I want to express my gratitude for the efforts of our team in continuing to run the business under challenging conditions and taking care of our customers. We're proud of the progress we're making, and we hope all of you are staying safe. We look forward to connecting with you next quarter. Thanks.
Operator, Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect.