Dropbox (NASDAQ:DBX) Q1 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to the first quarter 2020 Dropbox Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. It is now my pleasure to introduce Head of Investor Relations, Darin Yip. Thank you. Good afternoon, and welcome to Dropbox's first quarter 2020 earnings call.

0:45 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.

1:54 We 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 to non-GAAP results may be found in our earnings release, which was furnished with our Form 8K 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.

2:41 I would now like to turn the call over to Dropbox's co-founder and Chief Executive Officer, Drew Houston. Drew? 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 Vashi, our Chief Financial Officer. Olivia Nadebaum, 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.

3:26 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 as the vast majority of us have shifted to working 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 continuing to provide them with the tools they need to get work done.

4:20 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 their 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.

5:05 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 to our PLUS individual plan increased over 25% over these same periods. We'll be closely monitoring these newer cohorts for conversion trends and business contribution 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. And over the past couple of months, weekly active users on the new desktop app has increased by approximately 60%.

5:56 We've also seen significantly higher usage of HelloSign in recent months. and with the number of signature requests up three times from average levels across January and February. And Hello Works, our fully customizable document workflow solution, has seen an uptick in new COVID-19 related use cases. Lenders have leveraged the product to send out tens of thousands of small business loan relief applications and a New York-based urgent care facility relied on Hello Works 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.

6:45 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 frontlines. 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.

7:33 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 a 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. And 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 times increase in usage of our Zoom integration compared to February levels.

8:24 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 the 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 action as needed. The new dashboard allows admins to see which outside domains their team is sharing with and how often. generate out-of-gallant stats on paid license utilization, pending invites, active members, and suspended members, and monitor sharing activity for compliance. In Q1, we also launched new admin and security features into HelloSign Enterprise. Customers to this SKU 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.

9:24 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 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 eSignature workflows across several business functions. Together, our new Dropbox Business Insights dashboard and the advanced admin and security features we introduced for HelloSign helped to streamline the admin experience as teams scaled their deployments to 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 our best-of-breed SaaS environment.

10:12 Our advanced Team and Content Controls add-on, launched in partnership with BetterCloud, empowers IT admins with even greater control over data protection, Holtzman, and Eric Schubach. In Q1, we closed nine outbound deals where the advanced team and content controls 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 addressed 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.

11:00 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 will 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. Thank you, Drew. Our Q1 results demonstrate our strong execution and focus on delivering a healthy balance of top-line growth and profitability.

11:45 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 CSX rates used to calculate ARR. We ended Q1 with 14.6 million paying users, and ARPU was $126.30 in the period.

12:34 ARR 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 this strategy. Over the past several months, we've enhanced our mobile onboarding flows for users who sign up for a Dropbox Plus trial to 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 a plus trial to take these types of actions, thereby helping to drive notable improvements in our mobile trial conversion rates.

13:26 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, We're excited to announce that Usborne Publishing is now a Dropbox business customer. Usborne Publishing is a leading UK-based publisher of children's books that turned to Dropbox as part of its 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 to work from home with a tool that they could deploy quickly.

14:18 In less than a week, Dropbox Business was purchased and provisioned to all employees. Usborne cited Dropbox's widespread usage in the media industry and key integrations with Adobe products as being 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.

15:12 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.

16:02 Moving to the P&L, Gross margin for the quarter was 78%, an increase of 3 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.

16:56 S&M expense was $96 million in the first quarter, or 21% of revenue, and many more. 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.

17:46 Net income for the quarter was $70 million, up from $42 million a year ago. Diluted EPS was 17 cents per share. based on 419 million diluted weighted average shares outstanding, up from 10 cents 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.

18:37 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 and 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.

19:28 In Q1, we also added $35 million to our finance lease fines for data center equipment. We expect additions to our finance lease fines 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 being 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. And 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.

20:14 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 U.S. 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. And 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.

21:03 With that, let's move on. For the second quarter of 2020, we expect revenue to be in the range of $463 to $466 million. On a constant currency basis, we estimate that revenue would be approximately $5 million higher. We expect non-GAAP operating margins to be in the range of 16.5 to 17.5%, and diluted weighted average shares outstanding to be in the range of $417 to $420 million, based on our trailing 30-day average share price. For the full year of 2020, we are revising our revenue guidance range, which was previously 1.890 to account for FX headwinds introduced by COVID-19.

21:56 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 margins to be in the range of 17.5 to 18%. We are revising our free cash flow guidance range which was previously $475 to $485 million to $460 to $470 million to account for FX headwinds and lower interest rates as a result of COVID-19.

22:56 This range includes one-time spend 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 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, or approximately $15 million higher. Finally, we expect 2020 diluted weighted average shares outstanding to be in the range of $419 to $422 million based on our trailing 30-day average share price.

23:44 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. And 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, while we'll certainly continue investing in our business, 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.

24:38 We remain focused on generating over $1 billion of 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. 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.

25:26 Operator? Thank you. And as a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. We also ask that you please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. And our first question comes from the line of Alex Zukin with RBC Capital Markets. Hey, guys. Thanks for taking my question and hope everybody's staying safe. Maybe just the first one around the benefits or the tailwinds that you're seeing from work from home.

26:16 You mentioned, you know, the top of funnel. Yeah, I'd love to hear kind of anecdotally what you're seeing from existing customers, you know, expanding seat counts. And ultimately, what have you seen maybe, you know, thus far in Q2 in the month of April with respect to those conversion rates? and then I got one quick follow-up. Sure. Hey, Alex. 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, the engagement weekly actives are up 60% in the last couple months. And then conversions have held up so far and churn has been stable so far.

27:04 That said, we're monitoring everything pretty closely, given the macroeconomic environment and unpredictability that the second half may bring. But more broadly, we think this is a huge opportunity, because right now we've been all forced to work from home in the most unplanned and dramatic way possible. And I think there's a lot of room for improvement in that experience. And Dropbox has always helped people to work from wherever they are, and right now everyone needs that. But we've been very focused on how do we do more for our users, or how do we design that experience to be really great. And we've certainly seen a lot of elements of our strategy with our Slack and Zoom integrations and our Zoom integration engagement being at 2,000%, for example, as being good validation of that strategy.

27:54 But really just making sure that our roadmap is as aligned as possible to get after the opportunity is our biggest focus. Perfect. And then maybe just you mentioned Drew Chern and maybe just also for Ajay, just can you talk about what you're seeing in terms of Chern or net retention trends by the various cohorts, where you expect them to maybe end up or trough, and then how should we think about just exposure to either SMB trends or maybe troubled trends? Troubled Industries. Sure. This is Ajay. Happy to jump in there. And then, Drew, feel free to add any context that you'd like to.

28:41 As Drew mentioned, our business has been very resilient today. Churn was stable for us from Q4 of 19, 1 of 20, and that continues to be the case today. And 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, Alex, as you can imagine, have signed up over the past month, some just a little bit beyond that. And so it's still pretty early there. And we do need to keep an eye, like every other company, on the potential impact from broader macroeconomic trends on existing subscribers. But we are being proactive about where we're investing.

29:27 As Drew said, we've been adapting our product roadmap. Thank you, guys. Congratulations. Thank you. And just building on that, you know, we're really focused on helping our customers adapt to the remote work environment and ensure they're getting the most out of the platform. And then, as Ajay said, we're taking other measures to proactively address churn and offering support and selective financial relief to ensure that customers can manage.

30:17 But overall, we find that our customer base, even in SMBs, like knowledge workers who can work from home, have been less disrupted than before. Thank you. And our next question comes from the line of Jason Adder with William Blair. Yeah, thank you. Hey, guys. Thanks for the greater detail on the top of funnel metrics. It's definitely helpful to get some of that and be interested to hear your thoughts on kind of historical analytics around that.

31:08 But my question is probably the question I get most from investors. How big a market is there for Dropbox spaces 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. Sure. So, I mean, we see a big opportunity for us because when you look at our customers' workflows, they need to collaborate on content, and then that's usually a parallel or complementary experience to the messaging So when people are using something like Teams or Slack, often what they're talking about is content that lives in Dropbox.

31:59 These tend to be complementary experiences. And I think with the proliferation of all the different apps, more and more customers are turning to Dropbox for a platform-agnostic solution that pulls it all together because the bundled offerings tend to favor the and so on. And more and more we need a way to tie it all together. So the opportunity for Dropbox Spaces is, I mean, really every knowledge worker, every business, every team needs to collaborate around content. And I think more and more we're going to have a need to organize our work. in a way that's a bit of a different and complementary experience to messaging.

32:49 You know, the channel for chat is just one part of the experience, and we see the content workflows as really being our strength. But don't you think, Drew, don't you think the Teams is trying to, I mean, has a similar vision in terms of smart workspace, in terms of not just chat and messaging? Yeah, although I think there are challenges with that model with the kind of synchronous messaging or chat model as you scale. You know, I don't think in five years we'll look back and think, hey, the secret to productivity is putting people in like 50 different chat rooms simultaneously all day. I think it becomes a very noisy and distracting environment at scale.

33:37 By all means, chat remains and will always be an important ingredient. But I think the challenge is if you go on vacation for a couple days, you come back and have to read hundreds of pages of transcripts to figure out what's going on. And so I think there's already and will continue to be an increasing need to organize work and have a more focused place to go that can pull together all the different tools you're using. And I don't see Teams or the messaging apps doing that. And just to bring some of the... Right, yeah, I think those are fantastic points, Drew. And just, Jason, to bring this back to the metrics for us, you know, we are seeing higher and higher levels of adoption and engagement around that desktop 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 we've seen that 60% increase in activity over the past couple of months.

34:42 All right. Thank you. Thank you. And our next question comes from the line of Mark Murphy with J.P. Morgan. Yes, thank you, and congrats on the great resilience you're showing in the business model. Thank you. Drew, you mentioned solid uplift in the top of funnel metrics since mid-March. And I'm interested in how much of that activity do you think we'll look back on and say that it was one-time surge versus ongoing usage where they'll continue and take it into the workplace over time. And then, Audrey, I wanted to ask you that your fiscal year guidance, it seems to be adjusting for FX and interest rates. I was wondering if you could clarify what the assumption is for COVID-19 impact, or is it just that you see the tailwinds as offsetting?

35:40 Sure, I'll start. I mean, I think it's a little too early to tell to what extent this is a surge versus a permanent uplift. Certainly, a huge percentage of the world is being forced into a remote work state for the first time. But I think the effects of it will persist much or well beyond when we physically go back into the office. And, you know, I think one of the things that you immediately find missing when you're working from home is being able to have that kind of contact with the people around you and suddenly things that were relatively straightforward like, you know, what's everybody up to? What important things happened on my team today? become pretty challenging when your only window into work is like a video conference or a messaging tool. So we see a big opportunity to help.

36:36 The kinds of things we're working on are thinking about, well, how do I get a sense of everyone around me? How do I make it easier to figure out what's happening on my team without having to wade through hundreds of pages of chat messages and e-mail? and even after we physically go back to work, the shift to distributed work is going to be permanent and I think there's going to be a silver lining to that which is we're all going to have more flexibility because even if you're primarily going to the office but if you have a long commute, being able to work from home and be equally productive, that would be a big benefit to a lot of people but the tools aren't really designed for that right now. So that's really a big opportunity for us to expand what we do in terms of helping people with distributed work. And to answer the second part of your question on the guidance philosophies there, I would reiterate a couple of points, Mark. So one, given the resilience of the core business, to your point, we are largely maintaining our annual guidance, net of currency and interest rate movements introduced by COVID-19.

37:37 And we are seeing some encouraging top of funnel trends. It is still early on that front. We want to monitor those cohorts for both conversion and retention. We do remain mindful of the broader macroeconomic risks that the second half of the year may bring, and so there's certainly more that we will learn in the coming months, and we'll share an updated view of the second half of the year on our August call, and that will incorporate more granular perspective on top of funnel trends, subscriber mix, some of those retention rates of existing and new cohorts, as well as some more information on that realignment of our product roadmap to focus on really accelerating and enabling this move to distributed work for our customers. Thank you very much. Thank you. And our next question comes from the line of Rishi Jaluria with DA Davidson.

38:28 Hey, guys. 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 or using Dropbox at work. But for that remaining 20%, that's consumer, you know, especially with unemployment up at, I think, 33 million or higher, last I checked. You know, what are you seeing out of that? How are you thinking about that? And then I've got a follow-up. Well, I'd say we're primarily, as you pointed out, we certainly have a large audience, or we certainly have an audience of people who use Dropbox only products. who use Dropbox primarily for personal use cases.

39:14 But the vast majority over time, which are around 80% of our users, use Dropbox for work use cases or blended home and work use case. And so the big opportunity we see there, we're less focused on the pure consumer use cases because I think given a lot of the dynamics you mentioned, I think it's A little more challenging. That said, I think there's this blurred line between home and work that we're all particularly experiencing right now, not that we're working literally at a home. We see Dropbox as having a particular strength in that boundary where you can go between your personal and work life seamlessly in a way that other tools don't offer because they only focus on personal or they only focus on work.

40:06 So a number of the things we're working on in terms of our personal launches have a use case in a work context as well. And that's been true of Dropbox historically. So we prioritize these features that have both a personal and work use case. Certainly our primary focus is on work. But I think going after the pure consumer market is tougher from a business model perspective, and that's really not a big segment for us. Okay, got it. That's helpful. And then I wanted to ask, what are you seeing in terms of buying behavior from customers? Any, you know, things like extended payment or contract renegotiations and maybe alongside that, what are you seeing in terms of deal duration? Because, Ajay, I know, I believe it was a couple of quarters ago you did mention that you were seeing more customers opting for monthly over annual deals. just want to understand what are you seeing in terms of those trends.

41:09 Thanks. Hi, Rishi. This is Olivia, and I'll take that question. So we have had selective asks from certain customers, and we've considered each one thoughtfully, really gauging the moment of need for our customers and trying to make them successful. And we're doing targeted extension of net payment terms, and we're changing our invoice frequency as well in certain situations. These are all ARR-neutral mechanisms. that we're doing to help assist our customers in this crisis. And we also see the flip side of it. So we also see situations where customers are moving quickly to respond and immediately need to be provisioned extra seats and licenses. And we do that instantaneously. And then we wait for the paperwork and the contracting to catch up. So a hospital in Boston that needed an extra 100 additional seats to manage Bed Inventory. We spun that up immediately, and then we'll be catching it on the renewal cycle in a month when they do a true-up.

42:13 Yeah, and I would just add that on some of that relief, Rishi, you know, it's been offered to really a small number of customers, so a relatively immaterial impact on our business there. And as it relates to your question on duration, so annual versus monthly, that's more pertinent to the self-serve business and primarily to our individual subscribers in there. where we have seen some of this surge in demand, this increase in volumes over the past few months. A lot of that surge has been monthly as people kind of rapidly acclimate to a remote work and distributed work environment. But we're keeping a close eye on that. It does change week to week. All right, great. Thank you. Thank you. And our next question comes from the line of Heather Bellini with Goldman Sachs.

43:01 Thank you so much, guys, for taking the question. I just want to follow up. You mentioned some of those encouraging top-of-funnel trends, which is great to see. Ajay, I just wanted to go back. It was probably two quarters ago, and then you reiterated it again last quarter, that you expected these lower net sub-ads, the roughly $300,000 you added this quarter and the prior quarter. and you had talked about that, you know, the primary reason was just given the anniversary of the pricing increase. Is this something that we should assume is largely behind us at this point? And so, you know, when you're thinking about your guidance, you're thinking that sub number inflects a little bit higher or should we assume it stays the same? And I guess the flip side would be, you know, just kind of any commentary around ARPU trends for 2Q.

43:50 Thank you. Sure. I will say, like, to start, as it relates to some of the increase in top-of-funnel demand, that is still very early in that a lot of those users are still in a trial state, so they haven't yet converted into a paying user. And so there's more that we'll learn there and more that we'll share there in future months and quarters. But as you noted on our Q319 earnings call, we did note that paying user growth would be slightly lower in subsequent quarters as a result of our PLUS repricing and repackaging initiative. and that's consistent with our expectations when we launched it. And that initiative overall continues to be a tailwind to revenue. And I would also note that profitably growing our total ARR base versus optimizing for a specific net new paying user number is our priority and where you'll see us focus resourcing and commentary going forward. That being said, historically the primary driver of revenue growth for us has been conversion volume. The secondary driver has been ARPU expansion.

44:47 and that balance will persist for us going forward across this year and into the future. I think probably one data point I can share to give you a little bit more context and I shared a little bit about this last quarter is that the output of our conversion engine continues to be very consistent, that gross new conversion engine at a million gross new paying users per quarter and those trends were consistent in Q1 as well. Great. Thank you so much. Thank you. And our next question comes from the line of Sarah. Finley, and Bo with McQuarrie. Hi, guys. Thank you so much, Drew and Ajay. I just wanted to follow up on Alex's question at the start of the call. I think one of the things that I'm grappling with, and I think others are as well, is trying to just get a gauge as to how exposed you are to some of the major industry verticals that are particularly just shuttered from COVID-19 right now.

45:45 and, you know, we're trying to just balance how much demand you're seeing from work from home and school from home that's helping to offset that. So maybe a little bit more color on, you know, specific vertical exposure you have. And then I have a follow-up for you. I think this one's really better for Drew. Just thinking about the incredible conversion you're seeing with the desktop app, It's really impressive. And so what are you guys doing to drive the number of Teams users you're seeing up on that desktop app so quickly? Sure. I can speak to both. Yeah, I can speak to both at a very high level. And Olivia, yeah, please add to specific verticals. I mean, the first thing I'd say is we have customers of all sizes.

46:32 We have a very diversified customer base, which I think is a strength for us. and, you know, as I said before, a lot of the sectors that are hardest hit are ones where you can't go back to work or where the demand has totally evaporated and, you know, especially in segments like SMBs and knowledge workers, it's like kind of a sweet spot. A lot of those folks can continue working and for them, Dropbox continues to be an essential tool. So I think we're relatively less impacted by than the typical company, although given the macro environment, this is something we're going to be monitoring closely, and we've shared what we see so far.

47:20 And then the second, how we're driving conversion. Well, we're helping people, migrate people from kind of the classic use of Dropbox and navigating in the file system to showing them that they can have a much richer experience in the new desktop app, and that would include both the Dropbox tray where we've got a lot of machine intelligence features and make it a lot easier to access content that are much easier to find the content that you're looking for and then bringing a lot of the collaborative features into the core experience so that historically when we were kind of just in the operating system if I commented on a file you couldn't necessarily see that because that interface is provided by the operating system. In our new experience all of that is really built into the experience and more. So if you want to share something via Slack or use any number of our integrations, you can do that directly from the experience.

48:17 And the fact that we have a desktop app installed and can upgrade that way makes it a pretty seamless process. And so we're always tuning how we introduce people in that experience, but we're happy with the progress that we'll have. Great. Thank you so much. I appreciate that. Thank you. And our next question comes from the line of Pat Walravens with JMP Securities. And our next question comes from the line of Pat Walravens with JMP Securities. Hi, this is Mark for Pat. Thank you so much for taking my questions.

49:05 So you guys mentioned a little bit about the Hello Science strength. I was wondering if you can give us a little more whether the strength is coming from SMB or enterprise, and would you expect the strength continue after COVID? Thank you. I can start at a high level, and others chime in. When you think about having to work from home, then you can see how and many more. Drivers, and delivery services like Instacart have been using HelloWorks for a long time.

50:07 We just added another major delivery platform. And then we've seen a bunch of COVID-related use cases. So as I said, the lenders using HelloSign to help people process relief or loan applications. So I'd say it's been more on the... and either side, but we've actually seen pipeline or we've been building pipeline in both. Yeah, just to add to that, we see increase in trials across customer segments. It's pretty consistent across the board. Not surprisingly, obviously, given the new world that we're in, but it's nice to see the consistency of it. Got it. Thank you so much.

50:55 Thank you. And we have time for one more question. and that comes from the line of Zane Crane with Bernstein Research. I commend you guys on really great transparency in your 10K. You have some really helpful data on the quarterly ARR over the past couple of years. And when I look at how much incremental ARR you added this quarter relative to the paid user ads, It seems to suggest you've had a pretty substantial increase year over year in the effective average ARPU of the paid users you're adding. So it seems like there's a couple of ways to interpret that. On one hand, maybe you're bringing in a lot more business customers at much higher prices, and that's driving up the effective average ARPU of those ads.

51:40 On the other hand, you could have attrition of the lower-value consumers coming out that's driving it up just due to the mix shift. How should we think about what's driving that and the relative difference between those two factors? Or is there something else maybe I'm missing that could be driving that effective ARPU higher on net sub ads? Yeah, this is Ajay. It's a great question and observation, and I think reflective of our strategy as a company, and that's to focus on the high-value conversion to drive profitable ARR growth. And you're seeing that reflected in the metrics and in the numbers today. I think what you're alluding to is something that we disclosed at IPO called gross new ASP, which is effectively the ARPU for our new paying users. And we've pretty methodically increased gross new ASP over the past two years.

52:28 And it was the highest that it's ever been in this past quarter. And it meaningfully leads blended average ARPU. And so the new paying users that we're converting tend to convert at higher and higher rates every period to one of our premium plans, so to one of our team plans. or to our premium individual plan, Dropbox Professional. And so the tax rates increase for us every period, and then there's also a tailwind from some of the pricing and packaging changes that we've made over the past few quarters and years. Very helpful, very helpful. And just to follow up on that, go ahead. I was just going to add, and I think both trends, both of your hypotheses are true. I mean, we're less focused on pure consumer use cases. We're less focused on legacy use cases like cloud storage.

53:14 We're more focused on high-value use case. So that's a good measure of adding higher-value customers, and that's why we've been proportionally more focused on ARR in aggregate because we're trying to drive that mix shift intentionally. That's helpful. And just a quick follow-up. So should I interpret that to maybe mean that as the consumers become a smaller portion of the mix, You'll have enough new business customers coming in at higher prices that the year-over-year growth in net new ARR turns positive again? So we don't guide to ARR. I would look to our revenue growth for our revenue guidance for a sense of the growth that we expect, but certainly we're focused on driving some of those structural improvements to conversion volumes and the tailwinds that you see to ARPU are ones that we see persisting, both across the near and medium term, just Thank you. Thank you. I will now turn the call back over to CEO Drew Houston for any further remarks.

54:33 All right, well, thank you, everyone, for joining us. And I want to thank my team one more time for their heroic efforts in continuing to run the business under some pretty extreme conditions and taking care of our customers. And we're really proud of the progress we've been making. And so we hope, and for all of you, we hope you're all hanging in there and staying safe. And we'll see you next quarter. Thanks. ladies and gentlemen thank you for participating in today's conference this does conclude the program and you may now disconnect