Dropbox, Inc. (DBX) Q2 2020 Earnings Call Transcript

Dropbox, Inc. (DBX 1.43%)
Q2 2020 Earnings Call
Aug 06, 2020, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. Thank you for joining Dropbox's second-quarter 2020 earnings conference call. [Operator instructions] As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Dropbox's website following this call. I will now hand the call over to Lev Finkelstein, Dropbox' VP of corporate finance and strategy.

Please go ahead.

Lev Finkelstein -- Vice President of Corporate Finance and Strategy

Thank you. Good afternoon, and welcome to Dropbox's second-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 and offering new products and features; our strategy, as well as the ability of our key employees to execute 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 June 30, 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 financial measures should be considered in addition to and not as a substitute for or in isolation from our GAAP results. A reconciliation of GAAP to non-GAAP results may be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC, and may also be found in the supplemental investor materials posted on our Investor Relations website, which can be found 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 -- Co-Founder and Chief Executive Officer

Thanks, Lev, and good afternoon, everyone. Welcome to our Q2 earnings call. On the call with me is Ajay Vashee, our chief financial officer. And Olivia Nottebohm, our chief operating officer, will also join us during Q&A.

Similar to last quarter, 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. I'd like to start by thanking Ajay for all he's contributed to Dropbox over the last eight years. As you've likely seen, we've announced that he'll be leaving us this fall to spend more time with the family and then transition to a career in venture capital.

When Ajay started at Dropbox, the cloud collaboration market was still nascent, and we were just getting started. We only had 100 employees. During his tenure, he's helped us scale to a public company with a resilient, profitable business model and nearly 3,000 employees all over the world. We're grateful for the strong foundation and incredible team he's established, and we couldn't have gotten here without him.

Ajay's leadership and investment in his team makes this a relatively seamless transition. On that note, I'm excited to welcome Tim Regan, our chief accounting officer, as our new CFO. In his last three years of the company, Tim has demonstrated exceptional leadership with the operational skill and discipline needed for his new role. Tim brings over two decades of experience to Dropbox.

He was previously a controller of Pandora and held senior positions at Dolby and Ernst & Young. We couldn't be happier to have Tim as our new CFO and are confident that Dropbox will be successful in his capable hands. He'll officially step into the role on September 15, and Ajay will remain an advisor to the company until mid-October to ensure a smooth transition. With that, let's turn to the remainder of our call.

Today, I'll talk about our business and product highlights and the continued expansion of our ecosystem. Ajay will review our Q2 financial results, touch on our go-to-market strategy, and provide guidance for Q3 and fiscal 2020. Before we move to our quarterly results, I want to provide some updates around how we're managing operations in a distributed work environment. The health and safety of our employees remains our No.

1 priority, and we've officially extended our work from home policy through the end of the year. I also want to commend the entire team at Dropbox for doing an incredible job navigating these unprecedented circumstances. Over the past few months, they've been hard at work launching new features and products aimed at helping our users manage their most important workflows during these unique times. We've also been focused on providing extra support to our customers most impacted by COVID-19.

In certain cases, we provided relief by extending the payment terms and changing invoice frequency to ensure they have the tools they need to get their best work done. And over the past quarter, we also expanded several of our larger-scale educational deployments and onboarded new customers like the University of Michigan. Our deployment with the University of Michigan represents one of our largest educational deals to date as institutions around the world look to accelerate their digital transformation efforts and shift to a remote learning environment. Companies are also increasing their reliance on Dropbox as they make the transition to distributed work.

Just a few weeks ago, a major European luxury retail company significantly expanded their deployment with Dropbox to over 20,000 seats. As part of the seven-figure deal, the company plans to accelerate their shift to the cloud and cited our new desktop application as a critical tool for their employees to securely collaborate on with one another wherever they are. We're fortunate and proud that our product lends itself well to the facilitation of remote work and collaboration. I'm excited to announce that we now have more than 500,000 Dropbox Business teams on our platform.

And over the past quarter, more than 450,000 of those teams are now using our new desktop application, which gives knowledge workers a unified home for their content and connects them to popular tools like Slack, Zoom, and Atlassian. Across Q2, trial volumes to our team and individual plans also remained elevated and were 20% higher than pre-COVID levels. I'd note that the conversion rates of these larger cohorts have remained consistent with average historical figures, which is encouraging and underscores the value that users are driving from our products and platform. Turning to our quarterly results.

In Q2, we continue to see strength across our business. Revenue grew 18% year over year on a constant-currency basis driven by increases in both paying users and ARPU. We also drove robust margin expansion as we continue to deliver a healthy balance of growth and profitability. 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 focused on providing more value to our users through consistent feature and product introductions. And in Q2, we added a number of high-value features to our Plus SKU to give users the tools they need to better manage both their work and personal lives. First, we launched Dropbox Passwords.

Dropbox Passwords enables users to store login credentials for websites and apps and synced them across all of their devices. And with zero-knowledge encryption, users can ensure their data's securely protected and accessible only to them. We also launched Vault, a secure folder with an extra layer of security for all your most important personal files, like insurance cards and passports and personal financial information. Content stored in Vault is only accessible with a pin code, and users can enjoy peace of mind knowing that they can designate access to trusted friends and family members in the event of emergency.

And finally, we launched computer backup, a feature that allows users to automatically back up folders on their PC or Mac, including their desktop, downloads and documents folders, directly into their Dropbox. Files and folders are continuously synced between the cloud and the user's hard drive, and changes made to their content are automatically updated in both locations. These three features are now available in beta to our Plus subscribers and represent one of the biggest updates we've made to this SKU since its inception. In addition to improving the Plus plan, we also launched a brand-new SKU into beta last quarter: Dropbox Family.

This new SKU keeps a family's digital lives connected with one organized place to share photos, videos, and important documents. Dropbox Family lets up to six members share 2 terabytes of storage under one plan with one bill. Members can create shared spaces to make content easily accessible to the whole family, and each member has their own private space for personal content. We're currently beta testing the Dropbox Family product with select Dropbox users and plan to roll it out more broadly across the second half of the year.

In Q2, we also continue to make progress against our product integration strategy with HelloSign. HelloSign is now natively embedded in the Dropbox product surfaces. And now, when a user opens a file in Dropbox, they can quickly identify which fields need to be signed and send that file out for e-signature. And once the file is signed by the recipient, the complete document is automatically saved into the appropriate Dropbox folder.

This is a big improvement to the overall user experience. Not only does the entire end-to-end workflow live within Dropbox, but this also makes HelloSign the primary e-signature tool for Dropbox users around the world. To capitalize on the growing international opportunity, we also launched HelloSign in 21 additional languages this past quarter, bringing effortless e-signature functionality and a fully localized experience to businesses globally. We also expanded our customer service to include additional support hours for the EMEA and APJ regions.

Investments like the use have helped to propel adoption of the HelloSign product suite. Across Q2, usage of both the Hellosign API product, as well as the core eSignature solution increased by more than 25% relative to Q1 levels. And trials to HelloSign's digital fax solution, HelloFax, also increased by more than 25% during the same period. It's exciting to see this increased usage of HelloSign products, and we remain committed to leveraging our broad distribution channels to continue driving adoption of HelloSign SKUs.

And beyond the improvements we made to the core Dropbox and HelloSign experiences, we've also been focused on expanding our ecosystem of trusted partners to position Dropbox at the center of our users' workflows. And in Q2, we launched the new Dropbox App Center, a place where users can discover and learn about and connect apps to their Dropbox account, helping to create more engaging, higher-value, and retentive experience within our platform. Now customers can easily link commonly used tools from partners like Canva, Smartsheet, and Google to their Dropbox account with just a few clicks. In summary, we delivered another great quarter.

Demand for our products remain strong as more people have turned to both Dropbox and HelloSign to manage their most important workflows. We're also excited about the opportunity ahead. It's clear to me that the shift to distributed work will ultimately be as significant as the shift to mobile or the shift to cloud, and all knowledge workers need new and better ways to organize their working lives in this new environment. We've completely reoriented our product road map since March and see many opportunities to design new products and experiences for distributed work, and I'm excited to share more of what we've been working on in the second half of the year.

I'll now turn it over to Ajay to walk through our financial results.

Ajay Vashee -- Chief Financial Officer

Drew, thank you for all of your support and partnership over the past eight years. It's been an absolute pleasure working alongside you and the Dropbox team, and I'm going to miss everyone at the company as I move on to my next endeavor. I'd also like to convey how excited I am to pass the reins to Tim. Tim was my first hire as CFO and couldn't be more prepared to help lead Dropbox through its next phase.

Turning to the numbers. Our Q2 results continue to demonstrate our strong execution and focus on delivering a healthy balance of top-line growth and profitability. Total revenue for the quarter was up 16% year over year to $467 million. On a constant-currency basis, year-over-year growth would have been 18%.

ARR for the quarter was $1.931 billion, an increase of $67 million quarter over quarter, and an increase of 17% year over year. On a constant-currency basis, year-over-year ARR growth would have been 18%. We ended Q2 with 15 million paying users and ARPU was $126.88 in the period. Our continued growth in ARR reflects our strategy to methodically convert our highest-value users to drive sustainable monetization and retention.

We've also been focused on supporting our customers as they manage the transition to remote work and learning, from small and large businesses to global universities. With that, let's touch on some of the go-to-market strategies we implemented this past quarter. Over the last few months, our data science team has been experimenting with a HelloSign upsell model that identifies which Dropbox customers are most likely to convert to a paying HelloSign subscriber. Based on file types, shared folder activity, and certain engagement characteristics, the machine learning model aggregates a list of Dropbox users who would benefit from HelloSign's e-signature capabilities.

Armed with this context, our growth team surfaced a series of in-app targeted prompts and notifications promoting HelloSign and its feature set. The initial experimentation period has been promising. Users identified by the model signed up for a HelloSign trial at a 50% higher rate relative to a control group. And with the recent HelloSign and Dropbox deep integration that Drew mentioned earlier, we're excited about the opportunity for us to continue cross-selling HelloSign into our installed base of over 600 million registered users.

Let's move on to some of our customer highlights. In Q2, we had a number of wins across a range of verticals, including media, construction, education, and retail. We're excited to share that Divimove, a new-generation media company with nine offices across Europe, is now a Dropbox Business customer. Divimove approached Dropbox to find a more efficient way to collaborate across their organization.

Dropbox will be a critical part of Divimove's media workflows, and the company plans to leverage key integrations with Adobe, as well as native features like Dropbox Transfer to optimize how they manage the content creation life cycle from concept ideation to final asset delivery. In addition to facilitating increased productivity, we are also working closely with Divimove to provide seamless data migration services as they move their content to the Dropbox platform. In addition, we're pleased to announce that Tokyo Reiki Kogyo is now a Dropbox enterprise customer. Tokyo Reiki Kogyo is a Japan-based distributor and services provider for HVAC projects for large-scale building sites.

They turn to Dropbox to provide a secure cloud-based storage solution for their on-site and field workers. They were also focused on implementing a solution that would ensure their customers and partners could share and collaborate around large, content-rich file types. After evaluating Dropbox against two other competitors, Tokyo Reiki Kogyo selected Dropbox for a multiyear deployment to modernize how their teams work and collaborate. 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 excludes 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 79%, an increase of three percentage points compared to the second 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 now expect fiscal 2020 gross margin to be approximately two percentage points higher than 2019. Moving to operating expenses. Second-quarter R&D expense was $135 million or 29% of revenue, compared to 30% in Q2 a year ago.

The decrease as a percentage of revenue was driven by work from home related savings offset by higher headcount and investments in new product development and testing. S&M expense was $92 million in the quarter or 20% of revenue, compared to 24% in Q2 a year ago. The decrease was due to greater efficiencies in marketing-related spend relative to Q2 of 2019, as well as lower event-driven spend due to COVID-19. G&A expense was $48 million or 10% of revenue, compared to 11% of revenue in Q2 a year ago.

The decrease was due to work from home-related savings, as well as lower non-income-based taxes. Taken together, we earned $96 million in operating profit in the second quarter. This translates to a record 21% operating margin, which is an 11 percentage point improvement from Q2 of 2019. Net income for the quarter was $93 million, up from $42 million a year ago.

Diluted EPS was $0.22 per share based on 421 million diluted weighted average shares outstanding, up from $0.10 in Q2 a year ago. I'd also note that we were once again GAAP profitable in Q2. Moving on to cash balance and cash flow. We ended Q2 with cash and short-term investments of $1.118 billion.

Cash flow from operations was $146 million in the quarter. Capital expenditures were $26 million, yielding free cash flow of $120 million or 26% of revenue. CAPEX in Q2 included $14 million of spend on our corporate headquarters, of which $6 million was offset by tenant improvement allowances. In Q2, we continued to pay a portion of the deal consideration holdback related to our acquisition of HelloSign.

These payouts will occur quarterly through Q1 of 2022. Excluding the headquarter spend, net of TIAs of $8 million, and payout of HelloSign deal consideration holdback of $4 million, free cash flow would have been $132 million or 28% of revenue. In Q2, we also added $30 million to our finance lease lines for data center equipment. We expect additions to our finance lease lines to be approximately 8% of revenue in 2020.

Now let's turn to our guidance. While our business has certainly been resilient and we've benefited from some emergent tailwinds, we remain mindful of the broader macroeconomic risks and unpredictability that the second half of the year may bring. Similar to last quarter, we factored this into our guidance as appropriate. With that, let's move on.

For the third quarter of 2020, we expect revenue to be in the range of $481 million to $484 million. On a constant currency basis, we estimate that revenue would be approximately $2 million higher. We expect non-GAAP operating margin to be in the range of 17.5% to 18% and diluted weighted average shares outstanding to be in the range of 421 million to 426 million based on our trailing 30-day average share price. For the full-year 2020, we are raising our revenue guidance range, which was previously $1.880 billion to $1.900 billion to 1.891 billion to $1.901 billion.

On a constant-currency basis, we estimate that revenue would be approximately $13 million higher or a range of $1.904 billion to $1.914 billion. We are raising our non-GAAP operating margin guidance range, which was previously 17.5% to 18%, to 18% to 18.5%. And we are raising our free cash flow guidance range, which was previously $460 million to $470 million, to $465 million to $475 million. This range includes onetime spend related to the build-out of our 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 $515 million to $525 million. Finally, we expect 2020 diluted weighted average shares outstanding to be in the range of $420 million to $425 million based on our trailing 30-day average share price. In conclusion, the investments we've made in our business from both a product and go-to-market perspective, continue to perform well, especially amid a rapidly changing global environment. We've continued to innovate and deliver more value to our users, enabling them to do their best work, and I'm excited about our potential going forward.

I'll now turn it back to Drew for closing remarks.

Drew Houston -- Co-Founder and Chief Executive Officer

Thank you, Ajay. At Dropbox, we're committed to helping our users do their best work during these unprecedented times. And with our profitable self-serve business model and continued product innovation, we believe we're well-positioned to tackle the opportunity. 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?

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Alex Zukin with RBC Capital Markets. Your line is open.

Alex Zukin -- RBC Capital Markets -- Analyst

Hey, guys. Thank you for taking my question. And, Ajay, it's been a pleasure working with you on these calls, you will be missed. So maybe just two quick ones for me.

Drew, when you think about the combination of headwinds and tailwinds brought from COVID on the business with respect to the SMB market, given the net adds number, this quarter was the strongest you've had in some time. Is it fair to say that the tailwinds around the increasing need of your business and the strategic value proposition -- like, is it fair for us to think that you're now kind of starting to see an actual tailwind that could be durable? And I've got a quick follow-up.

Drew Houston -- Co-Founder and Chief Executive Officer

Sure. Thanks, Alex. Yes. As you saw, measures like trial volumes continue to be elevated.

I mean some of the surges tapered off since Q1. But in SMB, certainly, we see that our Dropboxers -- both have been turning to Dropbox for distributed work since the beginning, and they've continued to do that since COVID, and we've seen elevated demand. And more broadly, we see big opportunities to improve the distributed work experience in general. I mean we're addressing a universal need.

Every knowledge worker needs an organized place for their content that works with all platforms. And even with the shift to COVID, I mean, Dropbox is like an essential part of business operations. So we've seen sort of continued strength and resilience post-shift to COVID, and we see a lot of opportunities to reimagine the distributed work experience going forward.

Alex Zukin -- RBC Capital Markets -- Analyst

OK. And then maybe just on the quick follow-up is, how would you assess the health of the SMB market, maybe for Drew or Ajay? And then last quarter, you talked about seeing early signals in your kind of pipelines that were very positive, but you weren't ready to make the call whether that elevated pipeline is actually driving more deals or conversions. So now after a few months in COVID, can you talk to both of those two things?

Drew Houston -- Co-Founder and Chief Executive Officer

Sure. Well, I can start, and Ajay can chime in. Well, I think, again, with SMBs, we're mindful of the broader macroeconomic environment and what might happen in the second half. But in general, businesses that employ knowledge workers that can work from home have been less disrupted.

And again, Dropbox tends to be critical to an SMB's operations. So it's not really a discretionary purchase. So we feel good on that front.

Ajay Vashee -- Chief Financial Officer

Yes. This is Ajay. Just to jump in and maybe provide a little bit of commentary around some business metrics and trends, Alex, to help answer your question. The business has been resilient.

Our churn rate remained relatively stable from Q1 to Q2. That was the case last quarter as well, as we noted on that call, and that revenue retention improved for us quarter to quarter. And this is really because the majority of our subscribers are knowledge workers, and we play an important role in managing business-critical content for them really more so now than ever. And as it relates to some of those tailwinds that we saw in Q2 to ARR and to paying users, higher top-of-funnel demand, the demand that Drew talked to on trial volumes, did result in higher levels of conversions to our paid plans.

And then to the question you had in pipeline, we also closed some large outbound deals in university deployments in the period as well. All that being said, just one note I would make on as we provide commentary on paying users, our focus is on profitably growing our total ARR base, certainly, versus optimizing for a specific number there quarter to quarter. And so that will remain our priority going forward.

Alex Zukin -- RBC Capital Markets -- Analyst

Perfect. Thank you, guys, and congratulations again.

Operator

And next question comes from Mark Murphy with JP Morgan. Your line is open.

Mark Murphy -- J.P. Morgan -- Analyst

Yes. Thank you. Ajay, it's been great working with you, and I wanted to wish you all the best in your future role.

Ajay Vashee -- Chief Financial Officer

Thanks, Mark.

Mark Murphy -- J.P. Morgan -- Analyst

Yeah. Absolutely. And congrats on a very nice quarter and strong guidance. I wanted to hone in on the ARR growth of 18% in constant currency.

Again, nice to see the health and, actually, acceleration in the ARR growth. I know you touched on a couple of these, but I was curious if you could help us understand just to what extent -- when we see that acceleration, to what extent could we tie it to the conversion of the remote work-driven trials that Alex had asked about? Kind of to what extent were any of those outbound large deals kind of chunky that might have moved that and then to what extent could we maybe look at it and say that there's adoption of the new desktop app maybe factoring in?

Ajay Vashee -- Chief Financial Officer

Sure. It's really a combination of all of the above, Mark, is the answer, and I can kind of break it apart for you. Starting with some of those COVID tailwinds and the work from home tailwinds, Drew mentioned across Q2 those trial volumes to both our individual and team plans were up on average about 20% relative to pre-COVID levels. And we began to see some of those conversions come through in Q2, and those conversion rates remain consistent with historical levels.

And so that was part of the tailwind there. And as it relates to HelloSign, usage of their eSignature products, both their API product, as well as our core eSignature solution, we're also up about 25% Q2 to Q1. And so that was also a business tailwind. Those were two of the tailwinds that helped us deliver that $67 million of sequential net new ARR this past quarter.

And we also had a number of growth initiatives, and we're always working on cultivating that growth initiative pipeline. There are things we launch every quarter. A handful of those initiatives were also successful and a tailwind to the business. And our outbound team has reoriented really successfully from a team that was traveling more actively to one that's really been leveraging telesales.

And demand for our products has been strong, so they've been able to convert a number of those opportunities. So it was a combination, really, of all those factors that allowed us to accelerate that net new ARR growth on a year-over-year basis quarter to quarter.

Mark Murphy -- J.P. Morgan -- Analyst

OK. Got it. And Ajay, just since you mentioned some of the new initiatives, I wanted to ask, Drew, how you're thinking about maybe sizing the opportunity for Dropbox Passwords and just how you're thinking about the ability to ring fence and encrypt a data set that presumably is pretty sensitive, high-value information and potentially something that would be targeted.

Drew Houston -- Co-Founder and Chief Executive Officer

Sure. Well, we see Passwords as playing to a lot of our strengths around user trust and security and a lot of the huge investments we've made and continue to make there, and it's a natural fit. And for things like Dropbox Vault, Dropbox Passwords, these are pretty universal workflows that our customers have. And a lot of what motivated us to build more focused solutions around them was seeing that, one, a lot of customers were requesting Dropbox to do more in these areas.

And then secondly, people are already kind of using Dropbox -- or storing this information in Dropbox, and we see it -- we saw an opportunity to provide a more focused experience and then add value to our higher-tier plans. And so we think that these areas, again, play to our strengths and customers also want the ability to do this in a platform-agnostic or cross-platform way. A lot of the other alternatives they might be using might be tied to one device or one platform, but a lot of customers want to be able to work across their iPhone and their Windows PC, so that's another big strength of ours. And then I'd say more broadly, when you look at these use cases and you look at post-COVID, where the lines between home and work have blurred even more -- or about blurred as much as possible since we're literally working from home, we see one of Dropbox' core strengths is supporting both the work and personal use cases in a platform-agnostic way.

And then while both of these features were introduced for your personal lives, in the future, things like securing documents, managing passwords is also highly relevant at work. So we look at our personal and work product portfolios and road maps as reinforcing one another.

Mark Murphy -- J.P. Morgan -- Analyst

Very helpful. Thank you.

Operator

Our next question comes from Rishi Jaluria with D.A. Davidson. Your line is open.

Rishi Jaluria -- D.A. Davidson -- Analyst

Hey, guys. Thank you so much for taking my questions. Ajay, I'll echo my peers in saying it's been a pleasure working with you, and best wishes for the next gig. And also, I want to extend my congratulations to Tim on the new role.

I wanted to start first by talking about the Michigan deal, I mean, really impressive land. Wondering if you could give a little bit more color on that deal, especially because you are replacing a cloud competitor, not an on-premise to cloud motion. And presumably, Michigan chose you over Microsoft and Google even though they've got long-standing relationships with both vendors. So maybe a little bit more color on that? And broadly, how are you thinking about the higher ed opportunity, especially with so many universities going virtual this coming semester? And then I've got a follow-up.

Olivia Nottebohm -- Chief Operating Officer

Rishi, this is Olivia Nottebohm. I'll actually take this question, and thank you for the question. We were excited to partner with University of Michigan. It was across campus deployment, meaning that it was both for their students, as well as their faculty.

And for us, that's something we're very proud of, and we're partnering with them closely to build out what they need for remote education. And this is an area of focus for us. In fact, I hosted an education CIO forum this morning with a number of education CIOs, and they are very much on their front foot thinking about how does technology lead education going forward. And it's nice to see that they're bringing us into the conversation and very much think of ourselves as a partner to them.

Other education wins we've had were Northwestern and University of Pennsylvania and Arizona State, just to name a few. I think the other exciting part about this is that as the graduating classes of these educational institutions leave and graduate, they then take that Dropbox love with them. So it's an evergreen model where a quarter of the population is graduating and then, of course, being refilled as they come in. So we're excited about this business opportunity overall.

Rishi Jaluria -- D.A. Davidson -- Analyst

Great. That's really helpful, Olivia. And then, Ajay, I wanted to go a little bit more detail on the guidance for next quarter, specifically on the operating margin side. I mean you're talking about operating margins declining sequentially pretty meaningfully.

Just wondering if you could give a little bit more color on why it would be declining from Q2 to Q3. And what factors are driving that?

Ajay Vashee -- Chief Financial Officer

Sure. It's a great question. It's really driven by timing of spend. And we made the decision to shift some marketing spend from Q2 to Q3, and I'll turn things over to Olivia in just a moment to provide a little bit more context on that.

It's a campaign that we're going to be launching in the fall. But generally speaking, I will say, Rishi, that we are expecting to generate more efficiency this year. So this is the driver of us raising our FY '20 operating margin guidance to 18% to 18.5%, that being up from the 17.5% to 18% last quarter. So structurally, we are getting more and more efficient in the business.

And I think you can see, based on the results that we delivered in Q2, we've now executed to well within our prior long-term target range before we raised those targets earlier this year. So definitely, we feel good about the profitability trajectory we're on as a business. And I'll turn it over to Olivia to give a little bit more context on some of that marketing spend.

Olivia Nottebohm -- Chief Operating Officer

Right. So we ended up moving some marketing spend out into the early fall. We're going to be launching an awareness campaign to really drive knowledge about the Dropbox solutions for business and specifically for remote work. We're really excited for that.

It will be both a top-of-funnel awareness campaign but then also pulling those through so that we're ensuring that we have conversion off of the investment that we're putting at the top of the funnel.

Rishi Jaluria -- D.A. Davidson -- Analyst

Great. Really helpful. Thank you both.

Operator

Thank you. Our next question comes from Heather Bellini with Goldman Sachs. Your line is open.

Heather Bellini -- Goldman Sachs -- Analyst

Hey there, Andrew and Ajay. Ajay, best wishes. You will be missed. Thanks for everything over the years.

I just wanted to ask a little bit about any trends you're seeing that are noteworthy in terms of quarterly versus annual pay.

Ajay Vashee -- Chief Financial Officer

Sure. This is Ajay. I can start, and then Drew, feel free to chime in with any context that you have. I think from some of these larger, more elevated cohorts that we've seen post COVID as the world has shifted to a remote work and a remote learning mode, there has been higher demand for our monthly plans in those cohorts.

And so that drove some of the variance that you might have seen quarter to quarter to things like billings, absolute dollars of billings, and billings growth rate. So there has been a mix shift there from a gross new paying user perspective. On an aggregate basis across our 15 million paying users, it takes a lot to move that overall ratio between the annual and monthly, so that hasn't changed a whole lot. But from a gross perspective new paying user perspective quarter to quarter, we've seen a slightly higher uptick on kind of monthly relative to annual.

That being said, we have seen a lot of stability with respect to retention. As I mentioned earlier, that churn for us was pretty stable from Q1 to Q2. Net revenue retention improved quarter to quarter, again, that being because the vast majority of our paying users are knowledge workers, and we're playing a pretty important role for them in managing their content.

Heather Bellini -- Goldman Sachs -- Analyst

Great. Thank you very much.

Operator

Next question comes from Brent Thill with Jefferies. Your line is open.

Luv Sodha -- Jefferies -- Analyst

Hi. This is Luv Sodha on for Brent Thill. First of all, Ajay, best wishes to you. I had a couple of questions.

One was on the HelloSign opportunity. I know you guys mentioned that you're cross-selling more HelloSign deals to Dropbox users. So wanted to maybe get some color on what the cross-sell opportunity is. How many -- maybe how many Dropbox users currently are -- have HelloSign? And what's the opportunity there? And then I have a follow-up as well.

Drew Houston -- Co-Founder and Chief Executive Officer

Cool. I can start and Olivia, please chime in. But yes. As you noted, we continue to see strong demand for HelloSign and, given COVID and the shift remote work, obviously, a lot of elevated demand for eSignature.

And we're really excited that HelloSign has now been fully integrated into Dropbox. So in Q2, we launched a brand -- or an improved experience where HelloSign is now natively embedded into the Dropbox product. So our users can easily send and sign and safely store their most important agreements in one seamless workflow without ever having to leave Dropbox. And it's one of our fastest-growing businesses.

So definitely seeing elevated demand and a big opportunity there.

Olivia Nottebohm -- Chief Operating Officer

And then on the outbound side, we closed more than 20 deals where we had at least one of HelloSign's product bundled into the customer's Dropbox deployment. So more and more, we're seeing a demand for combined solutions on that front. I would also say our model is very much organic, where the self-serve motion begins and kicks us off. And I'm really, really excited that every single Dropbox user right now can have three free e-signatures on HelloSign, right? So they can get that experience and enjoy that experience, and then they have the opportunity to become a paid user.

So there's part of this element that's great because we don't even have to actively do the cross-sell. It's there for our own existing customers to see and use for themselves.

Luv Sodha -- Jefferies -- Analyst

Got it. And maybe for the follow-up --

Drew Houston -- Co-Founder and Chief Executive Officer

And even in Q2 -- I was just going to say, even in Q2, usage of the eSignature solution and HelloSign's API products increased by more than 25% versus Q1. So it's been good to see the tailwind there.

Luv Sodha -- Jefferies -- Analyst

Got it. And maybe one quick follow-up. It sounds like you guys are seeing some great tailwinds from work from home. I guess, as you look to 2021 and into the future, do you believe that these growth rates are sustainable going forward? And that's it for me.

Drew Houston -- Co-Founder and Chief Executive Officer

Sure. Well, for me, the big opportunity is, again, that we're addressing this universal need, right, that every knowledge worker needs an organized place for their content that works with all their platforms. And this is an even bigger need now that we're working from home post COVID because so many of us have Office docs and Google docs and Airtables scattered across a number of platforms, and we don't see any of our competitors solving this problem. So looking to 2020 -- or 2021, that's a big opportunity for us.

And we're building Dropbox into an organizing layer for all your content that's platform-agnostic and brings it all together. And second, moving higher in the stack and handling more of the workflows around your content, and things like Passwords and what we've done with HelloSign are good examples of that. And I think the shift to distributed work is a transformative opportunity and, as I said in my opening remarks, not unlike the shift to mobile or shift to the cloud. And we're in the first inning of that transformation.

None of the tools we're using are purpose-built for this environment. And I think you design things pretty differently for the new world. So that's what we've been doing. We've reoriented our product road map around this, and we'll have a bigger update in the second half about our smart workspace.

Ajay Vashee -- Chief Financial Officer

And I would just add on -- and I think that's a fantastic answer, Drew. I'd just add on a related note. We absolutely remain on a trajectory to achieve the long-term targets that we outlined earlier this year. And so we continue to be on a trajectory to deliver over $1 billion in annual free cash flow by 2024.

And certainly, as it relates to next year, we'll have more to share when we issue guidance on our call in February.

Luv Sodha -- Jefferies -- Analyst

Thank you.

Operator

Thank you. Our next question comes from Justice [Inaudible] with Citi. Your line is open.

Unknown speaker

Hey. Yeah. Hi, Dropbox team. Thank you.

I'm in for Walter Pritchard. A question on usage intensity. And it's really through the financial angle because, as I'm looking at the revenues year over year, you've increased your revenues, call it, 66 million and while you were keeping your cost of revenue essentially flat year over year. So it doesn't really look like you're rushing to install new servers or procure AWS capacity.

So what can you tell us about your average engagement per user during COVID?

Drew Houston -- Co-Founder and Chief Executive Officer

Well, I can speak to engagement, and Ajay can speak to financials. As I shared earlier, we've seen broad adoption across the board, both of things like HelloSign and our new desktop app. So progress we've made there, adoption of the new desktop app and 450,000 Dropbox Business teams that was up from 350,000 in the prior quarter. And again, weekly actives are up 50% quarter to quarter as well.

So those are some of the measures we look at. And the new desktop app's also a new foundation for us to drive adoption of all of our new products across the board. And so having these seamless experiences or having more surfaces allows us to have seamless integrations with HelloSign and all of our partner products.

Ajay Vashee -- Chief Financial Officer

Yes. And I would just add to that. On the gross margin front, we're always focused on bringing down our unit costs and driving incremental efficiency, and we've done a good job of that over the past few quarters and the past few years. So things like our rollout of SMR technology, as well as our new cold storage tier.

We're always innovating on that infrastructure layer, both as it relates for the unit cost of storage, as well as compute. And so that's helping us drive a lot of that year-over-year efficiency as utilization increases.

Drew Houston -- Co-Founder and Chief Executive Officer

And lastly, I'd just say -- well, just engagement is important to us because we see that customers who engage more retain better, have higher lifetime value, and same thing for collaborative users, same thing for folks that use our integrations. And so we're focused both on driving direct monetization by selling more high-value plans and then indirect monetization, just increasing retention and lifetime value.

Unknown speaker

OK. And then on the ARPU sequential increase, it was a little bit less than in prior quarters. To what extent did the trial conversions have an effect on that mix and what can you tell us about how that is going to evolve going forward?

Ajay Vashee -- Chief Financial Officer

Sure. This is Ajay. I can take that question. I would say it was really higher demand for our products resulted in the acceleration of some larger-scale deployments and conversions.

It's a point that you just made. And so we talked about University of Michigan. There were other larger-scale EDU deployments that Olivia mentioned. And so certainly, while all of those are a benefit to revenue, ARR and paying user growth and they underscore the value users are getting from our platform, those were a modest headwind to ARPU for the period and will be a modest headwind to ARPU for the year.

And so it's really that outperformance on the paying user front that's driving that. And the organic tailwinds to ARPU continue to be very strong. So those attach rates of new paying users to our premium and team plans, that mix shift from individual to team over time and gross new ASP for us, which is effectively the ARPU for new paying users, that continues to meaningfully lead our blended average ARPU. So that runway for expansion remains.

Unknown speaker

Great. Thank you.

Operator

Thank you. Our next question comes from Jason Ader with William Blair. Your line is open.

Billy Fitzsimmons -- William Blair -- Analyst

Hey, guys. This is Billy Fitzsimmons on for Jason Ader. One of the key data points you guys provided last quarter was around increased trials compared to pre-COVID levels, and that's something that obviously continued into this quarter as well. And I start with that because one of the interesting announcements last quarter was around changes to your mobile onboarding flow, so targeting users who are more likely to convert.

And mentioned you last -- you mentioned this quarter that you're making changes to your HelloSign conversion engine as well. So I understand it might be a bit early a sign to provide any initial takeaways from some of those changes to your mobile data-driven conversion engine. But any first kind of details or first thoughts that you've seen in the past couple of months on either shifts in mobile customer close rates or customer feedback since implementing those changes? And I ask because, though it's early, I had imagined changes in aggregate mobile conversions are good for future HelloSign conversions.

Drew Houston -- Co-Founder and Chief Executive Officer

Yes. I mean, we're focused on certainly improving the mobile experience and then just making the overall experience across all our surfaces more seamless. And the majority -- I mean, one way we look at the opportunity is the majority of our users who work are still either free users or on individual subscriptions. And so that represents a lot of embedded value, and it's one of our biggest upsell opportunities.

And other examples of streamlining and simplifying experiences are we want to help folks get into Dropbox Business teams. And so we streamlined -- we've made a lot of progress with things like streamlining the invitation process and onboarding process. And we've also continued to optimize our conversion engines -- or conversion engine to match users to higher-value plans and so on. And so we make steady progress on a number of dimensions on that front.

Operator

Thank you. And our last question comes from Zane Chrane with Bernstein Research. Your line is open.

Zane Chrane -- Bernstein Research -- Analyst

Hi, team. Thanks for fitting me in. I just wanted to dig into that net dollar retention rate. The expansion quarter over quarter, is that primarily a function of the mix shift to more business customers with business customers growing faster than those on consumer plans or is the mix holding relatively steady and the increase is driven by a kind of consistent renewal among your consumer plans with the expansion with your business users?

Ajay Vashee -- Chief Financial Officer

Yes. It's a great question. This is Ajay. Overall, we've seen those churn rates, the gross retention rates remain relatively stable across the business, and the expansion we've been able to drive there in net revenue retention twofold.

You touched on both of the factors. One is us continuing to drive expansion of existing Dropbox Business teams, so teams adding more licenses to their deployment. And we're also always driving a mix shift toward teams. So every period, we're converting more and more gross new licenses as team deployments relative to individual and so that mix shift over time is changing.

Zane Chrane -- Bernstein Research -- Analyst

OK. Got it. And when should we expect the net dollar retention rate to cross into the triple digits? It seems like that's really the inflection point where you could stabilize revenue growth and really accelerate the margin expansion.

Ajay Vashee -- Chief Financial Officer

Yes. We don't -- so we provide formal guidance or report formally against net retention, so we'll continue to provide color commentary. But certainly, we've been pleased with the trajectory and trend that that metric has been on since our IPO, and it has been improving pretty steadily. And so to the extent we have some milestones that we hit, that it makes sense to rest of share publicly, that's something that we'll certainly consider.

Zane Chrane -- Bernstein Research -- Analyst

OK. Great. Well, thanks, Ajay. And best wishes to the other side.

Take care.

Ajay Vashee -- Chief Financial Officer

Thank you.

Operator

Thank you. I will now turn the call back over to CEO Drew Houston for any further remarks.

Drew Houston -- Co-Founder and Chief Executive Officer

All right. Well, thanks again, everyone, for joining us this afternoon. We hope you're staying safe and healthy. And we look forward to speaking with you again next quarter.

Operator

[Operator signoff]

Duration: 55 minutes

Call participants:

Lev Finkelstein -- Vice President of Corporate Finance and Strategy

Drew Houston -- Co-Founder and Chief Executive Officer

Ajay Vashee -- Chief Financial Officer

Alex Zukin -- RBC Capital Markets -- Analyst

Mark Murphy -- J.P. Morgan -- Analyst

Rishi Jaluria -- D.A. Davidson -- Analyst

Olivia Nottebohm -- Chief Operating Officer

Heather Bellini -- Goldman Sachs -- Analyst

Luv Sodha -- Jefferies -- Analyst

Unknown speaker

Billy Fitzsimmons -- William Blair -- Analyst

Zane Chrane -- Bernstein Research -- Analyst

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