Box, Inc. (BOX) Earnings Call Transcript & Summary

Great. Welcome, everyone. Thank you so much for joining us today. I am very happy to introduce Aaron Levie, CEO of Box; and Dylan Smith, CFO of Box. Thank you both for being here. Before I get started, I have to read this disclosure. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures or at the registration desk.

Okay. Well, with that out of the way, Aaron, 2019, I would say was maybe a pretty transformational year for Box. When I was sitting here last year speaking to you guys, you were talking about initiatives you were putting in place to drive more cross-selling, more strategic selling, improving sales productivity, kind of easing the selling motion. And we're starting to see the benefits of that in Q4 with accelerating billings growth. So just to kind of kick off, can you talk about what you think has worked particularly well in 2019 in terms of the changes you made from a sales force perspective or product perspective? And what are you still working on for 2020?

Yes. So at the beginning of last year, we sort of set out with 2 strategic goals in the business. The first was we wanted to evolve our product to be really a much more robust multiproduct platform that included advanced security and advanced workflow as native solutions built into the platform. And that was the first big for us on the product front to make sure that we had a complete cloud content management platform that we can go and sell and cross-sell into customers. The second big component was making sure we evolved our go-to-market motion to really be able to drive that cross-sell and add-on product and see expansion within customers. So that was really the focus on the go-to-market side. I think when you look at the full year of execution, we are super happy at the end of the year to be able to have delivered on a lot of those strategic goals that we set out in the earlier part of the year. Obviously, our billings growth, our revenue outperformance versus guidance were really exciting. I think maybe the other big part that emerged throughout the year was that focus on additional leverage in the business and operating margin, which is a big focus coming into FY '21. So I think as we think about FY '21, there's sort of 2 big strategic components of the business. The first is, how do we make sure we're stabilizing growth rates and making sure that we are driving that cross-sell and add-on product expansion within existing customers to do so; and then the second is drive significant leverage in the business by increasing op margin. We guided to 9% to 10% this year and continue to steadily drive that up over the next couple of years from here. So really important year for us to stabilize growth, drive step function change in the profit level of the business as we continue to focus on improving both of those measures over the coming years.

And to build on that, Q4 was the first quarter that we had a full quarter following the introductions of both Relay and Shield, our 2 new products this year, and that was a lot of what drove the strength in the add-on bookings outcome of more than 60% year-on-year in Q4. And I think increasingly over time, as Aaron mentioned, that cross-sell motion is going to be a bigger and bigger contributor to our growth. Over the past year, we've seen the contribution of our total add-on product portfolio grow from 13% a year ago to 17% today, and that will be a big focus as we move forward into FY '21.

Right. Okay. So it sounds like there's a lot of good things happening on the top line. And if we're looking at your guidance for FY '21, on the most recent earnings call, you seem to be leaning a little bit more heavily towards the leverage side of the equation in terms of your guidance for 25%, combination of revenue growth plus free cash flow margins. Just given what's happening on the top line, and it seems like things are starting to come together for the business, can you maybe describe the rationale around focusing on leverage at this point versus growth?

Yes. So I think we're at a stage where we feel like we're in a position where we can drive leverage without necessarily trading off top line growth. We see significant areas where we can drive up productivity levels on go-to-market. If we think about certain regions that weren't performing as well as we'd like, we can take some of those investment dollars, put them into regions where we know that we can get higher performance levels from the organization. As you think about the introduction of Suites, we have a huge opportunity to drive higher ASPs or average contract value. So there's a bunch of things that we're doing that both continue to drive our growth and allow us to hit the levels that we talked about while, at the same time, benefiting from the scale that we're at to be able to drive additional op margin and not actually trading off between the 2. And I think, going forward, over the next few years, you will see us continue to drive both of those levers. So in areas like gross margin, we know that we have a really healthy amount of upside to be able to take what today is a kind of low 70s gross margin to more like the mid-70s in the next couple of years. If you look at our R&D, this is a year where we're not expecting to get leverage out of R&D, but will be an area that we put more focus on in the coming years. In areas like sales and marketing, as we continue to see higher productivity levels in certain investment areas, where we will shift more of our investment into those areas which, again, drives more leverage in the business. So we're at a stage where, yes, the profitability and op margin is definitely a bigger focus for us in management and the Board, but not at the level of trading off between growth rates that we currently expect to see or that we can drive going forward.

Okay. Shifting to Suites, which is a new part of the story over the past year or so. It sounds like there's a lot of opportunity. It still is very much early days in terms of penetrating the base. What has been resonating with customers around Suites? And then, I guess, the second question on that is what kind of ASP uplift you typically see on Suite adoptions versus a typical customer sale?

Yes. So on the resonance side, the great thing about the Suite is it includes our kind of core horizontal add-on products, Relay, Governance and Shield; and then on the upper end of one of our Suites, we have a platform licensing construct that helps customers scale with our developer platform. And so this is relevant for 100% of our customer base. Obviously, it's going to first focus on the customers that have a lot of usage of Box, and we can now bring advanced security to that usage where they can better protect their data from threats, they can better classify their content as it flows through their enterprise. With Box Relay, they're able to automate workflows and business processes that deal with content. With Governance, they can obviously do things like legal holds or retention. So it's really powerful in terms of the ability to take what some customers are using Box for today as a secure file sharing and collaboration tool and really help them use us as a platform to power more of their business process in a much more secure way. I think what we're expecting and what we're already seeing is that Shield will probably be the biggest catalyst of the sale of Suites. It's our newest product. It's growing at the fastest rate of any add-on product we've created in terms of how early it is in its life thus far, and we think that will be a major catalyst to the Suite adoption.

Yes. And on the pricing piece. So generally, we see, for each of our add-on products outside of platform, which is a little bit of a different model, roughly 20% to 30% uplift per product versus what a customer would be paying for core Box. When you compare that price for core Box versus a customer who adopts the breadth of our Enterprise Suite, we tend to see a rough doubling in the total price per seat as a result. Not all customers are going directly from only using core Box to the Suite, they might have already purchased 1 or 2 products along the way, but that's the relative impact in ASP between the full Suite and core Box.

Okay, that's helpful. In terms of Box Shield, I just want to dig into that because it seems like it's an interesting opportunity. A few questions related to that. First, does that change the end buyer? Are you selling to a different piece of the organization with Box Shield? And then secondly, does that change your competitive set? Is it a different set of competitors for that opportunity?

Yes. So it certainly changes or evolves some of the budget holders that are involved. We've always had security involved in our buying process because security teams or compliance teams inevitably have to vet critical cloud infrastructure where their data is going to be stored. But previously, we didn't pull as much budget from the CSOs or the security organization's budget. With Shield, it's the first time where we're seeing actually contribution come from the security organization to say, we actually think a native threat detection, threat prevention and content classification service makes a lot of sense built into the content management platform, and so we'll contribute some of the budget to the purchase of Box. And so that is changing some of the buying process and actually the budget holders over time. I think from a competitive standpoint, it's interesting. It certainly -- what we're mostly competing with is bolt-on technology that you might have to buy in addition to deploying Box. But many of those technologies will still have a customer that elect to purchase because they have to secure other SaaS applications. But if it relates to just content and securing content, we do believe that we're going to be able to pull in a lot of the dollars that relate to securing content in an enterprise. And so there's less one-to-one competition because, clearly, we should be the best at protecting the data that's stored in Box, so there's not a direct comparison of competition that we compete with. But when you look at things like data loss prevention technology or threat detection technology, these are some of the use cases that we will be competing with in a limited way or digital rights management solutions as another example.

Okay. And Box Relay, another new product for you or the newest version is out this past year, what does the new version of Box Relay bring that was -- that's different than the prior version? And what have you seen in terms of customer adoption?

Yes. So a little bit of history. So about 4 years ago, we launched a workflow solution in partnership with IBM. And the great thing is that workflow solution exceeded our expectations in terms of the amount of customer demand for Box having workflow as a kind of core capability. The challenge was that the functionality, the user experience was separate from the core Box experience because it was sold as a joint offering. And so we made the evaluation with IBM that it probably made more sense for that to be a native capability within Box. And so about 1.5 years ago, we went down the path of re-architecting the solution. We acquired a company as a tuck-in acquisition. We started on that development journey ultimately to release it last summer and one of the fastest kind of product development exercises that we have done as a company. Ultimately, now that it's a native solution, we obviously take 100% of the revenue for it. We are able to innovate rapidly on the product because it's obviously our code base and our user experience. And we can make sure that it supports all of the use cases that our specific set of customers have around workflow. And so it's a really important strategic decision, one that was really important to make. Now fast forward about kind of 6 or 7 months later, we are seeing a really exciting set of use cases where customers don't have the need for a heavy-end business process management system, but they do need to be able to drive workflow automation around content-oriented business processes. So things like contract review and approvals, digital asset management reviews, client onboarding, procurement processes, so anything where data needs to move through a multistep process and you want to do that in a repeatable, regimented way with an audit trail, that is what Box Relay goes and solves. Again, there's not a perfect external competitor that we were trying to take budget from. It's actually a lot of times business processes that are coming out of e-mail systems or other legacy solutions where the customer wants that to be tied to Box, they want to be able to have all the logging, all the security, all the compliance built into 1 platform. And so it is going to kind of create net new budget. But because it's included in the Suite, we think that the customers that we're going after, we'll be able to justify the price of the Suite maybe because of Shield or because of Governance, but then they're going to be able to get all of this added functionality, which further differentiates and makes Box stay here.

Okay, got it. So beyond Suites and beyond the add-ons, Dylan, you noted that the pricing on the core product is actually increasing as well modestly in the most recent call. What are you seeing from a pricing perspective? And what has enabled you to take a little bit of higher pricing?

Sure. So we've seen now a year-on-year improvement in our price per seat for well over a year. And that does include a slight increase in core Box. And that's, I think, because of our ability to build more and more value into that core platform, deliver, communicate that value to the market, is what's allowed us to make those incremental improvements. And we have still seen though the majority of the price per seat improvement over the last few years coming because of the impact of our add-on products. And that's where we have seen just both greater penetration and more of an uplift relative to the core pricing, but pretty pleased with the dynamics of -- given that kind of competitive backdrop over the last few years.

Right. And just following up on that, I mean, one of the key debates is the extent to which you are competitive with Microsoft or at least Microsoft is exerting pricing pressure in the market. You continue to integrate with Microsoft across a number of their different products within Office and otherwise. And so Aaron, can you just update us on the partnership with Microsoft? And to what extent are they partners versus competition?

Yes. So I think if you look at the kind of pie graph of all of the portfolio of Microsoft's products, and you sort of had Office 365 and Azure and Active Directory and Windows, we compete with a very small sliver of the overall portfolio of Microsoft. And by revenue in Microsoft, it's the smallest portion of a small sliver. So for the majority of Microsoft's technology portfolio, we integrate, we interoperate and we have complementary experiences for customers. We have a really significant set of partnership and integration updates that we're pretty excited about coming online this year, things like Microsoft Teams, continuing to work more with Azure in some key select areas, integrating more deeply with Office Online and some of the Office products. As an example, Office just released a new mobile app in the past 10 days that Box is included in the native integration for. So you're seeing more and more of these interoperability experience and integrations with Microsoft, and we continue to see that happen, and we expect more momentum there. Equally, though, what we're seeing as a broader trend from customers is they want to be able to make sure that they can integrate their content with the plethora of investments that they're making from a SaaS standpoint. So that's things like G Suite or Slack or Zoom or Salesforce or SAP or Oracle. And so we have integrations with the majority of those SaaS products, and we have more to come, of course, with the rest of the ecosystem. Our job is to make it so you can store content once, secure it once, govern it once and then integrate it into any application that an enterprise is using. And so we benefit massively from this massive tailwind of companies deploying more and more SaaS applications, making more and more SaaS investments from more vendors. And you want 1 source of truth for content as you drive that very kind of heterogeneous ecosystem.

Makes sense. Okay, let's just shift to sales productivity. So 1 region that you've noted has performed particularly well is Japan. It seems like you're seeing improved sales productivity there. There's 2 questions related to that. The first is, can you maybe comment if you're anticipating any potential disruption from coronavirus just given it is a major region for you? And then secondly, is there any of the principles that you've been able to see in Japan that have worked well that you could apply to other regions like the U.S. or EMEA?

Yes. So on the coronavirus, I'd say it's still too early to say. We are not yet seeing sort of this come up in any significant way in customer conversations within the Japan region or globally. However, obviously, this is an incredibly dynamic situation. So we're a little bit touch and go on that as a very realtime thing. So no knowledge at the moment of kind of major risk. But again, we're in definitely wait-and-see mode on that front. In terms of some of the success that we've seen in Japan, ultimately, it's an environment where we've got the right partners, the right team. We have the right sales motion. We got in early in the market, and we've seen a lot of success from that. Some of those things, we've been able to replicate. Some of those things, Japan learned from the U.S. in the early growth phase of the company. And so they were able to actually accelerate a few phases of maybe the natural market development. And obviously, it's off of a much smaller base. And so taking lessons from Japan to the U.S. or other markets can be difficult just because they're -- it's growing rapidly, but obviously on a smaller end count of total revenue. But ultimately, I think globally, what we're trying to drive is more consistency in our sales motion, generally. And we brought in a new Chief Revenue Officer. About 7, 8 months ago is when he started. And the kind of 3 big focus areas for him are, one, focus deeply on our existing customers and how do we make sure that we have a very customer-obsessed sales culture that can really go back into the installed base and drive that land-and-expand motion, which brings us to the second thing, which is that repeatable sales motion that we have to drive. Instead of just focusing on the 7-figure deals that obviously get a lot of excitement at the end of the quarter, how do we make sure that we are consistently driving 6-figure deals all throughout the quarter back into our installed base as much as possible. You saw the stat of 112 6-figure deals or higher back in Q4, up from 94 a year ago. And so that's a really good example of us going in and driving that repeatable sales motion across industries, across segments, across geographies. And then finally, the third big area is just making sure that we've got as much linearity in pacing the business. So how do we, again, make sure more of our reps are participating? How do we make sure we're driving productivity levels throughout the whole sales force? Again, instead of maybe some of this lumpiness that we've sometimes had in the market, and unfortunately, drives some of the variability in our performance.

Well, how far along do you think you are in those initiatives, in those areas of focus? And I ask because I believe you're guiding to flat sales head growth next year on low teens top line growth. And so you are assuming improved sales productivity. And so can you maybe just talk about what gives you confidence that you'll be able to achieve that?

Sure. So I would say that in terms of where we are, have seen a lot better performance in terms of the overall consistency and predictability of the business over the past few quarters now, we're just looking at the way we've been managing deals, sales forecast, accuracy, some of that consistency in the 6-figure deal segments that are mentioned. Pretty pleased with the progress we've made there. Would say that the consistency across our global markets last year is an area that I think we still have some room for improvements. And then in terms of kind of how that flows through and what gives us the confidence in the coming year, I would say that we do expect to see some improvement because this is the first year now that we are entering with a sales force that not only is a much more comprehensive product portfolio to sell from day 1 in the year, but also just where those reps are located, much more concentrated in our higher performing, more consistent mature markets. And do expect a lot of the uplift in the improvement that we see in sales productivity to come from those factors, so just kind of the general productivity trends that we're seeing, given the proportion of reps. So I'd say, all these things still continue to be in flight. But overall, pretty pleased with the progress that we've made, particularly in the back half of last year.

Okay. And then thinking about some of the productive versus not-as-productive regions. One area that I believe you said has been slightly underperforming is EMEA. And to what extent is that macro-driven as we've seen with other companies? Or is there still some execution-related changes that you need to make?

Yes. So it's probably been a balance of both execution and macro. Macro, maybe a little bit less on just Brexit, specifically, but overall conservatism on moving to the cloud, some of the factors that deal with the regulatory regimes throughout Europe and EMEA where, especially the category that we're in is -- faces a lot of scrutiny around how you do data protection and data security. And so while we meet all of the standards and the requirements, it still does create a significant level of conservatism in the market. At the same time, we haven't been happy about even the execution within that kind of headwind -- set of headwinds that we face. We've made some changes to some of the leadership and some of the operating side of things in EMEA and equally have set up, I think, more modest expectations for what we're going to deliver this year. So we know that we can be growing faster, but we are not in a position where we're factoring in a significant amount of kind of transformation in the region this year, while we're really trying to drive that stabilization.

Okay, got it. Now you mentioned that the add-ons represent now about 17% of total recurring revenue, I believe. Can you give us an idea of what your expectation is as we're looking into FY '21 and beyond and how that's going to ramp?

Sure. So I would say that to get a sense of the trajectory, again, we would -- that 17% of our total revenue was about 13% a year ago. We do expect to see continued improvement and a greater proportion of our revenue coming from add-on products. We now have a little more than half of our revenue coming from customers who purchased at least one of these add-on products. So because of the introduction of Suites and some of the newer product capabilities, we are confident that, that trend is going to continue. Have not given a specific number or target around percentage of revenue that's coming directly from those add-on products, but certainly have some tailwinds because of the product portfolio. And we'll continue to give color as we see that evolve throughout our sales force and customer base in the coming year.

Right. Okay, great. One more question, and then I'll open it up to the audience to see if there's any additional questions. So get ready for that. Just thinking about the longer-term targets that you all have discussed, FY '21 through FY '23. It does imply somewhat of a revenue acceleration relative to the guidance for FY '21. Can you just help us understand what's the driver of that improved revenue growth? Is that coming on the back of, again, just continued upsell and add-on activity? Or do you need to see an improvement in new customer adds?

Yes. And just to clarify from a long-term model standpoint, so this year, we guided to about 11% to 12% revenue growth. We've set up a longer-term model that suggests somewhere between 12% and 18% revenue growth. So we are kind of within the confines of that model, although we are focused on making sure we drive incremental growth from here. That will be driven predominantly by the sale of Suites and this add-on product motion, a lot of that being cross-sell and expansion within existing customers. Right now, between both seats and add-on products within the existing installed base of our customer base, we have billions of dollars of revenue opportunity just within the logos that we currently sell into. So right now, the focus is how do we go and make sure we drive as much repeatability in our sales motion as possible, how do we go out and reach those existing customers as well as efficiently bring on new logos so we have future customers we can expand, and both stabilize the revenue growth this year, while driving incremental performance in some of the out years, all the while making sure that we have consistent improvements to our operating margin so that we can achieve 35%, both growth and free cash flow margin by FY '23. And our commitment, from a business model standpoint, is that in any growth scenario, you will see that 35% target be achieved.

Okay, great. All right, let me just see if there's any questions in the audience. Otherwise, I've got more. No? Okay, great. Well, I'll continue. In terms of -- Dylan, this might be a question for you. In terms of the net expansion rate or net retention rate, can you just describe the dynamics and what's happening there? I think we've talked a lot about upsell opportunities, add-on activity. When should we start to see that expansion rate -- net expansion rate move higher?

Sure. So at a high level, that net retention rate that we disclose on a quarterly basis has an expansion and a retention component. On the retention side, we've been really pleased with the rates we've seen stable and in dollar terms of just over 5% annualized churn in terms of customers leaving the platform. And then on the expansion side, that is where we have seen some downward pressure over time. And we are pretty confident that we are at that overall trough in terms of the net retention rate, and we expect to see an improvement as soon as this quarter in Q1. One of the dynamics that has impacted that rate, and it's been a big driver of the lower expansion rate, is a single large customer reduction that occurred in Q1 a year ago. So in this first quarter, we'll be lapping the impact of that event which will lead to an improvement in that overall expansion as well as net retention rate. And then over time, some of the biggest drivers around where that rate ultimately lands is going to be in the same areas that Aaron has been talking about in terms of our success in driving continued penetration and traction with some of our add-on products from existing customers.

Okay. Got it. Thinking about the road map from here, we have Shield, we have Relay. It's still early days for those new products. Do you think FY '21 is going to be more digesting those new products and executing towards the existing product portfolio? Or should we expect to see some new products coming into the pipe?

Yes, I think right now, it's definitely a focus period for us to go deeper in our kind of core differentiation area. So if you think about it, why does the customer choose Box? There's 3 big reasons: native security and compliance ; secure collaboration and workflow; and then our platform and our APIs. So this is really a year of doubling down, in some respects, in those 3 areas. If I look at just Shield as an example, there's a tremendous amount of advanced security that our customers are clamoring for. Things like what you're seeing with ransomware, being able to prevent those types of events, being able to go from detection of threats to true prevention automatically of threats when you have data leakage events as an example. So we are just scratching the surface on areas like advanced security, like workflow, like our APIs. We are not missing any amount of kind of SKUs to go and drive revenue growth. So right now, we really feel like it's the time to bolster the value proposition of those products, including our core, quite frankly, to be able to make sure that we can hold up on the price points that we're delivering at and ultimately get this in front of more of our customer base. So FY '21, really, you have a lot of innovation, but going deep in our current product portfolio as opposed to we need more SKUs to go out and sell to be able to drive both this year's growth rate as well as, certainly, for the next few.

Great. Well, that's helpful. We're all out of time. Thank you so much, Aaron and Dylan. Thanks everyone for coming.

Great. Yes. Thank you. Appreciate it. Cool. Take care.