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

My name is Josh Baer. I'm a software analyst here at Morgan Stanley. And we have the pleasure of talking to Aaron Levie, CEO and Co-Founder of Box; and Dylan Smith, Co-Founder and CFO. Thank you for joining today. First, some disclosures for important disclosures, please see the Morgan Stanley research disclosure website, www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. All right. So thank you for joining. I think the future of work has really evolved significantly over the last 2 years, obviously.

So to start it off, how has Box changed over this time? And how is Box positioned to address the opportunity ahead?

Sure. Yes. Thanks. And good to see everybody, and thanks for having us. So there's sort of 3 big mega trends that we're focused on that we're all kind of creeping up in the past maybe a decade, but in the kind of post-covid environment, just further accelerated. So the 3 trends that we think a lot about are: one, the future is going to be hybrid. We are seeing every company that we work with is enabling some kind of hybrid and more distributed work strategy. So this could be small businesses up to the world's largest organizations. And while maybe things won't be as remote as they have been in the past 2 years, they will be incrementally more remote than they were maybe 3 or 4 years ago. So future is hybrid. Second big mega trend is just digital transformation is driving every single industry. So we know that every single business process, every single workflow is going to be digital in the future. And any kind of transaction with a customer any kind of business process is going to have some digital element to that. And then finally, cybersecurity is just front and center for every organization. We only see compounding trends that are driving that. So when you take those 3 megatrends that have only accelerated in this post-COVID environment, and then you think about how companies work with their information, 80% of the data that they're working with is unstructured content. It's unstructured data. It's the CAD files, it's the contracts, it's the financial assets, it's the marketing assets of the media content that companies are producing, and they need places to be able to work with that content, manage it, secure it, automate workflows around to get it signed, be able to integrate it across their applications. And so that's really the opportunity for Box and the Content Cloud that we've been building out. And so we have shifted our strategy incrementally to double down in those 3 big mega trends. You'll see our road map as we've laid out in the past couple of years and certainly going forward, and we have an Analyst Day next week where we'll be kind of highlighting some of the big investment areas. You'll see us double down in security and compliance, so going way deeper in how companies can protect their content, we're to go way deeper in workflow and collaboration. So how do we continue to help automate content-driven workflows, whether that's client onboarding, document review and approval, e-signatures, all of that built on the platform and then being able to integrate into every application that our customers are using. And so if you think about this post-COVID workplace, you've got Microsoft Teams. You've got Slack. You've got Zoom, you got to ServiceNow, you have Salesforce. Companies want the ability to manage content centrally and then extend their content across those applications as opposed to having data silos in each of those tools where you don't have a single source of truth. You don't have an authoritative record of which version of the document you're working on. And so that's really where our open platform comes into play. So that's what we've seen in this Post-COVID world and what we're going to be doubling down on going forward.

Perfect. And you have over 100,000 customers. So I'm wondering what you're seeing as far as the IT spending environment and how like where Box fits on the priority list and some of these megatrends as far as CIO's priorities?

Yes. So I think the demand has been relatively healthy, certainly in the past year. At the first part of COVID, we sort of some headwinds and tailwinds, but we got through that after about 2 or 3 quarters. And all throughout last year, FY '22, we saw incremental improvements from a demand standpoint for consecutive quarters of increased growth rates. And ultimately, now when we look at the environment today, whether it's small businesses that are growing across multiple sectors, Fortune 500 companies that are obviously continue to drive digital transformation. I think these mega trends are alive and well and content is an increasingly higher priority for organizations to pay attention to. And what's great is that these trends are really driving customers to need to replatform their content stack. So if you think about the legacy way of managing content, you had multiple on-premises systems from a variety of vendors, often these sort of legacy traditional vendors, at the same time, you have a variety of cloud applications that are these point solutions that customers have to adopt and integrate. And so what we're doing with our content cloud is letting customers have a single platform that powers the complete life cycle in one architecture, and that's what's driving a lot of this demand across industries.

Perfect. Before we dig into the story more, wanted to address the war in Ukraine, no you have a center of excellence in Poland, but I was hoping you could address any impact to that region?

Yes. So right now, we're seeing no business impact. We have no business exposure in the affected areas. Obviously, that could, over time, change as some of the downstream consequence of this, but we have no sort of regional impact in our Poland team we check in with daily and regularly. And other than those with maybe Ukrainian relatives, we are fully operational from a Poland standpoint.

Great. Want to dig into competition. you've made comments recently about how the competitive landscape is getting easier, maybe specifically with Microsoft and how you're strengthening your partnership with Microsoft has even strengthened. I was hoping you could dig into that what do you mean by that?

Yes. So I think probably the general view was 3 or 5 years ago that Box was sort of head-to-head competitive with Microsoft. That was because what we were largely disrupting was SharePoint and OneDrive by providing a solution that could retire both of those systems. That led to customers, again, perceiving oftentimes that this was a head-to-head battle and you had to kind of compare and contrast the 2 products. What we have done is sort of twofold. One is dramatically deep in our partnership with Microsoft. Much of this has also been driven by their level of cooperation on their end. So we just did a release last quarter where customers can actually turn off one drive and turn on box inside of Microsoft Teams. And so that was a pretty big breakthrough integration that they developed due to the demand that we were seeing from customers. And so that was a huge initiative on their end. We're doing similar levels of integrations with Microsoft Office. So you can turn off One Drive and turn on box for that level of integrated functionality. And at the same time, we've become incrementally less competitive or head-to-head competitive because we've expanded the portfolio of solutions that we provide into areas that Microsoft is not competing in. So when you think about e-signature, advanced data security and compliance, workflow automation around content, some of the future ways that companies want to be able to publish and manage their content at scale. These are areas that Microsoft is just not building products in. And so you'll see us that continue to go way deeper in content, whereas they're going much broader in sort of cloud and productivity generally. And at the same time, we're more integrated with Microsoft than ever before. The vast majority of our large Q4 deals, as an example, were coexist deals with Microsoft, and maybe the customer was getting rid of legacy content management systems and vendors but using Box alongside Microsoft Teams or Microsoft Office. And so we've built a much more complementary relationship with Microsoft.

Perfect. That's helpful. Aaron, you've laid out sort of your position in this very large TAM and thinking about like the TAM to solid competitive ratio as far as modern cloud-based vendors being pretty attractive compared to other large markets. I was hoping you could kind of lay out that -- thesis or that thought that you have?.

Yes, sure. So I think if you go to a large enterprise, pick a Fortune 500 company or a government agency and you say, show me your IT stack and show me what's in the cloud versus what's on-prem and you say, "Okay, show me your CRM system, by and large, their CRM systems in the cloud. It could be Salesforce, probably maybe it's Oracle, but it's a cloud system. And you say, let me look at your HR system. And you can just see by their own stats, it's probably going to be Workday. Maybe it's, again, Oracle or SAP in the cloud. You say, show me your right TSM environment. It's probably going to be service now. Then you say, let me see your content stack. And you sort of peel into the hood and you have everything from network attached storage vendors, EMC still Dell, HP, NetApp -- you look at the content management software, document management software, could be OpenText could be document and could be SharePoint on-prem. And then you say, okay, how are you moving data around your organization, could be FTP environments. And again, a lot of on-premises infrastructure that supports that. And so what we see is this massive replatforming opportunity where -- it's very clear that you're not going to have data centers be used only for content in the future. That would not make any sense when everything else is in the cloud. So we know that content is going to go to the cloud. And so when you look at then, let's say, you were to say, what is your selection criteria as an enterprise for moving your content to the cloud, you're going to want the world's best security, the best compliance, the best data governance, the best workflow automation, the greatest scalability of the platform, the ability to drive e-signatures or new ways of collaborating. And we have built the only platform in a multi-tenant SaaS-based architecture that provides those set of capabilities in one platform. And so we believe, as more and more companies look to replatform their content stack, we're going to be generally the biggest beneficiary of that moving to the cloud, at least as an independent vendor in the market. And so that's the kind of thesis of the legacy moving to the cloud. And at the same time, even if you kind of extract at the legacy for a second, you look at maybe the point solutions that customers have to have today in the cloud for collaboration, for workflow for content publishing for you Signature we have the ability to provide a single platform that can integrate all those capabilities in one offering. So whether it's companies going from legacy to the cloud or companies that want to consolidate their point solutions, we have a platform that kind of works for either of those environments.

Great. I want to talk about the new logo opportunity. Like we've seen the improvement in net retention rate and selling back into the base. But on new logos, what should we expect and where -- what market, market segments, geographies could we see customer growth?

Sure. So over the past couple of years, we've tended to drive 25% to 30% of our total new bookings from new logos and while we have a big customer acquisition opportunity in every segment in market that we serve, we tend to see the highest relative contribution from our international markets and from our smaller customers, our SMB segments. And a lot we're doing is we've really designed our sales force territories to suit the strengths of our sellers. You might have -- some folks who are more hunter-oriented who will have a few dozen prospect accounts, noncustomers and then the more farmer-oriented folks might have a handful of large existing customers. And then we also do offer incentives when our sales force is able to close new logo wins with any of the named target accounts that we have. So we do see a pretty big opportunity to continue kind of driving a healthy mix of growth from existing customers and continually adding new logos.

Great. You mentioned in the competitive conversation versus Microsoft, you're going deep in content. Are there adjacencies outside of security and governance, workflow collaboration around content that it makes sense for you to enter? Or should we expect future product innovation to be centered on those 3 key buckets around content?

I think they'll largely follow those buckets, but they will be adjacencies relative to what we've served today. So on -- we have no intention of adding to the competitive landscape and maybe the general workplace productivity categories. We think there's some very busy spaces right now. We'd rather be partners with a lot of those categories. And so if you think about kind of like complete adjacent markets of project management solutions or workplace OSs, the Mondays and the smart sheets and the Asanas of the world. We'd rather be integrated and interoperate with those platforms as opposed to compete with them. However, what we think about as adjacencies to our current offerings are how do you go way deeper in workflow around content. So today, we do some very kind of straightforward if this then that workflow automation around content. Well, how do you start to design much more comprehensive and sophisticated workflows. So you're a very large bank. You want to do client onboarding with a highly complicated routing decisions with, again, an e-signature at the end of that process. that's a big area that we'd like to be investing more into. If you think about we're just scratching the surface of what you can do with machine learning and AI in terms of processing content, whether it's the generation of data or the extraction of important information from content and then kicking off workflows. So that starts to transform what kind of work full automation we can drive. I'll give you 1 more category is just an example that we see as an adjacency, but still in the content realm, we do very little today in what I would call content publishing, so Box is a tremendous way to collaborate with your team, be able to manage content, organize it, share it in a group and across groups across the entire company. But if you want to say, okay, I want the sales team to know exactly the latest sales asset and what sales assets to pull. A lot of our customers are actually building software around box to go and implement that kind of capability. Well, we look at that and say, okay, that's an interesting adjacency that maybe we can build technology in over time. So you'll start to see us as we expand the core capabilities in Box, think about what are the business processes that our customers are trying to solve, how do we start to have more integrated capabilities in our platform that solve those use cases in a very native and seamless way. And then that will ultimately expand the TAM, get us into faster growth TAMs around that core content management market.

Great. Dylan, you mentioned incentives for new logos. What about incentives for suites, and just more broadly, what's driving the success that we're seeing in suites as far as use cases or products?

Yes. I think the first big use case that we're seeing is really around security. So that's what ultimately drove the Suites adoption in the past couple of years. And then I think going forward, and you'll start to see this as a general pattern we'll have new products that get introduced that they'll get mature over time. So today, our security offering with Shield and governance is incrementally more -- one of the more mature areas of our product, even though we're going to be continuing to invest in it. And then e-signature became a capability that we launched last year, and that's an area that we're going to be doubling down on pretty significantly. We see a lot of opportunity. That will then, we believe, drive the next phase of growth for our multiproduct plans now of which Enterprise Plus is the sort of best-performing plan in that portfolio. So you'll continue to see us add more functionality into the multiproduct configurations driving growth in those higher-end suites.

Great. So we -- obviously, there's a pricing component to suites. But as far as other impact, how does selling suites impact win rates how does suites impact retention rates, churn?

Sure. So really, the implications of suites, which are increasingly becoming our default sales motion, have a positive impact on our growth and customer economics. really top to bottom. So that includes everything from the pricing you mentioned, which translates into higher gross margins stronger net retention and much larger deals, both because of the pricing increases and because our Suites customers tend to see more value and end up deploying Box to far more users than those customers who aren't adapting suites.

Okay. Got it. Aaron, you were talking about how for certain adjacencies, the partnership model makes sense before digital signatures for e-signatures, you have box sign native. And so why does it make sense to have that native solution when you already had strong integrations with other providers?

Yes. So first and foremost, you should always consider any market that we enter or any space that we're in, we are going to be the most open and interoperable provider possible. So we want -- our whole platform strategy is you store content once and then you can extend it anywhere. And so that could be a signature provider that could be a collaboration tool that could be a communication vendor that could be a sort of a complementary sales portal or digital asset management system. So openness is sort of the MO of the company kind of at all times. That being said, there's a bunch of capabilities, when we go and ask our customers, "Hey, what are you doing around box that you'd love to see as a native capability in our platform that could add more value streamline workflows, make our product more seamless for use. And on a very regular basis, we're serving all of our customers and saying, "Hey, what would you like to see next in our platform. And about 2 years ago, certainly at the peak of the early phases of COVID, the #1 capability that our customers were asking for was native e-signature solutions built directly on Box. And that was not intended to be because of the competitive landscape. It was simply to add more value to our customer base. So we looked at the market, we found a very attractive acquisition to be able to onboard into the platform, really kind of a tech IP tuck-in play that led us very quickly accelerate entry into the eSign market within 9 months. We had box sign out that then gives us the most native seamless capability we can have in the platform. And so directly from Box, once you have your contracts or NDAs or compliance documents already in the platform. you click one button and then you can launch an e-signature workflow directly from the platform. So that's very powerful. At the same time, we're going to still continue to integrate and connect to any other e-sign vendor that our customers want to work with. So the intent is not to have any kind of preferential treatment from a platform standpoint. But what we have seen is that a lot of customers like having a native solution that is obviously going to be economically attractive to them because it comes included in the plans that they already have with Box. We will be charging and monetizing separately our API usage. We call that 1 6-figure deal in Q4 that was just for API volume on the platform for Bakin. So you'll see that be discretely monetized from an API standpoint, but we also wanted to have a very powerful native solution built into the platform to make it available to any of our end users and customers that want to be able to have that as an embedded functionality.

Got it. So you talked a little bit about monetization and how it can contribute there. Like is there a way to break out the impact to the model? Or have you talked about that from a contribution perspective?

We haven't talked about from a -- it would be hard to kind of break it out simply because if you go to our website, you look at the pricing tab, we now have an Enterprise Plus plan that has all of our add-on products. So Shield governance zones, it has all of our advanced e-signature capabilities. And so what we're doing from a sales motion, as Dylan mentioned, is just getting all of our customers into those multiproduct suites and making it as easy and attractive as possible to upsell into those plans. And so we wouldn't be able to sort of deduce exactly what percentage is being driven by eSign as an example.

What about adoption or engagement?

Yes. So it just became available in Q4 from a general availability standpoint, but the early adoption is strong. We call out a number of great examples on our customer call. We have a financial Analyst Day -- sorry, earnings call, we have a Financial Analyst next week. We'll share kind of additional qualitative examples of the early adoption. But the way to think about it is this is a market where even though there's at scale, very, very mature players and platforms in the market, we actually still think we're in the very early days of this space. If you go and ask most customers, how does the vast majority of their documents get signed. I think we're still in the early innings of being able to go and digitize and automate more of those workflows.

Great. I want to shift over to the financial side. We've seen an acceleration in growth over the last 4 quarters, which has been great to see. By definition, those make tougher comps now. So I was hoping you could talk about some of the leading demand indicators or other leading indicators that give you confidence in sort of maintaining that teens growth profile?

Yes. Our confidence in sustaining strong top line growth really comes down to 3 main factors. The first of which is the suites momentum and demand that we're seeing in the market where we have significant runway ahead. And as mentioned earlier, those types of sales tend to have higher win rates and much larger deals overall. So definitely a catalyst for growth. The second is the trends that we're seeing within our sales force. So this past year, we were able to deliver double-digit percentage gains in sales force productivity. And for the year ahead, we expect to grow the size of our sales force in the low to mid-teens. So we feel very confident that we have both the demand and the sales capacity to deliver against our growth goals. And then finally, we've continued to see strengthening customer economics. So one of the key metrics that we look at to monitor the health of the business is our dollar-based net retention rate. That improved in all 4 quarters of this past year is now at 111%, driven both by accelerating customer expansion and by an improvement in our full churn rate from 5% to 4%. So that gives us a really strong and sticky foundation to build on as we continue to deliver that -- against those growth targets.

Great. And a follow-up on the improvement in the churn metric. Anything to call out there that caused that improvement?

Yes. So I would say more generally, the biggest driver is enhancements to our product offering and suites in particular. So as we see customers adopt a more sophisticated capabilities that drives higher value use cases and much stickier use cases, -- and so we've been seeing our churn rate steadily improve over the course of the year toward that 4% where we landed at the end of the year. And as a reminder, that's a trailing 12-month metric. So reflects the underlying momentum that we've been seeing throughout the course of the past year.

Great. And Dylan, on the overall 111%, how should we think about the trajectory of that looking forward?

Yes. So we'd expect that to remain fairly steady at that roughly 10%, 11% level, at least through the course of this year. And then over time, I expect the biggest drivers and levers to improve that net retention rate are going to be around our ability to continue driving success in our upsell, cross-sell and retention motions as we've been doing.

Great. I wanted to ask one on gross margins. We've seen the improvements there, I think expecting another 2 points of improvement, I think in FY '23 76%. Where are we on the infrastructure efficiency path? And where can gross margins go over time? And at this point, where is the leverage coming from?

Yes. So kind of driving infrastructure efficiencies is going to be an ongoing effort for us. So we'll be on this path for a very long time. I would say that for the next couple of years, we expect the majority of our gross margin leverage to be coming through moving more and more workloads to the public cloud. So we've structured long-term agreements with our key public cloud partners to get a very compelling unit economics. And at the same time, that shift allows us to manage fewer servers internally, and you've already been seeing this impact in our model. So if you look back 2 years ago, capital lease liabilities plus CapEx was about 9% of revenue. This pass-through was 7%, and we expect that to be about 5% this year and to continue trending down from there. So longer term, we certainly see upside and additional expansion in gross margin, and we'll also be sharing some of the ways we're thinking about this over a multiyear period at our upcoming Analyst Day next week.

Have you talked about your -- like the percent of your workloads that are in public cloud? And if you could remind me or us where your data center footprint is currently?

Sure. So right now, we are in a couple of different data centers in Nevada in addition to all the public cloud infrastructure that we use. And I would say that there are different services that are in different points of that migration to the public cloud some like storage and databases, we're well on our way in that transition. And then there are other services such as compute and networking that will be following suite over the next couple of years.

Great. Moving down the income statement to operating margins. Obviously, there's been strong expansion there. If you could sort of unpack that a little bit and then also bridge to what you've been talking about for FY '23 with all the moving pieces there around effects and the return of travel and entertainment and just generally investments on the OpEx lines?

Sure. So over the past couple of years, we've made significant improvements to operating margin going from about 1% I guess, 3 years ago now to 20% this past year. So all that over a 2-year period. If you look at our FY '23 guidance, we expect to improve operating margin by a couple of hundred more basis points year-over-year to about 22%. That includes a couple of impacts that we called out, the first of which is FX, which we expect to have about a 1 point impact downward impact on operating margin and then the return of those COVID-related expenses, T&E, facilities, events, to have a little more than a 1-point impact as well. So if you look at the 200 basis points operating margin expansion that our FY '23 guidance calls for that represents only about half of the true underlying leverage that we're on track to deliver in the coming year.

Got it. Let me pause there and see if there's any questions in the audience. All right. I'll keep going. As far as capital allocation, you had over 20% free cash flow margin, I think, in FY '22 basically, you're generating hundreds of millions in free cash flow looking forward with a pretty healthy balance sheet. So how are you thinking about capital allocation?

Yes. So ultimately, we think about capital allocation in terms of what's going to deliver the most value to our shareholders. So to your point, we ended this past year with nearly $600 million in cash and investments. and we plan to use that strong balance sheet and our increasing free cash flow generation to accelerate product innovation through disciplined strategic M&A. I think what you saw from us last year is a great example of that. As Aaron mentioned, we acquired the team in technology in the e-signature space to be able to deliver Boxin to our customers in just about 6 months, and we were also able to bring on a different team in technology to significantly enhance our data migration services through Box Shuttle. So that's the type of approach that you can expect to see from an M&A point of view. On top of that, we expect to use the majority of our free cash flow generation to opportunistically return capital to shareholders in the form of stock repurchases.

Great. And from an M&A strategy perspective, you have this history of innovating and rolling out products internally, and you've also done some acquisitions. So how do you think about that build versus buy? Is it time to market? If you could expand on that, Aaron?

Yes. I think you kind of nailed it on the time market front. We basically have a multiyear horizon view of our product road map in all the spaces that we want to enter. And we I think probably biased toward organic development just because we really care about our platform-based approach where we want each service to be built on the platform as a service that becomes built in the services-oriented architecture. At the same time, if we think there's a massive time-to-market advantage and there's a technology that we can bring into that platform-based approach, we will absolutely consider disciplined M&A as a way of accelerating that. But I think as we expand to more non-U.S. engineering, that gives us more capacity to build out our road map faster ourselves, -- but at the same time, we do find that there's attractive opportunities to bring in technology from an acquisition standpoint to accelerate that road map.

Perfect. We're out of time. But before we close, I want to give you the opportunity to fill us in on the 3 key takeaways from Financial Analyst Day.

Yes, and you'll find those out next week.

All right Thank you.

Thank you.