Box, Inc. (BOX) Earnings Call Transcript
September 14, 2020
Earnings Call Speaker Segments
Good afternoon, everyone. My name is Taylor McGinnis, and I'm one of the software analysts here at Deutsche Bank. This session of Deutsche Bank's Virtual Technology Conference is with Dylan Smith, the CFO and Co-Founder of Box. Dylan, thanks for joining us.
Thanks for having me.
Awesome. [Operator Instructions] So with that, let's get started. So Dylan, maybe just to start off, for those that aren't familiar with Box, can you first start offering a brief background in the company and perhaps yourself as well.
Sure. So we started Box a little more than 15 years ago now. Originally set the company up as the most secure and user-friendly way to manage content. Over time, we have increasingly shifted our focus, both upmarket to serve larger and larger enterprise customers. And at the same time, both our offering and the broader market have evolved from more of a basic file sharing and collaboration solution to a full cloud content management platform. So we went public about 5.5 years ago now as a single product company, just what we call core Box today, and since then, have been increasingly moving into more advanced use cases including business process with capabilities like Box Relay, our workflow solution. A flexible and open platform to build on by a Box platform, is the product that serves that. And then more advanced security capabilities more recently, with Box Shield. And so continue to evolve our product and have now really built out a comprehensive cloud content management platform to really serve the end-to-end needs that enterprises have when they're looking to work with and securely manage all of their content in a single platform.
Great. Thanks for that introduction. And then maybe let's discuss the current environment given that, that's very topical. So can you talk about the impact that the pandemic is having on demand for cloud content management and collaboration software? So has there been a difference between the impact on new versus existing deal activity? And I would be curious for any trends that you're seeing in relation to churn and expansion and new business, just anything that you'd call out there.
Sure. So I think that our performance, in light of the pandemic and all the challenges that it brings, really does highlight the resiliency and underlying strength of our business model. So we are fortunate that more than 95% of our revenue is recurring revenue, and less than 10% of our revenue is generated by the industries that have been the hardest hit by COVID-19, so have been fortunate in that sense. And in terms of some of the trends that we're seeing, we are definitely seeing some different dynamics across some of the categories that you mentioned. Specifically, we've seen strength, in particular, in larger enterprise customers who are now really accelerating their adoption of remote work solutions and everything that we do is there are now more pronounced needs for Box' differentiated security, workflow automation and integration capabilities to enable increasingly distributed workforces. So I think that the current environment has really created some heightened pain points around file access and content security, which has led to continued strong demand in that set of use cases. And what we've seen on the other side is there had been some challenges and headwinds in small business demand, particularly in the industries that have been hit hardest by the pandemic. But just in general, those types of customers tend to be a little bit more sensitive to some of the macroeconomic challenges that we're facing right now. In light of that, because there's kind of some puts and takes. We are seeing strong and stable churn. So that remains -- has been stable over the last few quarters and actually improved a bit year-on-year with our full churn rate coming in about 5% annualized in dollar terms. And what we have seen as a result of the pandemic is more of a shift of the new business that we're closing coming from existing customers versus net new customers. And so the expansion, especially again, in enterprise customers has remained very strong. Although we are seeing, again, challenges on the SMB front. So that's kind of the high level dynamics and happy to drill into some of the specifics as well.
Yes. I'd love to drill into some of the specifics because I know that this is something that you guys talked a lot about on your last earnings call. So can you maybe elaborate on that a little bit more? So when we think about enterprise [ adoption ] is that really with the expansion of existing seats? Or are there certain modules that you're seeing a lot of traction within the existing base? Or maybe it's even new enterprise customers that you're seeing come in? And then on the SMB side, just curious how you would describe, I guess, the magnitude of that slowdown that you're seeing.
Sure. So in terms of the seats versus modules, I would say it's really been both. The immediate demand that we saw when this situation began to play out tended to be more of the expansion of the number of users with paid seats in those larger organizations, particularly as, for example, if you have been using legacy tools and really just focused on internal collaboration, those types of solutions were just no longer meeting the needs of this type of environment. So that was kind of the initial demand that we saw. Although, again, that has remained strong. And I think on the new product front, the modules, we have seen very strong demand and strong traction around Box Shield and Suites, in particular, especially in existing customers. So that's, again, being a bit of both and much more of an emphasis and strength in our existing customers, especially relative to our initial expectations for this year in light of everything going on. And then on the SMB front, we'd size the revenue impact of this in the mid-single-digits million range this year, which was incorporated into the guidance that we've given on our past couple of earnings calls. And this is one where we have seen -- pretty immediately, we did see some challenges in those customers as this -- as the pandemic began to play out. We have seen that stabilize and then start to improve in terms of the underlying demand in the second quarter, and that trend has continued so far in the third quarter where we are today. And that's also a category where, because of just the nature of the deal cycles, we don't have the same level of longer-term visibility from a pipeline point of view, but the underlying demand has stabilized and started to improve in that segment as well.
Got it. That's super helpful, so thank you for that. And then, I guess, as we look ahead, how would you characterize pipeline activity or lead generation at the start of 3Q relative to the first half of this year and prior years? So I guess, what is your guys' expectation for the slope of a recovery? And when you speak with customers, where do you feel content management and collaboration initiatives fit on the priority list relative to other SaaS projects.
Yes. So we'd say that in terms of the pipeline and spoke a bit on our most recent earnings call, that has remained strong, especially in the enterprise. And so [ we ] feel good about kind of the overall volume of business that we should be able to close in the back half of the year. And what changes now that I think there's been a little bit more time for customers to kind of settle in, wrap their heads around what they need to be doing from a kind of technology point of view to address some of these newer content management challenges. I think we're starting to see more of a shift and a greater contribution through some of those add-on products that I mentioned as we've kind of gotten past the -- how do we solve the immediate-term needs and start thinking about what the longer-term strategy is around content management and collaboration. And we'd say that relative to other SaaS projects, it's hard to say exactly kind of versus individual categories, I would say that overall, I think what we're seeing is this environment, as unfortunate it is from -- on a lot of different levels, I think it has created more of a sense of urgency and more prioritization around pushing our customers to think about what is that longer-term content strategy. And so I think you'll see a multiyear wave of adoption of these types of solutions like Box being somewhat compressed. Particularly on the enterprise side. And it's hard to say, I mean, exactly from a slope of recovery, but again, we are starting to see that in the SMB segment, and already, we weren't necessarily hit quite as much, fortunately, from an enterprise side. And so I think regardless of just what the shape and duration of this recovery looks like, we feel confident in the growth expectations that we've laid out and the underlying demand, as in some cases, we have benefited from these challenges.
Got it. And then I'd be curious when you talk about some of these legacy solutions not being very fit in this type of environment and customers struggling with those solutions, are you seeing a lot of displacements of those legacy solutions in this environment? Or is a lot of it more net new initiatives?
For the most part, I would describe it as net new and/or the expansion and kind of mix shift of where customers are collaborating and managing their content. So there haven't been as many kind of rip and replace of these legacy enterprise content management solutions over the past few months, especially as those types of projects tend to take some time. But more of the dynamic of what we're seeing is, let's just say, for example, a customer might have 10,000 employees, 2,000 of those users were using Box. Now because the dynamics of what's expected to be able to work effectively in this type of environment, a big chunk of those 8,000 users who might have been using other tools now just can't effectively get their jobs done. And so that will cause a customer to expand the number of seats they have. So kind of net new customers, but in many cases, the same types of use cases that they are already using. There's just now a much more relevant, a much larger and more relevant population of users where Box' differentiators are particularly important.
Got it. That makes a ton of sense. And then maybe shifting gears to something that you were talking about earlier, which is Box Relay. So I know when we've done a lot of our field work, we've talked with a lot of customers who have really highlighted the importance of workflow and process automation in this environment. And like you mentioned earlier, Box Relay allows customers to automate some of those content centric processes. So can you talk a little bit more to this product, the upsell opportunity and the traction that you've seen thus far? And do you feel that this environment has been a catalyst for that product?
Yes. So we'd definitely say that -- that hard to be -- actually, it's a fairly new product, how much of the traction that we've seen recently is just time in the market and customers, to better understand the capabilities and the value that Relay provides versus the specific environment. But we have seen a very healthy uptick in Relay sales, both from a stand-alone basis, but increasingly as part of being a catalyst for a customer to think about Box more broadly and adopt our suite. So we've mentioned on our last call, a full 30% of our 6-figure-plus deals were -- came in the form of the Box Suite and the Relay and Shield have been the 2 catalysts really driving that. So on the Relay front, we have done recently is expanding our template library to simplify workflows across departments, incorporated new security classifications into those automated workflows so that those content-centric recurring workflows like employee onboarding and off-boarding contract routing and approvals are just much more efficient. And I think, particularly as customers are rethinking the way that they go out and attack a lot of these problems in this new environment, Relay is a great way to address those new use case s. So I think there has been a little bit of a catalyst because, again, some of the existing processes that might have been in place in customers that maybe weren't perfect but were good enough in a previous environment are now just a lot more painful. And so I think on that level, it has been a catalyst. But we think about the sort of trends and adoption we've seen in Relay is probably as part of the broader kind of shift that we're seeing toward customers using Box and kind of the broad range of capabilities that we provide through the suite.
Got it. And then maybe sticking to the impact of the pandemic here. So I'd be curious, have you seen any changes on the competitive front amidst this environment? So for instance, that Microsoft had rapid adoption of Teams. And so I'm wondering if that has served as a competitive threat to sell things like SharePoint, or OneDrive, or Power Automate. Maybe there's perhaps more bundling or price discounting going on during this time. Have you noticed any changes in the environment from that?
No, we really haven't. And Microsoft has remained -- I think it's done very well of late and especially with kind of the Office 365 adoption and everything they've been doing on that front. And they remain the company that we compete against more than any other. But that really hasn't changed as a result of the environment as -- from a bundling and pricing point of view, the sort of offensively competitive categories and products that they have were already bundled into the Office 365 suite. And so that really hasn't changed even in this environment. And actually, one thing that we are seeing is increasingly going back a bit to some of the just broader technology adoption trends is we are increasingly hearing from customers the desire to build that sort of best-of-breed enterprise IT stack. So particularly, when you think about the adoption of services like Zoom, services like Slack, as customers are moving in that direction, that's one where it's actually -- Box can be a better partner and part of that technology footprint versus what Microsoft does.
Got it. That makes a ton of sense. And then maybe moving on to the financials for a second. So the operating margin guide for this year is within 12% to 13%, which is up significantly from the 1% last year. So can you talk about some of the drivers behind that greater level of profitability? And when we look ahead, in what areas are you able to drive more efficiency and cost discipline? And how do you think about balancing growth versus margin improvement.
Yes. So we'd say that the categories that we've outlined, where we've been driving most of the improvement, especially at the tail end of last year are in workforce strategy and expenses gross margin improvements, and then just overall kind of cost discipline and cost reductions. And been really pleased with the way that the team has been able to drive efficiencies across all of those areas and leverage so far this year. The single line item where we've had the greatest improvement on a year-on-year basis is on the sales and marketing side. And that's where not only are a lot of those kind of categories that I mentioned earlier kind of flowing through, but we have seen, at the tail end of last year, eliminating certain sales overlay functions and reducing some of the lower ROI sales roles as well as reallocating a lot of our investments from lower-performing to higher-performing regions and leveraging digital channels to more efficiently acquire and serve our customers. And so that's resulted in solid sales productivity improvements in the enterprise up about 10% year-on-year, which has helped drive some of this leverage and continued growth without increasing the kind of cost profile commensurately. And then in some of the other areas, from a gross margin point of view, a couple of things that we've driven and are now benefiting from this year. There's scaling into and generating efficiencies as we move into our expanded data center footprint, which was a long-term migration that we've wrapped up a couple of quarters ago. And then also continuing to drive efficiencies through the public cloud relationships and some of the kind of negotiations will be completed at the tail end of last year. And then just overall, just taking a much more rigorous approach to kind of the ROI of various -- whether it's marketing programs or other activities that we have as a company has benefited and is part of what led to the improvement in our operating margin outlook for this year. And then as we look forward, I think a lot of the categories that we'd expect to drive continued improvement from are generally in those same types of areas in terms of workforce expenses, gross margin improvement and overall cost discipline would say that we also expect to continue generating a leverage from a business model point of view. As we've talked about, we've shifted more of our focus from a growth point of view and where our sales and marketing energy is focused from net new customers into, really, the expansion and renewal of our existing customer base, which is a much more profitable type of sale. And then the other lever that we've not benefited from yet, but we've mentioned, is increasingly focus on our workforce and location strategy. So in particular, as we shift the head count to lower cost locations over time, a big part of that is going to be standing up our first kind of outside the Bay Area significant engineering site in Warsaw, Poland. So those are a couple of the initiatives that we're most focused on. And then as we think about the overall balance being growth and margin improvement, a lot of it comes down again to that framework we've laid out around really looking at on a segment-by-segment, geography-by-geography basis: what is the ROI; how are the sales productivity in particular trends working; how effectively consistently is our sales force ramping and performing as, I think, the kind of overall growth rate of our sales force is going to be the biggest lever from the sales and marketing side that really impacts that growth versus profitability dynamic.
Got it. And there's been a bunch of SaaS companies, especially during this time, in software companies overall, that have realized a lot of savings in this environment, whether that be T&E savings or from stay-at-home. So I'd be curious, do you feel that, that's been an area where you've been able to realize savings or have efficiency gains as well? And when you look at some of those savings that you have, do you feel looking forward that some of those might be stickier, whether that be in terms of, I know you said -- you talked about leveraging digital channels more for your sales force. So are there any of those when you look ahead, that might -- those savings might be here to stay to some extent?
Yes. So like some of those other companies you mentioned, we have benefited from a bottom line point of view, from some of the dynamics of this environment. And maybe the frame -- if you look at the expectations that we set for operating margin entering the year, we had laid out and guided to 9% to 10% operating margin as some of the initiatives have played out and as we've kind of realized the impact of COVID, raised that by 3 percentage points, the 12% to 13%, as you mentioned. And a little less than half of that is coming from the categories that are, what we would call COVID related: T&E facilities, expenses, marketing programs, things like that. So I would say that nontrivial, but certainly the minority of the improvements that we're driving this year. And to your point, while some of that we do think is going to bounce back as the kind of economy and macro stabilize, I think what this has also shown us is we've been able to kind of deliver growth and achieve a lot of the same goals in a fully virtual environment. So especially in areas like some of the marketing programs that we used to do, call it, field events, the T&E. We don't expect those to fully rebound to the pre-COVID level. So to your point, when you describe it as stickier improvements, we definitely do expect some of that to be the case. And for those overall spending levels and profitability levels associated with that, to be pretty durable even as the economy recovers.
Got it. And then maybe shifting gears. So in 2Q, it sounds like you delivered a new version of Box with several product enhancements and a simplified UI. Can you discuss the changes that were made to the platform, the new features added and how that's expected to drive adoption?
Yes. So, so far this year, we've been really, really proud of the level of kind of product innovation and development that we've made, both in the overall experience with our All-New Box as well as really going deeper and building out some of the areas -- new products that we introduced last year, Box Relay and Box Shield in particular. So in Q2, our last quarter, we launched the All-New Box which will become our core user experience that we're going to build on for years to come. As part of that, introducing Box collections to more easily navigate your filed annotations to comment on and more seamlessly work within Box, performance enhancements and things like that. So just overall, an updated and much more simplified design and faster performance that we've been really pleased with and have gotten very, very positive feedback on from our customers. It's also allowed -- has tied pretty nicely in terms of the overall productivity improvements in some of the kind of increasing areas that customers are using us for like on the workflow front, just using annotations as one example. That feature has been used pretty heavily to increase productivity on everything from marketing campaigns to legal contract reviews. And I think a lot of those process-related enhancements are particularly impactful and important in a remote work type of environment. That's on kind of the core Box experience you asked about. And then we also continue to build out our capabilities around Box Relay on the workflow front and Box Shield.
Got it. And just as a reminder, everyone, we're going to get to questions in a few minutes here. [Operator Instructions] So the next question, talking about some of those add-on features that you mentioned, like Box Shield, I know there's Zones and Governance, can you talk about which you're seeing is having like the most success today? Or when you look ahead, which you think has the biggest opportunity? And what are you seeing recently in terms of ARPU trends? And do you expect any of these add-ons to be needle-moving in the near future?
Yes. I would say that the kind of add-on that we'd point to in terms of what we've been most pleased with the recent trajectory and momentum in the market is definitely Box Shield. I think that's because of, number one, as mentioned some of the challenges and new dynamics related to this environment. But also because the type of feature that you can get value from effectively on day 1 when you light this up without requiring any type of end-user kind of behavioral changes. So similar to Governance in that regard, where -- especially when customers have a lot of different priorities and are working through a bunch of different things, I think it's been helpful to be able to have a high-value new module to add on that doesn't require heavy implementation or anything like that. And so that will allow customers to solve everything from auto-classifying content, solving data loss prevention in a native way and things like that. And so that's increasingly been a catalyst, not just as a significant driver of the add-on product traction, but the most compelling reason for a customer who might already be thinking about box in this -- in a more holistic way to now go and adopt the suite. So that's the one that we definitely highlight in terms of what is the most penetration today because of historical performance in the market is Box Governance, somewhat for similar dynamics, and that's also just been around a lot longer, about 5 years now. And then going forward, we do think there's a huge opportunity for Box Shield as well as with Box Relay in terms of what can drive the add-on product growth in the future, especially as part of that broader suite. And so as it relates to the overall ARPU trends, those have continued to be very strong with that increasing on a year-on-year basis even as we continue to go out market which comes with volume discounts. And just to get a sense of the type of magnitude, when we tend to sell any of those seat-based add-ons like Shield, Governance, Relay, we tend to see a 20% to 30% uplift beyond what a customer would be paying for core Box. And then as part of the suite, when you're implementing the full end-to-end suite versus what you'd be paying for core box, we tend to see a rough doubling in ARPU.
Awesome. Thanks for that additional color. That's really helpful. Now maybe we'll turn over to some of the questions from the audience. So the first question is related to your guide's M&A strategy. So one of the participants asked if there was any chance Box would consider creating value through an acquisition.
Yes. I mean it's certainly something that we would consider. And typically -- historically, our strategy has been more focused on where do we -- where can we build in and bundle in technology and talent to really accelerate existing product categories. I would say that we probably -- you wouldn't expect us to see -- expect to see us kind of consolidating the market and buying competitors. But certainly, especially in the ways that we can accelerate and then add more value around the things we're doing around security, workflow, areas like that, that's that -- where you could think about certainly the near- to medium-term focus being around from an M&A point of view. I think over time, there are some pretty interesting, call it, adjacent product categories that we're not yet in that do tie pretty closely to content. But if you kind of -- historically and at the moment because of just how rapidly we've expanded those capabilities, and with those new product introductions, particularly over the last year, our biggest focus is going to be around building out those road maps, especially in those areas like workflow and security, but then over time, certainly something that we're paying a lot of attention to and monitoring the market pretty closely.
Got it. Are there any other areas that you didn't mention maybe outside of security and workflow that you think are other adjacent markets or functionality that could create interesting opportunities as you look ahead? Or maybe even areas of improvement in your current platform?
Yes. I think about it as more a lot of the capabilities that are related to some of those workflow and security pieces, I think, related to, but a little bit different from security. Certainly, especially given some of the feedback we've gotten from our large customers, chief information security officers, chief risk officers, in particular, around the benefits of Box Shield and being able to just get a lot more visibility, setting up permissions, things like that. We are having similar conversations in terms of just questions around how we can do something similar in the areas of compliance. Just as once you have more and more content on Box, and that's kind of the kind of system of engagement increasingly system of record, being able to manage all of that once with permissions and understand the implications, not just from a security point of view, for threat prevention and things like that, but just ensuring that companies are staying and that our customers are staying compliant. That's definitely one. So I'd say in the area of compliance and managing that at scale as well is a category. And then one that -- I think workflow is pretty broad. But definitely some of those interesting adjacencies that we see are those that sort of build on or relate to workflow that are content centric. So just to give one example, and not necessarily one that we'd move into but just to get a sense of what we're talking about is something like e-signatures, right? Where it's certainly related to workflow, related to the content. And right now, because there are great partners that we have that are laser-focused on solving that problem, we haven't thought as -- [ have them out ] that makes sense for us to enter those markets as we have a more kind of horizontal approach to workflow. But I think over time, particularly in some of the industries where we see the biggest opportunity and where is the most penetration, could make sense to build out more specific functionality in some of those areas to really enhance our workflow capabilities over time.
Got it. That makes a ton of sense. And then maybe just as a last final question, given that we only have a few more minutes here. Very open-ended question, but just curious if there are some areas of the story that you feel are underappreciated, or anything that you would call out to the investors listening in on the line.
Yes. I don't know if there's necessarily any big areas of confusion. I do think that depending on how close one might be to our kind of offering and the overall landscape, do think there's still, in some cases, the perception of kind of expected pricing pressure or lack of perceived differentiation, especially with Microsoft. I think when you really dig in and see the products, that tends to be less of an issue. And I think the overall trends that we've seen from a win rate point of view, from a pricing point of view and overall gross margin improvement related to that, I think pretty clearly speak to that not showing up in the business. But I do think that there is, in some cases, a lack of fully understanding just how differentiated and important the differentiators are increasingly as customers are thinking through the future of their content strategy.
Got it. Well thank you so much, Dylan. We'll stop there. Really appreciate you joining us for Deutsche Bank's tech conference. Thanks so much for your time.
Yes, really appreciate it.
Okay. Thank you, everyone, for listening in.
Bye.
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