Box Inc (BOX) 2016 Q2 法說會逐字稿

Good day and welcome to the Box, Inc. second-quarter FY16 earnings conference call. This call is being recorded today, Wednesday, September 9, 2015.

(Operator Instructions)

It's now my pleasure to turn the call over to Alice Lopatto, Senior Manager of Investor Relations. You may begin.

Good afternoon, everyone, and welcome to Box's second-quarter FY16 earnings conference call. On the call today we have Aaron Levie, our CEO, Dan Levin, our COO and Dylan Smith, our CFO. Following our prepared remarks we will take questions.

Our press release was issued after close of market and is posted on our website where this call is being simultaneously webcast. The webcast replay of this call will be available for the next 90 days on our Company website under the Investor Relations link www.box.com/investors. During portions of today's call, we will be referring to presentation materials posted on our Investor Relations website. We'll also post the highlights of today's call on Twitter at the handle @BoxIncIR.

On this call, we will be making forward-looking statements, including our Q3 and FY16 financial guidance and our expectations regarding our financial results, market adoption of our solutions, our market size, our operating leverage, our path to and our expectations regarding achieving positive cash flow and profitability, our planned investments, our growth strategies, and expected benefits from our new products and partnerships. These statements reflect our best judgment based on factors currently known to us and actual events or results may differ materially.

Please refer to the press release and the risk factors in documents we file with the Securities and Exchange Commission, including our most recent quarterly report on Form 10-Q for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements. These forward-looking statements are being made as of today, September 9th, 2015 and we may disclaim any obligation to update or revise these statements. If this call is reviewed after today, the information presented during this call may not contain current or accurate information.

In addition, during today's call we will discuss non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not a substitute for, or in isolation from, our GAAP results. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results in our earnings press release and in the related PowerPoint presentation, which can be found on the Investor Relations page of our website.

With that, let me hand it over to Aaron.

Thank you, Alice. Good afternoon, everyone.

Q2 was a breakout quarter for Box across multiple dimensions. We feel more confident than ever that we're well positioned to capture the large and growing market for enterprise content management and collaboration. Box is growing quickly and we continue to invest in our products and distribution while making steady progress towards achieving positive free cash flow.

This quarter we added and expanded thousands of customers and continued to maintain our best-in-class low churn and high expansion metrics. We saw some important partnership and market developments, like our new global IBM partnership, Box's deepening relationship with Microsoft and integration with Office 365, and EMC's divestiture of its competing division, Syncplicity.

Also, we introduced new industry-leading functionality in our core enterprise content management product and continue to drive momentum with the Box platform and Box for Industries. These achievements illustrate our continued execution on our strategy and I will go into all of them in more detail in a few moments.

First, let me summarize our financial results. Revenue and billings in Q2 were $73.5 million and $79.6 million, representing year-over-year growth of 43% and 45%, respectively. We're now approaching an annualized revenue run rate of $300 million and compared with the broader SaaS landscape, we continue to show a rare combination of strong growth at significant scale. In Q2, our cash from operations was negative $21.7 million, compared to negative $26.3 million a year ago. As previously stated, we remain committed to achieving positive free cash flow in the quarter ending January 31st, 2017.

Dylan will go into more detail on our financial performance this quarter, but before I hand it, off I'd like to highlight three areas of substantial progress in Q2, customer momentum, partnership and market developments and continued innovation. First, let's start with customer momentum. This quarter, we're excited to announce that we now have more than 50,000 paying customers, including more than 52% of the Fortune 500 and 28% of the Global 2000. We closed 33 deals over $100,000 compared to 21 a year ago and we closed 4 deals over $500,000 compared to 3 a year ago.

We did deals with thousands of new and existing customers including Airbnb, Johnson & Johnson, Alcoa, Lionsgate, Limited Brands, Cushman & Wakefield, Monsanto, Uber and others. I'm also thrilled to announce that IBM is now a Box customer. IBM's IT leadership is world class and we're excited to be working with them. When fully rolled out, this will be one of our largest deployments to date.

Also, in the quarter our net retention rate was 121%, reflecting the continued strong seat expansion within existing accounts. For example, one of our customers, a global construction machinery company, now has more than 32,000 Box seats deployed, having started with just 10,000 seats in June of 2013. As a part of their enterprise license agreement, they will eventually deploy 50,000 seats. This is a common growth pattern and it demonstrates the increasing value of Box as we become more integrated into our customers' business processes.

Now I'm going to talk about a few major partnership and market developments. In Q2, we announced a major partnership with IBM. This is the most significant partnership in Box's history and one of the most significant enterprise cloud partnerships the industry has ever seen. IBM's global network of sales professionals will sell Box to their customer base, leveraging their deep CIO-level relationships and help with the implementation, training and consulting through IBM global services. As a result of this partnership, we are already in discussions with dozens of large global enterprises to become Box customers across a wide variety of industries.

At a product level, we are integrating Box and IBM's content management capabilities to give our shared customers a seamless experience across cloud and on-premises solutions. IBM and Box will jointly bring next-generation enterprise content management capabilities like content capture, e-discovery, work flow and case management to market. IBM will also integrate Box into select IBM MobileFirst for iOS applications, and we plan to jointly create new apps for customers in industries like healthcare and retail.

Finally, this partnership enables our customers to leverage the IBM cloud, which will eventually allow us to offer customers the ability to meet international, data localization and data residency requirements. We couldn't be prouder of our partnership with IBM and we're looking forward to working with them for years to come.

Also in the quarter, we continued to solidify our relationship with Microsoft. Building on previous integrations, we make it seamless for our customers to work with both Box and Office 365 now. The over 1 billion Office documents currently stored and shared and Box can now easily be opened and edited with Office online and this functionality will soon be available through Office on mobile and desktop experiences. This is significant, as enterprises like GE, Toyota, Eli Lilly and thousands of others can now take the best of Office 365 productivity capabilities and combine them with Box's leading secure content management. We see this as the beginning of a very exciting partnership with Microsoft, so stay tuned for more details on our work together in the coming months.

Another significant market development during Q2 was EMC announcing the divestiture of its Syncplicity business. With one of the leading incumbents in content management and storage infrastructure exiting this market, our competitive position continues to get stronger every quarter. In fact, this summer Box was named not only as the leader in Gartner's Magic Quadrant for Enterprise File Sync and Share, but also, and perhaps more importantly, we received the highest score for strategy and vision in Forrester's ECM Business Content Services Wave.

The third and final area I want to focus on today is our continued innovation. We are laser focused on extending Box's lead in enterprise content management and collaboration. In Q2, we introduced new enterprise functionality and continued to drive momentum with the Box platform and Box for Industries. In terms of new enterprise capabilities, we continued to roll out Enterprise Key Management, or EKM, to customers and officially launched our new Box Governance package. These are best-in-class offerings that not only help us win new business, but also make Box for valuable and mission critical to our current customers.

By solving incredibly complex IT problems, such as data control, retention management, and regulatory compliance, we enable our customers to fully realize the benefits of moving to the cloud with Box. And while it's still early, we've already seen pricing uplift of 20% to 30% in customer deployments that feature these new enterprise capabilities compared to our base offerings. This demonstrates that as we add deeper enterprise functionality, our customers are willing to invest even more in Box.

Second, to advance our platform forward, we're incredibly excited that we hired Jeetu Patel to lead the next phase of growth for our platform business. Previously, Jeetu was CEO and GM of EMC's Syncplicity business unit, where he was a fierce competitor of Box for several years. He was also formerly Chief Strategy Officer of EMC's Documentum, one of the leading incumbent providers of content management. He deeply understands this market opportunity and he's a great fit to lead our platform business going forward.

The Box platform team has delivered strong progress on Box Developer Edition, which we launched in a limited beta at a Box dev conference in April. Since then, we have seen many enterprise customers and third-party developers begin to rapidly build applications that extend Box functionality into their new use cases. We're incredibly excited to share more about Box Developer Edition at BoxWorks, our annual customer conference taking place later this month.

Third, turning to Box for Industries, in August we hired Adam Ross, a senior executive from NASDAQ, as Managing Director of Box for Financial Services and we announced the opening of our first Box office in New York to support the growth of financial services and other key markets. As a part of Box for Industries, we are continuing to build deep expertise, product enhancements, partnerships and go-to-market efforts in verticals like retail, media, fin serve, healthcare and government.

We'll talk more about future innovations and investments like these at BoxWorks, which will be our biggest conference yet, with more than 5,000 attendees expected. We have an incredible lineup of speakers, including Apple's Tim Cook, Cisco's John Chambers, Pixar's co-founder, Ed Catmull, and GE's CIO Jamie Miller. We'll be hosting thousands of CIOs and IT leaders and we'll make several announcements about our product and platform road map, partnerships and customer successes. We hope to see you there.

In summary, Q2 was a breakout quarter for Box. We continued our rapid growth at scale, invested in our products and distribution and we continued on our path to cash flow profitability. We are very excited about several developments this quarter, particularly our new partnership with IBM, deepening our enterprise functionality to extend our strong technology lead and building out our platform to further transform how customers use Box. Every year tens of billions of dollars are spent on enterprise content management, collaboration, content security, and storage technology. We have never been better positioned to go win in this market and we are incredibly excited about the opportunity ahead.

Now I'll hand it over to Dylan to discuss the financials. Dylan?

Thanks, Aaron. Good afternoon, everyone, and thank you for joining us today.

As Aaron highlighted, we had another strong quarter in which we exceeded expectations on key metrics of growth and profitability. We believe more than ever in our huge market opportunity and we have been investing to capitalize on our leadership position. In Q2, we added our 50,000th paying customer and we approached a run rate of $300 million in annualized revenue. As we continue to scale, we are seeing increasing efficiencies and we remain committed to achieving positive free cash flow in the quarter ending January 2017.

Now on to our results for the second quarter, which ended on July 31st. We delivered revenue of $73.5 million, representing year-over-year growth of 43%, well ahead of expectations. Billings were $79.6 million, up 45% from the prior year. Cash flow from operations was negative $21.7 million, or 30% of revenue. This compares to negative $26.3 million in the prior year, or 51% of revenue. This result illustrates the success of our financial model as we continue our march toward positive free cash flow. Non-GAAP operating margin was negative 45%, compared to negative 57% a year ago.

Finally, our retention rate was 121%, comprised of churn and net expansion. Our churn rate remains best in class for software companies at only 4% annualized and was a full percentage point better than the same quarter last year, demonstrating our customers' loyalty, as they are choosing to stay with Box for the long-term. Our net expansion rate was 25%, primarily reflecting strong seat growth in existing customers. As we continue to see customer contract value increase and our recurring revenue base grow, this will inherently put pressure on our net expansion rate. That being said, we expect to see net expansion remain above 20% for the foreseeable future.

Let me now provide a deeper look into our financial results, beginning with revenue. As I mentioned, we generated revenue of $73.5 million in Q2, up 43% year over year. We closed 33 deals over $100,000 in annual account value versus 21 a year ago. Of these, we closed four deals over $500,000, versus three a year ago.

Let me now turn to billings. Second-quarter billings were $79.6 million, representing 45% year-over-year growth. As a reminder, customer payment durations can range from monthly to multi-year, which effects our billings results and can create fluctuations in our quarter-to-quarter billings growth rates. Over time, we expect this impact to moderate and indeed, this quarter our normalized billings were also 45% as payment durations were similar to the year-ago period.

Given the timing, the IBM deal had a minimal impact on our revenue and billings in Q2. We are thrilled to have IBM as another of our large Fortune 100 customers, as well as a major strategic partner going forward. Turning to deferred revenue, we ended the second quarter with $130.3 million, up 41% year over year.

Now let's take a look at gross margin. As you'll remember from our last earnings call, we noted that we expected gross margin to decrease slightly over the course of this year. Non-GAAP gross margin came in at 75.3%, compared to 76.8% in the prior quarter. We are investing in our data center infrastructure and Box consulting ahead of our customers' needs. We are also incurring excess real estate expenses as we prepare to move into our new Redwood City facility, temporarily paying rent on two locations.

Once we complete this move in Q4, we will resume our gross margin trajectory upward in our long-term 75% to 80% range. I'd like to highlight that we continue to experience stable prizing pricing in the market as our customers value Box's differentiated offerings. As Aaron noted, with our new products and functionality, we are now often able to charge a premium on top of our basic service.

Next let's move to non-GAAP operating expenses. Sales and marketing expenses were $53.7 million, representing 73% of revenue compared to 91% in the prior year, demonstrating continued leverage in our sales and marketing efforts. Our direct sales force is ramping and becoming increasingly productive across a range of metrics and we continue to see growth in our online distribution and indirect partnership channels.

We also saw a year-over-year decrease in the cost to support our free users at 13% of revenue in the second quarter compared to 17% in the same quarter a year ago, despite significant growth in our user base. This illustrates how falling storage costs and scale continue to benefit Box as we incur lower expenses to serve our users' needs.

Finally, we are benefiting from our land and expand strategy focused on customer acquisition, expansion, and retention. We incur significantly lower sales and marketing expenses to expand and retain existing customers versus acquiring new customers. Over time, as our customer base grows and a relatively higher percentage of our revenue is attributable to renewals, we expect that sales and marketing expenses will continue to decrease as a percentage of revenue. We remain focused on improving sales and marketing efficiency, which will be an important lever to achieve positive free cash flow and continued operating leverage.

Research and development expenses were $20.2 million, 27% of revenue, up slightly from 26% in the prior year. While over time, we anticipate some leverage in research and development, we are committed to maintaining and extending Box's best-in-class product development organization and offerings. Finally, our general and administrative costs were $14.2 million, or 19% of revenue, compared to 22% in the prior year. We continue to drive efficiency and scale while also benefiting from lower legal expenses than the prior year.

Let me now move on to our cash balances and cash flow. We ended the second quarter with $242 million in cash, equivalents and short-term marketable securities. I have discussed our cash flow from operations and would like to provide additional detail on our capital expenditures for our Redwood City headquarters.

In Q2, total CapEx was $17.9 million. Of this, approximately $10 million was related to our Redwood City office and the remaining $8 million was related to data center investments and other projects. Once we move into our new headquarters and vacate our current space, we anticipate realizing several benefits, including sharply reduced capital expenditures and lowers facilities expenses, which currently impact both gross margin and operating margin.

I would also like to provide some additional detail on our cash flow breakeven targets. We have exceeded operating cash flow and free cash flow expectations for the first half of this year and we are committed to delivering positive free cash flow in the quarter ending January 2017, five quarters from now. We also expect to achieve positive free cash flow for the full year ending January 2018. We look to accomplish these milestones through the combination of continued billings growth, driving scale and leverage in our operating expenses, and increasing capital efficiencies and our data center investments.

Now let's turn to our guidance for the third quarter and updated guidance for the full year of FY16. For the third quarter of FY16, we expect revenue to be in the range of $76 million to $77 million, representing year-over-year growth of 33% to 35%. Next, we expect our non-GAAP operating margin to be in a range of negative 49% to negative 50%. As a reminder, our BoxWorks user conference occurs in Q3 and will represent an expense of approximately $5 million for the quarter. The weighted average share count used to calculate GAAP and non-GAAP net loss per share is expected to be approximately 122 million shares.

For the full year of FY16, we are raising our full-year revenue guidance by $8 million at the midpoint to $295 million to $297 million, representing year-over-year growth of 36% to 37%. We are also updating non-GAAP operating margin guidance and now expect it to improve at the midpoint by 200 basis points to a range of negative 47% to negative 49%.

And finally, our weighted average share count used to calculate GAAP and non-GAAP net loss per share is expected to be approximately 122 million shares. With respect to our Redwood City facility, we remain on track to execute the plan we laid out at the beginning of the year and we expect to incur the remaining $25 million of net cash spend for tenant improvements over the next two quarters. We expect CapEx related to data center investments to be in the 10% to 12% range of revenue across the second half of the year.

To recap, we are very pleased with the momentum we saw this quarter with organizations such as IBM, Airbnb, Cushman and Wakefield, Johnson & Johnson, Uber and over 50,000 other businesses leveraging Box for secure content management and collaboration. We continue to build out our partner ecosystem, including a major new partnership with IBM that will help us reach more enterprise customers.

We also launched Box Governance as an add-on feature to empower highly regulated industries in the cloud and we saw early progress with Enterprise Key Managements. And finally, we continue to be laser focused on disciplined spending, operational excellence and delivering operating leverage on our path to positive free cash flow in the quarter ending January 2017.

Before I close, I'd like to let everyone know that we will be hosting an Analyst Day luncheon on September 30th in conjunction with our annual user conference, BoxWorks. BoxWorks will take place in San Francisco from September 28th to the 30th. We would like to welcome the financial analyst community to attend and learn more about our platform offerings, the progress we've made on our Box for Industries initiative, how we differentiate versus the competition, and our plans for continued growth. If you would like to attend or would like to learn more, please reach out to our Investor Relations department at IR@box.com.

With that, I would like to open it up for questions. Operator?

(Operator Instructions)

We'll take our first question from Phil Winslow with Credit Suisse. Please go ahead.

Thanks, guys. Congrats on a great quarter. Just two questions here, one for Aaron and then a follow-up for Dylan. Aaron, obviously, you mentioned a lot of events that have taken place in the past few months here, but I really wanted to focus in on the IBM relationship. Wondering if you could just double click on that. From your perspective, what does it say when you have a large established legacy enterprise content management player such as IBM partner up with you guys? What was their thought process, what was yours and what do you think it means.

For Dylan, you mentioned obviously sales reps and leverage there on the sales and marketing line longer term. Why don't you give us a sense for what you're seeing as far as the mix of ramped versus ramping reps and just how you kind of think about sort of the matrix between you adding more reps going forward and productivity improving.

I'll go first. Thanks, Phil. So to the IBM question, this has been a little while in the making. IBM's obviously the leader in a lot of the systems that power enterprises, including enterprise content management and a lot of the technology that goes into that like work flow, e-discovery, case management, more than just the sort of basic management of files and sharing files.

So what we found with IBM was that our strengths were actually incredibly complementary. At Box, we're 100% focused on building incredibly great end-user experience to be able to share and collaborate around content in the cloud. IBM being incredibly great at the sort of depth of capabilities around working with content at scale and in enterprise and how you secure and manage it. What we found was instead of IBM kind of entering our space and building out a lot of the end-user functionality that we've created that we can actually partner up, where Box provides the secure file sharing collaboration tool to our joint customers and IBM takes a lot of the DNA and domain expertise they have in, again, all the new -- all the advanced ways you work with content and we're jointly developing new solutions around how to go do that.

That's in the joint product development area, so you'll see us actually bring new products to market, again leveraging IBM's existing technology and some new offerings as well as Box's cloud platform and then IBM, through their both sales force as well as consulting, will be able to actually resell and bring Box to market as kind of a key channel partner. We'll be doing the same with some of these new joint solutions. We think this opens up a huge part of the market that IBM is obviously a leader in and bringing us into those kind of conversations. So we're very, very excited about the partnership. We think it's very meaningful for our category, but also pretty meaningful for the enterprise software industry broadly.

Phil, this is Dylan. On the ramp versus ramping rep question, say approximately two-thirds of our sales force is fully ramped. Over the last couple years, as we've talked about, we've been investing more aggressively and hiring more rapidly in our field sales organization. Given the size of the market opportunity and what we're seeing in the market, we've been pretty focused on growing that sales force. We mentioned in the past we expect to grow that team by 20%-something over the course of this year. That said, as we highlighted, we're also very focused on driving additional productivity improvements across the sales force. And to give just a sense of some of the things we've been most focused on, we've talked a lot about our channel relationships that are maturing, including, most notably, IBM as we've highlighted on this call. We also have a major effort around revamping our website and online sales experience to be able to better serve customers and serve our smaller customers more efficiently, focusing on tools and automation and we've seen a lot of great progress there.

Similarly, really for this year, for the first time, we've been released new products such as Enterprise Key Management, Box Governance and soon the Box Developer Edition and those new products, combined with some of the change we've made in our pricing strategy, are also designed to give our reps more to sell and ultimately drive productivity improvements. So those are just some of the things we've been working on to increase rep productivity.

Thanks, guys.

And we'll take our next question from Melissa Gorham with Morgan Stanley. Please go ahead.

Great. Thanks for taking my question. I just had a follow-up question on the IBM relationship. I understand it is probably going to be a long rollout, but can you maybe help us understand the time line on how we should expect that to ramp, particularly the timing around when the IBM sales force will be able to sell Box?

Yes, so we're -- we've ramped up pretty quickly, I think, all things considered, given the scale of IBM and the scale of the partnership and so we are in market today working with joint customers. Given the sales cycle in general of enterprise software, we certainly think this will accelerate that to some extent, but we're still very early in kind of actually executing on the new transactions and sales. So I would expect this to become a pretty significant additional go-to-market effort for us, certainly going into next year, and in the near term it's all about really kind of laying those conversations right now and getting into more accounts.

Okay. Great. And then a question for Dylan on the net retention rate. That continues to be pretty impressive. I'm just wondering to what extent is that more seat driven, where you're going in, selling additional seats or are you starting to see some of the impacts of selling additional SKUs, like the Enterprise Key Management, where you are seeing that 20% to 30% uplift. Is that starting to impact the retention rate or is that more on the come?

Sure. So historically, as this is the retention rate over the last year, the vast majority of that output and that expansion has been driven by seat expansion. We are now for the first time, really at the very end of Q1 and moving into this most recent quarter, starting to see some impact from these additional products. But as you think about the overall rates, that is almost entirely driven through seat expansion rather than new products that we're selling into our customers.

Okay. Great. Thanks.

And we'll take our next question from Rob Owens with Pacific Crest.

Great. Thanks for taking my question. Wanted to drill down a little bit on your Enterprise Key Management and new Governance solution, just what the take rate looks like, what conversations with customers are. They are clearly differentiating versus what other folks have in the markets. I guess broader sense, what do sales cycles look like? Are they improving at this point? Just any color you can provide, thanks.

Sure. Yes. This is Aaron. There's been a significant amount of interest in both products. Obviously, e-Cam has been out in the market for a couple extra months. We have dozens of deals in the pipeline on the EKM side. The sales cycle is obviously a little bit longer, just because there's a whole evaluation of the encryption technology and the type of customer that's buying it is usually a very large customer in a regulated industry.

That said, it's getting us into very large number of new conversations and news accounts that we would not have been able to sell to otherwise. So it's already been extremely effective in enabling us to go sell to new companies even in cases where they haven't ended up needing EKM, that as an option or optionality in the future has actually become very important for us in our sales cycle. That's actually pretty important to note.

On Governance, it has -- Governance, because there's no kind of additional hardware any other kind of technology required, we believe this will be a little bit more universal than EKM. EKM is way more about large enterprises and regulated industries. Governance is for any type of company that wants to be able to manage the life cycle of their content and Governance as a package is still actually very early in Box, so today it contains legal hold and retention management capabilities, but over the long run, Governance will really be the set of capabilities for any customer that wants to replace things like archive and backup and any other kind of technology that's meant to manage the full life cycle of their content. That will support a lot of regulatory use cases. It supports the ability to retire legacy infrastructure in an enterprise. And we're already seeing a pretty significant amount of interest and pickup because of these set of capabilities. So we're early in selling both of these SKUs, but they're having very meaningful impact in our conversations and the kind of comprehensiveness of our platform which really goes toward differentiating against a lot of the other file sync and share players in the market and even gets us much closer to a lot of the incumbent enterprise content providers.

Great. Thank you.

And our next question will come from Mark Murphy with JPMorgan.

Yes, thank you very much. I will add my congratulations. Aaron, I believe you said over 1 billion Office documents are stored in Box. I guess I just wanted to verify whether I heard that correctly or not. And perhaps, could you help us to size that, maybe what percentage of your total content does that represent? Based upon the announcement with Microsoft, do you expect an increasing trend of Office 365 users leveraging Box based on that?

Yes, so you did hear the statistic correctly. We have 1 billion -- over 1 billion Office documents stored within Box. We don't break out the percentage of Office documents relative to other content types, but as you can imagine, for a lot of knowledge worker type use cases, Office represents a significant share of that type of information. But given all the variety of content we store, it's not sort of the majority.

In terms of our relationship with Microsoft and how that's has changed and where we see the impact being, we have long assumed that enterprises were going to move things like their e-mail, their office productivity, and calendaring to cloud solutions. We've been in a world which is all about powering that heterogeneous cloud oriented model for a long time. Now with our partnership and integration with Office 365, we can now deeply integrate with things like Office in the cloud, Office on mobile and the desktop coming soon. We're already integrated with Outlook on mobile, and so you'll see more Outlook integrations over time. We are incorporating Box into a set of new Azure security solutions. We're building a Windows 10 application.

You'll see us work with Microsoft across a variety of their products and thus you'll see more way more activity and engagement with customers that are going Office 365, using Box in tandem with those products and so we are seeing Box really get sold at the same time that a customer is going with Office 365 as the content management solution and set of capabilities around that product, but we're also being sold after a customers' gone with Office 365 and realizes that there's still a huge amount of requirements around content security, collaboration capabilities, work flow, metadata, a lot of the things that Box is uniquely specialized in that Office 365 doesn't have today. And so that's where we're seeing a significant amount of traction as well.

Okay. Great. Just as a follow-up, I was wondering how would you characterize the adoption trend for some of your value added layers that would seem to add to the stickiness of the product? I'm thinking of work flow, compliance, EKM security, version history, some of the other features. I definitely heard your comment on Governance becoming more universal near term, but I'm wondering at a higher level just how broad-based are those features becoming and maybe which ones you think are resonating best with customers?

I think first of all, our customer base is in a variety of stages of how they're leveraging the platform and the product. I think, as represented by our net retention rate and the fact of our 4% churn on an annual basis, you can really see the level of stickiness that our customers have around our product and when you think about that across the tens of thousands of businesses that we work with, we think that's actually a pretty important metric and point to note. And now with things like Governance, with EKM and with our platform in particular, you're going to start to see customers leverage Box for much more mission critical and in places, in a number of different contexts than they are using Box today. That's what our road map is really all about, so beyond things like version control or sort of advanced file sharing and collaboration tools, really enabling an all new set of use cases, so a hospital being able to use Box to enable access to medical images or medical records in a patient portal. A financial services firm using Box to be able to share and work with their clients and their investors. A retailer being able to distribute content across their entire supply chain. So when you think about, now, some of the more advanced use cases around content and collaboration, this is really where we are driving our platform in the future and where we're starting to see customers really begin to engage with us and that's where I think the big transformational opportunity will come into play and that's something that really none of our other competition is focused on right now.

That's great. One last very quick one for Dylan, if I may. Dylan, I seem to recall, I think at some point you might have given a metric around the percentage of registered users that are paying and I'm just curious if there's any -- if you've seen any change in trend or if there's any update to that disclosure?

Sure. We have continued to see the trend of a greater percentage of our overall user base as paid users. That's currently about 11%, just shy of 11% and up roughly 200 basis points year over year. So as we've increasingly focused on the enterprise, while (inaudible) users are still a very important part of our distribution strategy and how we go to market, we are seeing the trend continue where a greater percentage of our user base is paying.

Okay. Thank you very much for taking my questions. I appreciate it.

Thank you.

Thanks, Mark.

We'll go next to Terry Tillman with Raymond James. Please go ahead.

Hey, Aaron, hey, Dylan, how are you all?

How are you doing?

Pretty good. Aaron, first question, and it is, I'll warn you, it's a multi-part question. On the platform front, you've talked a lot about that. Sounds like you have a lot of optimism around platform opportunities. But maybe just give us an update after you early released that, what kind of responses you're seeing from your customers and prospects, how material you could see that either in this year or for next fiscal year billings and just generally speaking, maybe what the profitability profile would be on platform versus just direct selling?

Sure. I'll cover the first parts of that and let Dylan share a little bit on the financial side. But we're seeing pretty tremendous traction early on. Again, just as a note, we have products usually go through two phases. The first is sort of a beta version where we engage with early adopter customers and work out all the different kind of kinks and then the product becomes generally available thereafter. Our platform, our Box Developer Edition, which is the new platform sort of edition that we announced, that's still just in beta. We're not actually recognizing any revenue from that at this point. I think the impact for this fiscal year will not be meaningful or material, but it's starting to drive some very important conversations and use cases for our customers both next year and then obviously beyond. The interest is tremendous and we're seeing take-up in industries as far ranging as government agencies, financial services institutions, healthcare providers, ISVs and software companies, so really across the board there's a deep amount of interest in leveraging the technology that we've been building out for 10 years in unique ways in their applications to solve very different use cases than what Box has traditionally been able to solve.

That's really the opportunity for us, is to expose our technology to a market far broader than just the employees or knowledge workers within the companies that we sell to. So that's the opportunity around platform. We hired Jeetu, again, Jeetu Patel to help run that just in this quarter, so we're really adding a lot of leadership fire power to this area. We're going to be investing in really building this out as meaningful part of our business in the coming quarters and years.

This is Dylan. As it relates to the profitability profile of the Box Developer Edition, while it is early, based on some of the conversations and the pricing model that we're working on, we would expect the gross margin of that product to be the same, or even slightly better than, our core offering. The reason for that is while we do offer a lot of value to our customers and their customers as Aaron outlined, the use cases and the cost profile of a lot of the types of conversations we're having around the Box Developer Edition have a fairly light weight cost profile. Really, the majority of the use cases are all about file access, sharing and some of those things that don't have a heavy cost component. So we're pretty optimistic around the profitability profile of the platform initiatives.

Maybe only one other thing to note is I think it's also important to recognize that our customers have been using our APIs for quite some time, so building out a platform has not been new to the business. It's just we're charging for it in a very different way today. We already have thousands of customers that use our APIs and build unique applications on top of it and this is really about adding a new business model to that and enabling our customers to do way more transformational work flows on top of our technology, things like digitizing loan transactions, digitizing government work flows, all of these new use cases that Box won't directly go out and solve.

Okay. Thank you on that. Dylan, as it relates to four deals over $500,000, was IBM part of that mix? And were there any outliers in that mix of four deals?

Sure. IBM was one of those four deals and was, as we mentioned, one of the largest deals we've signed in our history. That was with largest of the four. But I wouldn't say there's any outliers or any that had a huge impact on the Q2 billings outcome.

Okay. And just Dylan, just as a wrap-up, is there anything we should think about comparability wise as we move into 3Q or 4Q in terms of anniversarying any extraordinarily large or outlier transactions or was it kind of meat and potatoes type deals last year that we're dealing with on the anniversarying? Thank you.

Sure. As it relates to looking into the back half of the year and some of the comparisons, especially on the billings front, we did have, especially in Q3, a very strong quarter last year. So not necessarily the result of any very large outlier deals, but we closed 48 deals of more than $100,000 in value in Q3 of last year, which was far more than the number of deals we closed in that category in Q1 and Q2 combined. So that is -- for that reason, we had a both calculated billings and adjusted billings growth north of 50% in Q3 of last year. So it's certainly a tough comp, but nothing sort of extraordinary in terms of payment terms or outlier deals, but just a very strong quarter overall that we'd be comparing to in our current Q3.

Got it. Thanks. Nice job.

We'll go next to Joyce Yang with Bank of America Merrill Lynch.

Hi, guys. Thank you for taking my question. I wanted to dig a little deeper into the large number of deals you guys have done over $500,000 and $100,000. Was there any deals bigger than the $500,000 that had EKM by any chance?

I don't believe any of the $500,000 deals involved EKM in this quarter.

Okay. And in terms of the large number of deals greater than $100,000, would you say that they're mostly driven by the new product launches that you guys had introduced in the last six months or would it be more of a general improving environment that you're seeing from the buyers?

Joyce, this is Dan. Thanks for the he question. As Aaron mentioned earlier, we're still pretty early in the deployment of our new products, so the strength that we've seen in larger deals in this quarter is really just the natural progression of our move into larger and larger enterprises over time.

Got it. That's helpful. Dylan, just one question about professional services, if you can give some more color on that.

Sure. Just the overall kind of effort and/or from a financial standpoint?

Yes, from a financial standpoint, as well as overall effort.

Sure. So we found that our customers who work with our Box consulting team are more engaged and so we've been recently ramping this team. Over the last few quarters, Box consulting revenue has come out in the 3% to 4% range of revenue and we expect it will remain in the single digit percentage of revenue range for a while, although trending slowly upward over time especially as we deal with these more -- with these larger enterprises and build these more strategic relationships, we think that there's -- it is a very important investment area for us and very important way for us to add more value to our customers. But from an overall revenue scale standpoint, we would still expect that to remain less than 10% for some time.

Got it. Thank you. That's helpful. Thanks, guys.

Just to clarify briefly, one of the four deals over $500,000 this quarter did include EKM.

Okay. Great. Thanks. Congratulations.

And we'll go next to Ittai Kidron with Oppenheimer. Please go ahead.

Thanks. Congrats, guys, great quarter. I wanted -- you touched a lot on IBM, but maybe can you talk about how the IBM business skews some of the economics. Is anything in either deal sizes or margin profile from this business different such that it skews some of the parameters that you're giving?

Thanks for the question. This is Dan. As we've discussed in the past, somewhere in the vicinity of 20% to 30% of our revenue comes through indirect channels, reseller partners of one form or another. AT&T is a great example. Our reseller relationship with IBM is on comparable economic terms to those other relationships and we've said in the past that we expect that overall to grow as a percentage of revenue going forward. So IBM as a reseller in our business will lead to us doing larger deals. It will lead to us doing deals with a more global footprint because they have boots on the ground in regions where we don't. But we don't expect it to skew our economics in a sort of unnatural way.

Okay. Very good. And a couple questions for you, Dylan. First on the net retention rate, the 121%, it's been declining for a few quarters and I understand kind of large numbers working their magic here, but as you mentioned before, this was most of the expansion up until now is seat driven. Now that Governance is kicking in and EKM, would you expect this number to stabilize, potentially start moving up or should we think about continued decline here?

And then the second thing, going back to the comparability question that you had before, yes, you had a very strong bookings number in the third quarter but you also had a very strong fourth quarter, if I remember correctly, at least from a $100,000 transaction number, if I remember correctly. So are we looking at two quarters perhaps, maybe not just one, but maybe a couple quarters of tough year-over-year comps to go through?

Sure. So on the first question around the retention rate, as mentioned, so as you noted that rate has been decreasing over the past few quarters and it was 25% in net expansion and what I would highlight is because of the combination of the new products that we're introducing, as well as just the steady state strong seat expansion that we have seen and would expect to see going forward, given the fact we still have a lot of room to grow in even many of our largest customers, we would expect that expansion rate to remain above 20% for some time to come. So we may see that gradually decline a little bit further but really stabilize, to your point, and we do have the opportunity, especially if we see really strong adoption of some of these new products and the Box Developer Edition that we've been laying out, there's some upside on those trends as well.

We wouldn't expect that rate to continue to decrease at the same rate that we've seen the last few quarters and we're still really proud of that retention rate, where it is currently at 121%. On the other component of that churn, as I mentioned, that has been getting steadily better over the past few quarters and that's now at 4% annualized and we've just, because of these new products and a lot of the trends we're seeing in our business, we expect to be able to maintain rates in that range. So that speaks to kind of the retention rate trends.

With respect to the large deal outcomes and in Q4 of last year, we did see a lot of large deal outcomes in Q4 as well, but we expect to see that just in terms of the overall seasonality of our business, especially for large enterprises and we see Q4 as being the seasonally strongest quarter. So while that was a very strong quarter for us in terms of large deal outcomes, I wouldn't call that unusually strong, whereas Q3, we had a much stronger outcome and more of those deals than we might normally expect based on typical seasonality and buying patterns.

Excellent. Very good. Congrats, guys. Good luck.

Thank you.

And it appears we have no further questions at this time. I'll return the program to our presenters for any closing remarks.

Thank you, everyone, for joining us on our call today and we look forward to speaking with you next quarter. Have a good night.

This does conclude today's teleconference. Please disconnect your lines at this time. Have a wonderful day.