Box Inc (BOX) 2016 Q3 法說會逐字稿

Welcome to the Box, Inc. third-quarter FY16 earnings conference call. This call is being recorded today, Wednesday, December 2, 2015.

(Operator Instructions)

It is now my pleasure to turn the floor over to Alice Lopatto of Investor Relations. You may begin.

Good afternoon, everyone, and welcome to Box's third-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 Q4 and FY16 financial guidance and our expectations regarding our financial results, our 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 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 our made as of today December 2, 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 as 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.

Thanks, Alice. Q3 was another record number for Box. Revenue was $78.7 million, an increase of 38% year over year. We added 4,000 paying customers in the quarter and we're proud to now have to be 55% of the Fortune 500 as Box customers, an increase from 52% in Q2.

In Q3 we had major wins and expansions with leading companies such as Amgen, Westfield Corporation, Sally Beauty Holdings, Grey Global Group, Southwest Airlines, Nest Labs, Universal Music Group, and many more. Enterprises today are investing in the new cloud platforms that will power their businesses for decades to come.

Just as they are with CRM and ERP, businesses are moving content management to the cloud where their information can be centrally secured, managed and made available to employees, customers, partners and their extended networks. Box is uniquely positioned to meet this demand.

To capture as much of this opportunity as possible we are executing against three key strategic objectives. First, we are investing in new products and innovation like Box Governance that will differentiate Box as the next-generation enterprise content platform.

Second, with the new Box Platform offering, we are expanding our adjustable market and pursuing a new growth driver. Companies in every industry are investing in building software that connects them with their employees, customers and partners through new digital experiences, and Box Platform will power content and collaboration for these new applications.

Third, we are building a world-class partner ecosystem to expand our product capabilities, drive interoperability with other key business applications, and create new go-to-market channels. These partnerships include Microsoft, Apple, IBM and several other leaders in enterprise IT.

In September we featured significant progress against all three key strategic objectives at BoxWorks, our annual customer conference held in San Francisco. We hosted nearly 5,000 attendees at this year's conference, representing thousands of customers and partners. As demonstrated at BoxWorks, our first strategic objectives is to invest in new products and innovation that not only solve basic file sharing and sync and collaboration, but that also extend into advanced enterprise content management, or ECM use cases.

By adding ECM capabilities, we make it easier for enterprises in every industry to move more content, more use cases and more spend to Box, while allowing them to retire costly legacy technology. For example, at BoxWorks we announced updates to Box Governance, which, in addition to data retention, will also include legal hold capabilities early next year.

Governance is a major differentiator against competitors and drove several key wins over OneDrive for Business in the quarter. Overall, we sold Box Governance to nearly 100 customers since its June launch.

In Q3 a large global pharmaceutical company adopted Box Governance as a part of its renewal with Box, expanding their total account value by $700,000, in part to help them retire legacy storage infrastructure. And a global consumer products company also invested in Box Governance, adding $200,000 to their total account value as part of expanding its Box deployment enterprise-wide. Box Governance was instrumental in meeting the legal requirements that enabled these customers to move more users, more content and more use cases to Box.

As we continue to deliver innovations like Box Governance, we are increasingly able to go after the nearly $6 billion spent annually on traditional ECM software, as tracked by industry analyst IDC. And this does not even include the tens of billions of dollars in related infrastructure that these systems require and that Box already can replace. We have been investing in the enterprise market for 10 years now and only Box has the talent and technology to seize on this massive opportunity.

Our second strategic objective is Box Platform, which we formally launched to customers at BoxWorks, and which became generally available to both enterprise customers and independent software vendors in October. Box Platform, which we previously called Box Developer Edition while it was in beta over the summer, is a new growth opportunity for Box. As enterprises in every industry create applications to interact with their own employees, partners and customers, Box Platform will power the core content management and collaboration within these experiences.

Instead of enterprises spending countless hours or millions of dollars on creating their own storage, encryption, compliance, collaboration and previewing technology, they can instead quickly and easily leverage the technology stack we have been building for the past decade. The licensing model for Box Platform is seat-based and derived from the number of people that use the apps our customers and partners develop. We have the potential now to power applications that will in aggregate reach hundreds of millions of people, greatly expanding our total addressable market.

Even though Box Platform was only generally available starting on October 15, we are thrilled to announce that we already closed our first two major Box Platform deals in Q3. Our first deal, valued in the high six figures annually, was with a large global financial services leader that will leverage Box Platform to securely share investment information with hundreds of thousands of clients.

The second deal was with a major investment bank that will use Box Platform to securely exchange trading data and documents at scale with their community of hedge funds. We are just scratching the surface of the Box Platform opportunity but these deals represent a strong start.

Our third key strategic objective is to build a dominant partner ecosystem to both add key product capabilities and drive go-to-market leverage as we grow. We have made major inroads on this front over the past year. And we have deepened our relationships with industry leaders like Apple, IBM and Microsoft, all three of which were prominently featured at BoxWorks.

Mobile is a massive opportunity in the enterprise. And as Tim Cook shared at BoxWorks, we are collaborating with Apple to drive new innovation on iOS devices. For example, we released Box Capture, an iOS exclusive app focused on helping companies more easily integrate field and mobile workers in the key business processes. Capture will help accelerate innovation in a variety of industries, and it's a great step in our collaboration with Apple to transform how people work.

We also saw fantastic momentum with our landmark IBM partnership in this quarter. IBM is deeply connected to our strategy to expand into traditional enterprise content management. At BoxWorks we announced the availability of the first joint IBM and Box solutions.

Additionally, at IBM Insight in October, we debuted one of the first joint Box-IBM customers, Sally Beauty Holdings. As a result of this partnership, Sally Beauty will roll out Box in combination with IBM solutions to more than 6,000 employees worldwide. While it is still early in our partnership with IBM we already have well over 100 joint deal prospects in the pipeline, with more being added every week.

We have also continued to build on our growing Microsoft relationship. First, we showcased our integration with Office 365 at BoxWorks. Then in November we debuted our new universal Box app for Windows 10 which was jointly developed with Microsoft support. And, finally, we were also selected by Microsoft as one of the first partners, along with Adobe and SAP, to integrate with Microsoft's Intune mobile security solution. You can expect even more new capabilities and deeper integrations between our products and platforms, including Office 365, in the months ahead.

To summarize, we are focused on three strategic objectives -- investing in new products and innovation, growing the Box Platform, and building a dominant partner ecosystem. By focusing on these key three objectives we are extending our competitive lead in the market and reinforcing our position as the next-generation enterprise content platform.

Before I hand it over to Dylan to provide more details on our financial performance, I want to take a brief moment to reiterate our commitment to achieving positive free cash flow at the end of our next fiscal year in the quarter ending January 31, 2017. We continue to experience great success across our business, and we intend to continue investing to capitalize on what we see as one of the largest market opportunities in all of enterprise IT today.

We are now benefiting from the increasing scale, customer expansion, diverse go-to-market channels, and in early calendar 2016 the completion of capital investment projects that will position us to more efficiently scale for years to come. As a result, while we anticipate continued strong growth, we also anticipate continued improvement in our cash from operations and a reduction in capital expenditures over the course of the next several quarters.

As we head into Q4 we couldn't be more excited to deliver a strong finish to our first year as a public company. Dylan?

Thanks, Aaron. Good afternoon, everyone, and thank you for joining us today. For the fourth quarter in a row we exceeded guidance on both growth and profitability. We continue to consistently deliver solid financial results, while innovating aggressively to develop products and services that are solving the productivity and security needs of the world's largest enterprises.

We are seeing benefits from the investments we have been making over the past several years and our customer base continues to grow and mature. This dynamic in our business model allows us to continue demonstrating leverage as we scale and sets us up to achieve positive free cash flow in the quarter ending January, 2017.

Now on to our results for the third quarter which ended on October 31. We delivered record revenue of $78.7 million, representing year-over-year growth of 38%. Billings set another record at $89.4 million, up 37% from Q3 of last year.

Cash flow from operations was negative $17.3 million, or 22% of revenue, improving from a negative $19.6 million, or 34% of revenue in the prior year. Non-GAAP operating margin was negative 48%, a 12 percentage point improvement compared to negative 60% a year ago. Finally, our retention rate was 119%, which includes churn of less than 4% and net expansion of 23%.

Let me now provide a deeper look into our financial results, beginning with revenue. As I mentioned, we generated revenue of $78.7 million in Q3, up 38% year over year. This strong result was driven by our growing enterprise customer base as well as our best-in-class retention rate.

Our churn rate remains best in class for software companies and improved to less than 4% annualized. This result was a full percentage point better than the same quarter last year, demonstrating the value our customers are getting from their Box investment.

Our net expansion rate was 23%, primarily driven by 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. On the other hand, our new products, including Box Platform, Box Governance and Enterprise Key Management, provide an opportunity for this rate to improve. In the third quarter these products were crucial in closing some major customer expansion wins.

Let me now turn to billings. Third-quarter billings were $89.4 million, representing 37% year-over-year growth. This strong performance we delivered this quarter was due to a combination of major customer wins, as well as longer customer payment durations which reflect our success in selling to large enterprises.

As a reminder customer payment durations can range from monthly to multi-year, which affects our billings results and can also create fluctuations in our quarter-to-quarter billings growth rates. Normalizing this quarter's payment durations, our adjusted Q3 billings growth was 35%.

As we reminded everyone on our last earnings call, Q3 of last year was exceptionally strong overall and therefore would be a tough compare. In the third quarter of this year we closed three deals over $500,000 in annual account value versus six a year ago, and 27 deals over $100,000 versus 48 a year ago. I'd note that we were able to close a couple of deals worth more than $1 million versus none a year ago, which contributed to our strong billings results this quarter.

We ended the third quarter with $141.1 million in deferred revenue, up 40% year over year, and consistent with the 41% growth we saw in the second quarter. These healthy deferred revenue balances provide us with strong visibility and predictability in our business model.

Now let's take a look at non-GAAP gross margin. As you'll remember from our last earnings call, we highlighted that we expected gross margin to decrease slightly over the back half of this year due to investments in our data center infrastructure and our Box consulting team in order to prepare for increasing demand. Non-GAAP gross margin came in as expect at 73.4%.

We have also been temporarily incurring real estate expenses on two headquarters locations. Earlier this week we moved into our new headquarters in Redwood City. And by the end of December we will no longer be incurring real estate expenses on our old headquarters.

Next let's move to non-GAAP operating expenses. Sales and marketing expenses during the quarter were $59 million, representing 75% of revenue compared to 91% in the prior year, demonstrating leverage in our sales and marketing efforts. We also saw a year-over-year decrease in the relative cost to support our free user base at 11% of revenue in the third quarter compared to 15% in the same quarter a year ago despite significant user growth.

As Aaron mentioned, we hosted thousands of customers and partners this past quarter at BoxWorks, our largest marketing event of the year. The cost impact of BoxWorks in the third quarter came in as expected at roughly 6% of Q3 revenue. We remain focused on improving sales and marketing efficiency, which is an important driver of leverage in our business model.

As our customer base grows we will naturally benefit from more efficient expansion and renewal sales. We also expect to improve efficiencies through a more tenured and productive sales force, sales of our newer products, and growth in our partner and online distribution channels.

Next, research and development expenses were $19.9 million or 25% of revenue, relatively flat from the prior year. While over time we anticipate some improved leverage in research and development, we are focused and committed to furthering our leadership position with the most innovative offerings and best-in-class product development organization.

Finally, our general and administrative costs were $16.7 million or 21% of revenue compared to 25% in the prior year. We continue to drive efficiency and scale in this area 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 third quarter with $244 million in cash, equivalents, short-term marketable securities, and restricted cash of roughly $29 million. Cash flow from operations in the quarter was negative $17.3 million, or 22% of revenue, compared to negative $19.6 million or 34% of revenue a year ago. As a reminder, our Q2 and Q3 cash flow results are typically lower than Q4 and Q1 due to the seasonality of our cash collections, as Q3 and Q4 are typically our strongest billings quarters.

In Q3 total CapEx was $20 million. Of this, approximately $16 million was related to our Redwood City facility and the remaining $4 million was related primarily to data center investments. 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 $23 million of net cash spend for tenant improvements over the next two quarters, with the bulk of the net cash spend of $18 million in Q4 and the remaining approximately $5 million in Q1.

As we enter FY17 we anticipate realizing sharply reduced facilities-related capital expenditures in addition to lower facilities expenses. We remain committed to achieving positive free cash flow in the fourth quarter of next year ending January 2017. We expect to exit FY17 with cash balances including restricted cash of at least $150 million. Given key headcount investments we have made so far in FY16 we believe we are well-positioned to support our growing business into FY17 with a lower rate of headcount and spending growth going forward.

Now let's turn to our guidance for the third quarter and updated guidance for the full year of FY16. For the fourth quarter of FY16 we expect revenue to be in the range of $81 million to $82 million, representing year-over-year growth of 29% to 31%. Next, we expect our non-GAAP operating margin to be in the range of negative 43% to negative 44%.

The weighted average share count used to calculate GAAP and non-GAAP net loss per share is expected to be approximately 123 million shares. We expect CapEx related to data center investments to be in the 5% to 6% range of revenue in Q4. This is in addition to the $18 million in net cash spend related to our new office that I mentioned earlier.

For the full year of FY16 we are raising our full-year revenue guidance by $3.5 million at the mid point to $299 million to $300 million, representing year-over-year growth of 38% to 39%. We're also updating non-GAAP operating margin guidance and now expect it to improve at the mid point by 200 basis points to approximately negative 46%. And, finally, our weighted average share count used to calculate GAAP and non-GAAP net loss per share is expected to be approximately 121 million shares.

To recap, we had tremendous success this quarter across the board, adding or expanding deployments with leading enterprises, including Amgen, Sally Beauty Holdings, Southwest Airlines, and over 54,000 other customers leveraging Box for secure content management and collaboration. We made significant progress around our partnership with IBM, including the launch of our first set of joint solutions. We are seeing strong momentum from this partnership across both of our global sales teams, and we already have more than 100 joint prospects in our pipeline.

We're seeing proven demand for our new Box Governance, EKM and Platform products, which we expect to drive additional revenue opportunities and further strengthen our competitive differentiation. And, finally, we continue to be laser focused on disciplined spending, operational excellence and delivering operating leverage on our path to achieving positive free cash flow in the quarter ending January 2017.

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

(Operator Instructions)

Mark Murphy, JPMorgan.

Thank you very much. Congratulations on the solid quarter. Aaron, I wanted to ask you, in terms of the replacement of legacy content management systems that Box is disrupting, is there any discernible change in the mix of those systems between, say, SharePoint, Documentum, FileNet, Intralinks, OpenText, whatever else you might be coming across? I'm just curious which of those are feeling the most vulnerable to replacement by Box.

Yes, great question. Maybe just two parts to the answer. Certainly any content management platform that is primarily used as really a document management system in an enterprise we now more and more have the capabilities to fully replace. So, many of the ways that SharePoint is used in an enterprises is just as a document management site, so we are often replacing those environments.

But for situations where SharePoint is powering complex workflows or complex business applications, we are not quite there yet from a functionality standpoint. We are seeing some customers begin to retire legacy content systems from Documentum, OpenText and others, but I don't know that I would point to a single vendor where we see a predominant trend.

And I think from a more macro standpoint the overall trajectory that we are seeing, at least in terms of early customers that are seeing this vision in the power of our platform, is content management is one of the few categories that over the past two decades or so large enterprises have just developed more and more of these content management systems in their enterprise. So, when we go into the average large 10,000, 20,000, 50,000 person company, they might be dealing with 5, 10, 20 different systems where content is being sprawled and where they have a lot of redundancy in terms of their spend where they don't really have a single source of truth with their information.

As we are seeing enterprise IT move toward new modern platforms, whether it's Workday for human capital management, or NetSuite for accounting and finance, or Salesforce for CRM, we're seeing more enterprises recognize that they want to take a similar approach to content management. Instead of having 10 or 20 different systems, how do they begin to centralize on one common platform across their business.

So, that's certainly what we talked more about at BoxWorks. That's what we're starting to see customers do because of Box Governance where they now have the ability to manage the full life cycle of their content. We think for the next couple of years that's really going to be the momentum in our customer base and driving our business forward, is doing both a lot of takeouts of legacy systems and really consolidating more and more content into Box as a single platform for our customers.

Thank you. And, Dylan, I had a quick one for you. Are you able to comment at all on the subscription versus services revenue mix, perhaps just anything at a high level directionally? Which way has it been trending the last quarter or two? Which way do you think that might trend going forward into the next few quarters there?

Sure. Our Box consulting revenue, which makes up the vast majority of that revenue you're talking about from services revenue, has been fairly stable over the past few quarters at 3% to 4% of revenue. And that was the outcome we saw again in Q3. And we expect that to likely remain in the mid single-digit percentage of revenue for some time, but to trend up slowly over time as we increasingly move and serve larger and larger enterprises.

Okay. And the last question I wanted to ask you is, I think we have been expecting the IBM relationship to drive perhaps some material impact next year. I was wondering if there is a possibility of some minor benefit in the January quarter just given that you have described over 100 joint prospects in the pipeline. Is there any chance that we could begin to feel some of that impact in your fiscal Q4 or would there be any change one way or the other in your timing expectations?

This is Dan. We are very excited about the level of engagement we're seeing with the IBM field organization around the world, and with the response on the part of customers and prospects to the idea of the two companies working together to change the future of enterprise content management. We do have over 100 deals in the pipeline. And while we expect the bulk of that benefit to occur in the next fiscal year, there is a reasonable possibility that we will see some impact in our fourth quarter.

Fantastic. Thank you very much for taking my questions.

Melissa Gorham, Morgan Stanley.

Great. Thanks for taking my question. Just to drill down on that question earlier on the IBM relationship. I know the IBM sales force can now sell Box but they'll likely require some education of the IBM sales force.

Can you maybe talk about where you are in terms of getting IBM fully ramped into selling Box? And those 100 potential deals in the pipeline, is that coming from IBM sourcing those deals or is it coming from the Box sales force?

We were incredibly fortunate in the timing of this relationship in that it occurred just prior to IBM's global sales kickoff process for their enterprise content management field organization. So, right at the very beginning of the relationship we had the opportunity to get in front of thousands of IBM sellers around the world in three different venues -- Madrid, Las Vegas, and Macau, I believe, was the third one -- to begin that education process.

And we have continued to engage very aggressively with the IBM field organization from a training and skilling point of view, as well as working with them closely on each of these 100 deals, not only obviously with the goal of closing them but in addition with the goal of educating the IBM field organization across the board about the benefits of selling Box products alongside IBM's analytics, security and enterprise content management products.

We are very pleased with the way that process is going. Those 100 deals were all sourced by IBM's field organization and then placed in our deal registration process and accepted by us, meaning we did not already have a significant level of engagement with that account.

Okay, great. That's helpful. And then just one quick one for Dylan. On gross margins, you noted a few factors that were driving margins lower in the quarter, including investments in infrastructure and consulting.

But can you maybe elaborate on other factors that could the impacting gross margin? In particular, I am interested in hearing if you are getting any leverage from lower storage costs, and then if you are seeing any changes in pricing.

Sure. As mentioned on the call, we have been making investments and building out our data center infrastructure in building out our Box consulting team to support our expected customer growth and what we are seeing, as well as the duplicative rent from the Redwood City facility buildout before we made that move just recently. I would say that they non-GAAP gross margin impact that we expect to be more one time in recovering steady state of Box consulting and facility spend was a combined 1.5% of revenue in Q3, with the remainder of the impact being from the data center infrastructure we have been building out.

There hasn't been significant changes in the recent past over the cost of storage. That is definitely a driver in the market that has benefited the Company over time, as we are not selling storage and that's not how our customers value us. As that pricing has come down that has benefited us and our bottom line.

And what I would also note is we have not seen any changes in price per seat in the market. Over the past many quarters we have continued to see price per seat in that $9 to $10 range per user per month. And with the launch of some of our newer products we also see the opportunity to improve price per seat over time.

Great. Thank you.

Joyce Yang, Bank of America.

Hi. Thanks for taking my question. Congrats on the quarter, guys. I have one question regarding the large deals that you guys saw this quarter. Can you talk about the large deals over $1 million? What's driving that because that's something we haven't seen before?

And also, are they being held by the IBM relationship from BoxWorks? And do they include Governance and Platform as part of the deal?

Great question. We certainly have done many seven-figure deals over the course of the history of the Company but we are seeing more and more of a trend where seven-figure deals are coming in every quarter at this point. That is being caused by both the Governance capabilities because customers can put more and more of their data onto Box. I should note that the $700,000 deal we did in the quarter pushed up that specific customer to greater than seven-figure total account value, just as an example of what Governance can drive from a total spend for existing customers, in this case.

Platform was also a meaningful driver for the growth of, again, total account value increase to seven figures for one customer. And we expect to continue to see that in Q4 and going into next year.

So, it's really just the platform becoming more robust, our customers beginning to put more mission-critical workloads onto Box and thus validating us as a more important part of their architecture and their strategy going forward. So, we will expect this trend to continue quite a bit into the future.

Thank you, Dylan. The only thing I'd add is that within those deal size categories that we break out, the average contract value of the deals in both the $100,000-plus and $500,000-plus deal categories were much larger this quarter than what we saw a year ago. And that is what driving some of the outcome, not just those million-dollar deals.

We also had a very healthy quarter for growth in our commercial business, adding more than 4,000 new customers in the quarter. We expect to see the size of deals within those categories that we break out continue to increase over time. And we will continue to give more color on this dynamic as we increasingly move up market and sell these newer products into our customer base.

Yes. That's helpful. Just to follow up, Aaron, that question you were mentioning, were a lot of these deals also coming from existing customers versus new customers?

I don't know if we break out the percentage but it was definitely a mix across some of the big names. We are continuing to drive upsells because of things like Governance and Platform. One of the seven-figure deals was a net new customer in the quarter but we do see a mix across the board.

Got it. And just one quick follow up on the EKM solution. You guys are already seeing 100 customers adopting EKM. Can you talk about the type of adoption there? How are customers integrating EKM into the Company? Is it deployed enterprise-wide across most of the customers that are adopting it?

It's a good question. The difference between EKM and Governance as it relates to now customer traction is, because Governance is a pure software-based solution you can very easily add it into your account. It doesn't require any change management. You literally turn on the feature and then you have retention management capabilities.

We have seen the friction to selling that be incredibly low, so that has really emerged across our sales team, again nearly 100 deals that have signed on in the quarter that we have been able to sell. And that's, again, driven upsells, as well, in the quarter.

On EKM, because it does require a very sophisticated security approach from the customer side, as well as managing the hardware security module within Amazon, we are seeing that for a far more constrained group of customers, either highly regulated organizations or deeply security conscious companies. But the really interesting thing is we're seeing EKM be an enabler to many deals that we would not have been able to get otherwise. So, the existence of that product and the fact that a customer can in the future elect to turn it on is driving a significant reduction in the barriers of the friction to being able to sell to large enterprises, even when they don't turn on the feature right away.

Yes. Got it. Thank you so much.

Rob Owens, Pacific Crest.

Hi, guys. This is Ben on for Rob. Thanks for taking my question. Dylan, I wanted to start with (inaudible), 35%. You still aren't really getting a big shift in long-term deferred. I was wondering if maybe you could provide a little bit more color what you are saying from a mix as far as contract duration. Is it just a shift from monthly to annual? Any additional color that you could provide there would be great.

Sure. Most of the shift we have been seeing over time, it's actually a little bit of both, on both the contract duration and then the payment durations. We had seen increasingly a shift, although it's having a somewhat modest impact on the overall billings rate, from customers paying monthly and quarterly into paying annually. That's what's driving that small difference, the 2 percentage point difference between our calculated billings rate and our adjusted or normalized billings rate of 37% versus 35%.

At the same time, as we've been moving up market over the past couple of years, we are increasingly signing up our largest customers to multi-year contracts. So, while, by volume the substantial majority of our customers are signing one-year agreements, that has been shifting over time, and the majority of our largest customers are signing on for multiple years.

As we are increasingly being involved in more strategic and broader use cases with customers, we are seeing that trend where we're expecting to be signing on more multi-year deals over time. So, I think you'll see those two dynamics play out in both the deferred revenue balance as well as the backlog, which we'll be breaking out on an annual basis.

Okay. Great. And then, Aaron, I know it's still really early days for the Platform, but just any color you can provide as far as the structure of how these deals are shaping up as far as, are the sales cycles of the developer platform looking like it would be consistent with what you see with your core product ASPs, how those are initially shaping up, as well as just the length of sales?

Yes. It is extremely early, as you mentioned. It was, again, made generally available with only 15 days left in the quarter. So we are only starting to see some of the early examples of what the sales cycle looks like. And that was a customer that was in beta throughout the summer so that wasn't a 15-day deal.

But we generally are expecting it to look similar to our other large deals from a deal length standpoint. We are executing on the strategy and on the go-to-market through our existing sales force, and starting first with many of our most successful customers and getting them to expand what they are doing with Box. In the case of the big deal that we mentioned in the call with a financial services firm, this is with an existing customer, but they ultimately paid for the platform at a level that was multiples higher than what their previous total account value was.

From an ASP standpoint, we see an opportunity where, depending on the use cases the customer has, they could be paying us two, three, four, five times more than they would have paid us on just an internal use case basis. But, again, it's so early in terms of the use cases we're seeing right now. I think we're going to see across the board, particularly driven by the number of customers that our customers are building applications for.

So, if you have a situation where one of our clients has maybe 10,000 employees but 100,000 clients or customers, that would maybe increase the TAV. But if you had a situation of a professional services firm that maybe had the same number or fewer number of clients than they have employees, then that wouldn't necessarily drive a multiple on top of the total account value. So, it will be across the board. But no matter what, we do see dramatically increasing both our strategic relevance for our customer as well as dramatically increasing the total account value.

Great. Thanks, guys.

Ittai Kidron, Oppenheimer.

Thanks. Hi, guys. Congrats on a good quarter. Dylan, I wanted to dig a little bit into the retention rate, the 119%. It's been declining steadily for several quarters. Can you just, first of all, remind us if this is an in-quarter retention rate or an annualized or fourth-quarter moving average kind of retention rate math?

It's based on what the total account value was 12 months ago and then the relative value of those same customers today. So, it is over a 12-month trailing period.

All right. So, it's an in-quarter calculation, meaning the third quarter of 2015, what it's doing in third quarter 2016.

Yes. It's related to that base, is how we calculate it for each quarter. But we disclose that blended average of how that rate's been trending over the past four quarters.

Right. Can you then explain why is it on a continuous steady decline? Is there a bottom to it? And how should we think about the progression of that figure going forward?

Sure. The sequential drop this quarter was due entirely to the net expansion growth rate, which declined about 2 percentage points, or a little over that, to 23%, while our retention rate continues to improve over time. And what we have said in the past is we expect that expansion rate of 23% to remain above 20% for some time. So, we do expect that to stabilize and level off in fairly short order, largely because of the new products that we have introduced in the market that are just now starting to show up in customer deals, as Aaron highlighted in a handful of different examples.

Would it be fair to say that over the next four or five quarters you could actually potentially see that number start moving up again?

It is possible depending on the success rate that we see and the attach rates of some of these newer products, particularly some of those with larger opportunities like Box Platform and Box Governance. Wouldn't necessarily set that expectation but would expect to see the trajectory change and for that to at least stabilize, although there is the potential for that to improve.

Very good. Can you update us please on the percent of paying users out of your registered number?

Sure. We ended the third quarter with 4.8 million paid users out of a registered user base of about 42 million. So, roughly 11% of our total user base is currently paying.

Okay. It's quite a significant sequential increase. That's good to see. But that also implies a very good solid seat expansion within your customer base. Am I calculating that correctly?

It's a combination of the expansion of seats within our base, but that paid number also includes the net new customers that we signed on in Q3 with respect to that paid growth. So, it's a little bit of both. I think it really more demonstrates the strength and the traction we are seeing across both expansion and net new customers, and really the relative focus and increasingly strong focus over time on paying businesses versus free users, if you think about our acquisition efforts.

Very good. And then, lastly, for you, Aaron, on Platform, you've highlighted the two deals, the first two deals that you mentioned, both with the financial industry, if I got this correctly. But if I am not mistaken, those were things that were in the oven for a little bit of time. I would assume those were beta customers for this, as well.

Can you talk about how the pipeline for this looks like? You mentioned how your pipeline looks like for Governance. I think you talked about 100 customers there, and the pipeline for IBM, the 100 prospects.

But about Platform specifically, how the pipeline is building for that. And is this going to be something that we should think about as a much longer sales cycle?

And just to clarify, the Governance was nearly 100 deals closed and the IBM number was 100 in the pipeline. We are not sharing the Platform pipeline because it's in general just literally rolling out right now. But it's strengthening pretty rapidly. We are going on road shows. We are starting to develop the marketing for Platform into our existing customer base. Really strong reception -- the receptivity of the customers is very strong right now. So, we're pretty excited about how that is developing.

Again, the sales cycle, because it is so early, it's going to be hard to stay what that sales cycle looks like, especially because of the diversity of use cases that our customers are going to have. Some are going to build transformational applications that completely digitize their business, and some customers will plug us into maybe an existing app that they've already created. And those two sales cycles will be very different. But, that said, we don't expect it to in aggregate look that different from our overall customer sales cycle.

Very good. Congratulations. Good luck, guys.

Brian Peterson, Raymond James.

Hi, guys. Thanks for taking the question. Just wanted to hit on the Box Platform. And congrats on the wins this quarter.

But I am just curious, on the $700,000 type of opportunity, as you look at the pipeline -- and I appreciate that it's early days -- is that something that you think is a consistent type of win that you guys can get? If you look at the gamut of opportunities could there potentially be seven-figure deals specifically from that product? Or is it just too early to tell?

It's really interesting. If you look at our top three deals, one of them was a net new customer -- not a net new customer but an aggregation of a set of subsidiaries that were already customers rolling into an ELA for a very large global enterprise. One of them was a large transaction driven by Governance where about one-third of the deal was Governance revenue and the rest was seat expansion enabled by the features of Governance, which allowed that organization, which is in a regulated business, to feel comfortable rolling Box out more broadly. And the third was this financial services institution that will be leveraging our platform to digitize their relationship with their customers.

That example of how the Platform is being used is very common. You see large enterprises around the world trying to figure out how to engage with their customers on mobile, how to engage with their customers in a more digital way. In many instances they will have many more customers than they have employees.

As Aaron said, it might be a 5,000- or 10,000-seat opportunity for us to sell our service to their employees; it might be a 50 or 100 or even 1 million seat opportunity for us to sell them the Box Platform to help revolutionize and digitize the experience they have with their end-user customers. So, we expect to see Platform deals of all sizes. We certainly expect to see small platform deals in pretty high volume. But we absolutely believe there is a large opportunity for six- and seven-figure deals for the Box Platform, and we have a number of such transactions in the pipeline today.

Okay, great. That's really good perspective. Last one for me, Dylan, just want to hit on the gross margin. I appreciate some of the color there but just curious what kind of gross margin assumption is embedded in your operating margin forecast. And I'm just trying to see when that decline should stabilize. Would that maybe be in the fourth quarter or the first quarter of next year? Thanks.

We would expect that to stabilize the next couple of quarters and to begin trending upwards in FY17 toward our 75% to 80% long-term range, which is still our current view in terms of the steady state and long-term gross margins of the business. Of those few factors that I mentioned, some of them we're going to see some pretty immediate relief from. For example, in terms of the real estate expenses that we have been paying on two headquarters, the fourth quarter is going to be the end of that dynamic, so that will get better in Q1.

Box Consulting we expect the drag on margins to improve pretty steadily over the next few quarters as we get to that steady-state margin. And then the data center investments, as we're depreciating that year and still in the midst of building out that project, we expect that to have a longer-term impact, but still, as we scale and over time, to scale into those investments and for that to improve within the next year or so, as well.

There's a lot of puts and takes and we'll provide a bit more color into what our expectations are for next year on our Q4 call. But we do expect that to turn around in fairly short order.

Thank you.

Aaron Rakers, Stifel.

Thanks for taking the question. And also congratulations on the quarter. I wanted to go back to the opportunity set that you seem to have in front of you going into next year. One of the comments earlier made was that you are currently seeing a $9 to $10 per seat per month type model. If you are successful in expanding into the platform into the EKM products, what do you think is a reasonable expectation of an uplift of that $9 to $10 range? Is it 20%, 30%? I'm just curious of what kind of goal post you might be looking for as we look out over the next 12 months.

For both products that would be sold that are on top of the core licenses and across the entire enterprise for Enterprise Key Management as well as Box Governance, we've seen, while there is a range of outcomes, in the customers who choose to deploy those products to their employee bases, we are seeing for each of those products an uplift of about 20% to 30% relative to what the core content and collaboration price is. So, independently it would be a 20% to 30% uplift in those cases combined, could think about 40% to 60%.

However, at the same time, as we are selling these products largely to larger enterprises, there is the headwinds of the volume discounts that we give. The overall price receipts may not change materially but in terms of the like-for-like comparisons within certain sized deals, we do see opportunity and have been able to actually increase those prices over time. So that's the dynamic with those two products.

Box Platform is a little bit different as the overall pricing model, while it is seat based, starts at $5 per app user per month, which is a fraction of the seat price for internal users but the opportunity, as Aaron and Dan have mentioned, is much greater in terms of the user population. So, wouldn't think about the price per seat as being a very good apples-to-apples comparison between Box Platform and the way that we sell other seats, but over time, and especially once we have sold more of those deals and have more of those in the pipeline, we will give more visibility into what that pricing is looking like over time, as well.

That was very helpful. And then two real quick follow-ups. First of all, I apologize if I missed it but did you give the percentage of revenue related to expenses for supporting free customers this quarter?

And then, also, I am just curious on the IBM relationship, as you expand that relationship, I think one of the points of leverage looks to be international expansion and the ability to leverage the software investments that IBM has made from a data center. I'm just curious where you stand on that 100 deals in the pipeline. Are you starting to see those actually utilize the SoftLayer data center from IBM or are those still bringing in-house to Box's data centers? And if so, when do you think SoftLayer might be a point of leverage?

This is Dylan. I'll take that first question and then turn it over to Aaron and Dan for the latter. On the free user expense, we did disclose that. In the third quarter we spent 11% of revenue on our free user base, which is down from an improvement on 15% of revenue in the year-ago period.

And we continue to see a lot of benefit out of that free user base, both directly and indirectly, influencing some of our larger deals. And at the same time we are very focused on making sure that we continue to drive efficiency in terms of how we serve those free users, as well as effectiveness in terms of how we monetize the free user base. So, over time you can expect that trend to continue, and in the coming quarters that to move into the single-digit range as a percentage of revenue.

This is Dan. Of the deals in the pipeline sourced by IBM, I would describe a significant percentage of them as being outside of North America, which is obviously delightful for us, especially when they are sourcing deals in regions where we do not have our own physical presence. While we have announced the intention to work with SoftLayer for international data centers, we haven't yet announced any concrete products or plans there, so I wouldn't expect to see any financial benefit deriving from the leverage of our relationship with SoftLayer in the near future.

Thank you, guys.

And there are no further questions at this time. I would like to hand it back over to the presenters for any closing remarks.

Thank you, everyone, for joining us on our call today. We look forward to speaking with you next quarter.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time. And have a wonderful day.