Box Inc (BOX) 2017 Q3 法說會逐字稿

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Box third-quarter FY17 earnings conference call.

(Operator Instructions)

I will now turn the call over to Stephanie Wakefield, Vice President of Investor Relations. You may begin your conference.

Good afternoon, and welcome to Box's third-quarter FY17 earnings conference call. On the call today we have Aaron Levi, our CEO; and Dylan Smith, our CFO. Following our prepared remarks, we will take questions.

Today's call is being webcast and also be available for replay on our investor relations website at www.Box.com/investor. Our webcast will be audio only. However, supplemental slides are now available for download from our 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 FY17 fiscal guidance and our expectations regarding financial results, market adoption of our solutions, our market size, our operating leverage, our expectations regarding achieving positive free cash flow and future profitability. Our planned investments and 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 SEC, including our most recent Form 10-Q quarterly report, for information on risks and uncertainties that may cause actual results to differ materially. These forward-looking statements are being made as of today, November 30, 2016, and we disclaim any obligation to update or revise these statements should they change or cease to be up-to-date.

In addition, during today's call we will discuss non-GAAP financial measures. These non-GAAP financial measure should be considered in addition to, but 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 with found on the investor relations website. Unless otherwise indicated, all reference to financial measures are on a non-GAAP basis. With that, let me hand it over to Aaron.

Thanks, Stephanie, and thanks, everyone, for joining the call. In Q3, we continued our streak of exceeding our guidance for the eighth quarter in a row, with better than expected financial performance across the board. Solid sales execution, strong momentum in new product adoption, and significant contribution from our strategic partners drove our results. We are more confident than ever in our ability to drive rapid growth and further operating leverage.

Q3 marked our first $100 million quarter, with record revenue of $102.8 million, an increase of 31% year over year. We grew our paying customer base to over 69,000 businesses, including new or expanded deployments with Cannon, Hertz, Konica Minolta Japan, Southwest Airlines and the US Department of Treasury.

We also achieved non-GAAP EPS of negative $0.14, well-ahead of our guidance as we drove operational efficiencies across the business. Cash flow from operations improved again to negative $6.8 million versus negative $17.3 million a year ago. These results demonstrate the natural leverage in our business model and progress towards achieving positive free cash flow in this current fiscal quarter.

BoxWorks, our customer conference that we hosted in September, highlighted the growing interest for enterprises to modernize their IT and business processes and Box's key role in driving that transformation. In our most successful event to date, we were thrilled to have executives from Microsoft, IBM, Google and Amazon sharing our stage, demonstrating Box's strategic position as the agnostic platform for managing corporate content.

The need for Box is clear. Today, business content is spread across separate legacy systems, on-premises storage, disparate collaboration and work flow tools, and sync-and-share solutions. Every year enterprises spend tens of billions of dollars on content management technology that are no longer innovating, simplifying their competitive environment. Box is where all work can come together, allowing enterprises to securely manage and collaborate on their information, and increase productivity across their business.

To go after this massive market opportunity, we've been executing against our three strategic objectives -- deliver new products to further differentiate Box, drive platform adoption and expand through strategic partnerships. We made solid progress against all three objectives in Q3.

Let's start with our products. Launched in April, Box Zones enables customers to store their Box data locally in regions outside the US. To date, Box Zones has been announced in several regions across Europe, Asia and North America, with more regions to come.

Additionally, Box is one of only a handful of cloud companies in the world to have received Binding Corporate Rules, or BCR, certification from the EU authorities, which requires detailed review by three separate EU countries. With this certification, our multinational customers know they can deploy to a validated cloud environment in accordance with the highest data protection standards available today. Combined, both BCR certification and Box Zones continues to differentiate Box from competitors and remove potential barriers for the large international customers moving to the cloud.

Box Governance, which allows enterprises to meet retention and compliance requirements in the cloud, continues to show strong momentum as well. We now have more than 500 Governance customers, and 40% of Q3 Governance deals came from new customers. In Q3, we had the largest Governance deal to date, a meaningful $500,000-plus deal with a multinational pharmaceutical company. In October, we also added security classification functionality to Box Governance.

Box customers will now be able to automatically identify sensitive content in Box and enforce security policies based on a predetermined confidentiality level. The value of Box Governance is proven in the 30% average price-per-seat uplift we see when we sell Box Governance deals.

Lastly, at BoxWorks, we announced Box Relay, our first product co-developed with IBM. Box Relay will make it incredibly simple for employees and businesses to build, track and automate their workflows, with all the security and collaboration benefits of Box. We are already seeing strong interest for Relay by organizations looking to automate workflows, such as HR or customer on-boarding processes, and closing deals and contracts, for example. These new products are major differentiators for Box, and allow us to continue to increase the value of accounts and further penetrate new markets and industries.

On our second strategic objective, we continued to make significant progress with Box Platform in Q3. With Box Platform, customers, partners and third-party developers can build custom applications on Box through our APIs and developer services. Coming on the heels of BoxWorks, interest in Box Platform has never been stronger. We grew our developer community now to more than 89,000 developers.

One example is a leading global manufacturer and a new Box customer that selected Box Platform to power an iPad application for thousands of their contractors in the field. The application allows technicians to capture photos, as well as browse product information and specifications, saving significant dollars over a legacy application. Additionally, a leading financial services provider further expanded their commitment by $500,000 a year, and they will be using Box Platform to power client interactions on their website, replacing a legacy vendor.

These are only a few examples proving that Box Platform is becoming a mission-critical investment for our customers. Box Platform and our new products are significant growth drivers for us. This past quarter, roughly half of the deals, over $100,000, included one of these new products.

Finally, our third strategic objective is driving innovation and distribution through our world-class partner ecosystem. At BoxWorks, we announced a strategic partnership with Google to bring together Box's secure content management capabilities with Google's productivity applications. The upcoming integration with Google Docs will allow customers to work seamlessly between Box and Google Docs -- Google Sheets and Slides -- with Box acting as the centralized content management solution. Customers will be able to choose to use Google Docs for its real-time concurrent editing capabilities, while leveraging Box's security, administration and advanced content management functionality.

Another strategic partner, IBM, contributed significantly to our results this quarter, including eight six-figure deals, and enabling their reseller network to go to market with Box. And as we mentioned, we announced Box Relay. Lastly, IBM was a key partner helping us win our first significant international platform deal. In Japan, Aon, one of the largest retailers in Asia, chose Box to improve security and collaboration across the Company.

Lastly, we're excited to collaborate with Facebook on their first-ever enterprise product, Facebook Workplace. In the coming months, we'll be working to build several integrations that will enable seamless productivity and communication around content in Box, helping power the future of work. To be the modern content platform for the enterprise, we have to integrate into every major applications our customers use to get work done. Our partnerships with leaders like IBM, Google, Microsoft and Facebook further solidify our role as the number-one content platform for enterprises.

In summary, Q3 was another strong quarter, based on great execution and our clear differentiation in the market. We remain committed to sustaining a high-growth trajectory while increasing our on operational efficiency, to become free cash flow positive in the current quarter. Today we deliver the world's only truly modern content platform, strengthening our leadership position in a market worth more than $40 billion. Now I'll hand it over to Dylan to review the financial results in more detail. Dylan?

Thanks, Aaron. Good afternoon, everyone, and thank you for joining us today. As Stephanie noted, GAAP to non-GAAP reconciliations are in the presentation that is available on our IR website. The financial measures I will be discussing on thus call are non-GAAP unless otherwise noted.

We achieved another successful quarter of strong top-line growth and significant bottom-line improvement, continuing our track record of financial out-performance. The increasing traction of our newer products validates strong customer demand for an end-to-end solution to power the future of work. We achieved record revenue of $102.8 million in Q3, our first quarter with more than $100 million in revenue. This result was above our guidance and up 31% year over year, driven by strong sales execution, momentum with our newer products, and our best-in-class retention rate.

Third quarter billings came in at $112.4 million, representing 26% calculated billings growth and 30% adjusted billings growth year over year. We continue to expect calculated billings growth to trend below revenue growth in Q4, due to the shift in customer payment duration that we have discussed in previous quarters. Also, given the particularly strong billings quarter a year ago, this Q4 will be a tough compare. As we move into next year and these payment durations are forecasted to normalize, we expect billings growth and revenue growth to track roughly in line for the full year of FY18.

We continue to win large enterprise deals, including 38 deals over $100,000 versus 26 a year ago, and seven deals over $500,000 versus three a year ago. Our newer products are becoming an important growth driver for us. In both large-deal categories, roughly half of these deals included at least one newer product. Additionally, eight of our six-figure deals were attributable to IBM. Deferred revenue was $192.6 million, up a solid 36% year over year, and providing us with strong revenue visibility going forward.

Turning to margins, non-GAAP gross margin improved significantly to 76.1% versus 73.4% a year ago and 74% last quarter. Over the past year, we've made several optimizations to our infrastructure that drove the substantial majority of this improvement, with an additional benefit from a change in the useful life of certain data center assets.

As we mentioned previously, we have also been preparing to move into a new data center in anticipation of customer demand. However, the launch of this new site shifted from Q3 to Q4, resulting in lower-than-expected infrastructure expenses in the quarter. Looking forward to Q4, with the launch of our new data center, we expect gross margin to be more normalized at roughly 74%, an improvement from our prior Q4 expectation of 73%.

In Q3 we had another successful quarter of driving greater operational efficiency while we continued to significantly grow our top line. Sales and marketing expenses during the quarter were $60.1 million, representing 58% of revenue, a notable improvement from 75% in the prior year. As a reminder, our annual customer conference, BoxWorks, takes place in our third quarter, and this year accounted for roughly $6 million of our Q3 spend. Excluding BoxWorks, sales and marketing expenses would have been 52% of revenue. The ongoing cost to support our free user base, which is a sales and marketing expense, continued to decrease to 6% of revenue in the third quarter, an improvement from 11% in the same quarter a year ago.

Next, research and development expenses were $21.9 million or 21% of revenue, better than 25% a year ago. We drove this improvement even as we made significant enhancements to our products, including expanding Box Zones into new regions, 3D images, annotations, classification and more. Our general and administrative costs were $13.5 million or 13% of revenue, an improvement from 21% in the prior-year quarter, as we benefited from process improvements and reduced legal expenses. Over time we expect to continue to drive leverage in G&A from greater operational excellence and scale.

We're extremely pleased that our improvements in operational efficiency drove our Q3 non-GAAP operating margin to a significant 31 percentage point improvement year over year, coming in at negative 17% versus negative 48% a year ago. This focus on leverage drove non-GAAP EPS to negative $0.14, a substantial improvement of $0.17 from a year ago and well-ahead of the high-end of our guidance.

One of the key elements that makes our business model so you powerful is our customer retention. Our best-in-class churn rate continues to be roughly 3% on an annualized basis. As our product becomes an increasingly critical part of our customer's business processes over time, features such as our platform APIs, data retention and workflows should continue to drive overall customer stickiness.

Our net expansion rate was 18%, primarily driven by strong seat growth in existing customers. As we benefit from cross-sells with our newer products, with are seeing this offset the natural pressure on this metric from our maturing customer base. As a result, we ended the quarter with a retention rate of 115%, in line with last quarter. This metric remains best-in-class and demonstrates the compounding effect of our land-and-expand business model.

Let me now move on to our balance sheet and cash flow. We ended the quarter with $195 million in cash, equivalents and restricted cash, of which roughly $27 million was restricted. Our cash flow from operations was a highlight at negative $6.8 million, an improvement of more than $10 million from negative $17.3 million in Q3 of last year. This result brings us even closer to achieving positive free cash flow in the January 2017 quarter.

In Q3, total CapEx was $1.9 million compared to $20 million a year ago, which included roughly $16 million in headquarters costs. As we mentioned earlier, having now completed our headquarters move, we would expect data center-related CapEx to be roughly 3% of revenue for the foreseeable future. Lastly, free cash flow in the third quarter was another highlight at negative $10.9 million. This represents a significant improvement from negative $37.8 million in the third quarter of last year.

With that, let's now turn to our guidance. For the fourth quarter of FY17, we are setting revenue guidance in the range of $108 million to $109 million. We expect our non-GAAP EPS to be in the range of negative $0.13 to negative $0.14, and for our GAAP EPS to be in the range of negative $0.32 to negative $0.33 on approximately 130 million shares.

For the full year of FY17, we are raising our full-year revenue guidance, and expect revenue to be in the range of $397 million to $398 million, which represents 31% growth at the midpoint of this range. We expect our non-GAAP EPS to be in the range of negative $0.59 to negative $0.60, and for our GAAP EPS to be in the range of negative $1.23 to negative $1.24 on approximately 127 million shares.

In summary, our third quarter yielded tremendous success across all financial metrics as we continue to widen our competitive differentiation through product innovation and key partnerships. We are well-positioned to maintain our rapid growth rate and to deliver on our commitment to achieve positive free cash flow in this current quarter. With that, I would like to open it up for questions. Operator?

(Operator Instructions)

Your first question is from Ben McFadden from Pacific Crest Securities.

Hey, guys, thanks for taking my questions. I wanted to start just kind of with the IBM relationship. You had eight six-figure deals, you mentioned, in the quarter. But are you seeing an inflection from that partnership? Do you believe these are from the amount of customers you're receiving from the IBM relationship or the size of deals you're getting from the IBM relationship? I'm just curious as far as any commentary whether that is inflecting or picking up potentially even more so than what you've seen the last quarter or two.

Yes, this is Aaron. What we have seen and kind of what we talked about and gave a little bit of color on last call was, the latter half of last year and the first half of this year was really a building period for the partnership. It was really about aligning our salesforces, making sure the field was well-trained on the partnership. It was strategizing on what we were going to be building from a product standpoint together. And the second half of this year is really where we expected to see the productivity of the partnership really show.

So I think we have see an inflection point in terms of what we are doing together, the kind of customer wins that we're seeing, especially in markets where Box doesn't necessarily have a lot of penetration because we're still maybe growing. So things like international markets, some highly regulated industries, we saw two big wins out of Japan in the past quarter that were really great examples of the partnership working at a large scale within the Japan ecosystem. So I think we can expect to continue to see these kinds of results. And we'll obviously keep updating everyone on the total growth that we're seeing from the partnership. But we've been very happy so far.

Great. And then a question for you, Dylan. Billings, I believe, was up on an absolute basis about $23 million year over year, but sales and marketing was only up $1 million. So help us try to understand kind of what's driving that improvement on the profitability side, and how that might be split between improved productivity on the sales rep side, the benefit that you could be getting from the channel?

Sure. So there's a few things that are contributing to that as the sales and marketing efficiency has been a huge focus for us. First of all, we'll just highlight the natural business model leverage that we're seeing. As we continue to expand our existing customers and as our renewal base grows, that does drive some of the just natural leverage in the model, because those tend to be much more efficient types of sales.

We also are seeing rep productivity improvements. We mentioned that last year, we saw roughly 10% improvement year on year, and we're continuing to make progress this year, especially as our salesforce becomes more tenured and they have more and more of these newer products to sell that are becoming increasingly impactful in the market. And then another kind of big push that has driven some of this improvement is the move to -- more and more of our customers -- to online sales channel. So we're signing up thousands of new customers to that channel every quarter, and that is our most efficient customer-acquisition cost.

So those are a lot of the changes that we've been making on the go-to-market side, and some of the leverage that we're seeing. And then on top of that, we're also seeing, or we've seen a pretty significant reduction in the cost to support our free user base, because of a lot of the optimizations we've been making in the cost to serve. So that drove 5% of the improvement year on year in sales and marketing, going from 11% to 6%.

Awesome. Thanks a lot.

The next question is from Melissa Gorham from Morgan Stanley.

Great, thanks for taking my question. Aaron, I was just wondering if you could maybe give us a little bit more detail on how Box Zones is maybe accelerating your traction in international markets? And I'm just wondering if you are making additional investments from a salesforce perspective to help accelerate that trend, or if you are leveraging some of your partnerships?

Yes, so Zones is incredibly important due to one of the biggest barriers for international companies being able to adopt the cloud being data residency. And while we have seen good traction internationally over the past few years in general, a lot of it hasn't been in regulated industries. Or in some cases, only a limited set of content from some of our customers. So Zones allows us to really come out and unlock more of that growth and that opportunity.

We're only about one quarter into the product being fully available in just a couple of the regions. We just went live in the past few weeks in Australia, as one of our newest regions. We'll be going live soon in Canada, and then we'll continue to expand out in more and more regions over time.

This certainly leads us into some of the investment that we're thinking about next year from an international standpoint, so growing even further throughout Europe from a sales and marketing standpoint. But we expect the performance of those teams to be very strong, because we've been able to remove one of the key privacy and data compliance barriers that we were dealing with previously.

Okay, that's helpful. And then a quick one for Dylan. Dylan, can you maybe provide a little bit more detail on the gross margin impacts this quarter? You talked about a change in the useful life. Can you maybe quantify what that impact was? And then in terms of moving forward beyond the next quarter, is 74% gross margin -- is that sort of where we should consider sort of the run rate?

Sure. So there's a handful of moving parts in gross margin. But overall, we saw about three quarters of the year on year -- of the total improvement that we saw in gross margin coming from underlying efficiency improvements. And then the remaining roughly quarter of that year-on-year improvement was driven by the change in the useful life of those data center assets.

And moving forward, as we grow into the expanded data center footprint that we expect to light up next quarter -- or in the current quarter, Q4, and continue to achieve efficiencies and economies of scale, we would expect our non-GAAP gross margin to stabilize at the 74% level. And for that to hold true through next year, and then trend slightly upward over time toward our long-term target model.

And the next question is from Richard Davis from Canaccord.

Hey, thanks very much. So you guys have added -- you talked about it a little on the call -- a handful of editing and visualization tools to your platform. If we kind of fast-forward two years, what kind of new features would a customer kind of expect to see on the Box Platform?

Yes, and just to clarify, do you mean Box Platform specifically to our developer platform, or Box, the kind of product broadly?

Oh, I'm sorry, yes, the product itself. You have your 3D visualization and those kind of things. Thanks.

Yes. So I think what you probably saw out of BoxWorks is a massive push toward becoming the modern content platform for enterprises. When we look at the state of the landscape today and you think about the legacy enterprise content management systems that are out there, companies like -- or products like Documenten, OpenText and others, even SharePoint. And you look at traditional storage infrastructure and storage architectures, most of these systems are not able to deliver modern user experiences, modern collaborations and workflows, modern mobile content access.

And so we're really building out a platform that can enable customers to fully replace those legacy ECN and storage capabilities that today they're spending billions and billion of dollars either maintaining or buying new -- buying maintenance on. And so the kind of capabilities that you'll continue to see on our platform are things around advancing our Governance solutions, advancing our enterprise content management capabilities, advancing our workflow options.

What you sort of mentioned is around data visualization or analytics, so being able to provide capabilities for our customers to see what's going on with their content, allow them to have instant access to all of the information of how people are sharing and collaborating in getting work done. And ultimately, building out a very modern architecture for how businesses manage their information.

We now have customers that have 600 million objects stored in the platform in a one-customer environment. So we really have been battle-tested to some of the largest enterprises in the most regulated industries in the world, and now we want to go continue to advance that road map, continue to differentiate even further, and really become that modern content platform for every enterprise.

Great, that's helpful. Thank you.

The next question is from Mark Murphy from JPMorgan.

Hey, guys, it's actually Albert on for Mark Murphy. Great job on the quarter. But another one on IBM. I don't know how incremental it was, but I thought I heard you say IBM is opening a reseller network to Box. Is that incremental, and can you talk about the potential there? And I also don't know if you talked about the economics of selling Box Relay since you jointly developed it with IBM? So any color on that would be great.

Yes, it is incremental in the sense it does add a further distribution channel from that partnership. So that's sort of IBM's extended reseller network that now Box can be sold through. In terms of Box Relay, that will be coming out next year, and it will be a product that we can co-sell. So both of our organizations are able to sell that, and we'll be doing some revenue sharing on that product. And we'll share a little bit more of the details when that product is generally available next year.

Got it. And just a quick follow-up on hiring. I know you talked already about some salesforce optimizations with the direct and self service channels, which I guess accounted for some of the moderation this past year in hiring. But are you able to give us any directional thoughts on where you think FY18 looks like? Thanks.

Yes, so we'll give more color certainly as we move into next year and get into the details. We have said in the past is, we would expect to grow our salesforce in the sort of mid- to high-teens compared to 13% last year. You saw we added about 70 employees over the past quarter, and we're seeing a very healthy pipeline, and lots of demand and interest in the market.

That said, we are of also driving a lot of leverage in a lot of the functions across the business. So we would expect to continue not just in sales, but across the rest of the organization, to be able to grow revenue faster than both hiring and overall expenses. So again, we'll give a little bit more color as we move into next year, but that's sort of some of the same trends that you've been seeing, could expect to more or less hold over the next several quarters.

Got it. Thank you very much.

The next question is from Kash Rangan from Bank of America Merrill Lynch.

Hey, guys, thanks for taking the question. Congrats on the superb business results. Two questions. One is, with respect to Google and Facebook, can you talk about the nature of these partnerships? Because I would assume that IBM having tentacles into the enterprise is very aligned with your distribution model and strategy of selling to the enterprise. But Google, Facebook, more on the consumer side. Wondering how that plays with your focus?

And also secondly, are you seeing a pattern at all where -- when I do the rough math of an estimated number of subs divided by number of customers, I get about 100 or so. But are you starting to see any pattern of improvement where the average engagement with a new customer is starting to pull away from what seems to be the computed average, so we can entertain at some point in time in the future that you get a lot deeper enterprise adoption, and not quite the breadth of enterprise adoption? Thank you.

I'll take the first question, Kash. This is Aaron. On the integration and partnership front, I think our partnerships take on a couple of different varieties. Some are for distribution and differentiation, and that's what you've seen with IBM. So very significant go-to-market effort there, with very significant salesforce that we're now tied into, as well as further differentiation due to the development of Box Relay.

On the other side, there are the applications that our customers are using, where they expect a very natural native integration into from Box, and that's where our partnerships with Facebook and Google come into play. So both of those partnerships are on the business-focus side of their offering -- so the Google suite, for instance, which is quite popular in the small and medium business market and moving up market over time. And then with Facebook, it's their new workplace product that is intended to be aimed at enterprises.

So in both of those cases, our core mission is to be the singular repository for how businesses manage, secure and govern all of their documents and all of their content. And we can only accomplish that mission if we're then integrated into all the different apps that enterprises are using. So whether that's Slack or Facebook or Google or DocuSign, we need to make sure that we are embedded into all of those applications. So different business goals with those partnership, but nevertheless, all incredibly important to our overall strategy of building the key platform in the enterprise.

And then on the overall sort of average number of subscribers per deal, in our business that average number of subscribers, as well as the average contract values, isn't a particularly meaningful metric. Just because we sell to companies of all sizes, from three users up to hundreds of thousands of users, and because of the really strong growth that we're seeing in the online sales -- a segment which is biased toward the smaller end of the market. While it's a very efficient growth channel and we're really pleased with the efforts, it does bring the average metrics down in the those categories.

So rather, I'd point to some of the large deal metrics that we break out, where in the past quarter, we grew the number of $500,000-plus deals by -- we more than doubled that from three to seven, and then saw really healthy growth in six-figure deals overall as well, from 26 to 38. So we're absolutely seeing much larger deployments, particularly in the enterprise, and that's really enabled, not just the [Atlantics band] business model, but particularly now that we can open up additional use cases with some of our newer products.

So we are definitely seeing some trends change in the scale of a lot of our larger deployments really pushing the bounds of what we've done in the past. But that won't necessarily show in an average number of subscriber or average deal-value metric.

Got it. So after the last phase -- and this is my final question -- and as you get into the expand phase, what are the implications for operating leverage, particularly from sales and marketing, as you go into the expand mode? That's it for me. Thank you.

Sure. So we did talk about is, for that particular type of sale, when we expand an existing customer, we spend less than $1 in total fully burdened sales and marketing for every new $1 of recurring revenue. So the payback period on that is less than 12 months. And we point to sort of the long-term, or rather the target model, at $1 billion, which is where we'd expect our sales and marketing as a percentage of revenue to be, just under 40% at that stage.

Great, thank you.

The next question is from Brian White from Drexel.

Yes, I'm wondering if you could talk about calendar 2017 in terms of a couple of new products that you're really excited about, that will have a financial impact, and maybe a couple products that you think will have a big strategic impact? You've announced a lot of new products. There's a lot going on here, a lot of excitement. But if you could just narrow it down to a couple that have a financial impact, and a couple maybe a strategic impact? Thanks.

Yes, great. So I think we are continuing to see pretty incredible traction on our Box Governance offering. We've been really impressed with the uptake really through all segments. So we have some customers in life sciences that allow -- that can now use Box as much more of a secure control, controlled environment for governing their content. As well as small businesses where in the past, they never had an information governance solution, and so this is really the first product of its kind that they're using now to create a real system of record for their enterprise. So Box Governance with over 500 deals now is -- we see it having a material impact on the business going into next year.

Box Zones will obviously be very helpful for us with our international customers. That does also contribute to a price-per-seat uplift for international customers. So I think those are probably maybe two that will have a very meaningful impact on revenue next year.

And then in terms of strategic impact, Box Relay will -- allows us to increase the number of use cases that Box can solve for. So being able to use Box to automate workflows around your content, whether that's an HR onboarding process, a sales contract review process, a legal review process. All of these are situations where customers have previously had to take their content out of Box or use a separate system to manage that workflow, and now they're going to be able to do that directly within the Box sort of suite, more broadly. So we think that will have a strategic impact next year, and then a revenue impact thereafter, just because it will be only released next year.

So those are, of the existing product set, I think where you'll see a lot of demand. And then we'll continue to be launching new products going into next year, and we'll be excited to see how those perform in the future.

And just quickly on the Facebook partnership, I just want to be clear. This has not been announced before, we're announcing it tonight for the first time, and when does it begin?

Yes, so actually, we did mention this when Facebook Workplace was released, in the past, I think, 30 days or so. So we did talk about that when Facebook Workplace was initially brought to the public. The integrations will be going live next year, and we'll have more formal information, formal announcements on that going into next year.

Great, thank you.

Yes.

The next question is from Aaron Rakers from Stifel.

Okay, great. This is Joe Quatrochi on for Aaron. Couple questions if I could. The first one, I just want to circle back on the gross margin, particularly on the guide. Can we talk to the puts and takes of the guidance relative to the opening of the new data center, and then the change in the depreciative life of the servers?

Sure. So that is one of the bigger sort of headwinds as it relates to gross margin, is not just moving into, but then building out the data center footprint. There's going to be some infrastructure and investments as we continue to broaden and expand our product portfolio, to make sure that we're supporting all of our customers and giving strong performance internationally through our global edge network. So that will be an investment area for us.

But at the same time, we expect to continue making several optimizations to our infrastructure. So one example is the way that we've been able to reduce the overall cost of storage, and then just the overall improved use of our public cloud footprint, moving more and more services to the public cloud over time. And then a lot of things we're doing that relates to the useful life change. But we are get longer life out of many of our data center assets due to better server utilization. So those are some of the major factors that we see at play, and which is why on balance, we feel very confident in being able to maintain that roughly 74% gross margin clip through next year.

So I guess just following up to that, the sequential loss of leverage, I guess, is all attributed to the new data center being built, or opened?

That's right. So not only beginning to pay a lot of the expenses associated with running that new space, but also beginning to depreciate the servers that will be going live when we put that new facility online.

Okay, great. And then just a quick follow-up. I was wondering if you could talk about some of the leverage that you're seeing from other partners outside of IBM? I know you signed a contract with Fujitsu, I think, earlier this year. Just wondering if any color there?

Yes, so we do have a growing partner ecosystem, partners like AT&T, for instance, have been very productive partners in driving the growth of Box. So a lot of customers that will be using AT&T for their mobility, we'll then be able to attach Box licenses on top of those contracts. We have a partnership with Cognizant that does further development on top of the Box Platform. Fujitsu, as you mentioned, was something that we did announce in Japan, and will be going live next year in a much more productive way.

And Japan -- broadly, we have many partnerships with some of the leading system integrators and networks out there. So our growing channel ecosystem and partner distribution model is something that is becoming more and more important and core to our strategy. And we'll be sharing a bit more about how that's playing out next year as we grow that ecosystem.

Thanks.

The next question is from Greg McDowell from JMP Securities.

Great, thank you very much. Just one question for you, Dylan, and it's going to be somewhat of a multi-part question on your favorite topic -- forward billings. I guess I just want to be really sensitive to how we model Q4, or I'm clear that the billings growth rate is going to be below the revenue growth rate.

But I just want to understand the puts and takes on the scale. Because as you pointed out, it's an incredibly difficult billings comp on an as-reported basis, given that you grew billings 59% in the year-ago quarter in Q4. On an adjusted basis, I think -- or I should say, a normalized basis, it's a 45% comp. But in the Q4 last year, you added an incredible $45 million of deferred revenue.

And I was just wondering, maybe you could remind us what happened last year, besides it just being a good Q4 in terms of sales execution? But if there were some abnormal stuff last year that we should think about as we model our Q4 billings this year? And just maybe any discussion on sort of puts and takes of what's going on this year in terms of strength of the big-deal pipeline and such? Sorry for the long-winded question.

No, I got it. So our pipeline for larger deals is certainly healthy as we move into Q4, and we are seeing strong momentum in the business, particularly with some of our newer products, as we mentioned. But to your point, it is going to be a pretty tough comp for a few reasons. There is just very strong sales execution that we had last Q4, that you highlighted.

But in addition to that, there were a couple of other factors that adds some increased kind of pressure and tough comparison there, the first of which is the high watermark that we had for multi-year prepays. So as we've discussed, we did have far more multi-year prepays last year, and we moved away from that this year. But last year in Q4 was when we saw the highest volume of those. So about 10% of our billings last year in Q4 were prepaid multi-year, and we'd expect that to be pretty small, low single-digit this year, virtually nonexistent, as we've seen throughout the course of the year. So that's a pretty big headwind there, given the shift in multi-year prepays.

And then the other factor is just that, as we mentioned on our last call, we also had $4 million of billings that would have normally renewed in Q4. But because of an upsell, because the customer was expanding and wanted to grow their deployment with us mid-year and mid-contract, we ended up pulling forward about $4 million of billings into Q2 from Q4. So that adds some additional pressure overall.

So from an optic standpoint, there's certainly some factors at play that are going to make the calculated billings growth rate pretty challenging. But again, from an overall business momentum standpoint, and all the signs that we're seeing, as you can sort of see from some of the large-deal metrics and just the overall growth metrics that we give out, we're really excited about and confident in the Q4 that we have ahead.

That's helpful. Thank you.

(Operator Instructions)

The next question is from Terry Tillman from Raymond James.

Hi, this is Brian Peterson for Terry. Thanks for taking the question. So Dylan, quick one for you. So if we think about your long-term growth profile, is there any way you could segregate that between seat expansion and then price-per-seat expansion? Just curious how that should look over the longer term.

Yes, so it's a little bit harder to say, especially as, while we have been seeing some really strong traction with our newer products, most of those have not been in the market for very long, and we still are really in the early stages of expanding our product portfolio, as well as our platform offering. So today, we do still see the substantial majority of our growth coming from the core service. Even though in a lot of cases, that is driven by some of the newer products that we have available, where the introduction of those products has opened up newer use cases, larger opportunities, opened new markets and areas that allow us to sell more of the core seats.

So over time, we'd expect that to be an increasingly impactful part of how we grow the business. And already seeing it show up in the numbers, is one of the big reasons that our net retention rate has stabilized at 115%. And then over time, as they become more material, we'll give additional color into how those are evolving. But for now, I'd say it's a little early to tell exactly how that's going to break down between additional seats and then the uplift that we see from some of our newer products.

Got it, understood. And maybe one quick clarification. The decline in supporting the free user base, that's actually gone down in dollars, I think for five, six, seven quarters consecutively. Is that something that we should continue to see on an absolute dollar basis, or is there a certain level where we can't really get it below this certain point? Thanks, guys.

Sure. So we'd expect in the coming quarters for that trend to continue, given a lot of the things that we continue to do to optimize the expenses associated with our free user base. And the fact, we are still -- it is a pretty important part of our model overall to allow not just our enterprise customers to be able to share and collaborate with anyone, but also give people the opportunity to use the product before they buy.

So we'd expect the offering to stay and to continue growing that, but would note that the overall growth rate in free users has been significantly slower than our growth rate in paying users. And that, combined with the efficiencies that we're driving on the infrastructure side, leads us to be pretty confident that we will continue to see those trends play out at least for the next several quarters.

Great. Thanks, Dylan.

There are no further questions. I will turn the call back over to the presenters.

Great. Thank you, everyone, for joining us today. We look forward to speaking to you next quarter.

This concludes today's conference call. You may now disconnect.