Box's Q3 2024: Contradictions Emerge on AI Adoption, Demand Outlook, M&A Strategy, and Net Retention

Date of Call: December 5, 2023

Financials Results

• Revenue: $262.0M in Q3, up 5% YOY (7% in constant currency)
• EPS: $0.36 diluted non-GAAP EPS in Q3, up 16% YOY (from $0.31)
• Gross Margin: 76.3% in Q3, vs 76.5% a year ago; negatively impacted by ~130 bps equipment-proceeds headwind
• Operating Margin: 24.7% non-GAAP operating margin in Q3, up 70 bps YOY (26.6% in constant currency)

Guidance:

• Q4 FY'24 revenue $262M–$264M (≈3% YOY at high end; ~5% in constant currency).
• Q4 gross margin ~78% (includes ~150 bps equipment-proceeds headwind).
• Q4 non‑GAAP operating margin ~25.5% (includes ~180 bps FX headwind; 150 bps equipment + 60 bps lease-mod impact).
• Q4 non‑GAAP EPS $0.38–$0.39; GAAP EPS $0.05–$0.06.
• FY'24 revenue $1.037B–$1.039B (≈5% YOY; 8% CC); FY'24 non‑GAAP EPS $1.42–$1.43.
• FY'24 gross margin ~77%; FY'24 non‑GAAP operating margin ~24.5% (includes ~200 bps FX headwind).
• Preliminary FY'25: ~5% reported revenue growth (≈100 bps FX headwind) and ~27% non‑GAAP operating margin (~250 bps improvement YOY).

Business Commentary:

* Revenue and Growth Strategy: - Box reported revenue growth of 5% year-over-year in Q3, aligning with their guidance, with 25% operating margins. - The company focused on driving adoption of Enterprise Plus to increase the efficiency of their sales motion, with 51% of revenue from Suite customers, up from 48% last quarter. - Growth was supported by enterprise clients prioritizing Box's Content Cloud despite macroeconomic headwinds, with key customer expansions including a leading biotech company and a technology giant.

• Box AI and Product Innovation:
• Box introduced new products like Box AI and Box Hubs, which are expected to revolutionize how companies work with their content.
• These innovations aim to provide metadata extraction, document understanding, and content publishing solutions to enhance enterprise productivity and knowledge management.

• The adoption of these AI-powered solutions is anticipated to drive customer engagement and retention.

• Customer Retention and Churn Rate:

• Box maintained a 102% net retention rate and a 3% full churn rate, which is considered best-in-class.
• The company saw pressure on seat growth due to macroeconomic factors, impacting new customer additions.

• However, ongoing enhancements in product offerings and strategic focus on upselling to Enterprise Plus have contributed to customer retention.

• Financial and Operating Margin Performance:

• Box achieved a 24.7% operating margin or 26.6% in constant currency, an improvement from the year ago period.
• Despite a significant impact from equipment proceeds headwinds, Box delivered diluted non-GAAP EPS of $0.36, up 16% from the previous year.
• Gross margin was negatively impacted by 130 basis points due to equipment proceeds headwinds, but further expansion is expected post-data center migration.

Sentiment Analysis:

Overall Tone: Neutral

• Management highlighted execution and margin expansion (Q3 revenue +5% YOY; non‑GAAP EPS $0.36, +16% YOY) but flagged FX and equipment‑proceeds headwinds and seat‑growth pressure; guidance is conservative (FY25 preliminary ~5% growth) while emphasizing product-driven upside (Box AI, Hubs).

Q&A:

• Question from Brian Peterson (Raymond James): Any trends through the quarter on linearity that changed?
  Response: No meaningful change to linearity; US stabilized as expected while some international variability (a few pushes in Japan) pressured near‑term billings.

• Question from Brian Peterson (Raymond James): In the 10%–15% longer‑term revenue target, is there an implied NRR or seat expansion assumption?
  Response: Long‑term targets imply net retention around ~110% (improvement over current levels) driven by seat growth and future product upsells.

• Question from Steven Enders (Citi): What gives you confidence in the implied acceleration into fiscal '25?
  Response: Confidence is based on current pipeline, customer conversations and prudent macro assumptions rather than any single new driver.

• Question from Steven Enders (Citi): How scrubbed is the pipeline and how long will seat‑growth be a headwind?
  Response: Seat‑growth pressure is expected to continue and is baked into guidance; pipeline qualification has improved and those conservatively feed the outlook.

• Question from Christopher Quintero (Morgan Stanley): Why isn't Suites momentum translating more into better in‑quarter results?
  Response: Suite adoption is strong, but overall top‑line is still constrained by weaker seat growth from macro conditions; Suites helps long‑term unit economics but seat pressure mutes near‑term revenue.

• Question from Christopher Quintero (Morgan Stanley): Excluding the 85 bps headwind, what's driving the modest operating‑margin guide reduction?
  Response: A small revenue impact and incremental FX pressure account for the remaining modest margin change; nothing material beyond those factors.

• Question from Pinjalim Bora (JPMorgan): For FY'25 outlook, what NRR are you assuming and is AI baked in?
  Response: Preliminary FY'25 assumes underlying retention roughly consistent with current levels; product upside (AI, Hubs, new Suite) is not materially baked into FY'25, though Enterprise Plus AI upgrades are included conservatively.

• Question from Pinjalim Bora (JPMorgan): Are you assuming consumption/volume‑based revenue from existing Suites customers next year?
  Response: No hard consumption assumptions are baked in; any consumption uptake is treated as upside and management is being conservative.

• Question from Pinjalim Bora (JPMorgan): What is billings growth adjusted for payment duration from a year ago (prepay effect)?
  Response: Adjusted for last year's large multiyear prepay, comparable billings growth is in the mid‑ to high‑single‑digit range.

• Question from Chad Bennett (Craig‑Hallum Capital): Any planned cost actions to accelerate operating‑margin leverage given S&M at ~27%–28% of revenue?
  Response: Management will balance continued bottom‑line leverage with targeted growth investments; expect margin improvement driven by cloud migration efficiencies and lower‑cost location strategy rather than major S&M cuts.

• Question from Chad Bennett (Craig‑Hallum Capital): How has the non‑Suite (Core‑only) business performed competitively YTD?
  Response: Core‑only shows more pressure on retention and seat growth versus Suites, but no material change in competitive dynamics; priority is migrating customers into Suites.

• Question from Richard Poland (RBC Capital Markets): When customers reduce seats, are you offsetting that with Suite upsells or discounts?
  Response: Renewal playbook focuses on moving customers into higher‑value functionality and plan tiers to retain value; seat reductions are often tied to customer cost pressures and are handled case‑by‑case.

• Question from Richard Poland (RBC Capital Markets): Will you report a breakout for Enterprise Plus adoption?
  Response: Enterprise Plus drives >90% of Suite sales and management currently treats Suites as the primary metric; they have considered breakouts but see Enterprise Plus as effectively encompassing Suites.

• Question from George Iwanyc (Oppenheimer): With new COO Olivia Nottebohm, will you change sales org or GTM over next quarters?
  Response: Expect incremental GTM optimizations—more partner expansion, vertical focus and efforts to move customers into higher tiers—aimed at scaling toward the $2B opportunity.

• Question from George Iwanyc (Oppenheimer): Early read on GCP Marketplace partnership and pipeline impact?
  Response: Partnership is in early stages ('day 1'); management is already seeing early pipeline anecdotes and expects the channel to provide a more efficient path to customers over time.

Contradiction Point 1

AI Adoption and Revenue Impact

This point highlights the differing expectations regarding the immediate impact of AI adoption on revenue growth, which is crucial for investor expectations and strategic planning.

Will the consumption-based pricing model contribute next year? - Christopher Quintero(Morgan Stanley)

2024Q3: No expectations for immediate consumption-based pricing impact. Early stages of Box AI's rollout, needs conservative estimate. - Aaron Levie(CEO)

Can you discuss early traction with AI unit consumption and its impact on platform revenue? - Josh Baer(Morgan Stanley)

2026Q1: AI unit adoption is early but growing, with varied use cases across industries. We expect this to be a significant revenue contributor in the coming quarters. - Aaron Levie(CEO)

Contradiction Point 2

Demand Picture and Cautious Approach

This contradiction focuses on the company's assessment of the macroeconomic environment and its impact on customer demand, which directly affects growth strategies and financial projections.

What is the current demand environment and pipeline pressure on seat growth, and how are these assumptions reflected in your outlook? - Steven Enders(Citi)

2024Q3: Continued pressure on seat growth expected, affecting both large deal counts and attach rates. Pipeline is qualified based on current learnings and resilience. - Dylan Smith(CFO)

Can you discuss demand and the prudence in guidance in the current macroeconomic environment? - George Kurosawa(Citi)

2026Q1: Overall, we're seeing very healthy and robust customer conversations, especially around AI. Our guidance reflects a balance between the current AI momentum and broader macroeconomic uncertainties. - Aaron Levie(CEO)

Contradiction Point 3

M&A Strategy and Focus on Organic Development

It involves changes in the company's approach to mergers and acquisitions, which are crucial for understanding the company's strategic direction and approach to growth.

Is the sales organization or go-to-market strategy being adjusted now that Olivia is on board? - George Iwanyc(Oppenheimer)

2024Q3: We focus on organic development and modernizing our AI platform. M&A would be considered for areas needing extra support or time-to-market. For now, we're happy with our platform development. - Aaron Levie(CEO)

How does AI adoption affect your M&A appetite? - Brian Christopher Peterson(Raymond James & Associates, Inc.)

2026Q2: M&A would be considered for areas needing extra support or time-to-market. For now, we're happy with our platform development. - Aaron Levie(CEO)

Contradiction Point 4

Net Retention Rates and Growth Drivers

This contradiction revolves around the expected trends in net retention rates and their impact on growth, which is critical for understanding the company's financial performance and strategic direction.

What are your assumptions for net retention and new business in fiscal '25? - Pinjalim Bora(JPMorgan)

2024Q3: Net retention continues at current levels next year. New products like AI will not significantly impact FY '25 revenue. - Dylan Smith(CFO)

Can you discuss demand trends and the prudence in guidance considering current macroeconomic conditions? - George Kurosawa(Citi)

2026Q1: Our guidance reflects a balance between the current AI momentum and broader macroeconomic uncertainties. - Aaron Levie(CEO)