Box Q4 sees add-on products and lower costs steering a path to profits

Profile picture for user pwainewright By Phil Wainewright February 28, 2020
Summary:
Box reduces headcount as it edges towards profitability, sees its content security add-on as a unique selling point to enterprise prospects

Box CEO Aaron Levie speaks at Boxworks 2019
Aaron Levie, Box, at Boxworks 2019

Content collaboration vendor Box pacified investors this week with evidence that it's on a solid path to profitability when it reported Q4 results for fiscal 2020. That's based on a mix of continued projected revenue growth of around 12%, alongside savings on operating costs — including ending Q4 with 60 fewer employees than at the start of the quarter. In the midst of yesterday's broad market declines, the company's stock price responded by rising almost 10%, before settling 2% higher at the end of the day.

The company just squeaked its first profit on a non-GAAP basis for the year to January 2020, and its Q4 results and outlook for the coming year topped analyst expectations. CEO Aaron Levie attributed its progress to success in selling add-on products introduced during the year and said the company is "focused on driving healthy growth and significantly improved profitability" in the year ahead.

The company now has nearly 100,000 customers and 13.6 million paid users. Customer churn, even when including lower-value contracts, came in at just over 5% on an annualized basis in Q4, while net retention was 104%. The quarter saw deal size continue to increase, with four $1+ million deals, 14 over $500,000 and 112 greater than $100,000. Add-on product bookings did particularly well at 60% higher than the same quarter last year. Other headline numbers include:

  • Q4 revenue of $183.6 million, up 12% year-over-year (YoY)
  • Q4 GAAP operating loss $28.6 million
  • FY2020 revenue of $696.3 million, up 14% on the year prior
  • FY2020 GAAP operating loss of $139.5 million, or 20% of revenue, a 2% improvement on the year before
  • FY2020 non-GAAP income of $9.3 million, or 1% of revenue, up 3% on the year before

Guidance for the new financial year is for revenue of around $774 million, representing approximately 11% to 12% year-over-year growth, and a non-GAAP operating margin of 9% to 10%, trending into the low teens by the final quarter. CFO Dylan Smith said the company will be watching free cash flow closely, with the target of achieving at least 25% of combined revenue growth plus free cash flow margin for the year, rising to 35% in FY2023. Although not mentioned on the earnings call, there has been pressure on Box to deliver improved returns after activist investor Starboard Value LP became the company's third largest investor last September.

Where Box is squeezing costs

The flipside of keeping shareholders happy with the direction of travel is maintaining the confidence of customers, who will carefully scrutinize where costs are being squeezed. Reassuringly, there is no change planned in the proportion of revenue spent on R&D. Smith set out three main areas of focus for cost reduction:

  • Reducing workforce costs "by eliminating non-strategic roles, reducing headcount in lower performing geographies, and hiring in more productive or lower cost locations."
  • Improving gross margin "by optimizing our data center footprint and other costs to deliver our service." An ongoing data center migration is due to complete in the next few months.
  • "Taking an ROI-based approach to all areas of spend, including greater cost discipline across the business." Actions include spending cuts to marketing programs and events, less spend on outside consultants, streamlining T&E, and taking advantage of automation to drive efficiencies.

Box has also redeployed sales people to focus on its best performing regions and segments, including upsells to add-on products such as Box Shield, which became available at the end of October. The service uses intelligent automation to proactively apply security policies and has performed particularly well, says Levie:

We're thrilled to share that Box Shield is already exceeding our expectations, growing faster at this point in its rollout than any other add-on product in our history. Further, our Enterprise Suites continue to be successful and making it easier for new and existing customers to adopt the full power of Box.

How Box Shield drives enterprise take-up

Earlier this week, I met Chief Product Officer Jeetu Patel during a visit to London. He expanded on the role that Shield plays in expanding enterprise take-up of Box. It's designed to apply security and compliance policies in a way that's compatible with the broad information-sharing needs of a modern enterprise. Rather than locking down everything, which only leads to people circumventing the rules, it applies controls in a very granular way and also takes context and behavior into account, he explained. This means it can identify usage patterns that are out-of-the-ordinary and thus stop potentially malicious misuse of confidential information. That makes it attractive to implement across an entire organization, he says:

Imagine that you're a company with 10,000 employees. Only 3,000 of them are using Box. There's such a huge need for those other 7,000 to use Box because ... if you have all 10,000 on Box, now you get full visibility over where all your data is flowing in and out.

Although it offers similar capabilities to dedicated security tools that block the sharing of certain types of sensitive data, Shield benefits from Box's awareness of the context in which information is being used. So, for example, instead of simply blocking an email that contains sensitive content, it will stop the user from including the information, so they can manage their behavior accordingly. That's important for organizations that want to encourage collaboration, Patel explains.

The goal of our security solutions is to open up 90% ... You will get more collaborative by implementing a security solution from Box [rather] than less collaborative.

Shield can also be used with other Box add-ons and features. For example, the Box Relay workflow automation tool, which also became available as native functionality last year, can apply security classifications as part of a workflow, or can have workflow that responds to a document's classification. Shield classifications and policies also continue to apply to Box content when it's shared in application integrations, such as in Microsoft Teams.

Protecting content is crucial

Enterprises value this kind of best-of-breed approach in the case of content because it's such an important asset, says Patel.

You will make choices and trade-offs. But the thing that you literally cannot have as a P2 or P3 priority is your intellectual property that your organization depends on. Making sure that that is secure and compliant, that it has the right privacy settings, and has the right level of ease-of-use and the right collaborative elements — so that people can go out and work together, so that they can innovate faster — that is literally something you can't put on the back burner.

The focus during the coming year will be on further deepening those integrations, so that the ability to work with content that's protected and managed by Box will become more and more seamless from other applications, he says.

What we now need to do is make sure that the quality of those integrations continues to keep getting better and better. So it doesn't even feel like two separate products, it feels like one product.

My take

Box is not the only enterprise content vendor feeling the heat from investors anxious to know whether it can deliver returns. Dropbox responded to similar pressure last week in its Q4 earnings report. For both companies, it's important to reassure shareholders about their long-term prospects.

At the same time, though, that reassurance for shareholders must not come at the expense of the customer experience. Fortunately for Box, it is now at a stage where various R&D investments over several years are now starting to bear fruit as add-on capabilities for which there is palpable enterprise demand. While cutting back on sales and marketing at such a time is not ideal, it seems there is scope to do that and still maintain current growth rates.

But Box has chosen probably the toughest part of the enterprise to sell into — majoring on features such as security, data protection and compliance, with business process automation thrown in. Such features appeal to the more established, regulated, and thus highly conservative end of the market, where sales are often long and complex to close. As a result, Box's growth rates are not as stellar as other players in the enterprise collaboration field with broader though less enterprise-y appeal. That must raise questions over its long-term independence. Perhaps Box would do better with the resources of a larger enterprise software company behind it, if it can prove an attractive enough acquisition target. In the meantime, it must strike a careful balance between delivering returns to shareholders and value to customers.

[Updated: When first published, the number of customers was incorrectly shown as 10,000 instead of 100,000]