Solid Q3 from Box as Levie sees upside in Salesforce-Slack deal

Phil Wainewright Profile picture for user pwainewright December 2, 2020
Box Q3 numbers announced last night were solid but CEO Aaron Levie wanted to focus on the implications of Salesforce buying Slack

Box CEO Aaron Levie speaks at Boxworks 2019

Box CEO Aaron Levie was eager for Wall St analysts on the company's Q3 earnings call last night to ask him about the market impact of Salesforce buying Slack, but none obliged. They were far too intent on probing for hidden meaning in a solid set of Q3 results and respectable forward guidance — we'll come back that below. Levie had to content himself with publishing a company blog post on the ramifications of the Slack deal, where he characterized it as:

A major moment for the enterprise software landscape, and importantly the best-of-breed software ecosystem.

Box has bet its strategy on succeeding in a best-of-breed landscape, with connections into not only Slack and Salesforce but other digital teamwork leaders such as Microsoft Teams, Cisco Webex, Zoom and Google Workspace. Levie sees the Salesforce acquisition of Slack as "massive validation of the modern, best-of-breed enterprise software stack," with Box taking its place in that stack as "the singular cloud content management platform that connects with all the technologies our customers use."

The untapped market potential is also huge, he believes. Picking up a sporting analogy he made during the company's Q1 earnings call earlier this year, he says the market is "still in the early innings," adding:

The last decade has been about building the tools that power new ways to work from anywhere, collaborate with anyone, and automate workflows and business processes in the cloud. The next decade will be the era when organizations adopt these technologies en masse and transform their enterprises ... 90%+ of the world's digital workers are still not leveraging these modern platforms for the majority of their work.

Rolling with the punches

The implication is that there's plenty more scope to expand on Box's expected revenues in the current fiscal year of just under $770 million, as guided by the company last night, which will keep its annual growth marginally above 10%. The past year has been a time for managing costs and Box was able to lift its guidance for non-GAAP operating margin from the previous 12-13% target outlined three months ago. It is now forecast to come in above 14%, a substantial increase from last year's 1%. That's quite an achievement given the challenges of the past year. As Levie told analysts on last night's call:

This has been a year where we've obviously had a lot of rolling with the different punches that we're seeing, [while we], obviously, just continue to drive strong performance in the process.

A quick summary of the key numbers in Box's Q3 results:

  • The quarter's revenue came in at $196.0 million, up 11% from the same quarter a year ago.
  • GAAP operating loss was $2.6 million, or 1% of revenue, improved from $39.2 million, or 22% of revenue, a year ago. The non-GAAP equivalent saw income of $35.2 million, or 18% of revenue, up from a loss of $0.5 million (0%) a year ago.
  • Net cash from operations came to $45.1 million, up from $8.9 million a year ago, while free cash flow was $26.2 million, compared to negative $1.7 million a year ago.
  • 62 deals worth more than $100,000 closed in the quarter, slightly down from 64 a year ago. Seven deals were over $500,000 (same as a year ago) but three were over $1 million (same as a year ago). Although the number of deals has stayed static, the value of deals has been trending upwards, says CFO Dylan Smith.
  • Net retention rate was 103%, down from 104% a year ago and from 106% in Q2. Churn remained at an annualized rate of 5% from Q2, and an improvement from 6% in the year ago period.

Keeping revenues on track

Margin improvement has been largely driven by reducing infrastructure and operational costs, following a program put in place at the end of last year. A big contribution in Q3 came from reductions in sales and marketing costs, which at $56.5 million were just 29% of revenue, compared to 42% in the same quarter a year ago. A whopping $5 million of that reduction came from the lower cost of hosting the annual Boxworks customer conference digitally rather than in person.

Box has been focusing its sales resources on the sectors where it does best, which has helped it keep revenues on track, despite some variation in demand by industry. While small business demand has been recovering, although not yet to pre-COVID levels, the main focus has continued to be on the enterprise segment, which accounts for 70% of revenues. Sales of additional products such as Box Shield and Box Relay have been expanding, and for the first time more than a third of deals above $100k were for more than one product.

While buyers carefully scrutinize budgets and ROI, there continues to be a consistent trend towards moving off legacy content management systems and going to the cloud, says Levie. He cited use cases seen at enterprise customers in the past few months including insurance claims processing, COVID-19 vaccination production, and secure collaboration and records management in government. Wins and expansions with leading organizations during the quarter included the Defense Contract Management Agency, FICO, Murata Manufacturing Company Ltd., National Bank of Canada, Sumitomo Corporation, USAA, and the US Department of the Air Force.

My take

Box started this financial year with a mission to improve its operating margins and can now claim success, although some of the extra boost in the second half has been from the temporary impact of reduced travel and premises costs during the current phase of remote selling and virtual events. Nevertheless it's in a much better cash position which in volatile times is helpful.

It's also maintained its sales momentum albeit with none of the barnstorming success of some others in the digital teamwork space, most notably Zoom. However Levie is right to single out Salesforce's acquisition of Slack as a major boost for his own company's strategy. The minutiae of which $100k deals have come in this quarter versus next — among the issues that preoccupied analysts on the earnings call — pales into insignificance against the bigger picture of a generational shift in how work gets done in the enterprise and the tools needed to enable it.

Box has done a great job of carefully carving out a niche as a trusted platform for enterprise content that can plug into all the major players in the emerging collaborative canvas of digital teamwork. Whether Slack's absorption into Salesforce results in a boost to its enterprise market share, or cedes ground to rivals such as Microsoft Teams, Box stands to gain either way as industry giants pour marketing dollars into promoting connected digital teamwork.

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