Short seller's wet dreams coming true as Box gets hammered for a beat

Profile picture for user gonzodaddy By Den Howlett June 1, 2016
Summary:
Box did well in its latest earnings but got thumped for not wowing the financial community. This is a pattern we expect to see repeated over the remainder of the year but should not deter all but the most skeptical of buyers.

Aaron Levie 2015
Aaron Levie, CEO Box

This part of the earnings season is turning into a bloodbath for the so-called momentum stocks - those priced for growth - and a wet dream for the short sellers. This time it is Box's turn to get the haircut treatment in after hours trading following a beat on revenue but, and this is what got the stock spiraling in after hours, no beat as upside on the forward outlook. Can you believe that? Let's see what happened.

From the top of the press release:

“First quarter revenue was strong at $90 million, representing 37% growth year-over-year. We also continued to drive operational efficiency, with GAAP and non-GAAP EPS improving by 9 and 10 cents, respectively, year-over-year,” said Aaron Levie, co-founder and CEO of Box. “We won more than 5,000 new customers and added or expanded deployments with leading enterprises like Airbnb, Brooks Brothers and The Whirlpool Corporation. We also introduced Box Zones, achieved FedRAMP certification and launched strategic partnerships with Adobe, Cognizant and others, continuing to expand our addressable market.”

“In the first quarter, we achieved a marked improvement in cash flow from operations of negative $4.2 million and, excluding a payment related to a litigation settlement, would have achieved near breakeven cash flow from operations of negative $500,000,” said Dylan Smith, co-founder and CFO of Box. “We are confident in our growth opportunity, driven by our product differentiation and expanding market, and we remain committed to achieving positive free cash flow in the fourth quarter of this fiscal year.”

Given that I have been skeptical of Box's business model in the past as more a 'feature' than an application, but have grown to like the platform play, I'd chalk this up to a decent outcome. So what am I missing? The long look pegs growth at $94-95 million in Q2 FY2017 with non-GAAP EPS of negative $0.19-0.20. The Street gamblers were expecting a forecast of $94.8 million and EPS $0.20. In betting terms, this didn't beat the odds and therefore the stock price was marked down. What else can we learn?

Excluding one off items, free cashflow improved significantly from negative $17.3 million to negative $0.5 million, suggesting to me that Box is on the cusp of at least breaking even on operating cash flow after many years of bleeding cash. But then when you look at the balance sheet, net cash declined from $185.7 million to $182.7 million in real terms since January 2016. What else? Well - gross margin declined from 73% to 69% year over year (largely explained away by infrastructure investments), deferred revenue declined from $168 million to $154.4 million sequentially and stock compensation grew from $12.8 million to $16.1 million year over year, lower than revenue growth by some distance but still a significant component in the non-GAAP report.

What did the company have to say on the earnings call?

Go to market

Much of the emphasis was on reiterating or sharing enterprise related vignettes. At the top of the commentary, CEO Aaron Levie said:

To further execute on these go-to-market efforts we’re bringing on board a chief marketing officer with 20 years of enterprise technology experience who will be joining us shortly. Further given the continued strength and demand that we're seeing and the growing market opportunity, we're also increasing this year's sales rep hiring targets.

This is an interesting move from our perspective because it indicates a management attuned to the different needs of enterprise B2B marketing. It remains to be seen how this works and my hope is that one of the first things he (or she) will do is start with a strategic plan that embraces the principles of zero based budgeting. That will allow Box to work from a clean slate, figuring out the things that matter to enterprise and how best to execute in marketing terms. I'm less convinced about any arbitrary raining of sales targets. The Box of today is very different from the Box of a year ago and simply raising targets without supplying the sales teams with a comprehensive bag of tools with which to explain the offering will be a tough ask.

One solid piece of the puzzle in Box's favor is the growth in the developer ecosystem:

Today 75,000 developers are building on Box’s APIs, using over 6 billion third-party APIs calls every single month. To make it easier for enterprises to build client facing digital experiences that leverage our content management and collaboration capabilities, we launched Box platform this fall. Overall demand for Box platform is growing with everything from apparel companies to banks beginning to build their applications on Box.

Nice but again, how will this translate into revenue opportunities? My guess is that when Box mixes that message with the platform agnostic, born in the cloud and secure network messages then the picture becomes attractive to the CIOs Box needs to woo. However, on the call, Levie seemed less than sure footed on the overall strategy, fluffily referring to Q1 as a pipeline 'building' quarter and with vague references to the positive impact Box is seeing from its partnerships with IBM, AT&T, Microsoft and Cognizant.

Adoption

Levie offered a useful tidbit around adoption in Microsoft Office environments that might be useful to buyers:

So what we're finding is because of our integration with O 365 across Outlook and Office, on the web or on mobile, customers are actually increasing their utilization of both Office 365 and Box because of that connectivity. So with customers like the commercial real estate company that I mentioned, but also many many others at this point what’s happening is, is Box is now being used for more of the daily collaboration, more of the daily document editing as well as becoming the secure repository for more and more cloud platforms that our customers are adopting. So we believe this is going to be really the start of a much broader trend. Obviously you can imagine all – many of the use cases that come with Office 365 and Box but more importantly being really that center of how content management is managed – content is managed in an enterprise across Slack, Salesforce, across Office 365, any of the applications that our customers are using. So that’s really the value add that we're offering with O 365 deployments.

Make sense? It does to us but then there will be the obvious competitive comparison with Microsoft. The question Box must answer is simple - how does this differentiate in language I can understand?

My take

Box turned in a decent quarter with a broadly in-line outlook. The problem is that on the call, the Box team didn't seem as assured as analysts were likely requiring in order to maintain the market's already fragile view of momentum company stocks.

As we have noted before, Box's differentiated focus on the enterprise is well established but right now, the messaging needs some punch beyond the technology niceties. In that context, they might want to take some lessons from the Workday playbook where a combination of easy to understand value propositions and solid customer stories are well balanced by the technology play needed to win over the hearts and minds of skeptical CIOs. The good news is that Microsoft Azure's growing presence can only reflect well in Box's favor