Earnings Call Transcript - BOX Q1 2024

Operator, Operator

Good afternoon, my name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the Box, Inc. First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Cynthia Hiponia, Head of IR. You may begin your conference.

Cynthia Hiponia, Vice President, Investor Relations

Good afternoon and welcome to Box's first quarter fiscal year ‘24 earnings conference call. I am Cynthia Hiponia, Vice President, Investor Relations. On the call today, we have Aaron Levie, Box's Co-Founder and CEO; and Dylan Smith, Box's Co-Founder and CFO. Following our prepared remarks, we will take your questions. Today's call is being webcast and will also be available for replay on our Investor Relations website at box.com/investors. 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 second quarter and full-year fiscal 2024 financial guidance and our expectations regarding our financial performance for fiscal 2024 and future periods including our free cash flow, gross margins, operating margins, operating leverage, future profitability, net retention rates, remaining performance obligations, revenue and billings and the impact of foreign currency exchange rates and our expectations regarding the size of our market opportunity, our planned investments, future product offerings, and growth strategies, our ability to achieve our revenue, operating margins and other operating model targets. The timing and market adoption of and benefits from our new products, pricing models, and partnerships, our ability to address enterprise challenges and deliver cost savings for our customers, the impact of the macro environment on our business and operating results and our capital allocation strategies, including potential repurchase of our common stock. These statements reflect our best judgment based on the factors currently known to us and actual events or results may differ materially. Please refer to our earnings press release filed today and the risk factors in documents we file with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K for information on risks and uncertainties that may cause actual results to differ materially from statements made on this earnings call. These forward-looking statements are made as of today, May 30, 2023, and we disclaim any obligation to update or revise them should they change or cease to be up to date. In addition, during today's call, we will discuss our non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, 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 related supplemental slides which can be found on the Investor Relations page of our website unless otherwise indicated, all references to financial measures on a non-GAAP basis. With that, let me hand it over to Aaron.

Aaron Levie, Co-Founder and CEO

Thank you, Cynthia, and thanks everyone for joining us today. We are pleased to deliver first quarter operating results above our guidance. This includes revenue growth of 6% year-over-year, and 10% on a constant currency basis, in addition to a strong focus on profitability resulting in operating margins of 23%, up 220 basis points from a year ago. Achieving these results in a challenging macro environment is a testament to the value of our Content Cloud platform, and the operational discipline of our Boxers as we deliver substantial year-over-year bottom line improvements. While the dynamic macro economy continues to pressure IT spend and headcount growth expectations from our customers, trends we’ve seen continue to play out most notably in EMEA and smaller businesses in the U.S., we are also seeing strong traction and stickiness of our platform in customers, and our message is well-aligned to the challenges they are facing today. Over the last quarter I’ve had the opportunity to speak with hundreds of business and technology leaders, and it’s clear that the dynamics enterprises face today are fully aligned with the pillars that underpin our strategy. Enterprises are focused on simplifying their IT environments, driving productivity across their businesses, and protecting their most sensitive data. And across nearly all my conversations in the last quarter, business leaders everywhere are looking to leverage the power of AI to help transform how they work, and get even more value out of their data. Box’s Content Cloud platform is best positioned to help these customers solve these challenges, and our Q1 customer wins illustrate how we will remain mission critical for them. These wins include: A global manufacturing company that collaborates with defense and federal government agencies, who is a new customer, who purchased Box in Q1 in order to meet FedRAMP and ITAR compliance for content management, also realizing the value to streamline its tech stack and integrate Box with its Salesforce instance to power the underlying compliant content layer for their customer portal. A multinational retailer, expanded its use of Box with a six-figure ramped enterprise license agreement and purchase of Box Shield to protect the vast amount of personal identifiable information that is stored in Box. And critical to our success is our continued execution of our product roadmap, which expands our total addressable market and adds value to our core platform with new product innovation. In Q1 we were pleased to announce the general availability of Box Canvas, which delivers a powerful new way for teams to unleash their creativity to take brainstorming and ideation to a new level, while leveraging the enterprise-grade security, compliance, and workflow automation capabilities of Box. Box customers now have access to unlimited Canvases included in their plans, which enables us to disruptively enter this market, and we’re already seeing amazing use-cases emerge across our customers. Since we launched Box Sign, Box customers are taking advantage of unlimited e-signatures included in their plans and have migrated use cases over from costly incumbents. In Q1 we released advanced e-signature features such as a dedicated Box Sign policy for Box Shield to provide users with the ability to seamlessly request signatures on documents subject to Box Shield's access policies. We launched a Box Sign-Relay integration that specifically enables post-signature actions to be orchestrated and enables our customers to build end-to-end e-signature workflows in the Content Cloud. We also announced the next generation of Box’s content migration solution, Box Shuttle, now built directly into the Box Admin Console. With Box Shuttle, content migration is a simple, accessible process, and organizations of all sizes can take full advantage of the many features and capabilities that the Content Cloud has to offer. Finally, an integral part of our product strategy is our ability to integrate deeply across the SaaS landscape, including the products like Microsoft Teams and Office, Webex, Zoom, Google Workspace, ServiceNow, IBM’s technology solutions, and much more. In Q1, in addition to delivering integration enhancements with Slack and Salesforce, we were pleased to announce a number of new technology partners that extend the value of Box, including Notion, Asana, Malwarebytes, and CloudFlare. As we look forward into FY ‘24 and beyond, our pace of innovation continues to accelerate. We are at the beginning stages of a new era of software. Similar to how cloud and mobile changed the technology landscape forever, AI has the opportunity to completely change how work gets done. As highlighted by the meteoric rise of ChatGPT, we've recently begun to see a huge breakthrough in the potential of Large Language Models or LLMs, which are now capable of bringing human-level reasoning to a large number of tasks. However, the real power of these new AI models is when you use their intelligence to help you work securely with your own proprietary data set. For years we've been able to ask questions about our structured data, like the information that's in a database, ERP system, or CRM system. You can ask those systems for financial forecasts, sales pipeline results, inventory levels, supply chain details, and more. But we’ve had limited ability to ask questions of our unstructured data, like content, which is 80% of corporate data. And now we can. By safely bringing leading AI models to enterprise data, enterprises can truly unlock the value that lies in their content. To do this, we need a way to connect these models safely, securely, and compliantly to our enterprise content. As we announced just earlier this month, with Box AI we're taking the power of the world's leading AI models starting initially with OpenAI’s ChatGPT3.5 and GPT4 and securely letting customers leverage them for their enterprise content. With Box AI, customers can ask questions of their content or generate new information leveraging Box Notes. Imagine being able to instantly ask things like 'how many days of parental leave can I take?' on an HR document or 'please summarize this report and provide five key takeaways on a quarterly earnings document' or 'how would you pitch this product to a customer in the automotive industry when looking at a product overview document.' But this is just the beginning. Ultimately, as a core platform capability, Box AI will be used throughout the product to continue to transform how we work with our content in a variety of ways. We can imagine in the future being able to use AI to automatically classify content in even more specific ways, automatically extract data using a Relay workflow, use platform APIs to interact with AI models from a variety of providers, and being able to ask a question of a larger set of documents on a specific topic. And as a platform-neutral vendor, we will also be AI-neutral, which means as new AI breakthroughs emerge from more vendors over time, we’ll be in a position to bring the full power of their technology to Box and our customers. In addition to our collaboration with OpenAI, we recently announced that we are building on our strategic partnership with Google Cloud to integrate Google’s advanced AI models into Box AI to create new ways for joint customers to work smarter and more productively with generative AI. Like any new technology area, our approach with Box AI is to execute on this opportunity with a high degree of thoughtfulness. Initial customer access will be granted through a Design Partner Program and we are excited to keep you updated as we continue to innovate with Box AI to capitalize on the exciting new product opportunities this technology shift has created. Now, turning to go-to-market, as we discussed at our Analyst Day in March, our optimized pricing and packaging initiatives have allowed us to see a greater total account value, higher net retention, higher gross margins, and a more efficient sales process. Our strategy is to continue launching new multi-product offerings over time, increasing the value to our customers by bringing them the full power of the Content Cloud.

Dylan Smith, Co-Founder and CFO

Thanks Aaron. Good afternoon, everyone, and thank you for joining us. Q1 was another strong quarter for Box, with revenue, EPS and operating margin results all above the high-end of guidance, despite the challenging macroeconomic environment. We continued investing in profitable growth, while optimizing our underlying cost structure, resulting in a resilient long-term financial model. Our balanced business model allows us to invest in innovative new products such as Box Canvas and Box AI, generate continued gross margin and operating leverage, and consistently return capital to our shareholders. In Q1 we delivered revenue of $252 million, up 6% year-over-year, above the high-end of our guidance, and representing 10% year-over-year growth on a constant currency basis. We now have nearly 1,680 total customers paying more than $100,000 annually, an increase of 14% year-over-year. Our Suites attach rate of 69% in large Q1 deals demonstrates the value our Content Cloud Platform is delivering to our large customers. 47% of our revenue is now attributable to Suites customers, a significant 10 point increase from 37% a year ago. Even in this dynamic environment, Box’s value proposition is resonating with customers as they look to Box to transform, simplify and secure their IT environments. We ended Q1 with remaining performance obligations, or RPO, of $1.2 billion, a 17% year-over-year increase, or 19% growth on a constant currency basis. This strong growth was driven by continued lengthening in customer contract durations, as well as an uptick in the volume of early renewals in recent quarters, as customers look to more quickly adopt the full value of our Suites offerings. We expect to recognize roughly 60% of our RPO over the next 12 months. Q1 billings of $192 million grew 11% year-over-year, ahead of our guidance of a mid-single-digit growth rate, and representing 15% growth in constant currency. Our strong billings outcome in Q1 was due in large part to a high volume of early renewals, pulling forward billings of roughly $6 million that had been scheduled to renew later in the year. Our net retention rate at the end of Q1 was 106%, in-line with our expectations. Our annualized full churn rate was 3%, versus 4% in the prior year, demonstrating the criticality and stickiness of our product offerings even in the current environment. We expect full churn to remain at roughly 3% throughout this year. For the remainder of FY ‘24 we expect our net retention rate to stabilize in the range of 104% to 105%, as we manage through the macroeconomic environment resulting in lower seat expansion rates, particularly in our U.S. Commercial and EMEA customers. Gross margin came in at 77.9% in Q1, up 160 basis points from 76.3% a year ago and well above the 76% range we had expected for the first-half of this year. Our Q1 gross margin reflects the optimizations we’re delivering as we execute on our public cloud migration strategy. We expect our duplicative public cloud and data center expenses to peak in Q2, leading to our gross margin expectations in the 76% range for Q2. As we look to the second-half of the year, we fully expect gross margins to rebound to the high 70’s. Q1 gross profit of $196 million was up 8% year-over-year, exceeding our revenue growth rate by 200 basis points. We once again delivered leverage across the entire business in Q1 with a 17% increase in operating income, to $57 million. Our 22.8% operating margin was up 220 basis points from the 20.6% we delivered a year ago. We delivered diluted non-GAAP EPS of $0.32 in Q1, up 39% from $0.23 a year ago and a full $0.05 above the high-end of our guidance, which includes an impact of negative $0.05 from FX. I would also note that Q1 marked the third consecutive quarter in which we delivered GAAP profitability. I’ll now turn to our cash flow and balance sheet. In Q1 we generated free cash flow of $108 million, a 19% increase from $91 million in the year ago period. We delivered cash flow from operations of $125 million, a 16% increase from $108 million in the year ago period. Capital lease payments, which we include in our free cash flow calculation were $10 million, down from $12 million in Q1 of last year. Let’s now turn to our Capital Allocation Strategy. We ended the quarter with $518 million in cash, cash equivalents, restricted cash, and short-term investments. In Q1 we repurchased 1.7 million shares for approximately $44 million. As of April 30, 2023, we had approximately $97 million of remaining buyback capacity under our current share repurchase plan. We remain very committed to returning capital to our shareholders through stock repurchases, and we expect to actively repurchase additional shares in Q2. With that, I would like to turn to our guidance for Q2 and fiscal 2024. The U.S. dollar has continued to strengthen resulting in a larger-than-expected FX headwind for Q2 and the second-half of the year versus our initial FY ‘24 guidance. As a reminder, approximately one third of our revenue is generated outside of the U.S., primarily in Japanese Yen. The following guidance includes the expected impact of FX headwinds, assuming current exchange rates. For the second quarter of fiscal 2024: We anticipate revenue in the range of $260 million to $262 million, representing 7% year-over-year growth at the high end of this range, or 11% in constant currency. We expect our Q2 billings growth rate to be in the low-single-digit range on an as reported basis, reflecting an expected 100 basis point headwind from FX, as well as the impact of the early renewals that contributed to our exceptionally strong Q1 billings result. We once again expect our Q2 RPO growth to be higher than our anticipated Q2 revenue growth rate. We expect our non-GAAP operating margin to increase to approximately 24%, representing a 230 basis point improvement year-over-year. We expect our non-GAAP EPS to be in the range of $0.34 to $0.35, representing a 25% year-over-year increase at the high-end of the range, and GAAP EPS to be in the range of $0.01 to $0.02. Weighted-average diluted shares are expected to be approximately 150 million, flat with Q1. Our Q2 GAAP and non-GAAP EPS guidance includes an expected headwind from FX of approximately $0.05, primarily due to fluctuations in the yen as discussed previously. For the full fiscal year ending January 31st, 2024. We now expect FY ‘24 revenue in the range of $1,045 million to $1,055 million, representing 6% year-over-year growth, or 10% on a constant currency basis. This revised range reflects both the recent strengthening of the U.S. dollar versus the yen and the IT spending environment we discussed earlier. We now expect FX to have a negative 350 basis point impact to our FY ‘24 revenue growth rate versus our prior expectation of 300 basis points. We expect FY ‘24 gross margin to be roughly 77.5%, 50 basis points above our previous expectations. As we continue to execute on our important transition to the public cloud and unlock additional leverage in our model, we will be exiting FY ‘24 with an even stronger gross margin profile. As a result, we are raising our FY ‘24 non-GAAP operating margin guidance by 50 basis points to approximately 25.5%, representing a 240 basis point improvement from last year’s result of 23.1%. We are also raising our FY ‘24 non-GAAP EPS expectations to be in the range of $1.44 to $1.50, representing a 25% increase at the high-end of the range versus $1.20 in the prior year, and we expect FY ‘24 GAAP EPS to be in the range of $0.17 to $0.23. Weighted-average diluted shares are expected to be approximately 151 million. Our FY ‘24 GAAP and non-GAAP EPS guidance includes an expected annual impact from FX of approximately $0.20. For the full-year of FY ‘24, we now anticipate currency headwinds to impact our billings growth rate by a little more than 100 basis points. We expect our FY ‘24 billings growth rate to be in the mid-single-digit range on an as reported basis. In summary, we are pleased with our execution in Q1. We once again demonstrated our disciplined and balanced model of investing for long-term growth while expanding both operating and free cash flow margins. We remain committed to achieving our FY ‘24 revenue growth plus free cash flow margin target of 35%, or 39% in constant currency. In this dynamic macroeconomic environment, the Box Content Cloud is the platform that enterprises need to transform their business while lowering their costs. With that, Aaron and I will be happy to take your questions.

Steve Enders, Analyst

Great. Thanks for taking the questions here. I guess I just want to ask a bit more on just the macroeconomic and what you're seeing out there? And I guess, what specifically is it in the EMEA and SMB business, that’s being impacted here. And I guess maybe how has that changed versus what we're seeing the of a couple of quarters?

Aaron Levie, Co-Founder and CEO

Yes. This is Aaron. I'll take that. I think overall, the general trends were pretty similar to kind of Q4 and what we were already seeing at the tail end of Q3 of last year. We did want to call out kind of an incremental element of softness on the SMB front in the U.S. and what we're seeing in EMEA. But as you can kind of see in the general guidance, as well as because of the FX impact, it really is just incremental, but we did want to kind of note that. Overall, I think as we've kind of talked about in the past couple of quarters, the general dynamic is you just sort of see that there's more scrutiny on larger deals, especially in those segments of the business where maybe previously, we'd be doing a $100,000 deal, and that would be in this today's environment, maybe fewer seats would be transacted and that would come under that level as an example. But overall, I think when you look at the kind of Q1 results, Q2 guide, I think we're seeing some healthy trends across the business, but we did want to just call it that incremental softness.

Steve Enders, Analyst

Okay. That's helpful there. And I think anyone asks on the AI side and, you know, in terms of the announcements that you've come out with already, but I guess, how should we think about the potential for monetization and maybe how you're thinking about funding and, kind of, going forward? I guess what's kind of the early read on how you're thinking about that aspect of the AI strategy?

Aaron Levie, Co-Founder and CEO

I want to mention that it's still quite early in our journey with our latest Box AI initiatives. While we have been in this space for some time and understand the potential of various use cases, the emergence of large language models presents new opportunities that we are very excited about. We aim to develop the right product user experience, pricing, and packaging as we move forward, which is why we are adopting a cautious approach during this rollout. Internally, we believe some use cases will become essential for our product. For example, generating content with AI and asking questions about data using AI are likely to be foundational features that we want to offer broadly. As we engage with our design partner program and beta testing, we will continue to refine these capabilities. Additionally, there will be more advanced features or those requiring higher consumption that we may monetize through our platform API or multiproduct suites. This will be guided by customer use cases, particularly from our design partners. In the next quarter or two, we ask you to stay tuned as we finalize our pricing and packaging strategy. Similar dynamics can be observed in other tech companies as they launch beta programs and determine appropriate pricing models, and we are following that same path. Importantly, we are fully committed to building this technology as we believe it will significantly change how we manage unstructured data and content.

Steve Enders, Analyst

Thanks for taking the questions.

Aaron Levie, Co-Founder and CEO

Yes, thank you.

Josh Baer, Analyst

Thanks for the question and congrats on a nice quarter. I wanted to ask a few on use cases for Box, whether it's positioning for AI or cost cutting in this environment. Are there any use cases for Box that are really resonating around some of these themes today? And then separately or related, just wondering if you could talk a little bit about the mix of your customers that are using Box to collaborate in some way externally, like the external use case with partners or suppliers or customers or clients?

Aaron Levie, Co-Founder and CEO

Yes. To start with, a significant portion of our larger deals is increasingly contributing to our overall revenue. There is a strong emphasis on both internal and external collaboration with our product. One of our main value propositions is that in the defense industry, collaboration with the government or manufacturing partners is essential. Companies need solutions that are compliant, such as with FedRAMP, and offer advanced security measures while enabling secure and reliable data movement in and out of their organization. This focus on external collaboration is a fundamental aspect of our value proposition across various sectors like financial services, life sciences, health care, defense, and technology. Regarding near-term business, we are seeing a broad range of industries engaging with us, including significant activity in life sciences, health care, retail, and technology. The use cases we are observing center around our three core pillars: enhancing organizational security by protecting critical data, improving collaboration and workflows around content, and our platform's connectivity with various software applications. This makes us a central hub for content that integrates with tools like ServiceNow, Slack, Salesforce, and Microsoft Teams among others. Our focus on these areas continues to be strong. While I wouldn't link any major deals in Q1 specifically to this development, we have noticed a growing number of conversations regarding the AI strategies of our customers and enterprises. There is considerable interest in our Box AI offerings, and more CIOs and even some CEOs have reached out to us about our AI strategy than we have seen with previous technology trends. Companies are actively exploring how to implement generative AI into their enterprise use cases, which entails significant effort in bridging AI models, customer data, and cloud infrastructure. We believe we are well-positioned to assist our customers in this endeavor.

Josh Baer, Analyst

Thanks, Aaron. If I could sneak one in for Dylan. Just wondering on the $6 million in early renewals, if you could provide some more color on what type of customers? What's driving that behavior? And then I guess, in regard to Q2 billings guidance, does that assume that the early renewal trend stops?

Dylan Smith, Co-Founder and CFO

Yes. So in terms of what's driving those early renewals, tends to be a handful of larger customers, and the main dynamic that would cause a customer and similarly in Q1, what we saw to decide to renew early is typically to move into suites and be able to support some of the higher-value newer use cases that they want to get into rather than, for example, waiting for the natural renewal cycle the following quarter to be in to adopt suites and those capabilities. So that tends to be what we see is just the clear buy-in and understanding the value proposition from customers and just wanted to move more quickly to take those on. And the most of that $6 million did come out of Q2, and we always tend to take a fairly conservative approach kind of the baseline of early renewals that we see, and that's baked into our kind of billings expectations in any given quarter so we're not necessarily expecting to see the same type of volume that we saw in Q1, but we would expect to see some customers elect to early renew in the second quarter as we tend to see maybe in the quarter.

Josh Baer, Analyst

Great, thank you.

Operator, Operator

Your next question comes from the line of Pinjalim Bora with JP Morgan. Your line is open.

Pinjalim Bora, Analyst

Great. Hey, thank you so much for taking the questions. Congrats on the quarter. Aaron, on AI, I understand you can't really talk about the monetization at this point. But as you're talking to your customers, what are you hearing from them in terms of uptake of these AI functionalities? And do you overall see kind of area as an accelerant to the growth rate maybe in the medium term?

Aaron Levie, Co-Founder and CEO

Absolutely. In discussions with customers, I've noticed a remarkable level of focused energy around AI that I haven't seen in my fifteen years with Box. In the past, it took us several years just to educate enterprises on the advantages of cloud computing and to see significant adoption across businesses. In contrast, with AI, there appears to be a swift convergence of interest among customers in exploring new use cases and products. Technologies like ChatGPT are in the spotlight, with some companies choosing to restrict its use while others embrace it. The question many businesses are grappling with is where the most significant productivity gains will arise—whether from direct interactions with an AI interface like ChatGPT or from AI analyzing existing data and workflows to enhance productivity. Through Box AI, we aim to assist customers in both areas. With Box Notes, users can generate content quickly using our AI model, and forthcoming features will enable inquiries about their existing data. We're just at the beginning stages of these engagements. For instance, some companies have extensive collections of documents—be it contracts, life sciences research, or other specialized content—and they're eager to derive insights from this information, track trends, and ask relevant questions. Currently, they rely on manual efforts to sift through this data, often unable to pursue more thrilling use cases due to limited human resources or high costs. AI can unlock the value of the data these companies already have within Box or by moving more of their data to us. We're witnessing some fascinating conversations, such as organizations believing they can discover new life sciences breakthroughs if they can link insights across various research documents. Similarly, in the advertising sector, one company is optimistic they can boost revenue by identifying the best projects for advertisers—insights that would require aggregating data across their entire organization. These kinds of use cases have great potential to enhance productivity and open new revenue streams for our customers, which is where we plan to focus our efforts. Regarding revenue acceleration, it's essential to be cautious given how early we are in this journey. We anticipate that AI will soon be foundational for all modern software, driving companies to restructure their data and content into secure, compliant cloud architectures while moving away from outdated, fragmented systems. We expect to benefit from this shift, but we also acknowledge that companies have a limited budget for new AI initiatives, which will create competition for that funding. Thus, we want to approach this situation with care.

Pinjalim Bora, Analyst

Got it. Very, very helpful. And one for Dylan. Dylan maybe the macro situation, the softness in the SMB and the EMEA. Maybe talk about the linearity of the quarter? How did that kind of fall through the three months in the quarter? Was it to towards the end, towards the beginning. And also, if you can touch upon kind of the sequential revenue decline. Is that largely because of Box Consulting?

Dylan Smith, Co-Founder and CFO

Sure. So starting with the linearity. We saw a pretty normal linearity in the first quarter both in those segments you mentioned, as well as the rest of the business, like our enterprise segments. So nothing unusual from that standpoint. And then in terms of the sequential revenue decline, that was primarily driven by the number of days that we had that there are in Q1 versus Q4, which has about a $9 million impact to the quarter's revenue versus Q4. And then there was also a couple of million dollars from a very strong Box Consulting revenue outcome in the fourth quarter. So those combined add up to about $11 million. And then the first of those, the todays dynamic, that's something that is not unique to this year, but usually doesn't show up in as pronounced of a way as we typically have a stronger and higher volume of bookings in the fourth quarter to offset that. But that was the main driver of the sequential chain of revenue.

Pinjalim Bora, Analyst

Got it. Very helpful, thank you.

Operator, Operator

Your next question comes from the line of Jason Ader with William Blair. Your line is open.

Jason Ader, Analyst

Thank you. Aaron, I wanted to continue the discussion on AI. First, I’d like to consider it from two perspectives. At a high level, what does this mean for knowledge worker positions, and is there any concern about that? Secondly, taking a more critical view, how does the competitive risk from Microsoft change, given that they have been leading in this area? On a more positive note, regarding monetization, I’m curious about how you might be leveraging this internally to enhance your cost structure and what your thoughts are on that. Dylan, feel free to add your insights as well.

Aaron Levie, Co-Founder and CEO

Yes, great. We'll try and cover those. So on the first one, and just so I clarify, that was sort of like a meta kind of philosophical question on seat changes over time.

Jason Ader, Analyst

Yes, just a pool of knowledge workers potentially not growing as fast as it would have otherwise.

Aaron Levie, Co-Founder and CEO

Yes, I believe from both a personal and corporate financial perspective that we are still in the early stages of our total seat population, which informs our view on Box's potential. I am confident this will positively impact knowledge worker productivity rather than serve as a replacement for large amounts of knowledge work. If you consider the tasks performed by our approximately 2,500 employees and those we collaborate with, most of the work consists of many subtasks that require a significant amount of context. AI is targeting these individual and grouped subtasks in ways that will enhance our overall productivity. Some roles might see a 5% productivity increase, while others could see up to a 50% increase. Ultimately, this means we will accelerate into the future more quickly rather than doing less work. Companies will want to grow faster through AI by enhancing employee productivity. In general, we expect to see increased numbers of graphic designers and engineers, and our sales representatives will work more efficiently with customers. Over time, this will create greater demand for those skills as companies become more efficient. Instead of sales reps or engineers spending time searching for information, they can focus on the more enjoyable and productive parts of their jobs, such as engaging with customers or developing features. This perspective reflects my optimism regarding the impact of AI on jobs. Regarding Microsoft, we are partnering with OpenAI, which naturally leads to a broader partnership with Microsoft since OpenAI's models typically run on Azure. There are exciting possibilities in this collaboration, allowing customers to access the same AI features they see in Microsoft products within Box as well. This enhances our relationship, especially with CoPilot, which already facilitates integrations with third-party software. Box was highlighted as a key integration at the Build conference recently. We will integrate closely across CoPilot and the various API endpoints they develop, enabling a seamless flow of data from Box and other platforms like Atlassian or Salesforce. Strategically, we plan to focus more deeply on content-related AI use cases than any other competitor, which is central to our value proposition and expertise. Our neutrality also serves as a significant advantage for our customers; while OpenAI has leading models and we've announced a partnership with Google, we can remain impartial in technology choices. This position allows our customers to benefit from various breakthroughs emerging in the market. Regarding our cost structure, I’ll let Dylan elaborate, but we aim to ensure our employees are as productive as possible by leveraging technology.

Dylan Smith, Co-Founder and CFO

And to build on that, I think our approach internally is pretty similar to what Aaron described on the overall knowledge worker dynamic, and it's a bit early to tell just exactly how this impacts everything and how AI ends up being embedded in the various tools that we use as Boxers. But broadly, we absolutely view it as a way to boost productivity. And so automating basic questions that Boxers will be answering is one example of that, an assistant to the subtasks that Aaron mentioned. And then there's just a lot of other cool ways for specific functions where, for example, can really supercharge the capabilities of our security instant response team and kind of identify anomalous activities on Box to be able to flag certain threats earlier. So I think it's really a lot of different jobs are going to be impacted in different ways, but we view it more as supercharging productivity and getting as much value out of the different tools that we're using as possible.

Jason Ader, Analyst

Great, thank you.

Operator, Operator

Your next question comes from the line of Tom Blakey with KeyBanc. Your line is open.

Tom Blakey, Analyst

Hey, thanks for taking my question. I have a few questions. Could you comment on the longer duration in deals? It’s interesting, given the current macro environment. Could you highlight why this might be happening, whether it's due to strategic reasoning or possibly discounting? Secondly, you mentioned weaker bookings at the end of fiscal 4Q. Could you comment on booking trends for fiscal 1Q and into fiscal Q2? That would be helpful. Finally, my question about AI relates to its usage in your business model. I've noticed some impact on companies' gross margins, which may be attributed to the consumption-based model. It would be helpful to get your thoughts on the long-term outlook regarding AI and margins. Thanks for your insights.

Dylan Smith, Co-Founder and CFO

Sure. Let's begin, and if I miss anything or the question is unclear, I'm happy to address it. Regarding the duration aspect, we have observed consistently over several quarters that despite a challenging macroeconomic environment, our customers are increasingly viewing us as a long-term strategic partner. Particularly with suite deals and our larger clients, these often involve multiyear renewals. When you factor in the trend of more customers opting for early renewals, this extends the average contract durations. This combination has contributed to a significant backlog growth of 22% year-over-year, not due to any unusual pricing strategies or discounting but rather because customers have long-term confidence and are choosing to sign longer contracts with us. When comparing booking trends from Q4 of last year to Q1 of this year, I would characterize them as fairly similar, with most areas of the business performing steadily and meeting our expectations. We did notice some slight softening in U.S. commercial and EMEA customers. While it’s early to provide insights on Q2, our expectations and what we are observing in the business are reflected in the guidance we've shared. Regarding the gross margin, the inquiry was focused on how we believe AI will specifically impact that.

Tom Blakey, Analyst

No. We've observed some companies offering AI functionality to customers, which has negatively affected their business model in terms of gross margin. I was curious if you would like to address that.

Aaron Levie, Co-Founder and CEO

Yes, this is Aaron. I'll respond to that. It relates back to the initial point; we aim to make some basic use cases more widely accessible, and because these are generally lighter, we expect them to have a lesser impact on our gross margin. For the more advanced and higher-end use cases, we plan to charge customers either by upgrading them to higher-tier plans or through our platform's consumption models. Overall, we are taking steps to mitigate any potential pressures. We are very optimistic about improving our long-term gross margins. We believe some of these capabilities will become standard offerings, but we don't anticipate them affecting the numbers we report.

Tom Blakey, Analyst

Very helpful, thank you.

Operator, Operator

Your next question comes from Chad Bennett with Craig-Hallum. Your line is open.

Chad Bennett, Analyst

Great, thanks for taking my questions. So just a follow-up on the duration question. So just in terms of how we think about the kind of the economics you've laid out on moving from kind of a single seat kind of point product to suite in Enterprise Plus and whatnot that you've laid out over a couple of Analyst Days, are those economics or uplift are they still intact with the longer-duration deals? I'm assuming these longer duration deals kind of lean more suite driven than anything else. Just any commentary on how those economics are playing out?

Dylan Smith, Co-Founder and CFO

Yes, we are seeing stronger customer economics across the board, especially with the pricing increase when comparing a typical suit or enterprise plus customer to a similarly sized customer using only the basic service. Currently, we are observing approximately a doubling in price per seat. Additionally, since we launched Suites and Enterprise Plus, these deals have generally been longer-term multiyear agreements. As more of our revenue shifts towards these customers, we are seeing higher average contract durations. There hasn't been a significant change recently, and we have noticed that our backlog has been growing at a faster rate than revenue or deferred revenue for quite a while now.

Chad Bennett, Analyst

Okay. And then just to reflect on net retention, considering your churn rate continues to improve or remain at historically high levels, net retention has decreased from 112 to 106 today. Can you rank whether the main drivers of this deceleration are seat growth or suite adoption?

Dylan Smith, Co-Founder and CFO

Yes, certainly. To provide clarity for everyone, our net retention rate consists of three key components. These include seat expansion, the effects of pricing changes, and the overall churn rate, which results from these two expansion factors. In this instance, it's clear that most of the change is due to reduced seat expansion. We have seen ongoing, steady improvements in price per seat, primarily because more customers are transitioning to higher-priced suites. Additionally, the overall churn rate has remained stable and robust. Therefore, the primary factor influencing our net retention is the decline in the seat expansion rate.

Chad Bennett, Analyst

Okay. Did you comment on how to think about billings growth for the year compared to revenue growth? Thanks.

Dylan Smith, Co-Founder and CFO

Yes. So we expect our reported billings growth to be in the mid-single-digit percentage range, and that does include a little more than 100 basis point headwind from FX. So in the general range of our expected reported revenue growth of 6% is how we describe that.

Chad Bennett, Analyst

Great, thanks so much.

Operator, Operator

Your next question comes from the line of Rishi Jaluria with RBC. Your line is open.

Rishi Jaluria, Analyst

Wonderful, hey, Aaron, hey Dylan. Thanks so much for taking my questions. Two for you. First, I'll cross another generative AI question just because it's so top of mind for everyone. But I want to think about the opportunities for you to maybe verticalize gen AI, especially given you are targeting a lot of verticals like health care, financial services, public sector, where, in many cases, you are a system of record. So it feels like there's some potential benefit there. But maybe if you could walk us through how you're thinking about the verticalization opportunity. That would be helpful. And then I've got a quick follow-up.

Aaron Levie, Co-Founder and CEO

Yes, you're correct that the value of AI significantly increases when it is closely integrated with specific business processes and domains. While the broad productivity features are compelling, the real business value emerges when we can collaborate with healthcare providers to automate crucial workflows for health record reviews or document creation. Similarly, we can assist talent agencies in efficiently routing movie scripts to the appropriate agents or help finance teams analyze earnings reports and extract key insights. Over time, we will identify specialized areas based on recurring use cases and concentrated customer needs. Our professional services team, partners, and sales strategies will work to simplify the adoption of these capabilities for clients. We will also establish workflow patterns within our platforms that utilize AI through tailored templates for different industries. There are numerous ways these developments will begin to manifest within our products, and we are just beginning to explore their potential. I believe that these vertical use cases will play a key role in delivering value.

Rishi Jaluria, Analyst

Wonderful. Really helpful. And then really quickly, apologies if I missed this. Any color on momentum in Japan and how we should be thinking about that going forward for the rest of the year?

Aaron Levie, Co-Founder and CEO

Yes. Overall, I would say we remain quite resilient. We experienced several strong wins this quarter, encompassing government agencies, manufacturers, and financial services, making it a solid quarter in Japan. We maintain reasonable and healthy expectations for our results this year.

Rishi Jaluria, Analyst

Right. Wonderful. Thank you so much.

Aaron Levie, Co-Founder and CEO

Yes, thank you.

Operator, Operator

This concludes our question-and-answer session for today. I now would like to turn the call back to Cynthia Hiponia.

Cynthia Hiponia, Vice President, Investor Relations

Great. Thank you, everyone, for joining this afternoon, and we look forward to updating you on our next earnings call.

Operator, Operator

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