Box, Inc. (BOX) Q1 2017 Earnings Report, Transcript and Summary

Good day and welcome to Box first quarter fiscal 2017 earnings conference call. This call is being recorded today, Wednesday, June 1, 2016. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management’s prepared remarks. [Operator Instructions] It’s now my pleasure to turn the floor over to Alice Lopatto of Investor Relations. You may begin.

Good afternoon, everyone, and welcome to Box’s first quarter fiscal year 2017 earnings conference call. On the call today, we have Aaron Levie, our CEO; and Dylan Smith, our CFO. Following our prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website where this call is being simultaneously webcast. The webcast replay of this call will be available for the next 90 days on our company website under the Investor Relations link, www.box.com/investors. During portions of today’s call, we will be referring to presentation materials posted on our Investor Relations website. We’ll also post highlights of today’s call on Twitter at the handle @BoxIncIR. On this call today, we will be making forward-looking statements, including our Q2 and FY 2017 financial guidance and our expectations regarding our financial results, market adoption of our solutions, our market size, our operating leverage, our expectations regarding achieving positive cash flow and future profitability, our planned investments and growth strategies, and expected benefits from our new products and partnerships. These statements reflect our best judgments based on factors currently known to us and actual events or results may differ materially. Please refer to the press release and the risk factors in documents we filed with the Securities and Exchange Commission, including our most recent quarterly report on Form 10-Q for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements. These forward-looking statements are being made as of today, June 1, 2016 and we disclaim any obligation to update or revise these statements. If this call is reviewed after today, the information presented during this call may not contain current or accurate information. In addition, during today’s call, we will discuss 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 in the related PowerPoint presentation, which can be found on the Investor Relations page of our website. Unless otherwise indicated, all references to financial measures are on a non-GAAP basis. With that, let me hand it over to Aaron.

Thanks, Alice and thanks everyone for joining our Q1 FY’17 earnings call. We had a solid start to fiscal 2017. We had strong customer momentum adding more than 5000 new customers in Q1, our largest number of new customers in a quarter. We also had wins and expansions with leading companies like Airbnb, GEICO, Whirlpool and Wyndham Hotels and Resorts. We now have more than 62,000 total paying customers. In addition, we continue to improve our already best-in-class customer retention with our customer churn rate improving to just below 3%. These metrics showcase how valuable and essential Box is to our growing global customer base. In Q1, we achieved record revenue of $90 million, up 37% year over year. We also continue to gain operational efficiency and demonstrate leverage in our business model as we move towards our commitment to achieve positive free cash flow in the fourth quarter and in January 2017. Cash flow from operations in Q1 improved to negative $500,000 in the quarter, excluding a one-time litigation settlement. This represents an improvement of roughly $7 million year over year. And non-GAAP EPS was negative $0.18, a $0.10 improvement from last year, well ahead of our guidance. Q1 billings came in at $76 million. As we noted in our last earnings call, we anticipated Q1 billings to be impacted by a few early renewals last quarter and our focus on annual payment durations versus multi-year prepayments. Lastly, as we’re becoming a more strategic investment for our customers, larger transactions are shifting towards later in the year. Looking ahead underlying demand for Box remains very strong and our competitive position in the market has never been better. Coming off of Box World Tour where we engaged with thousands of customers and prospective clients, we created record sales pipeline in the quarter with several seven figure deals in the mix. This has been driven by the growing demand for a modern approach to enterprise content management, our differentiated product offerings and our maturing partnerships that are becoming an integral part of our go- to-market strategy. 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 momentum coupled with our focus on improved operational efficiencies underscores our confidence in our position as a modern content management platform. At Box, our mission is to enable people and organizations to work collaboratively and have secure access to the information they need from anywhere. Today, we live this purpose by helping scientists at MD Anderson Cancer Center share research results to discover lifesaving treatments, and engineers at GE collaborate on new designs and filmmakers at Pixar create their best work. To address the needs of every organization and to go after the tens of billions of dollars that is spent every single year on content management and storage, we laid out three key strategic goals for this year. The first is to grow as a multi-product company, allowing us to deliver more innovation for current customers and penetrate new markets and industries. The number two goal is to expand our addressable market to include hundreds of millions of more users to the Box platform, and thirdly, build a world-class partner ecosystem that extends the capabilities of Box and increase their distribution. In Q1 we made significant progress against all three objectives. On our multi-product strategy, we made several announcements in Q1 that remove the barriers to cloud adoption and make Box more valuable to our customers. In April, we launched Box Zones which for the first time will enable our customers to store their Box data in regions outside of the US beginning with Europe and Asia. We've been working on the architecture for Box Zones for over two years which allows us to leverage public cloud providers like IBM Cloud and Amazon Web Services to meet our international customers’ data residency requirements while minimizing CapEx investments. Storing data in-region addresses many data residency and compliance concerns for global companies, enabling Box to serve previously unreachable enterprises for the very first time. We also expect existing customers will leverage Box Zones to implement Box across more parts of their organization. For example, Royal HaskoningDHV, an international engineering consultancy with 6500 employees and a large Box deployment today is now looking to leverage zones to standardize all of their content on Box. Box Zones follows other leading edge products like Box Governance and Box KeySafe that also unlock new use cases for customers and further positions Box as the leading content management platform. Box Governance continues to gain strong momentum with new and existing customers. Just one example, in Q1 a Fortune 500 company that offers financial planning services deployed Box Governance to retain more than 500 million regulated documents. By switching to Box from a legacy content management system the company is saving millions of dollars in infrastructure costs. With these new products customers are able to leverage Box to both transform their business and retire legacy storage and content management software. A new extensive research report by Forrester has found that customers at scale are saving millions of dollars driving their productivity and improving their security with Box. Finally, in early May, we launched Box for Government and announced that Box achieved FedRAMP certification from the U.S. Department of Defense. Because of our FedRAMP authorization government agencies can more easily deploy Box at scale. Box for Government joins other key industry initiatives like health care and financial services and allows us to accelerate our traction in the government where we already have great customers like the US Department of Justice, the States of New York, California and Washington and the United Nations. Achieving FedRAMP was a long multi-year process and I'm proud to say that Box is the only cloud content management platform to secure the certification. We also continued to make significant progress to Box platform in Q1. 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. To further drive growth and utilization of Box platform in Q1 we announced the partnership with Cognizant naming them as a preferred systems integrator. Cognizant’s expertise in key verticals will provide an opportunity to develop and deliver more industry solutions for healthcare, life sciences, financial services and retail. We also work with IBM as they launch their IBM MobileFirst for iOS Expert Seller app built on the Box platform. IBM Expert Seller is both used and sold by the IBM Global sales force offering seamless management of sales and marketing collateral to help sales team securely access their content and make the most of every interaction they have with clients and prospects. Given our partnerships with both IBM and Apple we expect their joint MobileFirst program to be a strong user of Box platform moving forward with several other apps in the pipeline. Our third strategic objective is building an unparalleled partner ecosystem. As more and more software moves to the cloud, enterprises are looking for a single repository to secure and manage their critical content. By creating seamless integrations with leading technology partners we’re able to provide customers with a centralized content management platform that lets them secure, govern and collaborate on files no matter what application they're using. At the end of Q1 we announced a new strategic relationship with Adobe to make it easier for customers to work with Box and Adobe’s Acrobat e-signature and document cloud experiences. For instance, customers of Adobe document cloud can now access their files stored in Box and Box users are able to edit and sign documents with Adobe Sign directly from Box on both mobile and desktop. And nowhere is our ecosystem strategy more relevant than our partnership with Microsoft which continues to yield significant dividends. For the first time ever customers can now collaboratively edit their Office documents that are stored in Box or edit them on their iPad or iPhone. Adoption of Office 365 continues to be a key driver for new customers to invest in Box as well as allow existing customers to expand their usage of Box. For example, a Fortune 500 commercial real estate company recently expanded with us increasing their deployment to 10,000 seats while rolling out Office 365. And AutoTrader, another significant Box customer, has seen major productivity and adoption gains since rolling out Box with Office 365. We will continue to work with Microsoft on further integrations with O 365 and their other platforms to drive more valuable -- more valuable experiences for our customers. Additionally we have a comprehensive slate of partners that we’re working with to create enhanced experiences and ensure customers can get access to their Box content from just about every application they work in. Overall Q1 was a solid start to fiscal 2017 as we continued to make strong progress on our strategic objectives while continuing to drive operational efficiency. Before I finish, I want to take a brief moment to emphasize Box's unique proposition and why we continue to lead in the enterprise content management and collaboration markets. First, we build the only enterprise content management platform that is 100% cloud based. With Box, enterprises get a modern architecture that solves everything from end user file sharing and collaboration to more mission critical content management use cases. And because of our cloud architecture we deliver new product innovations rapidly that meet the evolving needs of our customer base faster than any legacy competitor. Second, Box is a platform agnostic solution with an open architecture. With Box, content can be centralized and we can serve as a single source of truth for a company’s information. Our apps on iOS, Android, Windows and the web as well as integrations with partners like Adobe, Adobe, DocuSign, IBM, Microsoft, Salesforce, Slack and others allow customers to minimize their costs and confusion of spreading content across multiple solutions. Finally, we’re the uncontested leader in security. We provide robust administrative controls, watermarking, data loss prevention, customer managed encryption keys, document retention and compliance. Because of these unmatched capabilities we’re uniquely positioned to work with the world's leading financial institutions, engineering companies, life sciences firms, healthcare providers and governments. Our differentiation continues to increase and we are proud to be recognized by Forrester as the leader in enterprise file sync and share beating our competitors like Microsoft, Google and Dropbox. Going forward we have an ambitious and extremely exciting roadmap of innovation that we're thrilled to be announcing over the next several months, including At Box Works in September, which is shaping up to be another incredible event for Box and our customers. We already have Diane Green of Google, Peggy Johnson, Executive VP at Microsoft and the CIOs of Walmart, Dow Chemical and many others speaking at the event with many other announcements to come this summer. Now I’ll hand it over to Dylan to review the financial results in more detail.

Thanks, Aaron. Good afternoon everyone and thank you for joining us today. As Alice noted, you will find GAAP to non-GAAP reconciliations in the slides that are available on our website. The financial measures I will be discussing on this call are non-GAAP unless otherwise noted. We had a solid start to fiscal 2017 with both revenue and non-GAAP EPS coming in well ahead of our guidance as we continued to converge on becoming free cash flow positive in the fourth quarter of this fiscal year, roughly nine months from now. As Aaron noted, this quarter we drove record revenue of $90 million, up 37% year over year while adding more than 5000 new customers. Billings came in at $76 reflecting a number of factors that we discussed on our last earnings call and which I'll revisit in further detail later on this call. Deferred revenue grew to $172 million, up 39% from a year ago, demonstrating strong visibility and health in our future revenue. We achieved these top line results while driving significant leverage in our bottom line metrics. We delivered non-GAAP EPS of negative $0.18, an improvement of $0.10 from a year ago and well ahead of the high end of our guidance range. Our cash flow from operations was another highlight, improving by roughly $7 million from Q1 of last year to approximately negative $500,000, excluding $3.8 million in settlement costs associated with our previously announced OpenText litigation. These results demonstrate solid progress toward becoming free cash flow positive as well as the inherent leverage in our business model. Our best-in-class churn rate is now slightly below 3% annualized, an improvement of more than 100 basis points year over year. This reflects our increasing focus on enterprise customers who tend to have lower churn rates as well as the increasingly mission critical nature of how Box is being used by many of the world's largest enterprises. Our expansion rate was 19% primarily driven by strong seat growth in existing customers. This rate is now stabilizing and as we benefit from cross-sell opportunities with our new products, we expect this will offset the natural pressure from our expanding and maturing customer base over time. As a result, we ended the quarter with the retention rate of 116% which includes churn and expansion. Our ability to achieve strong revenue and customer growth while delivering meaningful improvement on our bottom line reaffirms that we are well positioned to grow quickly and sustainably as we scale toward profitability. Now let me begin with some highlights from our fiscal Q1. We generated record revenue of $90.2 million in Q1, above our guidance and up 37% year over year driven by our expanding enterprise customer base and our best-in-class retention rate. As you'll recall, this quarter we faced three factors that combined to create a tough comparison for Q1 billings. First, we began to standardize customers paying for multiple years upfront to annual billing terms in order to maximize long term contract value, shortening our average payment durations as a result. Second, in Q4 we renewed 4 million of customer contracts that would have normally been billed in Q1. Finally we had a particularly strong Q1 last year when we grew billings by 58% year over year. As we mentioned previously, we do not expect billings to be a meaningful indicator of the significant growth we expect this year. First quarter billings came in at $75.9 million, representing 9% calculated billings growth and 13% adjusted billings growth year over year. If we normalized for payment durations and those early renewals which create the most accurate year-over-year comparison, our billings growth rate would have been 19% year over year which is still clearly impacted by our strong Q1 last year. As we noted on our last earnings call, we fully expected Q1 billings growth to be well below Q1 revenue growth and we would expect billings growth to trend below revenue growth for the remainder of fiscal ’17 due to the aforementioned shift in payment durations. As we enter fiscal ’18 and these payment durations normalize, we would expect billings growth and revenue growth to track roughly in line going forward. As we shift further into an enterprise-driven business model we continue to see our business becoming more backend loaded from a quarterly billings perspective. As we’re becoming a more strategic investment for our customers we're experiencing additional seasonality with Q1 typically being slower for larger transactions and more of these transactions shifting to later in the year. We saw this trend materialize with a significant increase in large deals closed this past Q4 and fewer large deals in this most recent Q1. This past quarter we closed 17 deals over $100,000 versus 20 a year ago and no deals over $500,000 versus four year ago. As Aaron mentioned in Q1 we generated record pipeline which includes a healthy number of seven-figure deal that we're working on closing later this year. Turning to deferred revenue. We ended the first quarter with $172.2 million in deferred revenue, up a solid 39% year over year providing us with strong revenue visibility going forward. Now let's take a look at non-GAAP gross margin Non-GAAP gross margin came in as expected at 72.4%. As you’ll remember from our last earnings call, we highlighted that we expected gross margin to decrease slightly in the short term. In anticipation of strong customer demand which drives greater datacenter capacity needs, we plan to make continued infrastructure investments over the course of this fiscal year. These investments will allow us to extend our best-in-class service quality, security and reliability. As such, we continue to expect gross margin to stabilize near these levels for the remainder of this fiscal year. Sometime in FY ’18 as we grow into our expanded datacenter footprint and achieve greater infrastructure efficiencies and economies of scale we expect non-GAAP gross margin to trend back upward. For example, we recently moved in frequently accessed files to a lower cost storage tier with Amazon reducing our cost to store those files by more than 30%. In Q1 we had another successful quarter of gaining greater operational efficiency with reduced total operating expenses in dollar terms for the second quarter in a row. Sales and marketing expenses during the quarter were $54.2 million, representing 60% of revenue, a notable improvement sequentially and from 80% in the prior year. This includes a year-over-year decrease in the cost to support our free user base at 8% of revenue in the first quarter, an improvement from 14% in the same quarter a year ago. We remain very focused on improving sales and marketing efficiency which is a key driver of leverage in our business model. For example, this quarter we saw particular strength in the deals we closed through our online sales channel which contributed to the number of new customer wins this quarter and reduced our costs to acquire new customers. And as our customer base grows we will naturally benefit from more efficient expansion and renewal sales. As Aaron mentioned, while we remain focused on driving operational excellence and managing expense growth across all areas of our business, we will be increasing our target of field based sales rep hires based on the growing demand and opportunity we're seeing in our market both in the U.S. and internationally. Next, research and development expenses were $20.4 million, or 23% of revenue, an improvement from 27% of revenue a year ago as we made significant investments in our new products. Box Zones became generally available just last week and we continue to build out our enterprise content management capabilities to further expand our total addressable market. While we expect leverage in research and development we are also committed to furthering our leadership position with the most innovative offerings and best-in-class product development and thus expect continued investment here. Our general and administrative costs were $13.3 million or 15% of revenue, a significant improvement from 20% in the prior year quarter and was lower sequentially in absolute dollars. On a year-over-year basis, two points of this improvement was associated with higher legal costs a year ago primarily associated with the OpenText litigation which is now behind us. As a reminder, we've now completed our headquarters move and our Q1 results reflect a lower rent expense that we expect to see going forward. We will continue to drive leverage from greater operational efficiencies and scale in G&A. We are extremely pleased that our improvements in operational efficiency drove our Q1 non-GAAP operating margin to a significant 25 percentage point improvement year over year, coming in at negative 25% versus negative 50% a year ago. In addition to cutting our losses in half in percentage terms, on a dollar basis non-GAAP operating losses narrowed both year over year and sequentially for the second quarter in a row. These strong trends demonstrate our improved operational discipline and focus on operational efficiency. Let me now move on to our cash balances and cash flow. We ended the quarter with $211.4 million in cash, equivalents, short term marketable securities and restricted cash of which roughly $28 million was restricted. We delivered cash flow from operations at a near breakeven rate for the second consecutive quarter at approximately negative $500,000 excluding the payment related to our OpenText settlement. This represents an improvement of 93% year over year. In Q1 total Cap Ex was $11 million. Of this approximately $9 million was the final spend on tenant improvements related to our new Redwood City headquarters and the remaining $2 million was related primarily to data center investments. Having now completed our headquarters move, we would expect Cap Ex to be materially lower for the foreseeable future relative to our past four quarters. We’re committed to becoming free cash flow positive in our fourth quarter ending January 2017 and to remain free cash flow positive on an annual basis thereafter. Now let's turn to our guidance. For the second quarter of fiscal 2017 we expect revenue to be in the range of $94 million to $95 million. We expect our non-GAAP EPS to be in the range of negative $0.19 to negative $0.20 and for our GAAP EPS to be in the range of negative $0.36 to negative $0.37 on approximately 127 million shares. For the full year of fiscal 2017 we expect revenue to be in the range of $391 million to $395 million which represents roughly 30% growth at the midpoint of this range. We expect our non-GAAP EPS to be in the range of negative $0.75 to negative $0.78 and for our GAAP EPS to be in the range of negative $1.40 to negative $1.43 on approximately 128 million shares. In closing, we are proud of achieving strong customer adds in the quarter, solid revenue growth and significant leverage in our business model. Our product differentiation continues to expand with the launch of Box Zones and Box for Government and traction with Governance, KeySafe and Box platform. We continue to expand our partner ecosystem with new partners, including Adobe and Cognizant and existing partners such as IBM and Microsoft. And alongside our growth we main committed to driving efficiencies on our path toward profitability which we demonstrated again this quarter. With that, I would like to open it up for questions. Operator?

[Operator Instructions] We’ll take our first question from Phil Winslow with Credit Suisse.

Thanks guys for taking my question. Just want to drill in to the deal size metrics that you talked about. Obviously the customer adds at 5000 is particularly strong for Q1. But then you talked about, obviously the deal metrics year over year 100K deals et cetera, coming down, I understand that it was a strong Q1 but maybe give us some more color, sort of what you're seeing, and then in the context of the full year outlook, sort of any change on these larger deals which I'm assuming are more up-sell deals in that new versus what you're expecting, call it, three months ago?

Yeah. So this is Aaron. I think as you saw in the performance of Q4 in terms of the big deal metrics that we provided, certainly the business is becoming a little bit more seasonal for our larger transactions, Q1 was much more of a building period for us in terms of building pipeline across sort of all segments of the business and all regions. We are -- we did build a very very strong record pipeline in the quarter, including many many large deals that are in that mix that are -- the seven-figure level. And in terms of the 5000 new logos, a lot of this has been driven by innovations we've been working on for our online sales segment. So getting much more efficient about how we go out and acquire and bring on consumers in the sort of SMB segment but also giving us a lot of future up-sell customers in the mid market segments and beyond. So I think you'll see certainly bigger numbers be put up in terms of our larger deal sizes in Q2 and beyond.

And then just one quick follow up. I think you guys talked about exiting -- last fiscal you were at 44 million users, and I think it was 12% paid. Just wondering if we get a sense for where that was exiting Q1.

Yes. So we have 46 million users and about 13% of those users are now paying.

We’ll take the next question from Rob Owens with Pacific Crest.

Good afternoon. And thanks for taking my question. A couple of things. First off, just around strategic partnerships. Can you talk about how much of your business is partner influenced at this point, maybe share how IBM is ramping as well?

Yes. About 20% of our business is partner influenced and that’s through a mix of partners including AT&T and IBM. With IBM we saw again kind of record pipeline get created in the quarter because of IBM's customer base, obviously large enterprises and governments, a lot of those deals are much larger which means that the deal cycles do take a bit more time and we don't close those transactions within the quarter of the pipeline being generated. But we are seeing a tremendous amount of pipeline being built up with them, especially in international markets where we don't have as much of a presence on the ground. So we're seeing significant traction in really throughout Europe and that was also one of the big drivers for our Box Zones partnership with them. So the ability to use the IBM cloud for storing data in places like Germany, Ireland and other key markets that they operate in. So I think you're going to see pretty significant and healthy traction in a lot of international segments as well as larger businesses in the U.S. as well throughout this year.

And on the product fronts, realizing Box Zones is probably too new to really talk about. Some of the other capabilities you haven't had in the market for a while, whether it be Box KeySafe for some on that front, governance capabilities, can you talk about your success with those, what attach might look like at this point and then is pricing still holding for these up-sells? Thanks.

Yes. Pricing is still holding for the up-sells. We are still seeing about a 15% to 20% uplift in the ASP when the product gets attached or more. And we have nearly 300 customers that are on Governance right now. So we're still seeing a pretty strong growth with customers adopting Governance. The sales cycle for our add-on products is still something that we're figuring out. For each individual product there's a slightly different kind of sales dimension that Zones versus Governance versus KeySafe experiences but overall that mix of products is creating an incredible amount of differentiation against our competitors and providing significant uplift in the customers that elect to purchase those products.

This is Dylan. Just as a note, in Q1 both of the products, Aaron mentioned, KeySafe and Governance provide an uplift of more than 30% in the customers who deployed those products in the quarter. So we've been really pleased at the value that those products continue to provide to our customers and the uplift we're seeing as it relates to price per seat.

Thank you. Your next question comes from Mark Murphy with JP Morgan Securities.

Thank you very much. So Aaron, I wanted to ask you about the payment of the FedRAMP certification. What do you think it means for your business prospects with the federal government? And I'm wondering if you see potential for a blanket purchase agreement, do you see indications of interest or engagement from any of the agencies that are outside of the DOJ? And then I have a couple of follow-ups.

Yes. So one of the key elements of our certification is that it came from the Department of Defense which is -- which obviously has some of the highest degree of scrutiny around cloud platforms and technology that they use. So this is specifically from their information services organization. So we're very happy about who actually did the certification and who did the sponsorship. That is creating a strong ripple through at least the U.S. government, federal government agencies. But other state and local government agencies look toward the federal government standards for adopting cloud technology. So the pipeline has been growing. We actually have been working on building the pipeline even in advance of getting FedRAMP certification. FedRAMP certification is the actual ability to go transact with those agencies in a compliant way. So we're seeing really really strong traction in both civilian and defense agencies in the U.S. government as well as international agencies, so in the U.K. and beyond where we’re continuing to see strong traction. So we think this will be a key vertical for us and we'll certainly be sharing some of the results of this in future quarters once we get some of these bigger deals closed.

And Aaron, to what do you attribute the record pipeline growth that you mentioned in Q1? I'm just curious if there was something unusual about it and does that include any – does that include seven-figure deals that you think could be -- would be likely to close in Q2? Do you think we'll see some resumption there?

Yeah, we’re – we can’t give any specifics around on seven figure deals on when they close. But both the reason and a cause for the growth in Q1, we were doing a lot of -- we've been doing a lot of rebuilding on our marketing engine throughout sort of Q4 of last year and throughout Q1 of this year. So a lot of that execution is starting to fire on all cylinders. In terms of sales, the sales team was out in the field, really generating a lot of pipeline. This is a building quarter for us in many respects. We had our Box World Tour which interacted with thousands of prospective customers and existing customers from up-sell and as mentioned around IBM we're just seeing now a lot of that execution start to come to play. So being in the field with IBM with AT&T and others and starting to generate a lot of demand in those conversations. So I think when you put together all of the sort of major drivers of our go-to-market strategy we were executing -- we think in a very strong way throughout the quarter but it was very much a sort of building quarter for us.

And then Dylan, I had two quick ones for you. The first, I think you ended fiscal year ’16 with 1370 heads. Can you give us any thoughts on the headcount planned for this year, where do you think you would exit the year?

Sure. So we still expect to grow headcount although in a more metered rate than what we've seen in the past. What I would say and we could talk into the specifics a bit more is from a quota carrying AE headcount perspective before we had talked about sort of similar growth rate to what we had seen last year which was 13% year over year with the majority of that growth being in the field. And as Aaron and I mentioned recently on the call we expect that to be higher than our original target. So that would be an area for growth really building out our field sales organization both in the U.S. and internationally and many of the teams that support that. Similarly there are a lot of really interesting and exciting things we're doing from an infrastructure standpoint to making some investments in our technical operations team as well as continuing to invest in our engineering organization. So overall we would expect our headcount to grow year over year although at a more measured rate than what we've seen over the past couple of years, really making those big investments in the most mission critical areas as many parts of investment -- in many parts of the business we've done a pretty nice job of building a solid foundation and don't expect to see significant increases in headcount or costs in many areas of our business.

And then the final one, I did want to try to dig into the billings a bit. Do you think, Dylan, would it be reasonable to expect that this 19% normalized billings growth rate in Q1 could create a low watermark for the year in terms of that growth rate and/or any thoughts on just how we should construct our models in terms of deferred revenue and billings for the rest of the year? I don't think -- you haven't issued real granular guidance on that in the past but I'm just wondering if it's warranted given the kind of some of the unusual optics here?

Yes. So what I’d say is that because of really the relative strength of Q1 as I mentioned last year really was by far the strongest adjusted billings outcome that we've ever had as a public company, coming in at 53% and calculated billings at 58%. And we’re using that -- this was the toughest comparison from a year-over-year standpoint. And while that 90% does factor in the renewals, that was the other sort of one time nuance in Q1 that we wouldn't expect to see in other quarters. So while we would expect there to be lower billings growth versus revenue growth for the remainder of the year, we would also expect that spread to be less significant than what we saw in Q1, and I really sort of refer to the revenue guidance that we gave, to get an overall sense of how we are thinking about the growth going forward. And that on a quarterly basis we will continue to give additional color into payment durations and how the different billings metrics are tracking.

We’ll take our next question from George Iwanyc with Oppenheimer.

Thank you for taking my question. Just digging into the pipeline again. Can you give us a sense of how you look at your visibility through the end of the calendar year and given the larger deals that you're seeing at this point what a normal seasonality rate would be for the first quarter versus the fourth quarter?

Yeah. So I say that -- as we mentioned we would expect it to be more back heavy than what we've seen in the past. As a reminder, over the last couple of years we've seen an average of 18% and 34% of our total annual billings fall into Q1 and Q4 respectively and we’d expect that to be lighter in Q1 and stronger in Q4 just given the nature of what some of our biggest growth drivers are. And the other thing I’d note on visibility is in terms of new sales that we make, about 60% of those tend to be up-sells from existing customers and we have a pretty good sense of not just when those renewals are up but also what we usage is in those customers and tend to have a lot more visibility and predictability into when those deals will close. So we're still going to see that quarter to quarter variation that you'd expect to see as an enterprise software company but have a pretty high degree of confidence in that pipeline visibility as we talk through the seasonality.

And following up on the sales cycles, you talked about the larger deals taking a bit longer to get done just naturally. When you look at your overall sales cycles, are there any macro factors, are they getting longer, are they staying about the same, are you seeing any competitive impact from the prices that Microsoft made for OneDrive, any price sensitivity?

We're not seeing any changes in terms of the overall length of certain types of deals. I mean certainly we think about larger deployments especially when they are really focused on security, compliance, use cases where Governance might be involved or -- similarly we’d expect as we start selling more into the federal government we might see a longer deal cycle there but on a like-for-like basis we're seeing pretty consistent deal cycles year over year and really it’s just a function of the mix shift is why we tend to see longer deal cycles overall versus where we were a year or two ago.

And just finally on the competitive factor, are you seeing anything different with the Microsoft relationship?

We're not. No, so not only that’s not shown up in any of the deal metrics that we’re looking at but I’d also highlight that we continue to see very stable pricing in that $9 to $10 per user per month range which continues to be stable and we have pretty strong performance there in Q1 as well.

We’ll go next to Melissa Gorham with Morgan Stanley.

Thanks for taking my question. So I just want to dig into the billings dynamics just a little bit more. And then specifically related to the duration comment, I'm just wondering if you could give us some sort of guidance on what percentage of your base is currently on annual versus multi-years and then kind of how you expect that to ramp over the next year and over the next few years?

Sure. So I would say that the combination of customers in dollar terms who are billed for a year or longer is about 70% of our current customer base. The biggest shift and the biggest driver in the payment duration mix that I mentioned is really that shift from standardizing the customers who are paying for multiple years on to one year payment terms. And as mentioned on last call we've tended in the past to see somewhere in the mid to high single digit range in terms of percentage of customers prepaying for multi-years in advance whereas in Q1 we saw that at about 2% and we’d expect to see that type of shift going forward as being the biggest driver of that. And just as a reminder, the reason for that shift is given the strong top line performance that we saw last year and our strong visibility into becoming free cash flow positive, we really wanted to focus our sales team on securing annual billings terms. It is to really void giving discounts associated with multiple year prepayments, as we're really building a business for the long term and I think this is not just the right thing to do to maximize the long term contract value and revenue from our customers but also the right time to do so given our line of sight into becoming free cash flow positive.

That's really helpful. And then I just want to follow up on the comments on increasing the quota carrying sales heads. So just wondering if you can provide a little bit more detail on what the driver of that increase in hiring is, is related to you. And maybe you can just reconcile that guidance or that commentary with the outlook for operating margins to improve, where are you seeing improved sales productivity?

Yeah, so quickly on the context as we are selling more and more into larger enterprises, we're finding that productivity certainly goes up for sales reps when they can put more focus on a smaller number of accounts or named accounts in their territory. So as we are developing a much more consistent and predictable rhythm for selling larger transactions as we've seen in Q4, we want to make sure that we have the right number of people in the field that can go work on the next set of customers, the next set of transactions given the consistency of what that sale cycle looks like. So it's mostly a reflection of how we are seeing the market opportunity. The fact that our deals are getting much larger and that we see productivity going up and we can put more focus for our sales reps while still making sure we capture that opportunity.

Yes, and with respect to the metrics, I’d add, we’re very focused on improving sales rep productivity. As a reminder, last year we grew that by nearly 10% from fiscal ’15 to fiscal ’16 and we really hire and make these decisions in line with the demand we're seeing and based on the productivity outcomes we're seeing and we don't expect our increased hiring targets to have much of an impact on our rep productivity outcomes which is different from the overall sales and marketing leverage that we're driving in the business. So some of the more major factors that are allowing us to both increase our sales headcount and drive leverage over time is the online sales initiative that we've mentioned, we've been able to take a significant amount of costs out of the business as we focus reps further up market. The pipeline we're seeing and the lift that we're seeing and expect to continue seeing out of many of our channel partners with IBM in particular provide another area of a just way to drive more sales and marketing efficiency. And then finally I’d highlight the freeze of marketing expense where we've really been focused on streamlining those costs as we continue to double down and become more enterprise focused. We've seen that spend as a percentage of revenue drop by 6 points year on year from 14% to 8%. And there are a number of other things we're doing in order to continue improving our operational efficiency.

Next question comes from Aaron Rakers with Stifel.

Thanks for the question. A couple if I can. First of all, would you mind talking about the gross margin trajectory. I think last quarter you’d talked about the expectation of finding stabilization at current levels but yet we're still down about 90 basis points sequentially. So can you talk a little bit about how we should model that line item through the course of this fiscal year?

Sure. So we think about – and many of the sort of puts and takes we've talked about sort of balancing the continued data center investments with a lot of the operational efficiency improvement and scale that we're seeing in the model, I think net out to being roughly stable for the remainder of this year. So we’d expect this Q1 outcome to be pretty much what you could expect to see for the rest of fiscal ’17 and then over time as we scale -- and we expect to hit a point where we can mitigate those incremental investments and gain leverage in this line as well, by driving efficiencies both in the data center spend as well as the headcount, we'd expect our gross margin to begin trending back upwards some time in the fiscal ’18 year and then to remain in the 75% to 80% range longer term.

And then curious of what a materially lower CapEx trend looks like over the next couple of quarters?

Sure. So there was – largely speaking to the impact of the Redwood City CapEx, which was about $35 million net outlay that we saw over the previous – the trailing four quarters, and we wouldn’t expect to see that going forward as in Q1 was really the last part of that outlay, so that would be the biggest driver driving that material change. And then from an overall data center driven CapEx we'd expect that for the year, for that CapEx including capital leases to be in the 3% to 5% range of revenue which are a little bit lower than the sort of outlook that we've given a few months ago in the 4% to 6% range and that’s largely due to some of the efficiencies that we're finding as we continue to scale and build out our infrastructure.

And then a real quick final question is on again the quota bearing headcount expansion. You talked about 13% last year, I apologize if I'm a little bit confused -- are you saying that that rate of growth accelerates this year from the 192 that you had, or 192 total quota bearing heads that you have exiting fiscal ’16?

That's right. So earlier we said you could expect to see that headcount growth for AEs being roughly in line with that 13% and now we're expecting to see it a little bit higher than 13%. And just to give a bit more color to break it down, last year we saw about 20% growth in our field based quota carrying AEs and single digit growth in our inside sales force and that averaged out to 13%. And again this year -- just as last year we’d expect the most significant investments as it relates to our quota bearing headcount to be in the field.

We’ll take our next question from Joyce Yang with Bank of America.

Hi, thank you for taking my question. Aaron, I think if I heard you correctly, you mentioned that there was a Fortune 500 customer that increased deployment of 10,000 seats while rolling out Office 365. Can you talk about how the customer came to make that purchasing decision and kind of in which department were those seats deployed?

Yes. So that example is actually much more indicative of a broader trend where -- what we're seeing is Office 365 is incredible for doing things like online Office document editing, mobile device security, moving your email to the cloud but fundamentally customers still need a best-in-class content management and collaboration platform when using Office 365. 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.

So areas in companies where they're going to the cloud –

Yes, completely horizontal, so across every job function within the organization.

And just to follow up on that, what kind of – the 5000 customer adds, very impressive, and I'm curious to learn more about kind of what drove that strength versus say last year in Q1 you added a lot less customers, and kind of do you see change in environment in which these small medium businesses are approaching cloud and cloud storage? And also on top of that, what were the catalysts for companies that added – for some of the expanded deployments like Airbnb and Whirlpool?

Yeah. So actually last year is probably where we laid the foundation for this customer win where we've been doing a lot of improvements on our online sales and in online customer acquisition and transaction technology. So it's been about making it more efficient for customers to come on board on Box with being able to do that completely online in a much higher volume way. So that’s what’s driven a lot of the volume and then of course our continued investment in sales and marketing are just bringing on more and more customer logos. So that’s the difference over Q1 a year ago. In terms of what’s catalyzing customers to expand their adoption of Box, we see a natural rate of the users in these organizations virally adopting the technology. So in many cases we will deploy to an organization maybe 5000 or 10,000 seats but then Box will spread virally throughout that organization which allows us to go do an up-sell just in terms of the number of seats that that customer has. But there are many other cases where at a juncture of the partnership often times a renewal, the customer will decide to deploy Box more in a more sophisticated way across their organization, and that’s where things like Governance or KeySafe or Zones might come into play because that allows customers to move more of their strategic or mission critical business processes and content to Box. So it’s both seat based driven reasons for the customer expansion as well as enabling them to adopt Box for more use cases because of our new product innovation, both of those are driving the upsells of our customers.

We’ll take our next question from Richard Davis with Canaccord.

Two quick questions. Talking about hiring new reps and things like that, where are you kind of getting them from and what’s their experience level? And then the second question, if you could answer because it would help me explain to people as well. But is there any scenario when your costs go down that you get lower pricing because there’s still kind of an urban myth out there that if your cost of storage goes down this is actually a negative which in my opinion is probably a positive but those two topics would be great? Thanks.

Yes. So on the first thing on our sales rep background. We're obviously -- really we're evangelizing in a new market that is disrupting a legacy set of investments. So we look for sales reps that have that kind of capability. Often they've worked at other cloud companies and other SaaS providers but we've found success in people that have worked with a history in document management technology as well. So we've been successful with a very wide array of sales reps. So we're certainly targeting a number of profiles, it really comes down a lot of times to personality, how successful they've been at their prior companies as well as the paths that they've worked in. So those are the factors that tend to drive our sales rep hiring decisions. And then in terms of the cost of storage going down that has unequivocally remained a positive for our business and when Dylan mentioned our move to lower cost to Amazon storage that shows up directly in our lower infrastructure cost from a storage standpoint and has been certainly helping improve the efficiency of the platform.

Yes, the only thing I’d add there is that we've been giving unlimited storage to our customers for several years now and so really the value proposition how people think about Box is really disconnected from the underlying cost of storage that we see or that we're seeing in the market. And it’s as Aaron mentioned absolutely a good thing for us and with that savings it allows us to invest in performance, security and all the other functionality that allows us to differentiate ourselves from the competition and certainly the platforms and companies to focus more on a storage based proposition. So that is just one of those – yes, one of those trends have been very positive for us as a business.

And if I could just maybe add one more quick thought, the Box Zones architecture was very fundamental to this trend. We basically determined that the competitiveness of underlying public cloud providers was going to help us drive up our efficiency and allow us to focus on more and more technology above the layer of infrastructure. So whether it's being able to deploy in international data centers or being able to benefit from the lower cost of storage that those public cloud providers are creating all of that is both going to drive more innovation from Box, as well as lower cost footprints for our underlying infrastructure over time.

We’ll take our next question from Greg McDowell with JMP Securities.

Great, thank you very much. I want to specifically ask about cash flow from operations as you mentioned it was almost breakeven on an adjusted basis. And as I look at the model from last year, it actually improved from Q1 to Q2. So I was wondering how we should maybe think about cash flow from ops in Q2 and whether or not that number could be positive? Thanks.

Sure. So we actually tend to see cash from ops seasonality really mapping to entrailing our billings seasonality. So we typically see the strongest billings outcomes in Q3 and Q4 and see the strongest seasonally -- seasonal cash from ops outcomes into Q4 and Q1. And so if you’re looking at the cash flow results from last year and that sequential improvement from Q1 to Q2 I think that might be largely related, if you're looking at a $32 million number in Q1, that included a $25 million outlay associated with our move and a letter of credit with our Redwood City headquarters. So while it was $32 million in reported cash from ops we tend to talk about that and speak to it as $7 million negative, which is really the underlying business cash from ops outcome. So we saw an improvement from -- again on an adjusted basis negative $7 million to nearly breakeven, and just as we saw last year and seen in years historically we expected a slightly weaker Q2 and Q3 cash seasonality and stronger in Q4 and Q1.

That's helpful, thank you. And maybe one for you, Aaron. You mentioned bringing on a new chief marketing officer and I was wondering just what the marching orders are going to be for that new chief marketing officer? I mean when we went on -- attended the Box World Tour, certainly Box platform was a key theme and I know that that might be one area of increased marketing. But I was just wondering how you're maybe thinking about that -- the role of that new person?

Yes. I think it's certainly to build on and continue a lot of the efforts that you've seen recently. So we're certainly expanding our footprint and our story globally. So we're going into new markets we serve everything from small businesses to the largest enterprise on the planet. So there's a mix of field marketing as well as digital marketing that gets combined in there. And I think we are representing what a modern enterprise sort of marketing machine looks like in terms of digital marketing capabilities, making sure we can reach customers directly in their region as well as be able to extend our marketing leverage through partners, channel resellers et cetera. So that’s really the job of the of the CMO to take that work and continue to extend it in the future and do it in a best-in-class way.

And our next question comes from Brian White with Drexel Hamilton.

Dylan, I am wondering if you could just comment on the shorter payment duration. Is it something that is proactive that you're driving or is it something that your customers are driving?

Yes, it’s absolutely a proactive measure driven by us in order to maximize contract value as well as normalize the billing terms but most importantly to make sure that we are really getting as much in annual contract value versus having to discount those contracts as it is typically the case when securing multi-year prepayments.

And Aaron, when we look at Box platform, could you give us a little color on what you saw in the quarter in terms of wins or interest levels at customers obviously, this is a huge opportunity for Box. So any color would be appreciated.

So Q1 was the first time that we were kind of on out in the field with the platform story. We attached it to our Box World Tour. We are now doing a lot of in-region customer marketing. So this is the first few months where we are really driving that message directly to existing customers and working with their development teams, their technology organizations so the pipeline is building in a very healthy way. The use cases are representing nearly every single industry but with a key concentration in markets like financial services, health care, life sciences where you have a lot of regulated business processes with a deep need for secure and compliant content management and storage. And those customers are building new digital experiences to go work with their customers and their clients. So I mentioned one example of a bank that is going out and digitizing their customer interactions around how they share documents and how they share files with their clients. Those are the kinds of use cases that will be built on the Box platform and how we can extend both our revenue opportunity but as well as strategic footprint within those customer environments.

Next question is from Terry Tillman with Raymond James.

Hi, this is Brian Peterson in for Terry. Just one quick one from me. Dylan, just wanted to understand the mechanics on the full year revenue outlook. It looks like you’d be by close to 2 million this quarter and your full year guidance is going up by a million. So just wanted to understand what assumptions were baked into that.

Sure. So as we've talked about our pipeline for larger deals is healthy but given our more back end loaded business model, we're going to be pretty conservative in terms of setting the expectations around the revenue impact of those deals this year. I know that – and as you mentioned the guidance in that range is slightly higher, close to in line with we had guided to before. And so we'll continue to give color into sort of the bookings and the business as it’s developing. I’d say there's nothing materially different about our kind of assumptions that go into the guidance we gave beyond the increasing seasonality that we see in the business that we highlighted as we continue to move further up market. End of Q&A

And it appears we have no further questions. I'll return the floor to our speakers for closing comments.

Thank you everyone for joining us today and we look forward to speaking with you next quarter. Have a great day.

And this does conclude today's teleconference. Thanks for your participation. You may now disconnect. Have a great day.