Box - Q3 2024

Transcript

Operator (participant)

Good day. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Box Incorporated third quarter fiscal 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. I will now like to turn the conference over to Cynthia Hiponia, Vice President of Investor Relations. You may begin.

Cynthia Hiponia (VP of Investor Relations)

Good afternoon, and welcome to Box's third quarter fiscal year 2024 earnings conference call. I am Cynthia Hiponia, Vice President, Investor Relations. On the call today, we have Aaron Levie, Box Co-founder and CEO, and Dylan Smith, Box Co-founder and CFO. Following our prepared remarks, we will take your questions. Today's call is being webcast and will 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 the X platform at the handle, @BoxIncIR.

On this call, we'll be making forward-looking statements, including our fourth quarter and full year fiscal 2024 financial guidance and our expectations regarding our financial performance for fiscal 2024, fiscal 2025, 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.

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, the proceeds from the sale of our data center equipment, our ability to address enterprise challenges and deliver cost savings to 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 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 and 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 statements made on this earnings call. These forward-looking statements are being made as of today, December 5, 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 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 reconciliation with comparable GAAP results in our earnings press release and in the related supplemental slides, which can be found on the IR 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.

Aaron Levie (Co-Founder and CEO)

Thank you, Cynthia, and thanks everyone for joining us today. In Q3, we delivered revenue growth in line with our guidance, with year-over-year growth of 5% or 7% in constant currency. Our 25% operating margins were up 70 basis points from a year ago, demonstrating our operational discipline and delivering year-over-year margin expansion. Despite the various macro headwinds affecting IT budgets, companies still prioritize the Box Content Cloud to help power their hybrid workforces, secure their most important content, and automate and digitize their business processes. Examples of Box delivering this value to our customers in Q3 include: A leading biotech company expanded its use of Box with a six-figure upsell to enable both collaboration on GxP content in an efficient manner for both internal and external parties, as well as support content sharing and collaboration for non-GxP compliant content and use cases.

They also plan to integrate Box with their existing applications, including Okta and ServiceNow. An advertising and marketing firm expanded its use of Box with a six-figure upsell and ELA as they move the entire agency to Box to meet their content cloud needs. As the company adopts Box enterprise-wide, it will eliminate storage costs from other platforms and will be able to consolidate several SaaS applications, eliminating redundancy and complexity from their IT environment. One of the largest technology companies in the world expanded its use of Box with the purchase of KeySafe in an Enterprise Plus upsell to support the organization's content modernization initiative. With this upsell and access to governance capabilities, Box meets their highest level of security classification for content storage and can now be used for restricted content and records management content, while also supporting necessary integrations.

In the third quarter, we held our annual user conference, BoxWorks, and our exclusive CIO summit, CIO Works. With record BoxWorks attendance, we heard directly from our customers on how they are driving significant transformation across their businesses, even in the face of near-term economic pressures. Enterprises are also seeing new challenges as they respond to the rapidly evolving era of AI-powered work. We know that content is the lifeblood of so many businesses, and yet, right when content is more important than ever, the way that enterprises manage content in legacy systems no longer works. The challenge is that content is getting produced at an ever-increasing rate, and enterprises increasingly are finding it hard to secure all of this fragmented content or enable employees to access the right information to do their jobs.

This fragmented content will mean companies can't easily take advantage of the power of AI to get the most out of their data. More than ever before, enterprises will need a content cloud. By building the only end-to-end platform that can help customers power their complete content life cycle in a single architecture, we're reshaping what enterprises can do with their content. At BoxWorks, we made several key product announcements, delivering innovation across security and compliance, collaboration and workflow, and our platform. Our focus is to deliver the best ways to secure and protect sensitive content, ensure compliance for nearly every major industry and government requirement, and power the full document governance process for our customers. We have expanded Box Shield for ransomware protection capabilities in order to mitigate the ever-growing threat of malware and announced an AI-powered threat detection to identify anomalous file activities originating from Box Drive.

We also announced a new integration partnership with CrowdStrike, where security and IT teams can detect malicious files, ransomware, and suspicious activity, as well as configure security policies directly in Box's administrative console. Across collaboration and workflow, we're adding new capabilities to Box Notes, improving the experience and performance of Canvas, doubling down on our e-signature feature set, and continuing to advance next-gen workflow capabilities with the announcements of DocGen and Forms. This year, we've taken our strategy even further with the announcement of two major breakthroughs: Box AI and Box Hubs. With Box AI, we're going to revolutionize how companies work with their content. Since the early days of enterprise software, we could always query and understand our structured data, but we've never been able to do the same easily with our unstructured data or our content, which is estimated at 90% of corporate information.

All of the content that an enterprise produces is being dramatically underutilized relative to the value inside of this content. But now, with AI, we can solve problems that previously were only possible with high-level human understanding at scale. From extracting metadata efficiently at scale, getting expert analysis, to document understanding and summarization, and creating new content, with AI, we can now process information at a speed and at a cost that opens up completely new possibilities of what we can do with our information. Additionally, we also announced Box Hubs, a revolutionary way to publish content in the enterprise. With Box Hubs, we're enabling companies to take the most important content in their organization and make sure it's easily available and distributed to exactly the right people seamlessly.

Content sprawl is one of the biggest challenges facing enterprises today, and never before has there been a simple way for any line of business to point to the most important content that they need to share broadly in a customized fashion. Any team or department in an enterprise can create a hub to service its most relevant content, like a sales enablement portal, HR policy portals, marketing branding sites, and more. Importantly, when combined with Box AI, we are unleashing the power of enterprise content in an organization by turning unstructured data into valuable knowledge. Most importantly, because the content in a hub is curated by topic, enterprises can ensure that the answers they're getting from AI are accurate and based on the authoritative information in an organization.

The vision for what's possible when companies have a modern approach to working with their content with our new innovative products has been incredibly well-received by customers. At CIO Works, we heard from our customers directly who are using Box AI, and this quote from a CIO of a financial advisory firm after turning on Box AI is quite representative of what we're hearing. I quote: "We just enabled the Box AI beta this morning. Game changer, force multiplier, knowledge overload. The future is bright with Box. Thank you!" Finally, we recently announced an expanded partnership with Google Cloud, whereby Box will integrate with Vertex AI, Google Cloud's unified AI platform, to help customers process and analyze data faster and create a more personalized user experience, intelligent search, and more.

This builds on our earlier announcement to integrate Google Cloud's advanced large language model into Box AI, with Vertex AI helping to power our new metadata extraction feature. Further, part of our Google Cloud partnership announcement, Box will now be a part of the Google Cloud Marketplace. GCP customers will be able to buy Box directly through Marketplace and use their GCP credits toward the purchase of Box. This new channel for Box expands our opportunity to land new cost-conscious customers who can unlock the potential for cost savings against existing Google Cloud commitments... streamline lengthy procurement cycles, and consolidate billing. Now, turning more broadly to go-to-market, a key component of our strategy to drive profitable growth at scale is our ability to land, adopt, expand, and retain our customers.

Driving the adoption of Enterprise Plus is a critical strategic lever to increase the efficiency of our sales motion and bring the full value of the Box Content Cloud to our customers. By continually adding value through additional features and functionality to existing Suites plans, we strengthen our ability to retain customers, as shown by our best-in-class 3% churn rates in Q3. Our momentum with Enterprise Plus remains strong, and we have now reached 51% of our revenue coming from Suites customers, up from 48% last quarter. Given the large base of customers that we believe are still ripe for upgrading into Enterprise Plus, we have added Box AI into this plan to encourage further upsells to this plan.

At the same time, we know that there's going to be even more advanced AI capabilities that some of our customers will require, and we expect to introduce a higher tier plan next year to address these needs. Already within Q3, we saw numerous Enterprise Plus upgrades that were in part driven by the inclusion of Box AI in this offering, including a worldwide consulting firm who has been a Box customer since 2013, signed an Enterprise Plus upsell to get access to the Box AI data. Box AI has the potential to help the consultants be more productive day-to-day with automated metadata to help search and finding files. Box AI will be critical in transforming how this organization works with its petabyte of content in Box. An international corporate law firm moved to Enterprise Plus to give its lawyers and staff access to Box AI.

Being able to summarize large briefs and documents and find information in a matter of seconds will cut down on time, increase productivity, and be hugely beneficial to their employees. We're incredibly excited to be able to bring Box AI to our customers, and we will share more updates with all of you soon. As we look ahead to FY 2025, we are focused on continuing to drive profitable growth at scale. We are entering one of the most transformative periods in enterprise software, and we are focused on capitalizing on the opportunity in front of us. Next year, we'll be continuing to drive investments across AI, security, advanced content management, and workflow capabilities to help our customers transform how they work with their content.

Further, given the market opportunity right now, in FY 2025, we'll be expanding our focus on key strategic partners and system integrators, scaling our high ROI pipeline-generating initiatives, investing in growth in key verticals, and continuing to optimize our international growth efforts. We will drive these initiatives while at the same time delivering improving profitability, putting us on a path to achieve our long-term financial targets. To help drive these efforts forward, in November, we announced that Olivia Nottebohm has joined us as Chief Operating Officer, succeeding retiring COO, Steph Carullo. Olivia brings proven leadership and execution to Box, with executive roles at Google Cloud and most recently, Notion, a cloud-based productivity platform, and over a decade at McKinsey, focused on the software industry.

I'm excited to work with her as we deliver new products and plans, expand our partner and system integrator network, go deeper in key vertical markets, and continue our global expansion. I'd also like to provide a huge thank you to Stephanie Carullo, who has been an amazing partner to me and the team for over six years at Box, taking us from less than $500 million in revenue to over $1 billion in revenue, as well as helping execute a seamless transition to bring on Olivia. I'm wishing Steph the best in her retirement, and I'm excited to have her stay close as we continue to scale. In summary, while macro trends and currency rates have impacted our results in the near term, we have continued to execute our Content Cloud strategy, creating more high value and repeatable use cases that further differentiate Box and grow our TAM.

Demonstrating our product leadership with Box AI and Box Hubs positions us for growth, delivering to customers the platform that they need to meet the demands of the rapidly evolving era of AI-powered work. With that, let me turn it over to Dylan.

Dylan Smith (Co-Founder and CFO)

Thanks, Aaron. Good afternoon, everyone, and thank you for joining us. In Q3, we continued to deliver profitable growth while expanding operating margin and executing our disciplined capital allocation strategy. Revenue landed in line with our guidance, and EPS grew by 16% year-over-year. We also announced numerous enhancements to our Box Content Cloud platform, including significant innovation around Box AI and Box Hubs, which we believe will be important drivers of future revenue growth. In Q3, we generated revenue of $262 million, up 5% year-over-year, and representing 7% year-over-year growth on a constant currency basis.

We now have over 1,700 total customers paying us more than $100,000 annually, an increase of 10% year-over-year. Our Suites attach rate of 79% in large Q3 deals was up from 73% in Q3 of last year.

As Aaron mentioned, Suites customers now account for 51% of our revenue, up significantly from 42% of revenue a year ago and up from 48% last quarter. Our Suites value proposition is resonating with customers as they continue to prioritize solutions that enable transformation, simplification, and security of the content within their enterprises. We ended Q3 with remaining performance obligations, or RPO, of $1.1 billion, a 7% year-over-year increase, or 8% growth on a constant currency basis. We expect to recognize roughly 60% of our RPO over the next twelve months. Q3 billings of $254 million were down 2% year over year, with no impact from FX. Our previous guidance had anticipated a 200 basis point tailwind from FX.

As a reminder, our billings growth rate in Q3 of last year was unusually strong at 20%, including a large multiyear customer prepayment. Our net retention rate at the end of Q3 was 102%, as we continue to see pressure on seat growth within existing customers. Our annualized full churn rate remains strong and stable at 3%, as customers continue to prioritize the value that the Box Platform provides. We've also continued to achieve year-over-year pricing increases despite the pressures on IT budgets. In Q4, we expect both our full churn rate and our net retention rate to remain roughly flat with our Q3 results. As seat growth returns to more normalized levels, and as we continue driving pricing improvements, we're confident that our best-in-class full churn rate and expanding our suite of innovative products will enable a higher net retention rate over time.

We are proud to have achieved our goal of running our infrastructure in the public cloud as of the end of Q3. We have now begun selling the data center equipment that we are no longer using, which had been anticipated in our plans for this year. However, the market for this equipment has softened significantly over the past few months. As a result, we are reducing our estimate of expected proceeds from these sales. This created a headwind against our expense forecast of $3.3 million in Q3, and we expect another roughly $4 million impact in Q4, with no material impact to our financial results anticipated next fiscal year. Q3 gross margin came in at 76.3% versus 76.5% a year ago.

Q3 gross margin was negatively impacted by 100 basis points due to the equipment proceeds headwind that I just mentioned. Throughout the course of this migration, our team has delivered efficiencies above and beyond our initial expectations. We continue to expect further gross margin expansion next year as our data center expenses wind down and as we unlock additional benefits from running fully in the public cloud. We also continued to drive leverage across the business through our lower cost location strategy and rigorous cost discipline. This resulted in 24.7% operating margin, or 26.6% in constant currency, an improvement from the 24.0% we delivered in the year ago period.

Q3 operating margin landed slightly below our expectations of 25.5%, due entirely to the 130 basis points equipment proceeds headwind that I noted earlier. As a result, we delivered diluted non-GAAP EPS of $0.36 in Q3, up 16% from $0.31 a year ago, which includes a negative impact of $0.05 due to FX. This FX headwind was $0.01 higher than anticipated when we provided guidance last quarter, and EPS was also impacted by $0.02 from the equipment proceeds headwind. Adjusting for these unanticipated headwinds, EPS would have been $0.39 above the high end of our guidance. Finally, I'd highlight that Q3 marked our 5th consecutive quarter of achieving GAAP profitability. I'll now turn to our cash flow and balance sheet.

In Q3, we generated free cash flow of $58 million, a 6% increase from $55 million in the year ago period. We delivered cash flow from operations of $72 million, a 3% increase from $70 million in the year ago period. Capital lease payments, which we include in our free cash flow calculation, were $7 million, down from $10 million in Q3 of last year. Going forward, we expect capital lease payments to wind down over the next few quarters as we exit our managed data centers. Let's now turn to our capital allocation strategy. We ended the quarter with $440 million in cash, cash equivalents, restricted cash, and short-term investments. In Q3, we repurchased 1.9 million shares for approximately $52 million.

As of October 31, 2023, we had approximately $84 million of remaining buyback capacity under our current share repurchase plan. With that, I would like to turn to our guidance for Q4 and fiscal 2024. As a reminder, approximately one-third of our revenue is generated outside of the U.S., with roughly 60% of our international revenue coming from Japan. The following guidance includes the expected impact of FX headwinds, assuming current exchange rates. Our guidance also accounts for the continued pressure on seat growth that we anticipate due to the macroeconomic environment, as well as lower professional services revenue versus our prior expectations. As I stated earlier, we expect the equipment proceeds headwinds to have an impact of roughly $4 million on our Q4 expenses, for a total FY 2024 impact of a little more than $7 million.

Additionally, in the fourth quarter, we modified our Redwood City office lease to reduce the amount of square footage that we're leasing. This results in a one-time net exit expense that we will recognize in Q4, representing a 60 basis point headwind to Q4 operating margin. For the fourth quarter of fiscal 2024, we anticipate revenue in the range of $262 million-$264 million, representing 3% year-over-year growth at the high end of this range, or 5% in constant currency. We expect our Q4 billings growth rate to be in the low to mid-single digit range. This includes an expected headwind from FX of approximately 300 basis points. We expect our Q4 gross margin to be roughly 78%, which includes the equipment proceeds headwind of 150 basis points.

We expect our Q4 non-GAAP operating margin to be approximately 25.5%, which includes an expected negative impact of approximately 180 basis points due to FX. It's important to note that our Q4 operating margin expectations also incorporate two discrete items that were not included in our expectations as of last quarter. First, the equipment proceeds headwind on gross margin creates an equivalent 150 basis point impact on operating margin. Second, the lease modification discussed above represents an operating margin headwind of 60 basis points. We expect our Q4 non-GAAP EPS to be in the range of $0.38-$0.39, and GAAP EPS to be in the range of $0.05-$0.06. Weighted average diluted shares are expected to be approximately 147 million.

Our Q4 GAAP and non-GAAP EPS guidance includes an expected year-over-year headwind from FX of approximately $0.03, the equipment proceeds headwind of a little more than $0.02, and the lease modification headwind of approximately $0.01. For the full fiscal year, ending January 31, 2024, we now expect FY 2024 revenue in the range of $1.037 billion-$1.039 billion, representing 5% year-over-year growth or 8% on a constant currency basis. We expect our FY 2024 billings growth rate to be roughly 3% on an as-reported basis, or roughly 5% on a constant currency basis. We now expect our FY 2024 gross margin to be roughly 77%. This includes the previously mentioned second half headwind from equipment proceeds of 70 basis points.

We are revising our FY 2024 non-GAAP operating margin guidance to be approximately 24.5%, representing a 140 basis point improvement from last year's results of 23.1%. We expect FX to have a negative impact on operating margin of approximately 200 basis points. Our revised expectations also include the previously mentioned equipment proceeds and lease modification expenses, which have a combined impact of 85 basis points. We are updating our FY 2024 non-GAAP EPS expectations to be in the range of $1.42-$1.43, representing a 19% increase at the high end of this range versus $1.20 in the prior year. We expect FY 2024 GAAP EPS to be in the range of $0.15-$0.16. Weighted average diluted shares are expected to be approximately 149 million.

Our FY 2024 GAAP and non-GAAP EPS guidance includes an expected full-year negative impact from FX of approximately $0.17 and an additional impact of approximately $0.05 from the two non-recurring items that I mentioned previously. As we continue to navigate through this dynamic macroeconomic environment, we think it would be helpful to provide a high-level preliminary outlook for fiscal 2025. While we have been seeing a more stable demand environment, we want to be prudent in assuming that this challenging environment persists throughout the coming year. This outlook also assumes current FX rates. We currently expect our FY 2025 reported revenue growth rate to be approximately 5%. This includes an expected headwind from FX of roughly 100 basis points. We're generating significant business model leverage through our public cloud migration, workforce location strategy, and overall cost discipline.

The impact of these initiatives enables us to invest in the key growth initiatives that Aaron discussed, while also improving our already strong profitability profile. We currently expect FY 2025 non-GAAP operating margin of roughly 27%, representing an improvement of roughly 250 basis points year over year, which includes an expected headwind from FX of a little less than 100 basis points. We remain committed to delivering against the long-term financial targets that we outlined at our March Financial Analyst Day. We are reiterating our long-term revenue growth target of 10%-15%, gross margin of 80%-82%, operating margin of 32%-35%, and revenue growth plus free cash flow margin of at least 45%. Despite the challenging macroeconomic environment, this year, we continue to deliver against the core initiatives to achieve these long-term financial targets.

We are making significant enhancements to our innovative product offerings, expanding both operating margin and free cash flow margin, and consistently returning capital to our shareholders. As we capitalize on these initiatives and as the macroeconomic environment improves, we are well positioned to create significant long-term shareholder value. With that, Aaron and I will be happy to take your questions. Operator?

Cynthia Hiponia (VP of Investor Relations)

Actually, Dylan, before we open up for questions, it might be helpful to see our guidance and the adjustments we discussed in one table. Please refer to slide 12 of our earnings deck, which you can find on the IR website. Operator?

Operator (participant)

As a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from Brian Peterson from Raymond James. Please go ahead.

Brian Peterson (Managing Director of Application Software)

Oh, hey, guys. Thanks for taking the question. So I wanted to hit on linearity throughout the quarter. Obviously, the macro is very up, very much up for debate here. I'm just curious, any trends that you've seen throughout the quarter that you'd call out that changed?

Aaron Levie (Co-Founder and CEO)

Yeah, I would say no major changes to linearity. Really, you know, the way I would articulate some of our kind of bookings outcome or billings outcome in Q3 and certainly putting a little bit of pressure on the Q4 number was, you know, as we had called out in the prior call, more stabilization in the U.S., in particular, where our results came in, you know, effectively where we had expected, with some additional pressure in international markets where there was some variability. We did have a couple pushes out of Japan, but nothing that concerns us. But definitely that can be a dynamic that then impacts, you know, some of the billings in the near term.

So, but no meaningful change in linearity from our perspective.

Brian Peterson (Managing Director of Application Software)

Thanks, Aaron. And Dylan, you know, I appreciate the guidance for next year, and you guys are outlining kind of the mid-single-digit growth. You know, still looking at 10%-15% longer term. You know, is there an implied kind of NRR or seat expansion in that number? I get that it's like a little bit of cyclical pressure now, but I'd love to understand in a more normalized environment how should we be thinking about that NRR and seat trends in that 10%-15% target? Thanks, guys.

Dylan Smith (Co-Founder and CFO)

Yeah. So based on what we've been seeing in a variety of environments, we do expect, even from a long-term, target point of view, for the contribution, to growth of net new business and expansion, which is what the NRR represents, to be fairly consistent with what we've seen, and the contribution, from new business being in the, you know, low- to mid-digit, single-digit percentage. So the implied, net retention rate, in that long-term target, you could think about is kind of the mid, you know, kind of pushing, 10%, type, NRR.

and we do expect to see an improvement from current levels, both on seat growth as well as over time, the impact of some of the newer products, suites, et cetera, that we expect to introduce to the market next year. So while that'll take some time to flow through to the model, that's how I'd think about some of the upside and dynamics that drive our confidence in that longer term growth rate.

Brian Peterson (Managing Director of Application Software)

Thank you.

Dylan Smith (Co-Founder and CFO)

Thanks, Brian.

Operator (participant)

Your next question comes from the line of Steve Enders from Citi. Please go ahead.

Steve Enders (Equity Research Analyst)

Okay, great. Thanks for taking the question here. I guess maybe just following up on the guide and the outlook for next year. I mean, I guess, as you think about, you know, what that looks like, how do you get confidence around that number? Or what is it that gives you confidence in being able to see an acceleration as we head into fiscal 2025?

Dylan Smith (Co-Founder and CFO)

Yeah. So I would say, you know, expecting to see pretty similar growth next year, both kind of versus what we're expecting, you know, as we exit this year, and just kind of coincidentally what we happen to do for or what we're expecting to do for the current year. What I would say is, you know, we are gonna be lapping the impact of when we started to see some of these macroeconomic challenges set in. And as we think about, you know, getting through the next year, you know, certainly this is based on, as we had mentioned, pretty prudent expectations in terms of the overall macroeconomic environment.

So it's really based on kind of combination of everything that we've been seeing in the environment, the pipeline, the conversations that we've been having with with customers and all of that. So wouldn't really highlight any, you know, specific, new things in the business that are driving that, but it's really, you know, just based on a continuation of some of the trends that we've been seeing recently and Aaron, anything to add?

Aaron Levie (Co-Founder and CEO)

No, I mean, and obviously, if we could get more into the FY 2025 outlook and commentary, happy to build on that.

Steve Enders (Equity Research Analyst)

Okay, great. And then maybe just on, on the demand environment, you know, I guess as you look at the, the customers in, in the pipeline, and I know that, you know, there's been headwinds to, to, to the seat expansion side, I guess, where do you feel like we are in terms of, you know, that continuing to be a headwind? And as we think about, you know, the billings outlook and, you know, I guess, again, going into, into 25, you know, like, how scrubbed is the, the pipeline that you're seeing for renewables and the assumptions that are, that are, that are being made in there in terms of the, the, the seat expansion initiatives?

Dylan Smith (Co-Founder and CFO)

Yeah, I mean, I would say we are still expecting to see continued pressure on seat growth given the environment, and that is baked into the forward-looking expectations that we provided. And in terms of the pipeline, I would say similarly, you know, feel really good about the way that we have been qualifying that, and a lot based on a lot of the learnings from this year, just where we are seeing the strongest ROI, whether it's from, you know, some of the different demand initiatives or, you know, the geographies and segments of the business that are, you know, showing the most resilience in this environment. That's where we've really been focused.

And so from an overall pipeline quality point of view, and what we've learned, and how we bake that into our expectations, that is all incorporated into the numbers that we provided.

Steve Enders (Equity Research Analyst)

Okay, perfect. Thanks for taking the questions.

Operator (participant)

Your next question comes from the line of Josh Baer from Morgan Stanley. Please go ahead.

Chris Quintero (VP and Equity Research Analyst)

Hey, this is Chris Quintero on for Josh. Thanks for taking our questions. You all have been showing strong adoption of Suites for a few quarters now. So just curious why that continued Suite momentum is not exactly translating to those better in-quarter results.

Aaron Levie (Co-Founder and CEO)

Yeah, I think, getting our customers to move up to Suites has been a critical priority for us, and we saw a little bit of, you know, kinda less of the quarter-over-quarter growth than we wanted earlier in the year, and we've put an even greater focus on that, and I think we're seeing those results now play out. In terms of the total top-line results, obviously, that factors in things like seat count growth, that the Suite expansion doesn't specifically... You know, these are independent metrics of the percentage of customers who move up into Suites versus the amount of seat growth that we have in general, and that's been come under some pressure, as Dylan noted, just due to the macro environment.

And so, you know, you know, certainly as companies aren't hiring as quickly or you have layoffs in tech, as an example, these can create some seat growth pressure, which obviously is the combined metric that really drives that top-line revenue and the net retention rate. So I'd say we're still gonna be very, very focused on adding more and more value to our product plans. That means more customers can get into Enterprise Plus. We're gonna have additional functionality that will allow customers to upgrade even further in the future, and then seat growth becomes another lever, as hopefully, the economic environment, you know, improves over time.

Dylan Smith (Co-Founder and CFO)

Yeah, and this is Dylan. And just to build on that, you know, to clarify, really pleased with the, kind of attach rates and, the mix of what we are selling, to our customers in this environment, especially seeing strong attach rates, globally, which we had not, been seeing a year ago, was a little bit more, variable, from geography to geography. But it's really driven by just lower volume of overall deals, and you can see that, in some of the metrics, like the large deal, counts that we provide. But we are, you know, certainly pleased with the trajectory and momentum, of Suites within our customer base.

I would note that, we've continued to see, as we've called out in the past, that those Suites customers, once they buy in, adopt Suites, tend to have much stronger customer economics overall, from pricing to margins, to net retention. Even though the deal volume isn't quite where we'd like it to be, this year, the overall quality of the customer base and revenue base have been steadily improving because of that mix.

Chris Quintero (VP and Equity Research Analyst)

Got it. That's, that's very helpful. Dylan, maybe sticking with you on the operating margin guide for this year, if I exclude that 85 basis point headwind from the equipment and lease changes, you still guide it down the full year by, you know, 15 basis points or so. So just curious, is that mostly a function of that lower revenue flowing down, or is there something else you would call out there from a expense standpoint?

Dylan Smith (Co-Founder and CFO)

Yeah, I would say the only, you know, minor change, and again, pretty close to in line, there is a bit of a revenue impact, but also a little bit of an incremental FX impact. So, and both on revenue and on the margin side. So not material versus what we expected a few months ago, but that is a little bit of a contributor as well.

Chris Quintero (VP and Equity Research Analyst)

Got it. Thank you so much.

Operator (participant)

Your next question comes from the line of Pinjalim Bora from JPMorgan. Please go ahead.

Pinjalim Bora (Executive Director of Equity Research)

Oh, great. Thank you for taking the questions. I want to ask you about the fiscal 2025 outlook. Again, understanding it's preliminary or early, but any way to kind of understand the net retention versus new that you're baking in there? You're kind of at 102. You're talking about 5% reported or 6% constant currency. Seems like, what are you assuming for net retention? And then, is there anything you're baking in from the AI products that might be coming online next year?

Dylan Smith (Co-Founder and CFO)

Yeah, so, so I would say you could think about, the, the underlying, driver and assumption in that, preliminary guidance as being, pretty consistent, with current levels. As mentioned, you know, certainly see upside over time, but that, is not baked into, next year's numbers. And then as it relates to, you know, our product roadmap, broadly, you mentioned AI, but this would apply to some of the other newer products like, Hubs and the new Suite that we expect, to launch next year.

We just note that as enterprise sales cycles are typically a few quarters, and based on our recurring revenue model and how that translates into revenue, we don't expect those newer products and offerings to have a material impact on next year's revenue, but would be more meaningful growth drivers the following year in FY 2026 and beyond.

Aaron Levie (Co-Founder and CEO)

Yeah, as it relates to today's AI offering, which obviously is an Enterprise Plus plan, we do expect that to be a driver of Enterprise Plus upgrades for next year. So, just to build on that, AI definitely being a driver for next year. It is baked into the current outlook that we just shared. And as I mentioned on the Q3 numbers, we saw a number of customers upgrade to Enterprise Plus, specifically, or at least in large part, to be able to access Box AI. So we certainly expect them, you know, to continue to see that in Q4 and in next year, but we also want to be prudent on our total top line expectations, as we kinda work through the macro.

Pinjalim Bora (Executive Director of Equity Research)

Understood. Just specifically on the volume-based, or the consumption-based pricing that you, you kind of laid out, are you, are you assuming that the existing Suites customer starts contributing some kind of, or from that volume-based consumption-based pricing next year?

Aaron Levie (Co-Founder and CEO)

We don't, we don't have any particular hard expectations within the model on the consumption side. That would be, you know, kind of pure upside, and only because we wanna be super thoughtful as we, as we start to roll... I mean, Box AI literally is rolling out in November to the, to our Enterprise Plus customers. And so, so we wanna be conservative at this point on the, on the numbers there.

Pinjalim Bora (Executive Director of Equity Research)

Understood. One last question for Dylan. Dylan, what is the billings growth rate adjusted for payment duration from a year ago? Because I do remember last year you had kind of some big deals.

Dylan Smith (Co-Founder and CFO)

Yeah, I would say, we didn't give the exact number, but you can think about that large multi-year prepay that we had, you know, kind of mentioned at the time, and then recently as well, as being in the kinda mid to high single-digit percentage range. So last year, so that was a, you know, significant driver of the outsized billings growth that we showed in Q3 of last year. Although even independent of that, that one customer, it was a pretty strong quarter for us, overall, as it was late in the quarter, as a reminder that we started to see the macroeconomic headwinds show up in our business.

Pinjalim Bora (Executive Director of Equity Research)

Understood. Thank you.

Operator (participant)

Your next question comes from the line of Chad Bennett from Craig-Hallum Capital. Please go ahead.

Chad Bennett (SVP and Research Analyst)

Great. Thanks for taking my question. So just considering the, I guess, preliminary growth outlook for next year of 5%, and just, you know, and obviously the operating margin outlook, just curious, I mean, our growth outlook has clearly lowered from kind of what we thought it would be, obviously, this year and heading into next year. You know, and as a percentage of revenue, sales and marketing expenses are kind of hovering around 27%-28%. They've kind of been there for a couple of years now. Are there any, you know, planned, you know, actions on the cost side to maybe escalate or accelerate that operating margin leverage next year?

You know, even if that 5% turned into 8%, I'm not sure 27%-28% sales and marketing expense makes sense. Any commentary there?

Aaron Levie (Co-Founder and CEO)

Yeah. So, it's a great question. I think we're trying to balance both obviously continued leverage on the bottom line, which we, you know, see as incredibly important overall to the efficiency of the business and being able to support our capital allocation strategy. And at the same time, you know, because of the market opportunity between security, AI, our overall platform message, we do wanna balance the right amount of growth investments to drive top line, not only for next year, but really beyond. And so some of those investments, as obviously is kind of well understood, you have to start to make them, and then the payback is more tied to that long-term model.

And while these aren't, you know, particularly, you know, massive in any sense, you know, things like continuing to optimize our international markets, drive the next tier plan in terms of product investment, some of the verticals that we wanna double down in. These things, obviously, are still very important for us and to drive that long-term growth. So, we'll always pay close attention to where we're seeing kind of the efficacy of our investments, and we'll tune appropriately. But we think that continuing to make, you know, year-over-year improvements on the bottom line going forward is incredibly important to drive to that long-term model, but also making sure we're driving the right level of growth is super healthy as well.

That's the balance that we're trying to create.

Dylan Smith (Co-Founder and CFO)

Yeah, and to build on that, we still expect our annual operating margin improvement to be fairly consistent on an annual basis... as we march toward our long-term target model of having operating margins and delivering those in the 32%-35% range. For next year, on the heels of completing the public cloud migration that we've talked about, more of that is expected to come on the gross margin line than in a typical year over a multi-year time period. And then we also do expect continued driving efficiencies across the business, and in terms of big categories of leverage, as we mentioned, do expect our lower-cost location strategy to have an impact next year as well.

So that's a big focus. That doesn't show up in the sales and marketing line as much, and I know Aaron spoke to that, but that has been and is expected to be a continued driver of R&D and G&A leverage in particular. So those are a couple of the big areas from a near-term point of view that will fuel that operating margin expansion.

Chad Bennett (SVP and Research Analyst)

Got it. And then maybe just one quick follow-up for me. Just on the non-suite portion of the business, can you just speak to kinda year to date, what you've seen competitively there and, you know, if that business is... I mean, I assume that business has, you know, kinda got weaker as we've went along the year, and just kinda how that has played out relative to expectations?

Aaron Levie (Co-Founder and CEO)

Yeah, I think, you know, certainly we're very focused on encouraging any new customer to come into our multi-product suites, and that's a core part of our sales motion, that improves our competitive differentiation, you know, win rates, retention, and so on. In terms of the core-only population, you know, we do see, you know, more pressure in that audience, from a retention standpoint and some cases, a seat growth standpoint, although it can always, you know, vary by the quarter. But I'd say no change, you know, necessarily in the competitive market or competitive dynamics there. That's something that's sort of always been incorporated into our financial plan and model. So no major market change on that front.

Chad Bennett (SVP and Research Analyst)

Great. Thank you.

Aaron Levie (Co-Founder and CEO)

Yeah, thank you.

Operator (participant)

Your next question comes from the line of Rishi Jaluria from RBC Capital Markets. Please go ahead.

Rishi Jaluria (Managing Director of Software Equity Research)

Hey, this is Rich Poland on for Rishi. Thanks for taking my question. So first one for me, I guess when you're seeing some of the seat churn in contracts, are you having any success trying to offset some of that with the suites momentum and, and maybe perhaps giving any kind of a discount on the suite side? Or just kind of walk me through how that conversation typically goes.

Aaron Levie (Co-Founder and CEO)

Yeah, I mean, there can be, you know, a few different flavors, so it'd be hard to fully capture. But we do, you know, certainly if a customer is dealing with reduction in headcount or reduction in investment, you know, our at least seat-based model will correlate in some cases to that dynamic within that customer. And so, you know, usually that's tied to additional cost pressure in that customer. So, adding more product in return for fewer seats, that customer most likely is dealing with overall cost pressures that make that difficult. So I'd say that that's we certainly try multiple ways to get our customers to, you know, retain their total value, but we also wanna be, you know, thoughtful with customers and make sure we're adding the right amount of value and, and, you know, relationship, given whatever the environment they're dealing with is.

I'd say more typically, what we're able to do in a renewal motion is find ways to, you know, get that customer into expanded functionality or, or, you know, moving up a plan tier, you know, based on the kind of overall growth and health of the that customer relationship, and that's sort of certainly a core part of our renewal motion.

Rishi Jaluria (Managing Director of Software Equity Research)

Got it. That's very helpful. It's good to hear that the AI driving some of the Enterprise Plus conversion. Going forward, aside from watching just kinda the Suites momentum trajectory, what's the best way for us to kind of measure the pace of Enterprise Plus adoption? I guess alongside that, have you given any thought to kinda providing a breakout for any Enterprise Plus every once in a while, like you have done with Core and Core Plus in the past?

Aaron Levie (Co-Founder and CEO)

Well, so can I clarify, when you say breakout of Enterprise Plus, do you mean relative to our overall multi-product suites, or is there some other metric you're referring to?

Rishi Jaluria (Managing Director of Software Equity Research)

Correct. Correct.

Aaron Levie (Co-Founder and CEO)

I see. Yeah, I mean, we sort of discussed different ways to maybe convey that metric, and we're happy to certainly take more feedback offline. Because Enterprise Plus is our primary, you know, sort of sales motion, and more of the other, you know, Suites are equivalent to Enterprise Plus in terms of what products they've contained, minus now AI, but similar price points, we sort of think about them basically as the same metric. So we, you know, probably wouldn't break it out only because it really does, you know, it's effectively, you know, the same concept.

you know, to the extent that it's helpful, we could consider it over time, but I would just consider Enterprise Plus as the primary suite that's driving our growth and certainly taking up the bulk of that account base.

Dylan Smith (Co-Founder and CFO)

Yeah, and just as a reminder, for the past year or so, to kind of echo what Aaron's been saying, more than 90% of our overall suite sales have been Enterprise Plus. So that's certainly, you know, effectively all of the new suite sales, as well as some customers moving to Enterprise Plus from a prior suite under the hood. So it is the majority, but yeah, we try to capture that in one metric just to keep things simple, especially 'cause, you know, as our product offerings continue to evolve, just a cleaner way to track the overall Suites momentum, which is what's most important to really understand how our customers are using Box's products.

Rishi Jaluria (Managing Director of Software Equity Research)

Got it. That's all very helpful. Thank you.

Operator (participant)

Our last question comes from George Iwanyc from Oppenheimer. Please go ahead.

George Iwanyc (Executive Director)

Thank you for taking my question. Aaron, maybe going back to your comments on investing for growth, with Olivia coming on board, are there any changes being made to the sales organization and go-to-market motion over the next several quarters?

Aaron Levie (Co-Founder and CEO)

Yeah. So maybe at a high level, you know, as we did a search for the successor for Steph, and you know, this is a very collaborative process to find the next person that could take Box to, you know, take it for us from the $1 billion-$2 billion dollar mark. We were extremely intent to bring somebody that understood our model, understood both what we had built in terms of, you know, seeing similar environments, but also seeing where we're trying to go as a platform.

And so we found somebody in Olivia that deeply understands SaaS, our go-to-market motion, the land and expand motion, kind of driving higher price per seat through product expansion, driving partnerships with system integrators and channel partners, you know, that international mix. So we were extremely delighted to find somebody that really understood our model, but also where we wanna take it. I think I would say as we look out to next year, I would expect more incremental optimization, in the form of things like expanding with more partners, you know, going into, you know, kind of critical verticals that we need to continue to drive growth in, continue to move up customers into higher plan tiers.

So really a continuation of the things we've talked about on this call and to the street about, but obviously turbocharging wherever appropriate, you know, within the context of a financial model where we wanna deliver more bottom line efficiency as well. So that's sort of the balance that we continue to deal with. But I'd expect, you know, you to hear, you know, updates on more of those kind of strategic initiatives as we go into next year.

You know, coming out of BoxWorks and your new announcement with the GCP Marketplace, maybe give us a level set on, you know, new customer outreach and what the pipeline looks like from that perspective.

Yeah. So the GCP partnership has been something we've been working on now for quite some time. So we're excited to land the plane there. You know, it really kicked off at the start of Q4, so we're in the midst right now of some of those conversations. And I think the contours of the value really are when a customer is looking to buy Box, or maybe there's a gap in their IT strategy that Box can help with, and you know, a Google seller sort of identifies that, we can be brought in.

You have this much more efficient path for finding budget, in some cases, where a customer might have those unused credits within the GCP environment. So, very, just the earliest days of the partnership, but we're already hearing, you know, we're already seeing this in our pipeline and hearing anecdotes of it in customer conversations. But I'd say, I'd say just it's, it's sort of, you know, effectively day one right now. So we'll, we'll share more as, as we have updates.

George Iwanyc (Executive Director)

Great. Thank you.

Aaron Levie (Co-Founder and CEO)

Yeah, thanks.

Operator (participant)

Thank you, and I will now turn the call back to Cynthia for closing remarks.

Cynthia Hiponia (VP of Investor Relations)

Great. Thank you everyone for joining us today, and we look forward to updating you on our next call.

Operator (participant)

This concludes today's conference call. Thank you for your participation, and you may now disconnect.