Box (NYSE:BOX) recently reported its fiscal fourth-quarter and full-year 2019 earnings, and the market didn't like what it heard. The company's stock fell 18.6% the next day, wiping out basically all of its year-to-date gains.
While Box is known to be a well-run enterprise software business, it's a relatively young company that isn't yet profitable. Nevertheless, shares of similar software companies that are also unprofitable have done quite well in the recent past, so why does Box find itself in the penalty box? The answer is that Box, unlike some of its better-performing peers, has committed three cardinal sins, each of which is a big no-no in the world of high-growth software. Here are three different ways Box disappointed investors last quarter.
Revenue growth decelerated
While no business grows to the moon, investors usually need to see robust top-line growth in order to justify a young company's lack of profits. On that front, Box didn't deliver. Revenue grew just 19.8% last quarter, falling slightly short of analysts' expectations.
Stepping back and looking at the longer term, Box's revenue growth seems to be on a continuous downward trend. Full-year fiscal 2019 revenue growth clocked in at 20.2%, a deceleration from 26.8% growth in fiscal 2018 and 31.7% in fiscal 2017.
Unprofitable software companies need to post strong growth -- usually higher than 20% -- in order to leverage their fixed costs, as well as ongoing necessary investments in sales and R&D. The deceleration that Box is seeing makes it more difficult to make a case that it can achieve this, at least in the medium term.
Management blamed several near-term headwinds for its slowing revenue growth, including challenges in the Europe, Middle East, and Africa (EMEA) region, as well as large, more-complex deals that were pushed out from last quarter into the new fiscal year.
But if sales were merely delayed and not lost, one would anticipate better guidance. However, Box projected that revenue will rise to a range of $700 million to $704 million in fiscal 2020: up 15.1% to 15.7% year over year. That would represent another fairly significant deceleration from the past year.
Billings were even worse than revenue
Another unique feature of software companies is the all-important billings figure. Billings for a quarter can be calculated by adding quarterly revenue to the quarter-over-quarter change in deferred revenue.
Most software contracts are billed up front for the entire length of a term: say, one or two years. However, companies only recognize the portion of revenue that covers a particular reporting period: in this case, a quarter. Thus, the billings figure -- which incorporates not only near-term revenue but also booked contracts -- can be a good indicator of how much business a software company is actually bringing in.
Last quarter, Box committed a second software sin: Its billings growth was lower than its revenue growth. For the fourth quarter, billings rose just 16%, lower than the company's 19.8% revenue growth. For the full year, billings growth was even worse at 15%. That means that Box's tepid revenue growth could be overstating its actual business performance.
Again...this is not good.
Gross margin declines
A final aspect of high-growth software companies is that they usually expand their gross margins as they grow. Costs to deliver software are usually relatively small, and as more customers buy a service, revenue grows faster than the costs to deliver that growth.
On that front, Box also failed, with non-GAAP gross margin falling to 73.5% last quarter from 76.2% a year earlier. That's a huge decline, and it stands in stark contrast to the expectation that Box's gross margin should be expanding, not shrinking.
Management did explain that the decline was due to a large up-front investment in a new data center, since Box runs its software out of its own data centers. That may be true, and gross margin could increase in the future. However, if Box is to achieve its desired growth, these types of lumpy infrastructure investments will be necessary at certain points in its corporate life. So it's not as if this is a one-off occurrence, never to happen again.
A sinful earnings report
Box's recent quarter left much to be desired, to say the least. As growth seems to be stalling out, concerns around competition, notably from Microsoft's OneDrive 365, are likely to emerge in investors' minds.
The bull case for Box is that it has loyal enterprise customers, to which it can sell new services and tools. But as recent results show, these new products may be struggling to gain traction. In fact, one analyst challenged CEO Aaron Levie on a down-sell to a particular customer last quarter, which renewed at a lower rate after scrapping some higher-end use cases for Box. That's only one case, but if Box can't convince customers to buy additional solutions, there's only so much it can increase prices on its core content management software before a cloud giant swoops in with its own competitive offering.
In short, even though Box is nearly 20% cheaper than it recently was, it's still a no-go for me.