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Beware of Box's Increasing Profitability

By Herve Blandin – May 30, 2020 at 8:18AM

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The cloud platform's fiscal first-quarter results show management's strategy is materializing, but that means revenue growth will be decelerating.

Box (BOX 0.43%) posted fiscal first-quarter revenue growth of 13%, in line with guidance. Yet the bottom line came in better than expected thanks to reduced operating expenses. These results confirm that management's focus on improving profitability is taking shape, but that strategy will also have a negative effect on the top line.

A bigger bottom line

The company offers a cloud-based platform that allows employees to manage their documents from anywhere. Thus, in the context of increased coronavirus-induced demand for work-from-home solutions, Box posted solid fiscal first-quarter results compared to its guidance. 

Metric Management Guidance Fiscal First-Quarter Results
Revenue $183 million to $184 million $183.6 million
Non-GAAP earnings per share $0.04 to $0.06 $0.10
GAAP earnins per share (loss) ($0.25) to ($0.23) ($0.17)

Data Source: Box. GAAP = Generally Accepted Accounting Principles.

The software-as-a-service (SaaS) vendor profited from the surge in demand from its existing customers for extra seats to allow employees to work from home.

As a consequence, the net retention rate came in at 107%, up from 106% a year ago and 104% last quarter, which means existing customers spent 7% more than last year. They also represented over 70% of bookings, up from about 66% historically. 

That strong business with existing customers is also the result of the company's successful strategy consisting of offering extra capabilities such as advanced workflow (Box Relay), enhanced security (Box Shield), and data governance (Box Governance).

These solutions that now integrate deeply with enterprises' workflows also increase Box's stickiness. Customers who have adopted at least one add-on product represented about 54% of recurring revenue during the last quarter, up from about 45% last year. 

Serving existing customers reduces sales and marketing expenses compared to acquiring new ones, which boosted the company's profitability. Despite increasing revenue, sales and marketing expenses dropped to $72.8 million (39.6% of revenue), down from $78.8 million (48.4% of revenue) in the prior-year quarter.

Hands typing on laptop, with cloud and computer icons superimposed

Image source: Getty Images.

Revenue growth versus profitability

Box's growing profitability is partly due to greater efficiency in sales and marketing expenses, but investors should also expect revenue growth to slow. 

During last year's investor day, management communicated its objective of improving combined revenue growth and free-cash-flow margin to 35% by fiscal 2023, up from 16% last year. That target means management will be balancing profitability against revenue growth over the next few years.

You should keep in mind that free cash flow excludes share-based compensation (SBC), though. Granted, SBC is a non-cash expense, but it remains a significant cost for shareholders as it represented 21.8% of revenue during the last quarter. Those SBC expenses also explain most of the significant difference between the company's non-GAAP (adjusted) and GAAP earnings.

In any case, the full-year updated guidance indicates the balance is shifting toward improving profitability against a lower revenue growth outlook compared to previous forecasts.

Metric Previous Guidance Updated Guidance
Fiscal full-year revenue  $771 million to $777 million   $760 million to $768 million
Revenue growth (midpoint) 11.2% 9.7% 
Non-GAAP earnings per share $0.38 to $0.44 $0.47 to $0.52
GAAP earnings per share (loss) ($0.78) to ($0.71) ($0.55) to ($0.50)

Data Source: Box. GAAP = Generally Accepted Accounting Principles.

That trend remains in line with the company's performance over the last several years, though. With scale, sales and marketing expenses as a percentage of revenue have been decreasing, which bodes well for profitability and free cash flow. But revenue growth has been decreasing too.

BOX Sales and Marketing Expense (% of Quarterly Revenues) Chart

Data by YCharts.

Not a bargain

Based on the midpoint of management's full-year revenue guidance, the market values the company at an enterprise value-to-sales ratio of 4.1.

Compared to other growth stocks, that valuation seems reasonable. In addition, Box's competitor Dropbox, which is also shifting to a cloud platform model, is valued at a higher enterprise value-to-sales ratio, close to 5. But Box's lower valuation is due to its inferior revenue growth and profitability.

BOX Revenue (Quarterly YoY Growth) Chart

Data by YCharts.

Besides, since Box's revenue growth should decelerate over the next several years as the company plans to improve its margins, its apparently modest valuation doesn't represent a bargain. Prudent investors should stay on the sidelines as long as revenue growth is decelerating and GAAP profits still seem far away.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Box. The Motley Fool has a disclosure policy.

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