Aaron Levie - Chairman and CEO Dylan Smith - CFO Stephanie Wakefield - VP, IR.

Rob Owens - KeyBanc Capital Markets Greg McDowell - JMP Securities Mathew Coss - JPMorgan Brian Peterson - Raymond James Melissa Franchi - Morgan Stanley Brian White - Drexel.

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Box Second Quarter Fiscal 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

I will now turn the call over to Stephanie Wakefield, Vice President of Investor Relations. You may begin your conference..

Good afternoon and welcome to Box's second quarter fiscal year 2018 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. Today's call is being web cast and will also be available for replay on our Investor Relations website at www.box.com/investors.

Our web cast will be audio only. However, supplemental slides are now available for download on our web site. We will also post the highlights of today's call on Twitter at the handle @boxincir.

On this call, we will be making forward-looking statements, including our Q3 and full year 2018 financial guidance, and our expectations regarding our financial results, market adoption of our products, our market size, our operating leverage, our expectations regarding achieving and maintaining positive free cash flow and future profitability, our planned investments and growth strategies, our ability to achieve long term revenue and other operating model targets and expected timing and 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 factor documents we file with the SEC, including the most recent Form 10-Q quarterly report for information on risks and uncertainties that may cause actual results to differ materially.

These forward-looking statements are being made as of today, August 30, 2017 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 taken in consideration, in addition to, but 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 on our web site.

Unless otherwise indicated, all references to financial measures are on a non-GAAP basis. With that, let me hand it over to Aaron..

Thanks Stephanie and thanks everyone for joining the call. The second quarter was another strong performance for Box. We delivered year-over-year revenue growth of 28% and grew billings 31%. Our new investments this year in sales and marketing started to yield results as we generated our largest amount of pipeline to-date for a single quarter in Q2.

These results demonstrate the significant need for cloud content management in all industries, and we feel confident that the improvements we have been making in the business set us up well to reach our goal of profitability and $1 billion revenue in the coming years.

This quarter, we grew our leadership in the market with thousands of new or expanded deployments, including Amazon, Delta Global Services, a subsidiary of Delta Airlines, London's Metropolitan Police, Freedom Financial Network, and United Talent Agency.

We saw particularly strong traction in our international markets, including in Japan and EMEA, growth in our add-on products, and a significant new strategic partnership with Microsoft. As we have talked about before, this year, we are focusing on two major objectives.

Number one, innovating in cloud content management with additional products and platform capabilities, that help move enterprise workload to the cloud; and number two, advancing our global go-to-market efforts so that we can reach more enterprises all around the world. We continue to make solid progress on both of these fronts.

Let's start with innovation in cloud content management. Just a couple of weeks ago, we announced new advanced image recognition capabilities through an integration with Google Cloud Vision.

Image recognition has major implications in a range of industries from insurance companies, automatically tagging and classifying insurance claims, to retailers organizing their digital assets and catalogs.

This is incredibly exciting as it's our first of many used cases for artificial intelligence and machine learning to help enterprise improve workflows and drive efficiency through discovery and deeper insights into content stored in Box.

For many customers, computer powered image recognition will eliminate expensive manual processes that go into identifying text and objects from image content, further disrupting legacy ECM systems. Taking a step back, we believe AI is the most important technology trend since the cloud and has the potential to completely change the way that we work.

To leverage the strength of AI in machine learning, technology providers need three key assets; number one, you need a lot of data; number two, you need the ability to be able to use and learn from that data; and number three, you need frequent activity to be able to train your systems at scale.

At Box, we are fortunate to have all three with one of the largest corporate repositories of content in the world. This materially separates Box from traditional on-premises content management and storage providers. In this context, our new integration with Google Vision is just the beginning.

At BoxWorks, our annual customer conference in October, you will be hearing much more about how we will continue to add AI and machine learning capabilities into Box, making content even more valuable and completely changing the way that customers interact with their information.

In Q2, we also continued to innovate on our core Box products and platform. In June, we launched Box Drive, available to customers in Beta, as part of the core Box product, Drive, is an extremely simple way to stream all of your files in Box, even terabytes of data right to your desktop.

It makes moving to the cloud incredibly easy for enterprises, since users can access their files with an intuitive desktop experience that has the familiar feel of traditional network shared drives.

And by working in the cloud, enterprises are able to retire expensive legacy infrastructure like network file shares that can require millions of dollars annually in hardware, software, and maintenance costs.

We have had tremendous early demand for Drive and have heard from many customers that it has increased Box engagement amongst their employees; for some more than 60%. This quarter, we have also seen increased adoption of our Box KeySafe, Zones, Governance; and Platform products.

These products continue to be key competitive differentiators and are growth drivers for Box. This past quarter, 60% of our deals of more than $100,000, included at least one of these new products. On Box platform, we had our best quarter ever as more customers are appreciating the value that Box platform delivers.

This quarter we closed our largest platform transaction to-date, with one of the world's leading investment banks. Box was selected as a keystone of their digital transformation to next generation customer experiences.

By leveraging Box platform, as well as Governance and KeySafe, they will be building a new customer portal that will allow financial advisors to easily share content with their wealth management customers, while also meeting the extremely stringent security and regulatory requirements of the financial services sector.

Our new product capabilities not only support cloud content management strategy, they also open up opportunities for Box to replace legacy enterprise content management systems. We are seeing increasing momentum from customers, looking to move to Box and retire their legacy content management solutions over time.

For example, another large financial services provider selected Box this quarter to retire their multiple legacy ECM systems and make Box their only content management system companywide. With Box, they will be able to transform their loan underwriting process, increasing efficiency, while remaining secure and compliant.

All of this continued innovation was recognized this quarter by Gartner. We received the leading placement in the Gartner Magic Quadrant for Content Collaboration Platforms, and we were specifically recognized ahead of all other vendors for our vision.

Gartner is making major changes in how it assesses and evaluates content related markets this year, and has rescoped its categories of EFSS and enterprise content management. This new viewpoint recognizes the shift happening in customers’ expectations.

Digital transformation requires not just cloud storage, but true cloud content management and Box is pioneering in this new category. Our second major objective for FY 2018 is to reach and enable every business in the world through our global go-to-market efforts.

As we have discussed, we are investing in marketing technology in sales and marketing headcount this year, to seize our growing opportunity. We have been making significant progress in hiring enterprise sales reps for our large enterprise and international segments.

While we expect revenue contribution from these new investments to come in the next fiscal year, we are already seeing these efforts have an impact, as we generated our largest early stage pipeline to date in Q2. We are also excited to have welcomed Stephanie Carullo as a successor to Dan Levin last month.

After seven years at Box, Dan stepped down as COO and Stephanie joined us to lead the company's continued growth in the enterprise and international expansion efforts.

Stephanie has more than 25 years of leadership experience, driving global sales and go-to-market execution for some of the world's leading technology companies, like Apple, IBM, and Cisco. She has been ramping up quickly this past month, further integrating our global go-to-market efforts.

Channel and technology partners are also a critical component of our go-to-market strategy. In Q2, our channel partners such as IBM, AT&T and Itochu in Japan, played a role in over 40% of our deals over $100,000 and contributed to our lead generation awareness product and sales efforts around the world.

Another exciting milestone that we announced this quarter, is our expanded partnership with Microsoft, which signals a fundamental shift in our relationship. Under the new agreement, Box will use Azure as a strategic public cloud platform and Microsoft sales reps globally will co-sell and be compensated for selling Box offerings that use Azure.

The partnership will also enable future integrations between Azure's artificial intelligence and machine learning capabilities, with Box's cloud content management platform, and will eventually expand Box Zones to additional countries, using Azures 40 data centers around the world.

We are excited to have Microsoft executives, Scott Guthrie, who is EVP of Microsoft's Cloud and Enterprise Group, and Kevin Scott, CTO of Microsoft, join us on stage of BoxWorks to discuss how we are strengthening our partnership to deliver value to enterprises and developers all around the world.

We are incredibly excited about our product roadmap for the rest of the year. By adding AI and machine learning capabilities to box and continuing to innovate on core Box products, we are in a position to help enterprises in every industry power how they work with their information.

Looking ahead, we will execute on this roadmap and further grow our lead in cloud content management, and we will also continue to advance our global go-to-market efforts and see even more traction in our international markets, with the help of our new COO, Stephanie Carullo, and strategic partners like Microsoft and IBM.

And we will drive these growth strategies, while remaining committed to our goal of being free cash flow positive for the rest of the year, as we head towards an annual revenue target of $1 billion. Now I hand it over to Dylan..

Thanks Aaron. Good afternoon everyone and thank you for joining us today. As Stephanie noted, GAAP to non-GAAP reconciliations are in the presentation that is available on our IR web site. The financial measures I will be discussing on this call are non-GAAP, unless otherwise noted.

We delivered another strong quarter in Q2 with rapid growth in revenue, billings and deferred revenue. These results were driven by strong momentum in our core and add-on products, international sales and our best-in-class retention rate. We achieved record revenue of $122.9 million in Q2, above the high end of our guidance and up 28% year-over-year.

21% of Q2 revenue came from regions outside of the United States, compared to 17% a year ago. While revenue was a trailing metric, this quarter, more than a third of our six figure deals came from international markets, including the largest international transaction in Box's history.

Second quarter billings came in at $139.5 million, representing 31% calculated billings growth and 31% adjusted billings growth year-over-year. We continue to expect billings growth and revenue growth to tract roughly in line for the remainder of fiscal 2018.

We maintained our momentum with large enterprise customers, closing 39 deals over $100,000 versus 45 a year ago; eight deals over $500,000 versus five a year ago; and four deals over $1 million versus one a year ago. We showed the strongest traction to-date with our newer products, including Governance, Zones, KeySafe and Platform.

In Q2, more than 60% of our six figure deals included at least one of these newer products. Partners played a role in more than 40% of our deals over $100,000, with three of these deals attributable to IBM. Deferred revenue was $241 million, up a very strong 32% year-over-year.

Deferred revenue growth was primarily driven by solid sales execution, and was also positively impacted again by the enhanced developer access fee from one of our resellers.

Turning to margins; with stable pricing in the market and continued infrastructure efficiencies, non-GAAP gross margin came in at 75.5% versus 74.0% a year ago and 74.5% last quarter. We now expect our gross margin to come in at nearly 75% in the back half of FY 2018, up from our previous expectation of 74%.

Q2 was another successful quarter of driving greater operational efficiency, while significantly growing our top line. Sales and marketing expenses in the quarter were $65.3 million representing 53% of revenue, an improvement from 56% in the prior year.

Our investments in marketing technology and demand generation are continuing to pay off, as we generated record pipeline for the second consecutive quarter. These investments will allow us to drive top line growth and realize additional leverage in sales and marketing over time.

The ongoing cost to support our free user base, which is a sales and marketing expense, decreased to 3% of revenue in the second quarter, an improvement from 7% in the same quarter a year ago. We now have more than 55.8 million registered users, of which 9.4 million are paid.

Next, research and development expenses were $24.5 million or 20% of revenue, down from 22% a year ago. We drove this leverage, even as we made significant enhancements to our products, launching Box Drive and Box Elements and developing our first foray into artificial intelligence, with Intelligent Image Recognition.

Our general and administrative costs were $17.9 million or 15% of revenue compared to 15% in Q2 of last year. This includes investments in systems, processes and consultants to prepare for the new ASC 606 revenue standard, which will continue into next year.

This quarter, we also began paying double rent on our offices in London and Tokyo, as we prepare to move into these new facilities later this year.

These improvements in operational efficiency drove our Q2 non-GAAP operating margin to a significant 7 percentage point improvement year-over-year, coming in at negative 12% versus negative 19% a year ago.

This focus on leverage drove non-GAAP EPS to negative $0.11, as solid improvements from negative $0.14 a year ago and ahead of the high end of our guidance. One of the key elements that makes our business model so powerful, is our strong customer retention. Our churn rate remained best in class, at just over 3.5% on an annualized basis.

As we have discussed in the past, transactions through our channel partners have a somewhat higher churn rate, and we are seeing that impact our overall churn rate, as our channel business scales. Our net expansion rate was 17%, primarily driven by strong seat growth in existing customers and cross sells of our newer products.

As such, we ended the quarter with a retention rate of 113%. Let me now move on to our balance sheet and cash flow. We ended the quarter with $191.8 million in cash, equivalents and restricted cash, of which, roughly $26.5 million was restricted.

As expected, cash flow from operations was negative in Q2 coming in at negative $9.5 million versus negative $4.9 million a year ago. As we have noted in the past, Q2 was typically our weakest cash flow quarter, due to the seasonality of billings and collections.

In Q2, we also made some prepayments related to our annual customer conference, BoxWorks, which will take place in Q3. Given the strong results we have been seeing internationally, we chose to accelerate facilities' investments in Japan and London, as part of our continued focus on international expansion.

When comparing this quarter with Q2 of last year, facilities' expansion accounted for a roughly $5 million headwind year-over-year. Over the trailing 12 months, our business has generated positive cash flow from operations.

In Q2, total CapEx was flat year-over-year at roughly $1 million and capital lease payments were $4.2 million compared to $2.3 million a year ago. We expect data center CapEx and capital leases combined to be roughly 5% of revenue for the remainder of the year.

In addition, we expect to spend roughly 3% of revenue on CapEx related to facilities' expansion in the back half of this year. Free cash flow came in at negative $14.7 million compared to negative $7.9 million a year ago.

Going forward, we are committed to achieving positive free cash flow for both Q3 and Q4, as well as for the full year of fiscal 2018. With that, let's now turn to our guidance. For the third quarter of fiscal 2018, we are setting revenue guidance in the range of $128 million to $129 million.

We expect our non-GAAP EPS to be in the range of negative $0.13 to negative $0.14 and for our GAAP EPS to be in the range of negative $0.33 to negative $0.34 on approximately 135 million shares. For the full year of fiscal 2018, we expect revenue to be in the range of $503 million to $506 million.

We are tightening our guidance range, and expect our non-GAAP EPS to be in the range of negative $0.44 to negative $0.46 and for our GAAP EPS to be in the range of negative $1.21 to negative $1.23 on approximately 134 million shares. In summary, Q2 was a strong quarter for Box.

We launched new products such as Box Drive and Box Elements, launched a new partnership with Microsoft Azure and gained significant traction in international markets. We also brought on Stephanie Carullo as COO to help us drive our next phase of growth, and we look forward to introducing her at our upcoming Analyst Day.

We are well positioned against a $40 billion market opportunity, and we are confident in delivering positive free cash flow in both Q3 and Q4, and in achieving a $1 billion annualized revenue run rate, by Q4 of fiscal year 2021. We look forward to seeing you at our Analyst Day in San Francisco on October 12.

With that, I would like to open it up for questions.

Operator?.

[Operator Instructions]. Your first question is from Rob Owens from KeyBanc Capital Markets..

Great. Thanks and good afternoon guys.

Was hoping you could address some of the larger deal metrics that you had, specifically around the $100,000 deals, and just what you are seeing there specifically on a year-over-year basis? Are those typically follow-on deals or are those new deals and as you talk about the record pipeline that you generated in Q2, are you seeing those deal sizes increase versus historical, or just maybe a little bit of color would help? Thanks..

Yeah so, about two thirds of the deals are expansion deals, so follow-on deals, and we tend to see in the beginning part of the year, it's obviously much more of a pipeline development period in the first half of the year, which allows us to go and create more expansion opportunity for the second half of the year.

So the thing that we are really excited about seeing is, the eight deals over $500,000 and the four deals over $1 million, both pretty significant increases year-over-year in those two segments. And what that's really due to, is the overall, I think the proposition of using Box to replace and retire legacy ECM systems.

So we are seeing pretty significant growth on products like Governance, Zones and KeySafe in a lot of those larger deal segments. So we are happy overall about the run rate, we certainly wouldn't mind a little more volume in the $100,000 category and above.

But where I think you are going to see the business leaning more to over time is that $500,000 and $1 million segment. So we are very happy to see strong performance in those two categories..

And just to build on that a bit, we are seeing overall higher ACVs in that category holistically, and a lot of that is because we are now at a stage where we are seeing the customer demand to buy several products all at once.

Since that has driven not just larger overall ACVs within that category, but we did see, as we mentioned, the largest deal of all time in EMEA, the largest platform deal we have ever sold as well as the largest deal we have seen in the commercial segments in our history.

So definitely, a lot of positive trends as more and more customers are thinking about Box as a holistic cloud content management solution, and that might include three or four products, which is a pretty different trend than what we were seeing a year or two ago..

Great. And for my completely unrelated follow on question, maybe you could elaborate a little bit more on this coopetition relationship with Microsoft and pretty a interesting announcement, and when do you hope it will lend to some traction and when we might see it impact your model? Thanks..

Yeah, thanks. As we have long seen and continue to share with the market and what we are seeing from customers is Box and Microsoft complement each other in a significant portion of the product area, so whether it's our integration with Office 365, where you can edit documents very easily from Box directly.

Things like Azure Active Directory that we use as an identity service provider for our customers.

We have overall seen a very-very healthy relationship with Microsoft, but that expanded in June, where we created a partnership, where our customers are going to be able to use Box with Azure for things like storage in international locations, so that increases -- over time, that will increase our Box Zone's footprint to now 40 locations around the world, as well as begin to include new cognitive capabilities from the Azure stack, so there is a lot of technology they are working on, that can help customers process and better understand their content.

So we think this further enriches the capabilities that we can bring from Microsoft into our platform.

It helps us obviously tell a much better story for customers and it's something that we have seen them clamoring for, and then the kicker is really Microsoft Azure sellers now have some incentive to ensure that Box is being sold into their environments.

And so, we have been able to create some really-really great incentive mechanisms on both sides, to be able to help promote this partnership. So I think, overall, you are going to see more and more complementary relationship and I think a much more integrated experience between Box and Microsoft.

We will still compete on the edges, so that doesn't go away clearly. But overall, we are very-very happy about how this relationship is continuing to come together..

Great. Thank you..

The next question is from Greg McDowell from JMP Securities..

Great. Thank you very much. I first wanted to ask about, you have a new COO, Stephanie, and I know you mentioned she is ramping up quickly, and I know we will get to learn more about that at the upcoming Analyst Day.

But can you just talk about some of her initial priorities and where her head is focused on optimizing the organization? Then I have one follow-up..

Sure. Yeah. So we are incredibly excited to be able to bring Stephanie on board, that was the search that I had done with Dan for about a year. So we met with some incredible candidates, and Stephanie, far and above the rest was a perfect fit for what we were looking for.

She comes with 25 years -- as I mentioned, of both sales leadership, consulting leadership and overall go-to-market operations at some companies that we would obviously love to look like at scale, Cisco, Apple, IBM and others. So her primary focus is really about integrating all of our go-to-market work streams.

As we scale the company, from -- to now this point, where we are looking at $0.5 billion of revenue this year, and going to $1 billion and then beyond.

Given the international markets, the enterprise segments we are going into, continuing to move our customers through a journey of using more and more of the Box product, theer’s a lot of go-to-market integration really required in that.

And so, Stephanie is coming on right at a great inflection point for our company where customers are beginning to use us as this broader platform, and she can really turbo charge us on the go-to-market front.

So she has a few key focus areas, that certainly include an increase and a focus on increasing our average contract value with customers, so that will be really the sale of new and additional products to customers. Helping us really put a bigger focus and emphasis on our retention rate and helping expand customers.

Things like sales productivity, so as we have talked about in the past year or so, we are ramping up our sales headcount, that's because of the demand that we are seeing in the market.

So we want to ensure that we can get sales reps as productive as possible, as quickly as possible, and then ultimately, Stephanie also hails from a lot of sort of great international roles, so she is going to help us quite a bit on the international expansion front that we are very excited about.

So those are sort of four of the big focus areas that we are kind of having our focus on now. We don't expect any major sort of restructuring of any organizations. We really like the strategy we have in place and the structure we have in place. It's all about kind of tuning and optimizing and continuing to turbo charge our growth rate..

All right. Thanks Aaron and one quick follow-up for Dylan. I just want to ask about gross margin in the second half of the year.

It sounds like gross margin is tracking a little bit ahead of expectations, and I was just wondering if you could elaborate a little bit on what's driving the better gross margins in the back half of the year?.

Sure. So we have been really pleased with a lot of the optimizations that we have been able to make to our infrastructure. Not only in the first half of the year, but that we expect are going to flow through steady state into the back half of the year.

A couple of the big things I'd call out; first of all, I think we have seen a really better savings and the ability to move more workloads into the public cloud than we had originally expected. So really pleased with the way that that strategy and the different partnerships that we have across the ecosystem are playing out.

So that's a big driver and we see a lot of additional opportunities over time as we talked about, especially now that working much more closely with Microsoft. And then the other piece is around a lot of the things we are doing internally around our own infrastructure.

So everything from really focusing on driving better server utilization, which drives a longer life for our gear, denser filers and just even some of the tactical things like driving better power and networking efficiencies, have really combined to not just allow us to sort of exceed our expectations in the first half, as we enter the year, but also now, get us nearly a percentage point improvement, relative to what we had expected in the back half.

So definitely pleased with some of the progress that we have been able to make driving leverage in that line item..

Great. Thank you..

The next question is from Mark Murphy from JPMorgan..

This is Matthew Coss on for Mark Murphy. Thank you for taking my question. I think as of the last update, you mentioned over 3,500 active applications on the Box platform and the number of API calls to your platform, is up roughly five times year-over-year.

Can you describe some of the more interesting functionality built into those applications with the greatest number of API calls, and then how do you view the evolution of your platform, in terms of improving stickiness and then encouraging large customers to make strategic investments in Box for the long haul?.

Yeah. So we actually had a couple of key milestones in the quarter on the developer front. So we reached over $100,000 developers on the platform. We now have over 3,500 active applications being built on Box.

We launched a new product, Dylan highlighted it briefly called Box Elements, which let the developer much more rapidly integrate Box functionality into their application, so we kind of created a user interface -- pre-built user interface kit, that meant customers and developers can use to embed Box into the applications that they have.

So dramatically, drop the time it takes to use the Box platform. So a lot of great momentum on both the developer front, as well as the product front. Some great used cases that we are seeing, and is completely consistent with our overall cloud content management storage for customers, is we are seeing internal applications being built.

We have a very large retail customer that's building an internal training experience on top of the Box platform. That netted a certainly significant transaction on the platform this past quarter. So all of their training materials are being delivered through Box, in a very customized way to their employees.

We have a number now of financial services, institutions, that are building their customer facing applications on Box. So things like loan processing to wealth advisors. So there is a significant amount of documentation and ultimately document content that needs to be digitized in those workflows, and that's all being built on the Box platform.

So we are seeing a really-really rich range of used cases and ultimately, what we are seeing from customers is, they are seeing Box, not just as a place where they can store and share and collaborate around files in their daily workflows, but ultimately build their much more customer facing or much more integrated employee experiences on the Box platform as well.

That helps us go and replace and retire legacy enterprise content management systems, storage infrastructure and other sort of platform environment, that they would have had to built out otherwise. So overall, really-really strong traction and becoming much more integrated into the overall sale of Box.

So less of something that is a pure sort of separate add-on, as much as something that customers are buying directly with their Box transaction and with the core Box service..

That's extremely helpful.

And then quickly, can you comment or tell us what is the growth trait of quota carrying sales reps in the quarter? Or maybe, if you don't kind of do that, what's sort of your goal for the growth of your quota carrying sales rep this year?.

Yeah. So we will get the details on that, on an annual basis at the end of the year.

What I would say is, that we have been really pleased with the growth we have been saying in our quota carrying headcount year-to-date, not only adding a record number of rep store sales force in Q1 of this year, but very much on track to grow sales headcounts by 25% for the year, which is our target and which we are feeling really good about..

Thank you..

The next question is from Brian Peterson from Raymond James..

Hi, thanks for taking the question. So I wanted to hit on the record pipeline you guys referenced, both last quarter and then again this quarter.

Can you quantify what's driving that dynamic, if we were to split it between more users, as you expand geographically versus a potentially high revenue per user, as you add products to the portfolio?.

Yeah.

So it is a little bit of both -- this is Aaron, we are seeing both market expansion, in terms of geographies that we are entering and we are seeing pretty healthy pipeline build in places like Japan and throughout Europe, as well as due to the new investments, both from a product positioning as well as product innovation standpoint for cloud content management.

We are seeing a nice uptick in average contract values starting to show up in pipeline as well. So the customers are starting to see us as far more than just basic file sharing and file synchronization use cases, that ends up resulting in more strategic conversations with customers and increasing the deal value, showing up in the pipeline.

As well as just getting the overall engine going, with much more integrated go-to-market efforts. So we are pretty happy about how that has been maturing over the past couple of quarters. It's both again the maturing of the market itself, as well as our innovation and our go-to-market efforts, and we hope to see this continue at this pace..

Got it. And maybe one for you Dylan, just trying to understand; I think you referenced the retention being a little bit lower in the channel versus some of the direct business. Can you maybe spend a little bit on why that is? Thanks guys..

Sure.

So I mentioned this on the last call as well, and really what we see there is, while we take a very kind of focused approach to and spend a lot of time kind of in the field with our channel partners, naturally, there are some of those relationships and conversations, where we are just one step or half a step removed from the customer, relative to when we are engaging with that customer solely through our direct sales force.

So we do see, while we are really pleased and have a very strong overall retention rate, even in customers that we bring in through channel partners, we do find that in some situations, either of it -- the purchase of Box might be part of a larger ELA, or if we just don't spend quite as much time with that customer, whether it's our sales team or consulting team, we just find that at the margin, we do see in some of those customers lower adoption, and then ultimately, a little bit lower retention.

So still very much best-in-class retention, both from a kind of channel customer standpoint and overall. But that's the sort of dynamic where, the slightly higher churn rates through channel customers, now that channel partners account for about 30% of our overall business is showing up in our overall retention rate..

Okay. Thanks Dylan..

The next question is from Melissa Franchi from Morgan Stanley..

Great. Thanks for taking my question. Aaron, you talked about the traction that you are seeing internationally.

I am just wondering if the upcoming data privacy regulation is playing a role at all in that momentum, just given that you do have a pretty good security story, particularly as it relates to the digital transformation?.

Yeah. It absolutely is, I think, playing a pertinence in it. It helps with both customers that are sort of headquartered internationally, as well as U.S. based multinational. So both types of customers are pretty broadly impacted by the range of privacy issues that they are now dealing with. I think GDPR is sort of what you are specifically calling out.

But in general, we see a significant amount of headwind for large enterprises, having to deal with all of the varied compliance in privacy challenges of just operating a global business today in the digital age.

So that headwind for a customer, becomes a tailwind for us, because of our focus on all things security, international data residency, international compliance, and now a bigger focus on the privacy effort. One example from the quarter and certainly a quarter where we saw our largest European transaction was, the Metropolitan Police of London.

So a pretty significant government agency now choosing Box as their standard for a lot of their digital collaboration and content that needs to move back and forth.

So you can see that even some of the most stringent and security conscious government agencies internationally are choosing Box as their content management platform, which obviously we think has pretty significant implications for the private sector throughout Europe and Australia, Japan and other major regions.

So we are pretty happy about the growth that we are seeing internationally. We do think that privacy challenges play into our favor.

Obviously, we don't enjoy the complexity that our customers have to deal with, but it does play into our favor strategically, because of the focus that we have and the emphasis we have on security, privacy and compliance at Box..

Great, thanks. And then just one quick follow-up on the expansion internationally.

Just wondering maybe, for Dylan, to what extent, as you are continuing to build that momentum, are you focused on building out the channel and strategic relationship to drive that continued traction versus adding more feet on the street?.

Yeah. So it's a little bit of a mix and really varies by region. Would say that, proportionally, a materially greater percentage of both the business we have sold so far, as well as, what we expect in the future, internationally, is going to be working with our channel partners.

So for example, we do see a higher percentage sort of teaming with partners in EMEA. We see virtually all of our Japan business, working through partners, and just get a sense of even our largest retailer relationship, although it's a much deeper relationship that we have with IBM.

More than half of the opportunities, pipeline deals, etcetera, they have consistently generated, has been internationally as well.

So we are really also taking the approach, where the way we sort of think about new market opportunities and feeding those new markets, tends to be a combination of working with a small handful of really kind of aligned and important channel partners, as well as through our self-served business.

And then, as we continue to see success, start to build pipeline, continue to build our brands in those regions, that's when we start to lay in kind of more feet on the streets, from a direct sales force point of view.

So definitely a mix, but would definitely say that, we have seen and would expect continue seeing more kind of working closely with our channel partners, as we expand internationally..

Awesome. Thank you..

[Operator Instructions]. The next question is from Brian White from Drexel..

Yeah Aaron, just a question around the Google Cloud vision.

Do you see this as more of an opportunity to drive new revenue with new services, or is it simply going to enhance the Box platform?.

So we are actually -- stepping back to AI broadly. We think there is a number of services in the market that help do things, like object recognition and videos, text translation, audio transcription, and obviously, image recognition as well, which is things like character recognition, text recognition, as well as object recognition and images.

So AI has a significant sort of value to the content in Box, and what it can do is really two things to that question; first is, there is a bunch of companies that will spend upwards of millions of dollars on manual processes, to do things like extract text from images, call out objects that are inside of images.

So retailers for instance, insurance companies, they can spend a large amount of money on manual processes that do that. And so in that case, it allows us to go retire legacy costs for customers, and have some of that value correspondingly come into Box.

And then, there is a much larger part of the market, that previously wasn't doing anything around understanding their content. So it was often cost prohibitive for large sections of the market, to really do anything, to understand their unstructured data.

So we think we can bring these services to a large part of the market, that previously just wasn't solving these problems and introduced people in new business processes and automatic ways of understanding their data.

In both of these categories, we expect that there will be some set of functionality that we give to customers, to help them onboard very quickly and easily, in a very low friction way, as well as charge for additional levels of service and volume of service. So we will be sharing more about these plans at BoxWorks.

But overall, we are seeing really exciting reaction from customers around how can they go and automate the business processes that they have in Box and that opened up a whole new set of market for us..

Okay, great. Thank you..

There are no further questions at this time. I will turn the call back over to the presenters..

Thank you for joining us today. We look forward to seeing you at the Analyst Day on October 12 in San Francisco. Please contact me, if you have a request to attend that event and we will speak to you again next earnings. Thank you..

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