Cloud content management company Box (NYSE:BOX) released third-quarter 2020 earnings on Nov. 26, and they looked pretty good. Revenue beat its previous outlook, causing the company to raise revenue guidance for the next quarter.

Further, the company gave an encouraging forecast for next year, which includes increasing revenue and controlling costs to deliver an improving free cash flow situation. Investors cheered with the stock up over 10% on the good news.

cloud key on a keyboard

Image source: Getty Images.

The good

Box's previous guidance for fiscal third-quarter revenue was $174 million to $175 million. Considering this is a company with a bad habit of revising guidance, it was crucial to deliver. Box indeed did deliver with revenue of $177.2 million -- up 2.7% quarter over quarter and 13.6% year over year.

The launch of Box's new security product -- Box Shield -- was another important subject going into these quarterly results. Box Shield helps companies manage data and prevent sensitive data from leaking out to the wrong people. In the earnings call, Box CEO Aaron Levie said that Box Shield is currently selling better than any product the company has ever launched. That's very encouraging, but keep in mind that it's still early, and the product only launched at the end of October.

The not so good

Non-GAAP (adjusted) net loss for the third quarter came in at $0.01 per share. Non-GAAP numbers reflect what the company believes its net earnings would have been if not for certain anomalies. But it is not earnings as they actually are. GAAP losses for Box were $0.28 per share, the same as last year, despite the company's top line growth. Next quarter, the company is guiding for a marked improvement of $0.22 to $0.21 GAAP loss per share.

Free cash flow, although improved from last quarter, was also still negative for the quarter.

Fiscal Quarter Free Cash Flow Percent of Revenue
Q3 2019 ($4.1 million) (2.6%)
Q4 2019 $21.0 million 12.8%
Q1 2020 $13.4 million 8.2%
Q2 2020 ($19.0 million) (11.0%)
Q3 2020 ($1.7 million) (0.9%)

Data source: Box.

It's discouraging to see negative free cash flow considering total operating expenses are down. Two of the main drags on Box's cash flow are capital expenditures and capital lease payments. These two things cost the company about 4.5% of revenue in the latest period. For the fourth quarter, the company is projecting they will eat up 8% of revenue, likely keeping the company in negative cash flow territory. 

The future

All in all this was a good step by Box management to reestablish credibility. Now, it needs to keep the momentum going. Of specific interest is what Box Shield represents. According to Levie, Shield is essentially the last piece of the puzzle for Box, offering an end-to-end cloud content solution. Certainly, there will be more add-on features to various products in the future, but the core product lineup is now set.

Daniel Kline points out in his article on investing in technology stocks that it's not uncommon for tech companies to have profitability issues while scaling their businesses. But now that Box has a more complete product with Box Shield, investor expectations should begin to change. Now is really the time for it to begin generating cash.

To that end, Box issued guidance at its investor day: In fiscal 2021, it plans to increase revenue 12.5% year over year and increase free cash flow margin to 12.5%. This year's revenue guidance is between $693.7 million and $694.7 million. A 12.5% bump would put next year's revenue at around $780 million. A free cash flow margin of 12.5% would put free cash flow close to $100 million for the year -- that would be a very welcome improvement.

That said, Box's market cap is around $2.6 billion as of this writing, which means that it trades at 26 times future free cash flow. There's no magic price-to-free-cash-flow number out there, but 26 isn't exactly cheap. By comparison, although it's not a direct Box competitor, cloud storage company Dropbox trades for around 25 times trailing free cash flow.

I'll happily take this quarter for what it was -- an improvement. The guidance given by Box's management is where this company needs to go. Look for the company to keep building investor confidence next quarter by hitting its revenue guidance of $181 million to $182 million. Also look for Box Shield demand to remain high.