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The cybersecurity vendor Palo Alto Networks (PANW - Get Report) reported its fiscal Q4 earnings after the close on Wednesday. Once more, revenue and non-GAAP EPS came in above expectations, with revenue growing 22.4% to reach $805.8 million and non-GAAP EPS coming in at $1.47.

The end of the fiscal year was also the opportunity for the company to combine its quarterly earnings call with an analyst day.

Management presented an ambitious three-year plan and discussed the company's long-term potential. Considering the large revenue base, revenue growth is expected to slow down compared to the previous years. But the forecasted revenue compound annualized growth rate (CAGR) of about 20% is still impressive. And the growth above the cybersecurity market CAGR of 12% means Palo Alto will keep on gaining market share over the next several years.

Management also indicated non-GAAP operating margin would exceed 25% and free cash flow margin would exceed 30% in four to five years.

With these numbers, Palo Alto will generate more than $1.5 billion of free cash flow by 2022. And with a stock price at $213, the corresponding free cash flow multiple below 14.2 times is reasonable.

But this medium-term plan doesn't account for a few key aspects for shareholders to consider:

1. Thinner Operating Margins

When calculating non-GAAP operating margin, Palo Alto excludes many one-time items (litigation, facility exit costs, etc.). These adjustments make sense as these costs don't represent the value of the business. But the company also excludes an important recurring cost: share-based compensation (SBC). By definition, SBC isn't a cash expense. But it's a real cost to shareholders due to the dilution this type of remuneration involves.

As a percentage of revenue, SBC has been decreasing over the last several years. But SBC amounted to $567.7 million and still represented 20.4% of revenue during fiscal 2019.

Management forecasted the non-GAAP operating margin to be in the range of 21% to 22% by 2022. Thus, taking into account SBC, the operating margin is getting closer to a much lower range of 6% to 7%, assuming SBC will represent about 15% of revenue. 

Following the evolution of the SBC in the company's next earnings will be key to assess the real profitability of the company.

2. The Impact of Acquisitions

The non-GAAP operating margin also excludes the impact of potential M&A, even though Palo Alto has been expanding its platform with organic growth and acquisitions.

After several other transactions this year, the company announced during its fiscal Q4 earnings its intent to acquire the IoT (Internet of Things) security company Zingbox. And management didn't exclude the possibility for more acquisitions over the next years. Acquisition-related costs amounted to $29.8 million during fiscal 2019 and management forecasts an extra $45 million during next year.

Considering the potential for more acquisitions in the medium term, acquisitions-related expenses are a real recurrent cost to shareholders that the non-GAAP operating margin doesn't take into account. 

3. Free Cash Flow Is Only Part of the Story

I discussed above the significant impact of SBC. Of course, as SBC is a non-cash expense, the 30%+ free cash flow margin management announced excludes SBC.

Taking into account SBC, the real profit potential is actually lower than the impressive level of free cash flow suggested by the company. Also, free cash flow includes advance payments that are not recognized as revenue yet.

Thus, the expected free cash flow margin must be balanced with SBC and advance payments. Positive free cash flow together with growing revenue is definitely an attractive proposition as they contribute to a healthy balance sheet. But I prefer to focus on the operating margin to gauge the profitability of the company.

Conclusion

During fiscal Q4, Palo Alto again performed above expectations. And management expects the company to keep on gaining market share in the growing cybersecurity market. Also, the long-term plan includes impressive targets. Taking into account the ambitious goals, the price-to-sales ratio of about 6.9 times -- based on fiscal 2019 revenue and with a stock price at $213 -- corresponds to a reasonable valuation.

But understanding the context of the long-term plan is key. Despite a high non-GAAP operating margin and an impressive free cash flow margin potential over the next years, the company won't report any significant GAAP net income -- if any -- before fiscal 2022 due to the reasons listed above.

Thus, investing in Palo Alto remains a bet on flawless execution of its ambitious plan over the next few years.

Palo Alto Networks is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells PANW? Learn more now.

The author doesn't own any of the stocks discussed.