FireEye Tightens Up Its Operations

Detect, analyze, resolve: 3 functions at the core of FireEye's products and services. Image source:

Notwithstanding the news that CFO Michael Sheridan will be leaving to join a start-up in a non-related industry,FireEye'ssecond quarter 2015 earnings, reported last week, showed progress on a number of fronts. In an earnings preview articlefound here,I discussed five themes and trends for investors to watch in order to make sense of this fast-growing company, which is currently sacrificing earnings for market share. Let's briefly revisit those items, as well as two additional highlights from the earnings report.

1. Continued revenue momentum and customer signupsAs expected, FireEye enjoyed successful revenue growth during the quarter, reaching sales of $147.2 million, which represented a 56% year-over-year leap. The company handily exceeded its 220 new customer additions in Q1 2015 by adding more than 300 customers in the second quarter.

One benchmark to note is the number of new "million dollar plus" transactions closed by FireEye's sales team. According to CFO Sheridan, FireEye recorded 30 seven-figure deals during the quarter. This continues the solid performance in the first quarter, in which the company closed 28 such transactions.

2. Updates on new partnershipsAs expected, management didn't have much news regarding its nascent alliance with Visa to develop cybersecurity solutions for the payments industry. Executives did, however, relay some initial information regarding FireEye's newly formed cross-selling relationship with Hewlett-Packard during the earnings conference call.

CEO Dave DeWalt clarified that the partnership would target HP's largest "managed outsource" cybersecurity customers. According to DeWalt, the venture has been formally launched, and can claim a handful of deals which closed in the second quarter. Impressively, since its April announcement, the alliance already boasts a $20 million pipeline of prospective sales. We should be able to get a better sense of the potential impact of this relationship over the next few quarters, but it's off to a propitious start.

3. Sales and marketing expense versus revenueOne of FireEye's immediate tasks is to balance its appetite for market share with a realistic, sustainable profit and loss statement. As discussed in the earnings preview, sales and marketing is the company's largest expense line item, having exceeded recorded revenue in both of the last two fiscal years. Management has recently begun to provide guidance for its efforts to bring this expenditure in line.

The company showed a tangible improvement in sales and marketing expense to revenue in the second quarter, recording a ratio of 78% versus 100% in the prior year quarter.FireEye beat its own goal of keeping the non-GAAP version of this ratio in the range of 66%-70%. After adjusting for items related to stock compensation and amortization expense, the company, by my calculation, hit 63.4% on this ratio on a non-GAAP basis.

4. International business growthDue to vigorous expansion in U.S. business, non-U.S. sales were not able to hold at the level of one-third of total revenue established last quarter, dropping to 28%.However, these sales expanded by 65% over the prior year. Most impressively, the Asia Pacific segment, or APAC, which has been identified by management as a key growth area, grew at a rate of 136%, from $6.6 million in Q2 2014 to $15.6 million last quarter. Look for Asia to continue to provide tangible returns on sales investments for the near future.

5. The Mandiant effectOnce again,management called out its team of forensic cyber investigators and expert consultants as a key driver of company results. Formed out of FireEye's late 2013 acquisition of Mandiant Corp., the organization's cybersecurity professionals serve as a catalyst for winning large contracts, which often arise from "incidence response" consulting engagements.

While management didn't indicate target expansion goals for its investigative and consulting team, which at present numbers 300, CEO DeWalt confirmed that the company is still scaling up this resource. In one of the most impressive statistics of the earnings report, DeWalt revealed that FireEye received 30,000 job applications last quarter, a testament to the Mandiant brand, and an indication that FireEye will be able to continue to hire the best talent available as it grows this human expert base.

Other items: cash flow and deferred revenueFireEye took a significant step toward eventually being able to report positive GAAP net income on a consistent basis by reporting a surprise: positive operating cash flow of $39.1 million for the quarter. This compares quite favorably to the $61.9 million of operating cash FireEye burned through in Q2 2014. Management forecasted on its earnings call that, give or take $10 million, the company will reach a cash flow break-even point this year, a full two years ahead of schedule.

The improvement in cash flow is largely driven by an increase in the ratable mix of the company's products and services, that is, the amount of revenue that is earned equally over future periods. Selling more subscriptions and services versus installed "appliances" on customers' premises means that FireEye should begin to enjoy greater predictability of revenue and cash flow.

Future recurring revenue is also indicated by growth in the deferred revenue account, which increased 77% from the prior year to nearly $410 million.The balance in this account reflects monies collected in advance of the periods in which revenue will be recognized (i.e. earned). The fast expansion of deferred revenue indicates solid demand for cloud-based subscriptions, including offerings such as "FireEye-As-A-Service."

An operational bentTying all the strands above together, it appears that FireEye is beginning the transition to a profitability versus market share business model. Positive cash flow, a tighter control on selling expenses, and more stable revenue should form a base to provide shareholders with earnings to accompany top line growth. This begs at least two new questions: when will the bottom line turn positive, and how profitable can the company be? It's not too early to ask these questions, and we'll begin to look for clues over the remainder of this fiscal year.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends FireEye and Visa. The Motley Fool owns shares of FireEye and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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