FireEye's (NASDAQ: FEYE) third-quarter results turned out to be better than expected, but Wall Street wasn't satisfied with its conservative fourth-quarter guidance. Not surprisingly, FireEye lost over 10% of its market capitalization in a single day as investors pressed the panic button.
However, a closer look at the cybersecurity specialist's results suggests an overreaction on investors' part as FireEye's guidance isn't all that bad. The company is trying to reset expectations after gauging the response to its new security platform, which it believes will eventually lead to bottom-line improvements.
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So, is the unwarranted drop in FireEye's stock price an opportunity for savvy investors, or are there any red flags that investors should be aware of? Let's find out.
What's the problem?
FireEye expects fourth-quarter revenue of $193 million at the mid-point of its guidance range, and an adjusted net loss between break-even and $0.03 per share. These numbers fall just short of the consensus estimates that pinned the company's fourth-quarter revenue at $196 million and loss at $0.01 per share.
Furthermore, FireEye has reduced its full-year billings guidance by almost 2% at the mid-point, which is cause for concern as the metric indicates weakness in the company's ability to sign-up business for the long run. However, the cybersecurity specialist believes that these scaled-back numbers are nothing to worry about.
The lower guidance is a result of the recently launched Helix cybersecurity platform, which is leading to shorter contracts with customers. More specifically, the average contract length in the third quarter was 25 months, down from 27 months in the prior-year period. Looking ahead, FireEye expects contract lengths to stabilize in the range of 20 months to 24 months, so investors can expect further downward adjustments in the billings.
The decline in contract lengths is a result of the change in the company's business model. It was locking in customers for a longer period of three years when product-driven sales were its primary target. But the shift to the subscription model has given customers the flexibility to choose one- or two-year deals based on their requirements, but there is a big upside to this.
Shorter contracts will improve margins
FireEye management is assuring investors that the shorter contracts will positively impact its margins. This is because FireEye won't have to offer discounted prices that generally come with longer-term contracts. Moreover, the cost of servicing recurring customers that are brought in through the subscription model is cheap as compared to acquiring new ones.
The good news is that the change in contract lengths is already bearing fruit. The company's non-GAAP operating margin of negative 2% during the latest quarter was way better than the negative 14% in the prior-year period. In fact, FireEye was originally anticipating a negative operating margin range of 4% to 6% for the quarter.
Not surprisingly, FireEye lowered its full-year adjusted loss per share guidance to a range of $0.16 to $0.19 per share, well below the previous range of $0.19 to $0.24 a share. Therefore, the shift to the subscription business is a blessing for the company's margin profile as it has to spend less money on customer acquisition.
More importantly, the company looks well-placed to further improve its margin profile as it forecasts 13% annual billings growth in fiscal 2018. By comparison, FireEye's billings are on track to drop 9% this year.
The stronger billings guidance for next year is a clear indication of the improving traction of FireEye's subscription business, which now supplies almost 84% of the revenue as compared to 76% last year.
Investors shouldn't panic based on the company's short-term guidance as FireEye is on track to boost sales profitably, which is why the company's latest drop might be a buying opportunity for some investors.
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