5 Metrics Fueling FireEye’s Turnaround

Image source: Getty.

FireEye's (NASDAQ: FEYE) fourth-quarter report is now out, and investor focus is on the company's key strategic moves to get to profitability and growth. The stock hasn't been kind to investors, losing 75% over the last two years.

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With a year of transition behind the company, let's review some of the key metrics that might show that FireEye is moving back in the right direction. Stable gross margins, increasing deferred revenue, lower than expected operating expenses, and two other notable numbers demonstrate that FireEye's actions are starting to pay off.

Subscription growth +38% and product growth -30% year-over-year

FireEye is in the transition of moving its business and customers to the cloud. While product revenue has been on a steady decline, the company's subscription growth for 2016 more than makes up for it. Subscription revenue added $155.9 million in 2016 and product revenue only declined $64.7 million for the same period. This growth in subscription revenues combined with over a 90% customer retention rate makes FireEye's business more predictable, which helps the company to better plan its expenses and forecast revenues.

Stable 74% gross margins

A combination bar and line graph titled Operating Metrics - Gross Profit and Margins (non-GAAP) with the absolute gross profit in dollars growing over the last 12 quarters except for the last 5 quarters where growth has stalled. Throughout this period the line graph shows gross margin growing from 68% to be 73% or 74% for the last 3 quarters.

Image Source: FireEye, Q416 Investor Presentation

Even as FireEye continues the transition to a subscription based model, the company has been able to keep its gross margins stable. This shows that despite the challenges over the last several years FireEye's underlying business is a good one, and that customers are willing to pay recurring costs for a valuable service. Additionally, the non-GAAP gross margin for the subscription business is higher at 77% than the non-GAAP gross margin for product sales at 64%. As more of the revenue becomes subscription based, this will further improve overall gross margins for the company.

24% growth in deferred revenue

Trend of deferred revenue over the last 12 quarters steadily rising from $213 million in Q1-2014 to $654 million in Q4-2016.

Image Source: FireEye, Q416 Investor Presentation

With a subscription based revenue model, revenue is recognized as customers make monthly payments. Additionally, the company accounts for future monthly payments through the end of the contract period as deferred revenue. When the company adds customers and extends contracts, deferred revenue goes up. This metric will become more important to watch as the company continues its transition to subscription based cloud services. A 24% increase shows the progress of FireEye's transition to subscription-based revenue.

Operating expenses drop to 75% of revenue

Two graphs. The left graph is a rocky, but downward trend of operating expenses. The right chart is a rocky, but upward chart of operating margin.

Image Source: FireEye, Q416 Investor Presentation

In a company's income statement, operating expenses get subtracted from gross profit to determine if the company is making operating income. FireEye's gross profit for the fourth quarter was 74% of revenue, when you subtract operating expenses of 75% of revenue; it yields a 1% operating loss. FireEye's operating expenses have been dropping as a percent of revenue steadily through concerted efforts over the last two years. These efforts have resulted in FireEye's best operating margins in its history. As FireEye looks to continue this trend, the company has to make hard decisions on what expenses to cut, and which costs are value-added for its customers and the company. This prioritization process brings a healthy focused cost discipline that is refreshing for shareholders.

Support and services -- 34% of total full year revenue

A pie chart of FireEye's revenue with Services at 17% and Support at 17%. On the right a waterfall chart showing subscription, support and services revenue making up for the loss of product revenue, culminating in a 15% year-over-year gain.

Image Source: FireEye, Q416 Investor Presentation

FireEye has been steadily building its support and services business to bring more value to its relationships with its customers. Gartner has projected that security spending will grow to more than $100 billion annually by 2019, with two-thirds of that spending to be alocated to services. As FireEye continues to grow its services and support business, the revenue derived from this segment will help grow its overall revenue, offset declines in product sales, and help FireEye get back to being a solid consistent growth company.

FireEye is starting to gain traction with its transition efforts and the benefits are beginning to show up in the company's key metrics. While the company will continue to be in transition through 2017, shareholders should be pleased that FireEye's actions are yielding real results. If the company can continue this positive trend for the next couple of quarters, shareholders should start to see the benefits in the stock.