FireEye's Big Earnings Beat: Sunny Skies Ahead?

Shares of FireEye (MNDT) recently surged after the cybersecurity company's first quarter earnings and guidance all topped analyst expectations. But despite that big post-earnings jump, FireEye still trades almost 30% below its IPO price of $20.

Should bottom-fishing investors load up on FireEye now, or should they wait for more definitive proof of a full turnaround? Let's review some key growth figures to decide.

Image source: FireEye.

Understanding the slowdown

In the past, FireEye consistently posted double-digit annual sales growth every quarter. But that streak ended in the fourth quarter of 2016 as sales flatlined with 0% growth. FireEye attributed that decline to a shift from on-site appliances toward cloud-based services.

That shift temporarily throttled FireEye's top line growth, since installing appliances generates higher initial revenues. But over the long term, FireEye's shift toward cloud services should provide the company with more consistent and predictable growth in subscriptions revenue.

This push is centered around two products. The first is Helix, a unified platform which merges FireEye's threat prevention, MVX engine, iSight intelligence, and analytics services into a single interface. The second is HX, a next-gen product that protects network endpoints from malware. As FireEye pivots away from appliances toward these cloud services, its Products revenue is expected to drop as Subscription and Services revenue grow to offset the decline.

Is the transition paying off?

During the first quarter, FireEye's Product revenue fell 30% annually to $23.7 million, but its Subscription and Services revenue rose 12% to $150 million on the growth of its cloud platforms.

That growth lifted FireEye's total revenue 3.4% annually to $173.7 million, which beat Wall Street's expectations by $10 milion. Billings fell 18% to $152.4 million, but that decline was largely expected due to ongoing declines in appliance sales. Looking ahead, FireEye expects its top line growth to accelerate during the second half of the year, and its top line guidance for the current quarter and full year both match analyst expectations:

Source: Quarterly report, Financial Times.

Bottom line improvements

After Kevin Mandia became the new CEO of FireEye last June, he focused on improving the company's profitability by cutting costs and downsizing its workforce. Those moves paid off last quarter as its non-GAAP net loss narrowed from $0.47 per share in the prior year quarter to $0.09, exceeding estimates by $0.17.

Its GAAP net loss was more than halved, from $0.98 to $0.48 per share, partly due to a 32% year-over-year reduction in stock-based compensation (SBC) expenses. SBC expenses claimed 25% of FireEye's revenues during the quarter, compared to 38% in the prior year quarter.

That disciplined reduction of SBC expenses is impressive compared to the loose spending at many of the company's cybersecurity peers, which rely heavily on stock bonuses to compensate for a lack of consistent cash flows. Palo Alto Networks (PANW 3.79%), for example, barely reduced its SBC expenses as a percentage of revenues from 32% to 31% between the second quarters of 2016 and 2017. Looking ahead, FireEye expects its non-GAAP net losses to narrow throughout the year.

Source: Quarterly report, Financial Times.

So are sunny days ahead?

FireEye is clearly showing some signs of a turnaround, but it's a delicate one. Its operating cash flow remains negative, and it faces tough competition from a wide range of competitors across the threat prevention market.

Palo Alto Networks is expanding beyond next-gen firewalls with its own all-in-one Next-Generation Security platform. Larger security companies like Symantec (GEN 1.27%), which reportedly tried to buy FireEye last year, offer massive end-to-end security bundles which overlap with some of FireEye's services. As this competition escalates, FireEye might need to boost its spending again to stay competitive.

The bottom line

If FireEye weathers the competition and continues its transition toward high-growth services and subscriptions, the stock could be a bargain at today's prices. After all, its price-to-sales ratio of 3.3 is much lower than the industry average of 5.5, and its low market cap of $2.5 billion makes it a potential buyout target.

But if FireEye's sales growth unexpectedly flatlines again, the stock could quickly give up its gains. Therefore, investors should consider FireEye a speculative side bet instead of a healthy turnaround play for now.