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5 Things to Watch When FireEye Reports Earnings

By Asit Sharma - Jul 29, 2015 at 6:00PM

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Pertinent themes and trends to look for in the earnings report of this high-profile cybersecurity company, which is due to report after the markets close on Thursday.

The ominous "threat map" on FireEye's home page is an effective advertisement for the company's services. Image source: FireEye.com

Cybersecurity threat detection, prevention, and resolution firm FireEye ( FEYE 4.12% ) reports second-quarter 2015 earnings Thursday after the markets close. A spate of very visible security breaches at major corporations and governments so far this year has stoked investor interest in companies such as FireEye: Although having retraced somewhat over the past month, the stock has gained more than 48% year to date.

Understanding where to focus when evaluating a growth company's earnings can be puzzling, especially when management's strategy is to grab market share at the expense of current profit, as is FireEye's game plan. Let's review five key themes and trends investors should look for in Thursday's earnings report and subsequent earnings call with analysts, to get a balanced view of the company's performance so far in 2015.

1. Gauging the pace of new signups and revenue growth
As I indicated, the business model FireEye currently employs places an extremely high emphasis on revenue growth. After its late 2013 IPO, FireEye added 1,000 customers in 2014, and it kept up a similar pace in the first quarter of 2015, with the addition of 220 new customers. Investors should anticipate a similar magnitude of new customer signups during the quarter as in Q1 2015.

Yet customer acquisition should also be taken in a financial context. FireEye increased revenue 69% year over year in Q1 2015 and has projected total revenue for Q2 to fall between $140 million and $144 million, which represents an expansion in the neighborhood of 50% over last year. Missing the revenue projection would probably affect the company's stock post-earnings, as the FEYE ticker has seen such a steep ascent in 2015.

Shareholders will also examine the quality of revenue growth. Recently, management has offered up an interesting metric -- the number of "million-dollar" deals closed. Last quarter, FireEye sealed 28 new $1 million-plus transactions -- double the number of seven-figure deals closed in the prior-year quarter. Hitting anywhere near this number of large contracts in quarter two will be quite impressive.

2. Color on new partnerships
In 2015, FireEye has credibly extended its growth prospects by announcing alliances with influential partners, including Visa and Hewlett-Packard. FireEye will work with Visa to develop threat-detection tools for merchants and card issuers. In addition, it will create a Web service designed to relay threats and real-time security information to participants in the payments industry. 

While this partnership may take some time to show monetization benefits, the company's agreement with Hewlett-Packard to cross-sell services may have a more immediate impact. The deal, announced in April, gives HP access to FireEye's expert consultants from its 2013 acquisition of cyber-forensics investigation firm Mandiant. 

The agreement also puts FireEye's products and services in the hands of HP's army of 5,000 security salespeople, theoretically providing FireEye with a new avenue to growth. Investors should look to the company's press release Thursday or post-earnings call for initial indications on the progress of the selling partnership to date. 

3. Sales and marketing expense and its relationship to revenue
One of the metrics I'm eager to review is the relationship between FireEye's sales and marketing expense and total sales. 

Sales and marketing is by far the most significant expenditure on FireEye's profit-and-loss statement. In 2013, this line item was recorded at a staggering 104% of revenue, and in 2014, spending in this area equaled 94% of revenue.

Even for a company that wants to pour every available resource into expanding the top line, such ratios clearly aren't sustainable. FireEye has recognized as much and has issued guidance for Q2 2015 pegging this ratio in a range from 66%-70%. Management has similarly indicated a full-year sales and marketing expense-to-sales ratio of 64%-68%.

This ratio is one of the more crucial numbers to crunch on the release of Q2 earnings. If management can achieve both the revenue increase it has staked out and control its selling expenses, investors will gain some comfort in knowing that the company has a path to profitability in its sight lines. A ratio more in tandem with the past two years will conversely raise a yellow flag of caution.

4. International business growth
Last quarter, it became apparent that FireEye's international business is gaining critical momentum. Revenue from clients outside the U.S. grew 98% in Q1 versus the prior year, and international business now makes up 33% of overall revenue.

During last quarter's post-earnings conference call with analysts, CEO Dave DeWalt noted that FireEye is increasing international consultant hires and has expanded its global presence to 18 countries. While margins associated with international revenue aren't quite as high as U.S. margins because of ramp-up costs, global expansion represents a key opportunity for FireEye. This is particularly true in growing Asian economies, which are replete with specialized technology and manufacturing firms whose trade secrets pose ripe targets for hackers.

Shareholders should note the ratio of non-U.S. sales to total sales on the Q2 release and look for an increase in the 33% benchmark set last quarter. 

5. The Mandiant effect
While FireEye's virtual threat and detection software is increasingly geared for widespread adoption through cloud offerings, specifically its "FireEye-As-a-Service" option, the effectiveness of the human capital the company deploys is difficult to overstate.

FireEye's forensic experts acquired through Mandiant have expanded the company's ability to sell incidence-response engagements around the globe, and management has specifically cited their linchpin status in landing seven-figure contracts. Consultants also provide an additional layer of security monitoring for various higher-end service agreements. For all the company's software prowess, teams of human experts continue to be a primary differentiator between FireEye and its competitors.

Currently, the expert team numbers 300, and investors will want to see evidence of additional hiring or hiring plans, as consulting engagements appear to be central to revenue expansion. An absence of immediate growth in this human capital will be permissible if, as I mentioned, the trade-off is a substantially lower sales expense.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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