FireEye Earnings: The Guidance Says A Lot

Summary

• Q4 earnings above expectations but disappointing guidance.
• The guidance reveals the challenges for FireEye to compete with established and aggressive IT security companies.
• Considering the uncertainties, investing in FireEye is risky at the current stock price.

After having raised the yearly guidance three times in 2018, FireEye (FEYE) delivered Q4 and yearly results above expectations. Also, the company achieved full year non-GAAP profitability for the first time.

Despite this performance, the stock price dropped by more than 12%. The market didn't like the weak guidance as it reveals the company is struggling to improve its fundamentals.

Before getting into the details of the troubling guidance, let's have a closer look at the Q4 earnings.

Image source: TheDigitalWay via Pixabay

Q4 results above expectations

As usual, management presented the results in a table that shows only non-GAAP figures (except for the revenue).

Source: Presentation Q4 earnings

The company delivered some results within the guidance and some other results above the guidance.

During the earnings call, management gave more details about the drivers of the growth within the "Product and related subscription and support revenue" segment. The email security and endpoint solutions offset the 11% decline of the legacy appliance hardware business. The two other segments, cloud and services, also contributed to the revenue growth with an increase of 12.7% and 11.1%.

Total operating expenses improved as they represented 84.8% or the revenue against 95.2% the year before.

Also, the CEO highlighted in the press release:

“The fourth quarter was a strong finish to a record year for FireEye. [...] We posted double-digit billings growth for the quarter and the year, and achieved full-year non-GAAP profitability for the first time in our history.”

All these non-GAAP results look promising but they don't reveal the whole story to the shareholders. Some of the items excluded from the non-GAAP results like stock-based compensation represent a real and high cost to the shareholders. Non-GAAP adjustments amounted to $59.9 million during Q4.

The company still generated important losses as net losses amounted to about $48.4 million while the number of shares increased by about 6.7%.

The non-GAAP profitability of $16.39 million management highlighted for the FY 2018 becomes a GAAP loss of $243.1 million.

Let's not see what the guidance says about the expected performance.

The guidance confirms the challenges

At first sight, the guidance is encouraging.

Source: Presentation Q4 earnings

Both revenue and margins are expected to improve. The operating cash flow, benefiting from the operating leverage, is forecasted to exceed $90 million. And during the earnings call, management highlighted the $10 million+ deals in 2018 penalize the YoY comparison. It also means these deals are exceptional. As management doesn't expect $10 million+ deals in 2019, the company won't record such a deal for at least 6 quarters in a row.

And the guidance also shows the challenges will persist.

The company will still lose market share as billings and revenue growth are expected to stay below the IT security market growth. And when taking the dilution into account, revenue per share is expected to stay flat. The company doesn't take advantage of its smaller size to grow faster.

Also, if we consider about $250 million of expenses that are not included in the non-GAAP reporting, FireEye will generate GAAP losses above $100 million in 2019.

Thus, the guidance doesn't give any sign the company will stop under-performing.

The graph below shows that FireEye has been growing at a moderate pace compared with other IT security companies.

Yet, the company reports the lowest - and negative - operating margins. Check Point (CHKP) and F5 (FFIV) grow revenue at a comparable rate with FireEye. But these two companies operate at an operating margin of about 28% and 47% compared with -22% for FireEye. The important dilution is also a factor to consider with FireEye.

Data by YCharts

Data by YCharts

One important issue for FireEye is the legacy, declining, non-profitable business. And, as I wrote in a previous article, the company is entering into new businesses that compete with established and competitive IT security vendors like Palo Alto (PANW) and Fortinet (FTNT). Management stated during the Q4 earnings call Helix was becoming a SIEM solution. Thus, besides the endpoint solution, email security, and network security, Helix becomes one more product that will compete more and more with the other IT security vendors.

Valuation

With the 2019 guidance, the market values the company at an EV/sales ratio at about 3.6.

Source: author, based on company reports

Based on TTM revenue, the valuations of FireEye and F5 (FFIV) are more modest than the other competitors.

Data by YCharts

The reason for the lower valuation of these two companies is they grow at a slower pace. Check Point also grow at a slow pace but the company generates an impressive 40%+ net margin.

F5 is a cash machine with a 20%+ net margin. Thus, for a similar valuation, investing in F5 is less risky than investing in FireEye. F5 doesn't have to improve its operations to generate important profits and justify its valuation. FireEye must sill prove it can generate a positive GAAP net income.

Conclusion

The better-than-expected Q4 earnings didn't offset the disappointing outlook. Beyond the next year results, the guidance also shows the underperformance will persist.

FireEye will not generate GAAP profits anytime soon while the revenue is expected to grow at a rate below the market. And, as the company is getting into businesses that compete more and more with established and aggressive IT security vendors, the challenges are increasing.

Considering the difficulties, the lower market valuation compared to competitors is justified. The comparable valuation with F5 is the only surprise. F5 grows at a slower pace, but the company is a cash machine with 20%+ net margins.

The uncertainties are too high to consider an investment in FireEye at an EV/sales ratio above 4.

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Analyst’s Disclosure: I am/we are long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.