Document
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 

FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017

or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             

Commission File Number 001-36067
 

FireEye, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
20-1548921
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
1440 McCarthy Blvd.
Milpitas, CA 95035
(408) 321-6300
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No  ¨    

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨   No   x
The number of shares of the registrant's common stock outstanding as of May 1, 2017 was 178,368,034.


Table of Contents
TABLE OF CONTENTS


 
 
 
 
Page 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4.
 
 
Item 5.
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 



PART I — FINANCIAL INFORMATION
Item1.    Financial Statements
FIREEYE, INC.
Condensed Consolidated Balance Sheets
(In thousands, except per share data)
(Unaudited)
 
March 31,
2017
 
December 31,
2016
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
163,374

 
$
223,667

Short-term investments
711,637

 
712,058

Accounts receivable, net of allowance for doubtful accounts of $1,918 and $1,590 at March 31, 2017 and December 31, 2016, respectively
105,900

 
121,150

Inventories
6,195

 
5,955

Prepaid expenses and other current assets
30,278

 
25,081

Total current assets
1,017,384

 
1,087,911

Property and equipment, net
60,814

 
61,852

Goodwill
978,260

 
978,260

Intangible assets, net
229,245

 
244,032

Deposits and other long-term assets
10,292

 
10,910

TOTAL ASSETS
$
2,295,995

 
$
2,382,965

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
25,487

 
$
20,269

Accrued and other current liabilities
22,067

 
22,997

Accrued compensation
50,083

 
96,004

Deferred revenue, current portion
396,628

 
397,118

Total current liabilities
494,265


536,388

Convertible senior notes, net
751,206

 
741,980

Deferred revenue, non-current portion
235,557

 
256,398

Other long-term liabilities
8,320

 
7,087

Total liabilities
1,489,348


1,541,853

Commitments and contingencies (NOTE 9)

 

Stockholders' equity:
 
 
 
Common stock, par value of $0.0001 per share; 1,000,000 shares authorized, 177,843 shares and 174,596 shares issued and outstanding as of March 31, 2017 and December 31, 2016, respectively
18

 
17

Additional paid-in capital
2,731,108

 
2,682,909

Treasury stock, at cost; 3,333 shares as of March 31, 2017 and December 31, 2016
(150,000
)
 
(150,000
)
Accumulated other comprehensive loss
(1,419
)
 
(1,742
)
Accumulated deficit
(1,773,060
)
 
(1,690,072
)
Total stockholders’ equity
806,647


841,112

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
2,295,995


$
2,382,965

See accompanying notes to condensed consolidated financial statements.

1

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

 
Three Months Ended March 31,
 
2017
 
2016
Revenue:
 
 
 
Product
$
23,743

 
$
33,707

Subscription and services
149,995

 
134,259

Total revenue
173,738


167,966

Cost of revenue:
 
 
 
Product
12,851

 
17,133

Subscription and services
51,754

 
54,297

Total cost of revenue
64,605


71,430

Total gross profit
109,133


96,536

Operating expenses:
 
 
 
Research and development
58,352

 
85,983

Sales and marketing
94,880

 
123,028

General and administrative
27,615

 
42,256

Restructuring charges

 
1,670

Total operating expenses
180,847


252,937

Operating loss
(71,714
)

(156,401
)
Interest income
2,032

 
1,465

Interest expense
(12,245
)
 
(11,809
)
Other income, net
232

 
815

Loss before income taxes
(81,695
)

(165,930
)
Provision for (benefit from) income taxes
1,293

 
(10,030
)
Net loss attributable to common stockholders
$
(82,988
)

$
(155,900
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.48
)
 
$
(0.98
)
Weighted average shares used in computing net loss per share attributable to common stockholders, basic and diluted
172,236

 
158,781

See accompanying notes to condensed consolidated financial statements.

2

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2017
 
2016
Net loss
$
(82,988
)
 
$
(155,900
)
Change in net unrealized gains/(losses) on available-for-sale investments, net of tax
323

 
2,163

Comprehensive loss
$
(82,665
)

$
(153,737
)
See accompanying notes to condensed consolidated financial statements.

3

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(82,988
)
 
$
(155,900
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
26,365

 
30,503

Stock-based compensation
43,889

 
64,239

Non-cash interest expense related to convertible senior notes
9,226

 
8,780

Change in fair value of contingent earn-out liability
13

 

Deferred income taxes
251

 
(11,053
)
Other
2,119

 
938

Changes in operating assets and liabilities, net of business acquisitions:
 
 
 
Accounts receivable
14,584

 
43,144

Inventories
(1,090
)
 
2,325

Prepaid expenses and other assets
(4,619
)
 
(2,152
)
Accounts payable
3,331

 
(3,391
)
Accrued liabilities
(930
)
 
902

Accrued transaction costs of acquiree

 
(7,727
)
Accrued compensation
(7,006
)
 
(8,989
)
Deferred revenue
(21,331
)
 
17,997

Other long-term liabilities
1,234

 
(2,132
)
Net cash used in operating activities
(16,952
)

(22,516
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment and demonstration units
(8,483
)
 
(14,257
)
Purchases of short-term investments
(98,480
)
 
(88,805
)
Proceeds from maturities of short-term investments
94,689

 
111,319

Proceeds from sales of short-term investments
3,620

 

Business acquisitions, net of cash acquired

 
(204,926
)
Lease deposits
(70
)
 
(678
)
Net cash used in investing activities
(8,724
)

(197,347
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of debt of acquired business

 
(8,842
)
Payments for contingent earn-outs
(38,928
)
 

Payment related to shares withheld for taxes

 
(1,124
)
Proceeds from exercise of equity awards
4,311

 
2,840

Net cash used in financing activities
(34,617
)

(7,126
)
Net change in cash and cash equivalents
(60,293
)
 
(226,989
)
Cash and cash equivalents, beginning of period
223,667

 
402,102

Cash and cash equivalents, end of period
$
163,374


$
175,113

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
727

 
$
1,888

Cash paid for interest
$

 
$
22

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Vesting of early exercised stock options
$

 
$
496

Common stock issued in connection with acquisitions
$

 
$
39,300

Contingent earn-out in connection with acquisitions
$

 
$
35,588

Purchases of property and equipment and demonstration units in accounts payable and accrued liabilities
$
5,922

 
$
5,779

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents
FIREEYE, INC.
Notes to Condensed Consolidated Financial Statements


1. Description of Business and Summary of Significant Accounting Policies
Description of Business
FireEye, Inc., with principal executive offices located in Milpitas, California, was incorporated as NetForts, Inc. on February 18, 2004, under the laws of the State of Delaware, and changed its name to FireEye, Inc. on September 7, 2005.
FireEye, Inc. and its wholly owned subsidiaries (collectively, the “Company”, “we”, “us” or “our”) is a leader in stopping advanced cyber attacks that use advanced malware, zero-day exploits, and APT (“Advanced Persistent Threat”) tactics. Our solutions supplement traditional and next-generation firewalls, Intrusion Prevention Systems (“IPS”), anti-virus, and gateways, which cannot stop advanced threats, leaving security holes in networks. We offer a solution that detects and blocks attacks across Web, email, endpoint, cloud and content (file) threat vectors, as well as latent malware resident on file shares. Our solutions address all stages of an attack lifecycle with a signature-less engine utilizing stateful attack analysis to detect zero-day threats.
In February 2016, we acquired Invotas International Corporation (“Invotas”), a provider of security automation and orchestration technology. We paid upfront cash consideration of $17.7 million and issued 742,026 shares of our common stock with an estimated fair value of $11.1 million.
In January 2016, we acquired iSIGHT Security, Inc. (d/b/a iSIGHT Partners, Inc.) (“iSIGHT”), one of the world’s leading providers of cyber threat intelligence for global enterprises. We paid upfront cash consideration of $192.8 million, incurred liabilities of $39.1 million contingent upon the achievement of a threat intelligence bookings target on or before the end of the second quarter of 2018, and issued 1,793,305 shares of our common stock with an estimated fair value of $29.9 million.
We sell the majority of our products, subscriptions and services to end-customers through distributors, resellers, and strategic partners, with a lesser percentage of sales directly to end-customers.
Basis of Presentation and Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of FireEye, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and following the requirements of the Securities and Exchange Commission (“SEC”), for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These unaudited condensed consolidated financial statements have been prepared on the same basis as our annual consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair statement of our financial information. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017 or for any other interim period or for any other future year. The balance sheet as of December 31, 2016 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for annual consolidated financial statements.
The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2016 included in our Annual Report on Form 10-K, which was filed with the SEC on February 24, 2017.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Such management estimates include, but are not limited to, the best estimate of selling price for our products, subscriptions and services, commissions expense, bonus expense, future taxable income, contract manufacturer liabilities, litigation and settlement costs and other loss contingencies, fair value of our equity awards, achievement of targets for performance stock units, fair value of the liability and equity components of convertible senior notes and the purchase price allocation of acquired businesses. We base our estimates on historical experience and also on assumptions that we believe are reasonable. Changes in facts or circumstances may cause us to change our assumptions and estimates in future periods, and it is possible that actual results could differ from current or revised future estimates.
Summary of Significant Accounting Policies
There have been no significant changes to our significant accounting policies as of and for the three months ended March 31, 2017, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016.

5


Recent Accounting Pronouncements
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This standard eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge (i.e. Step 2 of the current guidance), instead measuring the impairment charge as the excess of the reporting unit's carrying amount over its fair value (i.e. Step 1 of the current guidance). The guidance is effective for us beginning in the first quarter of 2020, and should be applied prospectively. Early adoption is permitted for impairment testing dates after January 1, 2017. The adoption of this standard is not expected to have a significant impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. This standard changes the definition of a business by requiring at least one substantive process. It also states that if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, then the set of transferred assets and activities is not a business. The guidance is effective for us beginning in the first quarter of 2018, and should be applied prospectively. Early adoption is permitted. The adoption of this standard is not expected to have a significant impact on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This standard changes the impairment model for most financial assets and certain other instruments by introducing a current expected credit loss (CECL) model. The CECL model is a more forward-looking approach based on expected losses rather than incurred losses, requiring entities to estimate and record losses expected over the remaining contractual life of an asset. The guidance is effective for us beginning in the first quarter of 2020. Early adoption beginning in 2019 is permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This standard is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The guidance is effective for us beginning in the first quarter of 2019, and should be applied on a modified retrospective basis. Early adoption is permitted. We expect the adoption of this standard to have a material impact on our consolidated financial statements and related disclosures.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This standard provides a single model for revenue arising from contracts with customers and supersedes current revenue recognition guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
In July 2015, the FASB decided to defer the effective date by one year, and as a result, the guidance is effective for us beginning in the first quarter of 2018. Early adoption as of the original effective date would be permitted. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through a cumulative adjustment. The FASB subsequently issued several clarifying standards to address stakeholder questions and implementation issues.
We currently anticipate adopting the standard retrospectively to all prior periods presented. Our ability to apply the requirements retrospectively to all prior periods presented is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements.
We anticipate this standard will have a material impact on our consolidated financial statements and related disclosures. While we are continuing to assess all the potential impacts this standard will have, and as such we do not know or cannot reasonably estimate quantitative information related to the impact of this standard on our consolidated financial statements at this time, we currently believe the most significant impact relates to our accounting for intelligence dependent appliance and software license revenue. We expect revenue related to certain appliances and software licenses not dependent on intelligence, subscription and support offerings, cloud offerings and professional services to remain substantially unchanged. Specifically, under the new standard we expect to combine intelligence dependent appliances and software licenses with the related intelligence subscription and support as a single performance obligation. As a result, we expect to recognize intelligence dependent appliance and software license revenue ratably over the life of the related device or license, rather than at the time of shipping, when our contracts contain material right of renewal options. Where our contracts do not contain material right of renewal options, we expect to recognize intelligence dependent appliance and software license revenue ratably over the contractual term. Due to complexity of certain of our customer contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instance from the recognition models noted above. We currently believe appliance and software license revenue will be recognized predominantly over the useful life of the device or license as most of our appliance and license offerings are intelligence dependent. Additionally, we currently expect commissions expense to be deferred at the time of sale, and recognized ratably over the life of the related device or license or over the contractual term, rather than expensing commissions predominantly at the time of sale.

6


2. Fair Value Measurements
The accounting guidance for fair value measurements provides a framework for measuring fair value on either a recurring or nonrecurring basis, whereby the inputs used in our valuation techniques are assigned a hierarchical level. The following are the three levels of inputs to measure fair value:
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Inputs that reflect quoted prices for identical assets or liabilities in less active markets; quoted prices for similar assets or liabilities in active markets; benchmark yields, reported trades, broker/dealer quotes, inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Unobservable inputs that reflect our own assumptions incorporated in valuation techniques used to measure fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and consider an inactive market to be one in which there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, our own or the counterparty’s non-performance risk is considered in measuring the fair values of assets.
The following table presents our assets and liabilities measured at fair value on a recurring basis using the above input categories (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Description
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
2,896

 
$

 
$

 
$
2,896

 
$
449

 
$

 
$

 
$
449

Total cash equivalents
2,896






2,896


449






449

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit

 
7,886

 

 
7,886

 

 
9,569

 

 
9,569

Commercial paper

 
14,981

 

 
14,981

 

 
29,920

 

 
29,920

Corporate notes and bonds

 
433,491

 

 
433,491

 

 
420,684

 

 
420,684

U.S. Government agencies

 
255,279

 

 
255,279

 

 
251,885

 

 
251,885

Total short-term investments

 
711,637

 

 
711,637

 

 
712,058

 

 
712,058

Total assets measured at fair value
$
2,896

 
$
711,637

 
$

 
$
714,533

 
$
449

 
$
712,058

 
$

 
$
712,507

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent earn-out
$

 
$

 
$
67

 
$
67

 
$

 
$

 
$
41,332

 
$
41,332

Total liabilities measured at fair value
$


$


$
67


$
67


$


$


$
41,332


$
41,332

The estimated fair value of the contingent earn-out incurred in connection with our acquisition of iSIGHT is considered to be a Level 3 measurement due to the use of significant unobservable inputs. The value was determined using a discounted risk-adjusted expected (probability-weighted) cash flow methodology, by applying a real options approach model. The real options approach incorporated management's estimates of expected quarterly growth rates in bookings for certain products (63% on average), which could not be corroborated by observable market data, with the volatility of revenue for comparable companies (16.5% on average) and the correlation between comparable companies' quarterly revenue growth and that of the S&P 500 Index (44.7% on average), which are observable in the market, to determine the probability of achieving estimated bookings within the earn-out period of performance (2.5 years). The resulting expected earn-out payment was discounted back to present value using our cost of debt (ranging from 6.3% to 7.1%).
The following is a reconciliation of the Level 3 contingent earn-out liability (in thousands):
 
Amount
Balance as of December 31, 2016
$
41,332

Changes in fair value (1)
13

Cash payments
(41,278
)
Balance as of March 31, 2017
$
67

(1) Changes in fair value are recorded in general and administrative expenses in our condensed consolidated statements of operations.
Additionally, we have a restructuring liability related to certain real estate facilities which was calculated based on the present value of future lease payments, less estimated sublease income, discounted at a rate commensurate with our current cost of financing. This non-recurring fair value measurement is considered to be a Level 3 measurement due to the use of significant unobservable inputs. To the extent that actual sublease income or the timing of subleasing these facilities is different than initial estimates, we will adjust the

7


restructuring liability in the period during which such information becomes known. See Note 6 Restructuring Charges for a reconciliation of this liability.
We measure certain assets, including goodwill, intangible assets and our equity-method investment in a private company at fair value on a nonrecurring basis when there are identifiable events or changes in circumstances that may have a significant adverse impact on the fair value of these assets. No such events or changes occurred during the three months ended March 31, 2017.
The estimated fair value of the Convertible Senior Notes (as defined in Note 8) as of March 31, 2017 was determined to be $843.5 million, based on quoted market prices. We consider the fair value of the Convertible Senior Notes to be a Level 2 measurement as they are not actively traded.

8


3. Investments
Our investments consisted of the following (in thousands):
 
As of March 31, 2017
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Short-Term Investment
Certificates of deposit
$
7,880

 
$
7

 
$
(1
)
 
$
7,886

 
$
7,886

Commercial paper
14,984

 

 
(3
)
 
14,981

 
14,981

Corporate notes and bonds
434,274

 
17

 
(800
)
 
433,491

 
433,491

U.S. Government agencies
255,918

 

 
(639
)
 
255,279

 
255,279

Total
$
713,056


$
24


$
(1,443
)

$
711,637

 
$
711,637

 
As of December 31, 2016
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Short-Term Investment
Certificates of deposit
$
9,560

 
$
10

 
$
(1
)
 
$
9,569

 
$
9,569

Commercial paper
29,929

 

 
(9
)
 
29,920

 
29,920

Corporate notes and bonds
421,635

 
17

 
(968
)
 
420,684

 
420,684

U.S. Government agencies
252,676

 
2

 
(793
)
 
251,885

 
251,885

Total
$
713,800

 
$
29

 
$
(1,771
)
 
$
712,058

 
$
712,058

The following tables present the gross unrealized losses and related fair values of our investments that have been in a continuous unrealized loss position (in thousands):
 
As of March 31, 2017
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Certificates of deposit
$

 
$

 
$
199

 
$
(1
)
 
$
199

 
$
(1
)
Commercial paper
14,981

 
(3
)
 

 

 
14,981

 
(3
)
Corporate notes and bonds
343,313

 
(761
)
 
64,470

 
(39
)
 
407,783

 
(800
)
U.S. Government agencies
233,786

 
(625
)
 
14,994

 
(14
)
 
248,780

 
(639
)
Total
$
592,080


$
(1,389
)

$
79,663


$
(54
)

$
671,743


$
(1,443
)
 
As of December 31, 2016
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Certificates of deposit
$

 
$

 
$
199

 
$
(1
)
 
$
199

 
$
(1
)
Commercial paper
24,925

 
(9
)
 

 

 
24,925

 
(9
)
Corporate notes and bonds
294,818

 
(889
)
 
99,433

 
(79
)
 
394,251

 
(968
)
U.S. Government agencies
222,171

 
(763
)
 
17,657

 
(30
)
 
239,828

 
(793
)
Total
$
541,914


$
(1,661
)

$
117,289


$
(110
)

$
659,203


$
(1,771
)
Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2017 and December 31, 2016.
The following table summarizes the contractual maturities of our investments at March 31, 2017 (in thousands):
 
Amortized Cost
 
Fair Value
Due within one year
$
382,128

 
$
381,674

Due within one to two years
330,928

 
329,963

Total
$
713,056

 
$
711,637

All available-for-sale securities have been classified as current, based on management's intent and ability to use the funds in current operations.

9


We hold an 11.9% ownership interest in a private company, which is accounted for under the equity method based on our ability to exercise significant influence over operating and financial policies of the investee. This investment is classified within deposits and other long-term assets on our condensed consolidated balance sheets. The carrying value of this investment was $0.6 million and $0.9 million as of March 31, 2017 and December 31, 2016, respectively.
4. Property and Equipment
Property and equipment, net consisted of the following (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Computer equipment and software
$
151,258

 
$
144,892

Leasehold improvements
44,003

 
41,796

Furniture and fixtures
15,057

 
14,499

Machinery and equipment
447

 
447

Total property and equipment
210,765

 
201,634

Less: accumulated depreciation
(149,951
)
 
(139,782
)
Total property and equipment, net
$
60,814

 
$
61,852

Depreciation and amortization expense related to property and equipment and demonstration units during the three months ended March 31, 2017 and 2016 was $11.0 million and $14.1 million, respectively.
During the three months ended March 31, 2017 and 2016, we capitalized $4.7 million and $1.9 million, respectively, of software development costs related to our cloud subscription offerings. Amortization expense related to capitalized software development costs during the three months ended March 31, 2017 and 2016 was $0.8 million and $0.4 million, respectively.
5. Business Combinations
Acquisition of iSIGHT
On January 14, 2016, we acquired all of the outstanding shares of privately held iSIGHT, one of the world’s leading providers of cyber threat intelligence for global enterprises. The acquisition extends our intelligence network to create an advanced and comprehensive private cyber threat intelligence operation, providing customers with higher fidelity alerts, context to prioritize threats and the strategic insights to proactively prepare for threats that might target their industry or region.
In connection with this acquisition, we paid upfront cash consideration of $192.8 million, incurred liabilities of $39.1 million contingent upon the achievement of a threat intelligence bookings target on or before the end of the second quarter of 2018, and issued 1,793,305 shares of our common stock with an estimated fair value of $29.9 million, of which 1,793,297 shares were released in February 2017 to former stockholders of iSIGHT once the threat intelligence bookings target was determined to have been achieved. This resulted in total purchase consideration of $261.8 million. The number of shares was fixed at the completion of the acquisition and was the maximum number of shares that could be released. The contingent earn-out liability was also settled in February 2017 to former stockholders of iSIGHT once the threat intelligence bookings target was determined to have been achieved, resulting in a cash payment of $41.3 million.
The acquisition of iSIGHT was accounted for in accordance with the acquisition method of accounting for business combinations with FireEye as the accounting acquirer. Under the acquisition method of accounting, the total purchase consideration is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values, using information currently available to us. During the three months ended June 30, 2016, we finalized our valuation analysis and revised our preliminary estimates of the earn-out liability and related fair value of common stock contingent upon the achievement of a threat intelligence bookings target by $3.5 million and $1.7 million, respectively, resulting in a higher purchase price of $5.2 million. As a result, we also revised our preliminary estimate of customer relationship and content intangible assets by $1.1 million and $1.2 million, respectively, resulting in an additional $0.2 million of intangible amortization.
We expensed the related acquisition costs of $1.9 million in general and administrative expenses. We also assumed and paid liabilities of $7.0 million for transaction costs incurred by iSIGHT prior to acquisition, which were accounted for separate from consideration transferred.

10


Allocation of the purchase price of $261.8 million is as follows (in thousands):
 
Amount
Net tangible liabilities assumed
$
(18,248
)
Intangible assets
85,100

Deferred tax liability
(11,637
)
Goodwill
206,623

Total purchase price allocation
$
261,838

The purchase price exceeded the fair value of the net tangible and identifiable intangible assets acquired, resulting in the recognition of goodwill. Goodwill is primarily attributable to expected synergies in our subscription offerings and cross-selling opportunities. None of the goodwill is expected to be deductible for U.S. federal income tax purposes.
Intangible assets consist primarily of customer relationships, content, developed technology and other intangible assets. Customer relationship intangibles relate to iSIGHT's ability to sell current and future content, as well as products built around this content, to its existing customers. Content intangibles represent threat intelligence data gathered through the analysis of cyber-crimes, cyber attacks, hacking, and cyber criminals. Intangible assets attributable to developed technology include a combination of patented and unpatented technology, trade secrets, computer software and research processes that represent the foundation for the existing and planned new products to facilitate the generation of new content. The estimated useful life and fair values of the identifiable intangible assets are as follows (in thousands):
 
Estimated Useful Life (in years)
 
Amount
Customer relationships
7
 
$
33,700

Content
4
 
30,100

Developed technology
4-6
 
17,100

Trade name
5
 
3,100

Non-competition agreements
2
 
1,100

Total identifiable intangible assets
 
 
$
85,100

The value of customer relationships and content was estimated using the excess earnings method, an income approach (Level 3), which converts projected revenues and costs into cash flows. To reflect the fact that certain other assets contribute to the cash flows generated, the returns for these contributory assets were removed to arrive at estimated cash flows solely attributable to the customer relationships and content, which were discounted at rates of 15% and 14%, respectively.
The value of developed technology and the trade name was estimated using the relief-from-royalty method, an income approach (Level 3), which estimates the cost savings that accrue to the owner of the intangible asset that would otherwise be payable as royalties or license fees on revenues earned through the use of the asset. A royalty rate is applied to the projected revenues associated with the intangible asset to determine the amount of savings, which is then discounted to determine the fair value. The developed technology and trade name were valued using royalty rates of 10% and 1%, respectively, and discounted at rates of 14% and 15%, respectively.
The results of operations of iSIGHT have been included in our condensed consolidated statements of operations from the acquisition date, and contributed $9.4 million to our consolidated revenues and $2.3 million to our consolidated net loss during the three months ended March 31, 2016. Subsequent to March 31, 2016, the operations of iSIGHT were integrated with the Company's operations. Pro forma results of operations have not been presented because the acquisition was not material to our results of operations.
Acquisition of Invotas
On February 1, 2016, we acquired all of the outstanding shares of privately held Invotas, a provider of security automation and orchestration technology. This acquisition enables us to deliver a premier security orchestration capability as part of our global threat management platform to unify cyber attack detection results, threat intelligence and incident response elements of an organization’s security program into a single console, giving enterprises the ability to respond more quickly to attacks through automation.
In connection with this acquisition, we paid upfront cash consideration of $17.7 million and issued 742,026 shares of our common stock with an estimated fair value of $11.1 million. This resulted in total purchase consideration of $28.8 million. Additionally, we replaced unvested option awards with grants of 95,614 restricted stock units which will vest over the requisite service period of four years, and granted an additional 1,002,748 restricted stock units which were scheduled to vest upon the achievement of stated performance milestones over a period of approximately three years, subject to continuing service during that time. A portion of these awards have since been released following the achievement of the first milestone, while another portion of these awards were modified to vest subject only to continuing service. These awards are being recognized as operating expense over the requisite service periods as they relate to post-combination services.

11


The acquisition of Invotas was accounted for in accordance with the acquisition method of accounting for business combinations with FireEye as the accounting acquirer. We expensed the related acquisition costs of $0.5 million in general and administrative expenses. We also assumed and paid liabilities of $0.7 million for transaction costs incurred by Invotas prior to acquisition, which were accounted for separate from consideration transferred. Under the acquisition method of accounting, the total purchase consideration is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The total purchase price of $28.8 million was allocated using information currently available to us. Allocation of the purchase price is as follows (in thousands):
 
Amount
Net tangible liabilities assumed
$
(306
)
Intangible assets
8,400

Deferred tax liability
(688
)
Goodwill
21,349

Total purchase price allocation
$
28,755

The purchase price exceeded the fair value of the net tangible and identifiable intangible assets acquired, resulting in the recognition of goodwill. Goodwill is primarily attributable to increased selling opportunities. None of the goodwill is expected to be deductible for U.S. federal income tax purposes.
Intangible assets consist primarily of developed technology, in-process research and development and other intangible assets. Developed technology intangibles include a combination of patented and unpatented technology, trade secrets, computer software and research processes that represent the foundation for the existing and planned new product offerings. The in-process research and development intangible represents the estimated fair value of acquired research projects which had not reached technological feasibility at acquisition date, but have since been developed into products. The estimated useful life and fair values of the identifiable intangible assets are as follows (in thousands):
 
Estimated Useful Life (in years)
 
Amount
Developed technology
4
 
$
4,500

In-process research and development
N/A
 
2,800

Customer relationships
10
 
800

Non-competition agreements
3
 
300

Total identifiable intangible assets
 
 
$
8,400

The value of developed technology and in-process research and development (IPR&D) was estimated using the excess earnings method, an income approach (Level 3), which converts projected revenues and costs into cash flows. To reflect the fact that certain other assets contribute to the cash flows generated, the returns for these contributory assets were removed to arrive at estimated cash flows solely attributable to the developed technology and IPR&D, which were discounted at rates of 16% and 17%, respectively.
As of December 31, 2016, all in-process research and development obtained in our acquisition of Invotas was put into service.
The results of operations of Invotas have been included in our condensed consolidated statements of operations from the acquisition date. Pro forma results of operations have not been presented because the acquisition was not material to our results of operations.
Goodwill and Purchased Intangible Assets
There were no changes in the carrying amount of goodwill for the three months ended March 31, 2017.
Purchased intangible assets consisted of the following (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Developed technology
$
102,593

 
$
102,593

Content
158,700

 
158,700

Customer relationships
109,800

 
109,800

Contract backlog
12,500

 
12,500

Trade names
15,500

 
15,500

Non-competition agreements
1,400

 
1,400

Total intangible assets
400,493

 
400,493

Less: accumulated amortization
(171,248
)
 
(156,461
)
Total net intangible assets
$
229,245

 
$
244,032


12


Amortization expense of intangible assets during the three months ended March 31, 2017 and 2016 was $14.8 million and $15.2 million, respectively.
The expected future annual amortization expense of intangible assets as of March 31, 2017 is presented below (in thousands):
Years Ending December 31,
Amount
2017 (remaining nine months)
$
44,331

2018
47,433

2019
45,547

2020
31,171

2021
29,282

2022 and thereafter
31,481

Total
$
229,245

6. Restructuring Charges
We initiated a series of restructuring activities during 2016, including a restructuring plan approved by our Board of Directors designed to reduce operating expenses and align our expense structure with growth expectations. This restructuring plan resulted in a 10% reduction in our workforce, the consolidation of certain real estate facilities and the impairment of certain assets in 2016.
The following table sets forth a summary of restructuring activities during the three months ended March 31, 2017 (in thousands):
 
Severance and related costs
 
Facilities costs
 
Total costs
Balance, December 31, 2016
$
1,221

 
$
2,246

 
$
3,467

Cash payments
(686
)
 
(289
)
 
(975
)
Other adjustments
(380
)
 
(59
)
 
(439
)
Balance, March 31, 2017
$
155

 
$
1,898

 
$
2,053

Other adjustments of negative $0.4 million represent relief of unused benefits, changes in fair value and foreign currency fluctuations.
The remaining restructuring balance of $2.1 million at March 31, 2017 is composed of $0.2 million of severance payments which we expect to pay during the second quarter of 2017, and $1.9 million of non-cancelable lease costs which we expect to pay over the terms of the related obligations through the third quarter of 2024, net of sublease income.
7. Deferred Revenue
Deferred revenue consisted of the following (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Product, current
$
9,245

 
$
8,924

Subscription and services, current
387,383

 
388,194

Total deferred revenue, current
396,628

 
397,118

Product, non-current
4,059

 
4,748

Subscription and services, non-current
231,498

 
251,650

Total deferred revenue, non-current
235,557

 
256,398

Total deferred revenue
$
632,185

 
$
653,516

 
8. Convertible Senior Notes
Convertible Senior Notes
In June 2015, we issued $460.0 million principal amount of 1.000% Convertible Senior Notes due 2035 (the “Series A Notes”) and $460.0 million principal amount of 1.625% Convertible Senior Notes due 2035 (the “Series B Notes” and together with the Series A Notes, the “Convertible Senior Notes”), including the full exercise of the initial purchasers' over-allotment option, in a private placement to qualified institutional purchasers pursuant to an exemption from registration provided by Section 4(a)(2) and Rule 144A under the Securities Act of 1933, as amended. The net proceeds after the initial purchasers' discount of $23.0 million and issuance costs of $0.5 million from the Convertible Senior Notes were $896.5 million. The Series A Notes and Series B Notes bear interest at 1.000% per year and 1.625% per year, respectively, payable semiannually in arrears on June 1 and December 1 of each year, beginning December 1, 2015. The Convertible Senior Notes mature on June 1, 2035, unless earlier repurchased, redeemed or converted.

13


The Convertible Senior Notes are unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes. They rank equally in right of payment with all of our existing and future liabilities that are not expressly subordinated to the Convertible Senior Notes and effectively rank junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness. They are structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries.
The Convertible Senior Notes do not contain any financial covenants and do not restrict us from paying dividends or issuing or repurchasing our other securities.
The initial conversion rate on each series of Convertible Senior Notes is 16.4572 shares of our common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $60.76 per share of common stock. The conversion rate of each series of Convertible Senior Notes may be adjusted upon the occurrence of certain specified events, but not for accrued and unpaid interest.
Holders may convert the Convertible Senior Notes at their option in multiples of $1,000 principal amount prior to March 1, 2035, excluding the period from March 1, 2020 to June 1, 2020 in the case of the Series A Notes and March 1, 2022 to June 1, 2022 in the case of the Series B Notes, only under the following circumstances:
during any calendar quarter commencing after the calendar quarter ended on September 30, 2015 (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price for the Convertible Senior Notes of the relevant series on each applicable trading day;
during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Series A Notes or Series B Notes, as applicable, for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes of the relevant series on each such trading day;
if we call any or all of the Convertible Senior Notes of a series for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the relevant redemption date; or
upon the occurrence of specified corporate events, as specified in each indenture governing the Convertible Senior Notes.
Regardless of the foregoing conditions, holders may convert their Convertible Senior Notes at their option in multiples of $1,000 principal amount at any time during the period from March 1, 2020 to June 1, 2020 in the case of the Series A Notes and during the period from March 1, 2022 to June 1, 2022 in the case of the Series B Notes, or after March 1, 2035 until maturity for either series of Convertible Senior Notes. Upon conversion, the Convertible Senior Notes can be settled in cash, shares of our common stock or any combination thereof at our option.
We may be required by holders of the Convertible Senior Notes to repurchase all or any portion of their Convertible Senior Notes at 100% of the principal amount plus accrued and unpaid interest, on each of June 1, 2020, June 1, 2025 and June 1, 2030, in the case of the Series A Notes, and each of June 1, 2022, June 1, 2025 and June 1, 2030 in the case of the Series B Notes. Holders may also require us to repurchase the Convertible Senior Notes if we undergo a "fundamental change," as defined in each indenture governing the Convertible Senior Notes, at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest.
Additionally, we may redeem for cash all or any portion of the Series B Notes on or after June 1, 2020 until June 1, 2022 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending not more than three trading days immediately preceding the date we provide notice of redemption. We also may redeem for cash all or any portion of the Series A Notes on or after June 1, 2020 until maturity and all or any portion of the Series B Notes on or after June 1, 2022 until maturity, regardless of the foregoing sale price condition.
In accordance with accounting for debt with conversions and other options, we allocated the principal amount of the Convertible Senior Notes into liability and equity components. We also allocated the total amount of initial purchasers' discount and transaction costs incurred to the liability and equity components using the same proportions as the proceeds from the Convertible Senior Notes. Transaction costs of $0.4 million and $0.1 million and initial purchasers' discount of $17.6 million and $5.4 million were attributable to the liability component and equity component of the Convertible Senior Notes, respectively.

14


The liability and equity components of the Convertible Senior Notes consisted of the following (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
 
Series A Notes
 
Series B Notes
 
Series A Notes
 
Series B Notes
Liability component:
 
 
 
 
 
 
 
Principal
$
460,000

 
$
460,000

 
$
460,000

 
$
460,000

Less: Convertible senior notes discounts and issuance costs, net of amortization
(69,132
)
 
(99,662
)
 
(74,126
)
 
(103,894
)
Net carrying amount
$
390,868


$
360,338

 
$
385,874

 
$
356,106

 
 
 
 
 
 
 
 
Equity component, net of issuance costs
$
92,567

 
$
117,834

 
$
92,567

 
$
117,834

The unamortized discounts and issuance costs as of March 31, 2017 will be amortized over a weighted-average remaining period of approximately 4.3 years.
Interest expense for the three months ended March 31, 2017 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended March 31, 2017
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

Amortization of convertible senior notes discounts and issuance costs
4,993

 
4,232

Total interest expense recognized
$
6,143


$
6,101

 
 
 
 
Effective interest rate on the liability component
6.4
%
 
6.9
%
Interest expense for the three months ended March 31, 2016 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended March 31, 2016
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

Amortization of convertible senior notes discounts and issuance costs
4,743

 
4,037

Total interest expense recognized
$
5,893

 
$
5,906

 
 
 
 
Effective interest rate on the liability component
6.4
%
 
7.0
%
Prepaid Forward Stock Purchase
In connection with the issuance of the Convertible Senior Notes, we also entered into privately negotiated prepaid forward stock purchase transactions (each a “Prepaid Forward”) with one of the initial purchasers of the Convertible Senior Notes (the “Forward Counterparty”), pursuant to which we paid approximately $150.0 million. The amount of the prepaid is equivalent to approximately 3.3 million shares which are to be settled on or around June 1, 2020 and June 1, 2022, respectively, subject to any early settlement, in whole or in part, of each Prepaid Forward. The Prepaid Forwards are intended to facilitate privately negotiated derivative transactions by which investors in the Convertible Senior Notes will be able to hedge their investment in the Convertible Senior Notes. In the event we pay any cash dividends on our common stock, the Forward Counterparty will pay an equivalent amount back to us.
The related shares were accounted for as a repurchase of common stock, and are presented as Treasury Stock in the unaudited condensed consolidated balance sheets. The 3.3 million shares of common stock purchased under the Prepaid Forwards are excluded from weighted-average shares outstanding for basic and diluted EPS purposes although they remain legally outstanding.
9. Commitments and Contingencies
Leases
We lease our facilities under various non-cancelable operating leases, which expire on various dates through the year ending December 31, 2027. In August 2016, we entered into a lease agreement for our new corporate headquarters, expected to commence mid-2017. Rent expense is recognized using the straight-line method over the term of the lease. Rent expense, net of sublease income, was $4.1 million and $3.6 million for the three months ended March 31, 2017 and 2016, respectively.

15


The aggregate future non-cancelable minimum rental payments on our operating leases, as of March 31, 2017, are as follows (in thousands):
Years Ending December 31, 
Amount 
2017 (remaining nine months)
$
11,822

2018
16,553

2019
12,915

2020
12,787

2021
10,992

2022 and thereafter
39,276

Total
$
104,345

Total future non-cancelable minimum rental payments have not been reduced by future minimum sublease rentals totaling $7.1 million.
We are party to letters of credit totaling $3.2 million and $3.1 million as of March 31, 2017 and December 31, 2016, respectively, issued primarily in support of operating leases at several of our facilities. These letters of credit are collateralized by a line with our bank. No amounts have been drawn against these letters of credit.
Contract Manufacturer Commitments
Our independent contract manufacturers procure components and assemble our products based on our forecasts. These forecasts are based on estimates of future demand for our products, which are in turn based on historical trends and an analysis from our sales and product marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate supply, we may issue forecasts and orders for components and products that are non-cancelable. As of March 31, 2017 and December 31, 2016, we had non-cancelable open orders of $12.7 million and $10.2 million, respectively. We are required to record a liability for firm, non-cancelable and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of our future demand forecasts. As of March 31, 2017, we have not accrued any significant costs for such non-cancelable commitments.
Purchase Obligations
As of March 31, 2017, we had approximately $22.5 million of non-cancelable firm purchase commitments primarily for purchases of software and services. In those situations in which we have received delivery of the goods or services as of March 31, 2017 under purchase orders outstanding as of the same date, such amounts are reflected in the condensed consolidated balance sheet as accounts payable or accrued liabilities, and are excluded from the $22.5 million.
Litigation
We accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss. We have made an assessment of the probability of incurring any such losses and whether or not those losses are estimable.
On June 20, 2014, a purported stockholder class action lawsuit was filed in the Superior Court of California, County of Santa Clara, against the Company, current and former members of our Board of Directors, current and former officers, and the underwriters of our March 2014 follow-on public offering. On July 17, 2014, a substantially similar lawsuit was filed in the same court against the same defendants. The actions were consolidated and, on March 4, 2015, an amended complaint was filed, alleging violations of the federal securities laws on behalf of a purported class consisting of purchasers of the Company's common stock pursuant or traceable to the registration statement and prospectus for the follow-on public offering, and seeking unspecified compensatory damages and other relief. On April 20, 2015, defendants filed demurrers seeking that the amended complaint be dismissed. On August 11, 2015, the court overruled defendants' demurrers. On November 16, 2015, plaintiffs filed a motion seeking certification of the putative class, which the court granted in part and denied in part on July 11, 2016. On January 6, 2016, the Company and the individual defendants filed a motion for judgment on the pleadings seeking that the action be dismissed for lack of subject-matter jurisdiction, which the court denied on April 1, 2016. On May 19, 2016, the Company and the individual defendants filed a petition for a writ of mandate seeking the overturning of the court's denial of the motion for judgment on the pleadings. On September 8, 2016, the court of appeal denied the petition. On September 16, 2016, the Company and the individual defendants filed a petition for review with the Supreme Court of California. On November 9, 2016, the Supreme Court of California denied the petition for review. On December 8, 2016, the Company and the individual defendants filed a petition for a writ of certiorari before the United States Supreme Court. On February 6, 2017, the parties submitted to the Superior Court a stipulation of settlement. The terms of the settlement include a release and dismissal of all claims against all defendants without any liability or wrongdoing attributed to them. On February 7, 2017, plaintiffs filed an unopposed motion for preliminary approval of the settlement, which the Superior Court granted. The settlement, which is immaterial to the Company's consolidated financial statements, is subject to stockholder notice, court approval, and other customary conditions.
On January 28, 2015, certain of the Company’s officers and directors were named as defendants in a putative derivative action filed in the Superior Court of California, County of Santa Clara. On April 21, 2015, a substantially similar lawsuit was filed in the same court against the same defendants. The Company is named as a nominal defendant in both actions. The actions were consolidated and a

16


consolidated complaint was filed on June 15, 2015, purporting to allege claims for breach of fiduciary duty and unjust enrichment. On July 15, 2015, defendants filed demurrers to the consolidated complaint. On December 4, 2015, the court sustained, with leave to amend, defendants’ demurrers on the basis that plaintiffs had failed adequately to allege derivative standing. Plaintiffs filed an amended complaint on May 3, 2016. On June 8, 2016, defendants filed demurrers to the amended complaint, which the court sustained on August 29, 2016, dismissing the case with prejudice. Plaintiffs filed a notice of appeal on October 27, 2016. Based on information currently available, the Company has determined that the amount of any possible loss or range of possible loss is not reasonably estimable.
In February 2016, a lawsuit was filed in the Superior Court of California, County of Santa Clara, by one of the plaintiffs in the aforementioned putative derivative action against the Company, seeking production of certain books and records pursuant to Delaware and California law. On May 16, 2016, the court sustained the Company's demurrer to the petition, without leave to amend. Plaintiff filed a notice of appeal on October 27, 2016. The appeal was dismissed on April 14, 2017.
We are also subject to legal proceedings, claims and litigation, including intellectual property litigation, arising in the ordinary course of business. Such matters are subject to many uncertainties and outcomes, and are not predictable with assurance.
To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred, and the amount of such additional loss would be material, we will either disclose the estimated additional loss or state that such an estimate cannot be made. We do not currently believe that it is reasonably possible that additional losses in connection with litigation arising in the ordinary course of business would be material.
Indemnification
Under the indemnification provisions of our standard sales related contracts, we agree to defend our customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. Our exposure under these indemnification provisions is generally limited to the total amount paid by our customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. In addition, we indemnify our officers, directors, and certain key employees for actions taken while they are or were serving in good faith in such capacities. Through March 31, 2017, there have been no claims under any indemnification provisions.
10. Common Shares Reserved for Issuance
We have 100,000,000 shares of convertible preferred stock with a par value of $0.0001 per share authorized, none of which were issued and outstanding as of March 31, 2017 or December 31, 2016.
Under our amended and restated certificate of incorporation, we are authorized to issue 1,000,000,000 shares of common stock with a par value of $0.0001 per share as of March 31, 2017 and December 31, 2016. Each share of common stock outstanding is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when declared by our Board of Directors, subject to the prior rights of holders of all classes of convertible preferred stock outstanding.
We had reserved shares of common stock for issuance as follows (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Reserved under stock award plans
43,435

 
38,005

Convertible Senior Notes
15,141

 
15,141

ESPP
4,597

 
2,851

Total
63,173

 
55,997

11. Equity Award Plans
We have operated under our 2013 Equity Incentive Plan ("2013 Plan") since our initial public offering ("IPO") in September 2013. Our 2013 Plan provides for the issuance of restricted stock and the granting of options, stock appreciation rights, performance shares, performance units and restricted stock units to our employees, officers, directors and consultants. Our 2013 Plan provides for annual increases in the number of shares available for issuance on the first day of each fiscal year. Awards granted under the 2013 Plan vest over the periods determined by our Board of Directors or compensation committee of our Board of Directors, generally four years, and stock options granted under the 2013 Plan expire no more than ten years after the date of grant. In the case of an incentive stock option granted to an employee who at the time of grant owns stock representing more than 10% of the total combined voting power of all classes of stock, the exercise price shall be no less than 110% of the fair value per share on the date of grant, and the award shall expire five years from the date of grant. For options granted to any other employee, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant. In the case of non-statutory stock options and options granted to consultants, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant. Stock that is purchased prior to vesting is subject to our right of repurchase at any time following termination of the participant's service for so

17


long as such stock remains unvested. Approximately 11.4 million shares and 10.0 million shares of our common stock were reserved for future grants as of March 31, 2017 and December 31, 2016, respectively, under the 2013 Plan.
Our 2013 Employee Stock Purchase Plan ("ESPP") allows eligible employees to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the exercise date. Our ESPP provides for annual increases in the number of shares available for issuance on the first day of each fiscal year. An aggregate of approximately 4.6 million shares and 2.9 million shares of common stock were available for future issuance as of March 31, 2017 and December 31, 2016, respectively, under our ESPP.
From time to time, we also grant restricted common stock or restricted stock awards outside of our equity incentive plans to certain employees in connection with acquisitions.
Stock Option Activity
A summary of the activity for our stock option changes during the reporting period and a summary of information related to options vested and options exercisable are presented below (in thousands, except per share amounts and contractual life years):
 
Options Outstanding
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Grant Date
Fair Value
(per share)
 
Weighted-
Average
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
Balance — December 31, 2016
8,085

 
$
10.7

 
 
 
5.4
 
$
40,304

Exercised
(906
)
 
4.76

 
 
 
 
 
6,645

Cancelled
(160
)
 
29.74

 
 
 
 
 
 
Balance — March 31, 2017
7,019

 
$
11.04

 
 
 
5.2
 
$
37,567

Options exercisable — March 31, 2017
6,647

 
$
10.30

 
 
 
5.1
 
$
37,136

Restricted Stock Award (RSA) and Restricted Stock Unit (RSU) Activity
A summary of the activity for our restricted common stock, RSAs and RSUs, including those subject to performance conditions, during the reporting period and a summary of information related to unvested restricted common stock, RSAs and RSUs, including those expected to vest based on the achievement of a performance condition, are presented below (in thousands, except per share amounts and contractual life years):
 
Number of
Shares
 
Weighted-
Average
Grant Date
Fair Value
(per share)
 
Weighted-
Average
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
Unvested balance — December 31, 2016
19,883

 
$
22.23

 
1.5
 
$
236,605

Granted
9,674

 
11.53

 
 
 
 
Vested
(2,341
)
 
24.16

 
 
 
 
Cancelled
(2,233
)
 
16.04

 
 
 
 
Unvested balance — March 31, 2017
24,983

 
$
17.80

 
1.7
 
$
315,029

Unvested awards for which the requisite service period has not been rendered and vesting is subject to the achievement of a performance condition — March 31, 2017
4,694

 
$
14.66

 
2.2
 
$
59,192

Stock-Based Compensation
We record stock-based compensation based on the fair value as determined on the date granted. We determine the fair value of stock options and shares of common stock to be issued under the ESPP using the Black-Scholes option-pricing model. The fair value of restricted stock units and restricted stock awards equals the market value of the underlying stock on the date of grant. We grant performance-based restricted stock units and restricted stock awards to certain employees which vest upon the achievement of certain performance conditions, subject to the employees’ continued service relationship with us. We assess the probability of vesting at each reporting period and adjust our compensation cost based on this probability assessment. We recognize such compensation expense on a straight-line basis over the service provider’s requisite service period.

18


Stock-based compensation expense related to stock options, ESPP and restricted stock units and awards is included in the condensed consolidated statements of operations as follows (in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Cost of product revenue
$
535

 
$
667

Cost of subscription and services revenue
7,497

 
9,601

Research and development
14,525

 
24,430

Sales and marketing
14,015

 
16,154

General and administrative
7,317

 
13,215

Total
$
43,889


$
64,067

As of March 31, 2017, total compensation cost related to stock-based awards not yet recognized was $349.0 million, which is expected to be amortized on a straight-line basis over the weighted-average remaining vesting period of approximately 2.5 years.
12. Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax basis of assets and liabilities and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed.
We recognized a provision for income taxes of $1.3 million for the three months ended March 31, 2017, and a benefit from income taxes of $10.0 million during the three months ended March 31, 2016. The tax provision during the three months ended March 31, 2017 is primarily due to foreign and state income taxes. The tax benefit during the three months ended March 31, 2016 is primarily due to the reversal of the U.S. valuation allowances as a result of recording a similar amount of acquisition related U.S. deferred tax liabilities, which are considered a source of future taxable income available to realize the benefit of U.S. deferred tax assets.
13. Net Loss per Share
Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of employee share based awards and warrants. Diluted net income per common share is computed giving effect to all potentially dilutive common shares, including common stock issuable upon exercise of stock options, conversion of the Convertible Senior Notes, and unvested restricted common stock and stock units. As we had net losses for the three months ended March 31, 2017 and 2016, all potential common shares were determined to be anti-dilutive.
The following table sets forth the computation of net loss per common share (in thousands, except per share amounts):
 
Three Months Ended March 31,
 
2017
 
2016
Numerator:
 
 
 
Net loss
$
(82,988
)
 
$
(155,900
)
Denominator:
 
 
 
Weighted average number of shares outstanding—basic and diluted
172,236
 
158,781

Net loss per share—basic and diluted
$
(0.48
)

$
(0.98
)
The following outstanding options and unvested shares were excluded (as common stock equivalents) from the computation of diluted net loss per common share for the periods presented as their effect would have been anti-dilutive (in thousands):
 
As of March 31,
 
2017
 
2016
Options to purchase common stock
7,019

 
10,627

Unvested early exercised common shares

 
647

Unvested restricted stock awards and units
24,983

 
23,896

Convertible senior notes
15,141

 
15,141

ESPP shares
784

 
667


19


14. Employee Benefit Plan
401(k) Plan
We have established a 401(k) tax-deferred savings plan (the “401(k) Plan”) which permits participants to make contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. All participants’ interests in their deferrals are 100% vested when contributed. We are responsible for administrative costs of the 401(k) Plan and have made no matching contributions into our 401(k) Plan since inception. Under the 401(k) Plan, pre-tax contributions are allocated to each participant’s individual account and are then invested in selected investment alternatives according to the participants’ directions. The 401(k) Plan is intended to qualify under Sections 401(a) and 501(a) of the Code. As a tax-qualified retirement plan, contributions to the 401(k) Plan and earnings on those contributions are not taxable to the employees until distributed, and all contributions are deductible by us when and if made.
15. Segment and Major Customers Information
We conduct business globally and are primarily managed on a geographic basis. Our Chief Executive Officer, who is our chief operating decision maker, reviews financial information presented on a consolidated basis accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. There are no segment managers who are held accountable for operations, operating results, and plans for levels, components, or types of products or services below the consolidated unit level. Accordingly, we are considered to be in a single reportable segment and operating unit structure.
Revenue by geographic region based on the billing address is as follows (in thousands):
 
Three Months Ended March 31,
 
2017

2016
Revenue:
 
 
 
United States
$
115,004

 
$
115,852

EMEA
25,321

 
24,442

APAC
25,853

 
21,823

Other
7,560

 
5,849

Total revenue
$
173,738

 
$
167,966

Long lived assets by geographic region based on physical location is as follows (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
Property and Equipment, net:
 
 
 
United States
$
43,800

 
$
43,214

International
17,014

 
18,638

Total property and equipment, net
$
60,814

 
$
61,852

For the three months ended March 31, 2017 and 2016, one distributor represented 19% and 17%, respectively, and one reseller represented 12% and 11%, respectively, of the Company's total revenue. As of March 31, 2017 and December 31, 2016, no customer represented 10% or more of the Company's net accounts receivable balance.

20


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed with the SEC on February 24, 2017. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, statements regarding:
beliefs and objectives for future operations, financial condition and prospects, including trends in revenue, gross margin, operating expenses and other financial metrics;
our restructuring plan, including workforce reductions and related charges, as well as anticipated cost savings;
our business plan and our ability to effectively manage our growth and associated investments;
our ability to timely and effectively scale and adapt our existing technology;
our ability to pursue opportunities in new and existing markets;
our ability to innovate new products and bring them to market in a timely manner;
our ability to expand internationally;
our ability to further penetrate our existing customer base;
our expectations concerning renewal rates for subscriptions and services by existing customers as well as cancellations;
cost of revenue, including changes in costs associated with production, manufacturing and customer support;
operating expenses, including changes in research and development, sales and marketing, and general and administrative expenses;
our expectations concerning the transition of customers from product sales to our cloud-based solutions;
our expectations concerning relationships with third parties, including channel partners and logistics providers;
our expectations concerning investments in our product development organization and in the development of our sales and marketing teams;
economic and industry trends or trend analysis;
the effects of seasonal trends on our results of operations;
the attraction and retention of qualified employees and key personnel;
future acquisitions of or investments in complementary companies, products, subscriptions or technologies; and
the sufficiency of our existing cash and investments to meet our cash needs for at least the next 12 months
as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Item 1A of Part II of this Quarterly Report on Form 10-Q and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Overview
We provide comprehensive intelligence-based cybersecurity solutions that allow organizations to prepare for, prevent, respond to and remediate cyber attacks. Our portfolio of cybersecurity products and services is designed to detect and prevent attacks as well as enable rapid discovery and response when a breach occurs.
Our Business Model
We generate revenue from sales of our products, subscriptions and services. Our product revenue consists primarily of revenue from the sale of our appliance-based threat detection and prevention solutions, consisting of NX, EX, HX and FX Series of security appliances. While our NX Series of integrated appliances still accounts for the largest portion of our product revenue, we offer our threat detection and prevention products in multiple form factors for cloud and hybrid deployments. Our detection and prevention products are complemented by our forensics and investigation products, our security management appliance, our orchestration software and our

21


consulting services to enable a proactive approach to cybersecurity that extends across the entire security operations lifecycle. Revenue from sales of our security appliances is generally recognized at the time of shipment.
We require customers to purchase a subscription to our DTI cloud and support and maintenance services when they purchase any of our appliance-based detection and prevention products. Our customers generally purchase these subscriptions and services for a one or three year term, and revenue from such subscriptions is recognized ratably over the subscription period. Sales of these subscriptions and support services initially increase our deferred revenue, which totaled $632.2 million and $653.5 million as of March 31, 2017 and December 31, 2016, respectively. Amortization of this deferred revenue has contributed to the increase in our subscription and services revenue as a percentage of total revenue. For the three months ended March 31, 2017 and 2016, subscription and services revenue as a percentage of total revenue was 86% and 80%, respectively. While most of the growth in our subscription and services revenue during such periods relates to the amortization of the initial subscription and services agreements, renewals of such agreements have also supported this growth. Our renewal rate for subscriptions and support expiring in the 12 months ended March 31, 2017 was approximately 90%, and we expect to maintain high renewal rates in the future due to the significant value we believe these subscriptions and support add to the efficacy of our product portfolio.
Beyond the product and attached threat intelligence subscriptions and support and maintenance services, we offer several security-as-a-service offerings, including Cloud MVX, ETP, TAP, FireEye-as-a-Service and our newly introduced FireEye Helix platform. Revenue from these security-as-a-service subscriptions is recognized ratably over the subscription term, which is typically one to three years. We also offer professional services, including incident response and other security consulting services for our customers who have experienced a cybersecurity breach or require assistance assessing the resilience of their networks. Revenue from these professional services is recognized as the services are delivered.
Key Business Metrics
We monitor the key business metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. We discuss revenue and gross margin below under “Components of Operating Results.” Deferred revenue, billings (a non-GAAP metric), net cash flow provided by (used in) operating activities, and free cash flow (a non-GAAP metric) are discussed immediately below the following table.
 
Three Months Ended or As of
 
March 31,
 
2017

2016
 
(Dollars in thousands)
Product revenue
$
23,743

 
$
33,707

Subscription and services revenue
149,995

 
134,259

Total revenue
$
173,738


$
167,966

Year-over-year percentage increase
3
%
 
34
%
Gross margin percentage
63
%
 
57
%
Deferred revenue, current
$
396,628

 
$
329,095

Deferred revenue, non-current
$
235,557

 
$
236,987

Billings (non-GAAP)
$
152,407

 
$
185,963

Net cash used in operating activities
$
(16,952
)
 
$
(22,516
)
Free cash flow (non-GAAP)
$
(25,435
)
 
$
(36,773
)
Deferred revenue. Our deferred revenue consists of amounts that have been invoiced but have not yet been recognized as revenue as of period end. The majority of our deferred revenue consists of the unamortized balance of revenue from previously invoiced subscriptions to our threat intelligence, security-as-a-service and support and maintenance contracts. Subscriptions and support and maintenance contracts are generally non-cancelable, except for cause, and are typically invoiced and paid up-front. Because invoiced amounts for subscriptions and services can be for multiple years, we classify our deferred revenue as current or non-current depending on when we expect to recognize the related revenue. If the deferred revenue is expected to be recognized within 12 months it is classified as current, otherwise, the deferred revenue is classified as non-current. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.
Billings. Billings are a non-GAAP financial metric that we define as revenue recognized in accordance with generally accepted accounting principles, or GAAP, plus the change in deferred revenue from the beginning to the end of the period, excluding deferred revenue assumed through acquisitions. We consider billings to be a useful metric for management and investors, as a supplement to the corresponding GAAP measure, because billings drive deferred revenue, which is an important indicator of the health and visibility of trends in our business, and represent a significant percentage of future revenue. However, it is important to note that other companies, including companies in our industry, may not use billings, may define billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure.

22


For the three months ended March 31, 2016, billings exclude $21.1 million of deferred revenue assumed in connection with our acquisitions. A reconciliation of billings to revenue, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Three Months Ended March 31,
 
2017

2016
 
(in thousands)
Revenue
$
173,738

 
$
167,966

Add: Deferred revenue, end of period
632,185

 
566,082

Less: Deferred revenue, beginning of period
653,516

 
526,998

Less: Deferred revenue assumed through acquisitions

 
21,087

Billings (non-GAAP)
$
152,407

 
$
185,963

Net cash provided by (used in) operating activities. We monitor net cash provided by (used in) operating activities as a measure of our overall business performance. Our net cash provided by (used in) operating activities is driven in large part by sales of our products and from up-front payments for both subscriptions and support and maintenance services. Monitoring net cash provided by (used in) operating activities enables us to analyze our financial performance without the non-cash effects of certain items, such as depreciation, amortization, and stock-based compensation costs, thereby allowing us to better understand and manage the cash needs of our business.
Free cash flow. Free cash flow is a non-GAAP financial measure we define as net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure, less purchases of property and equipment and demonstration units. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by our business that, after the purchases of property and equipment and demonstration units, can be used by us for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening our balance sheet if and when generated. However, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow differently, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to cash flow provided by (used in) operating activities is provided below:
 
Three Months Ended March 31,
 
2017
 
2016
 
(In thousands)
Net cash used in operating activities
$
(16,952
)
 
$
(22,516
)
Less: purchase of property and equipment and demonstration units
8,483

 
14,257

Free cash flow (non-GAAP)
$
(25,435
)
 
$
(36,773
)
Net cash used in investing activities
$
(8,724
)
 
$
(197,347
)
Net cash used in financing activities
$
(34,617
)
 
$
(7,126
)
Factors Affecting our Performance
Market Adoption. We rely on market education to raise awareness of today’s next-generation cyber attacks and articulate the need for our security solutions and, in particular, the reasons to purchase our products. Our prospective customers often do not have a specific portion of their IT budgets allocated for products that address the next generation of advanced cyber attacks. We invest heavily in sales and marketing efforts to increase market awareness, educate prospective customers and drive adoption of our solution. This market education is critical to creating new IT budget dollars or allocating IT budget dollars across enterprises and governments for next-generation threat protection solutions and, in particular, our platform. Our investment in market education has also increased awareness of us and our solution in international markets. The degree to which prospective customers recognize the mission critical need for next-generation threat protection solutions, including recent enhancements to our endpoint solution and newly introduced FireEye Helix platform, and subsequently allocate budget dollars for our platform, will drive our ability to acquire new customers and increase renewals and follow-on sales opportunities, which, in turn, will affect our future financial performance.
Sales Productivity. Our sales organization consists of in-house sales teams who work in collaboration with external partners to identify new sales prospects, sell additional products, subscriptions and services, and provide post-sale support. To date, we have primarily targeted large enterprise and government customers, who typically have sales cycles that can last several months or more. We have also expanded our inside sales teams to pursue customers in the small and medium enterprise, or SME, market.
Newly hired sales and marketing resources will require several months to establish prospect relationships and drive overall sales productivity. In addition, sales teams in certain international markets will face local markets that have not had significant market education

23


about the advanced security threats that our platform addresses. All of these factors will influence the timing and overall levels of sales productivity, impacting the rate at which we will be able to convert prospects to sales and drive revenue growth.
Renewal Rates. New or existing customers who purchase one of our appliances are required to purchase a one or three year subscription to our DTI cloud and support and maintenance services. New or existing customers who purchase our Security Forensic Products System or Central Management System appliances are required to purchase support and maintenance services for a term of one or three years.
We believe our renewal rate is an important metric to measure the long-term value of customer agreements and our ability to retain our customers. We calculate our renewal rate by dividing the number of renewing customers who were due for renewal in any rolling 12 month period by the number of customers who were due for renewal in that rolling 12 month period. Our renewal rate for subscriptions and support expiring in the 12 months ended March 31, 2017 was approximately 90%. These high renewal rates are primarily attributable to the incremental value added to our appliances by our cloud subscriptions, support and maintenance services and other professional services. As cloud subscriptions, support and maintenance services and other professional services represented 86% and 80% of our total revenue during the three months ended March 31, 2017 and 2016, respectively, we believe our ability to maintain high renewal rates for these subscriptions and services will have a material impact on our future financial performance.
Follow-On Sales. After the initial sale to a new customer, we focus on expanding our relationship with such customer to sell additional products, subscriptions and services. To grow our revenue, it is important that our customers make additional purchases of our products, subscriptions and services. Sales to our existing customer base can take the form of incremental sales of appliances, subscriptions and services, either to deploy our platform into additional parts of their network or to protect additional threat vectors. Our opportunity to expand our customer relationships through follow-on sales will increase as we add new customers, broaden our product portfolio to support more threat vectors, add new services, increase network performance and enhance functionality. Follow-on sales lead to increased revenue over the lifecycle of a customer relationship and can significantly increase the return on our sales and marketing investments. With some of our most significant customers, we have realized follow-on sales that were multiples of the value of their initial purchases.
Components of Operating Results
Revenue
We generate revenue from the sales of our products, subscriptions and services. As discussed further in “Critical Accounting Policies and Estimates-Revenue Recognition” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on February 24, 2017, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured.
Product revenue. Our product revenue is generated from sales of our appliances, which we generally recognize at the time of shipment, provided that all other revenue recognition criteria have been met.
Subscription and services revenue. Subscription and services revenue is generated primarily from our cloud subscriptions, FireEye-as-a-Service, support and maintenance services and other professional services. We recognize revenue from subscriptions and support and maintenance services over the one or three year contract term, as applicable. Professional services, which includes incident response and compromise assessments, are offered on a time-and-material basis or through a fixed fee arrangement, and we recognize the associated revenue as the services are delivered.
Cost of Revenue
Our total cost of revenue consists of cost of product revenue and cost of subscription and services revenue. Personnel costs associated with our operations and global customer support organizations consist of salaries, benefits, bonuses and stock-based compensation. Overhead costs consist of certain facilities, depreciation and information technology costs.
Cost of product revenue. Cost of product revenue primarily consists of costs paid to our third-party contract manufacturers for our appliances and personnel and other costs in our manufacturing operations department. Our cost of product revenue also includes product testing costs, shipping costs and allocated overhead costs. We expect our cost of product revenue to decrease as our product revenue decreases, as customers' buying preferences shift away from on premise appliance-based solutions and towards cloud-based and cloud-enabled solutions. Our cost of product revenue may increase as a percentage of product revenue due to the fixed nature of a portion of these costs.
Cost of subscription and services revenue. Cost of subscription and services revenue consists of personnel costs for our global customer support and services organization and allocated overhead costs. We expect our cost of subscription and services revenue to decrease as a percentage of total revenue.

24


Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including our average selling price, manufacturing costs, the mix of products sold, and the mix of revenue among products, subscriptions and services. We expect our gross margins to fluctuate over time depending on these factors.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing and general and administrative expenses, as well as restructuring charges. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation and, with regard to sales and marketing expense, sales commissions. Operating expenses also include allocated overhead costs consisting of certain facilities, depreciation and information technology costs.
Research and development. Research and development expense consists primarily of personnel costs and allocated overhead. Research and development expense also includes prototype related expenses. We expect research and development expense to decrease as a percentage of total revenue.
Sales and marketing. Sales and marketing expense consists primarily of personnel costs, partner referral fees, incentive commission costs and allocated overhead. We expense commission costs as incurred. Sales and marketing expense also includes costs for market development programs, promotional and other marketing activities, travel, depreciation of proof-of-concept evaluation units and outside consulting costs. We expect sales and marketing expense to decrease as a percentage of total revenue.
General and administrative. General and administrative expense consists of personnel costs, professional service costs and allocated overhead. General and administrative personnel include our executive, finance, human resources, facilities and legal organizations. Professional service costs consist primarily of legal, auditing, accounting and other consulting costs. We expect general and administrative expense to decrease as a percentage of total revenue.
Restructuring charges. In February 2016, we initiated a series of business restructuring plans to reduce our cost structure and improve efficiency. The expenses incurred primarily consisted of employee severance charges and other termination benefits, as well as real estate and related fixed asset charges for the consolidation of certain leased facilities.
Interest Income
Interest income consists of interest earned on our cash and cash equivalent and investment balances. We have historically invested our cash in money-market funds and other short-term, high quality securities. We expect interest income to vary each reporting period depending on our average investment balances during the period, types and mix of investments and market interest rates.
Interest Expense
Interest expense is primarily a result of our convertible senior notes, consisting of interest at the stated rate (coupon) and amortization of discounts and issuance costs.
Other Income (Expense), Net
Other income (expense), net includes gains or losses on the disposal of fixed assets, gains or losses from our equity-method investment, foreign currency re-measurement gains and losses and foreign currency transaction gains and losses. We expect other income (expense), net to fluctuate depending primarily on foreign exchange rate movements.
Provision for (Benefit from) Income Taxes
Provision for income taxes primarily relates to income taxes payable in foreign jurisdictions in which we conduct business, withholding taxes, and state income taxes in the United States. The provision is offset by tax benefits primarily related to the reversal of valuation allowances previously established against our deferred tax assets. Should the tax benefits exceed the provision, then a net tax benefit from income taxes is reflected for the period. Income in certain countries may be taxed at statutory tax rates that are lower than the U.S. statutory tax rate. As a result, our overall effective tax rate over the long-term may be lower than the U.S. federal statutory tax rate due to net income being subject to foreign income tax rates that are lower than the U.S. federal statutory rate.

25


Results of Operations
The following table summarizes our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of results is not necessarily indicative of results for future periods.
 
Three Months Ended March 31,
 
2017
 
2016
 
Amount
 
% of total Revenue
 
Amount
 
% of total Revenue
 
(Dollars In thousands)
Revenue:
 
 
 
 
 
 
 
Product
$
23,743

 
14
 %
 
$
33,707

 
20
 %
Subscription and services
149,995

 
86

 
134,259

 
80

Total revenue
173,738

 
100

 
167,966

 
100

Cost of revenue:
 
 
 
 
 
 
 
Product
12,851

 
7

 
17,133

 
10

Subscription and services
51,754

 
30

 
54,297

 
33

Total cost of revenue
64,605

 
37

 
71,430

 
43

Total gross profit
109,133

 
63

 
96,536

 
57

Operating expenses:
 
 
 
 
 
 
 
Research and development
58,352

 
33

 
85,983

 
51

Sales and marketing
94,880

 
55

 
123,028

 
73

General and administrative
27,615

 
16

 
42,256

 
25

Restructuring charges

 

 
1,670

 
1

Total operating expenses
180,847

 
104

 
252,937

 
150

Operating loss
(71,714
)
 
(41
)
 
(156,401
)
 
(93
)
Interest income
2,032

 
1

 
1,465

 
1

Interest expense
(12,245
)
 
(7
)
 
(11,809
)
 
(7
)
Other income, net
232

 

 
815

 

Loss before income taxes
(81,695
)
 
(47
)
 
(165,930
)
 
(99
)
Provision for (benefit from) income taxes
1,293

 
1

 
(10,030
)
 
(6
)
Net loss attributable to common stockholders
$
(82,988
)
 
(48
)%
 
$
(155,900
)
 
(93
)%

26


Comparison of the Three Months Ended March 31, 2017 and 2016
Revenue
 
Three Months Ended March 31,
 
2017
 
2016
 
Change  
 
Amount
 
% of Total Revenue
 
Amount
 
% of Total Revenue
 
Amount
 
%
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
23,743

 
14
%
 
$
33,707

 
20
%
 
$
(9,964
)
 
(30
)%
Subscription and services
149,995

 
86

 
134,259

 
80

 
15,736

 
12

Total revenue
$
173,738

 
100
%
 
$
167,966

 
100
%
 
$
5,772

 
3
 %
Subscription and services by type:
 
 
 
 
 
 
 
 
 
 
 
Product subscription
$
87,054

 
50
%
 
$
74,163

 
44
%
 
$
12,891

 
17
 %
Support and maintenance
33,207

 
19

 
28,413

 
17
%
 
4,794

 
17

Professional services
29,734

 
17

 
31,683

 
19
%
 
(1,949
)
 
(6
)
Total subscription and services revenue
$
149,995

 
86
%
 
$
134,259

 
80
%
 
$
15,736

 
12
 %
Revenue by geographic region:
 
 
 
 
 
 
 
 
 
 
 
United States
$
115,004

 
66
%
 
$
115,852

 
69
%
 
$
(848
)
 
(1
)%
EMEA
25,321

 
15

 
24,442

 
15

 
879

 
4

APAC
25,853

 
15

 
21,823

 
13

 
4,030

 
18

Other
7,560

 
4

 
5,849

 
3

 
1,711

 
29

Total revenue
$
173,738

 
100
%
 
$
167,966

 
100
%
 
$
5,772

 
3
 %
Product revenue decreased by $10.0 million, or 30%, during the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The decrease in product revenue was primarily due to a shift in customer buying preferences away from on premise appliance-based solutions to cloud-based and cloud-enabled subscriptions, including security delivered as a service. As a result, revenue from sales of our threat prevention appliances has declined as revenue from our cloud-based solutions has increased. Our NX Series of security appliances continued to account for the largest portion of our product revenue. This reflects the fact that customers who purchase our product portfolio generally purchase more NX Series appliances than our other appliances, as their networks typically have more Web entry points than email or file entry points to protect. We expect product revenue to decline as part of this ongoing transition from on premise appliance-based solutions to cloud-based and cloud-enabled subscriptions.
Subscription and services revenue increased by $15.7 million, or 12%, during the three months ended March 31, 2017 compared to the three months ended March 31, 2016. This increase was comprised of subscription revenue of $12.9 million and support and maintenance revenue of $4.8 million, partially offset by a decrease in professional services revenue of $2.0 million. The increases in subscription revenue of $12.9 million and support and maintenance revenue of $4.8 million were primarily due to an increase in initial customer purchases of $5.6 million and the amortization of deferred subscription and support revenue related to renewals of $12.1 million during the three months ended March 31, 2017 compared to the three months ended March 31, 2016. We expect a continued transition of customers from product sales to our cloud subscriptions. Given our high renewal rate, we expect revenue from the amortization of deferred subscription and support related to renewals to increase as a percentage of our total revenue from subscription and support. Our renewal rate for subscription and support agreements expiring in the 12 months ended March 31, 2017 was approximately 90%.
Our international revenue increased $6.6 million, or 13%, during the three months ended March 31, 2017 compared to the three months ended March 31, 2016, which reflects our increasing international market presence.

27


Cost of Revenue and Gross Margin
 
Three Months Ended March 31,
 
2017
 
2016
 
Change
 
Amount
 
Gross 
Margin
 
Amount 
 
Gross 
Margin
 
Amount  
 
%
 
(Dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
12,851

 
 
 
$
17,133

 
 
 
$
(4,282
)
 
(25
)%
Subscription and services
51,754

 
 
 
54,297

 
 
 
(2,543
)
 
(5
)
Total cost of revenue
$
64,605

 
 
 
$
71,430

 
 
 
$
(6,825
)
 
(10
)%
Gross margin:
 
 
 
 
 
 
 
 
 
 
 
Product
 
 
46
%
 
 
 
49
%