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 September 30, 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 standards 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 October 31, 2017 was 184,587,980.


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)
 
September 30,
2017
 
December 31,
2016
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
160,807

 
$
223,667

Short-term investments
717,960

 
712,058

Accounts receivable, net of allowance for doubtful accounts of $2,397 and $1,590 at September 30, 2017 and December 31, 2016, respectively
120,170

 
121,150

Inventories
5,368

 
5,955

Prepaid expenses and other current assets
36,826

 
25,081

Total current assets
1,041,131

 
1,087,911

Property and equipment, net
67,147

 
61,852

Goodwill
978,260

 
978,260

Intangible assets, net
199,671

 
244,032

Deposits and other long-term assets
10,140

 
10,910

TOTAL ASSETS
$
2,296,349

 
$
2,382,965

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
32,487

 
$
20,269

Accrued and other current liabilities
21,918

 
22,997

Accrued compensation
59,117

 
96,004

Deferred revenue, current portion
409,442

 
397,118

Total current liabilities
522,964


536,388

Convertible senior notes, net
770,003

 
741,980

Deferred revenue, non-current portion
221,371

 
256,398

Other long-term liabilities
15,200

 
7,087

Total liabilities
1,529,538


1,541,853

Commitments and contingencies (NOTE 9)

 

Stockholders' equity:
 
 
 
Common stock, par value of $0.0001 per share; 1,000,000 shares authorized, 184,194 shares and 174,596 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
18

 
17

Additional paid-in capital
2,834,744

 
2,682,909

Treasury stock, at cost; 3,333 shares as of September 30, 2017 and December 31, 2016
(150,000
)
 
(150,000
)
Accumulated other comprehensive loss
(1,214
)
 
(1,742
)
Accumulated deficit
(1,916,737
)
 
(1,690,072
)
Total stockholders’ equity
766,811


841,112

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
2,296,349


$
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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
Product
$
30,472

 
$
43,857

 
$
85,418

 
$
118,340

Subscription and services
159,131

 
142,554

 
463,395

 
411,078

Total revenue
189,603


186,411


548,813


529,418

Cost of revenue:
 
 
 
 
 
 
 
Product
13,815

 
16,675

 
41,342

 
49,767

Subscription and services
54,403

 
52,378

 
158,173

 
158,143

Total cost of revenue
68,218


69,053


199,515


207,910

Total gross profit
121,385


117,358


349,298


321,508

Operating expenses:
 
 
 
 
 
 
 
Research and development
64,316

 
62,665

 
183,415

 
225,020

Sales and marketing
88,901

 
110,756

 
273,411

 
355,189

General and administrative
29,843

 
32,860

 
85,291

 
108,925

Restructuring charges

 
22,423

 

 
27,630

Total operating expenses
183,060


228,704


542,117


716,764

Operating loss
(61,675
)

(111,346
)

(192,819
)

(395,256
)
Interest income
2,468

 
1,687

 
6,668

 
4,779

Interest expense
(12,611
)
 
(12,019
)
 
(37,241
)
 
(35,737
)
Other income (expense), net

 
(467
)
 
112

 
(843
)
Loss before income taxes
(71,818
)

(122,145
)

(223,280
)

(427,057
)
Provision for (benefit from) income taxes
1,127

 
1,228

 
3,385

 
(8,464
)
Net loss attributable to common stockholders
$
(72,945
)

$
(123,373
)

$
(226,665
)

$
(418,593
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.41
)
 
$
(0.75
)
 
$
(1.29
)
 
$
(2.59
)
Weighted average shares used in computing net loss per share attributable to common stockholders, basic and diluted
179,732

 
164,728

 
176,232

 
161,862

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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net loss
$
(72,945
)
 
$
(123,373
)
 
$
(226,665
)
 
$
(418,593
)
Change in net unrealized gains/(losses) on available-for-sale investments, net of tax
179

 
(870
)
 
528

 
1,768

Comprehensive loss
$
(72,766
)

$
(124,243
)

$
(226,137
)

$
(416,825
)
See accompanying notes to condensed consolidated financial statements.

3

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

 
Nine Months Ended September 30,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(226,665
)
 
$
(418,593
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
78,612

 
90,852

Stock-based compensation
125,492

 
168,117

Non-cash interest expense related to convertible senior notes
28,023

 
26,670

Change in fair value of contingent earn-out liability
(54
)
 
1,756

Deferred income taxes
(53
)
 
(11,836
)
Other
5,142

 
6,984

Changes in operating assets and liabilities, net of business acquisitions:
 
 
 
Accounts receivable
(354
)
 
60,372

Inventories
(1,890
)
 
2,985

Prepaid expenses and other assets
(9,657
)
 
4,258

Accounts payable
(960
)
 
(11,598
)
Accrued liabilities
(1,079
)
 
(5,059
)
Accrued transaction costs of acquiree

 
(7,727
)
Accrued compensation
2,095

 
6,142

Deferred revenue
(22,703
)
 
68,334

Other long-term liabilities
8,116

 
(3,174
)
Net cash used in operating activities
(15,935
)

(21,517
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment and demonstration units
(25,924
)
 
(28,009
)
Purchases of short-term investments
(315,626
)
 
(379,695
)
Proceeds from maturities of short-term investments
304,042

 
438,624

Proceeds from sales of short-term investments
3,620

 
4,507

Business acquisitions, net of cash acquired

 
(204,926
)
Lease deposits
(451
)
 
(480
)
Net cash used in investing activities
(34,339
)

(169,979
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of debt of acquired business

 
(8,842
)
Payments for contingent earn-outs
(38,928
)
 
(87
)
Payment related to shares withheld for taxes
(1,004
)
 
(1,124
)
Proceeds from employee stock purchase plan
10,764

 
12,684

Proceeds from exercise of equity awards
16,582

 
10,460

Net provided by (cash used) in financing activities
(12,586
)

13,091

Net change in cash and cash equivalents
(62,860
)
 
(178,405
)
Cash and cash equivalents, beginning of period
223,667

 
402,102

Cash and cash equivalents, end of period
$
160,807


$
223,697

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
3,680

 
$
4,352

Cash paid for interest
$
6,038

 
$
6,060

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

 
$
1,296

Common stock issued in connection with acquisitions
$

 
$
41,000

Contingent earn-out in connection with acquisitions
$

 
$
39,088

Purchases of property and equipment and demonstration units in accounts payable and accrued liabilities
$
17,213

 
$
6,087

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 and nine months ended September 30, 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 and nine months ended September 30, 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.
The guidance is effective for us beginning in the first quarter of 2018, with early adoption permitted as of the original effective date of January 1, 2017. We plan to adopt the standard effective January 1, 2018. 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 are adopting the standard retrospectively to all prior periods presented. While 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 remain on schedule and have implemented key system functionality to enable the preparation of restated financial information. We are nearing completion of retrospectively adjusting financial information for fiscal year 2016, and expect to begin retrospectively adjusting financial information for fiscal year 2017 soon. We plan to quantify and disclose these impacts in our Annual Report on Form 10-K for the year ending December 31, 2017.
We have reached conclusions on key accounting assessments related to the standard. We will continue to monitor and assess the impact of any changes to the standard and interpretations as they become available.
This standard will have a material impact on our consolidated financial statements and related disclosures. The most significant impact relates to our accounting for intelligence dependent appliance and software license revenue. Revenue related to certain appliances and software licenses not dependent on intelligence, subscription and support offerings, cloud offerings and professional services will remain substantially unchanged. Specifically, under the new standard we will 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 longer of the life of the related appliance and license or the contractual term, rather than at the time of shipping, when our contracts contain material right of renewal options. For the contracts where the term is less than the life of the appliance and license, the intelligence subscription and support will be recognized ratably over the contractual term with the allocated value of the material right performance obligations being recognized in the period between the end of the contractual term and the useful life. Where our contracts do not contain material right of renewal options, or the contractual term is longer than the useful life, we expect to recognize intelligence dependent appliance and software license revenue ratably over the contractual term. Due to the 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 appliance and license as most of our appliance and license offerings are intelligence dependent.

6


Incremental costs to obtain a contract will be capitalized and amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. Most of our commission expenses and related payroll taxes meet this definition. In determining the amortization period, we are not only taking into consideration the pattern of transfer to which the asset relates, but also the portion of renewal commissions paid that may not be commensurate with the initial commissions paid. When initial commissions are not commensurate with renewal commissions, we will recognize the non-commensurate portion of initial commissions over an estimated useful life while the commensurate portion will be recognized over the contract term. Additionally, our appliance related cost of goods sold will be capitalized and amortized on a systematic basis that is consistent with the pattern of transfer to which the asset relates.
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 September 30, 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
$
844

 
$

 
$

 
$
844

 
$
449

 
$

 
$

 
$
449

Total cash equivalents
844






844


449






449

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit

 
1,440

 

 
1,440

 

 
9,569

 

 
9,569

Commercial paper

 
7,468

 

 
7,468

 

 
29,920

 

 
29,920

Corporate notes and bonds

 
443,499

 

 
443,499

 

 
420,684

 

 
420,684

U.S. Government agencies

 
265,553

 

 
265,553

 

 
251,885

 

 
251,885

Total short-term investments

 
717,960

 

 
717,960

 

 
712,058

 

 
712,058

Total assets measured at fair value
$
844

 
$
717,960

 
$

 
$
718,804

 
$
449

 
$
712,058

 
$

 
$
712,507

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent earn-out
$

 
$

 
$

 
$

 
$

 
$

 
$
41,332

 
$
41,332

Total liabilities measured at fair value
$


$


$


$


$


$


$
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):

7


 
Amount
Balance as of December 31, 2016
$
41,332

Changes in fair value (1)
(54
)
Cash payments
(41,278
)
Balance as of September 30, 2017
$

(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 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 nine months ended September 30, 2017.
The estimated fair value of the Convertible Senior Notes (as defined in Note 8) as of September 30, 2017 was determined to be $878.6 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.
3. Investments
Our investments consisted of the following (in thousands):
 
As of September 30, 2017
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Short-Term Investment
Certificates of deposit
$
1,440

 
$

 
$

 
$
1,440

 
$
1,440

Commercial paper
7,472

 

 
(4
)
 
7,468

 
7,468

Corporate notes and bonds
444,079

 
39

 
(619
)
 
443,499

 
443,499

U.S. Government agencies
266,183

 

 
(630
)
 
265,553

 
265,553

Total
$
719,174


$
39


$
(1,253
)

$
717,960

 
$
717,960

 
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 September 30, 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
$

 
$

 
$

 
$

 
$

 
$

Commercial paper
4,970

 
(4
)
 

 

 
4,970

 
(4
)
Corporate notes and bonds
254,558

 
(423
)
 
117,065

 
(196
)
 
371,623

 
(619
)
U.S. Government agencies
177,751

 
(402
)
 
87,802

 
(228
)
 
265,553

 
(630
)
Total
$
437,279


$
(829
)

$
204,867


$
(424
)

$
642,146


$
(1,253
)

8


 
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 September 30, 2017 and December 31, 2016.
The following table summarizes the contractual maturities of our investments at September 30, 2017 (in thousands):
 
Amortized Cost
 
Fair Value
Due within one year
$
403,921

 
$
403,285

Due within one to two years
315,253

 
314,675

Total
$
719,174

 
$
717,960

All available-for-sale securities have been classified as current, based on management's intent and ability to use the funds in current operations.
As of September 30, 2017, we held an 8.9% 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 private company. This investment is classified within deposits and other long-term assets on our condensed consolidated balance sheets. The carrying value of this investment was less than $0.1 million as of September 30, 2017 and was $0.9 million as of December 31, 2016. Subsequent to September 30, 2017, we elected to invest an additional $2.5 million in the private company, raising our current ownership interest to 12.5%.
4. Property and Equipment
Property and equipment, net consisted of the following (in thousands):
 
As of September 30, 2017
 
As of December 31, 2016
Computer equipment and software
$
157,580

 
$
144,892

Leasehold improvements
61,959

 
41,796

Furniture and fixtures
14,954

 
14,499

Machinery and equipment
447

 
447

Total property and equipment
234,940

 
201,634

Less: accumulated depreciation
(167,793
)
 
(139,782
)
Total property and equipment, net
$
67,147

 
$
61,852

Depreciation and amortization expense related to property, equipment and demonstration units during the three months ended September 30, 2017 and 2016 was $10.5 million and $12.6 million, respectively. Depreciation and amortization expense related to property, equipment and demonstration units during the nine months ended September 30, 2017 and 2016 was $32.5 million and $39.8 million, respectively.
During the three months ended September 30, 2017 and 2016, we capitalized $2.2 million and $1.4 million, respectively, of software development costs primarily related to our cloud subscription offerings. Amortization expense related to capitalized software development costs during the three months ended September 30, 2017 and 2016 was $1.7 million and $0.8 million, respectively.
During the nine months ended September 30, 2017 and 2016, we capitalized $10.0 million and $9.4 million, respectively, of software development costs primarily related to our cloud subscription offerings. Amortization expense related to capitalized software development costs during the nine months ended September 30, 2017 and 2016 was $3.8 million and $1.7 million, respectively.
5. Business Combinations
Acquisition of iSIGHT

9


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.
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.

10


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.
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


11


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 nine months ended September 30, 2017.
Purchased intangible assets consisted of the following (in thousands):
 
As of September 30, 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
(200,822
)
 
(156,461
)
Total net intangible assets
$
199,671

 
$
244,032

Amortization expense of intangible assets during the three months ended September 30, 2017 and 2016 was $14.8 million and $16.3 million, respectively. Amortization expense of intangible assets during the nine months ended September 30, 2017 and 2016 was $44.4 million and $47.9 million, respectively.
The expected future annual amortization expense of intangible assets as of September 30, 2017 is presented below (in thousands):
Years Ending December 31,
Amount
2017 (remaining three months)
$
14,757

2018
47,433

2019
45,547

2020
31,171

2021
29,282

2022 and thereafter
31,481

Total
$
199,671

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 nine months ended September 30, 2017 (in thousands):
 
Severance and related costs
 
Facilities costs
 
Total costs
Balance, December 31, 2016
$
1,221

 
$
2,246

 
$
3,467

Cash payments
(752
)
 
(1,186
)
 
(1,938
)
Other adjustments
(469
)
 
(69
)
 
(538
)
Balance, September 30, 2017
$

 
$
991

 
$
991

Other adjustments of negative $0.5 million represent relief of unused benefits, changes in fair value and foreign currency fluctuations.
The remaining restructuring balance of $1.0 million at September 30, 2017 is for 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.

12


7. Deferred Revenue
Deferred revenue consisted of the following (in thousands):
 
As of September 30, 2017
 
As of December 31, 2016
Product, current
$
7,714

 
$
8,924

Subscription and services, current
401,728

 
388,194

Total deferred revenue, current
409,442

 
397,118

Product, non-current
5,102

 
4,748

Subscription and services, non-current
216,269

 
251,650

Total deferred revenue, non-current
221,371

 
256,398

Total deferred revenue
$
630,813

 
$
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.
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.

13


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.
The liability and equity components of the Convertible Senior Notes consisted of the following (in thousands):
 
As of September 30, 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
(58,951
)
 
(91,045
)
 
(74,126
)
 
(103,894
)
Net carrying amount
$
401,049


$
368,955

 
$
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 September 30, 2017 will be amortized over a weighted-average remaining period of approximately 3.9 years.
Interest expense for the three and nine months ended September 30, 2017 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
 
Series A Notes
 
Series B Notes
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

 
$
3,450

 
$
5,606

Amortization of convertible senior notes discounts and issuance costs
5,123

 
4,334

 
15,175

 
12,848

Total interest expense recognized
$
6,273


$
6,203

 
$
18,625

 
$
18,454

 
 
 
 
 
 
 
 
Effective interest rate on the liability component
6.3
%
 
6.8
%
 
6.4
%
 
6.9
%
Interest expense for the three and nine months ended September 30, 2016 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended September 30, 2016
 
Nine Months Ended September 30, 2016
 
Series A Notes
 
Series B Notes
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

 
$
3,450

 
$
5,606

Amortization of convertible senior notes discounts and issuance costs
4,867

 
4,133

 
14,414

 
12,256

Total interest expense recognized
$
6,017

 
$
6,002

 
$
17,864

 
$
17,862

 
 
 
 
 
 
 
 
Effective interest rate on the liability component
6.4
%
 
6.9
%
 
6.5
%
 
7.0
%

14


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, with payments commencing December 2017. Rent expense is recognized using the straight-line method over the term of the lease. Rent expense, net of sublease income, was $5.6 million and $3.0 million for the three months ended September 30, 2017 and 2016, respectively. Rent expense, net of sublease income, was $14.1 million and $10.9 million for the nine months ended September 30, 2017 and 2016, respectively.
The aggregate future non-cancelable minimum rental payments on our operating leases, as of September 30, 2017, are as follows (in thousands):
Years Ending December 31, 
Amount 
2017 (remaining three months)
$
3,250

2018
19,302

2019
14,984

2020
13,463

2021
11,535

2022 and thereafter
39,694

Total
$
102,228

Total future non-cancelable minimum rental payments have not been reduced by future minimum sublease rentals totaling $6.9 million.
We are party to letters of credit totaling $3.3 million and $3.1 million as of September 30, 2017 and December 31, 2016, respectively, issued primarily in support of operating leases for 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 September 30, 2017 and December 31, 2016, we had non-cancelable open orders of $13.5 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 September 30, 2017, we have not accrued any significant costs for such non-cancelable commitments.
Purchase Obligations
As of September 30, 2017, we had approximately $14.7 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 September 30, 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 $14.7 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.

15


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 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, was given final approval by the Superior Court on August 7, 2017 and the matter has now ended.
On January 28, 2015, certain of the Company’s officers and directors were named as defendants in a putative stockholder 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 consolidated complaint was filed on June 15, 2015, purporting to allege claims for breach of fiduciary duty and unjust enrichment. On August 29, 2016, the case was dismissed with prejudice. Plaintiffs filed a notice of appeal on October 27, 2016. On August 29, 2017, plaintiffs abandoned the appeal, ending the matter.
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 September 30, 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 September 30, 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 September 30, 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 September 30, 2017
 
As of December 31, 2016
Reserved under stock award plans
38,091

 
38,005

Convertible Senior Notes
15,141

 
15,141

ESPP
3,636

 
2,851

Total
56,868

 
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

16


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 long as such stock remains unvested. Approximately 12.0 million shares and 10.0 million shares of our common stock were reserved for future grants as of September 30, 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 3.6 million shares and 2.9 million shares of common stock were available for future issuance as of September 30, 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
(per share)
 
Weighted-
Average
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
Balance — December 31, 2016
8,085

 
$
10.70

 
5.4
 
$
40,304

Exercised
(2,977
)
 
5.57

 
 
 
24,358

Cancelled
(292
)
 
34.33

 
 
 
 
Balance — September 30, 2017
4,816

 
$
12.44

 
5.0
 
$
40,793

Options exercisable — September 30, 2017
4,775

 
$
12.16

 
5.0
 
$
40,722

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 with vesting subject to 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
12,394

 
12.24

 
 
 
 
Vested
(5,729
)
 
22.40

 
 
 
 
Cancelled
(5,283
)
 
16.95

 
 
 
 
Unvested balance — September 30, 2017
21,265

 
$
17.31

 
1.5
 
$
356,618

Unvested awards for which the requisite service period has not been rendered and vesting is subject to the achievement of a performance condition — September 30, 2017
4,296

 
$
16.78

 
1.7
 
$
72,051

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

17


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.
The following table summarizes the assumptions used in the Black-Scholes option-pricing model to determine fair value of our common shares to be issued under the ESPP for the offering periods beginning in May 2017:
 
Three and Nine Months Ended September 30, 2017
 
Three and Nine Months Ended September 30, 2016
Fair value of common stock
$15.65
 
$11.15
Risk-free interest rate
1.05% - 1.12%
 
0.38% - 0.57%
Expected term (in years)
0.5 - 1.0
 
0.5 - 1.0
Volatility
51%
 
61%
Dividend yield
—%
 
—%
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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Cost of product revenue
$
546

 
$
516

 
$
1,600

 
$
1,797

Cost of subscription and services revenue
7,767

 
7,759

 
22,137

 
25,013

Research and development
14,400

 
11,422

 
42,982

 
54,877

Sales and marketing
11,674

 
13,915

 
35,908

 
47,675

General and administrative
7,821

 
11,815

 
22,867

 
37,440

Restructuring

 
1,144

 

 
1,144

Total
$
42,208


$
46,571


$
125,494


$
167,946

As of September 30, 2017, total compensation cost related to stock-based awards not yet recognized was $268.9 million, which is expected to be amortized on a straight-line basis over the weighted-average remaining vesting period of approximately 2.3 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 $1.1 million and $1.2 million for the three months ended September 30, 2017 and 2016, respectively. For both the three months ended September 30, 2017 and 2016, the provision for income taxes is primarily comprised of income taxes in foreign jurisdictions and withholding taxes.
We recognized a provision for income taxes of $3.4 million during the nine months ended September 30, 2017 and a benefit from income taxes of $8.5 million during the nine months ended September 30, 2016. The change to a provision for income taxes during the nine months ended September 30, 2017 from a benefit from income taxes during the nine months ended September 30, 2016 was primarily due to the reversal of a valuation allowance in connection with the acquisitions of iSIGHT and Invotas included in the nine months ended September 30, 2016, which was not included for the nine months ended September 30, 2017.
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 and nine months ended September 30, 2017 and 2016, all potential common shares were determined to be anti-dilutive.

18


The following table sets forth the computation of net loss per common share (in thousands, except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Net loss
$
(72,945
)
 
$
(123,373
)
 
$
(226,665
)
 
$
(418,593
)
Denominator:
 
 
 
 
 
 
 
Weighted average number of shares outstanding—basic and diluted
179,732
 
164,728

 
176,232

 
161,862

Net loss per share—basic and diluted
$
(0.41
)

$
(0.75
)

$
(1.29
)

$
(2.59
)
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 September 30,
 
2017
 
2016
Options to purchase common stock
4,816

 
8,911

Unvested early exercised common shares

 
139

Unvested restricted stock awards and units
21,265

 
23,258

Convertible senior notes
15,141

 
15,141

ESPP shares
594

 
802

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 September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
United States
$
126,337

 
$
129,619

 
$
365,847

 
$
366,502

EMEA
28,072

 
24,900

 
79,294

 
73,307

APAC
25,428

 
24,447

 
77,874

 
69,650

Other
9,766

 
7,445

 
25,798

 
19,959

Total revenue
$
189,603

 
$
186,411

 
$
548,813

 
$
529,418


19


Long lived assets by geographic region based on physical location is as follows (in thousands):
 
As of September 30, 2017
 
As of December 31, 2016
Property and Equipment, net:
 
 
 
United States
$
54,116

 
$
43,214

International
13,031

 
18,638

Total property and equipment, net
$
67,147

 
$
61,852

For each of the three months ended September 30, 2017 and 2016, one distributor represented 19%, and one reseller represented 14%, of the Company's total revenue. For the nine months ended September 30, 2017 and 2016, one distributor represented 19%, for each period, and one reseller represented 12% and 13%, respectively, of the Company's total revenue. As of September 30, 2017, one customer represented 13% of the Company's net account receivable balances. As of December 31, 2016, no customer represented 10% or more of the Company's net accounts receivable balance.
16. Subsequent Events
On October 20, 2017, we completed the acquisition of a private technology company in the email security space, that is expected to enhance our current email offerings. As consideration for the acquisition, we paid approximately $9 million in cash and equity, subject to adjustment per the terms of the agreement. We are currently in the process of completing the preliminary purchase price allocation, which will be included in our Annual Report on Form 10-K for the year ending December 31, 2017.

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 $630.8 million and $653.5 million as of September 30, 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 September 30, 2017 and 2016, subscription and services revenue as a percentage of total revenue was 84% and 76%, respectively. For the nine months ended September 30, 2017 and 2016, subscription and services revenue as a percentage of total revenue was 84% and 78%, 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 September 30, 2017 was approximately 90%, and we expect to maintain strong 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 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
 
Nine Months Ended or As of
 
September 30,
 
September 30,
 
2017

2016
 
2017
 
2016
 
(Dollars in thousands)
Product revenue
$
30,472

 
$
43,857

 
$
85,418

 
$
118,340

Subscription and services revenue
159,131

 
142,554

 
463,395

 
411,078

Total revenue
$
189,603


$
186,411


$
548,813


$
529,418

Year-over-year percentage increase
2
%
 
13
%
 
4
%
 
21
%
Gross margin percentage
64
%
 
63
%
 
64
%
 
61
%
Deferred revenue, current
$
409,442

 
$
362,081

 
$
409,442

 
$
362,081

Deferred revenue, non-current
$
221,371

 
$
254,337

 
$
221,371

 
$
254,337

Billings (non-GAAP)
$
201,680

 
$
215,378

 
$
526,110

 
$
597,751

Net cash provided by (used in) operating activities
$
12,487

 
$
14,131

 
$
(15,935
)
 
$
(21,517
)
Free cash flow (non-GAAP)
$
3,875

 
$
7,200

 
$
(41,859
)
 
$
(49,526
)
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

22


use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure. For the nine months ended September 30, 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 September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017
 
2016
 
(in thousands)
Revenue
$
189,603

 
$
186,411

 
$
548,813

 
$
529,418

Add: Deferred revenue, end of period
630,813

 
616,418

 
630,813

 
616,418

Less: Deferred revenue, beginning of period
618,736

 
587,451

 
653,516

 
526,998

Less: Deferred revenue assumed through acquisitions

 

 

 
21,087

Billings (non-GAAP)
$
201,680

 
$
215,378


$
526,110


$
597,751

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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Net cash provided by (used in) operating activities
$
12,487

 
$
14,131

 
$
(15,935
)
 
$
(21,517
)
Less: purchase of property and equipment and demonstration units
8,612

 
6,931

 
25,924

 
28,009

Free cash flow (non-GAAP)
$
3,875

 
$
7,200

 
$
(41,859
)
 
$
(49,526
)
Net cash provided by (used in) investing activities
$
(11,107
)
 
$
21,534

 
$
(34,339
)
 
$
(169,979
)
Net cash provided by (used in) financing activities
$
4,985

 
$
4,039

 
$
(12,586
)
 
$
13,091

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 our FireEye Helix platform and enhancements to our endpoint solution, 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

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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 September 30, 2017 was approximately 90%. These strong 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 84% and 76% of our total revenue during the three months ended September 30, 2017 and 2016, respectively, and 84% and 78% of our total revenue during the nine months ended September 30, 2017 and 2016, respectively, we believe our ability to maintain strong 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.

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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, the mix of products sold, the mix of revenue among products, subscriptions and services and manufacturing costs. 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.

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Results of Operations
The following tables summarize 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 September 30,
 
2017
 
2016
 
Amount
 
% of total Revenue
 
Amount
 
% of total Revenue
 
(Dollars In thousands)
Revenue:
 
 
 
 
 
 
 
Product
$
30,472

 
16
 %
 
$
43,857

 
24
 %
Subscription and services
159,131

 
84

 
142,554

 
76

Total revenue
189,603

 
100

 
186,411

 
100

Cost of revenue: