Forescout (FSCT) 10-Q 2019 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

———————————————

FORM 10-Q

———————————————

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

OR

☐ 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 001-38253

———————————————

FORESCOUT TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

———————————————

Delaware		51-0406800
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
190 West Tasman Drive
San Jose	California	95134
(Address of principal executive offices, including zip code)

(408) 213-3191

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.001 per share	FSCT	The NASDAQ Global Market

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  ☒ No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒��   No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐
		If an emerging growth company, indicate by checkmark if the registrant has not elected to use the extended transition period for complying with any new or revised financial accounting standards providing pursuant to Section 7(a)(2)(B) of the Securities Act	☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ☐   No   ☒

The number of shares outstanding of the registrant’s common stock as of November 1, 2019 was 47,173,269.

TABLE OF CONTENTS

		Page
	PART I - FINANCIAL INFORMATION	5
Item 1.	Financial Statements	5
	Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018	5
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2019 and 2018	6
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2019 and 2018	7
	Condensed Consolidated Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2019 and 2018	8
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018	9
	Notes to Condensed Consolidated Financial Statements	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36
	PART II - OTHER INFORMATION	38
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 6.	Exhibits	38
	Signatures

2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q 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 (the “Exchange Act”), which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “would,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

• the evolution of the cyberthreat landscape facing enterprises in the United States and other countries;

• developments and trends in the domestic and international markets for network security products and related services;

• our expectations regarding the size of our target market;

• our ability to educate prospective end-customers about our technical capabilities and the use and benefits of our products, and to achieve increased market acceptance of our solution;

• our beliefs and objectives regarding our prospects and our future results of operations and financial condition;

• the effects of increased competition in our target markets and our ability to compete effectively;

• our business plan and our ability to manage our growth effectively;

• our investment in our sales force and our expectations concerning the productivity and efficiency of our expanding sales force as our sales representatives become more seasoned;

• our growth strategy to maintain and extend our technology leadership, expand and diversify our end-customer base, deepen our existing end-customer relationships, and attract and retain highly skilled security professionals;

• our ability to enhance our existing products and technologies and develop or acquire new products and technologies;

• our plans to attract new end-customers, retain existing end-customers, and increase our annual revenue;

• our expectations concerning renewal rates of Software Products subscription contracts and support and maintenance contracts (collectively known as “term contracts”) with end-customers;

• our plans to expand our international operations;

• our ability to successfully and timely execute on, integrate, and realize the benefits of any acquisition, investment, or other strategic transaction we may make or undertake;

• our expectations regarding future acquisitions of, or investments in, complementary companies, services, or technologies;

• our ability to continue to generate a significant portion of our revenue from public sector customers;

3

• the effects on our business of evolving information security and data privacy laws and regulations, government export or import controls and any failure to comply with the U.S. Foreign Corrupt Practices Act and similar laws;

• our ability to maintain, protect, and enhance our brand and intellectual property;

• fluctuations in our quarterly results of operations and other operating measures;

• our expectations regarding changes in our cost of revenue, gross margins, and operating costs and expenses;

• our expectations regarding the portions of our revenue represented by license revenue, subscription revenue, and professional services revenue;

• our expectations concerning the impact on our results of operations of development of our distribution programs and sales through our channel partners;

• the impact on our revenue, gross margin, and profitability of future investments in the enhancement of Forescout eyeSight, Forescout eyeControl, Forescout eyeExtend, SilentDefense, and SilentDefense Command Center, and expansion of our sales and marketing programs;

• the impact of the Tax Cuts and Jobs Act on our business;

• our ability to successfully acquire and integrate companies and assets;

• sufficiency of our existing liquidity sources to meet our cash needs; and

• our potential use of foreign exchange forward contracts to hedge our foreign currency risk and our general use of our foreign currency.

We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, operating results, cash flows, or prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors, including, but not limited to, those described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q and, in particular, the risks discussed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and those discussed in other documents we file with the SEC. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information, or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements. You should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

4

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except par value)

	September 30, 2019			December 31, 2018
Assets
Current assets:
Cash and cash equivalents	$	55,436		$	66,895
Marketable securities	38,235			47,632
Accounts receivable	84,539			79,255
Inventory	782			1,501
Deferred commissions - current	12,231			12,543
Prepaid expenses and other current assets	13,564			13,353
Total current assets	204,787			221,179
Deferred commissions - non-current	22,584			22,831
Property and equipment, net	24,022			24,349
Operating lease right-of-use assets	30,404			—
Restricted cash - non-current	1,257			1,266
Intangible assets, net	16,591			19,002
Goodwill	92,045			92,482
Other assets	7,306			7,369
Total assets	$	398,996		$	388,478
Liabilities and stockholders' equity
Current liabilities:
Accounts payable	$	10,654		$	12,118
Accrued compensation	29,562			32,649
Accrued expenses	15,268			14,558
Deferred revenue - current	104,739			101,900
Notes payable - current	7,397			7,331
Operating lease liabilities - current	5,217			—
Total current liabilities	172,837			168,556
Deferred revenue - non-current	71,948			69,618
Notes payable - non-current	2,692			8,248
Operating lease liabilities - non-current	33,342			—
Other liabilities	24,336			14,335
Total liabilities	305,155			260,757
Stockholders' equity:
Common stock, $0.001 par value; 1,000,000 shares authorized;
47,109 and 43,403 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively	47			43
Additional paid-in capital	704,192			639,237
Accumulated other comprehensive loss	(616		)	(302		)
Accumulated deficit	(609,782		)	(511,257		)
Total stockholders’ equity	93,841			127,721
Total liabilities and stockholders' equity	$	398,996		$	388,478

 

See Notes to Condensed Consolidated Financial Statements.

5

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Revenue:
License	$	50,203		$	51,082		$	126,714		$	115,185
Subscription	36,570			30,339			105,191			85,684
Professional services	4,849			4,207			13,565			12,050
Total revenue	91,622			85,628			245,470			212,919
Cost of revenue:
License	9,892			8,947			23,121			21,002
Subscription	5,376			4,069			16,182			11,602
Professional services	6,429			6,181			18,850			17,792
Total cost of revenue	21,697			19,197			58,153			50,396
Total gross profit	69,925			66,431			187,317			162,523
Operating expenses:
Research and development	20,556			15,062			58,493			44,552
Sales and marketing	51,035			46,098			163,131			133,416
General and administrative	15,318			13,880			47,369			40,872
Total operating expenses	86,909			75,040			268,993			218,840
Loss from operations	(16,984		)	(8,609		)	(81,676		)	(56,317		)
Interest expense	(156		)	(208		)	(391		)	(676		)
Other income, net	374			865			1,496			2,040
Loss before income taxes	(16,766		)	(7,952		)	(80,571		)	(54,953		)
Income tax provision	16,747			334			17,954			1,935
Net loss	$	(33,513	)	$	(8,286	)	$	(98,525	)	$	(56,888	)
Net loss per share, basic and diluted	$	(0.72	)	$	(0.20	)	$	(2.17	)	$	(1.41	)
Weighted-average shares used to compute net loss per share, basic and diluted	46,584			42,064			45,433			40,294

See Notes to Condensed Consolidated Financial Statements.

6

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited, in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Net loss	$	(33,513	)	$	(8,286	)	$	(98,525	)	$	(56,888	)
Other comprehensive income (loss), net of tax:
Change in unrealized gains (losses) on marketable securities	3			135			138			(35		)
Foreign currency translation adjustments	—			—			(452		)	—
Comprehensive loss	$	(33,510	)	$	(8,151	)	$	(98,839	)	$	(56,923	)

See Notes to Condensed Consolidated Financial Statements.

7

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited, in thousands)

	Nine Months Ended September 30, 2019
	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
	Shares	Amount
Balance as of December 31, 2018	43,403	$	43	$	639,237	$	(302	)	$	(511,257	)	$	127,721
Other comprehensive loss, net of tax	—	—		—		(1,979		)	—			(1,979		)
Stock-based compensation	—	—		13,828		—			—			13,828
Issuance of common stock in connection with employee equity incentive plans	1,706	2		9,407		—			—			9,409
Vesting of early exercised stock options	24	—		202		—			—			202
Net loss	—	—		—		—			(34,252		)	(34,252		)
Balance as of March 31, 2019	45,133	$	45	$	662,674	$	(2,281	)	$	(545,509	)	$	114,929
Other comprehensive income, net of tax	—	—		—		1,662			—			1,662
Stock-based compensation	—	—		14,065		—			—			14,065
Issuance of common stock in connection with employee equity incentive plans	746	1		7,014		—			—			7,015
Vesting of early exercised stock options	24	—		204		—			—			204
Net loss	—	—		—		—			(30,760		)	(30,760		)
Balance as of June 30, 2019	45,903	$	46	$	683,957	$	(619	)	$	(576,269	)	$	107,115
Other comprehensive income, net of tax	—	—		—		3			—			3
Stock-based compensation	—	—		13,822		—			—			13,822
Issuance of common stock in connection with employee equity incentive plans	1,206	1		6,413		—			—			6,414
Vesting of early exercised stock options	—	—		—		—			—			—
Net loss	—	—		—		—			(33,513		)	(33,513		)
Balance as of September 30, 2019	47,109	$	47	$	704,192	$	(616	)	$	(609,782	)	$	93,841

	Nine Months Ended September 30, 2018
	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
	Shares	Amount
Balance as of December 31, 2017	38,122	$	38	$	551,986	$	(112	)	$	(436,421	)	$	115,491
Other comprehensive loss, net of tax	—	—		—		(246		)	—			(246		)
Stock-based compensation	—	—		13,590		—			—			13,590
Issuance of common stock in connection with employee equity incentive plans	567	1		3,621		—			—			3,622
Issuance of common stock in connection with public offering, net of underwriter discounts and commissions and offering costs	500	—		12,572		—			—			12,572
Vesting of early exercised stock options	25	—		219		—			—			219
Net loss	—	—		—		—			(28,196		)	(28,196		)
Balance as of March 31, 2018	39,214	$	39	$	581,988	$	(358	)	$	(464,617	)	$	117,052
Other comprehensive income, net of tax	—	—		—		76			—			76
Stock-based compensation	—	—		12,936		—			—			12,936
Issuance of common stock in connection with employee equity incentive plans	2,256	3		4,606		—			—			4,609
Vesting of early exercised stock options	24	—		210		—			—			210
Issuance of common stock upon exercise of common stock warrants	67	—		—		—			—			—
Net loss	—	—		—		—			(20,406		)	(20,406		)
Balance as of June 30, 2018	41,561	$	42	$	599,740	$	(282	)	$	(485,023	)	$	114,477
Other comprehensive income, net of tax	—	—		—		135			—			135
Stock-based compensation	—	—		13,018		—			—			13,018
Issuance of common stock in connection with employee equity incentive plans	1,108	1		5,689		—			—			5,690
Vesting of early exercised stock options	25	—		209		—			—			209
Net loss	—	—		—		—			(8,286		)	(8,286		)
Balance as of September 30, 2018	42,694	$	43	$	618,656	$	(147	)	$	(493,309	)	$	125,243

See Notes to Condensed Consolidated Financial Statements.

8

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Nine Months Ended September 30,
	2019			2018
Cash flows from operating activities:
Net loss	$	(98,525	)	$	(56,888	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities
Stock-based compensation	41,715			39,544
Depreciation and amortization	8,777			5,490
Other	(138		)	113
Changes in operating assets and liabilities
Accounts receivable	(5,459		)	(3,414		)
Inventory	713			3,348
Deferred commissions	559			1,143
Prepaid expenses and other current assets	(217		)	(1,924		)
Other assets	67			(154		)
Accounts payable	(1,448		)	(6,110		)
Accrued compensation	(3,075		)	(1,539		)
Accrued expenses	2,293			1,027
Deferred revenue	5,028			27,222
Other liabilities	17,022			(466		)
Net cash (used in) provided by operating activities	(32,688		)	7,392
Cash flows from investing activities:
Purchases of property and equipment	(5,611		)	(6,766		)
Purchases of marketable securities	(63,569		)	(54,530		)
Proceeds from maturities of marketable securities	73,345			97,050
Net cash provided by investing activities	4,165			35,754
Cash flows from financing activities:
Repayments of notes payable	(5,625		)	(5,625		)
Proceeds from sales of shares through employee equity incentive plans	27,376			24,648
Payment related to shares withheld for taxes on vesting of restricted stock units	(4,538		)	(10,727		)
Proceeds from public offerings, net	—			13,818
Payments of deferred offering costs	—			(1,542		)
Net cash provided by financing activities	17,213			20,572
Effect of exchange rate changes on cash and cash equivalents	(4		)	—
Net change in cash, cash equivalents, and restricted cash for period	(11,314		)	63,718
Cash, cash equivalents, and restricted cash at beginning of period	69,012			67,357
Cash, cash equivalents, and restricted cash at end of period	$	57,698		$	131,075

Reconciliation of cash, cash equivalents, and restricted cash within the condensed consolidated balance sheets to the amounts shown in the statements of cash flows above:
Cash and cash equivalents	$	55,436	$	129,035
Restricted cash included in prepaid expenses and other current assets	1,005		851
Restricted cash - non-current	1,257		1,189
Total cash, cash equivalents, and restricted cash	$	57,698	$	131,075

See Notes to Condensed Consolidated Financial Statements.

9

FORESCOUT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Description of Business and Summary of Significant Accounting Policies

Company and Background

Forescout Technologies, Inc. (the “Company”) was incorporated in the State of Delaware and commenced operations in April 2000. The Company designs, develops, and markets device visibility, control, and orchestration software that helps organizations gain complete situational awareness of all devices in their interconnected environment and orchestrate actions to mitigate both their cyber and operational risk.

The Company offers its solution across 2 product groups: (i) products for visibility and control capabilities, and (ii) products for orchestration capabilities. The Company’s products for visibility and control capabilities consist of eyeSight, eyeControl, and SilentDefense. eyeSight and eyeControl provide for visibility and control capabilities across the extended enterprise, from campus to data center to hybrid cloud to operational technology (“OT”) devices, while SilentDefense provides for visibility and control capabilities deeper within the OT portion of the network. The Company’s products for orchestration capabilities are comprised of its portfolio of eyeExtend family of products.

The Company offers its solution across 2 product types: (i) software products and (ii) hardware products. The Company’s software products include eyeSight, eyeControl, eyeExtend, SilentDefense, and SilentDefense Command Center (“Software Products”). The Company’s hardware products include hardware that is sold separately for use with the Company’s Software Products and appliances that are embedded with the Company’s software (“Hardware Products”).

The Company sells its Software Products, Hardware Products, support and maintenance contracts, and professional services to end-customers through distributors and resellers, who are supported by the Company’s sales and marketing organization, and to a lesser extent directly to end-customers.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) using accounting policies that are consistent with those used in the preparation of the Company’s audited consolidated financial statements for the year ended December 31, 2018. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted as permitted by the SEC's rules and regulations. The Company’s condensed consolidated financial statements include the results of Forescout Technologies, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The condensed consolidated financial statements are unaudited and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s quarterly results. The condensed consolidated balance sheet as of December 31, 2018 was derived from the audited consolidated financial statements at that date but does not include all the disclosures required by GAAP for the annual financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

Prior to the first quarter of fiscal 2019, the Company presented revenue and cost of revenue on the condensed consolidated statements of operations as (i) product and (ii) maintenance and professional services. Under the new presentation of revenue and cost of revenue included in the condensed consolidated statements of operations beginning in the first quarter of fiscal 2019, product has been retitled as license revenue, and maintenance and professional services is now presented as two separate line items on the condensed consolidated statements of operations as (i) subscription and (ii) professional services. The related prior period financial data were adjusted to reflect the new presentation of the Company’s revenue and cost of revenue. There is no impact on total revenue and total cost of revenue.

10

The preparation of interim condensed consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts in the condensed consolidated financial statements and accompanying notes. These estimates form the basis of judgments made about carrying values of assets and liabilities, which are not readily apparent from other sources. The areas where management has made estimates requiring judgment include, but are not limited to, the best estimate of standalone selling prices for license and related support, the period over which deferred sales commissions are amortized to expense, accruals, stock-based compensation, provision for income taxes including related reserves, identified intangibles and goodwill, purchase price allocation of an acquired business, and incremental borrowing rate for operating leases. Actual results could differ materially from those estimates.

Foreign Currency

Prior to July 1, 2019, the Company’s functional currency was the U.S. dollar for the majority of its foreign operations except for Forescout Technologies, B.V. whose functional currency was the Euro. Translation gains and losses from the application of the U.S. dollar as the reporting currency during the period that the Euro was the functional currency for Forescout Technologies, B.V. were included as a component of accumulated other comprehensive loss on the consolidated balance sheets.

The Company re-assessed its functional currency and determined that, as of July 1, 2019, its functional currency for Forescout Technologies, B.V. had changed from the Euro to the U.S. dollar following the transfer of all of the intellectual property from Forescout Technologies, B.V. to the Company effective July 1, 2019. The change in functional currency was accounted for prospectively from July 1, 2019 and financial statements prior to and including the period ended June 30, 2019 were not restated for the change in functional currency.

Transactions denominated in currencies other than the applicable functional currency are converted to the functional currency at the exchange rate on the transaction date. At period end, monetary assets and liabilities are remeasured using the current exchange rate at the balance sheet date. Non-monetary assets and liabilities and capital accounts are remeasured using historical exchange rates. Revenue and expenses have been remeasured using the average exchange rates in effect during each period. Resulting foreign currency remeasurement gains and losses are recorded in other income (expense), net on the consolidated statements of operations.

Summary of Significant Accounting Policies 

Except for the impact of the adoption of Topic 842, as discussed in Note 5, there have been no changes to the Company’s significant accounting policies described in the Annual Report on Form 10-K for the year ended December 31, 2018 that have had a material impact on the Company’s condensed consolidated financial statements and related notes.

11

Note 2. Revenue, Deferred Revenue and Deferred Commissions

Disaggregation of Revenue

The Company generates revenue from the sale of Software Products, Hardware Products, support and maintenance contracts, and professional services. All revenue recognized in the condensed consolidated statements of operations is considered to be revenue from contracts with customers. The following table depicts the disaggregation of revenue according to revenue type and is consistent with how the Company evaluates its financial performance (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Revenue:
License
Software Products
Perpetual license	$	32,044	$	28,423	$	78,478	$	68,718
Term license	1,996		—		13,510		—
Hardware Products	16,163		22,659		34,726		46,467
Subscription	36,570		30,339		105,191		85,684
Professional services	4,849		4,207		13,565		12,050
Total revenue	$	91,622	$	85,628	$	245,470	$	212,919

License Revenue

License revenue consists of sales of Software Products and Hardware Products. Software Products are sold with either a perpetual license or a term license. License revenue includes the value allocated to license within Software Products subscription contracts. License revenue is recognized at the time of transfer of control, which is generally upon delivery of access to software downloads or shipment, provided that all other revenue recognition criteria have been met.

Subscription Revenue

Subscription revenue is derived from support and maintenance contracts and the value allocated to support and maintenance within Software Products subscription contracts. Support and maintenance contracts have terms that are generally either one or three years, but can be up to five years. Software Products subscription contracts are available in terms of either one or three years. Subscription revenue is recognized ratably over the term of the contract and any unearned subscription revenue is included in deferred revenue.

Professional Services Revenue

Professional services revenue is derived primarily from customer fees for optional installation of the Company’s products or training. Generally, the Company recognizes revenue for professional services as the services are rendered.

Revenue from Contracts with Customers

Contract Assets and Contract Liabilities

A contract asset is a right to consideration in exchange for products or services that the Company has transferred to a customer when that right is conditional and is not just subject to the passage of time. The Company’s payment terms typically range between 30 to 90 days. The Company has 0 material contract assets. A contract liability is an obligation to transfer products or services for which the Company has received consideration, or for which an amount of consideration is due from the customer. Contract liabilities include customer deposits under non-cancelable contracts included in accrued expenses, and current and non-current deferred revenue balances. The Company’s contract balances are reported in a net contract asset or liability position on a contract-by-contract basis at the end of each reporting period.

Significant changes in contract liabilities during the periods presented are as follows (in thousands):

12

	Three Months Ended September 30, 2019
	Contract Liabilities
Balance as of June 30, 2019	$	173,833
Additions	95,285
Gross revenue recognized	(91,622		)
Balance as of September 30, 2019	$	177,496

	Nine Months Ended September 30, 2019
	Contract Liabilities
Balance as of December 31, 2018	$	172,031
Additions	250,935
Gross revenue recognized	(245,470		)
Balance as of September 30, 2019	$	177,496

During the three months ended September 30, 2019, the Company recognized revenue of $34.4 million that was included in the contract liabilities balance as of June 30, 2019. During the nine months ended September 30, 2019, the Company recognized revenue of $83.6 million that was included in the contract liabilities balance as of December 31, 2018.

During the three months ended September 30, 2018, the Company recognized revenue of $28.5 million that was included in the contract liabilities balance as of June 30, 2018. During the nine months ended September 30, 2018, the Company recognized revenue of $66.5 million that was included in the contract liabilities balance as of December 31, 2017.

Performance Obligations

Contracted not recognized revenue was $180.4 million as of September 30, 2019, of which the Company expects to recognize approximately 60% of the revenue over the next 12 months and the remainder thereafter.

Note 3. Fair Value Measurements

Financial assets are recorded at fair value on the condensed consolidated balance sheets and are categorized based upon the level of judgment associated with inputs used to measure their fair value.

The accounting guidance establishes a fair value hierarchy based on the independence of the source and objective evidence of the inputs used. There are three fair value hierarchies based upon the level of inputs that are significant to fair value measurement:

•Level 1—Observable inputs that reflect quoted prices in active markets for identical assets or liabilities.

•Level 2—Observable inputs that reflect quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets or liabilities in active markets, 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—Inputs that are generally unobservable and are supported by little or no market activity, and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

13

There have been no transfers between fair value measurement levels during the periods presented. The following table presents the fair value of the Company’s financial assets according to the fair value hierarchy as of September 30, 2019 and December 31, 2018 (in thousands):

	September 30, 2019						December 31, 2018
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents:
Cash	$	44,843	$	—	$	—	$	46,017	$	—	$	—
Money market accounts	10,593		—		—		20,878		—		—
Total cash and cash equivalents	55,436		—		—		66,895		—		—
Marketable securities:
Commercial paper	—		5,982		—		—		3,991		—
Corporate debt securities	—		26,237		—		—		35,640		—
U.S. government securities	—		6,016		—		—		8,001		—
Total marketable securities	—		38,235		—		—		47,632		—
Restricted cash (current and non-current)	2,262		—		—		2,117		—		—
Total financial assets	$	57,698	$	38,235	$	—	$	69,012	$	47,632	$	—

Note 4. Marketable Securities

The following table summarizes the amortized cost, unrealized gains and losses, and fair value of the Company’s marketable securities as of September 30, 2019 and December 31, 2018 (in thousands):

	September 30, 2019								December 31, 2018
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value		Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Marketable securities:
Available-for-sale:
Commercial paper	$	5,982	$	—	$	—	$	5,982	$	3,991	$	—	$	—		$	3,991
Corporate debt securities	26,161		76		—		26,237		35,730		—		(90		)	35,640
U.S. government securities	6,009		7		—		6,016		8,012		—		(11		)	8,001
Total marketable securities	$	38,152	$	83	$	—	$	38,235	$	47,733	$	—	$	(101	)	$	47,632

The following table summarizes the amortized cost and fair value of the Company’s available-for-sale securities as of September 30, 2019 and December 31, 2018 by the contractual maturity date (in thousands):

	September 30, 2019				December 31, 2018
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due within one year	$	38,152	$	38,235	$	47,733	$	47,632
Total	$	38,152	$	38,235	$	47,733	$	47,632

The Company had 0 marketable securities in an unrealized loss position as of September 30, 2019. The Company had 13 marketable securities in an unrealized loss position as of December 31, 2018. For individual marketable securities that were in an unrealized loss position as of December 31, 2018, the fair value and gross unrealized loss for these securities aggregated by investment category and length of time in a continuous unrealized loss position are presented in the following table (in thousands):

14

	December 31, 2018
	Less Than 12 Months					Greater Than 12 Months					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Corporate debt securities	$	4,020	$	(3	)	$	31,620	$	(87	)	$	35,640	$	(90	)
U.S. government securities	—		—			8,001		(11		)	8,001		(11		)
Total	$	4,020	$	(3	)	$	39,621	$	(98	)	$	43,641	$	(101	)

Unrealized losses related to these marketable securities are due to interest rate fluctuations as opposed to credit quality. In addition, the Company does not intend to sell and it is not likely that the Company would be required to sell these marketable securities before recovery of their amortized cost basis, which may be at maturity. As a result, there are 0 other-than-temporary impairments for these marketable securities as of September 30, 2019 or December 31, 2018.

Note 5. Leases

Effective January 1, 2019, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2016-02, Leases (“ASU 2016-02”), ASU No. 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”), and ASU No. 2018-11, Targeted Improvements (“ASU 2018-11”), (collectively “Topic 842”). All amounts and disclosures set forth in this Quarterly Report on Form 10-Q have been updated to comply with Topic 842. The Company adopted Topic 842 effective January 1, 2019 using the transition method to apply the new lease standards at the adoption date and recognized a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The adoption had a material impact on the total assets and total liabilities reported on the Company’s condensed consolidated balance sheets resulting in an increase in long-term assets and total liabilities of approximately $20.3 million as of January 1, 2019. The adoption of this standard did not have a material impact on the Company’s condensed consolidated statements of operations.

The Company has operating leases for corporate offices, vehicles, and office equipment. The leases have remaining lease terms of up to seven years, some of which may include options to extend the leases for up to five years.

Leases with an initial term of 12 months or less are not recorded on the balance sheet. The Company recognizes lease expense for these leases on a straight-line basis over the lease term. The Company elected to combine the lease components (e.g., fixed payments including rent, real estate taxes, and insurance costs) and the non-lease components (e.g., common-area maintenance costs) for all classes of underlying assets, and to not reassess prior conclusions related to contracts containing leases, lease classification, and initial direct costs.

The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, current operating lease liabilities, and non-current operating lease liabilities on the Company’s condensed consolidated balance sheets. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. The lease terms may include options to extend the lease when it is reasonably certain that the Company will exercise that option. Lease expense is recognized on a straight-line basis over the lease term.

For the three and nine months ended September 30, 2019, the Company recognized operating lease cost of $2.8 million and $7.3 million, respectively, which included short-term leases and variable lease costs that were immaterial.

15

Maturities of lease liabilities as of September 30, 2019 were as follows (in thousands):

Years Ending December 31,	Operating Leases
2019 (excluding the nine months ended September 30, 2019)	$	1,796
2020	7,948
2021	7,598
2022	7,411
2023	7,370
Thereafter	15,632
Total lease payments	$	47,755
Less: Imputed interest	9,196
Present value of lease liabilities	$	38,559

Lease Term and Discount Rate	September 30, 2019
Operating leases
Weighted-average remaining lease term	6 years
Weighted-average discount rate	7.1	%

Other information (in thousands)	Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	905	$	4,684
Leased assets obtained in exchange for new operating lease liabilities	$	10,561	$	14,963

Note 6. Equity Award Plans

Stock-Based Compensation

Stock-based compensation expense included in the accompanying condensed consolidated statements of operations is as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Cost of revenue:
License	$	75	$	67	$	247	$	174
Subscription	454		349		1,367		1,099
Professional services	415		366		1,237		1,112
Research and development	3,040		2,613		8,809		7,473
Sales and marketing	6,330		6,165		20,014		18,195
General and administrative	3,508		3,458		10,041		11,491
Total	$	13,822	$	13,018	$	41,715	$	39,544

16

Stock Options

The following table summarizes option activity under the Company’s 2000 Stock Option and Incentive Plan and the Company’s 2017 Equity Incentive Plan, and related information (in thousands, except per share and contractual life amounts):

	Options Outstanding
	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Balance—December 31, 2018	6,013		$	11.65	6.4	$	86,624
Options exercised	(2,228	)	$	10.24
Options forfeited	(189	)	$	18.06
Balance—September 30, 2019	3,596		$	12.19	5.8	$	92,539
Options vested and exercisable—September 30, 2019	3,190		$	11.24	5.7	$	85,091

As of September 30, 2019, the total unrecognized compensation cost related to unvested options was $3.5 million, which is expected to be amortized on a straight-line basis over a weighted-average period of approximately 1.2 years.

The fair value of stock option awards granted to employees is estimated using the Black-Scholes option-pricing model. NaN stock option awards were granted during the three and nine months ended September 30, 2019 and three months ended September 30, 2018. The assumptions used to determine the grant date fair value of employee stock options for the periods presented are as follows:

	Nine Months Ended September 30,
	2018
Fair value of common stock	$29.92 – $30.97
Risk-free interest rate	2.4% – 2.8%
Expected term (in years)	6.1
Volatility	48%
Dividend yield	—%

Restricted Stock Units (“RSUs”) and Performance Based Stock Units (“PSUs”)

The following table summarizes RSU and PSU activity under the Company’s 2000 Stock Option and Incentive Plan and the Company’s 2017 Equity Incentive Plan (the “2017 Plan”), and related information (in thousands, except per share and contractual life amounts):

	RSUs and PSUs Outstanding
	Number of Shares		Weighted- Average Grant Date Fair Value Per Share		Weighted- Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Balance—December 31, 2018	5,709		$	28.01	1.8	$	148,389
Granted	1,599		$	35.85
Vested	(1,333	)	$	26.98
Forfeited	(529	)	$	29.24
Balance—September 30, 2019	5,446		$	30.45	1.6	$	206,521

Beginning in 2019, the Company issued PSUs to select executives under the 2017 Plan. The majority of the PSUs vest over a period of four years from the date of grant subject to both the continued employment of the participant with the Company and the achievement of one or more pre-established financial performance goals. Stock-based compensation

17

expense for PSUs is recognized using the accelerated attribution method over the requisite service periods when it is probable that the performance condition will be achieved.

As of September 30, 2019, the total unrecognized compensation cost related to unvested RSUs and PSUs was $123.8 million, which is expected to be amortized over a weighted-average period of approximately 2.6 years.

Note 7. Income Taxes

The Company estimates its annual effective tax rate each quarter and specific events are discretely recognized as they occur. For the three and nine months ended September 30, 2019, the Company recorded a tax provision of $16.7 million and $18.0 million, respectively, representing an effective tax rate of (99.9)% and (22.3)%, respectively. For the three and nine months ended September 30, 2018, the Company recorded a tax provision of $0.3 million and $1.9 million, respectively, representing an effective tax rate of (4.2)% and (3.5)%, respectively. The Company’s effective tax rates for these periods were negative as it has maintained a valuation allowance on the U.S. losses. The key components of the income tax provision primarily consist of foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The effective tax rate decreased for the three and nine months ended September 30, 2019 as compared to the three and nine months ended September 30, 2018 primarily due to an increase in income tax expense related to the completion of an intra-group transfer of certain intellectual property rights (the “IP”) from the Netherlands to the United States. The Company recognized a discrete tax expense of $17.1 million associated with this IP transfer. The discrete tax expense consists of a current tax expense of $20.8 million for the accrual of an uncertain tax position and a deferred tax benefit of $3.7 million related to the reversal of the acquired intangible asset deferred tax liability. The uncertain tax position, included in other liabilities in the Company’s condensed consolidated balance sheets, was $21.0 million and $1.2 million as of September 30, 2019 and December 31, 2018, respectively. The increase in the uncertain tax position was primarily related to the intra-group transfer of the IP as described above.

Note 8. Net Loss Per Share

Basic net loss per share is computed by dividing net loss by basic weighted-average shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by diluted weighted-average shares outstanding, including potentially dilutive securities, unless anti-dilutive.

The following table presents the computation of basic and diluted net loss per share (in thousands, except per share amounts):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Net loss	$	(33,513	)	$	(8,286	)	$	(98,525	)	$	(56,888	)
Weighted-average shares used to compute net loss per share, basic and diluted	46,584			42,064			45,433			40,294
Net loss per share, basic and diluted	$	(0.72	)	$	(0.20	)	$	(2.17	)	$	(1.41	)

The following securities were excluded from the computation of diluted net loss per share for the periods presented because their inclusion would reduce the net loss per share (in thousands):

	As of September 30,
	2019	2018
Options to purchase common stock	3,596	6,503
Unvested early exercised common shares	—	71
Unvested restricted stock units	5,446	5,014
Employee Stock Purchase Plan	172	148

18

Note 9. Related Party Transactions

Consulting agreement with Night Dragon II, LLC

On June 5, 2019, the Company entered into a consulting agreement (the “Consulting Agreement”) with Night Dragon II, LLC (“Night Dragon”). One of the board of directors (“the Board”) of the Company is a principal and the chief executive officer of Night Dragon and will personally provide services to the Company under the Consulting Agreement.

Pursuant to the Consulting Agreement, Night Dragon will provide consulting and business development services to the Company, including customer engagement, speaking activities, competitive and market analysis, business development assistance and expertise, and other services as described in the Consulting Agreement. In consideration for the consulting and business development services to the Company, the Board granted the director a number of performance stock units (“PSUs”) with a grant date fair value of $2.1 million. The PSUs will vest on the achievement of certain milestones detailed in the Consulting Agreement, in each case, so long as the Consulting Agreement remains in effect. The term of the Consulting Agreement commenced on June 5, 2019 and will continue for two years or until terminated in accordance with its terms.

For the three and nine months ended September 30, 2019, the stock-based compensation expense related to the Consulting Agreement was included in general and administrative expense and was immaterial. The balance of approximately $1.6 million will be recorded over the remaining period.

Related party sale

During the three months ended September 30, 2019, the Company sold products and services to a company related to a member of the Company’s board of directors. Specifically, for the three months ended September 30, 2019, the Company recorded license revenue of $1.5 million and an immaterial amount of subscription revenue relating to this contract. As of September 30, 2019, the related amounts receivable and deferred revenue were $2.2 million and $0.7 million, respectively.

Note 10. Subsequent Events

On October 2, 2019, the Company entered into a definitive Asset Purchase Agreement (the “Purchase Agreement”) to acquire certain assets from Bullguard Israel Ltd., an IoT security company, for a total purchase price of $10.3 million in cash. This transaction is intended to support and to accelerate the Company’s development of cloud-delivered products as part of its end-to-end device visibility and control platform. The Company has not yet completed the accounting for this transaction and is in the process of evaluating the impact of this transaction on its consolidated financial statements.

19

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 (1) unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) audited consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the year ended December 31, 2018 included in our Annual Report on Form 10-K for the year ended December 31, 2018. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. See the section titled “Special Note Regarding Forward-Looking Statements.”

Unless expressly indicated or the context requires otherwise, the terms “Forescout,” “we,” “us,” and “our” in this document refer to Forescout Technologies, Inc., a Delaware corporation, and, where appropriate, its wholly owned subsidiaries.

Overview

We offer our solution across two product groups: (i) products for visibility and control capabilities, and (ii) products for orchestration capabilities. Our products for visibility and control capabilities consist of eyeSight, eyeControl, and SilentDefense. Our eyeSight and eyeControl provide for visibility and control capabilities across the extended enterprise, from campus to data center to hybrid cloud to OT devices, while our SilentDefense product provides for visibility and control capabilities deeper within the OT portion of the network. Our products for orchestration capabilities are comprised of our portfolio of eyeExtend family of products. On November 6, 2019, we announced eyeSegment, a cloud-based offering that marries device visibility and control with network segmentation.

We offer our solution across two product types: (i) software products and (ii) hardware products. Our software products include eyeSight, eyeControl, eyeExtend, eyeSegment, SilentDefense, and SilentDefense Command Center (“Software Products”). Our hardware products include hardware that is sold separately for use with our Software Products and appliances that are embedded with our software (“Hardware Products”).

We also offer our solution across license types and increments. Our Software Products are sold with a perpetual license or a subscription license. Customers can purchase in license increments of 100 devices, with hardware sold separately based on customer deployment requirements. Customers can manage their own deployments of our products in varying options capable of scaling and managing deployments of up to 2,000,000 devices under a single console. Customers can purchase our SilentDefense products in license increments that are on a per sensor basis.

We generate revenue from sales of Software Products, Hardware Products, support and maintenance contracts, and professional services.

Third Quarter 2019 Financial Highlights

Since our inception through September 30, 2019, we have sold to nearly 3,600 end-customers in nearly 90 countries, including 24% of the Global 2000. For the three months ended September 30, 2019 and 2018, we sold to 9% and 7% of the Global 2000, respectively. Our end-customers represent a broad range of industries, including government, financial services, healthcare, manufacturing, technology, energy, services, retail, entertainment, and education.

20

The following table summarizes our key financial highlights for the periods presented in dollars and as a percentage of our total revenue.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
	(Dollars in thousands)
Total revenue	$	91,622		$	85,628		$	245,470		$	212,919
Total revenue year-over-year percentage growth	7		%	23		%	15		%	32		%
Gross margin	76		%	78		%	76		%	76		%
Loss from operations	$	(16,984	)	$	(8,609	)	$	(81,676	)	$	(56,317	)
Loss from operations as a percentage of total revenue	(19		)%	(10		)%	(33		)%	(26		)%
Net loss	$	(33,513	)	$	(8,286	)	$	(98,525	)	$	(56,888	)
Net cash (used in) provided by operating activities							$	(32,688	)	$	7,392

Continued Retention and Sales to Existing End-Customers

We believe the net-recurring revenue retention rate over the trailing 12 month period on our subscription revenue and on the annualized value of our subscription license revenue is an important metric to measure our ability to retain and increase sales to our existing end-customers. We calculate the net-recurring revenue retention rate using the following formula:

X = (A + B + C)/(B + D)

where:

X = net-recurring revenue retention rate

A = annualized value of term contracts renewed over the trailing 12 month period

B = trailing 12 month annualized value of term contracts not subject to renewal because the scheduled expiration date of the multi-year contract falls outside of the 12 month period under measurement

C = trailing 12 month annualized value of new term contracts from end-customers that have been end customers for more than one year

D = 12 months annualized value of term contracts scheduled to terminate or renew during the 12 month period under measurement

We believe this metric is an indication of the continuing value we provide to our end-customers because it shows the renewal rate of their support and maintenance contracts and Software Products subscription contracts. Our net-recurring revenue retention rate as of September 30, 2019 and December 31, 2018 were 119% and 117%, respectively. The 200 basis point increase primarily reflects the increased adoption of new Software Products subscription contracts from end-customers that have been end-customers for more than one year for the twelve months ended September 30, 2019. A net retention rate over 100% indicates that our products are expanding within our end-customer base, whereas a rate less than 100% indicates that our products are constricting within our end-customer base. Additionally, this calculation includes all changes to the annualized value of the recurring revenue from term contracts used in the calculation, which includes scheduled expiration periods, stub periods, changes in pricing, additional products purchased, lost end-customers, early renewals, and decreases in the number of devices licensed to be managed by our license under contract. This metric does not take into account perpetual license revenue or professional services revenue. The annualized value of our contracts is a legal and contractual determination made by assessing the contractual terms with our end-customers. The annualized value of our term contracts is not determined by reference to historical revenue, deferred revenue, or any other GAAP financial measure over any period.

21

Recurring Revenue Rate

We are focused on providing our customers with more licensing and delivery options from which to purchase our products. In the last 24 months, we introduced centralized licensing options as an alternative to our legacy options of licensing by individual units of physical and virtual appliances. We introduced Software Products subscription contracts in the first quarter of 2019 and began deriving revenue from these Software Products subscription contracts in the second quarter of 2019. In the future, we intend to offer our Software Products, in addition to our current on-premise offerings, in a form that also includes critical functionality being delivered from our cloud hosted facilities.

Included in our license revenue is the value allocated to license within our Software Products subscription contracts, which is recognized at the time of transfer of control, which is generally upon delivery of access to software downloads or shipment, provided that all other revenue recognition criteria have been met or upon commencement of a renewed term contract.

Included in our subscription revenue is the value allocated to support and maintenance within our Software Products subscription contracts and revenue derived from support and maintenance contracts. Subscription revenue is recognized ratably over the term of the contract.

We introduced the recurring revenue rate metric in the second quarter of 2019 since we believe it is an important metric in understanding the impact of customer buying preferences for the varying Software Products options upon our reported revenue. We calculate the recurring revenue rate as a subscription revenue plus the portion of license revenue that is derived from the value allocated to license within our Software Products subscription contracts, collectively, as a percent of total revenue, as measured over the trailing 12 month period. We calculate the recurring revenue rate using the following formula:

X = (A + B)/C

where:

X = recurring revenue rate

A = subscription revenue over the trailing 12 month period

B = value allocated to license revenue within our Software Products subscription contracts over the trailing 12 month period

C = total revenue

Our recurring revenue rate as of September 30, 2019 and December 31, 2018 were 46% and 40%, respectively. The 600 basis point increase primarily reflects the increased adoption of new subscription contracts in the nine months ended September 30, 2019. The numerator does not take into account perpetual license revenue or professional services revenue. The numerator does include the value allocated to license within our Software Products subscription contracts for all contract durations. Those contract durations that are greater than 12 months will raise the recurring revenue rate for the first 12 months of the contract duration and will lower the recurring revenue rate for the balance of the contract duration after the first 12 months relative to the annualized value of such Software Products subscription contracts.

Key Financial Metrics

Non-GAAP Operating (Loss) Income and Free Cash Flow

In addition to our results determined in accordance with GAAP, we monitor the non-GAAP financial metrics described below to evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and measure and assess operational efficiencies.

We define non-GAAP operating (loss) income as (loss) income from operations excluding stock-based compensation expense, acquisition-related expenses, and amortization of acquired intangible assets. Acquisition-related expenses include transaction costs such as accounting and legal fees, and other employee retention expenses arising

22

from the acquisition. We consider non-GAAP operating (loss) income to be a useful metric for investors and other users of our financial information in evaluating our operating performance because it excludes the impact of stock-based compensation, a non-cash charge that can vary from period to period for reasons that are unrelated to our core operating performance, and non-recurring and non-operating acquisition-related expenses. This metric also provides investors and other users of our financial information with an additional tool to compare business performance across companies and periods, while eliminating the effects of items that may vary for different companies for reasons unrelated to core operating performance.

We define free cash flow as net cash (used in) provided by operating activities less purchases of property and equipment. We consider free cash flow to be an important metric because it measures the amount of cash we use or generate and reflects changes in working capital.

A reconciliation of non-GAAP operating (loss) income to loss from operations, 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,
	2019			2018			2019			2018
	(In thousands)
Non-GAAP operating (loss) income:
Loss from operations	$	(16,984	)	$	(8,609	)	$	(81,676	)	$	(56,317	)
Add:
Stock-based compensation expense	13,822			13,018			41,715			39,544
Acquisition-related expenses	1,014			481			3,710			481
Amortization of acquired intangible assets	777			—			2,319			—
Non-GAAP operating (loss) income	$	(1,371	)	$	4,890		$	(33,932	)	$	(16,292	)

A reconciliation of free cash flow to net cash (used in) provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:

	Nine Months Ended September 30,
	2019			2018
	(In thousands)
Free cash flow (non-GAAP):
Net cash (used in) provided by operating activities	$	(32,688	)	$	7,392
Less: purchases of property and equipment	(5,611		)	(6,766		)
Free cash flow (non-GAAP)	$	(38,299	)	$	626
Net cash provided by investing activities	$	4,165		$	35,754
Net cash provided by financing activities	$	17,213		$	20,572

It is important to note that other companies, including companies in our industry, may not use non-GAAP operating (loss) income or free cash flow, may calculate these metrics differently, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of these non-GAAP metrics as comparative measures.

As a result, our non-GAAP operating (loss) income and free cash flow should be considered in addition to, not as substitutes for or in isolation from, measures prepared in accordance with GAAP.

We compensate for these limitations by providing investors and other users of our financial information, reconciliations of non-GAAP operating (loss) income to the corresponding GAAP financial measure, operating loss,

23

and reconciliations of free cash flow to the corresponding GAAP financial measure, cash flow (used in) provided by operating activities. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view non-GAAP operating (loss) income and free cash flow in conjunction with the corresponding GAAP financial measure.

Results of Operations

The following tables summarize our results of operations for the periods presented in dollars and as a percentage of our total revenue. The period-to-period comparison of results is not necessarily indicative of results for future periods.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
	(In thousands)
Condensed Consolidated Statements of Operations Data:
Revenue:
License	$	50,203		$	51,082		$	126,714		$	115,185
Subscription	36,570			30,339			105,191			85,684
Professional services	4,849			4,207			13,565			12,050
Total revenue	91,622			85,628			245,470			212,919
Cost of revenue:
License (1)	9,892			8,947			23,121			21,002
Subscription (1)	5,376			4,069			16,182			11,602
Professional services (1)	6,429			6,181			18,850			17,792
Total cost of revenue	21,697			19,197			58,153			50,396
Total gross profit	69,925			66,431			187,317			162,523
Operating expenses:
Research and development (1)	20,556			15,062			58,493			44,552
Sales and marketing (1)	51,035			46,098			163,131			133,416
General and administrative (1)	15,318			13,880			47,369			40,872
Total operating expenses	86,909			75,040			268,993			218,840
Loss from operations	(16,984		)	(8,609		)	(81,676		)	(56,317		)
Interest expense	(156		)	(208		)	(391		)	(676		)
Other income, net	374			865			1,496			2,040
Loss before income taxes	(16,766		)	(7,952		)	(80,571		)	(54,953		)
Income tax provision	16,747			334			17,954			1,935
Net loss	$	(33,513	)	$	(8,286	)	$	(98,525	)	$	(56,888	)

24

_____________________    

(1)    Includes stock-based compensation expense as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
	(In thousands)
Cost of revenue:
License	$	75	$	67	$	247	$	174
Subscription	454		349		1,367		1,099
Professional services	415		366		1,237		1,112
Research and development	3,040		2,613		8,809		7,473
Sales and marketing	6,330		6,165		20,014		18,195
General and administrative	3,508		3,458		10,041		11,491
Total	$	13,822	$	13,018	$	41,715	$	39,544

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
	(As a percentage of total revenue)
Condensed Consolidated Statements of Operations Data:
Revenue:
License	55	%	60	%	52	%	54	%
Subscription	40		35		42		40
Professional services	5		5		6		6
Total revenue	100		100		100		100
Cost of revenue:
License	11		10		9		10
Subscription	6		5		7		6
Professional services	7		7		8		8
Total cost of revenue	24		22		24		24
Total gross profit	76		78		76		76
Operating expenses:
Research and development	22		18		25		21
Sales and marketing	56		54		66		63
General and administrative	17		16		19		19
Total operating expenses	95		88		110		103
Loss from operations	(19	)	(10	)	(34	)	(27	)
Interest expense	—		—		—		—
Other income, net	—		1		1		1
Loss before income taxes	(19	)	(9	)	(33	)	(26	)
Income tax provision	18		1		7		1
Net loss	(37	)%	(10	)%	(40	)%	(27	)%

25

Comparison of the Three Months Ended September 30, 2019 and 2018

Revenue

Our revenue is comprised of license revenue, subscription revenue, and professional services revenue. License revenue is derived from sales of Software Products and Hardware Products, which includes the value allocated to license within our Software Products subscription contracts. Subscription revenue is derived from term contracts with terms that are generally either one or three years, but can be up to five years. Professional services revenue is generally recognized over time as the services are rendered. As a percentage of total revenue, we expect our license revenue, subscription revenue, and professional services revenue to vary from quarter to quarter based on seasonal and cyclical factors.

	Three Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount			%
	(Dollars in thousands)
Revenue:
License	$	50,203	$	51,082	$	(879	)	(2	)%
Subscription	36,570		30,339		6,231			21	%
Professional services	4,849		4,207		642			15	%
Total revenue	$	91,622	$	85,628	$	5,994		7	%

License revenue decreased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to a $6.5 million decrease in Hardware Products revenue, which was partially offset by a $5.6 million increase in Software Products revenue.

Subscription revenue increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to $3.6 million increase attributed to support and maintenance contracts associated with initial product sales and a $2.6 million increase attributed to support and maintenance contracts that were renewals.

Professional services revenue increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to an increase in the sale of optional installation and training services.

Cost of Revenue

Our cost of revenue is comprised of cost of license revenue, cost of subscription revenue, and cost of professional services revenue.

Cost of license revenue primarily consists of costs paid to our third-party contract manufacturer for our Hardware Products. Our cost of license revenue also includes allocated costs, shipping costs and personnel costs associated with logistics for our Hardware Products, and amortization of acquired developed technology. We expect our cost of license revenue to fluctuate from quarter to quarter based on product mix between Software Products and Hardware Products; however, over time, we expect our cost of license revenue to decline as a percentage of license revenue reflecting the continuing shift towards Software Products in our product mix.

Cost of subscription revenue consists of personnel costs for our global customer support organization and warranty-related hardware support costs. We expect our cost of subscription revenue to increase in absolute dollars slightly over time as we grow our customer support organization to accommodate our anticipated subscription revenue growth rate.

Cost of professional services revenue consists of personnel costs for our global professional services organization and costs paid to third-party contractors that deliver some of our services. We expect our cost of professional services

26

revenue to decline over time as a percentage of our professional services revenue as we expect to scale our professional services organization at a lower growth rate than our anticipated professional services revenue growth rate.

	Three Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount		%
	(Dollars in thousands)
Cost of revenue:
License	$	9,892	$	8,947	$	945	11	%
Subscription	5,376		4,069		1,307		32	%
Professional services	6,429		6,181		248		4	%
Total cost of revenue	$	21,697	$	19,197	$	2,500	13	%

Cost of license revenue increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to $0.5 million in amortization expense associated with acquired developed technology and a $1.4 million increase due to higher quantities of hardware sold separately for use with our Software Products, partially offset by a $1.2 million decrease due to lower quantities of appliances sold that are embedded with our software.

Cost of subscription revenue increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to increases in personnel costs related to a 39% increase in headcount in our customer support organization.

Cost of professional services revenue increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to increases in personnel costs related to a 10% increase in headcount in our professional services organization.

Gross Profit and 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 the mix of products sold between Software Products and Hardware Products; the mix between high-margin and low-margin Hardware Products; the mix of revenue between license, subscription, and professional services; the average sales price of our Software Products, Hardware Products, support and maintenance contracts, and professional services; amortization of acquired developed technology; and manufacturing costs.

Margin on our Software Products was approximately 98% and 99% for the three months ended September 30, 2019 and 2018, respectively. Margin on our Hardware Products varies. The average margin on hardware sold separately for use with our Software Products was approximately 13% and 25% for the three months ended September 30, 2019 and 2018, respectively. Margin on appliances, which are the hardware appliances that are embedded with our software, varies. The average margin on our high-end appliances was approximately 74% and 80%, and the average margin on our low-end appliances was approximately 40% and 57%, for the three months ended September 30, 2019 and 2018, respectively.

We expect our margins to fluctuate from quarter to quarter based on product mix; however, over time, we expect our margins to increase as a percentage of license revenue primarily due to a shift in product mix towards increased sales of Software Products.

27

	Three Months Ended September 30,
	2019					2018					Change
	Gross Profit (Loss)			Gross Margin		Gross Profit (Loss)			Gross Margin		Gross Profit (Loss)			Gross Margin %
	(Dollars in thousands)
Gross profit:
License	$	40,311		80	%	$	42,135		82	%	$	(1,824	)	(2	)%
Subscription	31,194			85	%	26,270			87	%	4,924			(2	)%
Professional services	(1,580		)	(33	)%	(1,974		)	(47	)%	394			14	%
Total gross profit	$	69,925		76	%	$	66,431		78	%	$	3,494		(2	)%

Gross profit increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018. The increase is consistent with the changes in our revenue and cost of revenue.

Gross margin decreased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018.

The decrease in margin on our license revenue was primarily driven by a shift in product mix within Hardware Products revenue due to a lower concentration of high-end appliances revenue for the three months ended September 30, 2019 compared to the three months ended September 30, 2018. This decrease was partially offset by a higher concentration of revenue generated from Software Products. The mix between Software Products revenue and Hardware Products revenue shifted to 68:32 for the three months ended September 30, 2019, from 56:44 for the three months ended September 30, 2018. Within Hardware Products revenue, the mix among hardware sold separately for use with our Software Products, low-end appliances that are embedded with our software, and high-end appliances that are embedded with our software shifted to 37:21:43 for the three months ended September 30, 2019, from 22:28:50 for the three months ended September 30, 2018.

The decrease in margin on our subscription revenue was due to higher personnel costs related to increased headcount in our support organization, as compared to our subscription revenue growth.

The increase in margin on our professional services revenue was primarily driven by improvements made within professional services as we scale our professional services organizations at a lower growth rate than our anticipated professional services revenue growth rate.

Operating Expenses

Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. 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.

Research and development expense consists primarily of personnel costs. Research and development expense also includes consulting expense and allocated costs including facilities and information technology related costs. Sales and marketing expense consists primarily of personnel costs. Sales and marketing expense also includes sales commissions, costs for market development programs, promotional and other marketing costs, travel costs, professional services, amortization of acquired customer relationships, and allocated costs including facilities and information technology related costs. Incremental commissions incurred to acquire customer contracts are deferred and recognized as we recognize the associated revenue or over the estimated customer life. General and administrative expense consists of personnel costs, professional services, and allocated costs including facilities and information technology related costs. General and administrative personnel include our executive, finance, human resources, and legal organizations. Professional services consist primarily of legal, auditing, accounting, and other consulting costs. We expect operating expenses to increase in absolute dollars as we continue to invest in our future products and services; however, we expect our operating expenses to decline as a percentage of total revenue in the long term as we scale the business.

28

	Three Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount		%
	(Dollars in thousands)
Operating expenses:
Research and development	$	20,556	$	15,062	$	5,494	36	%
Sales and marketing	51,035		46,098		4,937		11	%
General and administrative	15,318		13,880		1,438		10	%
Total operating expenses	$	86,909	$	75,040	$	11,869	16	%

Research and development expense increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to an increase in personnel costs of $3.5 million resulting from a 37% increase in headcount.

Sales and marketing expense increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to an increase in personnel costs of $5.3 million resulting from a 12% increase in headcount.

General and administrative expense increased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to an increase in personnel costs of $2.4 million resulting from a 7% increase in headcount.

Interest Expense

Interest expense consists of interest on our outstanding indebtedness.

	Three Months Ended September 30,
	2019			2018			Change
	Amount			Amount			Amount		%
	(Dollars in thousands)
Interest expense	$	(156	)	$	(208	)	$	52	(25	)%

Interest expense decreased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, primarily due to the decreasing notes payable balance associated with our amended and restated loan and security agreement entered into on December 22, 2016.

Other Income, Net

Other income, net consists primarily of interest income earned on our cash, cash equivalents, and marketable securities, sublease income, and foreign currency exchange gains (losses) related to transactions denominated in currencies other than the U.S. Dollar.

	Three Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount			%
	(Dollars in thousands)
Other income, net	$	374	$	865	$	(491	)	(57	)%

29

Other income, net decreased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018 primarily driven by a decrease in short-term investments.

Provision for Income Taxes

Provision for income taxes consists primarily of foreign income taxes, unrecognized tax benefits, withholding taxes, and U.S. state income taxes. We maintain a full valuation allowance for domestic net deferred tax assets. Our foreign deferred tax assets are immaterial. 

	Three Months Ended September 30,
	2019			2018			Change
	Amount			Amount			Amount		%
	(Dollars in thousands)
Income tax provision	$	16,747		$	334		$	16,413	4,914	%
Effective tax rate	(99.9		)%	(4.2		)%

We recorded an income tax provision for the three months ended September 30, 2019 due to foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The increase in income tax provision for the three months ended September 30, 2019 was primarily due to an increase in income tax expense from completion of an intra-group transfer of certain intellectual property rights (the “IP”) from the Netherlands to the United States. We recognized a discrete tax expense of $17.1 million associated with this IP transfer. The discrete tax expense consists of a current tax expense of $20.8M for the accrual of an uncertain tax position and a deferred tax benefit of $3.7M related to the reversal of the acquired intangible asset deferred tax liability. Accordingly, the effective tax rate decreased for the three months ended September 30, 2019 compared to the three months ended September 30, 2018.

Comparison of the Nine Months Ended September 30, 2019 and 2018

Revenue

	Nine Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount		%
	(Dollars in thousands)
Revenue:
License	$	126,714	$	115,185	$	11,529	10	%
Subscription	105,191		85,684		19,507		23	%
Professional services	13,565		12,050		1,515		13	%
Total revenue	$	245,470	$	212,919	$	32,551	15	%

License revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to a $23.3 million increase in Software Products revenue, which was partially offset by a $11.7 million decrease in Hardware Products revenue. The increase in Software Products revenue included a $21.3 million increase in the sale of eyeSight and eyeControl (functionalities generally purchased together).

Subscription revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to a $11.9 million increase attributed to support and maintenance contracts associated with initial product sales and a $7.6 million increase attributed to support and maintenance contracts that were renewals.

Professional services revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to an increase in the sale of optional installation and training services.

30

Cost of Revenue

	Nine Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount		%
	(Dollars in thousands)
Cost of revenue:
License	$	23,121	$	21,002	$	2,119	10	%
Subscription	16,182		11,602		4,580		39	%
Professional services	18,850		17,792		1,058		6	%
Total cost of revenue	$	58,153	$	50,396	$	7,757	15	%

Cost of license revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to $1.4 million in amortization expense associated with acquired developed technology and a $3.7 million increase due to higher quantities of hardware sold separately for use with our Software Products, partially offset by a $3.6 million decrease due to lower quantities of appliances sold that are embedded with our software.

Cost of subscription revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to increases in personnel costs related to a 39% increase in headcount in our customer support organization.

Cost of professional services revenue increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to increases in personnel costs related to a 10% increase in headcount in our professional services organization.

Gross Profit and Gross Margin

Margin on our Software Products was approximately 98% and 99% for the nine months ended September 30, 2019 and 2018, respectively. Margin on our Hardware Products varies. The average margin on hardware sold separately for use with our Software Products was approximately 21% and 25% for the nine months ended September 30, 2019 and 2018, respectively. Margin on appliances, which are the hardware appliances that are embedded with our software, varies. The average margin on our high-end appliances was approximately 76% and 80%, and the average margin on our low-end appliances was approximately 38% and 54%, for the nine months ended September 30, 2019 and 2018, respectively.

We expect our margins to fluctuate from quarter to quarter based on product mix; however, over time, we expect our margins to increase as a percentage of license revenue primarily due to a shift in product mix towards increased sales of Software Products.

31

	Nine Months Ended September 30,
	2019					2018					Change
	Gross Profit (Loss)			Gross Margin		Gross Profit (Loss)			Gross Margin		Gross Profit (Loss)		Gross Margin %
	(Dollars in thousands)
Gross profit:
License	$	103,593		82	%	$	94,183		82	%	$	9,410	—	%
Subscription	89,009			85	%	74,082			86	%	14,927		(1	)%
Professional services	(5,285		)	(39	)%	(5,742		)	(48	)%	457		9	%
Total gross profit	$	187,317		76	%	$	162,523		76	%	$	24,794	—	%

Gross profit increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. The increase is consistent with the changes in our revenue and cost of revenue.

Gross margin remained flat for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018.

The margin on our license revenue remained relatively flat for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. The mix between Software Products revenue and Hardware Products revenue shifted to 73:27 for the nine months ended September 30, 2019, from 60:40 for the nine months ended September 30, 2018. Within Hardware Products revenue, the mix among hardware sold separately for use with our Software Products, low-end appliances that are embedded with our software, and high-end appliances that are embedded with our software shifted to 52:20:28 for the nine months ended September 30, 2019, from 30:31:39 for the nine months ended September 30, 2018.

The decrease in margin on our subscription revenue was due to higher personnel costs related to increased headcount in our support organization, as compared to our subscription revenue growth.

The increase in margin on our professional services revenue was primarily driven by improvements made within professional services as we scale our professional services organizations at a lower growth rate than our anticipated professional services revenue growth rate.

Operating Expenses

	Nine Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount		%
	(Dollars in thousands)
Operating expenses:
Research and development	$	58,493	$	44,552	$	13,941	31	%
Sales and marketing	163,131		133,416		29,715		22	%
General and administrative	47,369		40,872		6,497		16	%
Total operating expenses	$	268,993	$	218,840	$	50,153	23	%

Research and development expense increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to an increase in personnel costs of $9.2 million resulting from a 37% increase in headcount, which includes an increase in stock-based compensation expense of $1.2 million. The increase was further driven by an increase in allocated IT and facilities cost of $1.9 million.

32

Sales and marketing expense increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to an increase in personnel costs of $26.0 million resulting from a 12% increase in headcount, which includes an increase in commissions expense of $5.3 million and an increase in stock-based compensation expense of $1.9 million. The increase was further driven by an increase in travel and entertainment cost of $3.0 million.

General and administrative expense increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to an increase in personnel costs of $6.3 million resulting from a 7% increase in headcount.

Interest Expense

	Nine Months Ended September 30,
	2019			2018			Change
	Amount			Amount			Amount		%
	(Dollars in thousands)
Interest expense	$	(391	)	$	(676	)	$	285	(42	)%

Interest expense decreased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily due to the decreasing notes payable balance associated with our amended and restated loan and security agreement entered into on December 22, 2016.

Other Income, Net

	Nine Months Ended September 30,
	2019		2018		Change
	Amount		Amount		Amount			%
	(Dollars in thousands)
Other income, net	$	1,496	$	2,040	$	(544	)	(27	)%

Other income, net decreased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 primarily driven by a decrease in short-term investments.

Provision for Income Taxes

	Nine Months Ended September 30,
	2019			2018			Change
	Amount			Amount			Amount		%
	(Dollars in thousands)
Income tax provision	$	17,954		$	1,935		$	16,019	828	%
Effective tax rate	(22.3		)%	(3.5		)%

We recorded an income tax provision for the nine months ended September 30, 2019 due to foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The increase in the provision for the nine months ended September 30, 2019 was primarily due to an increase in income tax expense from completion of an intra-group transfer of certain IP rights from the Netherlands to the United States. We recognized a discrete tax expense of $17.1 million associated with this IP transfer. The discrete tax expense consists of a current tax expense of $20.8M for the accrual of an uncertain tax position and a deferred tax benefit of $3.7M related to the reversal of the acquired intangible asset

33

deferred tax liability. Accordingly, the effective tax rate decreased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018.

Liquidity and Capital Resources

The following data should be read in conjunction with our condensed consolidated statements of cash flows.

	As of
	September 30, 2019		December 31, 2018
	(In thousands)
Working capital	$	31,950	$	52,623
Cash, cash equivalents, and marketable securities:
Cash and cash equivalents	$	55,436	$	66,895
Marketable securities	38,235		47,632
Total cash, cash equivalents, and marketable securities	93,671		114,527
Total notes payable	10,089		15,579
Net cash, cash equivalents, and marketable securities	$	83,582	$	98,948

Our liquidity and capital resources are derived from cash received from our initial public offering and follow-on offering, and cash flows from operations. Our cash equivalents are comprised of cash and money market accounts. Our marketable securities are comprised of commercial paper, corporate-debt securities, and U.S. government securities. We believe our existing cash, cash equivalents, and marketable securities will be sufficient to meet our projected operating requirements for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, and the continuing market acceptance of our products.

At September 30, 2019, our cash, cash equivalents, and marketable securities of $93.7 million were held for general corporate purposes, of which approximately $23.7 million was held outside of the United States. We will continue to reinvest our foreign cash outside of the United States. If we were to repatriate these earnings to the United States, any associated withholding tax would not be material.

The significant components of our working capital are cash and cash equivalents, marketable securities, accounts receivable, current deferred commissions, and prepaid expenses and other current assets, reduced by accounts payable, accrued compensation, accrued expenses, current deferred revenue, current notes payable, and current operating lease liabilities. Working capital decreased by $20.7 million during the nine months ended September 30, 2019, primarily due to a decrease in cash and cash equivalents, a decrease in marketable securities, an increase in current operating lease liabilities, and an increase in current deferred revenue, partially offset by an increase in accounts receivable, a decrease in accrued compensation, and a decrease in accounts payable. The following table summarizes our cash flows for the nine months ended September 30, 2019 and 2018.

	Nine Months Ended September 30,
	2019			2018
	(In thousands)
Net cash (used in) provided by operating activities	$	(32,688	)	$	7,392
Net cash provided by investing activities	4,165			35,754
Net cash provided by financing activities	17,213			20,572
Effect of exchange rate changes on cash and cash equivalents	(4		)	—
Net change in cash, cash equivalents, and restricted cash for period	$	(11,314	)	$	63,718

34

Operating Activities

Our operating activities have consisted of net loss adjusted for certain non-cash items and changes in assets and liabilities.

Cash (used in) provided by operating activities was $(32.7) million and $7.4 million for the nine months ended September 30, 2019 and 2018, respectively, representing a decrease of $40.1 million as compared to the nine months ended September 30, 2018. The decrease in generation of cash during the nine months ended September 30, 2019 was due primarily to lower billings and higher operating expenses as we continue to invest in the long-term growth of our business, partially offset by proceeds from collections.

Investing Activities

Our investing activities have consisted of financial instrument purchases and capital expenditures. We expect to continue such activities as our business grows.

Cash provided by investing activities during the nine months ended September 30, 2019 was $4.2 million, primarily resulting from proceeds from maturities of marketable securities of $73.3 million, partially offset by purchases of marketable securities of $63.6 million, and capital expenditures to purchase property and equipment of $5.6 million related to the continuing growth of our business.

Cash provided by investing activities during the nine months ended September 30, 2018 was $35.8 million, primarily resulting from proceeds from maturities of marketable securities of $97.1 million, partially offset by purchases of marketable securities of $54.5 million and capital expenditures to purchase property and equipment of $6.8 million related to the continuing growth of our business.

Financing Activities

Our financing activities have consisted of proceeds from the issuance of common stock, issuance of shares through our employee equity incentive plans, and repayments of notes payable.

Cash provided by financing activities for the nine months ended September 30, 2019 was $17.2 million, primarily from the proceeds from the sales of shares through our employee equity incentive plans of $27.4 million, partially offset by the repayment of notes payable of $5.6 million and payments related to shares withheld for taxes on the vesting of restricted stock units of $4.5 million.

Cash provided by financing activities for the nine months ended September 30, 2018 was $20.6 million, primarily from the sale of shares through our employee equity incentive plans of $24.6 million and proceeds from our follow-on offering of $13.8 million, partially offset by payments related to shares withheld for taxes on the vesting of restricted stock units of $10.7 million, the repayment of notes payable of $5.6 million, and payments of deferred offering costs related to the follow-on offering of $1.5 million.

Contractual Obligations and Commitments

There were no material changes outside the ordinary course of business during the nine months ended September 30, 2019 in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.

Off-Balance Sheet Arrangements

Through September 30, 2019, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

35

Critical Accounting Policies and Estimates

See Part II, Item 7, “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2018. Other than discussed below, there were no changes to our Critical Accounting Policies and Estimates for the nine month period ended September 30, 2019.

Income Taxes

We estimate our income taxes in each of the jurisdictions in which we operate. Further, we recognize liabilities for uncertain tax positions based on determining whether the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. We consider many factors when evaluating and estimating our tax positions, which may require periodic adjustments and may not accurately forecast actual outcomes. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision. The material uncertain tax position that was recorded since our last Annual Report on Form 10-K for the year ended December 31, 2018, filed March 1, 2019, related to the intra-group transfer of IP from the Netherlands to the United States.

Recent Accounting Pronouncements

See Note 1. Description of Business and Summary of Significant Accounting Policies of our Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our assessment of our exposures to market risk have not changed materially since the presentation set forth in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on our evaluation, our principal executive officer and principal financial officer concluded that, as of September 30, 2019, our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission (“SEC”) rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended September 30,

36

2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

37

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. Such matters are subject to many uncertainties and outcomes 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.

ITEM 1A. RISK FACTORS

Refer to the description of the risk factors associated with our business in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. There have been no material changes from the risk factors described under Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Before you buy our common stock, you should know that making such an investment involves some risks and uncertainties, including, but not limited to, the risks described in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Additionally, any one of those risks could harm our business, financial condition and results of operations, which could cause our stock price to decline. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 6. EXHIBITS

The documents listed in the Exhibit Index of this Quarterly Report on Form 10-Q are herein incorporated by reference or are filed with this Quarterly Report on Form 10-Q, in each case as indicated therein (numbered in accordance with Item 601 of Regulation S-K).

38

EXHIBIT INDEX

Exhibit Number	Description
31.1	Certification of the Principal Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Principal Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1†	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
32.2†	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH	Inline XBRL Taxonomy Schema Linkbase Document.
101.CAL	Inline XBRL Taxonomy Calculation Linkbase Document.
101.DEF	Inline XBRL Taxonomy Definition Linkbase Document.
101.LAB	Inline XBRL Taxonomy Labels Linkbase Document.
101.PRE	Inline XBRL Taxonomy Presentation Linkbase Document.
104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

† This certification is deemed not filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Forescout Technologies, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10‑Q, irrespective of any general incorporation language contained in such filing.

39

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	FORESCOUT TECHNOLOGIES, INC.
Dated: November 6, 2019	By: /s/ Darren J. Milliken
	Darren J. Milliken
	Senior Vice President, General Counsel, Corporate Secretary and Corporate Compliance Officer

Dated: November 6, 2019	By: /s/ Christopher Harms
	Christopher Harms
	Chief Financial Officer
	Principal Financial Officer

40