Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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(Mark One)




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

For the quarterly period ended June 30, 2019




☐	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

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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 August 1, 2019 was 46,210,958.

TABLE OF CONTENTS






		Page
	PART I - FINANCIAL INFORMATION	5
Item 1.	Financial Statements	5
	Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018	5
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2019 and 2018	6
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2019 and 2018	7
	Condensed Consolidated Statements of Stockholders’ Equity for the Three and Six Months Ended June 30, 2019 and 2018	8
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 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	19
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

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 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;


•	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.

PART I. FINANCIAL INFORMATION



ITEM 1.	FINANCIAL STATEMENTS

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except par value)



	June 30, 2019			December 31, 2018
Assets
Current assets:
Cash and cash equivalents	$	46,872		$	66,895
Marketable securities	58,065			47,632
Accounts receivable	66,903			79,255
Inventory	2,093			1,501
Deferred commissions - current	11,716			12,543
Prepaid expenses and other current assets	13,180			13,353
Total current assets	198,829			221,179
Deferred commissions - non-current	21,848			22,831
Property and equipment, net	23,701			24,349
Operating lease right-of-use assets	22,271			—
Restricted cash - non-current	1,293			1,266
Intangible assets, net	17,369			19,002
Goodwill	92,045			92,482
Other assets	6,889			7,369
Total assets	$	384,245		$	388,478

Liabilities and stockholders' equity
Current liabilities:
Accounts payable	$	9,563		$	12,118
Accrued compensation	31,739			32,649
Accrued expenses	14,087			14,558
Deferred revenue - current	103,365			101,900
Notes payable - current	7,375			7,331
Operating lease liabilities - current	5,240			—
Total current liabilities	171,369			168,556
Deferred revenue - non-current	69,779			69,618
Notes payable - non-current	4,550			8,248
Operating lease liabilities - non-current	24,376			—
Other liabilities	7,056			14,335
Total liabilities	277,130			260,757

Stockholders' equity:
Common stock, $0.001 par value; 1,000,000 shares authorized;
45,903 and 43,403 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively	46			43
Additional paid-in capital	683,957			639,237
Accumulated other comprehensive loss	(619		)	(302		)
Accumulated deficit	(576,269		)	(511,257		)
Total stockholders’ equity	107,115			127,721
Total liabilities and stockholders' equity	$	384,245		$	388,478

See Notes to Condensed Consolidated Financial Statements.

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Revenue:
License	$	38,831		$	34,323		$	76,511		$	64,103
Subscription	34,822			28,986			68,621			55,345
Professional services	4,627			4,285			8,716			7,843
Total revenue	78,280			67,594			153,848			127,291
Cost of revenue:
License	5,622			4,919			13,229			12,055
Subscription	5,599			3,732			10,806			7,533
Professional services	6,235			6,062			12,421			11,611
Total cost of revenue	17,456			14,713			36,456			31,199
Total gross profit	60,824			52,881			117,392			96,092
Operating expenses:
Research and development	19,440			14,803			37,937			29,490
Sales and marketing	56,173			45,039			112,096			87,318
General and administrative	15,838			13,260			32,051			26,992
Total operating expenses	91,451			73,102			182,084			143,800
Loss from operations	(30,627		)	(20,221		)	(64,692		)	(47,708		)
Interest expense	(142		)	(225		)	(235		)	(468		)
Other income, net	505			513			1,122			1,175
Loss before income taxes	(30,264		)	(19,933		)	(63,805		)	(47,001		)
Income tax provision	496			473			1,207			1,601
Net loss	$	(30,760	)	$	(20,406	)	$	(65,012	)	$	(48,602	)
Net loss per share, basic and diluted	$	(0.68	)	$	(0.50	)	$	(1.45	)	$	(1.23	)
Weighted-average shares used to compute net loss per share, basic and diluted	45,494			40,457			44,848			39,394

See Notes to Condensed Consolidated Financial Statements.

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited, in thousands)



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Net loss	$	(30,760	)	$	(20,406	)	$	(65,012	)	$	(48,602	)
Other comprehensive income (loss), net of tax:
Change in unrealized gains (losses) on marketable securities	60			76			135			(170		)
Foreign currency translation adjustments	1,602			—			(452		)	—
Comprehensive loss	$	(29,098	)	$	(20,330	)	$	(65,329	)	$	(48,772	)

See Notes to Condensed Consolidated Financial Statements.

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited, in thousands)



	Six Months Ended June 30, 2019
	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
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



	Six Months Ended June 30, 2018
	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
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

See Notes to Condensed Consolidated Financial Statements.

FORESCOUT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



	Six Months Ended June 30,
	2019			2018
Cash flows from operating activities:
Net loss	$	(65,012	)	$	(48,602	)
Adjustments to reconcile net loss to net cash provided by operating activities
Stock-based compensation	27,893			26,526
Depreciation and amortization	5,790			3,529
Other	(8		)	28
Changes in operating assets and liabilities
Accounts receivable	12,177			30,442
Inventory	(593		)	1,887
Deferred commissions	1,809			506
Prepaid expenses and other current assets	318			(2,208		)
Other assets	551			(41		)
Accounts payable	(2,509		)	(6,006		)
Accrued compensation	(905		)	143
Accrued expenses	407			(685		)
Deferred revenue	1,495			12,281
Other liabilities	(160		)	1,236
Net cash (used in) provided by operating activities	(18,747		)	19,036
Cash flows from investing activities:
Purchases of property and equipment	(3,402		)	(4,832		)
Purchases of marketable securities	(63,569		)	(46,121		)
Proceeds from maturities of marketable securities	53,354			49,400
Net cash used in investing activities	(13,617		)	(1,553		)
Cash flows from financing activities:
Repayments of notes payable	(3,749		)	(3,750		)
Proceeds from sales of shares through employee equity incentive plans	20,726			17,823
Payment related to shares withheld for taxes on vesting of restricted stock units	(4,302		)	(9,592		)
Proceeds from public offerings, net	—			13,818
Payments of deferred offering costs	—			(1,542		)
Net cash provided by financing activities	12,675			16,757
Effect of exchange rate changes on cash and cash equivalents	(4		)	—
Net change in cash, cash equivalents, and restricted cash for period	(19,693		)	34,240
Cash, cash equivalents, and restricted cash at beginning of period	69,012			67,357
Cash, cash equivalents, and restricted cash at end of period	$	49,319		$	101,597



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	$	46,872	$	99,560
Restricted cash included in prepaid expenses and other current assets	1,154		351
Restricted cash - non-current	1,293		1,686
Total cash, cash equivalents, and restricted cash	$	49,319	$	101,597

See Notes to Condensed Consolidated Financial Statements.

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 two 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 two 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 are unaudited and 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.

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.

Summary of Significant Accounting Policies

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”), as discussed in detail in Note 5. 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.

Except for the impact of the adoption of Topic 842, 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.

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 June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Revenue:
License
Software Products
Perpetual license	$	20,675	$	24,493	$	46,434	$	40,295
Term license	11,190		—		11,514		—
Hardware Products	6,966		9,830		18,563		23,808
Subscription	34,822		28,986		68,621		55,345
Professional services	4,627		4,285		8,716		7,843
Total revenue	$	78,280	$	67,594	$	153,848	$	127,291

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 no 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):



	Three Months Ended June 30, 2019
	Contract Liabilities
Balance as of March 31, 2019	$	178,785
Additions	73,328
Gross revenue recognized	(78,280		)
Balance as of June 30, 2019	$	173,833



	Six Months Ended June 30, 2019
	Contract Liabilities
Balance as of December 31, 2018	$	172,031
Additions	155,650
Gross revenue recognized	(153,848		)
Balance as of June 30, 2019	$	173,833

During the three months ended June 30, 2019, the Company recognized revenue of $33.9 million that was included in the contract liabilities balance as of March 31, 2019. During the six months ended June 30, 2019, the Company recognized revenue of $59.4 million that was included in the contract liabilities balance as of December 31, 2018.

During the three months ended June 30, 2018, the Company recognized revenue of $43.3 million that was included in the contract liabilities balance as of March 31, 2018. During the six months ended June 30, 2019, the Company recognized revenue of $47.9 million that was included in the contract liabilities balance as of December 31, 2017.

Performance Obligations

Contracted not recognized revenue was $174.0 million as of June 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.

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 (in thousands):



	June 30, 2019						December 31, 2018
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Financial Assets
Cash and cash equivalents:
Cash	$	36,459	$	—	$	—	$	46,017	$	—	$	—
Money market accounts	10,413		—		—		20,878		—		—
Total cash and cash equivalents	46,872		—		—		66,895		—		—
Marketable securities:
Commercial paper	—		15,894		—		—		3,991		—
Corporate debt securities	—		30,182		—		—		35,640		—
U.S. government securities	—		11,989		—		—		8,001		—
Total marketable securities	—		58,065		—		—		47,632		—
Restricted cash (current and non-current)	2,447		—		—		2,117		—		—
Total financial assets	$	49,319	$	58,065	$	—	$	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 June 30, 2019 and December 31, 2018 (in thousands):



	June 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	$	15,894	$	—	$	—	$	15,894	$	3,991	$	—	$	—		$	3,991
Corporate debt securities	30,118		64		—		30,182		35,730		—		(90		)	35,640
U.S. government securities	11,974		15		—		11,989		8,012		—		(11		)	8,001
Total marketable securities	$	57,986	$	79	$	—	$	58,065	$	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 June 30, 2019 and December 31, 2018 by the contractual maturity date (in thousands):



	June 30, 2019				December 31, 2018
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due within one year	$	55,963	$	56,041	$	47,733	$	47,632
Due between one and five years	2,023		2,024		—		—
Total	$	57,986	$	58,065	$	47,733	$	47,632

The Company had no marketable securities in an unrealized loss position as of June 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):



	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 no other-than-temporary impairments for these marketable securities as of June 30, 2019 or December 31, 2018.

Note 5. Leases

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 the practical expedients 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 our 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.



Lease Cost (in thousands)	Three Months Ended June 30, 2019		Six Months Ended June 30, 2019
Operating lease cost ⁽¹⁾	$	2,030	$	4,473

_____________________

(1) Includes short-term leases and variable lease costs, which are immaterial.

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



Years Ending December 31,	Operating Leases^(a)
2019 (excluding the six months ended June 30, 2019)	$	3,759
2020	6,701
2021	5,349
2022	4,576
2023	4,540
Thereafter	11,933
Total lease payments	$	36,858
Less: Imputed interest	7,242
Present value of lease liabilities	$	29,616

_____________________

(a) Operating lease payments exclude $4.7 million of legally binding minimum lease payments for leases signed but not yet commenced.



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



Other information (in thousands)	Three Months Ended June 30, 2019		Six Months Ended June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	1,961	$	3,779
Leased assets obtained in exchange for new operating lease liabilities	$	2,785	$	4,402

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 June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Cost of revenue:
License	$	89	$	54	$	172	$	107
Subscription	470		371		913		750
Professional services	421		352		822		746
Research and development	2,691		2,513		5,769		4,860
Sales and marketing	7,198		5,850		13,684		12,030
General and administrative	3,196		3,796		6,533		8,033
Total	$	14,065	$	12,936	$	27,893	$	26,526

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	(1,586	)	$	10.20
Options forfeited	(145	)	$	18.31
Balance—June 30, 2019	4,282		$	11.96	5.9	$	93,774
Options vested and exercisable—June 30, 2019	3,633		$	10.85	5.6	$	83,580

As of June 30, 2019, the total unrecognized compensation cost related to unvested options was $5.5 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. No stock option awards were granted during the three and six months ended June 30, 2019 and three months ended June 30, 2018. The assumptions used to determine the grant date fair value of employee stock options for the periods presented are as follows:



	Six Months Ended June 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	1,151		$	35.51
Vested	(763	)	$	26.25
Forfeited	(378	)	$	28.67
Balance—June 30, 2019	5,719		$	29.71	1.7	$	193,647

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

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 June 30, 2019, the total unrecognized compensation cost related to unvested RSUs and PSUs was $131.5 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 six months ended June 30, 2019, the Company recorded a tax provision of $0.5 million and $1.2 million, respectively, representing an effective tax rate of (1.6)% and (1.9)%, respectively. For the three and six months ended June 30, 2018, the Company recorded a tax provision of $0.5 million and $1.6 million, respectively, representing an effective tax rate of (2.4)% and (3.4)%, 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 increased for the three and six months ended June 30, 2019 as compared to the three and six months ended June 30, 2018 primarily due to an increase in worldwide loss before income taxes. The loss was primarily generated in the United States and does not impact the provision for income taxes as it was offset by a full valuation allowance.

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 June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Net loss	$	(30,760	)	$	(20,406	)	$	(65,012	)	$	(48,602	)
Weighted-average shares used to compute net loss per share, basic and diluted	45,494			40,457			44,848			39,394
Net loss per share, basic and diluted	$	(0.68	)	$	(0.50	)	$	(1.45	)	$	(1.23	)

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 June 30,
	2019	2018
Options to purchase common stock	4,282	7,355
Unvested early exercised common shares	—	96
Unvested restricted stock units	5,719	4,100
Shares estimated under Employee Stock Purchase Plan	172	126

Note 9. Related Party Transactions

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 six months ended June 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 $2.1 million will be recorded over the remaining two years.

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.

We offer our solution across two product types: (i) software products and (ii) hardware products. Our software products include eyeSight, eyeControl, eyeExtend, 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.

Second Quarter 2019 Financial Highlights

Since our inception through June 30, 2019, we have sold to nearly 3,500 end-customers in over 80 countries, including 24% of the Global 2000. For the three months ended June 30, 2019 and 2018, we sold to 8% and 6% of the Global 2000, respectively. Our end-customers represent a broad range of industries, including government, financial services, technology, healthcare, manufacturing, services, energy, retail, entertainment, and education.

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 June 30,						Six Months Ended June 30,
	2019			2018			2019			2018

	(Dollars in thousands)
License revenue	$	38,831		$	34,323		$	76,511		$	64,103
License revenue year-over-year percentage growth	13		%	28		%	19		%	36		%
Subscription revenue	$	34,822		$	28,986		68,621			55,345
Subscription revenue year-over-year percentage growth	20		%	45		%	24		%	42		%
Professional services revenue	$	4,627		$	4,285		8,716			7,843
Professional services revenue year-over-year percentage growth	8		%	37		%	11		%	28		%
Total revenue	$	78,280		$	67,594		153,848			127,291
Total revenue year-over-year percentage growth	16		%	35		%	21		%	38		%
Gross profit	$	60,824		$	52,881		117,392			96,092
Gross margin	78		%	78		%	76		%	75		%
Loss from operations	$	(30,627	)	$	(20,221	)	(64,692		)	(47,708		)
Loss from operations as a percentage of total revenue	(39		)%	(30		)%	(42		)%	(37		)%
Net loss	$	(30,760	)	$	(20,406	)	(65,012		)	(48,602		)
Net cash (used in) provided by operating activities							(18,747		)	19,036

Factors Affecting Our Performance

We believe that the growth of our business and our future success are dependent upon many factors, including our ability to continue to increase the efficiency by which our sales force engages our end-customers, to extend the reach of our sales force footprint to engage more end-customers, to retain and increase sales to existing end-customers, and to provide our customers with more licensing and delivery options from which to purchase our products. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address in order to sustain the growth of our business and improve our results of operations.

Increasing the Efficiency by which Our Sales Force Engages Our End-Customers

We are focused on increasing the efficiency of our sales force. Over the last 12 months, we have increased hiring in sales enablement and marketing, enhanced sales training activities, and implemented company-wide standards for product positioning in order to instill a culture of success and discipline in our sales organization. Our sales strategy depends on attracting top talent from security organizations, expanding our sales coverage, increasing our pipeline of business, and enhancing productivity. We focus on productivity per quota-carrying sales representative across different levels within the sales organization, and the time it takes our sales representatives to reach productivity. We manage our pipeline on a quarterly basis by sales representative to ensure sufficient coverage of our bookings targets. Our ability to manage our sales productivity and pipeline are important factors to the success of our business.

Extending the Reach of Our Sales Force Footprint

We have made substantial investments in our sales force in recent periods in order to address the significant opportunity created primarily by the increase in the attack surface within organizations driven by the influx of the Internet of Things in the campus and data centers, the digital transformation from data centers to third party hosted cloud providers, and the emergence of the critical need to secure OT networks. We expect to continue to make substantial investments in our sales force to capitalize on the market opportunity for device visibility and control.

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 of their support and maintenance contracts and Software Products subscription contracts. Our net-recurring revenue retention rate as of June 30, 2019 and December 31, 2018 were 121% and 117%, respectively. The 400 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 June 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.

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 June 30, 2019 and December 31, 2018 were 44% and 40%, respectively. The 400 basis point increase primarily reflects the increased adoption of new subscription contracts in the three month period ending June 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 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 as loss 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 from the acquisition. We consider non-GAAP operating loss 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 to loss from operations, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018

	(In thousands)
Non-GAAP operating loss:
Loss from operations	$	(30,627	)	$	(20,221	)	$	(64,692	)	$	(47,708	)
Add:
Stock-based compensation expense	14,065			12,936			27,893			26,526
Acquisition-related expenses	1,058			—			2,696			—
Amortization of acquired intangible assets	771			—			1,542			—
Non-GAAP operating loss	$	(14,733	)	$	(7,285	)	$	(32,561	)	$	(21,182	)

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:



	Six Months Ended June 30,
	2019			2018

	(In thousands)
Free cash flow (non-GAAP):
Net cash (used in) provided by operating activities	$	(18,747	)	$	19,036
Less: purchases of property and equipment	(3,402		)	(4,832		)
Free cash flow (non-GAAP)	$	(22,149	)	$	14,204
Net cash used in investing activities	$	(13,617	)	$	(1,553	)
Net cash provided by financing activities	$	12,675		$	16,757

It is important to note that other companies, including companies in our industry, may not use non-GAAP operating loss 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 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 to the corresponding GAAP financial measure, operating loss, and reconciliations of free cash flow to the corresponding GAAP financial measure, cash flow 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 and free cash flow in conjunction with the corresponding GAAP financial measure.

Components of Financial Performance

Revenue

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

Our revenue is comprised of the following:

•

License Revenue. Our 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. We recognize license revenue 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. As a percentage of total revenue, we expect our license revenue to vary from quarter to quarter based on seasonal and cyclical factors.


•	Subscription Revenue. Our subscription revenue is derived from term contracts with terms that are generally either one or three years, but can be up to five years. We recognize revenue from subscription over the contractual service period. As a percentage of total revenue, we expect our subscription revenue to vary from quarter to quarter based on seasonal and cyclical factors.


•	Professional Services Revenue. Our professional services revenue is generally recognized over time as the services are rendered. As a percentage of total revenue, we expect our professional services revenue to vary from quarter to quarter based on seasonal and cyclical factors.

Cost of Revenue

Our cost of revenue is comprised of the following:

•

Cost of License 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. 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 slightly over time as we grow our customer support organization to accommodate our anticipated subscription revenue growth rate.

•

Cost of Professional Services Revenue. 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 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.

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 June 30, 2019 and 2018, respectively. Margin on our Hardware Products vary. The average margin on hardware sold separately for use with our Software Products was approximately 27% and 29% for the three months ended June 30, 2019 and 2018, respectively. Margin on appliances, which are the hardware appliances that are embedded with our software, vary. The average margin on our high-end appliances was approximately 75% and 79%, and the average margin on our low-end appliances was approximately 27% and 47%, for the three months ended June 30, 2019 and 2018, respectively.

Margin on our Software Products was approximately 98% and 99% for the six months ended June 30, 2019 and 2018, respectively. Margin on our Hardware Products vary. The average margin on hardware sold separately for use with our Software Products was approximately 25% and 25% for the six months ended June 30, 2019 and 2018, respectively. Margin on appliances, which are the hardware appliances that are embedded with our software, vary. The average margin on our high-end appliances was approximately 82% and 80%, and the average margin on our low-end appliances was approximately 37% and 52%, for the six months ended June 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.

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. 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. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services; however, we expect our research and development expense to decline as a percentage of total revenue in the long term as we scale the business.

•

Sales and Marketing. 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. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations; however, we expect our sales and marketing expense to decline as a percentage of total revenue in the long term as we scale the business.

•

General and Administrative. 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 general and administrative expense to increase in absolute dollars due to additional costs associated with accounting, compliance, insurance, and investor relations as we continue to support our growth; however, we expect our general and administrative expense to decline as a percentage of total revenue in the long term as we scale the business.

Interest Expense

Interest expense consists of interest on our outstanding indebtedness.

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.

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.

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 June 30,						Six Months Ended June 30,
	2019			2018			2019			2018

	(In thousands)
Condensed Consolidated Statements of Operations Data:
Revenue:
License	$	38,831		$	34,323		$	76,511		$	64,103
Subscription	34,822			28,986			68,621			55,345
Professional services	4,627			4,285			8,716			7,843
Total revenue	78,280			67,594			153,848			127,291
Cost of revenue:
License ⁽¹⁾	5,622			4,919			13,229			12,055
Subscription ⁽¹⁾	5,599			3,732			10,806			7,533
Professional services ⁽¹⁾	6,235			6,062			12,421			11,611
Total cost of revenue	17,456			14,713			36,456			31,199
Total gross profit	60,824			52,881			117,392			96,092
Operating expenses:
Research and development ⁽¹⁾	19,440			14,803			37,937			29,490
Sales and marketing ⁽¹⁾	56,173			45,039			112,096			87,318
General and administrative ⁽¹⁾	15,838			13,260			32,051			26,992
Total operating expenses	91,451			73,102			182,084			143,800
Loss from operations	(30,627		)	(20,221		)	(64,692		)	(47,708		)
Interest expense	(142		)	(225		)	(235		)	(468		)
Other income, net	505			513			1,122			1,175
Loss before income taxes	(30,264		)	(19,933		)	(63,805		)	(47,001		)
Income tax provision	496			473			1,207			1,601
Net loss	$	(30,760	)	$	(20,406	)	$	(65,012	)	$	(48,602	)

_____________________

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



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018

	(In thousands)
Cost of revenue:
License	$	89	$	54	$	172	$	107
Subscription	470		371		913		750
Professional services	421		352		822		746
Research and development	2,691		2,513		5,769		4,860
Sales and marketing	7,198		5,850		13,684		12,030
General and administrative	3,196		3,796		6,533		8,033
Total	$	14,065	$	12,936	$	27,893	$	26,526



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018

	(As a percentage of total revenue)
Condensed Consolidated Statements of Operations Data:
Revenue:
License	50	%	51	%	50	%	50	%
Subscription	44		43		44		44
Professional services	6		6		6		6
Total revenue	100		100		100		100
Cost of revenue:
License	7		7		9		10
Subscription	7		6		7		6
Professional services	8		9		8		9
Total cost of revenue	22		22		24		25
Total gross profit	78		78		76		75
Operating expenses:
Research and development	25		21		24		23
Sales and marketing	72		67		73		69
General and administrative	20		20		21		21
Total operating expenses	117		108		118		113
Loss from operations	(39	)	(30	)	(42	)	(38	)
Interest expense	—		—		—		—
Other income, net	—		1		1		1
Loss before income taxes	(39	)	(29	)	(41	)	(37	)
Income tax provision	—		1		1		1
Net loss	(39	)%	(30	)%	(42	)%	(38	)%

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

Revenue



	Three Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Revenue:
License	$	38,831	$	34,323	$	4,508	13	%
Subscription	34,822		28,986		5,836		20	%
Professional services	4,627		4,285		342		8	%
Total revenue	$	78,280	$	67,594	$	10,686	16	%

License revenue increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to a $7.4 million increase in Software Products revenue, which was partially offset by a $2.9 million decrease in Hardware Products revenue. The increase in Software Products revenue included a $15.4 million increase in the sale of eyeSight and eyeControl (functionalities generally purchased together), which was partially offset by a $8.7 million decrease in the sale of eyeExtend.

Subscription revenue increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to $3.1 million increase attributed to support and maintenance contracts associated with initial product sales and a $2.7 million increase attributed to support and maintenance contracts that were renewals.

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

Cost of Revenue



	Three Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Cost of revenue:
License	$	5,622	$	4,919	$	703	14	%
Subscription	5,599		3,732		1,867		50	%
Professional services	6,235		6,062		173		3	%
Total cost of revenue	$	17,456	$	14,713	$	2,743	19	%

Cost of license revenue increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to $0.5 million in amortization expense associated with acquired developed technology and a $2.0 million increase due to higher quantities of hardware sold separately for use with our Software Products, partially offset by a $1.8 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 June 30, 2019 compared to the three months ended June 30, 2018, primarily due to increases in personnel costs related to a 45% increase in headcount in our customer support organization.

Cost of professional services revenue increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to increases in personnel costs related to a 4% increase in headcount in our professional services organization.

Gross Profit and Gross Margin



	Three Months Ended June 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	$	33,209		86	%	$	29,404		86	%	$	3,805	—	%
Subscription	29,223			84	%	25,254			87	%	3,969		(3	)%
Professional services	(1,608		)	(35	)%	(1,777		)	(41	)%	169		6	%
Total gross profit	$	60,824		78	%	$	52,881		78	%	$	7,943	—	%

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

Gross margin remained relatively flat for the three months ended June 30, 2019 compared to the three months ended June 30, 2018.

The margin on our license revenue remained relatively flat for the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The mix between Software Products revenue and Hardware Products revenue shifted to 82:18 for the three months ended June 30, 2019, from 71:29 for the three months ended June 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 76:19:5 for the three months ended June 30, 2019, from 27:43:30 for the three months ended June 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



	Three Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Operating expenses:
Research and development	$	19,440	$	14,803	$	4,637	31	%
Sales and marketing	56,173		45,039		11,134		25	%
General and administrative	15,838		13,260		2,578		19	%
Total operating expenses	$	91,451	$	73,102	$	18,349	25	%

Research and development expense increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to an increase in personnel costs of $3.1 million resulting from a 36% increase in headcount.

Sales and marketing expense increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to an increase in personnel costs of $10.5 million resulting from a 23% increase in headcount, which includes an increase in stock-based compensation expense of $1.3 million and an increase in commissions expense of $2.5 million. The increase was further driven by an increase in travel and entertainment cost of $1.3 million.

General and administrative expense increased for the three months ended June 30, 2019 compared to the three months ended June 30, 2018, primarily due to an increase in personnel costs of $2.0 million resulting from an 8% increase in headcount.

Interest Expense



	Three Months Ended June 30,
	2019			2018			Change
	Amount			Amount			Amount		%

	(Dollars in thousands)
Interest expense	$	(142	)	$	(225	)	$	83	(37	)%

Interest expense decreased for the three months ended June 30, 2019 compared to the three months ended June 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



	Three Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount			%

	(Dollars in thousands)
Other income, net	$	505	$	513	$	(8	)	(2	)%

Other income, net remained relatively flat for the three months ended June 30, 2019 compared to the three months ended June 30, 2018.

Provision for Income Taxes



	Three Months Ended June 30,
	2019			2018			Change
	Amount			Amount			Amount		%

	(Dollars in thousands)
Income tax provision	$	496		$	473		$	23	5	%
Effective tax rate	(1.6		)%	(2.4		)%

We recorded an income tax provision for the three months ended June 30, 2019 due to foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The effective tax rate increased for the three months ended

June 30, 2019 compared to the three months ended June 30, 2018 primarily due to an increase in worldwide loss before income taxes, which was largely generated in the United States and offset by a full valuation allowance.

Comparison of the Six Months Ended June 30, 2019 and 2018

Revenue



	Six Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Revenue:
License	$	76,511	$	64,103	$	12,408	19	%
Subscription	68,621		55,345		13,276		24	%
Professional services	8,716		7,843		873		11	%
Total revenue	$	153,848	$	127,291	$	26,557	21	%

License revenue increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to a $17.6 million increase in Software Products revenue, which was partially offset by a $5.2 million decrease in Hardware Products revenue. The increase in Software Products revenue included a $21.0 million increase in the sale of eyeSight and eyeControl (functionalities generally purchased together), which was partially offset by a $5.4 million decrease in the sale of eyeExtend.

Subscription revenue increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to a $8.3 million increase attributed to support and maintenance contracts associated with initial product sales and a $5.0 million increase attributed to support and maintenance contracts that were renewals.

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

Cost of Revenue



	Six Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Cost of revenue:
License	$	13,229	$	12,055	$	1,174	10	%
Subscription	10,806		7,533		3,273		43	%
Professional services	12,421		11,611		810		7	%
Total cost of revenue	$	36,456	$	31,199	$	5,257	17	%

Cost of license revenue increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to $0.9 million in amortization expense associated with acquired developed technology and a $2.3 million increase due to higher quantities of hardware sold separately for use with our Software Products, partially offset by a $2.4 million decrease due to lower quantities of appliances sold that are embedded with our software.

Cost of subscription revenue increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to increases in personnel costs related to a 45% increase in headcount in our customer support organization.

Cost of professional services revenue increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to increases in personnel costs related to a 4% increase in headcount in our professional services organization.

Gross Profit and Gross Margin



	Six Months Ended June 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	$	63,282		83	%	$	52,048		81	%	$	11,234	2	%
Subscription	57,815			84	%	47,812			86	%	10,003		(2	)%
Professional services	(3,705		)	(43	)%	(3,768		)	(48	)%	63		5	%
Total gross profit	$	117,392		76	%	$	96,092		75	%	$	21,300	1	%

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

Gross margin increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

The increase in margin on our license revenue was due to a higher concentration of Software Products revenue compared to Hardware Products revenue, which was principally driven by a shift in product mix towards increased sales of eyeSight, eyeControl, and eyeExtend. The mix between Software Products revenue and Hardware Products revenue shifted to 75:25 for the six months ended June 30, 2019, from 63:37 for the six months ended June 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 64:21:15 for the six months ended June 30, 2019, from 37:35:28 for the six months ended June 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.

Operating Expenses



	Six Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount		%

	(Dollars in thousands)
Operating expenses:
Research and development	$	37,937	$	29,490	$	8,447	29	%
Sales and marketing	112,096		87,318		24,778		28	%
General and administrative	32,051		26,992		5,059		19	%
Total operating expenses	$	182,084	$	143,800	$	38,284	27	%

Research and development expense increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to an increase in personnel costs of $5.7 million resulting from a 36% increase in headcount. The increase was further driven by an increase in allocated IT and facilities cost of $1.2 million.

Sales and marketing expense increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to an increase in personnel costs of $20.7 million resulting from a 23% increase in headcount, which includes an increase in commissions expense of $4.4 million and an increase in stock-based compensation expense of $1.7 million. The increase was further driven by an increase in travel and entertainment cost of $2.8 million and an increase in other marketing activities costs of $1.7 million, partially offset by a decrease in allocated IT and facilities cost of $1.7 million.

General and administrative expense increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to an increase in personnel costs of $3.9 million resulting from a 8% increase in headcount. The increase was further driven by an increase in professional fees of $1.8 million.

Interest Expense



	Six Months Ended June 30,
	2019			2018			Change
	Amount			Amount			Amount		%

	(Dollars in thousands)
Interest expense	$	(235	)	$	(468	)	$	233	(50	)%

Interest expense decreased for the six months ended June 30, 2019 compared to the six months ended June 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



	Six Months Ended June 30,
	2019		2018		Change
	Amount		Amount		Amount			%

	(Dollars in thousands)
Other income, net	$	1,122	$	1,175	$	(53	)	(5	)%

Other income, net remained relatively flat for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

Provision for Income Taxes



	Six Months Ended June 30,
	2019			2018			Change
	Amount			Amount			Amount			%

	(Dollars in thousands)
Income tax provision	$	1,207		$	1,601		$	(394	)	(25	)%
Effective tax rate	(1.9		)%	(3.4		)%

We recorded an income tax provision for the six months ended June 30, 2019 due to foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The decrease in the provision for the six months ended June 30, 2019 was primarily due to income tax benefit associated with amortization of intangible assets in a non-U.S. jurisdiction. The effective tax rate increased for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 primarily due to an increase in worldwide loss before income taxes, which was largely generated in the United States and offset by a full valuation allowance.

Liquidity and Capital Resources

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



	As of
	June 30, 2019		December 31, 2018

	(In thousands)
Working capital	$	27,460	$	52,623
Cash, cash equivalents, and marketable securities:
Cash and cash equivalents	$	46,872	$	66,895
Marketable securities	58,065		47,632
Total cash, cash equivalents, and marketable securities	104,937		114,527
Total notes payable	11,925		15,579
Net cash, cash equivalents, and marketable securities	$	93,012	$	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 June 30, 2019, our cash, cash equivalents, and marketable securities of $104.9 million were held for general corporate purposes, of which approximately $26.2 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, inventory, 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 $25.2 million during the six months ended June 30, 2019, primarily due to a decrease in cash and cash equivalents, a decrease in accounts receivable, an increase in current operating lease liabilities, and an increase in current deferred revenue, partially offset by an increase in marketable securities and a decrease in accounts payable. The following table summarizes our cash flows for the six months ended June 30, 2019 and 2018.



	Six Months Ended June 30,
	2019			2018

	(In thousands)
Net cash (used in) provided by operating activities	$	(18,747	)	$	19,036
Net cash used in investing activities	(13,617		)	(1,553		)
Net cash provided by financing activities	12,675			16,757
Effect of exchange rate changes on cash and cash equivalents	(4		)	—
Net change in cash, cash equivalents, and restricted cash for period	$	(19,693	)	$	34,240

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 $(18.7) million and $19.0 million for the six months ended June 30, 2019 and 2018, respectively, representing a decrease of $37.8 million as compared to the six months ended June 30, 2018. The decrease in generation of cash during the six months ended June 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 used in investing activities during the six months ended June 30, 2019 was $13.6 million, primarily resulting from purchases of marketable securities of $63.6 million, and capital expenditures to purchase property and equipment of $3.4 million related to the continuing growth of our business, partially offset by proceeds from maturities of marketable securities of $53.4 million.

Cash used in investing activities during the six months ended June 30, 2018 was $1.6 million, primarily resulting from purchases of marketable securities of $46.1 million and capital expenditures to purchase property and equipment of $4.8 million related to the continuing growth of our business, partially offset by proceeds from maturities of marketable securities of $49.4 million.

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 six months ended June 30, 2019 was $12.7 million, primarily from the proceeds from the sales of shares through our employee equity incentive plans of $20.7 million, partially offset by payments related to shares withheld for taxes on the vesting of restricted stock units of $4.3 million, and the repayment of notes payable of $3.7 million.

Cash provided by financing activities for the six months ended June 30, 2018 was $16.8 million, primarily from the sale of shares through our employee equity incentive plans of $17.8 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 $9.6 million, the repayment of notes payable of $3.8 million, and payments of $1.5 million for deferred offering costs related to the follow-on offering.

Contractual Obligations and Commitments

There were no material changes outside the ordinary course of business during the six months ended June 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 June 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.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the year ended December 31, 2018.

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 June 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 June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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).

EXHIBIT INDEX



Exhibit Number		Description
10.1*		Form of 2017 Equity Incentive Plan Performance-Based Restricted Stock Unit Grant Agreement.
10.2*		Amendment One to Forescout Technologies, Inc. Employment Agreement between Registrant and Pedro Abreu, dated May 24, 2019.
10.3*		Consulting Agreement by and between the Company and Night Dragon II, LLC dated as of June 5, 2019 (incorporated herein by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K (File No. 001-38253) filed on June 7, 2019).
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.



*	Indicates a management or compensatory plan.
†	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.

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: August 7, 2019	By: /s/ Darren J. Milliken
	Darren J. Milliken
	Senior Vice President, General Counsel, Corporate Secretary and Corporate Compliance Officer




Dated: August 7, 2019	By: /s/ Christopher Harms
	Christopher Harms
	Chief Financial Officer
	Principal Financial Officer