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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
———————————————
FORM 10-Q
———————————————
(Mark One)
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
OR
 
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
            
Commission File Number 001-38253
———————————————
FORESCOUT TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
———————————————
Delaware
 
51-0406800
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
190 West Tasman Drive
San Jose
California
95134
(Address of principal executive offices, including zip code)
(408213-3191
(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 May 1, 2020 was 49,264,795.





TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
Page
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 6.
 
 


2


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “would,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

the merger agreement and our proposed acquisition by entities affiliated with Advent International Corporation (“Advent”);

the effect of the COVID-19 pandemic and related actions by individuals, governments, and private industry on our business, markets, and the economy

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;



3


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 (including developments and volatility arising from COVID-19 and customer uncertainty related to the acquisition);

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;

our expectations of material future costs related to restructuring plans;

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, 2019 and in Part II, Item 1A of this Quarterly Report on Form 10-Q 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.

4


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.

5

PART I. FINANCIAL INFORMATION


ITEM 1.
FINANCIAL STATEMENTS
FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except par value)

March 31, 2020
 
December 31, 2019
Assets
 
 

Current assets:

 

Cash and cash equivalents
$
83,795

 
$
69,030

Marketable securities
16,126

 
29,181

Accounts receivable
39,650

 
84,168

Inventory
377

 
372

Deferred commissions - current
12,854

 
12,843

Prepaid expenses and other current assets
12,867

 
17,024

Total current assets
165,669

 
212,618

Deferred commissions - non-current
21,294

 
23,036

Property and equipment, net
22,618

 
23,835

Operating lease right-of-use assets
28,326

 
29,626

Restricted cash - non-current
1,530

 
1,555

Intangible assets, net
18,353

 
19,367

Goodwill
98,018

 
98,018

Other assets
7,460

 
8,172

Total assets
$
363,268

 
$
416,227

 
 
 
 
Liabilities and stockholders' equity

 

Current liabilities:

 

Accounts payable
$
6,377

 
$
10,692

Accrued compensation
26,881

 
34,007

Accrued expenses
15,397

 
16,279

Deferred revenue - current
111,402

 
112,232

Notes payable - current
6,402

 
8,248

Revolving credit facility
16,000

 

Operating lease liabilities - current
5,704

 
5,840

Total current liabilities
188,163

 
187,298

Deferred revenue - non-current
68,438

 
75,366

Operating lease liabilities - non-current
30,333

 
32,125

Other liabilities
23,705

 
23,893

Total liabilities
310,639

 
318,682

 
 
 
 
Stockholders' equity:

 

Common stock, $0.001 par value; 1,000,000 shares authorized;

 

49,040 and 48,064 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
49

 
48

Additional paid-in capital
744,299

 
727,922

Accumulated other comprehensive loss
(688
)
 
(633
)
Accumulated deficit
(691,031
)
 
(629,792
)
Total stockholders’ equity
52,629

 
97,545

Total liabilities and stockholders' equity
$
363,268

 
$
416,227

 

See Notes to Condensed Consolidated Financial Statements.

6


FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)

Three Months Ended
March 31,

2020

2019
Revenue:



License
$
14,799


$
37,680

Subscription
37,526

 
33,799

Professional services
4,828

 
4,089

Total revenue
57,153


75,568

Cost of revenue:
 
 
 
License
5,419


7,607

Subscription
7,013

 
5,207

Professional services
7,165


6,186

Total cost of revenue
19,597


19,000

Total gross profit
37,556


56,568

Operating expenses:
 
 
 
Research and development
23,246


18,497

Sales and marketing
47,288


55,923

General and administrative
24,481


16,213

Restructuring
2,512

 

Total operating expenses
97,527


90,633

Loss from operations
(59,971
)

(34,065
)
Interest expense
(235
)

(93
)
Other (expense) income, net 
(601
)

617

Loss before income taxes
(60,807
)

(33,541
)
Income tax provision
432


711

Net loss
$
(61,239
)

$
(34,252
)
Net loss per share, basic and diluted
$
(1.26
)

$
(0.78
)
Weighted-average shares used to compute net loss per share, basic and diluted
48,593


44,196


See Notes to Condensed Consolidated Financial Statements.


7


FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands)
 
Three Months Ended
March 31,
 
2020

2019
Net loss
$
(61,239
)

$
(34,252
)
Other comprehensive (loss) income, net of tax:
 
 
 
Change in fair value adjustment on marketable securities
(55
)

75

Foreign currency translation adjustments

 
(2,054
)
Comprehensive loss
$
(61,294
)

$
(36,231
)

See Notes to Condensed Consolidated Financial Statements.


8



FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, in thousands)

 
Three Months Ended March 31, 2020
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Balance as of December 31, 2019
48,064

 
$
48

 
$
727,922

 
$
(633
)
 
$
(629,792
)
 
$
97,545

Other comprehensive loss, net of tax

 

 

 
(55
)
 

 
(55
)
Stock-based compensation

 

 
13,478

 

 

 
13,478

Issuance of common stock in connection with employee equity incentive plans
976

 
1

 
2,899

 

 

 
2,900

Net loss

 

 

 

 
(61,239
)
 
(61,239
)
Balance as of March 31, 2020
49,040

 
$
49

 
$
744,299

 
$
(688
)
 
$
(691,031
)
 
$
52,629


 
Three Months Ended March 31, 2019
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
Balance as of December 31, 2018
43,403

 
$
43

 
$
639,237

 
$
(302
)
 
$
(511,257
)
 
$
127,721

Other comprehensive loss, net of tax

 

 

 
(1,979
)
 

 
(1,979
)
Stock-based compensation

 

 
13,828

 

 

 
13,828

Issuance of common stock in connection with employee equity incentive plans
1,706

 
2

 
9,407

 

 

 
9,409

Vesting of early exercised stock options
24

 

 
202

 

 

 
202

Net loss

 

 

 

 
(34,252
)
 
(34,252
)
Balance as of March 31, 2019
45,133

 
$
45

 
$
662,674

 
$
(2,281
)
 
$
(545,509
)
 
$
114,929


See Notes to Condensed Consolidated Financial Statements.

9


FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

Three Months Ended
March 31,

2020

2019
Cash flows from operating activities:



Net loss
$
(61,239
)

$
(34,252
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities




Stock-based compensation
13,858


13,828

Depreciation and amortization
3,056


2,845

Other
358


(15
)
Changes in operating assets and liabilities




Accounts receivable
44,518


22,227

Inventory
(196
)

253

Deferred commissions
1,731


1,520

Prepaid expenses and other current assets
4,168


(203
)
Other assets
328


385

Accounts payable
(4,274
)

(2,705
)
Accrued compensation
(7,126
)

(4,512
)
Accrued expenses
(1,715
)

549

Deferred revenue
(7,758
)

6,559

Other liabilities
(172
)

(40
)
Net cash (used in) provided by operating activities
(14,463
)

6,439

Cash flows from investing activities:



Purchases of property and equipment
(823
)

(1,589
)
Purchases of marketable securities


(37,651
)
Proceeds from maturities of marketable securities
13,000


29,123

Net cash provided by (used in) investing activities
12,177


(10,117
)
Cash flows from financing activities:



Proceeds from revolving credit facility
16,000

 

Repayments of notes payable
(1,875
)

(1,875
)
Proceeds from sales of shares through employee equity incentive plans
5,207


12,173

Payment related to shares withheld for taxes on vesting of restricted stock units
(2,319
)
 
(2,764
)
Others
13

 

Net cash provided by financing activities
17,026


7,534

Effect of exchange rate changes on cash and cash equivalents

 
(70
)
Net change in cash, cash equivalents, and restricted cash for period
14,740


3,786

Cash, cash equivalents, and restricted cash at beginning of period
71,591


69,012

Cash, cash equivalents, and restricted cash at end of period
$
86,331


$
72,798



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
$
83,795

 
$
70,663

Restricted cash included in prepaid expenses and other current assets
1,006

 
852

Restricted cash - non-current
1,530

 
1,283

Total cash, cash equivalents, and restricted cash
$
86,331

 
$
72,798



See Notes to Condensed Consolidated Financial Statements.

10


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, eyeSegment, eyeControl, and SilentDefense; eyeSight, eyeSegment, 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, eyeSegment, 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.
Proposed Merger
On February 6, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Ferrari Group Holdings, L.P., a Delaware limited partnership (“Parent”), and Ferrari Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”). Parent and Merger Sub are affiliates of Advent.
The Merger Agreement provides that, subject to the terms and conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company (the “Merger”), with the Company surviving the Merger and becoming a wholly owned subsidiary of Parent (the “Surviving Corporation”). Under the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of the Company’s common stock (except for certain shares specified in the Merger Agreement) will be canceled and automatically converted into the right to receive cash in an amount equal to $33.00, without interest.
Consummation of the Merger is subject to the satisfaction or waiver of customary closing conditions, including (1) approval of the Merger Agreement by the Company’s stockholders; (2) the absence of any law or order restraining, enjoining or otherwise prohibiting the Merger; and (3) the expiration or termination of the waiting period under the United States Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and clearance under the antitrust laws of certain non-United States jurisdictions. On February 24, 2020, the U.S. Federal Trade Commission granted early termination of the waiting period under the HSR Act. On April 23, 2020, our stockholders approved the Merger Agreement. The Merger is expected to close in the second fiscal quarter of 2020. Upon consummation of the Merger, the Company’s common stock will no longer be listed on any public market.
COVID-19

11


Due to the COVID-19 pandemic, there has been uncertainty and disruption in the global economy and financial markets, which has decreased, and may further decrease, demand for a broad variety of goods and services, while also disrupting sales channels and marketing activities for an unknown period of time until the pandemic is contained. At this point, the extent to which COVID-19 may impact our financial condition or results of operations is uncertain.

Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) using accounting policies that are consistent with those used in the preparation of the Company’s audited consolidated financial statements for the year ended December 31, 2019. 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, 2019 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, 2019.
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, including but not limited to the potential impacts arising from the recent COVID-19 and public and private policies and initiatives aimed at reducing its transmission. 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. As the extent and duration of the impact from COVID-19 continue to evolve and additional information becomes available, the Company’s estimates and assumptions may change materially in future periods. Actual results could differ materially from those estimates.
Summary of Significant Accounting Policies 
Restructuring cost
The Company records restructuring activities including costs for one-time termination benefits in accordance with ASC Topic 420 (“ASC 420”), Exit or Disposal Cost Obligations. A liability is recognized when management has committed to a restructuring plan and has communicated those actions to employees. Restructuring cost for employee workforce reductions are recorded upon employee notification for employees whose required continuing service period is 60 days or less and ratably over the employee’s continuing service period for employees whose required continuing service period is greater than 60 days. Employee termination benefits covered by existing benefit arrangements are recorded in accordance with ASC Topic 712, Non-retirement Post-employment Benefits. These costs are recognized as restructuring charges in the condensed consolidated statement of operations when management has committed to a restructuring plan and the severance costs are probable and estimable. Refer to Note 5 for further details.

Credit losses
Effective January 1, 2020, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,

12


which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. The Company adopted ASU 2016-13 effective January 1, 2020 with the cumulative effect of adoption recorded as an adjustment to retained earnings. The effect on its consolidated financial statements and related disclosures is not material.
Except for restructuring cost and the impact of the adoption of Topic 326, 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, 2019 that have had a material impact on the Company’s condensed consolidated financial statements and related notes.
Recently Issued and Not Yet Adopted Accounting Pronouncements
In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes that eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. The standard is effective for annual and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the timing and impact of the adoption of this standard on its consolidated financial statements.

13


Note 2. Revenue, Deferred Revenue and Deferred Commissions
Disaggregation of Revenue
The Company derives revenue from sale of Software Products, Hardware Products, term 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 March 31,
 
2020
 
2019
Revenue:
 
 
 
License
 
 
 
Software Products
 
 
 
Perpetual license
$
9,359

 
$
25,759

Term license
653

 
324

Hardware Products
4,787

 
11,597

Subscription
 
 
 
Software as a service (“SaaS”)
126

 

Support and maintenance
37,400

 
33,799

Professional services
4,828

 
4,089

Total revenue
$
57,153

 
$
75,568


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, the value allocated to support and maintenance within Software Products subscription contracts, and software-as-a-service (“SaaS”) offering contracts. SaaS customers do not have the right to take possession of the cloud-based software. Subscription contracts have terms that are generally either one or three years, but can be up to five 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):

14


 
Three Months Ended March 31, 2020
 
Contract Liabilities
Balance as of December 31, 2019
$
188,907

Additions
48,920

Gross revenue recognized
(57,153
)
Balance as of March 31, 2020
$
180,674

During the three months ended March 31, 2020, the Company recognized revenue of $34.1 million that was included in the contract liabilities balance as of December 31, 2019. During the three months ended March 31, 2019, the Company recognized revenue of $31.5 million that was included in the contract liabilities balance as of December 31, 2018.
Performance Obligations
Contracted not recognized revenue was $180.4 million as of March 31, 2020, of which the Company expects to recognize approximately 62% 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.

15


There have been no transfers between fair value measurement levels during the periods presented. The following table presents the fair value of the Company’s financial assets according to the fair value hierarchy as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
December 31, 2019
 
  Level 1
 
Level 2
 
Level 3
 
  Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
      Cash
$
63,778

 
$

 
$

 
$
62,188

 
$

 
$

      Money market accounts
20,017

 

 

 
6,842

 

 

Total cash and cash equivalents
83,795

 

 

 
69,030

 

 

Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
      Commercial paper

 

 

 

 
1,998

 

      Corporate debt securities

 
16,126

 

 

 
24,168

 

      U.S. government securities

 

 

 

 
3,015

 

Total marketable securities

 
16,126

 

 

 
29,181

 

Restricted cash (current and non-current)
2,536

 

 

 
2,561

 

 

Total financial assets
$
86,331

 
$
16,126

 
$

 
$
71,591

 
$
29,181

 
$



Note 4. Marketable Securities
The following table summarizes the Company’s marketable securities by significant investment categories as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
December 31, 2019
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
Amortized Cost
 
Unrealized Gains
 
Fair Value
Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
$

 
$

 
$

 
$

 
$
1,998

 
$

 
$
1,998

Corporate debt securities
16,131

 
3

 
(8
)
 
16,126

 
24,122

 
46

 
24,168

U.S. government securities

 

 

 

 
3,012

 
3

 
3,015

Total marketable securities
$
16,131

 
$
3

 
$
(8
)
 
$
16,126

 
$
29,132

 
$
49

 
$
29,181


The following table summarizes the amortized cost and fair value of the Company’s available-for-sale securities as of March 31, 2020 and December 31, 2019 by the contractual maturity date (in thousands):
 
March 31, 2020
 
December 31, 2019
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due within one year
$
16,131

 
$
16,126

 
$
29,132

 
$
29,181

     Total
$
16,131

 
$
16,126

 
$
29,132

 
$
29,181


The Company had 5 marketable securities in unrealized loss position as of March 31, 2020. The Company had no marketable securities in an unrealized loss position as of December 31, 2019. For individual marketable securities that were in an unrealized loss position as of March 31, 2020, the fair value and gross unrealized loss for these securities aggregated by investment category and length of time in an unrealized loss position are presented in the following tables (in thousands):

16


 
March 31, 2020
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Corporate debt securities
$
8,058

 
$
(8
)
 
$

 
$

 
$
8,058

 
$
(8
)
Total
$
8,058

 
$
(8
)
 
$

 
$

 
$
8,058

 
$
(8
)

Unrealized losses related to these marketable securities were immaterial. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the impact. 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.
Note 5. Restructuring
Q1 2020 Restructuring Plan
In the first quarter of fiscal year 2020, the Company initiated a restructuring plan (the “Q1 2020 Restructuring Plan”) as part of the Company’s effort to realign its cost structure in both its go-to-market and engineering organizations. The Q1 2020 Restructuring Plan included reduction in force of approximately 90 employees within the sales, marketing, and engineering functions and was largely completed by March 31, 2020 with no material future costs expected to be incurred.
The following table summarizes the activity related to the accrual for restructuring charges (in thousands):
 
 
Workforce Reduction Cost
Accrual balance as at December 31, 2019
 
$

Restructuring charges
 
2,512

Cash payments
 
(1,343
)
Accrual balance as at March 31, 2020
 
$
1,169


The accrued restructuring balance as at March 31, 2020 is included in accrued expenses on the Company’s condensed consolidated balance sheets.

17


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 March 31,
 
2020
 
2019
Cost of revenue:
 
 
 
License
$
122


$
83

Subscription
524

 
443

Professional services
516


401

Research and development
3,683


3,078

Sales and marketing
5,804


6,486

General and administrative
3,209


3,337

     Total
$
13,858


$
13,828


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, 2019
3,066

 
$
12.33

 
5.6
 
$
62,759

     Options exercised
(450
)
 
$
11.60

 

 

     Options forfeited
(25
)
 
$
20.11

 

 

Balance—March 31, 2020
2,591

 
$
12.39

 
5.3
 
$
49,762

Options vested and exercisable—March 30, 2020
2,425

 
$
11.79

 
5.2
 
$
48,022


As of March 31, 2020, the total unrecognized compensation cost related to unvested options was $1.6 million, which is expected to be amortized on a straight-line basis over a weighted-average period of approximately 1.1 years.
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, 2019
6,391

 
$
31.37

 
1.7
 
$
209,621

    Granted
178

 
$
30.80

 
 
 

    Vested
(597
)
 
$
31.01

 
 
 


     Forfeited
(476
)
 
$
31.94

 
 
 
 
Balance—March 31, 2020
5,496

 
$
31.35

 
1.6
 
$
173,622



18


The Company has 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 March 31, 2020, the total unrecognized compensation cost related to unvested RSUs and PSUs was $134.9 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 under the provisions of ASC 740-270, Income Taxes: Interim Reporting. For the three months ended March 31, 2020 and 2019, the Company recorded a tax provision of $0.4 million and $0.7 million, respectively, representing an effective tax rate of (0.7)% and (2.1)%, 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 months ended March 31, 2020 as compared to the three months ended March 31, 2019 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.
In response to COVID-19, President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) on March 27, 2020. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of Social Security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain refundable employee retention credits. The impact of the CARES Act does not have a material impact to the Company’s consolidated financial statements.
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 March 31,
 
2020
 
2019
Net loss
$
(61,239
)
 
$
(34,252
)
Weighted-average shares used to compute net loss per share, basic and diluted
48,593

 
44,196

Net loss per share, basic and diluted
$
(1.26
)
 
$
(0.78
)

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 March 31,
 
2020
 
2019
Options to purchase common stock
2,591

 
4,717

Unvested early exercised common shares

 
24

Unvested restricted stock units
5,496

 
5,470

Employee Stock Purchase Plan
196

 
233


ITEM 2.

19


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, 2019 included in our Annual Report on Form 10-K for the year ended December 31, 2019. 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, eyeSegment, eyeControl, and SilentDefense. Our eyeSight, eyeSegment, and eyeControl products 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 our eyeExtend family of products.
We offer our solution across two product types: (i) software products and (ii) hardware products. Our software products include eyeSight, eyeSegment, 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.
Proposed Merger
On February 6, 2020, we entered into an Agreement and Plan of Merger (“Merger Agreement”) with Ferrari Group Holdings, L.P., a Delaware limited partnership (“Parent”), and Ferrari Merger Sub, Inc. (“Merger Sub”), a Delaware corporation and a wholly owned subsidiary of Parent. Parent and Merger Sub are affiliates of Advent.
The Merger Agreement provides that, subject to the terms and conditions set forth in the Merger Agreement, Merger Sub will merge with and into Forescout (the “Merger”), with Forescout surviving the Merger and becoming a wholly-owned indirect subsidiary of Parent. Under the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our common stock (except for certain shares specified in the Merger Agreement) will be canceled and automatically converted into the right to receive cash in an amount equal to $33.00, without interest.
Consummation of the Merger is subject to the satisfaction or waiver of customary closing conditions, including (1) approval of the Merger Agreement by our stockholders; (2) the absence of any law or order restraining, enjoining or otherwise prohibiting the Merger; and (3) the expiration or termination of the waiting period under the United States Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and clearance under the antitrust laws of certain non-United States jurisdictions. On February 24, 2020, the U.S. Federal Trade Commission granted early termination of the waiting period under the HSR Act. On April 23, 2020, our stockholders approved the Merger Agreement. The Merger is expected to close in the second fiscal quarter of 2020. Upon consummation of the Merger, our common stock will no longer be listed on any public market.

20


Impact of COVID-19 on our Results of Operations
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, which continues to spread throughout the U.S. and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns.
The broader impact of COVID-19 on our results of operations and overall financial performance remains uncertain as the extent and duration of the impact from COVID-19 continue to evolve and additional information becomes available and will impact our business and consolidated results of operations and may impact our financial condition in the future. Our operations have been impacted by office closures globally and restrictions on employee travel and in-person meetings; however, we have generally been able to deliver our products and services remotely. To support the health and well-being of our employees, customers, partners and communities, a vast majority of our employees are working remotely as of March 15, 2020. The economic uncertainty from the COVID-19 pandemic has also impacted our customers and their available budgets to spend on our products and services, which has resulted in an unfavorable impact on our revenue growth and gross margin in the first quarter of 2020 and which may also delay the timing of future sales. We will continue to evaluate the nature and extent of the impact of COVID-19 to our business. In addition, during the first quarter of fiscal 2020, we borrowed $16.0 million under our revolving credit facility as a precautionary measure to provide additional liquidity in light of global economic uncertainty and financial market conditions caused by COVID-19. The amount borrowed has been gradually paid down and will be fully paid upon consummation of the Merger. See section titled “Risk Factors” for further discussion of the possible impact of COVID-19 on our business.
First Quarter 2020 Financial Highlights
Since our inception through March 31, 2020, we have sold to nearly 3,800 end-customers in nearly 100 countries, including 26% of the Global 2000. For the three months ended March 31, 2020 and 2019, we sold to 9% and 8% of the Global 2000, respectively. Our end-customers represent a broad range of industries, including government, financial services, healthcare, technology, manufacturing, energy, services, 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 March 31,
 
2020
 
2019
 
 
 
 
 
(Dollars in thousands)
Total revenue
$
57,153

 
$
75,568

Total revenue year-over-year percentage growth
(24
)%
 
27
 %
Gross margin
66
 %
 
75
 %
Loss from operations
$
(59,971
)
 
$
(34,065
)
Loss from operations as a percentage of total revenue
(105
)%
 
(45
)%
Net loss
$
(61,239
)
 
$
(34,252
)
Net cash (used in) provided by operating activities
$
(14,463
)
 
$
6,439

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:

21


X = net-recurring revenue retention rate
A = annualized value of term contracts renewed over the trailing 12 month period
B = trailing 12 month annualized value of term contracts not subject to renewal because the scheduled expiration date of the multi-year contract falls outside of the 12 month period under measurement
C = trailing 12 month annualized value of new term contracts from end-customers that have been end customers for more than one year
D = 12 months annualized value of term contracts scheduled to terminate or renew during the 12 month period under measurement
We believe this metric is an indication of the continuing value we provide to our end-customers because it shows the renewal rate of their support and maintenance contracts and Software Products subscription contracts. Our net-recurring revenue retention rate as of March 31, 2020 and December 31, 2019 were 121% and 122%, respectively. The 100 basis point decrease primarily reflects the decreased 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 March 31, 2020. 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 believe this metric 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

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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 March 31, 2020 and December 31, 2019 were 53% and 49%, respectively. The 400 basis point increase primarily reflects the increased adoption of new subscription contracts in the three months ended March 31, 2020. 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.
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 March 31,
 
2020
 
2019
 
 
 
 
 
(In thousands)
Condensed Consolidated Statements of Operations Data:
 
 
 
Revenue:
 
 
 
License
$
14,799

 
$
37,680

Subscription
37,526

 
33,799

Professional services
4,828

 
4,089

Total revenue
57,153

 
75,568

Cost of revenue:
 
 
 
License (1)
5,419

 
7,607

Subscription (1)
7,013

 
5,207

Professional services (1)
7,165

 
6,186

Total cost of revenue
19,597

 
19,000

Total gross profit
37,556

 
56,568

Operating expenses:
 
 
 
Research and development (1)   
23,246

 
18,497

Sales and marketing (1)   
47,288

 
55,923

General and administrative (1)   
24,481

 
16,213

Restructuring
2,512

 

Total operating expenses
97,527

 
90,633

Loss from operations
(59,971
)
 
(34,065
)
Interest expense
(235
)
 
(93
)
Other (expense) income, net
(601
)
 
617

Loss before income taxes
(60,807
)
 
(33,541
)
Income tax provision
432

 
711

Net loss
$
(61,239
)
 
$
(34,252
)

23


_____________________    
(1)    Includes stock-based compensation expense as follows:
 
Three Months Ended March 31,
 
2020
 
2019
 
 
 
 
 
(In thousands)
Cost of revenue:
 
 
 
License
$
122

 
$
83

Subscription
524

 
443

Professional services
516

 
401

Research and development
3,683

 
3,078

Sales and marketing
5,804

 
6,486

General and administrative
3,209

 
3,337

     Total
$
13,858

 
$
13,828


 
Three Months Ended March 31,
 
2020
 
2019
 
 
 
 
 
(As a percentage of total revenue)
Condensed Consolidated Statements of Operations Data:
 
 
 
Revenue:
 
 
 
License
26
 %
 
50
 %
Subscription
66

 
45

Professional services
8

 
5

Total revenue
100

 
100

Cost of revenue:
 
 
 
License
9

 
10

Subscription
12

 
7

Professional services
13

 
8

Total cost of revenue
34

 
25

Total gross profit
66

 
75

Operating expenses:
 
 
 
Research and development
41

 
25

Sales and marketing
83

 
74

General and administrative
43

 
21

Restructuring
4

 

Total operating expenses
171

 
120

Loss from operations
(105
)
 
(45
)
Interest expense

 

Other (expense) income, net
(1
)
 
1

Loss before income taxes
(106
)
 
(44
)
Income tax provision
1

 
1

Net loss
(107
)%
 
(45
)%


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Comparison of the Three Months Ended March 31, 2020 and 2019
Revenue
Our revenue is comprised of license revenue, subscription revenue, and professional services revenue. License revenue is derived from sales of Software Products and Hardware Products, which includes the value allocated to license within our Software Products subscription contracts. Subscription revenue is derived from term contracts with terms that are generally either one or three years, but can be up to five years. Professional services revenue is generally recognized over time as the services are rendered. As a percentage of total revenue, we expect our license revenue, subscription revenue, and professional services revenue to vary from quarter to quarter based on seasonal and cyclical factors as well as the impact of COVID-19 and other factors that may impact customer behavior such as our pending transaction with Advent.
 
Three Months Ended March 31,
 
 
 
 
 
2020
 
2019
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
License
$
14,799

 
$
37,680

 
$
(22,881
)
 
(61
)%
Subscription
37,526

 
33,799

 
3,727

 
11
 %
Professional services
4,828

 
4,089

 
739

 
18
 %
Total revenue
$
57,153

 
$
75,568

 
$
(18,415
)
 
(24
)%

License revenue decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to a $16.1 million decrease in Software Products revenue, and a $6.8 million decrease in Hardware Products revenue. The decrease in Software Products revenue included a $10.8 million decrease in the sales of eyeSight, eyeControl, and SilentDefense, and a $5.3 million decrease in the sale of eyeExtend. The decrease in license revenue primarily resulted from the economic slowdown caused by the global impact of the COVID-19 pandemic, as well as customer uncertainty related to the Merger.
Subscription revenue increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to $3.1 million increase attributed to support and maintenance contracts that were renewals and a $0.5 million increase attributed to support and maintenance contracts associated with initial product sales.
Professional services revenue increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to an increase in the sale of optional installation and training services.
Cost of Revenue
Our cost of revenue is comprised of cost of license revenue, cost of subscription revenue, and cost of professional services revenue.
Cost of license revenue primarily consists of costs paid to our third-party contract manufacturer for our Hardware Products. Our cost of license revenue also includes allocated costs, shipping costs and personnel costs associated with logistics for our Hardware Products, and amortization of acquired developed technology. We expect our cost of license revenue to fluctuate from quarter to quarter based on product mix between Software Products and Hardware Products; however, over time, we expect our cost of license revenue to decline as a percentage of license revenue reflecting the continuing shift towards Software Products in our product mix.
Cost of subscription revenue consists of personnel costs for our global customer support organization and warranty-related hardware support costs. We expect our cost of subscription revenue to increase in absolute dollars over time as we grow our customer support organization to accommodate our anticipated subscription revenue growth rate. In

25


addition, we also expect the cost of subscription revenue to increase in absolute dollars as costs of the infrastructure for our SaaS products increase.
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. Although we are continuing to scale our organization and, therefore, expect that cost of professional services revenue will increase in absolute dollars, we expect our cost of professional services revenue to decline over the longer term as a percentage of our professional services revenue as we expect to scale our professional services organization at a lower growth rate than our anticipated professional services revenue growth rate.
 
Three Months Ended March 31,
 
 
 
 
 
2020
 
2019
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
License
$
5,419

 
$
7,607

 
$
(2,188
)
 
(29
)%
Subscription
7,013

 
5,207

 
1,806

 
35
 %
Professional services
7,165

 
6,186

 
979

 
16
 %
Total cost of revenue
$
19,597

 
$
19,000

 
$
597

 
3
 %

Cost of license revenue decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to a $1.5 million decrease due to lower quantities of appliances sold that are embedded with our software and a $0.7 million decrease due to lower quantities of hardware sold separately for use with our Software Products.
Cost of subscription revenue increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to increases in personnel costs related to an 11% increase in headcount in our customer support organization and an increase in cloud-based cost with the expansion of our SaaS offering.
Cost of professional services revenue increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to increases in personnel costs related to a 14% increase in headcount in our professional services organization.
Gross Profit and Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the mix of products sold between Software Products and Hardware Products; the mix between high-margin and low-margin Hardware Products; the mix of revenue between license, subscription, and professional services; the average sales price of our Software Products, Hardware Products, support and maintenance contracts, and professional services; amortization of acquired developed technology; and manufacturing costs.
Margin on our Software Products was approximately 94% and 98% for the three months ended March 31, 2020 and 2019, respectively. Margin on our Hardware Products varies. The average margin on hardware sold separately for use with our Software Products was approximately (8)% and 24% for the three months ended March 31, 2020 and 2019, respectively. The negative margin on hardware sold separately for use with our Software Products primarily reflects two large deals that were deeply discounted as a result of one off negotiations. Margin on appliances, which are the hardware appliances that are embedded with our software, varies. The average margin on our high-end appliances was approximately 71% and 84%, and the average margin on our low-end appliances was approximately 26% and 42%, for the three months ended March 31, 2020 and 2019, respectively.

26


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.
 
Three Months Ended March 31,
 
 
 
 
 
2020
 
2019
 
Change
 
Gross Profit (Loss)

Gross Margin
 
Gross Profit (Loss)
 
Gross Margin
 
Gross Profit (Loss)
 
Gross Margin %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
License
$
9,380

 
63
 %
 
$
30,073

 
80
 %
 
$
(20,693
)
 
(17
)%
Subscription
30,513

 
81
 %
 
28,592

 
85
 %
 
1,921

 
(4
)%
Professional services
(2,337
)
 
(48
)%
 
(2,097
)
 
(51
)%
 
(240
)
 
3
 %
Total gross profit
$
37,556

 
66
 %
 
$
56,568

 
75
 %
 
$
(19,012
)
 
(9
)%

Gross profit decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The decrease is consistent with the changes in our revenue and cost of revenue.
Gross margin decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019.
The decrease in margin on our license revenue was primarily driven by a shift in product mix within Hardware Products revenue due to a lower concentration of high-end appliances revenue and higher concentration of revenue from hardware sold separately for use with our Software Products for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. 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 89:10:1 for the three months ended March 31, 2020, from 57:22:21 for the three months ended March 31, 2019. The mix between Software Products revenue and Hardware Products revenue was relatively consistent representing 68:32 for the three months ended March 31, 2020 and 69:31 for the three months ended March 31, 2019.
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 decrease was further driven by an increase in cloud-based cost with the expansion of our SaaS offering.
The increase in margin on our professional services revenue was primarily driven by improvements made within professional services as we scale our professional services organizations at a lower growth rate than our anticipated professional services revenue growth rate.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation, and with regard to sales and marketing expense, sales commissions.

27


Research and development expense consists primarily of personnel costs. Research and development expense also includes consulting expense, amortization of acquired developed technology, and allocated costs including facilities and information technology related costs. Sales and marketing expense consists primarily of personnel costs. Sales and marketing expense also includes sales commissions, costs for market development programs, promotional and other marketing costs, travel costs, professional services, amortization of acquired customer relationships, and allocated costs including facilities and information technology related costs. Incremental commissions incurred to acquire customer contracts are deferred and recognized as we recognize the associated revenue or over the estimated customer life. General and administrative expense consists of personnel costs, professional services, and allocated costs including facilities and information technology related costs. General and administrative personnel include our executive, finance, human resources, and legal organizations. Professional services consist primarily of legal, auditing, accounting, and other consulting costs. We expect operating expenses to increase in absolute dollars as we continue to invest in our future products and services; however, we expect our operating expenses to decline as a percentage of total revenue in the long term as we scale the business.
 
Three Months Ended March 31,
 
 
 
 
 
2020
 
2019
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Operating expenses:
 
 
 
 
 
 
 
Research and development
$
23,246

 
$
18,497

 
$
4,749

 
26
 %
Sales and marketing
47,288

 
55,923

 
(8,635
)
 
(15
)%
General and administrative
24,481

 
16,213

 
8,268

 
51
 %
Restructuring
2,512

 

 
2,512

 
100
 %