Forescout (FSCT) 10-Q2020 Q1 Quarterly report

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

The Company offers its solution across 2 product groups: (i) products for visibility and control capabilities, and (ii) products for orchestration capabilities. The Company’s products for visibility and control capabilities consist of eyeSight, 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 2 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.

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.

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.

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.

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.

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):

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 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 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.

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

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

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.

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.

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:

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):

The following table summarizes the Company’s marketable securities by significant investment categories as of March 31, 2020 and December 31, 2019 (in thousands):

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):

The Company had 5 marketable securities in unrealized loss position as of March 31, 2020. The Company had 0 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):

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.

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):

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

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.

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):

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.

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.

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):

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):

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.

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.

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.

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.

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:

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.

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:

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.

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.

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.

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.

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

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.

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 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.

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.

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.

Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation, and with regard to sales and marketing expense, sales commissions.

Research and development expense consists primarily of personnel costs. Research and development expense also includes consulting expense, 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.

Research and development expense increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to an increase in personnel costs of $4.6 million resulting from 22% increase in headcount, net of 5% decrease in headcount attributable to the Q1 2020 Restructuring Plan.

Sales and marketing expense decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to a decrease in personnel costs of $4.5 million resulting from a 16% decrease in headcount mainly attributable to the Q1 2020 Restructuring Plan and includes a decrease in commissions of $2.3 million consistent with the decrease in revenue for the period. The decrease was further driven by decreases in travel and entertainment expenses and sales and marketing expenses as various marketing events and travels were ceased in response to the COVID-19 pandemic.

General and administrative expense increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to an increase in professional fees of $9.1 million which includes consulting and legal fees in relation to the Merger Agreement.

Restructuring expense increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to the Q1 2020 Restructuring Plan that resulted in a reduction in force of approximately 90 employees worldwide.

Interest expense consists of interest on our outstanding indebtedness.

Interest expense increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019, primarily due to a $16.0 million drawdown of revolving credit facility.

Other (expense) 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.

Other (expense) income, net decreased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 primarily driven by foreign currency remeasurement and transaction losses.

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. 

We recorded an income tax provision for the three months ended March 31, 2020 due to foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The decrease in income tax provision for the three months ended March 31, 2020 was primarily related to a decrease in discrete tax expenses. The effective tax rate increased for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 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.

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 our consolidated financial statements.

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

Our liquidity and capital resources are derived from cash received from our initial public offering and follow-on offering, and cash flows from operations. Further, during the three months ended March 31, 2020, we elected to drawdown on the revolving credit facility available to us in light of the macro-economic conditions and its potential impact on credit market availability in the future. Our cash equivalents are comprised of cash and money market accounts. Our marketable securities are comprised of corporate-debt 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 as well as the timing of the closing of the Merger and the duration and extent of the COVID-19 pandemic and its effect on our business.

At March 31, 2020, our cash, cash equivalents, and marketable securities of $99.9 million were held for general corporate purposes, of which approximately $29.3 million was held outside of the United States. We will continue to reinvest our foreign cash outside of the United States. If we were to repatriate these earnings to the United States, any associated withholding tax would not be material.

The significant components of our working capital are cash and cash equivalents, marketable securities, accounts receivable, current deferred commissions, and prepaid expenses and other current assets, reduced by accounts payable, accrued compensation, accrued expenses, current deferred revenue, current notes payable, and current operating lease liabilities. Working capital decreased by $47.8 million during the three months ended March 31, 2020, primarily due to a decrease in accounts receivable, an increase in the revolving credit facility ($16 million), decrease in marketable securities, and decrease in prepaid expenses and other current assets, partially offset by increase in cash and cash equivalents, decrease in accrued compensation, decrease in accounts payable, and decrease in current notes payable. The following table summarizes our cash flows for the three months ended March 31, 2020 and 2019.

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 $(14.5) million and $6.4 million for the three months ended March 31, 2020 and 2019, respectively, representing a decrease of $20.9 million as compared to the three months ended March 31, 2019. The decrease in generation of cash during the three months ended March 31, 2020 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.

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

Cash provided by investing activities during the three months ended March 31, 2020 was $12.2 million, primarily resulting from proceeds from maturities of marketable securities of $13.0 million, partially offset by capital expenditures to purchase property and equipment of $0.8 million related to the continuing growth of our business.

Cash used in investing activities during the three months ended March 31, 2019 was $10.1 million, primarily resulting from purchases of marketable securities of $37.7 million and capital expenditures to purchase property and equipment of $1.6 million related to the continuing growth of our business, partially offset by proceeds from maturities of marketable securities of $29.1 million.

Our financing activities have consisted of proceeds from revolving credit facility, 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 three months ended March 31, 2020 was $17.0 million, primarily from the proceeds from drawdown of revolving credit facility of $16.0 million and the proceeds from the sales of shares through our employee equity incentive plans of $5.2 million, partially offset by payments related to shares withheld for taxes on the vesting of restricted stock units of $2.3 million and the repayment of notes payable of $1.9 million.

Cash provided by financing activities for the three months ended March 31, 2019 was $7.5 million, primarily from the sale of shares through our employee equity incentive plans of $12.2 million, partially offset by payments related to shares withheld for taxes on the vesting of restricted stock units of $2.8 million, and the repayment of notes payable of $1.9 million.

During the three months ended March 31, 2020, we elected to drawdown $16.0 million on the revolving credit facility available to us in light of the macro-economic conditions and its potential impact on credit market availability in the future, if it were to be necessary. Aside from the drawdown of the revolving credit facility, there were no material changes outside the ordinary course of business during the three months ended March 31, 2020 in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019.

Through March 31, 2020, 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.

See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2019. There were no changes to our Critical Accounting Policies and Estimates for the three months ended March 31, 2020.

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.

Our sales contracts are primarily denominated in U.S. Dollar. A portion of our operating expenses are incurred outside of the United States, are denominated in foreign currencies, and are subject to fluctuations due to changes in foreign currency exchange rates. We performed a sensitivity analysis of these risks to our financial positions as of March 31, 2020 to determine whether material changes in market risks pertaining to currency and interest rates have occurred as a result of COVID-19. 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, 2019. See section titled “Risk Factors” for further discussion of the possible impact of COVID-19 on our business.

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 March 31, 2020, 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,

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.

On January 2, 2020, a complaint was filed in the United States District Court, Northern District of California, by Christopher L. Sayce, individually, and on behalf of all others similarly situated, against the Company and two of its executive officers, for violations of the federal securities laws following the Company’s pre-earnings release announcement on October 10, 2019. The complaint, which purports to be brought on behalf of a class of purchasers of the Company’s securities during the period from February 7, 2019 through October 9, 2019, seeks to recover damages for such violations and to pursue remedies under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The claim does not state a value for potential damages. Based on the Company’s preliminary review, the Company believes the claim to be without merit and plans to vigorously defend itself to the maximum extent allowed by the law.