Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
———————————————
FORM 10-Q
———————————————
(Mark One)
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
 
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to             
Commission File Number 001-38253
———————————————
FORESCOUT TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
———————————————
Delaware
51-0406800
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
190 West Tasman Drive
San Jose, California 95134
(Address of principal executive offices, including zip code)
(408) 213-3191
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x
Smaller reporting company
¨
(Do not check if a smaller reporting company)
 
Emerging growth company
x
 
 
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
x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨   No   x
The number of shares outstanding of the registrant’s common stock as of April 30, 2018 was 40,180,616.




TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
Page
 
 5
Item 1.
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
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,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

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

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

our expectations regarding the size of our target market;

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

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

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

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

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

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

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

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

our expectations concerning renewal rates for services and maintenance by existing end-customers and growth of our recurring revenue retention;

our expectations regarding our relationships with third parties, including further development of our relationships with our manufacturer, value-added resellers and channel partners, alliance partners, and our technology and distribution partners;

our plans to expand our international operations;

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

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

3



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

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

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

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

our expectations regarding the portions of our revenue represented by product revenue and maintenance and professional services revenue;

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

the impact on our revenue, gross margin, and profitability of future investments in the enhancement of ForeScout CounterACT®, ForeScout Enterprise Manager, and ForeScout Extended Modules and expansion of our sales and marketing programs;

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

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 described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.


4

PART I. FINANCIAL INFORMATION


ITEM 1.
FINANCIAL STATEMENTS
FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except share and per share amounts)

March 31, 2018
 
December 31, 2017 *As Adjusted
Assets
 
 

Current assets:

 

Cash and cash equivalents
$
82,356

 
$
63,009

Marketable securities
140,663

 
123,384

Accounts receivable
54,780

 
64,686

Inventory
136

 
3,660

Deferred commission - current
10,928

 
10,957

Prepaid expenses and other current assets
10,992

 
9,213

Total current assets
299,855

 
274,909

Deferred commission - non-current
21,413

 
21,795

Property and equipment, net
23,918

 
23,260

Severance pay deposits
2,158

 
2,118

Restricted cash - non-current
4,144

 
4,146

Other assets
2,135

 
2,490

Total assets
$
353,623

 
$
328,718

 
 
 
 
Liabilities and stockholders' equity

 

Current liabilities:

 

Accounts payable
$
1,744

 
$
7,348

Accrued compensation
21,814

 
25,358

Accrued expenses
9,057

 
10,023

Customer deposits
974

 
1,008

Deferred revenue - current
102,273

 
79,631

Notes payable - current
7,266

 
7,245

Total current liabilities
143,128

 
130,613

Deferred revenue - non-current
66,918

 
55,228

Notes payable - non-current
13,754

 
15,579

Accrued severance pay liability
2,780

 
2,617

Other liabilities
9,991

 
9,190

Total liabilities
236,571

 
213,227

 
 
 
 
Stockholders' equity:

 

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

 

39,214,251 and 38,121,951 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively
39

 
38

Additional paid-in capital
581,988

 
551,986

Accumulated other comprehensive loss
(358
)
 
(112
)
Accumulated deficit
(464,617
)
 
(436,421
)
Total stockholders’ equity
117,052

 
115,491

Total liabilities and stockholders' equity
$
353,623

 
$
328,718

 

* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.
See Notes to Condensed Consolidated Financial Statements.

5


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

Three Months Ended
March 31,

2018

2017 *As Adjusted
Revenue:



Product
$
29,780


$
20,308

Maintenance and professional services
29,917


21,868

Total revenue
59,697


42,176

Cost of revenue:



Product
7,136


4,092

Maintenance and professional services
9,350


8,431

Total cost of revenue
16,486


12,523

Total gross profit
43,211


29,653

Operating expenses:



Research and development
14,687


10,947

Sales and marketing
42,279


35,045

General and administrative
13,732


9,215

Total operating expenses
70,698


55,207

Loss from operations
(27,487
)

(25,554
)
Interest expense
(243
)

(345
)
Other income (expense), net 
662


(144
)
Revaluation of warrant liabilities


(392
)
Loss before income taxes
(27,068
)

(26,435
)
Income tax provision
1,128


635

Net loss
$
(28,196
)

$
(27,070
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.74
)

$
(4.57
)
Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted
38,312,835


5,923,858


* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.
See Notes to Condensed Consolidated Financial Statements.


6


FORESCOUT TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands)
 
Three Months Ended
March 31,
 
2018
 
2017 *As Adjusted
Net loss
$
(28,196
)
 
$
(27,070
)
Other comprehensive loss, net of tax:
 
 
 
Change in unrealized gains on marketable securities
(246
)
 

Comprehensive loss
$
(28,442
)
 
$
(27,070
)

* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.
See Notes to Condensed Consolidated Financial Statements.


7


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

Three Months Ended
March 31,

2018

2017 *As Adjusted
Cash flows from operating activities:



Net loss
$
(28,196
)

$
(27,070
)
Adjustments to reconcile net loss to net cash provided by operating activities:




Stock-based compensation
13,590


4,218

Depreciation
1,607


1,381

Revaluation of warrant liabilities


392

Other
(148
)

90

Changes in operating assets and liabilities:




Accounts receivable
9,906


27,961

Inventory
3,524


495

Deferred commission
411


382

Prepaid expenses and other current assets
(1,779
)

(1,791
)
Other assets
253


232

Accounts payable
(5,355
)

(4,172
)
Accrued compensation
(3,544
)

(2,034
)
Accrued expenses
(1,255
)

(1,412
)
Customer deposits
(34
)

11,524

Deferred revenue
34,332


2,501

Severance pay, net
123


179

Other liabilities
1,019


(107
)
Net cash provided by operating activities
24,454


12,769

Cash flows from investing activities:



Purchases of property and equipment
(2,313
)

(1,237
)
Purchases of marketable securities
(26,304
)


Proceeds from maturities of marketable securities
9,000



Net cash used in investing activities
(19,617
)

(1,237
)
Cash flows from financing activities:



Repayments of notes payable
(1,875
)

(1,874
)
Proceeds from exercise of stock options
3,627


122

Repurchase of unvested common stock
(5
)


Payments of deferred offering costs
(1,057
)

(1,479
)
Proceeds from public offerings, net
13,818



Net cash provided by (used in) financing activities
14,508


(3,231
)
Net change in cash, cash equivalents, and restricted cash for period
19,345


8,301

Cash, cash equivalents, and restricted cash at beginning of period
67,357


83,877

Cash, cash equivalents, and restricted cash at end of period
$
86,702


$
92,178



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
$
82,356

 
$
87,855

Restricted cash included in prepaid expenses and other current assets
202

 
201

Restricted cash
4,144

 
4,122

Total cash, cash equivalents, and restricted cash
$
86,702

 
$
92,178


* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.
See Notes to Condensed Consolidated Financial Statements.

8


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 provides an agentless approach to network security that discovers and classifies IP-based devices in real time as the devices connect to the network and continuously monitors and assesses the devices' security posture. The Company's agentless approach supports heterogeneous wired and wireless networks, as well as both virtual and cloud infrastructures, while scaling to meet the needs of globally distributed organizations. The Company offers its solution across two product groups: ForeScout CounterACT and ForeScout Extended Modules. ForeScout CounterACT provides visibility and policy-based mitigation of security issues while ForeScout Extended Modules expand ForeScout CounterACT’s see and control capabilities by sharing contextual device data with third-party systems and by automating policy enforcement across those disparate systems.
The Company sells its products, maintenance 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.
Follow-On Offering
On March 23, 2018, the Company closed its follow-on offering (the “Offering”), in which it issued and sold 500,000 shares of common stock. Further, an additional 4,572,650 shares of its common stock held by certain stockholders were sold, inclusive of the underwriters’ option to purchase additional shares from certain of the selling stockholders. The price to the public was $29.00 per share. The Company received aggregate proceeds of $16.4 million from the Offering, net of underwriters’ discounts and commissions of $0.7 million and inclusive of approximately $2.6 million received by the Company in connection with the exercise by certain selling stockholders of options to purchase an aggregate of 425,436 shares of common stock that were sold in the Offering. The Company incurred offering costs of approximately $1.2 million. The Company did not receive any proceeds from the sale of shares by the selling stockholders in the Offering.
The Company issued and sold shares in the Offering primarily to satisfy a portion of the anticipated tax withholding and remittance obligations related to the initial settlement of outstanding restricted stock units for its executive officers. The Company expects to use the remaining proceeds for general corporate purposes, including headcount expansion, working capital, sales and marketing activities, product development, general and administrative matters, and capital expenditures.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information 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, 2017. 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, except for changes associated with the recent accounting standard for revenue recognition, as detailed in Note 2. The condensed consolidated balance sheet as of December 31, 2017 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

9


consolidated financial statements and related notes in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.
The preparation of interim condensed consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts in the condensed consolidated financial statements and accompanying notes. These estimates form the basis of judgments made about carrying values of assets and liabilities, which are not readily apparent from other sources. The areas where management has made estimates requiring judgment include, but are not limited to, the allocation of revenue in multiple performance obligation contracts, sales return reserve, accruals, stock-based compensation, and provision for income taxes including related reserves. Actual results could differ materially from those estimates.
Summary of Significant Accounting Policies 
Effective January 1, 2018, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2014-09 (Topic 606), Revenue from Contracts with Customers (“ASC 606”), as discussed in detail in Note 2. All amounts and disclosures set forth in this Quarterly Report on Form 10-Q have been updated to comply with ASC 606, as indicated by the "as adjusted" footnote to certain tables.
Except for the impact of the adoption of ASC 606, 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, 2017, filed with the SEC on February 22, 2018, that have had a material impact on the Company's condensed consolidated financial statements and related notes.
Recently Adopted Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606. The Company adopted ASC 606 effective January 1, 2018 using the full retrospective method, which required the Company to restate each prior reporting period presented. Refer to Note 2 for the details of any impacts to previously reported results.
In November 2016, the FASB issued ASU No. 2016-18 (Topic 230), Statement of Cash Flows: Restricted Cash. The new standard requires an entity to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows, and an entity will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. The standard is effective for annual and interim periods within those fiscal years, beginning after December 15, 2017, and should be applied retrospectively. The Company adopted this standard effective January 1, 2018 and as a result of adopting this standard, the Company no longer includes the changes in its restricted cash in net cash used in investing activities. The Company's restricted cash primarily consists of letters of credit issued as security deposits required for facility leases.
Recently Issued and Not Yet Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases. The new guidance requires lessees to recognize right-of-use assets and lease liabilities for those leases classified as operating leases under previous GAAP. The standard is effective for annual and interim periods within those fiscal years, beginning after December 15, 2018, and will be applied on a modified retrospective basis, with the option to elect certain practical expedients. Early adoption is permitted. The Company is currently evaluating the timing and impact of the adoption of this standard on its condensed consolidated financial statements.
Note 2. Revenue, Deferred Revenue and Deferred Commissions
The Company adopted ASC 606 effective January 1, 2018 using the full retrospective method, which required the Company to restate each prior reporting period presented to be consistent with the standard. The most significant impact to revenue recognized related to the accounting for the sale of ForeScout Extended Modules and to a lesser extent the sale of ForeScout CounterACT. ForeScout’s software products include ForeScout CounterACT, ForeScout Extended Modules, CounterACT Virtual Appliances, and CounterACT Enterprise Manager Virtual Appliance ("Software Products"). ForeScout’s hardware products include hardware that is sold separately that is used with ForeScout CounterACT, CounterACT Appliance which are hardware appliances that are embedded with ForeScout CounterACT, and CounterACT Enterprise Manager Appliance (“Hardware Products”).

10


Under previously reported GAAP, the Company established Vendor Specific Objective Evidence (“VSOE”) for professional services, and support and maintenance on Software Products, except Extended Modules, beginning January 1, 2016. Under previously reported GAAP, Software Product related revenue was recognized ratably over the contractually committed support and maintenance period when VSOE was not established. Professional services sold in conjunction with such Software Products were also recognized ratably over the contractually committed support and maintenance period. Under ASC 606, the requirement to have VSOE for undelivered elements is eliminated and the Company now generally recognizes Software Product revenue at the time of delivery, and any related professional services revenue as services are provided to the customers. Further, revenue allocated from future deliverables (primarily support and maintenance) to Hardware Products is now recognized upon delivery under ASC 606 when the standalone selling price is different from the contract price. Under previously reported GAAP, such differences were recognized over the contractual support and maintenance period. Additionally, ASC 606 requires the capitalization of costs to obtain a contract, primarily sales commissions, and the amortization of these costs over the contract period or estimated customer life, which resulted in the recognition of a deferred charge on the Company's condensed consolidated balance sheets. Under previously reported GAAP, the Company expensed all sales commissions and other incremental costs to acquire contracts as they were incurred.
Impacts on Financial Statements
The Company adjusted its condensed consolidated financial statements from amounts previously reported due to the adoption of ASC 606. Select condensed consolidated balance sheet line items, which reflects the adoption of ASC 606, are as follows (in thousands):
 
December 31, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Assets
 
 
 
 
 
Accounts receivable
$
65,428

 
$
(742
)
 
$
64,686

Deferred commission - current
$

 
$
10,957

 
$
10,957

Prepaid expenses and other current assets
$
8,655

 
$
558

 
$
9,213

Deferred commission - non-current
$

 
$
21,795

 
$
21,795

Other assets
$
2,002

 
$
488

 
$
2,490

Liabilities and stockholders' equity (deficit)
 
 

 
 
Deferred revenue - current
$
98,027

 
$
(18,396
)
 
$
79,631

Deferred revenue - non-current
$
64,731

 
$
(9,503
)
 
$
55,228

Accumulated deficit
$
(497,376
)
 
$
60,955

 
$
(436,421
)

11


Select condensed consolidated statement of operations line items, which reflect the adoption of ASC 606, are as follows (in thousands):

 
March 31, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Revenue:
 
 
 
 
 
Product
$
22,105

 
$
(1,797
)
 
$
20,308

Maintenance and professional services
$
22,248

 
$
(380
)
 
$
21,868

Cost of revenue:
 
 


 
 
Product
$
4,411

 
$
(319
)
 
$
4,092

Operating expenses:
 
 


 
 
Sales and marketing
$
34,454

 
$
591

 
$
35,045

Loss from operations
$
(23,105
)
 
$
(2,449
)
 
$
(25,554
)
Net loss
$
(24,621
)
 
$
(2,449
)
 
$
(27,070
)
Net loss per share attributable to common stockholders, basic and diluted
$
(4.16
)
 
$
(0.41
)
 
$
(4.57
)
Unaudited revenue by geographic area based on the billing address of the customer, which reflects the adoption of ASC 606, is as follows (in thousands):

Three Months Ended March 31, 2017

As Previously Reported

Impact of Adoption

As Adjusted
Revenue:








Americas





      United States
$
34,337


$
(889
)

$
33,448

      Other Americas
1,322


(123
)

1,199

      Total Americas
35,659


(1,012
)

34,647

Europe, Middle East, and Africa (“EMEA”)
6,063


(848
)

5,215

Asia Pacific and Japan (“APJ”)
2,631


(317
)

2,314

Total revenue
$
44,353


$
(2,177
)

$
42,176


The adoption of ASC 606 impacted certain line items in the cash flows from operating activities as follows (in thousands):
 
Three Months Ended March 31, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Cash flows from operating activities:
 
 
 
 
 
Net loss
$
(24,621
)
 
$
(2,449
)
 
$
(27,070
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 


 
 
Deferred commission
$

 
$
382

 
$
382

Prepaid expenses and other current assets
$
(1,519
)
 
$
(272
)
 
$
(1,791
)
Other assets
$
69

 
$
163

 
$
232

Deferred revenue
$
325

 
$
2,176

 
$
2,501



12


For each significant customer, both of which are distributors, accounts receivable as a percentage of total accounts receivable, which reflects the adoption of ASC 606, is as follows:
 
December 31, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Customers
 
 
 
 
 
Customer A
32
%
 
1
%
 
33
%
Customer B
17
%
 
%
 
17
%

Revenue Recognition
The Company derives its revenue from sales of products and associated maintenance and professional services. The Company offers its solution across two product groups: ForeScout CounterACT and ForeScout Extended Modules. The Company’s portfolio of Extended Modules are sold as software add-ons to ForeScout CounterACT. ForeScout’s software products include ForeScout CounterACT, ForeScout Extended Modules, CounterACT Virtual Appliances, and CounterACT Enterprise Manager Virtual Appliance. ForeScout’s hardware products include hardware that is sold separately that is used with ForeScout CounterACT, CounterACT Appliance, which are hardware appliances that are embedded with ForeScout CounterACT, and CounterACT Enterprise Manager Appliance. All of the Company’s products are sold with a perpetual license.
Following the adoption of ASC 606, the Company determines revenue recognition through the following steps, which are described in more detail below:
Identification of the contract, or contracts, with a customerA contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services, (ii) the contract has commercial substance, and (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer. The Company’s payment terms typically range between 30 to 90 days.
Identification of the performance obligation(s) in the contractPerformance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the goods or services either on their own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, the Company applies judgment to determine whether promised goods or services are capable of being distinct, and are distinct in the context of the contract. If these criteria are not met, the promised goods or services are accounted for as a combined performance obligation.
Determination of the transaction priceThe transaction price is determined based on the consideration that the Company will be entitled to in exchange for transferring goods or services to the customer. In determining the transaction price, the Company considers uncertainties such as historical rates of product returns and/or concessions.
Allocation of the transaction price to the performance obligation(s) in the contractIf the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price ("SSP") basis. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.
Recognition of revenue when, or as, a performance obligation is satisfiedThe Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized

13


at the time the related performance obligation is satisfied by transferring a promised good or service to a customer.
The following describes the nature of the Company’s primary types of revenue and the revenue recognition policies as they pertain to the types of transactions the Company enters into with its customers.
Product Revenue
Product revenue consists of sales of ForeScout CounterACT, which are sold as Software Products and Hardware Products, and ForeScout Extended Modules, and are recognized at the time of transfer of control, which is generally upon shipment, provided that all other revenue recognition criteria have been met.
Support and Maintenance Revenue
The majority of the products are sold with a support and maintenance contract. Support and maintenance contracts are generally offered as renewable, fixed fee contracts where payments are typically due in advance and generally have a term of one or three years, but can be up to five years. Support and maintenance revenue is recognized ratably over the term of the support and maintenance contract and any unearned support and maintenance 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 performed.
Contract Costs
The Company capitalizes contract origination costs that are incremental and recoverable costs of obtaining a contract with a customer. The Company expects that sales commissions and associated payroll taxes and third-party referral fees related to customer contracts are both incremental and recoverable. The contract origination costs are capitalized and amortized to sales and marketing expense when the related performance obligations are met. Incremental contract origination costs relating to products are expensed as the related products are delivered. Incremental contract origination costs relating to support and maintenance contracts are capitalized and amortized over either the contractual performance period or on a straight-line basis over the average customer life of five years, depending on whether the costs relate to a specific support and maintenance contract or the customer relationship. The Company determines its average customer life by taking into consideration its customer contracts, technology, and other factors. Capitalized costs are periodically reviewed for impairment.
Capitalized contract costs were $33.3 million and $33.8 million as of March 31, 2018 and December 31, 2017, respectively. For the three months ended March 31, 2018, amortization expense for the contract costs was $4.2 million, and there was no impairment loss in relation to the costs capitalized. For the three months ended March 31, 2017, amortization expense for the contract costs was $3.2 million, and there was no impairment loss in relation to the costs capitalized.
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 has no material contract assets. A receivable will be recorded on the condensed consolidated balance sheets when the Company has unconditional rights to consideration. 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 cancelable contracts 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.

14


Significant changes in contract liabilities during the period are as follows (in thousands):
 
Contract Liabilities
January 1, 2018
$
135,866

Additions
94,133

Revenue recognized
(59,834
)
March 31, 2018
$
170,165

During the three months ended March 31, 2018, the Company recognized $27.6 million pertaining to amounts deferred as of December 31, 2017. During the three months ended March 31, 2017, the Company recognized $17.5 million pertaining to amounts deferred as of December 31, 2016.
Contract modifications entered into during the three months ended March 31, 2018 did not have a significant impact on the Company’s contract assets or contract liabilities.
Performance Obligations
The majority of the contracted but not invoiced performance obligations are subject to cancellation terms. Revenue allocated to remaining performance obligations represent contracted revenue that has not yet been recognized (“contracted not recognized”), which includes deferred revenue, certain customer deposits, and non-cancelable amounts that will be invoiced and recognized as revenue in future periods and excludes performance obligations that are subject to cancellation terms. Contracted not recognized revenue was $176.1 million as of March 31, 2018, of which the Company expects to recognize approximately 61% of the revenue over the next 12 months and the remainder thereafter.
Practical Expedients
The Company does not disclose the value of consideration associated with unsatisfied or partially unsatisfied performance obligations for contracts for which the Company recognizes revenue at the amount to which it will have the right to invoice for services performed.
The Company also reflects the aggregate effect of all modifications to a contract that occurred before the earliest period presented instead of retrospectively restating contracts for all previous contract modifications.
Disaggregation of Revenue
The Company generates revenue from the sale of Software Products, Hardware Products, support and maintenance, and professional services. All revenue recognized in the condensed consolidated statement 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,
Revenue:
2018
 
2017
Software products
$
15,802

 
$
6,748

Hardware products
13,978

 
13,560

Support and maintenance
26,359

 
18,876

Professional services
3,558

 
2,992

Total revenue
$
59,697

 
$
42,176

Note 3. Fair Value Measurements
Financial assets are recorded at fair value on the consolidated balance sheets and are categorized based upon the level of judgment associated with inputs used to measure their fair value.
Fair value reflects the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value measurements, the Company considers the principal or most advantageous market and also market-based risk.

15


The accounting guidance for fair value measurements requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The accounting guidance also establishes a fair value hierarchy based on the independence of the source and objective evidence of the inputs used. There are three fair value hierarchies based upon the level of inputs that are significant to fair value measurement:
Level 1—Observable inputs that reflect quoted prices in active markets for identical assets or liabilities.
Level 2—Observable inputs that reflect quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets or liabilities in active markets, inputs other than quoted prices that are observable for the assets or liabilities, or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3—Inputs that are generally unobservable and are supported by little or no market activity, and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.
There have been no transfers between fair value measurement levels during the periods presented. The following table presents the fair value of the Company’s financial assets according to the fair value hierarchy (in thousands):
 
March 31, 2018
 
December 31, 2017
Financial Assets
  Level 1
 
Level 2
 
Level 3
 
  Level 1
 
Level 2
 
Level 3
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
      Cash
$
60,739

 
$

 
$

 
$
24,526

 
$

 
$

      Money market accounts
21,617

 

 

 
38,483

 

 

Total cash and cash equivalents
82,356

 

 

 
63,009

 

 

Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
      Commercial paper

 
54,144

 

 

 
40,610

 

      Corporate debt securities

 
62,706

 

 

 
58,948

 

      U.S. government securities

 
23,813

 

 

 
23,826

 

Total marketable securities

 
140,663

 

 

 
123,384

 

Restricted cash (current and non-current)
4,346

 

 

 
4,348

 

 

Total financial assets
$
86,702

 
$
140,663

 
$

 
$
67,357

 
$
123,384

 
$

Note 4. Marketable Securities
The following table summarizes the amortized cost, unrealized gains and losses, and fair value of the Company’s marketable securities as of March 31, 2018 and December 31, 2017 (in thousands):
 
March 31, 2018
 
December 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
$
54,144

 
$

 
$

 
$
54,144

 
$
40,610

 
$

 
$

 
$
40,610

Corporate debt securities
63,008

 

 
(302
)
 
62,706

 
59,031

 

 
(83
)
 
58,948

U.S. government securities
23,869

 

 
(56
)
 
23,813

 
23,855

 

 
(29
)
 
23,826

Total marketable securities
$
141,021

 
$

 
$
(358
)
 
$
140,663

 
$
123,496

 
$

 
$
(112
)
 
$
123,384

The following table summarizes the amortized cost and fair value of the Company’s available-for-sale securities as of March 31, 2018 and December 31, 2017 by the contractual maturity date (in thousands):

16


 
March 31, 2018
 
December 31, 2017
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due within one year
$
122,397

 
$
122,163

 
$
83,419

 
$
83,374

Due between one and five years
18,624

 
18,500

 
40,077

 
40,010

     Total
$
141,021

 
$
140,663

 
$
123,496

 
$
123,384

For individual marketable securities that were in an unrealized loss position as of March 31, 2018 and December 31, 2017, the fair value and gross unrealized loss for these securities aggregated by investment category and length of time in a continuous unrealized loss position are presented in the following tables (in thousands):
 
March 31, 2018
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Corporate debt securities
$
62,239

 
$
(302
)
 
$

 
$

 
$
62,239

 
$
(302
)
U.S. government securities
23,800

 
(56
)
 

 

 
23,800

 
(56
)
Total
$
86,039

 
$
(358
)
 
$

 
$

 
$
86,039

 
$
(358
)
 
December 31, 2017
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Corporate debt securities
$
58,581

 
$
(83
)
 
$

 
$

 
$
58,581

 
$
(83
)
U.S. government securities
23,771

 
(29
)
 

 

 
23,771

 
(29
)
Total
$
82,352

 
$
(112
)
 
$

 
$

 
$
82,352

 
$
(112
)
Unrealized losses related to these marketable securities are due to interest rate fluctuations as opposed to credit quality. In addition, the Company does not intend to sell and it is not likely that the Company would be required to sell these marketable securities before recovery of their amortized cost basis, which may be at maturity. As a result, there are no other-than-temporary impairments for these marketable securities at March 31, 2018 or December 31, 2017.
Note 5. Equity Award Plans
Stock-Based Compensation
Stock-based compensation expense for both employees and non-employees included in the accompanying condensed consolidated statements of operations is as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017
Cost of revenue:
 
 
 
Product
$
53

 
$
21

Maintenance and professional services
773

 
325

Research and development
2,347

 
800

Sales and marketing
6,180

 
1,657

General and administrative
4,237

 
1,415

     Total
$
13,590

 
$
4,218


17



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 (the “Plans"), and related information (in thousands, except share, 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, 2017
9,313,633

 
$
10.63

 
7.2
 
$
198,012

     Options granted
43,525

 
$
30.81

 

 

     Options exercised
(567,189
)
 
$
6.39

 

 

     Options forfeited
(126,678
)
 
$
16.11

 

 

Balance—March 31, 2018
8,663,291

 
$
10.93

 
6.9
 
$
186,364

Options vested and exercisable—March 31, 2018
5,578,396

 
$
8.90

 
6.3
 
$
131,327

As of March 31, 2018, the total unrecognized compensation cost related to unvested options was $22.5 million, which is expected to be amortized on a straight-line basis over a weighted-average period of approximately 1.9 years.
The fair value of stock option awards granted to employees is estimated using the Black-Scholes option-pricing model. The assumptions used to determine the grant date fair value of employee stock options for the periods presented are as follows:
 
Three Months Ended March 31,
 
2018
 
2017
Fair value of common stock
$29.92 – $30.97
 
$16.73 – $17.78
Risk-free interest rate
2.4% – 2.8%
 
2.0% – 2.1%
Expected term (in years)
6.1
 
6.0 – 6.1
Volatility
48%
 
49%
Dividend yield
—%
 
—%

Restricted Stock Units (“RSUs”)
The following table summarizes RSU activity under the Plans, and related information (in thousands, except share, per share, and contractual life amounts):
 
RSUs Outstanding
 
Number
of
Shares
 
Weighted-
Average
Grant Date Fair Value Per Share
 
Weighted-
Average
Remaining
Contractual
Life (Years)
 
Aggregate
Intrinsic
Value
Balance—December 31, 2017
4,216,001

 
$
20.57

 
1.7
 
$
134,448

     RSUs granted
938,388

 
$
30.59

 
 
 

     RSUs forfeited
(26,236
)
 
$
23.24

 
 
 
 
Balance—March 31, 2018
5,128,153

 
$
22.39

 
1.6
 
$
166,357

As of March 31, 2018, the total unrecognized compensation cost related to unvested RSUs was $86.4 million, which is expected to be amortized over a weighted-average period of approximately 2.3 years.

18


Note 6. 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, 2018 and 2017, the Company recorded a tax provision of $1.1 million and $0.6 million, respectively, representing an effective tax rate of (4.2)% and (2.4)%, respectively. The Company’s effective tax rates for these periods were negative as it has maintained a valuation allowance on the U.S. losses. The key components of the income tax provision primarily consist of foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. As compared to the same period last year, the difference in the effective tax rate is primarily due to a change in the uncertain tax positions as a result of a statutory income tax and withholding tax audit in one of our foreign subsidiaries.
In connection with the Tax Cuts and Jobs Act (the "Tax Act") enacted in December 2017, the Company recorded a provisional amount related to the re-measurement of deferred tax assets from 34% to 21% of $36.5 million, offset by valuation allowance in its income tax expense for the year ended December 31, 2017. The effects of the Tax Act may be adjusted within a one-year measurement period from the enactment date for items that were previously reported as provisional, or where a provisional estimate could not be made. Income tax provision for the three months ended March 31, 2018 did not reflect any adjustment to the provisional amounts previously recorded. The Company will continue to assess the effects of the Tax Act and expects to complete its analysis within the measurement period.  
In addition, the Tax Act provides for new international rules for Global Intangible Low-Tax Income ("GILTI"), Base Erosion Anti-Abuse Tax ("BEAT"), and Foreign Derived Intangible Income ("FDII"), which are effective for tax years beginning after December 31, 2017. BEAT and FDII are not expected to be applicable to the Company in the current year and the income inclusion associated with GILTI is expected to be fully offset by losses generated in the current year.
Note 7. Net Loss Per Share
Basic net loss per share is computed by dividing net loss attributable to common stockholders by basic weighted-average shares outstanding during the period. Diluted net loss per share attributable to common stockholders is computed by dividing net loss attributable to common stockholders 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 attributable to common stockholders (in thousands, except share and per share amounts):
 
Three Months Ended March 31,
 
2018
 
2017 *As Adjusted
 
 
 
 
Net loss attributable to common stockholders
$
(28,196
)
 
$
(27,070
)
Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted
38,312,835

 
5,923,858

Net loss per share attributable to common stockholders, basic and diluted
$
(0.74
)
 
$
(4.57
)
* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.


19


The following securities were excluded from the computation of diluted net loss per share attributable to common stockholders for the periods presented because their inclusion would reduce the net loss per share:
 
As of March 31,
 
2018
 
2017
Options to purchase common stock
8,663,291

 
9,530,252

Unvested early exercised common shares
120,862

 
295,114

Unvested restricted stock units
5,128,153

 
1,899,621

Shares estimated under Employee Stock Purchase Plan
217,931

 

Warrants to purchase common stock
83,237

 
233,023

Redeemable convertible preferred stock

 
24,789,525

Warrants to purchase redeemable convertible preferred stock

 
292,862

Note 8. Segment Information
The Company’s business is conducted globally. The Company’s chief operating decision maker, who is the CEO, reviews financial information presented on a consolidated basis accompanied by information regarding revenue by geographic region for purposes of allocating resources and evaluating financial performance. There is one business activity and there are no segment managers who are held accountable for operations, operating results, and plans for levels, components, or types of products or services below the consolidated unit level. Accordingly, the Company has a single reporting segment and operating unit structure.
Revenue by geographic area is attributed based on the billing address of the customer and is as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017 *As Adjusted
Revenue:
 
 
 
Americas
 
 
 
      United States
$
45,164

 
$
33,448

      Other Americas
2,053

 
1,199

      Total Americas
47,217

 
34,647

Europe, Middle East, and Africa (“EMEA”)
8,519

 
5,215

Asia Pacific and Japan (“APJ”)
3,961

 
2,314

Total revenue
$
59,697

 
$
42,176

* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.

Long-lived assets, net by geographic area are attributed based on legal entity structure and are as follows (in thousands):
 
As of
 
March 31, 2018
 
December 31, 2017
Long-lived assets, net:
 
 
 
United States
$
19,456

 
$
18,989

Israel
4,287

 
3,453

Other
175

 
818

Total long-lived assets, net
$
23,918

 
$
23,260


20


Note 9. Subsequent Events
On April 25, 2018 (the “Settlement Date”), an aggregate of 892,996 shares underlying the RSUs held by the Company's directors and then-current employees vested and settled. Substantially all of the RSUs vest upon the satisfaction of both a service-based vesting condition and a performance-based vesting condition. The performance-based vesting condition became probable on October 26, 2017, which is the effective date of the registration statement for the Company's initial public offering ("IPO"), and was satisfied on the Settlement Date. For the Company's executive officers, 227,044 of the vested shares were withheld to satisfy the tax obligations due for the RSUs that settled on the Settlement Date. The closing price of the Company's common stock on the Settlement Date was $32.76 per share, resulting in tax obligations of $7.4 million in the aggregate. For RSUs held by the Company’s non-executive employees, subject to tax withholding obligations, the Company sold 55,904 shares on the Settlement Date to cover tax obligations of $1.8 million in the aggregate.

21


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our (1) unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) our 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, 2017 included in our Annual Report on Form 10-K for the year ended December 31, 2017. 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 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 generate revenue from sales of products and associated maintenance and professional services. We offer our solution across two product groups: ForeScout CounterACT and ForeScout Extended Modules. Our portfolio of Extended Modules are sold as software add-ons to ForeScout CounterACT. Our software products include ForeScout CounterACT, ForeScout Extended Modules, CounterACT Virtual Appliance and CounterACT Enterprise Manager Virtual Appliances. Our hardware products include hardware that is sold separately that is used with ForeScout CounterACT, CounterACT Appliance (hardware appliances that are embedded with ForeScout CounterACT), and CounterACT Enterprise Manager Appliance. All of our products are sold with a perpetual license. End-customers typically purchase maintenance and professional services when they purchase one or more of our products. Our support and maintenance contracts typically have a one-year or three-year term. We offer a portfolio of professional services and extended support contract options to assist with additional deployment and ongoing advanced technical support. We market and sell our products, maintenance, and professional services through a direct touch, channel-fulfilled model. Our direct sales force is responsible for cultivating relationships and selling solutions to enterprise and government accounts globally. We leverage the global breadth and reach of our channel ecosystem, including value-added resellers and distributors, to fulfill orders and sell to our mid-market end-customers.
Our ForeScout CounterACT and ForeScout Extended Modules are priced based on the number of devices licensed to be managed in increments of 100 devices. Within our ForeScout CounterACT product group, our portfolio of CounterACT Appliances and CounterACT Virtual Appliances are priced based on the number of devices licensed to be managed. Our largest CounterACT Appliances and CounterACT Virtual Appliances are licensed to manage up to 10,000 devices, while our smallest CounterACT Appliances and CounterACT Virtual Appliances are licensed to manage up to 100 devices. Our Hardware Products that are sold separately and used with ForeScout CounterACT can manage up to 20,000 devices. Our CounterACT Enterprise Manager Appliance and CounterACT Enterprise Manager Virtual Appliances (“Enterprise Manager”) are priced based on the number of CounterACT Appliances and CounterACT Virtual Appliances (“Appliances”) managed, respectively. Our high-end Enterprise Managers are licensed to manage up to 200 Appliances, while our low-end Enterprise Managers are licensed to manage up to five Appliances.
First Quarter 2018 Financial Highlights
As of March 31, 2018, we have sold to over 2,800 end-customers in 80 countries, including 19% of the Global 2000, since our inception. For each of the three months ended March 31, 2018 and 2017, we sold to 6% of the Global 2000. Our end-customers represent a broad range of industries, including government, financial services, healthcare, technology, manufacturing, services, entertainment, energy, retail, and education.
We have experienced rapid growth in recent periods. For the three months ended March 31, 2018 and 2017, our revenue was $59.7 million and $42.2 million, respectively, representing period-over-period growth of 42%.
Product revenue was $29.8 million for the three months ended March 31, 2018, an increase of 47% from the three months ended March 31, 2017. Maintenance and professional services revenue was $29.9 million for the three months ended March 31, 2018, an increase of 37% from the three months ended March 31, 2017.

22


For the three months ended March 31, 2018, gross profit was $43.2 million, or 72% of total revenue, compared to gross profit of $29.7 million, or 70% of total revenue, in the three months ended March 31, 2017.
For the three months ended March 31, 2018, operating loss was $27.5 million, or 46% of total revenue, compared to an operating loss of $25.6 million, or 61% of total revenue, in the three months ended March 31, 2017.
For the three months ended March 31, 2018, net loss was $28.2 million compared to a net loss of $27.1 million in the three months ended March 31, 2017.
Net cash provided by operating activities was $24.5 million for the three months ended March 31, 2018, compared to net cash provided by operating activities of $12.8 million in the three months ended March 31, 2017.
Factors Affecting Our Performance
We believe that the growth of our business and our future success are dependent upon many factors, including our ability to retain and increase sales to existing end-customers, extend the reach of our sales force footprint to engage more end-customers, and continue to increase the efficiency by which our sales force engages our end-customers. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address in order to sustain the growth of our business and improve our results of operations.
Continued Retention and Sales to Existing End-Customers
We believe the net-recurring revenue retention rate on our support and maintenance contracts 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 on support and maintenance contracts as the 12 month annualized value of support and maintenance contracts renewed plus the trailing 12 month annualized value of support and maintenance contracts not subject to renewal because the scheduled expiration date of the multi-year support and maintenance contract falls outside of the 12 month period under measurement plus the annualized value of new support and maintenance contracts from end-customers acquired one year prior, in the aggregate, divided by the aggregate of the 12 months annualized value of support and maintenance contracts scheduled to terminate or renew during the 12 month period plus the trailing 12 month annualized value of support and maintenance contracts not subject to renewal because the scheduled expiration date of the multi-year support and maintenance contract falls outside of the 12 month period under measurement. We believe this metric is an indication of the continuing value we provide to our end-customers because it shows the renewal of their support and maintenance contracts on their existing IP-based devices and the expanded value to our end-customers demonstrated by increases in the number of their IP-based devices. Our net-recurring revenue retention rate on support and maintenance contracts as of March 31, 2018 and December 31, 2017 were 127% and 126%, respectively. 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 support and maintenance contracts for the designated set of support and maintenance 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 Software Products or Hardware Products under contract. This metric does not take into account product revenue or professional services revenue. The annualized value of our support and maintenance contracts is a legal and contractual determination made by assessing the contractual terms with our end-customers. The annualized value of our support and maintenance contracts is not determined by reference to historical revenue, deferred revenue, or any other GAAP financial measure over any period.

23


Extending the Reach of Our Sales Force Footprint
We have made substantial investments in our sales force in recent periods in order to address the significant enterprise opportunity caused by an increase in unmanaged devices coming onto networks. We have almost tripled the size of our quota-bearing sales representatives from the beginning of 2015 to March 31, 2018. We expect to continue to make substantial investments in our sales force to increase adoption within the Global 2000 and public sector.
Increasing the Efficiency by which Our Sales Force Engages Our End-Customers
We are focused on increasing the efficiency of our sales force. Over the last 12 months, we have increased hiring in sales enablement and marketing, enhanced sales training activities, and implemented company-wide standards for product positioning in order to instill a culture of success and discipline in our sales organization. Our sales strategy depends on attracting top talent from security organizations, expanding our sales coverage, increasing our pipeline of business, and enhancing productivity. We focus on productivity per quota-carrying sales representative across different levels within the sales organization, and the time it takes our sales representatives to reach productivity. We manage our pipeline on a quarterly basis, by sales representative, to ensure sufficient coverage of our bookings targets. Our ability to manage our sales productivity and pipeline are important factors to the success of our business.
Key Financial Metrics
Non-GAAP Operating Loss and Free Cash Flow
In addition to our results determined in accordance with GAAP, we monitor the non-GAAP financial metrics described below to evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and measure and assess operational efficiencies.
We define non-GAAP operating loss as loss from operations excluding stock-based compensation expense. We consider non-GAAP operating loss to be a useful metric for investors and other users of our financial information in evaluating our operating performance because it excludes the impact of stock-based compensation, a non-cash charge that can vary from period to period for reasons that are unrelated to our core operating performance. This metric also provides investors and other users of our financial information with an additional tool to compare business performance across companies and periods, while eliminating the effects of items that may vary for different companies for reasons unrelated to core operating performance.
We define free cash flow as net cash provided by operating activities less purchases of property and equipment. We consider free cash flow to be an important metric because it measures the amount of cash we use or generate and reflects changes in working capital.
A reconciliation of non-GAAP operating loss to loss from operations, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Three Months Ended March 31,
 
2018

2017
 
 
 
 
 
(In thousands)
Non-GAAP operating loss:
 
 
 
Loss from operations
$
(27,487
)
 
$
(25,554
)
Add: stock-based compensation expense
13,590

 
4,218

Non-GAAP operating loss
$
(13,897
)
 
$
(21,336
)

24


A reconciliation of free cash flow to net cash provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Three Months Ended March 31,
 
2018
 
2017
 
 
 
 
 
(In thousands)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities
$
24,454

 
$
12,769

Less: purchases of property and equipment
(2,313
)
 
(1,237
)
Free cash flow (non-GAAP)
$
22,141

 
$
11,532

Net cash used in investing activities
$
(19,617
)
 
$
(1,237
)
Net cash provided by (used in) financing activities
$
14,508

 
$
(3,231
)
It is important to note that other companies, including companies in our industry, may not use non-GAAP operating loss or free cash flow, may calculate these metrics differently, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of these non-GAAP metrics as comparative measures.
As a result, our non-GAAP operating loss and free cash flow should be considered in addition to, not as substitutes for or in isolation from, measures prepared in accordance with GAAP.
We compensate for these limitations by providing investors and other users of our financial information, reconciliations of non-GAAP operating loss to the corresponding GAAP financial measure, operating loss, and reconciliations of free cash flow to the corresponding GAAP financial measure, cash flow provided by operating activities. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view non-GAAP operating loss and free cash flow in conjunction with the corresponding GAAP financial measure.
Components of Financial Performance
Revenue
We derive revenue from sales of our products, maintenance, and professional services.
Our revenue is comprised of the following:
Product Revenue. Our product revenue is derived from sales of ForeScout CounterACT, which are sold as Software Products and Hardware Products, and ForeScout Extended Modules, and are recognized at the time of transfer of control, which is generally upon shipment, provided that all other revenue recognition criteria have been met. As a percentage of total revenue, we expect our product revenue to vary from quarter to quarter based on seasonal and cyclical factors.
Maintenance and Professional Services Revenue. Our maintenance revenue is derived from support and maintenance contracts with terms that are generally either one or three years, but can be up to five years. We typically bill for support and maintenance contracts upfront. We recognize revenue from support and maintenance over the contractual service period. Our professional services revenue is generally recognized over time as the services are rendered. We intend to invest in our professional services organization to improve the time to deliver these services. As a percentage of total revenue, we expect our maintenance and professional services revenue to vary from quarter to quarter based on seasonal and cyclical factors.
Cost of Revenue
Our cost of revenue is comprised of the following:

25


Cost of Product Revenue. Cost of product revenue primarily consists of costs paid to our third-party contract manufacturer for our Hardware Products. Our cost of product revenue also includes allocated costs, shipping costs, and personnel costs associated with logistics. There is no direct cost of revenue associated with our Software Products because Software Products are delivered electronically. We expect our cost of product revenue to fluctuate from quarter to quarter based on product mix; however, over time, we expect our cost of product revenue to decline as a percentage of product revenue primarily due to a shift in product mix towards increased sales of ForeScout CounterACT deployed in virtual environments, which does not use hardware provided by us, and ForeScout Extended Modules.
Cost of Maintenance and Professional Services Revenue. Cost of maintenance and professional services revenue consists of personnel costs for our global customer support and professional services organization and costs paid to third-party contractors that deliver some of our services. We expect our cost of maintenance and professional services revenue to decline over time as a percentage of our maintenance and professional services revenue as we expect to scale our customer support organization at a lower growth rate than our anticipated maintenance and professional services revenue growth rate.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the mix of products sold between Software Products and Hardware Products; the mix between high-margin and low-margin Hardware Products; the mix of revenue between products, maintenance, and professional services; the average sales price of our products, maintenance and professional services; and manufacturing costs.
Our product margins vary by product. Within the Hardware Products mix, product margin on our high-end CounterACT Appliances was approximately 81% and product margin on our low-end CounterACT Appliances was approximately 58% for each of the three months ended March 31, 2018 and 2017. Product margin on hardware sold separately to be used with ForeScout CounterACT ranged between 20% to 23% for the three months ended March 31, 2018 and 2017. Product margin on our Software Products was approximately 99% for each of the three months ended March 31, 2018 and 2017. We expect our product margins to fluctuate from quarter to quarter based on product mix; however, over time, we expect our product margins to increase as a percentage of product revenue primarily due to a shift in product mix towards increased sales of ForeScout CounterACT deployed in virtual environments, which does not use hardware provided by us, and ForeScout Extended Modules.
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 consists of salaries, benefits, bonuses, stock-based compensation, and with regard to sales and marketing expense, sales commissions.
Research and Development. Research and development expense consists primarily of personnel costs. Research and development expense also includes consulting expense and allocated costs including facilities and information technology related costs. We expect research and development expense to increase in the near term in absolute dollars as we continue to invest in our future products and services; however, we expect our research and development expense to decline as a percentage of total revenue in the long term as we scale the business.
Sales and Marketing. Sales and marketing expense consists primarily of personnel costs. Sales and marketing expense also includes sales commissions, costs for market development programs, promotional and other marketing costs, travel costs, professional services, 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. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations; however, we expect our sales and marketing expense to decline as a percentage of total revenue in the long term as we scale the business.
General and Administrative. General and administrative expense consists of personnel costs, professional services, and allocated costs including facilities and information technology related costs. General and

26


administrative personnel include our executive, finance, human resources, and legal organizations. Professional services consist primarily of legal, auditing, accounting, and other consulting costs. We expect general and administrative expense to increase in absolute dollars due to additional costs associated with being a public company, such as accounting, compliance, insurance, and investor relations; however, we expect our general and administrative expense to decline as a percentage of total revenue in the long term as we scale the business.
Interest Expense
Interest expense consists of interest on our outstanding indebtedness.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income earned on our cash, cash equivalents, and marketable securities, and foreign currency exchange gains (losses) related to transactions denominated in currencies other than the U.S. Dollar.
Revaluation of Warrant Liabilities
Revaluation of warrant liabilities includes adjustments to the estimated fair value of our preferred stock warrants outstanding offset by any gain realized from the exercise of outstanding warrants when the fair value of the warrants exercised is greater than the fair value of the redeemable stock. Prior to our IPO, we mark-to-market our warrant liabilities on a quarterly basis. These warrants were exercised upon our IPO.
Provision for Income Taxes
Provision for income taxes consists primarily of foreign income taxes and 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, 2018 due to foreign income taxes, income tax reserves and U.S. state minimum taxes.

27


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,
 
2018
 
2017
 
 
 
 
 
(In thousands)
Condensed Consolidated Statements of Operations Data:
 
 
 
Revenue:
 
 
 
Product
$
29,780

 
$
20,308

Maintenance and professional services
29,917

 
21,868

Total revenue
59,697

 
42,176

Cost of revenue:
 
 
 
Product (1)
7,136

 
4,092

Maintenance and professional services (1)
9,350

 
8,431

Total cost of revenue
16,486

 
12,523

Total gross profit
43,211

 
29,653

Operating expenses:
 
 
 
Research and development (1)   
14,687

 
10,947

Sales and marketing (1)   
42,279

 
35,045

General and administrative (1)   
13,732

 
9,215

Total operating expenses
70,698

 
55,207

Loss from operations
(27,487
)
 
(25,554
)
Interest expense
(243
)
 
(345
)
Other income (expense), net
662

 
(144
)
Revaluation of warrant liabilities

 
(392
)
Loss before income taxes
(27,068
)
 
(26,435
)
Income tax provision
1,128

 
635

Net loss
$
(28,196
)
 
$
(27,070
)
_____________________    
(1)
Includes stock-based compensation expense as follows:
 
Three Months Ended March 31,
 
2018
 
2017
 
 
 
 
 
(In thousands)
Cost of revenue:
 
 
 
Product
$
53

 
$
21

Maintenance and professional services
773

 
325

Research and development
2,347

 
800

Sales and marketing
6,180

 
1,657

General and administrative
4,237

 
1,415

     Total
$
13,590

 
$
4,218



28


 
Three Months Ended March 31,
 
2018
 
2017
 
 
 
 
 
(As a percentage of total revenue)
Condensed Consolidated Statements of Operations Data:
 
 
 
Revenue:
 
 
 
Product
50
 %
 
48
 %
Maintenance and professional services
50

 
52

Total revenue
100

 
100

Cost of revenue:
 
 
 
Product
12

 
10

Maintenance and professional services
16

 
20

Total cost of revenue
28

 
30

Total gross profit
72

 
70

Operating expenses:
 
 
 
Research and development
24

 
26

Sales and marketing
71

 
83

General and administrative
23

 
22

Total operating expenses
118

 
131

Loss from operations
(46
)
 
(61
)
Interest expense

 
(1
)
Other income (expense), net
1

 

Revaluation of warrant liabilities

 
(1
)
Loss before income taxes
(45
)
 
(63
)
Income tax provision
2

 
1

Net loss
(47
)%
 
(64
)%

Comparison of the Three Months Ended March 31, 2018 and 2017
Revenue
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Product
$
29,780

 
$
20,308

 
$
9,472

 
47
%
Maintenance and professional services
 

 
 

 
 

 
 

Support and maintenance
26,359

 
18,876

 
7,483

 
40
%
Professional services
3,558

 
2,992

 
566

 
19
%
Total maintenance and professional services
29,917

 
21,868

 
8,049

 
37
%
Total revenue
$
59,697

 
$
42,176

 
$
17,521

 
42
%

Product revenue increased $9.5 million, or 47%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to a $9.1 million increase in Software Product revenue, which included

29


a $7.1 million increase in the sale of ForeScout CounterACT and a $2.0 million increase in the sale of Extended Modules. Our Hardware Product revenue remained relatively consistent over these two periods, increasing by $0.4 million.
Maintenance and professional services revenue increased $8.0 million, or 37%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. $2.9 million of the increase in maintenance and professional services revenue was attributed to support and maintenance contract value associated with an initial product sale, $4.5 million was attributed to support and maintenance contracts that were renewals, and $0.6 million was attributed to increased sales of professional services.
Cost of Revenue
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Cost of revenue:
 
 
 
 
 
 
 
Product
$
7,136

 
$
4,092

 
$
3,044

 
74
%
Maintenance and professional services
9,350

 
8,431

 
919

 
11
%
Total cost of revenue
$
16,486

 
$
12,523

 
$
3,963

 
32
%

Total cost of revenue increased $4.0 million, or 32%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.
Product cost of revenue increased $3.0 million, or 74%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to a higher volume of Hardware Products sold, which included a $4.1 million increase in the product costs of hardware sold separately to be used with ForeScout CounterACT, partially offset by $1.0 million decrease in the product costs of CounterACT Appliances sold.
Maintenance and professional services cost of revenue increased $0.9 million, or 11%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 due to increases in personnel costs related to increasing headcount in our customer support and professional services organization. From March 31, 2017 to March 31, 2018, we increased our customer support and professional services organization’s headcount by 9%.
Gross Profit and Gross Margin
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Gross Profit

Gross Margin
 
Gross Profit
 
Gross Margin
 
Gross Profit
 
Gross Margin
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
Product
$
22,644

 
76
%
 
$
16,216

 
80
%
 
$
6,428

 
(4
)%
Maintenance and professional services
20,567

 
69
%
 
13,437

 
61
%
 
7,130

 
8
 %
Total gross profit
$
43,211

 
72
%
 
$
29,653

 
70
%
 
$
13,558

 
2
 %

Gross profit increased by $13.6 million, or 46%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase is consistent with the increases in our revenue and cost of revenue. 

30


Gross margin increased by approximately 200 basis points for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.
Reflective of customer deployment preferences, ForeScout CounterACT can be deployed with or without hardware provided by us. For the three months ended March 31, 2018, the decline of 400 basis points in product margin is reflective of higher concentration of customer deployments using hardware provided by us. While the mix between Software Product revenue and Hardware Product revenue increased to 53% and 47%, respectively, for the three months ended March 31, 2018 from 33% and 67%, respectively, for the three months ended March 31, 2017, the concentration of hardware sold separately to be used with ForeScout CounterACT increased to 43% from 5% of Hardware Products revenue for the three months ended March 31, 2018 and for the three months ended March 31, 2017, respectively. Conversely, the concentration of CounterACT Appliances, which are the hardware appliances that are embedded with ForeScout CounterACT, decreased to 57% from 95% of Hardware Products revenue for the three months ended March 31, 2018 and for the three months ended March 31, 2017, respectively.
The increase of 800 basis points in maintenance and professional services margin was driven by a combination of a shift in revenue mix to higher margin support and maintenance revenue, as well as improvements made within maintenance and professional services as we scale our customer support and professional services organizations at a lower growth rate than our anticipated maintenance and professional services revenue growth rate.
Operating Expenses
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Operating expenses:
 
 
 
 
 
 
 
Research and development
$
14,687

 
$
10,947

 
$
3,740

 
34
%
Sales and marketing
42,279

 
35,045

 
7,234

 
21
%
General and administrative
13,732

 
9,215

 
4,517

 
49
%
Total operating expenses
$
70,698

 
$
55,207

 
$
15,491

 
28
%

Research and development expense increased $3.7 million, or 34%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in personnel costs of $3.4 million driven by a 16% increase in headcount and including an increase in stock compensation expense of $1.5 million.
Sales and marketing expense increased $7.2 million, or 21%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in personnel costs of $7.3 million, including an increase in stock compensation expense of $4.5 million, an increase in commissions of $1.2 million due to higher sales, and an increase in other personnel costs of $1.6 million driven by a 4% increase in headcount.
General and administrative expense increased $4.5 million, or 49%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in personnel costs of $3.6 million driven by a 3% increase in headcount and including an increase in stock compensation expense of $2.8 million.

31


Interest Expense
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Interest expense
$
(243
)
 
$
(345
)
 
$
102

 
(30
)%
Interest expense decreased $0.1 million, or 30%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to the decreasing notes payable balance associated with our amended and restated loan and security agreement entered into on December 22, 2016.
Other Income (Expense), Net
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Other income (expense), net 
$
662

 
$
(144
)
 
$
806

 
560
%
Other income (expense), net increased $0.8 million, or 560%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in interest income from marketable securities.
Revaluation of Warrant Liabilities
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Revaluation of warrant liabilities
$

 
$
(392
)
 
$
392

 
(100
)%

Revaluation of warrant liabilities decreased $0.4 million, or 100%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, as there were no preferred stock warrants outstanding during the three months ended March 31, 2018.
Provision for Income Taxes
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Income tax provision
$
1,128

 
$
635

 
$
493

 
78
%
Effective tax rate
(4.2
)%
 
(2.4
)%
 
 
 
 

We recorded an income tax provision for the three months ended March 31, 2018 due to foreign income taxes, unrecognized tax benefits and U.S. state minimum taxes. The increase in the provision for the three months ended

32


March 31, 2018 compared to the three months ended March 31, 2017 was primarily due to an increase in income tax reserves related to a statutory income tax and withholding tax audit in one of our foreign subsidiaries.
Liquidity and Capital Resources
The following data should be read in conjunction with our condensed consolidated statements of cash flows.
 
 
As of
 
 
March 31, 2018
 
December 31, 2017
 
 
 
 
 
 
 
(In thousands)
Working capital
 
$
156,727

 
$
144,296

Cash, cash equivalents, and marketable securities:
 
 
 
 
Cash and cash equivalents
 
$
82,356

 
$
63,009

Marketable securities
 
140,663

 
123,384

         Total cash, cash equivalents, and marketable securities
 
223,019

 
186,393

Total notes payable
 
21,020

 
22,824

Net cash, cash equivalents, and marketable securities
 
$
201,999

 
$
163,569


Our liquidity and capital resources are derived from our IPO and the Offering and cash flows from operations. Our cash equivalents are comprised of cash and money market accounts. Our marketable securities are comprised of commercial paper, corporate debt securities, and U.S. government securities. We believe our existing cash, cash equivalents, and marketable securities will be sufficient to meet our projected operating requirements for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, and the continuing market acceptance of our products.
At March 31, 2018, our cash, cash equivalents, and marketable securities of $223.0 million were held for general corporate purposes, of which approximately $10.9 million was held outside of the United States. As discussed further in Note 6 to our condensed consolidated financial statements, U.S. taxes have been provided for as prescribed by the Tax Act. We will continue to reinvest our foreign cash outside of the United States. If we were to repatriate these earnings to the United States, any associated withholding tax would not be material.
The significant components of our working capital are cash and cash equivalents, marketable securities, accounts receivable, inventory, current deferred commissions, and prepaid expenses and other current assets, reduced by accounts payable, accrued compensation, accrued expenses, customer deposits, current deferred revenue, and current notes payable. Working capital increased by $12.4 million during the three months ended March 31, 2018, primarily due to an increase in cash and cash equivalents, an increase in marketable securities, an increase in prepaid expenses and other current assets, and a decrease in accounts payable and accrued compensation, partially offset by a decrease in accounts receivable and inventory and an increase in current deferred revenue. The following table summarizes our cash flows for the three months ended March 31, 2018 and 2017.
 
 
Three Months Ended March 31,
2018
 
2017
 
 
 
 
 
 
 
(In thousands)
Net cash provided by operating activities
 
$
24,454

 
$
12,769

Net cash used in investing activities
 
(19,617
)
 
(1,237
)
Net cash provided by (used in) financing activities
 
14,508

 
(3,231
)
Net change in cash, cash equivalents, and restricted cash for period
 
$
19,345

 
$
8,301



33


On the Settlement Date, an aggregate of 892,996 shares underlying the RSUs held by our directors and then-current employees vested and settled. Substantially all of our RSUs vest upon the satisfaction of both a service-based vesting condition and a performance-based vesting condition. The performance-based vesting condition became probable on October 26, 2017, which is the effective date of the registration statement for our IPO, and was satisfied on the Settlement Date. For our executive officers, 227,044 of the vested shares were withheld to satisfy the tax obligations due for the RSUs that settled on the Settlement Date. The price of the Company's common stock on the Settlement Date was $32.76 per share, resulting in tax obligations of $7.4 million in the aggregate. For RSUs held by our non-executive employees, subject to tax withholding obligations, we sold 55,904 shares on the Settlement Date to cover tax obligations of $1.8 million in the aggregate.
Operating Activities
Our operating activities have consisted of net loss adjusted for certain non-cash items and changes in assets and liabilities.
Cash provided by operating activities of $24.5 million for the three months ended March 31, 2018 was primarily due to a net loss of $28.2 million adjusted by non-cash charges of $15.0 million, primarily relating to stock-based compensation and depreciation of property and equipment, and a net increase of $37.6 million in the net change of our operating assets and liabilities. The increase in the net change of our operating assets and liabilities was primarily the result of an increase of $34.3 million in deferred revenue due to higher sales, a decrease of $9.9 million in accounts receivable resulting from increased collections, a decrease of $3.5 million in inventory, and an increase of $1.0 million in other liabilities due to a change in the uncertain tax positions as a result of a statutory income tax and withholding tax audit in one of our foreign subsidiaries. This increase was partially offset by a decrease of $5.4 million in accounts payable, a decrease of $3.5 million in accrued compensation, an increase of $1.8 million in prepaid expenses and other current assets, and a decrease of $1.3 million in accrued expenses, all due to payments made.
Cash provided by operating activities of $12.8 million for the three months ended March 31, 2017 was primarily due to a net loss of $27.1 million adjusted by non-cash charges of $6.1 million, primarily relating to stock-based compensation and depreciation of property and equipment, and a net increase of $33.8 million in the net change of our operating assets and liabilities. The increase in the net change of our operating assets and liabilities was primarily the result of a decrease of $28.0 million in accounts receivable and an increase of $11.5 million in customer deposits resulting from increased collections, and an increase of $2.5 million in deferred revenue due to higher sales. This increase was partially offset by a decrease of $4.2 million in accounts payable, an increase of $1.8 million in prepaid expenses and other current assets, and a decrease of $1.4 million in accrued expenses, all due to payments made. This increase was further offset by a decrease of $2.0 million in accrued compensation as a result of lower commissions payable.
Investing Activities
Our investing activities have consisted of financial instrument purchases and capital expenditures. We expect to continue such activities as our business grows.
Cash used in investing activities during the three months ended March 31, 2018 was $19.6 million, primarily resulting from $26.3 million in purchases of marketable securities, and capital expenditures to purchase property and equipment and demonstration units of $2.3 million related to the continuing growth of our business, partially offset by proceeds from maturities of marketable securities of $9.0 million.
Cash used in investing activities during the three months ended March 31, 2017 was $1.2 million, primarily resulting from capital expenditures to purchase property and equipment and demonstration units of $1.2 million.
Financing Activities
Our financing activities have consisted of proceeds from the issuance of common stock, issuance of shares through our employee equity incentive plans, and repayments of notes payable.
Cash provided by financing activities for the three months ended March 31, 2018 was $14.5 million, primarily due to the proceeds from the Offering of $13.8 million and from the exercise of employee stock options of $3.6 million,

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partially offset by the repayment of notes payable of $1.9 million and payments of $1.1 million for deferred offering costs related to the Offering.
Cash used in financing activities for the three months ended March 31, 2017 was $3.2 million, primarily from the repayment of notes payable of $1.9 million and payments of $1.5 million for deferred offering costs related to our IPO.
Contractual Obligations and Commitments
There were no material changes outside the ordinary course of business during the three months ended March 31, 2018 in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.
Off-Balance Sheet Arrangements
Through March 31, 2018, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
Except for accounting policies related to our adoption of ASC 606, there have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the year ended December 31, 2017. Refer to “Recently Adopted Accounting Pronouncements” in 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.
Revenue Recognition
We derive our revenue from sales of products and associated maintenance and professional services. To the extent a contract includes multiple promised goods or services, we apply judgment to determine whether promised goods or services are capable of being distinct and distinct in the context of the contract. If these criteria are not met, the promised goods or services are accounted for as a combined performance obligation.
Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price, or SSP, basis. We determine standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.
Contract Costs
Incremental contract origination costs relating to support and maintenance contracts are capitalized and amortized over either the contractual performance period or on a straight-line basis over the average customer life of five years, depending on whether the costs relate to a specific support and maintenance contract or the customer relationship. We determine our average customer life by taking into consideration our customer contracts, our technology, and other factors.
Recent Accounting Pronouncements
Refer to 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.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
Our sales contracts are primarily denominated in U.S. Dollars. 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, particularly changes in the Israeli Shekel and British Pound. Additionally, fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our condensed consolidated statements of operations. The effect of an immediate 10% adverse change in foreign exchange rates on foreign-denominated accounts as of each of March 31, 2018 and December 31, 2017 would result in a loss of $1.1 million on our condensed consolidated statements of operations. As our international operations grow, we will continue to reassess our approach to managing the risks relating to fluctuations in foreign currency.
Interest Rate Sensitivity
As of March 31, 2018, we had cash and cash equivalents, and marketable securities of $223.0 million. The primary objectives of our investment activities are to preserve principal, provide liquidity, and maximize income without significantly increasing risk. Some of the marketable securities we invest in are subject to interest risk. To minimize this risk, we maintain our portfolio of cash and cash equivalents, and marketable securities in a variety of securities, including money market accounts, commercial paper, corporate debt securities, and U.S. government securities. Due to the short duration and conservative nature of our investment portfolio, a movement of 10% in market interest rates would not have a material impact on our operating results and the total value of the portfolio. The effect of an immediate 10% change in interest rates at March 31, 2018 would not have been material to our operating results and the total value of the portfolio assuming consistent investment levels.
 
 
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on our evaluation, our principal executive officer and principal financial officer concluded that, as of March 31, 2018, our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission ("SEC") rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

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Changes in Internal Control over Financial Reporting
Except for the implementation of certain internal controls related to the adoption of ASC 606, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the three months ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We implemented certain internal controls to ensure we adequately evaluated our contracts and properly assessed the impact of ASC 606 on our financial statements to facilitate its adoption effective January 1, 2018. In addition, we have made some changes to certain internal controls to reflect new processes that were implemented as a result of the adoption of ASC 606.

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PART II. OTHER INFORMATION

 
 
ITEM 1.
LEGAL PROCEEDINGS
None.
 
 
ITEM 1A.
RISK FACTORS
You should carefully consider the following risks and uncertainties described below, together with all of the other information contained in this Form 10-Q, including the sections titled "Special Note Regarding Forward Looking Statements" and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes. Any of the risks, if realized, could have a material adverse effect on our business, results of operations, prospects, and financial condition, and could cause the trading price of our common stock to decline, which would cause you to lose all or part of your investment. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or deemed to be material by us may impair our operations and performance.
Risks Related to Our Business
As a result of recent changes in our market, sales organization, and go-to-market strategy, our ability to forecast our future results of operations and plan for and model future growth is limited and subject to a number of uncertainties.
Although we were founded in 2000 and launched ForeScout CounterACT in 2006, much of our growth has occurred in recent periods. Our growth reflects a number of macro changes impacting the cyber security market, particularly through the emergence of the Internet of Things ("IoT"), and previously Bring Your Own Device ("BYOD"), initiatives, both of which have contributed to a significant increase in the number of unmanaged devices accessing IT networks and resulted in growing demand for our products. To address this demand, we have made substantial investments in our sales force, which has almost tripled the size of our quota-bearing sales representatives from the beginning of 2015 to March 31, 2018. In ad