10-Q 1 forescout0930201810q.htm 10-Q 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 September 30, 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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  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.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x
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 November 1, 2018 was 42,862,220.





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

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

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

our expectations regarding the size of our target market;

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

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

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

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

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

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

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

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

our expectations concerning renewal rates of maintenance contracts with end-customers;

our plans to expand our international operations;

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

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

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


3


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® 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. 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)

September 30, 2018
 
December 31, 2017 *As Adjusted
Assets
 
 

Current assets:

 

Cash and cash equivalents
$
129,035

 
$
63,009

Marketable securities
81,289

 
123,384

Accounts receivable
67,967

 
64,686

Inventory
322

 
3,660

Deferred commissions - current
10,667

 
10,957

Prepaid expenses and other current assets
11,786

 
9,213

Total current assets
301,066

 
274,909

Deferred commissions - non-current
20,942

 
21,795

Property and equipment, net
24,376

 
23,260

Severance pay deposits
2,162

 
2,118

Restricted cash - non-current
1,189

 
4,146

Other assets
2,196

 
2,490

Total assets
$
351,931

 
$
328,718

 
 
 
 
Liabilities and stockholders' equity

 

Current liabilities:

 

Accounts payable
$
902

 
$
7,348

Accrued compensation
23,819

 
25,358

Accrued expenses
11,410

 
10,023

Customer deposits
331

 
1,008

Deferred revenue - current
95,448

 
79,631

Notes payable - current
7,309

 
7,245

Total current liabilities
139,219

 
130,613

Deferred revenue - non-current
66,633

 
55,228

Notes payable - non-current
10,089

 
15,579

Accrued severance pay liability
2,783

 
2,617

Other liabilities
7,964

 
9,190

Total liabilities
226,688

 
213,227

 
 
 
 
Stockholders' equity:

 

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

 

42,694,365 and 38,121,951 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
43

 
38

Additional paid-in capital
618,656

 
551,986

Accumulated other comprehensive loss
(147
)
 
(112
)
Accumulated deficit
(493,309
)
 
(436,421
)
Total stockholders’ equity
125,243

 
115,491

Total liabilities and stockholders' equity
$
351,931

 
$
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
September 30,
 
Nine Months Ended
September 30,

2018

2017 *As Adjusted
 
2018
 
2017 *As Adjusted
Revenue:



 
 
 
 
Product
$
51,082


$
43,204

 
$
115,185

 
$
90,354

Maintenance and professional services
34,546


26,136

 
97,734

 
71,143

Total revenue
85,628


69,340

 
212,919

 
161,497

Cost of revenue:
 
 
 
 
 
 
 
Product
8,947


7,240

 
21,002


16,877

Maintenance and professional services
10,250


8,688

 
29,394


25,662

Total cost of revenue
19,197


15,928

 
50,396


42,539

Total gross profit
66,431


53,412

 
162,523


118,958

Operating expenses:
 
 
 
 
 
 
 
Research and development
15,062


10,985

 
44,552


32,634

Sales and marketing
46,098


34,028

 
133,416


102,629

General and administrative
13,880


9,148

 
40,872


27,265

Total operating expenses
75,040


54,161

 
218,840


162,528

Loss from operations
(8,609
)

(749
)
 
(56,317
)

(43,570
)
Interest expense
(208
)

(290
)
 
(676
)

(953
)
Other income (expense), net 
865


160

 
2,040


(66
)
Revaluation of warrant liabilities



 


(342
)
Loss before income taxes
(7,952
)

(879
)
 
(54,953
)

(44,931
)
Income tax provision
334


412

 
1,935


1,221

Net loss
$
(8,286
)

$
(1,291
)
 
$
(56,888
)

$
(46,152
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.20
)

$
(0.21
)
 
$
(1.41
)
 
$
(7.65
)
Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted
42,064,356


6,139,876

 
40,294,019

 
6,032,427


* 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
September 30,
 
Nine Months Ended
September 30,
 
2018

2017 *As Adjusted
 
2018
 
2017 *As Adjusted
Net loss
$
(8,286
)

$
(1,291
)
 
$
(56,888
)
 
$
(46,152
)
Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on marketable securities
135



 
(35
)
 

Comprehensive loss
$
(8,151
)

$
(1,291
)
 
$
(56,923
)
 
$
(46,152
)

* 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)

Nine Months Ended
September 30,

2018

2017 *As Adjusted
Cash flows from operating activities:



Net loss
$
(56,888
)

$
(46,152
)
Adjustments to reconcile net loss to net cash provided by operating activities:




Stock-based compensation
39,544


12,060

Depreciation
5,490


4,451

Revaluation of warrant liabilities


342

Other
113


259

Changes in operating assets and liabilities:




Accounts receivable
(3,414
)

(4,286
)
Inventory
3,348


835

Deferred commissions
1,143


(2,483
)
Prepaid expenses and other current assets
(1,924
)

66

Other assets
(154
)

336

Accounts payable
(6,110
)

(3,319
)
Accrued compensation
(1,539
)

3,820

Accrued expenses
1,704


(567
)
Customer deposits
(677
)

5,788

Deferred revenue
27,222


32,333

Severance pay, net
122


208

Other liabilities
(588
)

(128
)
Net cash provided by operating activities
7,392


3,563

Cash flows from investing activities:



Purchases of property and equipment
(6,766
)

(3,386
)
Purchases of marketable securities
(54,530
)


Proceeds from maturities of marketable securities
97,050



Net cash provided by (used in) investing activities
35,754


(3,386
)
Cash flows from financing activities:



Repayments of notes payable
(5,625
)

(5,624
)
Proceeds from sales of shares through employee equity incentive plans
24,648


960

Payment related to shares withheld for taxes on vesting of restricted stock units
(10,727
)
 

Proceeds from public offerings, net
13,818

 

Payments of deferred offering costs
(1,542
)

(2,708
)
Net cash provided by (used in) financing activities
20,572


(7,372
)
Net change in cash, cash equivalents, and restricted cash for period
63,718


(7,195
)
Cash, cash equivalents, and restricted cash at beginning of period
67,357


83,877

Cash, cash equivalents, and restricted cash at end of period
$
131,075


$
76,682



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
$
129,035

 
$
72,344

Restricted cash included in prepaid expenses and other current assets
851

 
201

Restricted cash
1,189

 
4,137

Total cash, cash equivalents, and restricted cash
$
131,075

 
$
76,682


* 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
The Company closed its follow-on offering (the “Offering”) in March 2018, in which it issued and sold 500,000 shares of its common stock. Further, an additional 4,572,650 shares of its common stock were sold by certain stockholders in the Offering, 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.
Common Stock Warrants
During the second quarter of 2018, 83,163 common stock warrants, which were outstanding and exercisable as of December 31, 2017 were exercised. In lieu of payment of the aggregate warrant price, the warrant holder elected a “cashless exercise”, whereby a portion of the shares equal to the aggregate warrant price were withheld. The fair market value one day prior to the exercise date was $33.36, which resulted in 66,661 shares being issued by the Company. As of September 30, 2018, 74 common stock warrants remained outstanding and exercisable.
Basis of Presentation
The accompanying condensed consolidated financial statements are unaudited and have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) using accounting policies that are consistent with those used in the preparation of the Company’s audited consolidated financial statements for the year ended December 31, 2017. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted as permitted by the SEC's rules and regulations. The Company’s condensed consolidated financial statements include the results of ForeScout Technologies, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The condensed consolidated financial statements are unaudited and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s quarterly results, except for changes associated with the recent accounting standard for revenue recognition, as detailed

9


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 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. See 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 (“ASU 2016-02”). The new standard requires lessees to recognize leases on their balance sheet as a right-of-use asset and a lease liability. The standard requires a modified retrospective transition approach and provides certain optional transitional relief. In July 2018, the FASB issued ASU No. 2018-10 (Topic 842), Codification Improvements to Topic 842, Leases (“ASU 2018-10”), and ASU No. 2018-11 (Topic 842), Targeted Improvements (“ASU 2018-11”). ASU 2018-11 provides a new transition method in which an entity can initially apply the new lease standards at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The standard is effective for the Company in the first quarter of fiscal 2019, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this standard on its condensed consolidated financial statements. The Company expects that most of its operating lease commitments will be subject to the new standard and recognized as lease liabilities and right-of-use assets upon adoption, which will increase the total assets and total liabilities reported.

10


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 Appliances (“Software Products”). ForeScout’s hardware products include hardware that is sold separately for use with ForeScout CounterACT, CounterACT Appliances which are hardware appliances that are embedded with ForeScout CounterACT, and CounterACT Enterprise Manager Appliances (“Hardware Products”).
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 reflect 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 commissions - current
$

 
$
10,957

 
$
10,957

Prepaid expenses and other current assets
$
8,655

 
$
558

 
$
9,213

Deferred commissions - 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):

 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
39,192

 
$
4,012

 
$
43,204

 
$
83,889

 
$
6,465

 
$
90,354

Maintenance and professional services
$
25,164

 
$
972

 
$
26,136

 
$
71,026

 
$
117

 
$
71,143

Cost of revenue:
 
 


 
 
 
 
 
 
 
 
Product
$
7,201

 
$
39

 
$
7,240

 
$
17,117

 
$
(240
)
 
$
16,877

Operating expenses:
 
 


 
 
 
 
 
 
 
 
Sales and marketing
$
34,957

 
$
(929
)
 
$
34,028

 
$
104,515

 
$
(1,886
)
 
$
102,629

Loss from operations
$
(6,623
)
 
$
5,874

 
$
(749
)
 
$
(52,278
)
 
$
8,708

 
$
(43,570
)
Net loss
$
(7,165
)
 
$
5,874

 
$
(1,291
)
 
$
(54,860
)
 
$
8,708

 
$
(46,152
)
Net loss per share attributable to common stockholders, basic and diluted
$
(1.17
)
 
$
0.96

 
$
(0.21
)
 
$
(9.09
)
 
$
1.44

 
$
(7.65
)
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 September 30, 2017
 
Nine Months Ended September 30, 2017

As Previously Reported

Impact of Adoption

As Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Revenue:








 
 
 
 
 
 
Americas





 
 
 
 
 
 
      United States
$
50,348


$
4,649


$
54,997

 
$
119,409

 
$
3,973

 
$
123,382

      Other Americas
1,602


529


2,131

 
3,989

 
719

 
4,708

      Total Americas
51,950


5,178


57,128

 
123,398

 
4,692

 
128,090

Europe, Middle East, and Africa
8,071


(308
)

7,763

 
21,275

 
1,836

 
23,111

Asia Pacific and Japan
4,335


114


4,449

 
10,242

 
54

 
10,296

Total revenue
$
64,356


$
4,984


$
69,340

 
$
154,915

 
$
6,582

 
$
161,497


12



The adoption of ASC 606 impacted certain line items in the cash flows from operating activities as follows (in thousands):
 
Nine Months Ended September 30, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Cash flows from operating activities:
 
 
 
 
 
Net loss
$
(54,860
)
 
$
8,708

 
$
(46,152
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
 
Deferred commissions
$

 
$
(2,483
)
 
$
(2,483
)
Prepaid expenses and other current assets
$
177

 
$
(111
)
 
$
66

Other assets
$
(131
)
 
$
467

 
$
336

Deferred revenue
$
39,014

 
$
(6,681
)
 
$
32,333


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 is 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 Appliances. ForeScout’s Hardware Products include hardware that is sold separately for use with ForeScout CounterACT, CounterACT Appliances, which are hardware appliances that are embedded with ForeScout CounterACT, and CounterACT Enterprise Manager Appliances. 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

13


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 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 $32.2 million and $33.8 million as of September 30, 2018 and December 31, 2017, respectively. For the three and nine months ended September 30, 2018, amortization expense for the contract costs was $3.7 million and $11.7 million, respectively, and there was no impairment loss in relation to the costs capitalized. For

14


the three and nine months ended September 30, 2017, amortization expense for the contract costs was $2.8 million and $8.7 million, respectively, 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 non-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.
Significant changes in contract liabilities during the periods presented are as follows (in thousands):
 
Three Months Ended September 30, 2018
 
Contract Liabilities
Balance as of June 30, 2018
$
147,539

Additions
100,496

Gross revenue recognized
(85,623
)
Balance as of September 30, 2018
$
162,412

 
Nine Months Ended September 30, 2018
 
Contract Liabilities
Balance as of January 1, 2018
$
135,867

Additions
239,597

Gross revenue recognized
(213,052
)
Balance as of September 30, 2018
$
162,412

During the three and nine months ended September 30, 2018, the Company recognized revenue of $28.5 million and $66.5 million that was included in the contract liabilities balance as of June 30, 2018 and December 31, 2017, respectively. During the three and nine months ended September 30, 2017, the Company recognized revenue of $22.7 million and $44.0 million that was included in the contract liabilities balance as of June 30, 2017 and December 31, 2016, respectively.
Contract modifications entered into during the nine months ended September 30, 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 $162.6 million as of September 30, 2018, of which the Company expects to recognize approximately 59% of the revenue over the next 12 months and the remainder thereafter.

15


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 September 30,
 
Nine Months Ended September 30,
Revenue:
2018
 
2017
 
2018
 
2017
Software products
$
28,423

 
$
18,550

 
$
68,718


$
35,038

Hardware products
22,659

 
24,654

 
46,467


55,316

Support and maintenance
30,339

 
22,789

 
85,684


61,674

Professional services
4,207

 
3,347

 
12,050


9,469

Total revenue
$
85,628

 
$
69,340

 
$
212,919


$
161,497

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.
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.

16


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):
 
September 30, 2018
 
December 31, 2017
Financial Assets
  Level 1
 
Level 2
 
Level 3
 
  Level 1
 
Level 2
 
Level 3
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
      Cash
$
46,352

 
$

 
$

 
$
24,526

 
$

 
$

      Money market accounts
82,683

 

 

 
38,483

 

 

Total cash and cash equivalents
129,035

 

 

 
63,009

 

 

Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
      Commercial paper

 
12,948

 

 

 
40,610

 

      Corporate debt securities

 
52,407

 

 

 
58,948

 

      U.S. government securities

 
15,934

 

 

 
23,826

 

Total marketable securities

 
81,289

 

 

 
123,384

 

Restricted cash (current and non-current)
2,040

 

 

 
4,348

 

 

Total financial assets
$
131,075

 
$
81,289

 
$

 
$
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 September 30, 2018 and December 31, 2017 (in thousands):
 
September 30, 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
$
12,948

 
$

 
$

 
$
12,948

 
$
40,610

 
$

 
$

 
$
40,610

Corporate debt securities
52,521

 

 
(114
)
 
52,407

 
59,031

 

 
(83
)
 
58,948

U.S. government securities
15,966

 

 
(32
)
 
15,934

 
23,855

 

 
(29
)
 
23,826

Total marketable securities
$
81,435

 
$

 
$
(146
)
 
$
81,289

 
$
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 September 30, 2018 and December 31, 2017 by the contractual maturity date (in thousands):
 
September 30, 2018
 
December 31, 2017
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due within one year
$
81,435

 
$
81,289

 
$
83,419

 
$
83,374

Due between one and five years

 

 
40,077

 
40,010

     Total
$
81,435

 
$
81,289

 
$
123,496

 
$
123,384

The Company had 18 and 20 marketable securities in unrealized loss positions as of September 30, 2018 and December 31, 2017, respectively. For individual marketable securities that were in an unrealized loss position as of September 30, 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):

17


 
September 30, 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
$
52,407

 
$
(114
)
 
$

 
$

 
$
52,407

 
$
(114
)
U.S. government securities
15,933

 
(32
)
 

 

 
15,933

 
(32
)
Total
$
68,340

 
$
(146
)
 
$

 
$

 
$
68,340

 
$
(146
)
 
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 September 30, 2018 or December 31, 2017.
Note 5. Equity Award Plans
Stock-Based Compensation
Stock-based compensation expense included in the accompanying condensed consolidated statements of operations is as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenue:
 
 
 
 
 
 
 
Product
$
67


$
19


$
174


$
60

Maintenance and professional services
715


286


2,211


930

Research and development
2,613


630


7,473


2,043

Sales and marketing
6,165


1,602


18,195


4,868

General and administrative
3,458


1,372


11,491


4,159

     Total
$
13,018


$
3,909


$
39,544


$
12,060



18


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
(2,583,539
)
 
$
8.05

 

 

     Options forfeited
(270,588
)
 
$
15.87

 

 

Balance—September 30, 2018
6,503,031

 
$
11.57

 
6.8
 
$
170,314

Options vested and exercisable—September 30, 2018
4,490,307

 
$
9.84

 
6.4
 
$
125,351

As of September 30, 2018, the total unrecognized compensation cost related to unvested options was $15.1 million, which is expected to be amortized on a straight-line basis over a weighted-average period of approximately 1.5 years.
The fair value of stock option awards granted to employees is estimated using the Black-Scholes option-pricing model. No stock option awards were granted during the three months ended September 30, 2018. The assumptions used to determine the grant date fair value of employee stock options for the periods presented are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Fair value of common stock
-
 
$19.78 – $19.78
 
$29.92 – $30.97
 
$16.73 – $19.78
Risk-free interest rate
-
 
1.9% – 2.0%
 
2.4% – 2.8%
 
1.9% – 2.1%
Expected term (in years)
-
 
6.0 – 6.1
 
6.1
 
6.0 – 6.1
Volatility
-
 
47% – 48%
 
48%
 
47% – 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
2,379,117

 
$
32.99

 
 
 

     RSUs vested
(1,472,140
)
 
$
14.60

 
 
 


     RSUs forfeited
(108,755
)
 
$
24.88

 
 
 
 
Balance—September 30, 2018
5,014,223

 
$
28.12

 
1.9
 
$
189,337

As of September 30, 2018, the total unrecognized compensation cost related to unvested RSUs was $112.2 million, which is expected to be amortized over a weighted-average period of approximately 2.9 years.

19


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 vested 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 was 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, 55,904 shares were sold on the Settlement Date to cover tax obligations of $1.8 million in the aggregate.
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 and nine months ended September 30, 2018, the Company recorded a tax provision of $0.3 million and $1.9 million, respectively, representing an effective tax rate of (4.2)% and (3.5)%, respectively. For the three and nine months ended September 30, 2017, the Company recorded a tax provision of $0.4 million and $1.2 million, respectively, representing an effective tax rate of (46.9)% and (2.7)%, respectively. The Company’s effective tax rates for these periods were negative as it has maintained a valuation allowance on the U.S. losses. The key components of the income tax provision primarily consist of foreign income taxes, unrecognized tax benefits, and U.S. state minimum taxes. The effective tax rate increased for the three months ended September 30, 2018 compared to the three months ended September 30, 2017 primarily due to an increase in worldwide loss before income taxes. The loss was primarily generated in the United States and does not impact the provision for income taxes as it was offset by a full valuation allowance.
On April 22, 2018, the Supreme Court of Israel ruled to uphold a decision for stock based compensation to be included within Israeli entities’ transfer pricing reimbursement arrangements. For the second quarter of 2018, the Company had appropriately recorded an uncertain tax position for this matter, but required additional time to assess the application of the court ruling to the Company's facts. In the third quarter of 2018, the Company concluded that its Israeli tax return filing position should include a transfer pricing adjustment for stock based compensation. As a result, the Company’s liability associated with uncertain tax positions decreased by approximately $1.9 million with a corresponding increase to current income tax payable included in accrued expenses.
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 Tax Act also provided for a one-time deemed mandatory repatriation of post-1986 undistributed foreign subsidiary earnings and profits ("E&P") through the year ended December 31, 2017. The Company had a provisional $6.9 million of undistributed foreign E&P subject to repatriation, however, no tax liability was recognized as of the calendar year end because the deemed repatriation is expected to be fully offset by net operating losses. 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 and nine months ended September 30, 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 there was no income inclusion associated with GILTI for the three and nine months ended September 30, 2018.
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.

20


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 September 30,
 
Nine Months Ended September 30,
 
2018
 
2017 *As Adjusted
 
2018
 
2017 *As Adjusted
Net loss attributable to common stockholders
$
(8,286
)
 
$
(1,291
)
 
$
(56,888
)
 
$
(46,152
)
Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted
42,064,356

 
6,139,876

 
40,294,019

 
6,032,427

Net loss per share attributable to common stockholders, basic and diluted
$
(0.20
)
 
$
(0.21
)
 
$
(1.41
)
 
$
(7.65
)
* See Note 2 for a summary of adjustments related to the adoption of the new revenue recognition standard.

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 September 30,
 
2018
 
2017
Options to purchase common stock
6,503,031

 
9,413,141

Unvested early exercised common shares
71,249

 
231,423

Unvested restricted stock units
5,014,223

 
3,031,223

Shares estimated under Employee Stock Purchase Plan
148,145

 

Warrants to purchase common stock
74

 
233,023

Redeemable convertible preferred stock

 
24,788,362

Warrants to purchase redeemable convertible preferred stock

 
292,862

Note 8. Subsequent Events
On November 7, 2018, the Company completed the acquisition of SecurityMatters, B.V. (“SecurityMatters”) for a total purchase price of approximately $113.3 million in cash, subject to purchase price adjustments. The SecurityMatters acquisition is intended to enhance the Company’s market-leading solutions with deeper visibility into the operational technology network stack. The acquisition will be accounted for as a business combination. The Company has not yet completed its acquisition accounting for this transaction and is in the process of evaluating the impact of the business combination on its consolidated financial statements.

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) 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 for use with ForeScout CounterACT, CounterACT Appliances (hardware appliances that are embedded with ForeScout CounterACT), and CounterACT Enterprise Manager Appliances. 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 sell to our end-customers.
Beginning in April 2018, customers can purchase ForeScout CounterACT in license increments of 100 devices, with hardware sold separately based on customer deployment requirements. Customers can also purchase CounterACT Appliances and CounterACT Virtual Appliances that are licensed to manage device counts as small as 100 devices and as large as 10,000 devices. Customers can purchase our portfolio of ForeScout Extended Modules in license increments of 100. Customers can manage their deployments of our products in its varying options that can scale and manage deployments of up to 2,000,000 devices under a single CounterACT Enterprise Manager.
Third Quarter 2018 Financial Highlights
As of September 30, 2018, we have sold to over 3,000 end-customers in over 80 countries, including 20% of the Global 2000, since our inception. For the three months ended September 30, 2018 and 2017, we sold to 7% and 6% of the Global 2000, respectively. Our end-customers represent a broad range of industries, including government, financial services, healthcare, technology, manufacturing, services, entertainment, retail, energy, and education.

22


The following table summarizes our key financial highlights for the periods presented in dollars and as a percentage of our total revenue.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Product revenue
$
51,082

 
$
43,204

 
$
115,185

 
$
90,354

Product revenue year-over-year percentage growth
18
 %
 
 
 
27
 %
 
 
Maintenance and professional services revenue
34,546

 
26,136

 
97,734

 
71,143

Maintenance and professional services revenue year-over-year percentage growth
32
 %
 
 
 
37
 %
 
 
Total revenue
85,628

 
69,340

 
212,919

 
161,497

Total revenue year-over-year percentage growth
23
 %
 
 
 
32
 %
 
 
Gross profit
66,431

 
53,412

 
162,523

 
118,958

Gross margin
78
 %
 
77
 %
 
76
 %
 
74
 %
Loss from operations
(8,609
)
 
(749
)
 
(56,317
)
 
(43,570
)
Loss from operations as a percentage of total revenue
(10
)%
 
(1
)%
 
(26
)%
 
(27
)%
Net loss
(8,286
)
 
(1,291
)
 
(56,888
)
 
(46,152
)
Net cash provided by operating activities
 
 
 
 
7,392

 
3,563

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 over the trailing 12 month period 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 using the following formula:
X = (A + B + C)/(B + D)
where:
X = net-recurring revenue retention rate on support and maintenance contracts
A = annualized value of support and maintenance contracts renewed over the trailing 12 month period
B = 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
C = trailing 12 month annualized value of new support and maintenance contracts from end-customers that have been end customers for more than one year
D = 12 months annualized value of support and maintenance contracts scheduled to terminate or renew during the 12 month period under measurement

23


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 September 30, 2018 and December 31, 2017 were 120% 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.
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 more than tripled the size of our quota-bearing sales representatives from the beginning of 2015 to September 30, 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 Income (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 income (loss) as loss from operations excluding stock-based compensation expense and acquisition-related expenses. We consider non-GAAP operating income (loss) to be a useful metric for investors and other users of our financial information in evaluating our operating performance because it excludes the impact of stock-based compensation, a non-cash charge that can vary from period to period for reasons that are unrelated to our core operating performance, and non-recurring and non-operating acquisition-related expenses. This metric also provides investors and other users of our financial information with an additional tool to compare business performance across companies and periods, while eliminating the effects of items that may vary for different companies for reasons unrelated to core operating performance.
We define free cash flow as net cash 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.

24


A reconciliation of non-GAAP operating income (loss) to loss from operations, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018

2017
 
2018

2017
 
 
 
 
 
 
 
 
 
(In thousands)
Non-GAAP operating income (loss):
 
 
 
 
 
 
 
Loss from operations
$
(8,609
)
 
$
(749
)
 
$
(56,317
)
 
$
(43,570
)
Add:
 
 
 
 
 
 
 
Stock-based compensation expense
13,018

 
3,909

 
39,544

 
12,060

Acquisition-related expenses
481

 

 
481

 

Non-GAAP operating income (loss)
$
4,890

 
$
3,160

 
$
(16,292
)
 
$
(31,510
)
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:
 
Nine Months Ended September 30,
 
2018

2017




 
(In thousands)
Free cash flow (non-GAAP):



Net cash provided by operating activities
$
7,392


$
3,563

Less: purchases of property and equipment
(6,766
)

(3,386
)
Free cash flow (non-GAAP)
$
626


$
177

Net cash provided by (used in) investing activities
$
35,754


$
(3,386
)
Net cash provided by (used in) financing activities
$
20,572


$
(7,372
)
It is important to note that other companies, including companies in our industry, may not use non-GAAP operating income (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 income (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 income (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 income (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:

25


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. 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:
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.
Product margin on our Software Products was approximately 99% for each of the nine months ended September 30, 2018 and 2017. Product margin on our Hardware Products vary. The average product margin on hardware sold separately for use with ForeScout CounterACT was approximately 25% and 26% for the nine months ended September 30, 2018 and 2017, respectively. Product margin on CounterACT Appliances, which are the hardware appliances that are embedded with ForeScout CounterACT, vary. The average product margin on our high-end CounterACT Appliances was approximately 80% and 82%, and average product margin on our low-end CounterACT Appliances was approximately 54% and 57%, for the nine months ended September 30, 2018 and 2017, respectively. 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.

26


Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation, and with regard to sales and marketing expense, sales commissions.
Research and Development. Research and development expense consists primarily of personnel costs. Research and development expense also includes consulting expense and allocated costs including facilities and information technology related costs. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services; however, we expect our research and development expense to decline as a percentage of total revenue in the long term as we scale the business.
Sales and Marketing. Sales and marketing expense consists primarily of personnel costs. Sales and marketing expense also includes sales commissions, costs for market development programs, promotional and other marketing costs, travel costs, professional services, 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 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.
Provision for Income Taxes
Provision for income taxes consists primarily of foreign income taxes, unrecognized tax benefits, withholding taxes, and U.S. state income taxes. We maintain a full valuation allowance for domestic net deferred tax assets. Our foreign deferred tax assets are immaterial. 

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 September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018

2017
 
 
 
 
 
 
 
 
 
(In thousands)
Condensed Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Product
$
51,082

 
$
43,204

 
$
115,185

 
$
90,354

Maintenance and professional services
34,546

 
26,136

 
97,734

 
71,143

Total revenue
85,628

 
69,340

 
212,919

 
161,497

Cost of revenue:
 
 
 
 
 
 
 
Product (1)
8,947

 
7,240

 
21,002

 
16,877

Maintenance and professional services (1)
10,250

 
8,688

 
29,394

 
25,662

Total cost of revenue
19,197

 
15,928

 
50,396

 
42,539

Total gross profit
66,431

 
53,412

 
162,523

 
118,958

Operating expenses:
 
 
 
 
 
 
 
Research and development (1)   
15,062

 
10,985

 
44,552

 
32,634

Sales and marketing (1)   
46,098

 
34,028

 
133,416

 
102,629

General and administrative (1)   
13,880

 
9,148

 
40,872

 
27,265

Total operating expenses
75,040

 
54,161

 
218,840

 
162,528

Loss from operations
(8,609
)
 
(749
)
 
(56,317
)
 
(43,570
)
Interest expense
(208
)
 
(290
)
 
(676
)
 
(953
)
Other income (expense), net
865

 
160

 
2,040

 
(66
)
Revaluation of warrant liabilities

 

 

 
(342
)
Loss before income taxes
(7,952
)
 
(879
)
 
(54,953
)
 
(44,931
)
Income tax provision
334

 
412

 
1,935

 
1,221

Net loss
$
(8,286
)
 
$
(1,291
)
 
$
(56,888
)
 
$
(46,152
)
_____________________    
(1)
Includes stock-based compensation expense as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018

2017
 
 
 
 
 
 
 
 
 
(In thousands)
Cost of revenue:
 
 
 
 
 
 
 
Product
$
67

 
$
19

 
$
174

 
$
60

Maintenance and professional services
715

 
286

 
2,211

 
930

Research and development
2,613

 
630

 
7,473

 
2,043

Sales and marketing
6,165

 
1,602

 
18,195

 
4,868

General and administrative
3,458

 
1,372

 
11,491

 
4,159

     Total
$
13,018

 
$
3,909

 
$
39,544

 
$
12,060



28


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(As a percentage of total revenue)
Condensed Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Product
60
 %
 
62
 %
 
54
 %
 
56
 %
Maintenance and professional services
40

 
38

 
46

 
44

Total revenue
100

 
100

 
100

 
100

Cost of revenue:
 
 
 
 
 
 
 
Product
10

 
10

 
10

 
10

Maintenance and professional services
12

 
13

 
14

 
16

Total cost of revenue
22

 
23

 
24

 
26

Total gross profit
78

 
77

 
76

 
74

Operating expenses:
 
 
 
 
 
 
 
Research and development
18

 
16

 
21

 
20

Sales and marketing
54

 
49

 
63

 
64

General and administrative
16

 
13

 
19

 
17

Total operating expenses
88

 
78

 
103

 
101

Loss from operations
(10
)
 
(1
)
 
(27
)
 
(27
)
Interest expense

 

 

 
(1
)
Other income (expense), net
1

 

 
1

 

Revaluation of warrant liabilities

 

 

 

Loss before income taxes
(9
)
 
(1
)
 
(26
)
 
(28
)
Income tax provision
1

 
1

 
1

 
1

Net loss
(10
)%
 
(2
)%
 
(27
)%
 
(29
)%

Comparison of the Three Months Ended September 30, 2018 and 2017
Revenue
 
Three Months Ended September 30,
 
 
 
 
 
2018
 
2017
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Product
$
51,082

 
$
43,204

 
$
7,878

 
18
%
Maintenance and professional services
 

 
 

 
 

 
 

Support and maintenance
30,339

 
22,789

 
7,550