ServiceNow, Inc. — Q3 2023 Form 10-Q
Business and period: ServiceNow provides cloud-based workflow software through its Now Platform. This quarterly report covers the three and nine months ended September 30, 2023; comparisons are with the corresponding 2022 periods. Figures below are in U.S. dollars.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Total revenue | $2.288B (+25%) | $1.831B | $6.534B (+23%) | $5.305B |
| Subscription revenue | $2.216B (+27%) | $1.742B | $6.315B (+26%) | $5.031B |
| Professional services and other revenue | $72M (-19%) | $89M | $219M (-20%) | $274M |
| Gross profit / gross margin | $1.792B / 78% | $1.431B / 78% | $5.129B / 79% | $4.147B / 78% |
| Operating income / margin | $231M / 10% | $91M / 5% | $492M / 8% | $200M / 4% |
| Net income | $242M | $80M | $1.436B | $175M |
| Diluted EPS | $1.17 | $0.39 | $7.00 | $0.86 |
Cash flow (nine months): Operating cash flow was $1.793B, versus $1.561B. Capital expenditures were $433M. Company-defined, non-GAAP free cash flow was $1.384B, up 19% from $1.160B. Investing activities used $1.723B, including $282M net cash paid for business combinations; financing activities used $422M, including $282M of share repurchases and $333M of taxes paid on net share settlement of equity awards.
Liquidity and debt: Cash and cash equivalents were $1.112B at September 30, 2023; short- and long-term investments totaled $5.894B, for approximately $7.0B in cash and investments. Long-term debt, net, was $1.487B, principally $1.5B of 1.40% unsecured notes due in 2030. Management said available cash, investments and expected operating cash flows should meet liquidity needs for at least the next 12 months.
Operating indicators: Remaining performance obligations were $14.4B, up 26% year over year; 52% was expected to be recognized over the next 12 months. Customers with ACV above $1M increased to 1,789 from 1,535. The reported renewal rate was 98%, unchanged year over year.
Changes and notable items
- Subscription growth drove overall revenue expansion, while professional services revenue declined as ServiceNow shifted implementation delivery toward its partner ecosystem.
- Q3 subscription gross margin was 81%, down from 83%; total gross margin remained 78%. The company cited higher headcount, infrastructure depreciation, data-center capacity and public-cloud costs. Subscription gross margin for the nine months was 82%, versus 83%.
- Operating expenses rose year over year: Q3 sales and marketing $799M (+15%), R&D $549M (+20%), and G&A $213M (+14%). Stock-based compensation was $413M in Q3 and $1.191B for the nine months.
- Nine-month net income included a $775M income tax benefit, primarily from releasing valuation allowances on U.S. federal and state deferred tax assets. The company released $843M as a discrete benefit and $142M through the effective tax rate; it expects a further $65M release in Q4 and retains a $177M allowance against California deferred tax assets. This tax item materially affects comparisons of reported net income.
- ServiceNow acquired G2K Group GmbH, an AI-powered platform company, in July for $464M in cash, payable in two installments. The acquisition added $413M of goodwill; its reported financial results were not material.
- The board authorized up to $1.5B in repurchases in May. The company repurchased 0.5M shares for $282M in Q3; approximately $1.2B remained authorized at quarter-end.
Outlook, commentary and risks
Management expected 2023 subscription revenue to increase in dollars and slightly as a share of revenue compared with 2022; professional services revenue was expected to decline in dollars and slightly as a share. It expected subscription costs to rise in dollars and slightly as a share of revenue, with subscription gross margin decreasing slightly. Sales and marketing costs were expected to rise in dollars but decrease slightly as a percentage of revenue; R&D and G&A costs were expected to rise in dollars, with their revenue shares broadly stable. No specific full-year revenue or earnings guidance figure is provided in the supplied filing text.
Management noted macroeconomic uncertainty, including higher interest rates and inflation, and monitored the Russia-Ukraine and Israel-Gaza conflicts; it did not believe those conflicts had a material impact at the time, but worsening disruptions could affect results. The filing highlights cybersecurity and data-protection risks, including attacks on ServiceNow, customers and third-party providers, customer misconfiguration, and dependence on public-cloud infrastructure. Foreign-exchange movements, execution of growth investments, and the ability to realize deferred tax assets are also relevant considerations.
Ordinary-course litigation was disclosed; management did not believe pending matters were likely to have a material adverse effect, except matters for which loss contingencies had been recorded. A U.S. federal channel partner and systems integrator represented 26% of accounts receivable at quarter-end, though the company reported no historical collection concerns. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor verification points
- Assess the durability and composition of subscription growth, RPO growth and the 98% renewal rate, including the timing effects of federal contracts and foreign exchange.
- Separate operating performance from the substantial one-time tax benefit when evaluating nine-month net income and EPS; verify the remaining valuation allowance and expected Q4 release.
- Track subscription gross-margin pressure, infrastructure and cloud costs, and the unusually high level of stock-based compensation.
- Monitor cash generation and investment balances alongside repurchases, acquisition spending, the 2030 debt maturity and the concentrated receivable exposure.
- Review cybersecurity, third-party cloud and customer-configuration risks, as well as the G2K purchase-price allocation, which remained preliminary.