ServiceNow, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; filed August 8, 2018. ServiceNow provides enterprise cloud software and related professional services. Prior-year comparisons below are as adjusted for the full retrospective adoption of ASC 606.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Total revenue | $631.1m (+41%) | $448.3m | $1,220.3m (+39%) | $877.0m |
| Subscription revenue | $585.3m (+45%) | $402.7m | $1,128.6m (+43%) | $790.3m |
| Professional services and other | $45.8m (approximately flat) | $45.6m | $91.7m (+6%) | $86.8m |
| Gross profit / margin | $477.9m / 76% | $326.1m / 73% | $923.6m / 76% | $638.8m / 73% |
| Operating loss | $(32.0)m | $(37.8)m | $(52.3)m | $(59.6)m |
| Net loss | $(52.7)m; $(0.30) per share | $(55.8)m; $(0.33) per share | $(42.1)m; $(0.24) per share | $(77.3)m; $(0.46) per share |
- Growth and margins: Q2 subscription growth reflected higher purchases by existing customers and customer additions. IT operations management subscription revenue grew 96% in Q2 and 90% in H1; service management grew 39% and 37%, respectively. Subscription gross margin was 83% in Q2 and H1, while professional services remained loss-making at a 12% Q2 gross margin and 9% H1 gross margin.
- Operating costs and cash flow: Q2 operating expenses rose 40% year over year to $509.9m; stock-based compensation was $135.6m, or 21% of revenue. H1 operating cash flow was $376.0m, versus $316.3m; capital expenditures were $88.4m, producing reported non-GAAP free cash flow of $287.6m, up 16%.
- Liquidity and debt: At June 30, cash and cash equivalents were $704.8m, short-term investments $1,044.8m, and long-term investments $304.6m. Current liabilities were $1,837.0m, including $1,320.9m of deferred revenue. Convertible notes had approximately $998.8m principal outstanding: $782.5m due 2022 and $216.3m remaining on 2018 notes. The company paid $358.7m principal on 2018 note conversions during H1 and expected further cash settlements.
- Operating indicators: Total backlog was $4.2bn at quarter-end, including $2.8bn unbilled backlog; management expected about 50% to be recognized as revenue over the following 12 months. Remaining non-cancelable performance obligations were approximately $4.0bn. Customers with ACV above $1m rose to 575 from 410; renewal rate was 98%.
Changes, outlook and notable items
- Management expects subscription revenue to grow in absolute dollars and as a share of revenue in 2018. It expects subscription gross margin to improve slightly, while sales and marketing, R&D, G&A, and stock-based compensation are expected to rise in dollars but remain relatively flat as percentages of revenue. Management expects a GAAP loss for 2018; no specific full-year revenue or earnings guidance is stated in the provided filing text.
- Management said cash and operating cash generation should be sufficient for liquidity needs, including note repayments and planned investment, for at least the next 12 months. The 2022 notes became convertible at holders’ option through September 30, 2018; management reported no conversion requests through the filing date. Remaining 2018 notes were due November 1, 2018.
- ASC 606 was adopted retrospectively and changed the timing of revenue recognition for certain on-premises software, the capitalization and amortization of commissions, and classification of Knowledge forum proceeds. Comparisons use adjusted prior periods. The H1 2018 net loss was also affected by a $23.1m one-time indirect tax benefit related to ASC 606 and $19.3m of gains on marketable equity securities; these items contributed materially to the year-over-year improvement.
- Other significant items include $3.9m of H1 losses on early note conversions and a new foreign-currency hedging program. Currency movements benefited reported revenue and billings; billings also grew 34% in Q2 and 33% in H1, but are a non-GAAP measure and can vary with contract timing, duration, and exchange rates.
- Lease commitments were $787.4m at June 30, 2018, with total operating lease and other contractual commitments of $903.4m. The company also disclosed $453.7m of incremental payments under headquarters lease agreements through February 2035. It anticipated a material balance-sheet impact from adopting the lease standard in 2019.
- Key risks include management’s expectation that revenue growth will continue to decline, continued GAAP losses and investment needs, competition, service reliability and cybersecurity, privacy regulation, foreign exchange exposure, and cash requirements or dilution related to convertible notes and warrants. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much reported growth and H1 loss improvement reflects underlying customer demand versus ASC 606 timing, the tax benefit, marketable-security gains, and foreign-exchange effects.
- Whether backlog and remaining performance obligations convert into revenue on the expected schedule, and whether billings growth remains consistent with subscription growth.
- The cash impact and settlement timing of the remaining 2018 notes and any conversions of the 2022 notes, plus potential dilution from outstanding warrants and equity awards.
- Whether rapid hiring and rising sales, R&D, infrastructure, and lease costs can be supported while improving operating profitability and cash generation.
- The eventual balance-sheet effect of lease accounting adoption and the company’s exposure to cybersecurity, privacy, service interruptions, tax assessments, and currency movements.