ServiceNow, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless otherwise noted. ServiceNow provides enterprise cloud software and digital workflow services. Figures below are in U.S. dollars.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $788.9 million | $589.2 million | +34% |
| Subscription revenue | $740.0 million | $543.3 million | +36% |
| Professional services and other revenue | $48.9 million | $45.9 million | +7% |
| Gross profit / gross margin | $602.7 million / 76% | $445.7 million / 76% | Margin stable |
| Operating loss | $(15.7) million | $(20.3) million | Loss narrowed |
| Net income (loss) | $(1.5) million | $10.6 million | Turned to loss |
| Diluted EPS | $(0.01) | $0.06 | |
| Cash from operations | $360.8 million | $250.1 million | +44% |
| Free cash flow (non-GAAP) | $313.7 million | $214.7 million | +46% |
Subscription revenue growth reflected increased purchases from existing customers and a larger customer base. Digital workflow revenue rose 38% to $638.7 million; IT operations management revenue rose 25% to $101.3 million. Revenue outside North America was 33% of total revenue, versus 34% a year earlier. The stronger U.S. dollar reduced Q1 2019 revenue by approximately $22.4 million compared with translation at prior-year exchange rates.
Operating expenses increased 33% to $618.4 million, led by research and development (+47%) and sales and marketing (+27%). Stock-based compensation was $157.5 million, about 20% of revenue, compared with $121.3 million a year ago. Subscription gross margin improved to 83% from 82%; professional services and other gross margin worsened to negative 22% from negative 5%, leaving total gross margin unchanged at 76%.
Balance sheet and liquidity
- Cash and cash equivalents were $639.7 million; short-term investments were $1.022 billion. Together these totaled approximately $1.662 billion. Long-term investments were $674.6 million.
- Total assets were $4.399 billion and total liabilities were $3.204 billion at March 31, 2019.
- Convertible notes had a $669.9 million net carrying value and $782.5 million principal, with 0% coupon and maturity on June 1, 2022. The company said it currently intends to pay converted principal in cash.
- Adoption of lease accounting added $393.6 million of operating lease right-of-use assets and $422.9 million of lease liabilities. The company also disclosed $413.4 million of undiscounted commitments for leases not yet commenced.
- Operating cash flow benefited from noncash items and working-capital movements. Investing activities used $200.9 million, including $47.1 million of property and equipment purchases; financing activities used $86.4 million, including $139.5 million of taxes paid on net share settlement of equity awards.
Material changes, outlook, and notable items
- Billings, a company-defined non-GAAP measure, rose 24% to $857.5 million, slower than revenue growth. Foreign exchange and longer billing durations reduced reported billings by $23.6 million and $18.4 million, respectively.
- Total backlog was $5.2 billion, including $3.5 billion of unbilled backlog; management expected approximately 51% to be recognized as revenue within 12 months. Separately, remaining performance obligations were approximately $5.1 billion, with about 50% expected to be recognized over the following 12 months.
- Management expected subscription revenue to grow in absolute dollars and as a share of revenue in 2019. It expected professional-services revenue to grow in dollars but decline as a share of revenue, and anticipated a professional-services gross loss for 2019. Management also expected subscription gross margin to improve slightly, while research and development spending was expected to increase as a share of revenue. No specific full-year revenue or earnings guidance is stated in the provided filing text.
- The company recorded a $9.9 million income tax benefit and maintained a valuation allowance on U.S. and certain foreign deferred tax assets. Management said that, if Irish subsidiary performance continued, a possible release of the Irish valuation allowance within 12 months could produce an income tax benefit exceeding $500 million; this was a possibility, not a forecasted or recorded benefit.
- Approximately 2.7 million shares were issued during Q1 from partial exercise of 2018 warrants; a further approximately 1.6 million shares were issued in Q2, after quarter-end. The 2018 warrants are no longer outstanding. The company estimated approximately 1.0 million shares could be issued under 2022 warrants based on the March 31 share price, but the actual amount is uncertain.
- On April 29, 2019, CFO Michael Scarpelli notified the company of his planned resignation after Q2 earnings; the filing said a successor search had begun. Management reported disclosure controls were effective and no material legal proceedings were identified.
Risks and investor verification priorities
- Verify the drivers and sustainability of subscription growth, billings, backlog conversion, customer renewals, and the gap between billings growth and revenue growth. The reported renewal rate was 98% in both periods; customers with ACV above $1 million increased to 717 from 541.
- Assess margin and profitability trends against rising operating costs, professional-services losses, and substantial stock-based compensation. GAAP results remain sensitive to tax items and equity-award expense.
- Review the 2022 notes’ conversion and cash-settlement exposure, warrant-related dilution, and the company’s capacity to meet debt and lease obligations. Management stated that available liquidity and operating cash flow should meet anticipated needs for at least 12 months.
- Consider the contingent nature of any Irish tax valuation-allowance release, foreign-exchange exposure, and the impact of currency movements on revenue and billings.
- Evaluate disclosed business risks, particularly cybersecurity and service availability, intense competition and pricing pressure, international and privacy-law compliance, and reliance on partners for implementation services.
- Confirm the CFO transition and whether subsequent filings update management’s outlook, tax assumptions, conversion activity, or share dilution. The filing cautions that quarterly results are not necessarily indicative of full-year results.