Business context and reporting period
ServiceNow, Inc. provides cloud-based software for automating enterprise IT operations, with subscription services as its primary revenue source. This Form 10-Q covers the quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods unless otherwise noted.
Financial performance and position
- Revenue: Third-quarter revenue was $111.3 million, up 73%; subscription revenue was $93.0 million, up 68%, and professional services and other revenue was $18.3 million, up 101%. Nine-month revenue was $299.4 million, up 78%.
- Profit and margins: Third-quarter gross profit was $69.7 million, or 63% of revenue, versus 57% a year earlier. Operating loss was $14.7 million and net loss was $14.7 million, compared with losses of $13.3 million and $13.1 million, respectively. Nine-month operating loss was $46.9 million and net loss was $49.5 million, versus $28.0 million and $27.4 million. Basic and diluted loss per share was $0.11 for the quarter and $0.37 for the nine months.
- Cash flow: Nine-month operating cash flow was $45.5 million, compared with $32.1 million. Investing cash outflow was $93.1 million, including $39.1 million of property and equipment purchases and $13.3 million for the Mirror42 acquisition. Financing cash inflow was $49.0 million. Operating cash flow less property and equipment purchases was approximately $6.4 million.
- Liquidity and debt: At September 30, cash and cash equivalents were $121.1 million and investments were $231.7 million, totaling approximately $352.8 million. Current assets were $342.4 million and current liabilities $268.1 million. The balance sheet presents no borrowings or other interest-bearing debt line. Management said cash, investments and operating cash flows should fund operations for at least 12 months, barring unforeseen circumstances.
- Other metrics: Deferred revenue was $225.8 million; accounts receivable was $84.5 million. Stock-based compensation was $44.7 million for the first nine months. The company had 1,900 customers at quarter-end, up 41% year over year; its reported renewal rate was 97% for the quarter and upsell rate was 29%.
Material changes versus the prior comparable period
- Growth was driven by customer additions, upsells and renewals; professional services growth also reflected higher utilization and improved pricing. Revenue outside North America accounted for 31% of quarterly revenue.
- Gross margin improved six percentage points to 63%. Subscription gross margin rose to 75% from 68%; professional services gross margin improved to 1% from negative 6% for the quarter.
- Operating expenses grew 68% to $84.3 million in the quarter, including sales and marketing up 68%, research and development up 93%, and general and administrative up 45%. Headcount was 1,654, versus 963 a year earlier.
- Cash and investments totaled approximately $352.8 million, while total assets increased to $578.7 million from $478.1 million at December 31, 2012. The company acquired Mirror42 for $13.3 million in cash in July; the acquisition added $8.5 million of goodwill and $6.2 million of net intangible assets.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is provided. Management expects operating expenses to increase in dollars, while generally declining or remaining relatively flat as a percentage of revenue. It expected subscription gross margin to decline slightly for the rest of 2013 as infrastructure and support investments continued; professional services margin was expected to remain relatively flat.
- Management emphasized continued investment in infrastructure, product development, sales and marketing, international expansion and hiring. It cautioned that rapid growth may strain operations and that growth rates may decline; the company did not expect to be profitable in the foreseeable future.
- Key business risks include service outages or performance problems at scale, data security incidents, dependence on third-party data centers, competition and pricing pressure, customer renewals, and the ability to scale sales and infrastructure efficiently. A few large customers had recently experienced reduced availability, performance or functionality at scale.
- Operating lease commitments totaled $125.9 million, including $8.8 million for a vacated San Diego office. The company disclosed an IRS examination covering the year ended June 30, 2011 and the six months ended December 31, 2011, and noted that its effective tax rate may fluctuate. Ordinary-course legal matters were not expected by management to have a material adverse effect.
- Management reported disclosure controls were effective at a reasonable assurance level and no material quarterly change in internal control over financial reporting. The filing discusses prior control weaknesses management believed had been remediated, but notes required Section 404 testing was not complete; auditor attestation was expected for year-end 2013 as the company ceased to be an emerging growth company.
Important facts for investors to verify
- Whether customer growth, upsells and renewal rates remain strong, and whether deferred revenue translates into future recognized revenue.
- Whether investment in data-center capacity resolves customer performance issues while supporting subscription margins.
- The sustainability of professional services margin improvement, particularly excluding the annual Knowledge conference contribution.
- The impact of $44.7 million in nine-month stock-based compensation and substantial outstanding options and restricted stock units on dilution and future expenses.
- Progress on Section 404 internal-control testing, the outcome of the IRS examination, and any changes to liquidity or lease commitments.