ServiceNow, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. The unaudited filing covers ServiceNow’s cloud-based enterprise IT workflow and automation business. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $56.8 | $29.5 | $104.2 | $54.7 |
| Subscription revenue | $46.8 | $24.8 | $86.4 | $46.0 |
| Gross profit / margin | $33.9 / 60% | $20.0 / 68% | $60.1 / 58% | $36.0 / 66% |
| Operating income (loss) | $(9.1) | $2.3 | $(14.7) | $5.4 |
| Net income (loss) | $(8.7) | $2.0 | $(14.4) | $5.0 |
| Operating cash flow | Not presented quarterly | $23.0 | $26.8 |
- Q2 revenue rose 93% year over year; first-half revenue rose 91%. Subscription revenue accounted for 82% of Q2 revenue and 83% of first-half revenue.
- Gross margin declined as subscription hosting, infrastructure, personnel and depreciation costs grew. Subscription gross margin was 70% in Q2 and 71% for the first half, versus 81% and 80%, respectively, a year earlier. First-half professional services and other gross margin remained negative at 6%.
- Operating expenses increased to $43.0 million in Q2 from $17.7 million and to $74.8 million for the first half from $30.6 million. The company reported $10.4 million of stock-based compensation in the first half, versus $1.8 million a year earlier.
- At June 30, cash and cash equivalents were $65.5 million and short-term investments were $22.8 million. Current assets were $152.1 million versus current liabilities of $151.8 million. No debt balance is reported in the supplied financial statements; liabilities primarily include deferred revenue and operating obligations.
- First-half investing cash outflow was $43.1 million, including $20.2 million of capital expenditures and $23.9 million of investment purchases. Financing provided $18.1 million. Cash and cash equivalents decreased $2.6 million to $65.5 million.
Material changes and business developments
- Customers increased 56% year over year to 1,201 at June 30, 2012; headcount increased to 882 from 375. Management attributed growth to new customers and increased subscriptions among existing customers.
- Renewal rates were 95% for Q2 and 96% for the first half, compared with 96% in both comparable 2011 periods. Upsells represented 36% of Q2 and 34% of first-half annual contract value signed, versus 25% and 30%, respectively, in 2011.
- International revenue represented 28% of first-half revenue, up from 24%. Europe represented 25% of first-half revenue, versus 21% a year earlier.
- On July 5, after quarter-end, the company closed its IPO at $18 per share, issuing 10.35 million shares and receiving approximately $169.9 million in net proceeds after underwriting discounts and estimated expenses, according to the use-of-proceeds disclosure. All preferred shares converted into 83.7 million common shares. The notes separately describe approximately $173.3 million of proceeds after underwriting discounts and before estimated expenses.
Outlook, risks and unusual items
- Management said it did not expect to be profitable for the remainder of 2012 and expected operating expenses to rise as it expanded sales, research and development, professional services and hosting capacity.
- Management expected subscription gross margin of approximately 64%–65% in each remaining quarter of 2012, with improvement in 2013 after exiting redundant managed-service data centers and improving capacity utilization. The transition was expected to finish in the second half of 2012.
- The company expected approximately $25 million of capital expenditures during the remainder of 2012. Management believed cash, operating cash flow and IPO proceeds would fund operating needs for at least 12 months, barring unforeseen circumstances.
- The company disclosed a potential charge of up to $3.5 million related to its planned exit from an existing San Diego office lease; it was evaluating sublease options. Future minimum operating lease payments totaled $46.9 million at June 30.
- An immaterial $0.7 million software development cost capitalization error was corrected in Q2; the filing states the correction did not affect first-half results. A $5.3 million founder receivable for withholding taxes was settled during the first half.
- Key risks include execution of the data-center transition, service availability and security, rapid hiring and growth, competition, customer renewals and sales cycles, international and foreign-currency exposure, and continued losses. Management reported effective disclosure controls, but the filing also describes previously identified material weaknesses in financial reporting controls and ongoing remediation efforts.
- The company reported no pending litigation expected by management to have a material adverse effect. It also noted customer indemnification obligations for certain intellectual-property claims and a $0.9 million liability for uncertain tax positions, excluding interest and penalties.
Investor facts to verify
- Track subscription growth, renewal rates, upsells and deferred revenue alongside reported revenue, which is recognized over subscription terms.
- Monitor gross-margin trends, data-center exit milestones, capital spending and whether the stated 2013 margin improvement is achieved.
- Reconcile IPO proceeds disclosures: approximately $173.3 million before estimated expenses in the notes versus approximately $169.9 million net of discounts and estimated expenses in the use-of-proceeds section.
- Assess dilution from the preferred-stock conversion, IPO issuance and substantial outstanding equity awards; verify the timing and impact of shares becoming eligible for sale after lock-up periods.
- Review progress in remediating previously identified internal-control material weaknesses, and any subsequent developments involving the office lease, tax positions or contingencies.