Business context and reporting period
ServiceNow, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2020. The company sells enterprise cloud software for digital workflows, principally through annual subscriptions; subscription revenue accounted for 95% of Q1 revenue.
Financial performance and position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenue | $1,046.3 million | $788.9 million | +33% |
| Subscription revenue | $994.7 million | $740.0 million | +34% |
| Professional services and other revenue | $51.6 million | $48.9 million | +6% |
| Gross profit / gross margin | $823.0 million / 79% | $602.7 million / 76% | Margin +3 percentage points |
| Operating income (loss) | $49.3 million | $(15.7) million | Turned profitable |
| Net income (loss) | $48.2 million | $(1.5) million | Turned profitable |
| Diluted EPS | $0.24 | $(0.01) | Improved |
| Cash from operations | $491.6 million | $360.8 million | +36% |
| Free cash flow (non-GAAP) | $408.4 million | $313.7 million | +30% |
| Billings (non-GAAP) | $1,103.2 million | $857.5 million | +29% |
Subscription gross margin was 84%, versus 83%; professional services and other had a gross loss margin of 23%, versus 22%. Operating expenses rose 25% to $773.6 million, including sales and marketing of $441.2 million, research and development of $226.7 million, and general and administrative expense of $105.7 million. Stock-based compensation was $188.3 million, or 18% of revenue.
At March 31, 2020, cash and cash equivalents were $808.7 million, short-term investments $1.050 billion, and long-term investments $1.078 billion. Total current assets were $2.806 billion and current liabilities $2.721 billion. Total liabilities were $3.931 billion. Convertible notes had a $701.3 million net carrying value and $780.0 million principal amount, due June 2022; the notes carry no coupon. Operating lease liabilities totaled $501.8 million.
Operating, investing, and financing cash flows were $491.6 million provided, $385.0 million used, and $61.0 million used, respectively. Cash, cash equivalents, and restricted cash increased by $34.9 million during the quarter.
Material changes versus the prior comparable period
- Revenue growth was led by digital workflow subscriptions, up 36% to $867.3 million; ITOM subscription revenue rose 26% to $127.4 million.
- Operating and net results moved from losses to profits, while gross margin expanded. Operating expenses still grew materially, principally reflecting hiring and investment.
- Remaining performance obligations were approximately $6.6 billion, with about 51% expected to be recognized as revenue over the next 12 months. Customers with annual contract value above $1 million increased to 933 from 718.
- Renewal rate was 97%, compared with 98% in Q1 2019. Management notes that renewal timing can make quarter-to-quarter comparisons less meaningful.
- Operating cash flow and free cash flow increased, while investing cash use rose to $385.0 million, including $82.9 million for acquisitions and higher capital spending.
Outlook, management commentary, risks, and unusual items
- Management expected 2020 subscription revenue to increase in absolute dollars, with subscription revenue remaining relatively flat as a share of total revenue. It also expected professional services revenue and operating expenses to increase in absolute dollars. No specific full-year revenue or earnings guidance is provided in the supplied filing text.
- Management said the effects of COVID-19 were uncertain and might not be fully reflected in Q1 results. Risks cited include reduced customer spending or contract duration, delayed purchasing and collections, longer sales cycles, and disruption to employees, partners, vendors, and data-center operations. Most offices were temporarily closed, employees worked remotely, the in-person Knowledge conference was replaced with a digital event, and Financial Analyst Day was postponed.
- ServiceNow recorded $8.4 million of unrecoverable costs for canceled or changed events. It also agreed to a $3.9 million payment to its CEO under an amended employment agreement.
- Foreign exchange movements reduced Q1 subscription revenue by an estimated $11.6 million versus prior-year exchange rates; foreign-currency losses net of derivatives were $6.5 million. The company uses foreign-currency forwards but says they may not fully offset exchange-rate effects.
- Two acquisitions closed in February for approximately $91.6 million combined: Loom Systems and Passage AI. They added $54.6 million of goodwill and developed-technology intangibles, and were not material to consolidated results for the quarter.
- Based on conversion requests received by the filing date, the company expected to settle approximately $15.2 million of 2022-note principal in cash in Q2 2020, with possible additional requests. Management said available cash, investments, and expected operating cash flows should cover liquidity needs for at least 12 months.
- Other key risks include intense competition, privacy and data-transfer regulation, cybersecurity and service availability, international operations and currency exposure, acquisitions and integration, and potential dilution from stock compensation and 2022 warrants. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether COVID-19 affected new sales, renewals, contract duration, collections, and customer budgets after Q1, including trends in RPO, billings, and the 97% renewal rate.
- How much of reported profit and operating cash flow reflects non-cash stock compensation, and how stock-based awards affect dilution; Q1 stock-based compensation was $188.3 million.
- Cash requirements and any additional conversions of the $780.0 million 2022 notes, including the intended cash settlement of principal and the potential effect of the note hedge and warrants.
- Investment portfolio valuation and credit exposure: available-for-sale securities had $17.5 million of gross unrealized losses at March 31, 2020, which management attributed primarily to pandemic-related market disruption rather than issuer credit risk.
- Execution and integration of the two acquisitions, investment spending, and the effect of foreign-currency movements on revenue, expenses, and billings.