ServiceNow, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context and performance
ServiceNow provides cloud-based workflow software through its Now Platform, organized across Technology, Customer and Industry, Employee, and Creator workflows. Growth came primarily from increased purchases by new and existing customers.
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Subscription revenue | $2,075 | $1,658 | $4,099 | $3,289 |
| Professional services and other revenue | $75 | $94 | $147 | $185 |
| Total revenue | $2,150 | $1,752 | $4,246 | $3,474 |
| Gross profit | $1,679 | $1,363 | $3,337 | $2,716 |
| Income from operations | $117 | $22 | $261 | $109 |
| Net income | $1,044 | $20 | $1,194 | $95 |
| Diluted earnings per share | $5.08 | $0.10 | $5.83 | $0.47 |
Financial position, cash flow and liquidity
- Q2 total revenue grew 23% year over year; subscription revenue grew 25%. For the first six months, total revenue grew 22% and subscription revenue 25%. Professional services and other revenue fell 20% in Q2 and 21% for the six-month period.
- Gross margin was 78% in Q2 versus 78% a year earlier, and 79% for the six months versus 78%. Subscription gross margin was 81% in Q2 versus 83%, and 82% for the six months versus 83%.
- Operating income rose to $117 million in Q2 from $22 million. Net income was substantially affected by an $870 million Q2 income tax benefit, primarily from releasing valuation allowances on certain U.S. federal and state deferred tax assets. The six-month tax benefit was $832 million. The filing reported a $177 million valuation allowance against California deferred tax assets.
- For the six months, operating cash flow was $1.482 billion, up from $1.296 billion; capital expenditures were $297 million, compared with $244 million; and company-defined free cash flow was $1.185 billion, up 13% from $1.052 billion. Management attributed higher operating cash flow primarily to increased collections from revenue growth.
- At June 30, cash and cash equivalents were $1.663 billion and short- and long-term investments totaled $5.824 billion. Management cited $7.5 billion of cash, cash equivalents and investments as available liquidity and expected these resources and operating cash flows to cover needs for at least 12 months.
- Long-term debt, net, was $1.487 billion, principally the $1.5 billion, 1.40% unsecured notes due September 2030. Total liabilities were $7.997 billion and stockholders’ equity was $6.926 billion.
Material changes and outlook
- Remaining performance obligations (RPO) were $14.2 billion, with 51% expected to be recognized over the next 12 months. RPO and current RPO grew 24% and 25%, respectively, year over year. The company reported 1,724 customers with ACV above $1 million, versus 1,466 a year earlier; renewal rates were 99% for Q2 and 98% for the six-month period, unchanged year over year.
- Management expected 2023 subscription revenue to increase in absolute dollars and slightly as a percentage of revenue; professional services revenue to decline; and subscription gross margin to decrease slightly. It expected operating expenses to rise in dollars, with certain expense categories flat or lower as a percentage of revenue. The filing provides no specific numerical full-year revenue or earnings guidance.
- Subscription cost growth reflected increased headcount, customer support—including regulated-market requirements—and infrastructure and public-cloud costs. Stock-based compensation was $397 million in Q2 and $778 million for the six months.
- In May, the board authorized up to $1.5 billion of share repurchases; none had been made by June 30. In July, after quarter-end, ServiceNow acquired G2K Group GmbH for approximately $500 million in cash, payable in two installments, to add AI-powered IoT capabilities. Purchase accounting was still being finalized.
Risks, contingencies and unusual items
- The large tax benefit is a significant non-recurring factor in reported net income; realization of deferred tax assets remains subject to reassessment, and California assets continue to carry a valuation allowance.
- Management identified evolving privacy, data residency, sovereignty and AI/ML laws and customer requirements as risks that could increase costs, limit product development or use, and affect demand or service delivery across jurisdictions.
- Macroeconomic uncertainty, interest rates, inflation, bank failures, foreign exchange movements and the Russia-Ukraine conflict were monitored. Management reported no material impact from recent bank failures and did not expect the conflict to have a material impact, while noting worsening conditions could affect results.
- Available-for-sale securities had $76 million of gross unrealized losses at June 30; management did not consider the declines other-than-temporary and said credit-related impairment losses were not material. One U.S. federal channel partner represented 14% of accounts receivable, with no historical collection concerns reported.
- The company disclosed ordinary-course litigation and indemnification obligations, but stated it was not party to legal proceedings expected to have a material adverse effect. It also had a $500 million, five-year cloud-services agreement with Microsoft entered into in 2022.
Important facts for investors to verify
- How much future reported earnings growth reflects underlying operations rather than the deferred-tax valuation-allowance release.
- Whether RPO and customer growth convert into recognized subscription revenue at the expected pace, considering contract timing, foreign exchange and seasonality.
- Whether infrastructure, regulated-market and cloud costs pressure subscription margins beyond management’s expected slight decline.
- The final purchase-price allocation, cash-payment timing and integration results for the G2K acquisition.
- Potential effects of AI, privacy and data-residency regulation, and the scale of stock-based compensation and any share repurchases.