Servicenow, Inc. annual report, FY2019

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Business context and reporting period

ServiceNow, Inc. filed this Form 10-K for the fiscal year ended December 31, 2019. It provides enterprise cloud software for digital workflows across IT, employee and customer functions, primarily through subscription services on its Now Platform. The company reported approximately 6,200 enterprise customers; no customer represented more than 10% of revenue.

Financial performance and position

  • Revenue: $3.46 billion, up 33% from $2.61 billion in 2018. Subscription revenue was $3.26 billion, up 34%, and 94% of total revenue; professional services and other revenue was $205.4 million, up 10%.
  • Profit and margins: Gross profit was $2.66 billion, with a 77% gross margin versus 76% in 2018. Operating income was $42.1 million, compared with an operating loss of $42.4 million. Net income was $626.7 million versus a $26.7 million net loss; 2019 net income included a $574.2 million tax benefit from releasing the valuation allowance on Irish deferred tax assets. Diluted EPS was $3.18.
  • Cash flow: Operating cash flow was $1.24 billion, versus $811.1 million. Capital expenditures were $264.9 million; company-defined free cash flow was $971.1 million, versus $586.6 million. Billings, a non-GAAP measure, rose 30% to $4.00 billion.
  • Liquidity and debt: Cash and cash equivalents were $775.8 million, short-term investments $915.3 million and long-term investments $1.01 billion. Convertible notes had $782.5 million principal outstanding, due June 2022, and a net carrying amount of $695.0 million. The notes are convertible under specified conditions; the company intended to settle principal conversions in cash.
  • Other indicators: Remaining performance obligations (RPO) were $6.6 billion, up from $4.9 billion; about 50% was expected to be recognized over the next 12 months. Customers with ACV above $1 million increased to 892 from 677. Renewal rate was 98%, unchanged from 2018.

Material changes versus the prior comparable period

  • Revenue growth remained strong, while operating results turned positive. Net income’s large improvement principally reflects the Irish deferred-tax valuation-allowance release, rather than recurring operating earnings.
  • Operating cash flow and free cash flow increased. Investing cash outflow rose to $724.5 million from $347.4 million, mainly due to greater net investment purchases, intangible-asset acquisitions and capital expenditures.
  • Research and development expense rose 41% and sales and marketing expense 28%; as a share of revenue, these were 22% and 44%, respectively, compared with 20% and 46% in 2018. Professional-services gross loss widened to 20% from 9%.
  • RPO increased by $1.7 billion. Foreign exchange reduced 2019 billings by $67.7 million, according to the company’s analysis.

Outlook, commentary, risks and unusual items

  • Management expected 2020 subscription revenue to increase in absolute dollars and slightly as a share of revenue. It expected subscription gross margin to remain relatively flat; professional-services revenue to rise in dollars but decline slightly as a share of revenue; and sales and marketing, R&D and G&A expenses to rise in dollars. The filing provides no clear numerical 2020 revenue or earnings guidance in the supplied text.
  • Management said existing cash and operating cash generation should meet liquidity needs for at least 12 months, including investment in data centers, personnel, facilities and equipment. The $782.5 million notes principal is due in 2022.
  • Key disclosed risks include intense competition and pricing pressure; cybersecurity incidents or service disruptions; privacy, data-transfer and regulatory requirements; dependence on successful customer implementations and partners; international, currency and macroeconomic exposure; and possible variability in operating results. The company expects revenue growth rates to decline over time.
  • Management identified seasonality: customer agreements and historically billings and RPO growth are highest in the December quarter. The company also warned that subscription revenue recognition over contract terms can delay the effect of changes in sales or renewals.
  • Leadership changed during the year: William R. McDermott became CEO in November 2019 and Gina Mastantuono became CFO in January 2020. Subsequent to year-end, the company acquired Loom Systems for $58.4 million and Passage AI for $33.2 million in cash.
  • The company reported no pending legal proceedings expected to have a material adverse effect. The independent auditor issued unqualified opinions on the financial statements and internal controls; revenue recognition for contracts with multiple performance obligations and realizability of Irish deferred tax assets were identified as critical audit matters.

Important facts for investors to verify

  1. Separate recurring operating performance from the $574.2 million Irish tax benefit; review tax assumptions and the remaining U.S. deferred-tax valuation allowance.
  2. Assess the sustainability of subscription growth, 98% renewal rate, large-customer expansion and $6.6 billion RPO, including expected recognition timing and foreign-exchange effects.
  3. Compare operating cash flow and non-GAAP free cash flow with capital spending, deferred commissions, stock-based compensation and working-capital movements.
  4. Review the 2022 convertible notes’ conversion and cash-settlement exposure, and potential dilution from the related warrants.
  5. Track expense growth, subscription and professional-services margins, and execution of 2020 investment plans and the two post-year-end acquisitions.