ServiceNow, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; compared with the corresponding 2018 periods. ServiceNow provides enterprise cloud software for digital workflows. Unless noted otherwise, amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $833.9m (+32%) | $631.1m | $1,622.8m (+33%) | $1,220.3m |
| Subscription revenue | $781.0m (+33%) | $585.3m | $1,521.0m (+35%) | $1,128.6m |
| Gross profit / margin | $635.8m / 76% | $477.9m / 76% | $1,238.4m / 76% | $923.6m / 76% |
| Operating loss | $(27.0)m | $(32.0)m | $(42.7)m | $(52.3)m |
| Net loss | $(11.1)m; $(0.06) per share | $(52.7)m; $(0.30) per share | $(12.6)m; $(0.07) per share | $(42.1)m; $(0.24) per share |
| Operating cash flow | Not separately stated | Not separately stated | $604.6m | $376.0m |
| Free cash flow (non-GAAP) | Not separately stated | Not separately stated | $507.6m | $287.6m |
- Q2 subscription revenue was 94% of total revenue. Subscription gross margin was 83%; professional services and other had an 18% gross loss margin, compared with 12% a year earlier.
- Q2 operating expenses rose 30% to $662.8m, below revenue growth; research and development increased 43%, sales and marketing 27%, and general and administrative 20%. Stock-based compensation was $171.8m for the quarter and $329.2m for the half-year.
- Six-month billings, a non-GAAP measure, were $1,728.5m, up 28%. Q2 billings were $871.0m, up 31%. Management cited unfavorable currency effects on billings of $18.5m in Q2 and $42.0m in the first half.
- At June 30, cash and cash equivalents were $583.6m and short-term investments $1,069.8m; long-term investments were $746.7m. The company reported $604.6m of operating cash flow for the half-year. Cash, cash equivalents and restricted cash totaled $586.7m.
- Convertible notes had $782.5m principal due June 2022 and a $678.1m net carrying amount. The notes bear 0% stated interest; holders could convert during the applicable period, and ServiceNow said it intended to settle principal in cash. No conversion requests had been received. Operating lease liabilities totaled $428.9m.
Changes, outlook and notable items
- Revenue growth was driven by increased purchases from existing customers and a larger customer base. Customers with annual contract value above $1m increased to 766 from 577 a year earlier; the reported renewal rate was 98%, versus 99%.
- Total backlog was $5.6bn at June 30, up from $5.1bn at year-end; management expected approximately 50% to be recognized as revenue over the following 12 months. Separately, non-cancelable remaining performance obligations were approximately $5.4bn, with about 50% expected to be recognized over the next 12 months.
- Management expected subscription revenue to grow in absolute dollars and as a share of revenue in 2019. It expected subscription gross margin to improve slightly, professional services revenue to grow more slowly than subscription revenue and decline as a share of total, and professional services to remain loss-making. Sales and marketing and general and administrative expenses were expected to decline as a percentage of revenue, while research and development expenses were expected to rise as a percentage. The filing does not provide clear numerical full-year revenue or earnings guidance in the text provided.
- The company continued expanding its workforce and infrastructure: headcount reached 9,382, up from 7,150 a year earlier. It was shifting internal professional services toward strategic advisory work and relying more on partners for implementation delivery.
- Management said current cash and operating cash generation should meet liquidity needs, including operating expansion and note repayment, for at least 12 months. However, the 2022 notes were conditionally convertible, and cash settlement could affect liquidity.
- ServiceNow adopted lease accounting Topic 842 on January 1, 2019, recording approximately $334.7m of right-of-use assets and $362.7m of lease liabilities at adoption; prior-year comparative balance sheets were not restated.
- A potential tax item is unusually large: management said a release of the Irish subsidiary’s deferred-tax valuation allowance could produce an income tax benefit exceeding $500m if performance provides sufficient positive evidence. Timing and realization were uncertain; the company maintained full valuation allowances against U.S. and certain foreign deferred tax assets.
Risks and contingencies
- Management highlighted intense competition, pricing pressure, execution and product-development risks, dependence on customer renewals and partner delivery, and the possibility that revenue growth will continue to decline while investment and costs rise.
- Cybersecurity incidents, service outages, privacy regulation, foreign currency movements, international expansion, and economic or geopolitical disruption could affect customer demand, costs, and results. The filing notes that currency hedges may reduce but cannot eliminate exposure.
- Lease commitments include $408.7m of undiscounted payments for leases not yet commenced. The company also had $22.1m of letters of credit. Management reported no pending legal proceeding expected to have a material adverse effect, and no material contractual commitments entered outside the ordinary course during the half-year.
- Approximately 4.3m shares were issued upon exercise of the 2018 warrants during the first half. The 2022 warrants could result in future share dilution; the amount is not yet known. The filing also disclosed that CFO Michael Scarpelli was expected to leave on August 15, 2019.
- Disclosure controls were assessed as effective, and management reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether subscription growth, backlog conversion, billings and the 98% renewal rate continue to support future revenue growth.
- How operating expenses, particularly research and development and stock-based compensation, affect profitability and per-share dilution.
- The potential timing, evidence requirements and actual financial impact of any Irish valuation allowance release; the disclosed benefit above $500m is conditional, not guidance.
- The cash and dilution consequences of any 2022 note conversions, the 2022 maturity, and future warrant settlement.
- Whether lease commitments, including leases not yet commenced, and planned infrastructure and headcount investment remain consistent with management’s liquidity assessment.