ServiceNow, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. ServiceNow provides enterprise cloud software, primarily through annual subscriptions. The company reported approximately 5,223 employees at quarter-end, up from 3,991 a year earlier.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Total revenue | $416.8 million | $305.9 million; up 36% |
| Subscription revenue | $376.1 million | $267.4 million; up 41% |
| Professional services and other revenue | $40.6 million | $38.5 million; up 6% |
| Gross profit and margin | $300.3 million; 72% | $211.6 million; 69% |
| Operating loss | $42.5 million | $324.2 million, including $270.0 million in legal settlement charges |
| Net loss and diluted loss per share | $40.7 million; $0.24 | $333.3 million; $2.06 |
| Cash from operating activities | $187.4 million | $78.7 million |
| Free cash flow, company-defined | $154.2 million | $49.6 million |
| Billings, company-defined | $529.2 million | $376.7 million; up 40% |
Subscription gross margin was 81%, compared with 80%; professional services and other gross margin was negative 13%, compared with negative 8%. The company attributed the latter deterioration to lower utilization as it invested in specialized resources for newer products. Stock-based compensation was $89.9 million, or 22% of revenue.
At March 31, 2017, cash and cash equivalents were $439.9 million, short-term investments $535.4 million, and long-term investments $326.3 million. Total cash and investments were approximately $1.302 billion. Current liabilities were $1.140 billion, including $961.6 million of current deferred revenue. Convertible senior notes had $575 million principal outstanding and a $516.5 million net carrying amount; principal is due November 1, 2018. The company said existing liquidity and operating cash generation should meet needs for at least the next 12 months.
Material changes and operating metrics
- Revenue growth was driven by subscription upsells and customer additions. IT Operations Management subscription revenue grew 86% to $42.5 million; Service Management revenue grew 36% to $333.6 million.
- Customers with annualized contract value above $1 million rose to 370 from 245; Global 2000 customers rose to 763 from 657. Renewal rate was 97% in both periods.
- Operating cash flow improved partly because deferred revenue increased $112.4 million and receivables declined. Free cash flow also benefited from the prior-year comparison, which included a $17.5 million legal settlement payment.
- Cash used in investing was $128.5 million, including investment purchases, capital expenditures and $15.0 million for the DxContinuum acquisition. The acquisition added predictive capabilities.
- Q1 2016 results included $270.0 million of aggregate HPE and BMC legal settlement charges; the company said all financial obligations under those settlements were fulfilled.
Outlook, commentary and risks
- Management expected subscription revenue to grow in absolute dollars and as a share of revenue in 2017. It expected a GAAP loss for 2017, citing growth investments, equity compensation and acquired-intangible amortization.
- Management expected subscription gross margin to improve slightly in 2017, while professional services gross margin was expected to decline as the company invested in newer products. Sales and marketing, R&D and G&A expenses were expected to rise in dollars but decline slightly as a percentage of revenue.
- Billings grew 40%; foreign exchange reduced Q1 billings by $9.5 million, while longer billing durations added $21.3 million, primarily reflecting one five-year billing contract. Billings and free cash flow are non-GAAP measures defined by the company.
- The company planned to adopt ASC 606 in 2018 using the full retrospective method. It did not expect a material timing impact for cloud subscriptions, but estimated 2016 revenue would have been $22–$27 million higher under the new standard, primarily due to on-premises offerings. Commission accounting was also expected to change.
- Operating lease commitments were approximately $353.0 million; total disclosed leases, purchase obligations and other commitments were $406.0 million. The company anticipated that the new lease standard would materially affect its balance sheet.
- Key disclosed risks include competition and pricing pressure, continued GAAP losses and potentially declining revenue growth, dependence on new products and international expansion, cybersecurity and service disruptions, foreign-exchange volatility, tax uncertainty, and the cash requirements and potential dilution associated with the 2018 convertible notes. The company reported no pending legal proceeding it believed would individually or collectively have a material adverse effect.
- John J. Donahoe began employment in February and became CEO and a director effective April 3, 2017. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether subscription growth, billings growth and customer expansion continue, and how billings duration and foreign exchange affect comparisons.
- Whether improving subscription margins can offset investment spending and persistently negative professional-services margins; also track GAAP losses and stock-based compensation.
- Cash generation and the composition and liquidity of investments, alongside the $575 million note principal due in November 2018 and contractual commitments.
- The actual effects of ASC 606 and the lease standard, including retrospective restatement and changes to revenue, commissions and balance-sheet liabilities.
- Execution and customer adoption of newer products, integration of acquisitions, and exposure to cybersecurity, service reliability, competition, currency and tax risks.