Business context and reporting period
ServiceNow, Inc. (NASDAQ: NOW) filed this unaudited Form 10-Q for the quarter ended March 31, 2016. The company provides enterprise cloud software, primarily through annual subscriptions. Its results are compared with the three months ended March 31, 2015; balance-sheet figures are compared with December 31, 2015.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Subscription revenue | $267.4 million | $179.9 million | +49% |
| Professional services and other revenue | $38.5 million | $32.1 million | +20% |
| Total revenue | $305.9 million | $212.0 million | +44% |
| Gross profit / gross margin | $211.6 million / 69% | $135.1 million / 64% | Margin +5 percentage points |
| Operating loss | $(324.2) million | $(54.2) million | Worsened, primarily due to settlement expense |
| Net loss / diluted loss per share | $(333.3) million / $(2.06) | $(58.1) million / $(0.38) | Loss increased |
| Operating cash flow | $78.7 million | $67.4 million | +17% |
| Free cash flow (non-GAAP) | $49.6 million | $40.7 million | +22% |
Subscription revenue was 87% of total revenue, up from 85%. Subscription gross margin improved to 80% from 76%, attributed to data-center density and economies of scale. Professional services gross margin remained negative, at (8)% versus (7)%. Free cash flow is defined as operating cash flow less property and equipment purchases and includes a $17.5 million legal-settlement payment.
At March 31, cash and cash equivalents were $453.5 million, short-term investments $447.4 million, and long-term investments $361.8 million. Management reported $900.9 million of cash and cash equivalents plus short-term investments, and expected available resources and operating cash generation to meet needs for at least 12 months. Total liabilities were $1.572 billion, including $482.6 million net carrying value of convertible notes (principal $575 million), due November 2018. The notes carry a 0% coupon; debt-discount amortization produces a 6.5% effective interest rate. The notes were not convertible at quarter-end.
Deferred revenue was $682.5 million in total ($672.0 million current). The company reported 162.8 million common shares outstanding. Stock-based compensation was $75.3 million, or 25% of revenue.
Material changes versus the prior comparable period
- Revenue growth was led by subscription sales, attributed to customer additions and upsells; IT Operations Management subscription revenue grew 70% to $21.6 million.
- Billings, a non-GAAP measure, increased 41% to $376.7 million. Deferred revenue change contributed $70.8 million, versus $55.9 million in Q1 2015.
- The $270.0 million legal-settlement charge drove much of the increase in operating and net losses. Excluding that item, the filing does not present an adjusted GAAP profit measure.
- Sales and marketing expense rose 44% to $158.6 million; research and development rose 32% to $65.9 million; and general and administrative expense rose 40% to $41.2 million. Employee headcount increased to 3,991 from 3,047 year over year.
- Cash from financing activities shifted to an $8.7 million use from $29.7 million provided, primarily reflecting higher taxes paid on net share settlement of equity awards and lower employee stock-plan proceeds.
Outlook, management commentary, risks and unusual items
- Management expects revenue growth to continue to decline and expects GAAP losses for the remainder of 2016; the filing does not provide a clear numerical full-year revenue or earnings guidance range.
- Management expects IT Operations Management subscription revenue to grow in absolute dollars and as a share of revenue. Professional services revenue is expected to grow more slowly than subscription revenue; subscription gross margin is expected to remain relatively flat.
- Q2 2016 sales and marketing expense was expected to include approximately $26 million for the Knowledge conference. Management anticipated operating cash flow would decrease in Q2 because of settlement payments.
- The company recorded a $270 million aggregate charge for confidential settlements resolving HPE and BMC patent litigation. It paid $17.5 million in Q1 and accrued $250 million at quarter-end, payable in Q2. The BMC settlement was signed April 8, 2016, after quarter-end; the filing states both settlements cover all financial obligations and leave no remaining settlement obligations.
- On April 8, 2016, ServiceNow acquired ITapp for approximately $15 million in cash; purchase accounting was still pending.
- Operating lease commitments exceeded $300 million at March 31. Management expects the new lease accounting standard, effective in 2019, to materially affect the balance sheet, but not materially affect expense recognition.
- Key disclosed risks include intensifying competition and pricing pressure; continued GAAP losses and potentially slowing growth; execution in newer product markets and international expansion; foreign-exchange exposure; cybersecurity or service outages; dependence on renewals, upsells, and sales-force productivity; and potential dilution and cash requirements related to convertible notes and equity awards. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Settlement cash-payment timing and the reconciliation of the $270 million charge, $17.5 million paid, and $250 million accrued balance.
- Underlying subscription growth, deferred-revenue and billings trends, renewal rate (97% in both periods), and customer expansion, alongside management’s warning of decelerating revenue growth.
- Cash generation after settlement payments and planned data-center, headcount, facilities, and acquisition spending; assess liquidity separately from investments and operating lease commitments.
- The effect of $75.3 million quarterly stock-based compensation and equity-plan reserves on future expenses and share dilution.
- Convertible-note terms, cash settlement exposure, and potential dilution from the associated warrants; confirm any subsequent changes to conversion status or debt obligations.