Business context and reporting period
ServiceNow provides cloud-based software-as-a-service applications and a platform for automating enterprise IT and business workflows. This Form 10-K covers the year ended December 31, 2012. The company changed its fiscal year-end from June 30 to December 31, so comparisons with prior periods require care; the filing includes a six-month transition period and unaudited calendar-year 2011 comparative information.
Financial performance and position
- Revenue: $243.7 million, up 90% from $128.1 million in calendar 2011. Subscription revenue was $204.5 million, up 84%; professional services and other revenue was $39.2 million, up 128%.
- Profitability and margins: Net loss was $37.3 million, compared with a $1.7 million loss in 2011; diluted loss per share was $0.51. Gross margin declined to 57% from 64%. Subscription gross margin fell to 69% from 78%; professional services gross margin improved to negative 4% from negative 30%. Operating loss was $37.6 million.
- Cash flow and investment: Operating cash flow was $48.8 million. Capital expenditures were $42.1 million, implying operating cash flow less capital expenditures of approximately $6.7 million. Investing cash outflow was $239.1 million, primarily reflecting purchases of short-term investments. Financing provided $241.8 million, mainly from public offerings.
- Liquidity: At year-end, cash and cash equivalents were $119.0 million and short-term investments were $195.7 million. Working capital, excluding deferred revenue, was $364.4 million. Deferred revenue totaled $170.4 million, up from $104.6 million. Management said available funds and operating cash flows were expected to cover operating needs for at least 12 months.
- Debt and obligations: The balance sheet reports total liabilities of $234.7 million; it does not present a separate debt balance. Operating lease commitments totaled $111.3 million, including $98.2 million for facilities and $13.1 million for data centers.
- Operating indicators: Customers increased 55% to 1,512; renewal rate was 97%, and upsells represented 30% of annual contract value signed. Backlog rose to approximately $379 million from $210 million. International revenue was 29% of total revenue.
Material changes versus the prior comparable period
Revenue growth was driven by both new customers and expansion within existing accounts; 66% of the subscription-revenue increase came from existing customers. Expenses rose sharply as ServiceNow expanded sales, research and development, staffing and cloud infrastructure. Year-end headcount increased to 1,077 from 603. Subscription costs grew faster than subscription revenue, reducing subscription gross margin. Professional-services economics improved following a shift toward time-and-materials pricing and tighter project scoping, but the segment remained loss-making.
Outlook, commentary, risks and unusual items
- Management outlook: For 2013, management expected operating expenses to continue increasing. It anticipated subscription gross margin to improve as subscription revenue growth outpaced cost growth, and projected operating cash flow less capital expenditures to be relatively flat versus 2012 despite higher capital spending. Management expected sales and marketing expense to rise in dollars but remain relatively flat as a percentage of revenue; research and development expense was expected to rise in dollars and as a percentage of revenue.
- Key risks: The filing highlights service availability, performance and security risks, including reduced availability or functionality experienced by some large customers and a distributed denial-of-service incident at a London data center. Other material risks include scaling infrastructure, intense competition and pricing pressure, customer renewals, long enterprise sales cycles, international and foreign-exchange exposure, and continued losses. Management also disclosed previously identified internal-control material weaknesses that it believed had been remediated, while noting documentation and testing were incomplete; the company had not yet completed its first management assessment under Section 404.
- Unusual items and contingencies: The company recorded $2.5 million of lease-abandonment costs related to its former San Diego office and $1.7 million of accelerated depreciation associated with exiting managed-service data centers. Stock-based compensation was $27.9 million. Service-level credit accruals ended the year at $1.2 million. Management reported no pending legal proceeding expected to have a material adverse effect. The auditor issued an unqualified opinion on the financial statements.
Important facts for investors to verify
- Assess whether rapid revenue and customer growth can translate into improving subscription margins and sustainable profitability.
- Track service uptime, large-customer performance, security incidents, customer renewals and the reported 97% renewal rate.
- Verify that infrastructure expansion and 2013 capital spending deliver the expected capacity, reliability and cost efficiencies.
- Review cash generation against capital expenditures, deferred-revenue growth, lease commitments and any future financing needs.
- Monitor progress on internal-control documentation and testing, and confirm whether the previously identified weaknesses remain remediated.
- Consider dilution from equity compensation and offerings; the filing reported 36.1 million outstanding options and 1.5 million restricted stock units at year-end.