ServiceNow, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement figures below are in millions unless otherwise noted.
Business context
ServiceNow sells enterprise cloud software for digital workflows, principally through annual subscriptions. Subscription revenue represented 95% of revenue in both the quarter and nine-month period. The company reported 12,643 employees at quarter-end, up from 9,929 a year earlier.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $1,152 | $886 | $3,269 | $2,509 |
| Subscription revenue | $1,091 | $835 | $3,102 | $2,356 |
| Operating income | $69 | $56 | $181 | $14 |
| Net income | $13 | $41 | $102 | $28 |
| Diluted EPS | $0.06 | $0.21 | $0.50 | $0.14 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1,101 | $815 |
| Free cash flow (non-GAAP) | Not provided for quarter | Not provided for quarter | $816 | $629 |
Q3 revenue increased 30% year over year; subscription revenue rose 31%, led by digital workflow products (+33%). Nine-month revenue also grew 30%. Gross margin was 78% in Q3 and for the nine-month period, versus 77% in each prior-year comparison; subscription gross margin remained 83%. Professional services gross loss margin improved to 3% in Q3 from 21% a year earlier, and to 12% for nine months from 20%.
Operating margin was approximately 6.0% in Q3 versus 6.4% a year earlier, and 5.5% for nine months versus 0.5%. Q3 net income declined despite revenue and operating income growth, primarily reflecting a $41 million loss on extinguishment of 2022 Notes and foreign-exchange losses; lower interest income also contributed. Nine-month net income increased substantially from the prior year.
Cash and cash equivalents were $1.35 billion at September 30, 2020, with short-term investments of $1.60 billion and long-term investments of $1.26 billion. Operating cash flow for nine months increased 35%. Investing cash outflow was $1.33 billion, reflecting investment purchases, capital spending and acquisitions. The company reported approximately $3.0 billion of cash and short-term investments and said available resources and expected operating cash flows should meet liquidity needs for at least 12 months.
Long-term debt carrying value was $1.71 billion, including $1.48 billion for newly issued 2030 Notes and $224 million for the remaining 2022 Notes. Total liabilities were $5.03 billion and stockholders’ equity was $2.67 billion. Current deferred revenue was $2.27 billion.
Material changes and unusual items
- In August, ServiceNow issued $1.5 billion of 1.40% unsecured notes due in 2030. It repurchased $496.8 million principal of 2022 convertible notes and received $1.1 billion from a partial unwind of the related note hedge. The repurchase and early conversions resulted in a reported $42 million nine-month loss on extinguishment.
- Remaining performance obligations were $7.3 billion at quarter-end; management expected to recognize approximately 52% over the following 12 months.
- Billings, a non-GAAP measure, grew 25% in Q3 and 26% for nine months. Renewal rate was 98% for Q3 and 97% for nine months, compared with 99% and 98%, respectively, in 2019.
- Acquisitions of Sweagle, Passage AI and Loom were completed during 2020 for disclosed cash consideration totaling approximately $116 million. The filing says these acquisitions did not materially affect the financial statements.
- Stock-based compensation was $220 million in Q3 and $625 million for nine months, respectively, equal to 19% of revenue for Q3 and 19% for nine months. A modification to 2020 performance targets is expected to add $29 million of expense over the remaining vesting period.
Outlook, management commentary and risks
Management expected 2020 subscription revenue and professional-services revenue to increase in absolute dollars; it expected subscription gross margin to remain relatively flat and sales and marketing expense to decline as a percentage of revenue. The filing provides no clear numerical full-year revenue or earnings guidance. Management expected research and development expense to increase in dollars and slightly as a share of revenue. These expectations were subject to COVID-19 effects and used foreign-exchange rates as of September 30.
Management said the pandemic had adversely affected customers, partners and vendors and created uncertainty around demand, contract duration, collections, sales cycles and future results. The company had moved most employees to remote work, restricted travel and shifted or canceled in-person events. Other highlighted risks include intense competition, cybersecurity and service disruptions, privacy and data-transfer regulation, foreign-exchange volatility, customer implementation challenges, and cash settlement requirements for convertible notes. Management stated that pending legal proceedings were not expected to have a material adverse effect and that disclosure controls were effective.
Important facts for investors to verify
- How much Q3 and year-to-date earnings were affected by the 2022 Notes repurchase, conversions, foreign-exchange losses and related hedge transactions.
- Whether cash generation and deferred-revenue/RPO trends support continued subscription growth, given lower reported Q3 net income and the decline in renewal rates.
- The eventual cash settlement of 2022 Notes conversions, including the approximately $70 million principal expected to be settled in Q4 2020, and potential dilution from remaining warrants.
- How COVID-19, customer spending and contract duration affect future billings, renewals, collections and the company’s outlook.
- The scale and future impact of stock-based compensation, capital expenditures, lease commitments and acquisition-related costs.