ServiceNow, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; year-over-year comparisons are against the corresponding 2015 periods. ServiceNow provides enterprise cloud software, with revenue primarily from subscriptions.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $357.7 million (+37%) | $261.2 million | $1,004.8 million (+40%) | $719.8 million |
| Subscription revenue | $318.9 million (+43%) | $223.2 million | $877.0 million (+45%) | $603.6 million |
| Gross profit / margin | $254.8 million / 71% | $179.3 million / 68% | $711.1 million / 71% | $481.3 million / 66% |
| Operating loss | $(26.8) million | $(28.0) million | $(399.2) million | $(135.5) million |
| Net loss | $(36.3) million | $(41.0) million | $(419.2) million | $(161.0) million |
| Net loss per share | $(0.22) | $(0.26) | $(2.56) | $(1.04) |
Subscription growth reflected upsells and customer additions. IT Operations Management subscription revenue rose 66% in Q3 and 72% for the nine-month period; Enterprise Service Management revenue rose 41% and 43%, respectively. Professional services and other revenue grew 2% in Q3 and 10% year to date.
Q3 subscription gross margin improved to 81% from 79%, which management attributed to data-center density and economies of scale. Professional services and other gross margin fell to negative 7% from 6% in Q3, primarily due to lower utilization and investment in specialized resources. For the nine months, that margin was 4%, down from 10%.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $27.2 million, down from $211.2 million. The company cited $267.5 million paid for legal settlements as the primary reason for the decline. Capital expenditures were $84.1 million, producing negative free cash flow of $56.9 million, versus positive free cash flow of $148.6 million in 2015.
- At September 30, cash and cash equivalents were $325.1 million and short-term investments were $481.8 million; together, $806.9 million. Long-term investments were $281.4 million. The company said $165.6 million of cash and cash equivalents and short-term investments was held by foreign subsidiaries.
- Current assets were $1.127 billion and current liabilities were $898.3 million. Deferred revenue totaled $761.7 million, including current deferred revenue of $743.7 million.
- The 0% convertible notes have $575 million principal and mature November 1, 2018. Their balance-sheet carrying value was $499.3 million; the reported effective interest rate on the liability component was 6.5%. Management intended to settle principal in cash. Notes were not convertible as of quarter-end.
- Management stated existing cash, investments and cash generated from operations should meet liquidity needs for at least the next 12 months. Operating cash flow and free cash flow remain sensitive to settlement payments, growth investment and working-capital changes.
Changes, outlook and notable items
- The nine-month net loss includes a $270 million charge for settlements with Hewlett Packard Enterprise and BMC. The lawsuits were dismissed, settlement obligations were fulfilled, and the filing states no remaining financial obligations under those settlements.
- Billings, a non-GAAP measure defined as revenue plus the change in deferred revenue, were $404.3 million in Q3 (+41%) and $1.156 billion for nine months (+38%). Renewal rates were 99% for Q3 and 98% for nine months, compared with 98% and 97% in 2015. Customers with ACV above $1 million increased to 301 from 203; Global 2000 customers increased to 705 from 607.
- Headcount rose to 4,501 from 3,402 a year earlier. Stock-based compensation was $81.1 million in Q3 and $234.5 million for nine months, representing 23% of revenue in each period.
- Management expected subscription revenue to grow in absolute dollars and IT Operations Management to increase as a share of subscription revenue. It expected professional services revenue to grow more slowly than subscription revenue and anticipated a GAAP loss for the remainder of 2016. The filing provides no numerical revenue or earnings guidance.
- Management expected subscription gross margin to improve for full-year 2016 versus 2015, with sales and marketing expense roughly flat as a percentage of revenue. It anticipated higher absolute spending in several expense categories as the company expanded, and approximately $8.5 million of remaining 2016 amortization expense on the notes.
- BrightPoint Security and ITapp were acquired for approximately $19.6 million and $14.5 million, respectively, in cash. Their results were included from acquisition dates; management said the acquisitions had no material financial-statement impact.
- Operating lease commitments were approximately $300 million. The company expected the new lease accounting standard to materially affect its balance sheet, but not materially affect its income statement.
- Key disclosed risks include slowing revenue growth, continued GAAP losses, competition and pricing pressure, execution in newer product markets and international expansion, currency exposure, cybersecurity and service interruptions, and intellectual-property litigation. The company reported no material change in market-risk disclosures and said disclosure controls were effective.
Important facts for investors to verify
- Whether subscription growth, renewals, large-customer additions and billings continue to support reported revenue growth.
- How quickly operating cash flow and free cash flow recover after the legal settlements, and how much ongoing investment growth requires.
- Whether improving subscription margins can offset weaker professional-services margins and rising operating expenses and stock-based compensation.
- Cash availability and settlement mechanics for the $575 million principal of notes due in 2018, including potential conversion or repurchase obligations.
- The scale and timing of lease commitments, acquisition-related costs, and any future legal, tax, currency, security or service-continuity exposures.