ServiceNow, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014, compared with the three months ended March 31, 2013. ServiceNow provides cloud-based IT service automation applications on a subscription basis.
Financial results
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Subscription revenue | $117.4 | $71.6 | +64% |
| Professional services and other revenue | $21.7 | $14.4 | +51% |
| Total revenue | $139.1 | $85.9 | +62% |
| Gross profit / gross margin | $86.0 / 62% | $53.6 / 63% | Margin down 1 percentage point |
| Operating expenses | $122.2 | $66.5 | +84% |
| Operating loss | $(36.2) | $(12.9) | Loss widened |
| Net loss / diluted loss per share | $(43.3) / $(0.30) | $(13.4) / $(0.10) | Loss widened |
| Operating cash flow | $24.2 | $15.0 | +61% |
| Investing cash flow | $(75.7) | $(11.0) | Greater investment outflow |
- Subscription revenue represented 84% of total revenue. Subscription gross margin was 73%, versus 74%; professional services and other gross margin fell to negative 1%, from 3%.
- Stock-based compensation was $29.2 million, compared with $12.0 million. It was a significant non-cash expense and contributed to the divergence between net loss and positive operating cash flow.
- Cash and cash equivalents were $337.9 million at March 31, down from $366.3 million at year-end. Short-term investments were $317.8 million and long-term investments were $268.6 million. The company reported $655.8 million in cash, cash equivalents and short-term investments.
- Current assets were $828.6 million and current liabilities were $365.5 million. Deferred revenue totaled $308.5 million, including current and long-term balances.
- Convertible notes had $575 million principal and a net carrying amount of $421.8 million. The notes bear no coupon, mature in November 2018, and produced $7.1 million of non-cash interest expense in the quarter; the liability component’s effective interest rate was 6.5%.
Material changes and operating developments
- Customer count increased 34% to 2,195 from 1,640. Headcount increased to 2,103 from 1,269 a year earlier.
- Operating expenses grew faster than revenue, with sales and marketing up 82%, research and development up 94%, and general and administrative up 76%. Operating expenses rose to 88% of revenue from 78%.
- Revenue outside North America was approximately 32% of total revenue. North America revenue was $95.0 million, EMEA $36.3 million, and Asia Pacific and other $7.8 million.
- Investing cash outflow reflected net investment purchases and $11.0 million of property and equipment purchases. Financing cash flow of $23.2 million was primarily from employee stock plans and related tax benefits.
Outlook, risks and unusual items
- Management expected subscription gross margin to increase slightly for the rest of 2014 as revenue growth leveraged existing data-center infrastructure. Excluding the annual Knowledge conference, it expected professional-services gross loss percentage to worsen, sales and marketing expense to rise in dollars but decline as a percentage of revenue, R&D to remain relatively flat as a percentage of revenue, and G&A to decline slightly as a percentage of revenue.
- For Q2 2014, management expected approximately $8 million of Knowledge conference revenue and approximately $15 million of related sales and marketing expense. These items may affect quarter-to-quarter comparisons.
- Management said existing cash and cash generation were expected to meet liquidity needs for at least the next 12 months. It also cautioned that revenue growth was expected to decline and that continued investment could prevent the company from achieving or sustaining profitability or positive operating cash flow.
- HP filed suit on February 6, 2014, alleging infringement of eight patents and seeking unspecified damages and an injunction. ServiceNow planned to defend the case; the company said it could not reasonably estimate potential loss.
- Principal risks include service availability and security incidents, rapid growth and hiring, competition, customer renewals and upsells, international expansion and currency exposure, and intellectual-property litigation. The filing states disclosure controls were effective and reports no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Check the sustainability and economics of growth: revenue rose 62%, but operating expenses grew faster and net loss widened.
- Assess cash generation quality, including deferred-revenue and other working-capital movements, stock-based compensation, and continued infrastructure and investment spending.
- Review the convertible notes’ cash-settlement and conversion terms, potential dilution from the associated warrants, and the note-hedge counterparty exposure.
- Monitor the HP patent litigation; the filing provides no clear estimate of potential loss.
- Reconcile customer-performance metrics: the filing gives quarterly upsell rates of 34% and 33% in one discussion, but also reports trailing-twelve-month upsell rates of 32% for both comparison periods; renewal-rate figures likewise vary by discussion.