Business context and reporting period
ServiceNow, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It provides cloud-based enterprise workflow and service-management software, principally through subscriptions, and reports as one segment. The filing is annual; fourth-quarter figures are noted separately below.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Total revenue | $1.391 billion | $1.005 billion | +38% |
| Subscription revenue | $1.222 billion | $848.3 million | +44% |
| Gross profit / margin | $991.8 million / 71% | $676.1 million / 67% | Margin +4 percentage points |
| Operating loss | $422.8 million | $166.4 million | Loss increased |
| Net loss | $451.8 million | $198.4 million | Loss increased |
| Cash from operations | $159.9 million | $317.8 million | Down 50% |
| Free cash flow (non-GAAP) | $54.4 million | $230.3 million | Down substantially |
Subscription gross margin improved to 81% from 78%, attributed to improved data-center utilization and scale. Professional services and other gross margin fell to 3% from 7%, principally due to lower utilization and investment in specialized resources. FY 2016 billings, a company-defined non-GAAP metric, rose 41% to $1.691 billion, the same growth rate as in 2015.
Fourth-quarter 2016 revenue was $385.7 million, up from $285.7 million in Q4 2015. Net loss was $32.6 million versus $37.4 million.
At year-end, cash, cash equivalents and investments totaled approximately $1.162 billion; cash and cash equivalents plus short-term investments were $899.4 million. Working capital excluding deferred revenue was $1.133 billion. The company reported $575 million principal of 0% convertible notes due November 1, 2018 (carrying value $507.8 million); it intended to settle principal in cash. Management said available liquidity and operating cash flow should meet needs for at least 12 months.
Material changes versus prior year
- Revenue grew 38%, slower than 47% in 2015. Subscription revenue remained the main growth driver; professional services and other revenue increased 7%.
- Net loss widened primarily because of $270 million in one-time charges for HPE and BMC patent settlements. The company paid $267.5 million in cash for the settlements during 2016; the matters were resolved with no remaining financial obligations under those settlements.
- Operating cash flow and free cash flow declined, mainly reflecting the settlement payment. Free cash flow also reflects $105.6 million of property and equipment purchases.
- Deferred revenue increased to $895.1 million from $603.8 million, and backlog rose to approximately $1.9 billion from $1.3 billion.
- Customers with annual contract value above $1 million increased to 341 from 227; Global 2000 customers increased to 735 from 633. The reported renewal rate was 98% in both 2016 and 2015.
Outlook, commentary and risks
- Management expected subscription revenue to grow in absolute dollars and as a share of revenue in 2017. It also expected a slight increase in subscription gross margin and improvement in professional-services gross margin. Operating expenses were expected to increase in dollars, though several expense categories were expected to decline slightly as a percentage of revenue.
- The company expected to continue reporting GAAP losses in 2017, citing investment needs, stock-based compensation, acquired-intangible amortization and other expenses. Management warned that revenue growth was expected to continue decelerating.
- Key risks include intense competition and pricing pressure; execution in newer product areas; cybersecurity incidents or service disruptions; international, currency and privacy-regulation exposure; and dependence on retaining customers and expanding sales. International markets represented 32% of revenue.
- ServiceNow planned to adopt the new revenue standard in 2018, expected to affect timing of revenue and expense recognition for on-premises contracts and deferred commissions. On-premises revenue under the existing ratable model was less than 10% of total revenue.
- Contractual obligations totaled $921.5 million, including $575 million of notes due in 2018 and $298.5 million of operating lease payments. An additional $52.1 million of lease commitments entered into after year-end was not included. The filing also disclosed approximately $18.1 million in potential cancellation penalties for certain conference commitments.
- CEO Frank Slootman was to resign effective April 3, 2017, with John Donahoe appointed as successor; founder Fred Luddy retired as Chief Product Officer in October 2016 but remained a director.
Important facts for investors to verify
- Whether subscription growth, billings growth and renewal performance remain durable as management anticipates slower overall growth.
- How much reported profitability and cash generation are affected by the one-time settlements, ongoing stock-based compensation and continued investment.
- The cash, dilution and settlement implications of the $575 million convertible notes, including maturity and conversion provisions.
- The actual effects of adopting the revenue-recognition standard, particularly on historical comparisons and commission assets.
- Whether newer product lines and international expansion deliver growth sufficient to support their costs, amid competition, currency and regulatory risks.