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NOW > SEC Filings for NOW > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for SERVICENOW, INC.

Form 10-Q for SERVICENOW, INC.


7-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2013 included in the form 10-K dated as of, and filed with the Securities and Exchange Commission, or the SEC, on February 28, 2014 (File No.


001-35580). This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors", set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

ServiceNow is a leading provider of cloud-based services to automate and manage IT service relationships across the global enterprise. Our services include a suite of IT service automation applications built on our proprietary platform that can be rapidly deployed and configured. Customers use our services to create a single system of record for enterprise IT, automate manual tasks, standardize processes and consolidate legacy systems. Using ServiceNow, enterprise IT departments can accelerate their shift from the management of IT infrastructure to the management of IT service relationships across the enterprise with greater transparency, accountability and auditability. Our proprietary platform enables our customers to create custom applications and evolve the IT service model to service domains inside and outside the enterprise.

We offer our services under a SaaS business model. Our subscription fees include access to the ordered subscription service and related support and include updates of the subscribed service during the subscription term. We provide a scaled pricing model based on the duration of the subscription term and we frequently extend discounts to our customers based on the number of users. We generate sales through our direct sales team and indirectly through channel partners and third-party referrals. We also generate revenues from professional services for implementation and training of customer personnel. We generally bill our customers annually in advance for subscription services and monthly in arrears for our professional services as the work is performed.

Many customers initially subscribe to our services to solve a specific and immediate problem. Once that problem is solved, many of our customers deploy additional applications as they become more familiar with our services and apply them to new IT processes. In addition, many customers either repurpose our IT applications or build custom applications that automate various processes for business uses outside of IT such as human resources, facilities and quality control management. A majority of our revenues come from large global enterprise customers. We continue to invest in the development of our services, infrastructure and sales and marketing to drive long-term growth. We increased our overall employee headcount to 2,103 as of March 31, 2014 from 1,269 as of March 31, 2013.

Key Factors Affecting Our Performance

Upsell rate. To grow our business it is important for us to generate additional sales from existing customers, which we refer to as our upsell rate. We calculate our upsell rate as the annual contract value of upsells signed during the period, net of any decreases in annual contract value of renewals during the period, divided by our total annual contract value signed during the period. Annual contract value is equal to the first 12 months of expected subscription revenues under a contract. The upsell rate was 34% and 33% for the three months ended March 31, 2014 and 2013, respectively. Our upsells are primarily derived by an increase in the number of seat licenses purchased by our customers and are also derived from the addition of other subscription services.

Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the annual contract value from lost customers, divided by the total annual contract value from all customers that renewed during the period and from all lost customers. A lost customer is a customer that did not renew a contract expiring in the period and that, in our judgment, will not renew. In certain instances, when a customer informs us of their intent not to renew in a period prior to the expiration of their contract, we record the customer as lost immediately in our renewal rate calculation. Typically a customer that reduces its subscription upon renewal is not considered a lost customer. However, in instances where the subscription decrease represents the majority of the customer's annual contract value, we may deem the renewal as a lost customer. We believe our renewal rate is an important metric to measure the long-term value of customer agreements and our ability to retain our customers. Our renewal rate was 97% and 96% for the three months ended March 31, 2014 and 2013, respectively.

Total customers. We believe our total customer count is a key indicator of our market penetration, growth and future revenues. We have aggressively invested in, and intend to continue to invest in, our direct sales force and additional partnerships with our indirect sales channel. We generally define a customer as an entity with an active service contract as of the measurement date. In situations where there is a single contract that applies to entities with multiple subsidiaries or divisions, universities or governmental


organizations, each entity that has contracted for a separate production instance of our services is counted as a separate customer. As of March 31, 2014 and 2013, our total customer count was 2,195 and 1,640, respectively.

Investment in growth. We have invested, and intend to continue to invest in, expanding our operations, including increasing our headcount, expanding our cloud-based infrastructure, increasing access for our partners to utilize our tools and resources, and developing technology to support our growth. We have recently, and may in the future, also enter into acquisition transactions.

Expansion beyond IT. Our customers can purchase access to our application suite for use outside of the IT department. Customers may also purchase access to our services to develop custom applications using our platform. Although in the near term we expect our revenue growth to be primarily driven by adoption and penetration of our suite of applications for use within IT, we continue to enhance the development capabilities within our platform, allowing custom application development to expand within our customer base. We believe the extensibility and simplicity of our platform is resulting in an increased use of our application suite outside of the IT department as well as an increase in customer application development.

Components of Results of Operations

Revenues

Subscription revenues. Subscription revenues are primarily comprised of fees that give customers access to the ordered subscription service, related support and updates to the subscribed service during the subscription term. Pricing includes multiple instances, hosting and support services, data backup and disaster recovery services, as well as future upgrades, when and if available, offered during the subscription period. In addition, we offer three separately priced enabling technologies: Discovery, Orchestration and Performance Analytics. We typically invoice our customers for subscription fees in annual increments upon execution of the initial contract or subsequent renewal. Our average initial contract term was approximately 36 months for the three months ended March 31, 2014 and 32 months for the three months ended March 31, 2013. Our contracts are generally non-cancelable, though customers can terminate for breach if we materially fail to perform.

We generate sales directly through our sales team and, to a lesser extent, through our channel partners. Sales to our channel partners are made at a discount and revenues are recorded at the discounted price when all revenue recognition criteria are met. From time to time, our channel partners also provide us referrals for which we pay a referral fee. We pay referral fees to channel partners and other third parties typically ranging from 5% to 15% of the first year's annual contract value. These fees are included in sales and marketing expense.

Professional services and other revenues. Professional services revenues consist of fees associated with the implementation and configuration of our subscription service. Our pricing for professional services are primarily on a time-and-materials basis. We generally invoice our professional services monthly in arrears based on actual hours and expenses incurred. Other revenues include primarily fees from customer training delivered on-site or publicly available classes, royalties from licensing training materials, attendance and sponsorship fees for our annual Knowledge user conference and other customer forums. Typical payment terms require our customers to pay us within 30 days of invoice.

Allocation of Overhead Costs

Overhead costs associated with facilities, IT and certain depreciation related to noncloud-based infrastructure are allocated to cost of revenues and operating expenses based on headcount. Depreciation related to our cloud-based infrastructure hardware equipment is classified as cost of subscription revenues.

Cost of Revenues

Cost of subscription revenues. Cost of subscription revenues consists primarily of expenses related to hosting our services and providing support to our customers. These expenses are comprised of data center capacity costs; personnel related costs directly associated with our cloud-based infrastructure and customer support, including salaries, benefits, bonuses and stock-based compensation; and allocated overhead.

Cost of professional services and other revenues. Cost of professional services and other revenues consists primarily of personnel related costs directly associated with our professional services and training departments, including salaries, benefits, bonuses and stock-based compensation; the costs of contracted third-party vendors; and allocated overhead.

Professional services associated with the implementation and configuration of our subscription services are performed directly by our services team, as well as by contracted third-party vendors. Fees paid to third-party vendors are primarily recognized as cost of revenues as the professional services are delivered. Cost of revenues associated with our professional services


engagements contracted with third-party vendors as a percentage of professional services and other revenues was 15% and 18% in the three months ended March 31, 2014 and 2013, respectively.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses, commissions and stock-based compensation. Sales and marketing expenses also includes third-party referral fees, marketing and promotional events, including our annual Knowledge user conference, online marketing, product marketing and allocated overhead.

Research and Development Expenses

Research and development expenses consist primarily of personnel related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation, and allocated overhead.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel related expenses for our executive, finance, legal, human resources and administrative personnel, including salaries, benefits, bonuses and stock-based compensation; external legal, accounting and other professional services fees; other corporate expenses; and allocated overhead.

Provision for Income Taxes

Provision for income taxes consists of federal, state and foreign income taxes. Due to cumulative losses, we maintain a valuation allowance against our U.S. deferred tax assets as of March 31, 2014 and 2013. We consider all available evidence, both positive and negative, including but not limited to, earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets in assessing the extent to which a valuation allowance should be applied against our U.S. deferred tax assets.


Results of Operations

To enhance comparability, the following table sets forth our results of
operations for the periods presented. The period-to-period comparison of
financial results is not necessarily indicative of future results.

                                             Three Months Ended March 31,
                                               2014                 2013
                                                    (in thousands)
Revenues:
Subscription                             $      117,375       $       71,558
Professional services and other                  21,715               14,381
Total revenues                                  139,090               85,939
Cost of revenues(1):
Subscription                                     31,189               18,312
Professional services and other                  21,925               13,996
Total cost of revenues                           53,114               32,308
Gross profit                                     85,976               53,631
Operating expenses(1):
Sales and marketing                              69,416               38,226
Research and development                         31,110               16,039
General and administrative                       21,631               12,279
Total operating expenses                        122,157               66,544
Loss from operations                            (36,181 )            (12,913 )
Interest and other income (expense), net         (5,963 )                119
Loss before provision for income taxes          (42,144 )            (12,794 )
Provision for income taxes                        1,167                  564
Net loss                                 $      (43,311 )     $      (13,358 )

(1) Stock-based compensation included in the statements of operations above was as follows:

                                       Three Months Ended March 31,
                                             2014                   2013
                                              (in thousands)
Cost of revenues:
Subscription                    $         3,076                   $ 1,794
Professional services and other           2,392                       821
Sales and marketing                       9,043                     3,985
Research and development                  7,839                     3,114
General and administrative                6,879                     2,332


                                          Three Months Ended March 31,
                                            2014                2013
Revenues:
Subscription                                 84  %               83  %
Professional services and other              16                  17
Total revenues                              100                 100
Cost of revenues:
Subscription                                 22                  21
Professional services and other              16                  16
Total cost of revenues                       38                  37
Gross profit                                 62                  63
Operating expenses:
Sales and marketing                          50                  44
Research and development                     22                  19
General and administrative                   16                  15
Total operating expenses                     88                  78
Loss from operations                        (26 )               (15 )
Interest and other income, net               (4 )                 -
Loss before provision for income taxes      (30 )               (15 )
Provision for income taxes                    1                   1
Net loss                                    (31 )%              (16 )%



                             Three Months Ended March 31,
                                   2014                  2013
                                    (in thousands)
Revenues by geography
North America          $         94,964                $ 60,145
EMEA (1)                         36,306                  20,304
Asia Pacific and other            7,820                   5,490
Total revenues         $        139,090                $ 85,939

(1) Europe, the Middle East and Africa


Comparison of the three months ended March 31, 2014 and 2013

Revenues

                                    Three Months Ended March 31,
                                      2014                2013          % Change
                                       (dollars in thousands)
Revenues:
Subscription                    $      117,375       $      71,558          64 %
Professional services and other         21,715              14,381          51 %
Total revenues                  $      139,090       $      85,939          62 %
Percentage of revenues:
Subscription                                84 %                83 %
Professional services and other             16                  17
Total                                      100 %               100 %

Subscription revenues increased $45.8 million during the three months ended March 31, 2014, compared to the same period in the prior year, driven by our upsells, renewals and an increase in our customer count. Our upsell rate and renewal rate for the trailing twelve months ending March 31, 2014 and 2013 were 32% and 96%, respectively, for both periods. Total customer count at March 31, 2014 was 2,195 compared to 1,640 at March 31, 2013, an increase of 34%. Revenues from our direct sales organization and channel partners represented 88% and 12%, respectively, for the three months ended March 31, 2014 and March 31, 2013.

Professional services and other revenues increased $7.3 million during the three months ended March 31, 2014, compared to the same period in the prior year, due to an increase in the services provided to our growing customer base and improvements in pricing of our professional services engagements. In the three months ended June 30, 2014, we expect to recognize approximately $8.0 million in revenues from Knowledge, our annual user conference. Excluding the revenues from Knowledge, we expect professional services and other revenues to increase at a slower rate than subscription revenues as we continue to focus on strengthening and supporting our network of professional services partners. We believe excluding Knowledge revenues facilitates a more meaningful comparison between comparative periods for our professional services and other revenue and gross profit.

Our average total revenues per customer, defined as trailing four quarters' revenues divided by the average number of customers during the trailing four quarters, increased to approximately $241,000 for the three months ended March 31, 2014 compared to approximately $198,000 for the three months ended March 31, 2013.

Cost of Revenues and Gross Profit Percentage

                                    Three Months Ended March 31,
                                       2014                2013          % Change
                                       (dollars in thousands)
Cost of revenues:
Subscription                    $      31,189         $      18,312          70 %
Professional services and other        21,925                13,996          57 %
Total cost of revenues          $      53,114         $      32,308          64 %
Gross profit/(loss) percentage:
Subscription                               73  %                 74 %
Professional services and other            (1 )%                  3 %
Total gross profit percentage              62  %                 63 %
Gross Profit                    $      85,976         $      53,631
Headcount (at period end)
Subscription                              381                   234          63 %
Professional services and other           337                   204          65 %
Total headcount                           718                   438          64 %


Cost of subscription revenues increased $12.9 million during the three months ended March 31, 2014, compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $6.3 million in personnel-related costs excluding stock-based compensation, an increase of $1.3 million in stock-based compensation, an increase of $1.7 million in depreciation expense primarily due to purchases of cloud-based infrastructure hardware equipment for our data centers and an increase of $1.0 million in other overhead expenses. Hosting expenses increased $1.5 million primarily due to the expansion of our data centers.

Our subscription gross profit percentage was 73% for the three months ended March 31, 2014 compared to 74% for the three months ended March 31, 2013. We expect our subscription gross profit percentage to increase slightly for the remainder of the year as we continue to leverage the investment we have made in our existing data center infrastructure and our revenues continue to increase at a higher rate compared to the increase in cost of subscription revenues.

Cost of professional services and other revenues increased $7.9 million during the three months ended March 31, 2014 as compared to the same period in the prior year, primarily due to increased headcount resulting in an increase of $5.3 million in personnel-related costs excluding stock-based compensation, an increase of $1.6 million in stock-based compensation, an increase of $0.8 million in overhead expenses, and an increase of $0.4 million in outside services costs.

Our professional services and other gross profit (loss) percentage decreased to
(1)% during the three months ended March 31, 2014 compared to 3% for the three months ended March 31, 2013 primarily due to increased stock-based compensation. In the three months ended June 30, 2014, we expect to recognize approximately $8.0 million in revenues from Knowledge, our annual user conference, with all expenses recorded in sales and marketing. Excluding revenues from Knowledge, we expect an increase in our professional services and other gross loss percentage for the remainder of the year primarily driven by increasing stock-based compensation and additional investment in our professional services organization.

Sales and Marketing

                             Three Months Ended March 31,
                                2014               2013          % Change
                                (dollars in thousands)
Sales and marketing       $      69,416       $      38,226          82 %
Percentage of revenues               50 %                44 %
Headcount (at period end)           730                 452          62 %

Sales and marketing expenses increased $31.2 million during the three months ended March 31, 2014 compared to the same period in the prior year, primarily due to increased headcount that resulted in an increase of $14.6 million in personnel-related costs excluding stock-based compensation, an increase of $5.1 million in stock-based compensation, an increase of $2.1 million in overhead expenses and an increase of $6.8 million in commissions expense. Commissions increased primarily due to an increase in bookings. Commissions and referral fees amounted to 11% and 9% of subscription revenues for three months ended March 31, 2014 and 2013, respectively. Marketing program expenses, which include events, advertising and market data, increased $2.3 million during the three months ended March 31, 2014 compared to the same period in the prior year.

In the second quarter of 2014, we expect to incur sales and marketing expenses of approximately $15.0 million related to Knowledge, our annual user conference. Excluding the charges related to Knowledge, we expect sales and marketing expenses to increase for the remainder of the year, in absolute dollar terms, but to decrease as a percentage of total revenues as we continue to expand our direct sales force, increase our marketing activities, grow our international operations, build brand awareness and sponsor additional marketing events. Excluding the charges from Knowledge makes it easier to compare our sales and marketing expenses in the three months ended March 31, 2014 with our sales and marketing expenses in other quarters.

Research and Development


                                       20
--------------------------------------------------------------------------------


                             Three Months Ended March 31,
                                2014               2013          % Change
                                (dollars in thousands)
Research and development  $      31,110       $      16,039          94 %
Percentage of revenues               22 %                19 %
Headcount (at period end)           410                 231          77 %

Research and development expenses increased $15.1 million during the three months ended March 31, 2014 compared to the same period in the prior year, primarily due to increased headcount, which resulted in an increase of $8.0 million in personnel-related costs excluding stock-based compensation, an increase of $4.7 million in stock-based compensation and an increase of $1.7 million in overhead expenses.

We expect research and development expenses to increase for the remainder of the year, in absolute dollar terms, but to remain relatively flat as a percentage of total revenues as we continue to improve the existing functionality of our services, develop new applications to fill market needs and continue to enhance our core platform.

General and Administrative

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