Enterprise workflow software maker ServiceNow (NYSE:NOW) fell short of analyst expectations in Q2 FY2022 quarter, with revenue up 24.3% year on year to $1.75 billion. ServiceNow made a GAAP profit of $20 million, down on its profit of $59 million, in the same quarter last year.
ServiceNow (NOW) Q2 FY2022 Highlights:
- Revenue: $1.75 billion vs analyst estimates of $1.76 billion (0.63% miss)
- EPS (non-GAAP): $1.62 vs analyst estimates of $1.55 (4.43% beat)
- Subscription revenue guidance for Q3 2022 is $1.75 billion at the midpoint, below analyst estimates of $1.88 billion
- The company provided subscription revenue guidance for the full year of $6.92 billion at the midpoint
- Free cash flow of $287 million, down 62.7% from previous quarter
- Customers: 1,463 customers paying more than $1m annually
- Gross Margin (GAAP): 77.7%, up from 76.6% same quarter last year
Founded by Fred Luddy who wrote the code for the initial prototype on a single flight from San Francisco to London, ServiceNow (NYSE:NOW) offers software as a service platform that helps companies become more efficient by allowing them to automate workflows across IT, HR and Customer Service.
A simple example would be a new employee on-boarding, which is typically a multi-departmental experience, and involves getting a badge from security, desk from facilities, laptop from IT, dealing with finance, compliance and HR. With ServiceNow, employees are able to do all that through a self-help portal, saving significant amounts of time. The key to the success of the Now platform is allowing the companies to design and build these workflows in a no-code environment, without needing any software developers.
ServiceNow's clients can sell their custom workflow applications to other users in the ServiceNow App Store and as a result, ServiceNow is generally most useful for larger customers, who have many complex workflows that may (for example) require a multitude of approvals as well as being time sensitive. In turn, large customers are more valuable to ServiceNow, as they are likely to need more users and thus generate more revenue and a greater number of custom workflows for sale in the App Store.
The story of ServiceNow started when Fred Luddy, the founder, wrote the code for the initial working prototype of ServiceNow on a single flight from San Francisco to London, after being frustrated how bad the experience using software at work was compared to the software he was using at home.
The whole purpose of software is to automate tasks to increase productivity. Today, innovative new software techniques, often involving AI and machine learning, are finally allowing automation that has graduated from simple one- or two-step workflows to more complex processes integral to enterprises. The result is surging demand for modern automation software.
Other providers of software for creating digital workflows include BMC, Oracle (NYSE:ORCL), Salesforce (NYSE:CRM), and SAP (NYSE:SAP).
As you can see below, ServiceNow's revenue growth has been strong over the last year, growing from quarterly revenue of $1.4 billion, to $1.75 billion.
Even though ServiceNow fell short of revenue estimates, its quarterly revenue growth was still up a very solid 24.3% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $30 million in Q2, compared to $108 million in Q1 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.
Ahead of the earnings results the analysts covering the company were estimating sales to grow 25.3% over the next twelve months.
Large Customers Growth
You can see below that at the end of the quarter ServiceNow reported 1,463 enterprise customers paying more than $1m annually, an increase of 62 on last quarter. That is quite a bit more contract wins than last quarter and quite a bit above what we have typically seen lately, demonstrating that the business itself has good sales momentum. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is working very well.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. ServiceNow's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 77.7% in Q2.
That means that for every $1 in revenue the company had $0.77 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a good gross margin that allows companies like ServiceNow to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity. It is good to see that the gross margin is staying stable which indicates that ServiceNow is doing a good job controlling costs and is not under pressure from competition to lower prices.
Cash Is King
If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. ServiceNow's free cash flow came in at $287 million in Q2, up 7.08% year on year.
ServiceNow has generated $2.02 billion in free cash flow over the last twelve months, an impressive 30.7% of revenues. This robust FCF margin is a result of ServiceNow asset lite business model, scale advantages, and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.
Key Takeaways from ServiceNow's Q2 Results
Sporting a market capitalization of $84.7 billion, more than $3.83 billion in cash and with positive free cash flow over the last twelve months, we're confident that ServiceNow has the resources it needs to pursue a high growth business strategy.
We were very impressed how strongly ServiceNow accelerated the rate of new contract wins this quarter. And we were also glad to see good revenue growth. On the other hand, it was unfortunate to see that ServiceNow missed analysts' revenue expectations. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. But the market was likely expecting more and the company is down 6.41% on the results and currently trades at $419 per share.
Is Now The Time?
When considering ServiceNow, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think ServiceNow is a good business. Its revenue growth has been solid. On top of that, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its strong gross margins suggest it can operate profitably and sustainably.
ServiceNow's price to sales ratio based on the next twelve months is 11.0x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. There is definitely a lot of things to like about ServiceNow and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.The Wall St analysts covering the company had a one year price target of $613.4 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.
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