Enterprise workflow software maker ServiceNow (NYSE:NOW) reported results in line with analysts' expectations in Q3 FY2023, with revenue up 25% year on year to $2.29 billion. Turning to EPS, ServiceNow made a non-GAAP profit of $2.92 per share, improving from its profit of $1.96 per share in the same quarter last year.
ServiceNow (NOW) Q3 FY2023 Highlights:
- Revenue: $2.29 billion vs analyst estimates of $2.27 billion (small beat)
- RPO (remaining performance obligations) and cRPO (current remaining performance obligations) both beat and these are leading indicators of revenue
- EPS (non-GAAP): $2.92 vs analyst estimates of $2.55 (14.6% beat)
- Subscription Revenue Guidance for Q4 2023 is $2.32 billion at the midpoint, below analyst estimates of $2.39 billion
- Free Cash Flow of $175 million, down 60.9% from the previous quarter
- Customers: 1,789 customers paying more than $1m annually
- Gross Margin (GAAP): 78.3%, in line with the same quarter last year
Founded by Fred Luddy, who wrote the code for the company's initial prototype on a flight from San Francisco to London, ServiceNow (NYSE:NOW) offers a 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 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 two years, growing from $1.51 billion in Q3 FY2021 to $2.29 billion this quarter.
This quarter, ServiceNow's quarterly revenue was once again up a very solid 25% year on year. On top of that, its revenue increased $138 million quarter on quarter, a very strong improvement from the $54 million increase in Q2 2023. This is a sign of acceleration of growth and great to see.
Looking ahead, analysts covering the company were expecting sales to grow 21.7% over the next 12 months before the earnings results announcement.
Large Customers Growth
This quarter, ServiceNow reported 1,789 enterprise customers paying more than $1m annually, an increase of 65 from the previous quarter. That's quite a bit more contract wins than last quarter and quite a bit above what we've typically observed in past quarters, demonstrating that the business 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's left after paying for servers, licenses, technical support, and other necessary running expenses, was 78.3% in Q3.
That means that for every $1 in revenue the company had $0.78 left to spend on developing new products, sales and marketing, and general administrative overhead. ServiceNow's impressive gross margin allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity. It's also comforting to see its gross margin remain stable, indicating that ServiceNow is controlling its costs and not under pressure from its competitors to lower prices.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. ServiceNow's free cash flow came in at $175 million in Q3, up 69.9% year on year.
ServiceNow has generated $2.38 billion in free cash flow over the last 12 months, an eye-popping 29% of revenue. This robust FCF margin stems from its asset-lite business model, scale advantages, and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a healthy cash balance.
Key Takeaways from ServiceNow's Q3 Results
Sporting a market capitalization of $113 billion, more than $4.07 billion in cash on hand, and positive free cash flow over the last 12 months, we believe that ServiceNow is attractively positioned to invest in growth.
Revenue beat slightly but two important leading indicators of revenue growth--RPO and cRPO (total and current remaining performance obligations) beat more handily. We were also impressed by ServiceNow's significant improvement in new large contract wins this quarter. On profitability, the company exceeded expectations for operating income. Finally, the company raised its full year outlook for subscription revenue and slightly raised its full year outlook for operating margins while reiterating gross and free cash flow margins. Overall, we think this was good quarter that should please many shareholders. The stock is up 5.92% after reporting and currently trades at $562.11 per share.
Is Now The Time?
ServiceNow may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
There are several reasons why we think ServiceNow is a great business. While we'd expect growth rates to moderate from here, its revenue growth has been solid over the last two years. Additionally, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its impressive gross margins indicate excellent business economics.
ServiceNow's price to sales ratio based on the next 12 months of 10.6x indicates that the market is definitely optimistic about its growth prospects. And looking at the tech landscape today, ServiceNow's qualities stand out, we think that the multiple is justified and we still like it at this price.Wall Street analysts covering the company had a one-year price target of $642.3 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.
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