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ServiceNow (NYSE:NOW) Misses Q3 Sales Targets, But Stock Soars 11%


Full Report / October 26, 2022
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Enterprise workflow software maker ServiceNow (NYSE:NOW) fell short of analyst expectations in Q3 FY2022 quarter, with revenue up 21% year on year to $1.83 billion. ServiceNow made a GAAP profit of $80 million, improving on its profit of $63 million, in the same quarter last year.

ServiceNow (NOW) Q3 FY2022 Highlights:

  • Revenue: $1.83 billion vs analyst estimates of $1.85 billion (1.11% miss)
  • EPS (non-GAAP): $1.96 vs analyst estimates of $1.85 (6.13% beat)
  • Subscription revenue guidance for Q4 2022 is $1.83 billion at the midpoint, below analyst estimates of $1.97 billion
  • Free cash flow of $103 million, down 64.1% from previous quarter
  • Customers: 1,530 customers paying more than $1m annually
  • Gross Margin (GAAP): 78.1%, up from 76.8% 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).

Sales Growth

As you can see below, ServiceNow's revenue growth has been strong over the last two years, growing from quarterly revenue of $1.15 billion in Q3 FY2020, to $1.83 billion.

ServiceNow Total Revenue

Even though ServiceNow fell short of revenue estimates, its quarterly revenue growth was still up a very solid 21% year on year. On top of that, revenue increased $79 million quarter on quarter, a very strong improvement on the $30 million increase in Q2 2022, which shows acceleration of growth, and is great to see.

Ahead of the earnings results the analysts covering the company were estimating sales to grow 22.8% over the next twelve months.

Large Customers Growth

You can see below that at the end of the quarter ServiceNow reported 1,530 enterprise customers paying more than $1m annually, an increase of 67 on last quarter. That's in line with the number of contracts wins in the last quarter and quite a bit again above what we have typically seen over the last year, confirming the company is sustaining a good pace of sales.

ServiceNow customers paying more than $1m annually

Profitability

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 78.1% in Q3.

ServiceNow Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.78 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 $103 million in Q3, down 54.4% year on year.

ServiceNow Free Cash Flow

ServiceNow has generated $1.9 billion in free cash flow over the last twelve months, an impressive 27.5% 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 Q3 Results

Sporting a market capitalization of $75.9 billion, more than $3.95 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.

It was unfortunate to see that ServiceNow missed analysts' revenue expectations. Overall, this quarter's results could have been better. The company is up 11% on the results and currently trades at $407 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. We would expect growth rates to moderate from here, but its revenue growth has been solid, over the last two years. On top of that, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its impressive gross margins are indicative of excellent business economics.

The market is certainly expecting long term growth from ServiceNow given its price to sales ratio based on the next twelve months is 8.8x. 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 $533.9 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.

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