Enterprise workflow software maker ServiceNow (NYSE:NOW) reported results in line with analysts' expectations in Q2 FY2023, with revenue up 22.7% year on year to $2.15 billion. ServiceNow made a GAAP profit of $1.04 billion, improving from its profit of $20 million in the same quarter last year.
ServiceNow (NOW) Q2 FY2023 Highlights:
- Revenue: $2.15 billion vs analyst estimates of $2.13 billion (0.98% beat)
- EPS (non-GAAP): $2.37 vs analyst estimates of $2.05 (15.8% beat)
- Subscription revenue guidance for Q3 2023 is $2.19 billion at the midpoint, above analyst estimates of $2.14 billion
- The company provided subscription revenue guidance for the full year of $8.59 billion at the midpoint, above analyst estimates of $8.50 billion
- Free cash flow of $448 million, down 39.2% from the previous quarter
- Customers: 1,724 customers paying more than $1m annually
- Gross Margin (GAAP): 78.1%, in line with the 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 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 over the last two years, growing from $1.41 billion in Q2 FY2021 to $2.15 billion this quarter.
This quarter, ServiceNow's quarterly revenue was once again up a very solid 22.7% year on year. However, its growth did slow down compared to last quarter as the company's revenue increased by just $54 million in Q2 compared to $156 million in Q1 2023. While we'd like to see revenue increase by a greater amount each quarter, a one-off fluctuation is usually not concerning.
Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 21.7% over the next 12 months.
Large Customers Growth
This quarter, ServiceNow reported 1,724 enterprise customers paying more than $1m annually, an increase of 42 from the previous quarter. That's in line with the number of contracts wins in the last quarter but quite a bit below what we've typically observed over the last year, suggesting that the sales slowdown we observed in the last quarter could continue.
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 78.1% in Q2.
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. Despite the recent drop, ServiceNow still has an excellent gross margin that allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity.
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 $448 million in Q2, up 56.1% year on year.
ServiceNow has generated $2.31 billion in free cash flow over the last 12 months, an eye-popping 28.5% 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 Q2 Results
With a market capitalization of $119 billion, a $4.75 billion cash balance, and positive free cash flow over the last 12 months, we're confident that ServiceNow has the resources needed to pursue a high-growth business strategy.
ServiceNow reported a slight beat on revenue and a beat on non-GAAP operating income. Free cash flow also came in ahead. Guidance for Q3 and full year subscription revenue was also ahead. However, cRPO (current remaining performance obligations, a leading indicator of revenue) guidance for next quarter of 21.5% year-on-year growth excluding currency impacts, was slightly below expectations of 22+%. Additionally gross margin declined and missed expectations. Zooming out, we think this was still a mixed quarter, and the stock is down 1.77% after reporting, trading at $567.5 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. There are a number of reasons why we think ServiceNow is a great business. While we would expect growth rates to moderate from here, 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.
ServiceNow's price to sales ratio based on the next twelve months of 12.1x 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.The Wall St analysts covering the company had a one year price target of $602.6 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.
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