Enterprise workflow software maker ServiceNow (NYSE:NOW) reported results in line with analyst expectations in Q4 FY2022 quarter, with revenue up 20.1% year on year to $1.94 billion. ServiceNow made a GAAP profit of $150 million, improving on its profit of $26 million, in the same quarter last year.
ServiceNow (NOW) Q4 FY2022 Highlights:
- Revenue: $1.94 billion vs analyst estimates of $1.94 billion (inline)
- EPS (non-GAAP): $2.28 vs analyst estimates of $2.02 (12.6% beat)
- Subscription revenue guidance for Q1 2023 is $1.99 billion at the midpoint
- Management's subscription revenue guidance for upcoming financial year 2023 is $8.47 billion at the midpoint
- Free cash flow of $1.01 billion, up from $103 million in previous quarter
- Customers: 1,637 customers paying more than $1m annually
- Gross Margin (GAAP): 78.6%, 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).
As you can see below, ServiceNow's revenue growth has been strong over the last two years, growing from quarterly revenue of $1.25 billion in Q4 FY2020, to $1.94 billion.
Even though ServiceNow fell short of revenue estimates, its quarterly revenue growth was still up a very solid 20.1% year on year. On top of that, revenue increased $109 million quarter on quarter, a very strong improvement on the $79 million increase in Q3 2022, which shows re-acceleration of growth, and is great to see.
For the upcoming financial year management expects subscription revenue to be $8.47 billion at the midpoint.
Large Customers Growth
You can see below that at the end of the quarter ServiceNow reported 1,637 enterprise customers paying more than $1m annually, an increase of 107 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 78.6% in Q4.
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 have followed 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 $1.01 billion in Q4, up 36.8% year on year.
ServiceNow has generated $2.17 billion in free cash flow over the last twelve months, an impressive 30% 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 Q4 Results
Sporting a market capitalization of $89.3 billion, more than $4.28 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. That feature of these results really stood out as a positive. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. But the market was likely expecting more and the company is down 4.34% on the results and currently trades at $429 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.
ServiceNow's price to sales ratio based on the next twelve months of 10.4x indicates that the market is certainly optimistic about its growth prospects. 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 $517.2 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.
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