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ServiceNow (NYSE:NOW) Q3: Beats On Revenue


Full Report / October 27, 2021
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Enterprise workflow software maker ServiceNow (NYSE:NOW) reported strong growth in the Q3 FY2021 earnings announcement, with revenue up 31.2% year on year to $1.51 billion. ServiceNow made a GAAP profit of $63 million, improving on its profit of $12.8 million, in the same quarter last year.

ServiceNow (NOW) Q3 FY2021 Highlights:

  • Revenue: $1.51 billion vs analyst estimates of $1.47 billion (2.24% beat)
  • EPS (non-GAAP): $1.55 vs analyst estimates of $1.39 (11.5% beat)
  • Subscription revenue guidance for Q4 2021 is $1.51 billion at the midpoint, below analyst estimates of $1.59 billion
  • Free cash flow of $226 million, down 15.6% from previous quarter
  • Customers: 1,266 customers paying more than $1m annually
  • Gross Margin (GAAP): 76.8%, down from 78.1% 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.

As corporations digitize their processes, they build and buy more and more apps and systems that often don’t directly connect with each other. That in effect drives demand for software platforms like ServiceNow, that function as operating systems for the enterprise and are able to tie all the other systems together.

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 very strong over the last year, growing from quarterly revenue of $1.15 billion, to $1.51 billion.

ServiceNow Total Revenue

And unsurprisingly, this was another great quarter for ServiceNow with revenue up an absolutely stunning 31.2% year on year. On top of that, revenue increased $103 million quarter on quarter, a very strong improvement on the $49 million increase in Q2 2021, and a sign of acceleration of growth.

Analysts covering the company are expecting the revenues to grow 25.1% over the next twelve months, although estimates are likely to change post earnings.

Large Customers Growth

You can see below that at the end of the quarter ServiceNow reported 1,266 enterprise customers paying more than $1m annually, an increase of 65 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.

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, licences, technical support and other necessary running expenses was at 76.8% in Q3.

ServiceNow Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.76 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 a pressure from competition to lower prices.

Key Takeaways from ServiceNow's Q3 Results

With a market capitalization of $134 billion, more than $3.03 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

It was good to see ServiceNow deliver strong revenue growth this quarter. And we were also glad to see the acceleration in new contract wins. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. The company is down 2.93% on the results and currently trades at $645.5 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. We think ServiceNow is a good business. Its revenue growth has been strong. 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.

The market is certainly expecting long term growth from ServiceNow given its price to sales ratio based on the next twelve months is 19.5. There are definitely things to like about ServiceNow and there's no doubt it is a bit of a market darling, at least for some. But when considering the company against the backdrop of the tech stock landscape, it seems that there is a lot of optimism already priced in and we are wondering whether there might be better opportunities elsewhere right now.

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