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ServiceNow's (NYSE:NOW) Q1 Sales Top Estimates, Gross Margin Improves


Full Report / June 29, 2022
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Enterprise workflow software maker ServiceNow (NYSE:NOW) reported results ahead of analyst expectations in the Q1 FY2022 quarter, with revenue up 26.6% year on year to $1.72 billion. ServiceNow made a GAAP profit of $75 million, down on its profit of $82 million, in the same quarter last year.

ServiceNow (NOW) Q1 FY2022 Highlights:

  • Revenue: $1.72 billion vs analyst estimates of $1.69 billion (1.34% beat)
  • EPS (non-GAAP): $1.73 vs analyst estimates of $1.70 (1.66% beat)
  • Subscription revenue guidance for Q2 2022 is $1.67 billion at the midpoint
  • The company provided subscription revenue guidance for the full year of $7.03 billion at the midpoint
  • Free cash flow of $770 million, roughly flat from previous quarter
  • Customers: 1,401 customers paying more than $1m annually
  • Gross Margin (GAAP): 78.5%, in line with 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 year, growing from quarterly revenue of $1.36 billion, to $1.72 billion.

ServiceNow Total Revenue

This quarter, ServiceNow's quarterly revenue was once again up a very solid 26.6% year on year. On top of that, revenue increased $108 million quarter on quarter, a solid improvement on the $102 million increase in Q4 2021. Happily, that's a slight acceleration of growth.

Ahead of the earnings results the analysts covering the company were estimating sales to grow 25.4% over the next twelve months.

Large Customers Growth

You can see below that at the end of the quarter ServiceNow reported 1,401 enterprise customers paying more than $1m annually, an increase of 42 on last quarter. That is a bit less contract wins than last quarter and also quite a bit below what we have typically seen over the past couple of quarters, suggesting that the sales momentum with large customers is slowing down.

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 78.5% in Q1.

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. Significantly up from the last quarter, 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.

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 $770 million in Q1, up 22.8% year on year.

ServiceNow Free Cash Flow

ServiceNow has generated $2 billion in free cash flow over the last twelve months, an impressive 32% 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 Q1 Results

With a market capitalization of $91.4 billion, more than $4.01 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 improve their gross margin this quarter. And we were also glad to see good revenue growth. On the other hand, it was unfortunate to see the slowdown in new contract wins. Overall, this quarter's results were decent. The company is up 4.4% on the results and currently trades at $475 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.

ServiceNow's price to sales ratio based on the next twelve months is 12.1x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. 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 $738.4 per share right before these results, implying that they saw upside in buying ServiceNow even in the short term.

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