ServiceNow (NOW)

Enterprise workflow software maker ServiceNow (NYSE:NOW) met Wall Street’s revenue expectations in Q1 CY2025, with sales up 18.6% year on year to $3.09 billion. Its non-GAAP profit of $4.04 per share was 5.4% above analysts’ consensus estimates.

Company Overview

Founded by Fred Luddy, who coded the company's initial prototype on a flight from San Francisco to London, ServiceNow (NYSE:NOW) is a software provider helping companies automate workflows across IT, HR, and customer service.

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.

A company’s long-term sales performance is one signal of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Thankfully, ServiceNow’s 22.4% annualized revenue growth over the last three years was decent. Its growth was slightly above the average software company and shows its offerings resonate with customers.

This quarter, ServiceNow’s year-on-year revenue growth was 18.6%, and its $3.09 billion of revenue was in line with Wall Street’s estimates.

Looking ahead, sell-side analysts expect revenue to grow 18.7% over the next 12 months, a deceleration versus the last three years. We still think its growth trajectory is attractive given its scale and suggests the market sees success for its products and services.

While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.

ServiceNow’s ARR punched in at $12.02 billion in Q1, and over the last four quarters, its growth was impressive as it averaged 21.3% year-on-year increases. This performance aligned with its total sales growth and shows that customers are willing to take multi-year bets on the company’s technology. Its growth also makes ServiceNow a more predictable business, a tailwind for its valuation as investors typically prefer businesses with recurring revenue.

The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.

It’s relatively expensive for ServiceNow to acquire new customers as its CAC payback period checked in at 54.9 months this quarter. The company’s slow recovery of its sales and marketing expenses indicates it operates in a competitive market. A silver lining is that once it acquires its customers, they typically don’t leave and increase their spending - a sign of high switching costs.

What makes the software-as-a-service model so attractive is that once the software is developed, it usually doesn’t cost much to provide it as an ongoing service. These minimal costs can include servers, licenses, and certain personnel.

ServiceNow’s robust unit economics are better than the broader software industry, an output of its asset-lite business model and pricing power. They also enable the company to fund large investments in new products and sales during periods of rapid growth to achieve higher profits in the future. As you can see below, it averaged an excellent 78.9% gross margin over the last year. Said differently, roughly $78.92 was left to spend on selling, marketing, and R&D for every $100 in revenue.

ServiceNow produced a 78.9% gross profit margin in Q1, marking a 1.1 percentage point decrease from 80% in the same quarter last year. Zooming out, the company’s full-year margin has remained steady over the past 12 months, suggesting its input costs have been stable and it isn’t under pressure to lower prices.

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

ServiceNow has been a well-oiled machine over the last year. It demonstrated elite profitability for a software business, boasting an average operating margin of 12.9%. This result isn’t surprising as its high gross margin gives it a favorable starting point.

Analyzing the trend in its profitability, ServiceNow’s operating margin rose by 2.9 percentage points over the last year, as its sales growth gave it operating leverage.

In Q1, ServiceNow generated an operating profit margin of 14.6%, up 1.9 percentage points year on year. The increase was encouraging, and because its gross margin actually decreased, we can assume it was more efficient because its operating expenses like marketing, R&D, and administrative overhead grew slower than its revenue.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

ServiceNow has shown terrific cash profitability, driven by its lucrative business model that enables it to reinvest, return capital to investors, and stay ahead of the competition while maintaining an ample cushion. The company’s free cash flow margin was among the best in the software sector, averaging an eye-popping 32.2% over the last year.

ServiceNow’s free cash flow clocked in at $1.48 billion in Q1, equivalent to a 47.8% margin. This cash profitability was in line with the comparable period last year and above its one-year average.

Over the next year, analysts’ consensus estimates show they’re expecting ServiceNow’s free cash flow margin of 32.2% for the last 12 months to remain the same.

Businesses that maintain a cash surplus face reduced bankruptcy risk.

ServiceNow is a profitable, well-capitalized company with $6.60 billion of cash and $2.40 billion of debt on its balance sheet. This $4.20 billion net cash position is 2.2% of its market cap and gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

This was a strong quarter, with cRPO (current remaining performance obligations) and RPO (remaining performance obligations) both beating. Although reported revenue just met expectations, profitability outperformed, leading to beats for adjusted operating income and adjusted EPS. Looking ahead, the company raised subscription revenue guidance for the full year, which is an encouraging sign. The stock traded up 9% to $887.71 immediately following the results.

Updated: May 21, 2025 at 10:17 PM EDT

Before deciding whether to buy ServiceNow or pass, we urge investors to consider business quality, valuation, and the latest quarterly results.

ServiceNow is a high-quality business worth owning. For starters, its revenue growth was solid over the last three years. On top of that, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its impressive operating margins show it has a highly efficient business model.

ServiceNow’s price-to-sales ratio based on the next 12 months is 15.6x. Despite the higher valuation, ServiceNow’s fundamentals really stand out, and we like it at this price. We think it deserves a spot in your portfolio.

Wall Street analysts have a consensus one-year price target of $1,083 on the company (compared to the current share price of $1,010), implying they see 7.2% upside in buying ServiceNow in the short term.

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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