ServiceNow (NYSE: NOW) is a global IT company that offers cloud-based solutions for management and human resources needs. The company takes on the burden of infrastructure and platform management, allowing its clients to only be responsible for application management. The company has data centers in Australia, Brazil, Canada, England, Hong Kong, the Netherlands, Singapore and the United States. ServiceNow serves several industries including financial, healthcare, higher education, managed service providers and life sciences. Founded in 2004, ServiceNow specializes in providing enterprise software related to data management with over 2,800 customers including marquee names such as Amazon (AMZN), Microsoft (MSFT), NetApp (NTAP) and Splunk (SPLK).

Strong Sales Momentum with Cloud Solutions

While ServiceNow offers several products and solutions, it operates primarily in the Platform As A Service (PaaS) industry for enterprises. The company develops and deploys management applications in cloud form which allow its customers to avoid having to own any hardware, pay for hosting or invest in infrastructure. ServiceNow has a high adoption rate for its other Infrastructure As A Service (IaaS) and Software As A Service (SaaS) products which enable a more universal, comprehensive and low cost approach to IT management for its customers because by combining relevant, seamlessly integrated ServiceNow products, users can put together have a complete end-to-end solution with a reasonable degree of customization suited to their specific needs. This integrated suite of products and solutions has helped ServiceNow boast a 37% rate of upsells (as a percentage of total annual contract value) and a stellar customer renewal rate of 98% in the most recent quarter. GAAP profits were hurt by an increase in sales and marketing, R&D and G&A expenses.

The PaaS market is expected to be worth about $7 billion by 2018 as more companies seek faster application deployment in response to customer demand, with reduced human resource costs and improved scalability that drive up operating efficiencies. Currently, PaaS’ regional high growth markets are in Asia-Pacific, Canada, EMEA and Latin America, all locations where ServiceNow already has existing operations. The PaaS market is on a sizable growth (estimated to grow from about $1.3 billion in 2013 to $7 billion by 2018 at a compounded annual growth rate of 33%). Additionally, the mobile PaaS market is another attractive, up and coming, and growing niche that ServiceNow plans to tap into. In the cloud services sector, ServiceNow faces intense competition from Amazon’s AWS Web Services (AMZN), Google’s Alphabet subsidiary (GOOG), International Business Machines (IBM), Microsoft (MSFT) and Salesforce (CRM).

512% Jump in Free Cash Flow

For 3Q15 (three months ended September 30, 2015), ServiceNow reported total revenues of $261.2 million, up 46% from $178.7 million in Q3 2014. Revenue from the subscription segment increased 48% and revenue from the professional services segment increased 34%. The company beat analysts’ revenue estimates of $256.2 million despite negative impact from a stronger US dollar that reduced foreign collections in dollar denominated terms. For the quarter, ServiceNow reported gross profit of $179.3 million, $5.7 million in non-GAAP earnings and a GAAP net loss of $41.0 million, or $0.26 per share. The company also reported a 512% year over year jump in free cash flow to $42.3 million. ServiceNow ended the quarter with customers across more than a third of all Global 2000 companies and with 206 customer accounts that bring in over $1 million in annual contracted sales – up 62% over the past year.

Looking ahead, for 4Q15, the company expects total revenues of $277 million to $282 million, with the subscription segment contributing $239 million – $243 million in sales. Forward guidance reflects sales growth of 40% – 42% year-over-year, with gross margins of approximately 82%.

As of market close on December 4, 2015, ServiceNow shares were trading at $89.99, up about 46% over the last year. Since going public in 2012, shares have climbed over 265% are currently trade slightly below the high end of the company’s 52-week range of $59.98 – $91.28. UBS maintained a Buy rating on ServiceNow but increased its price target from $84 to $97 (8% upside) citing competitive differentiation, diverse solutions and advanced cloud technology. Pacific Crest maintained an Overweight rating and price target of $95 (6% upside potential over the next 12 months). ServiceNow has a high price target of $110 which represents upside potential of 22% over the next year.

Three years ago, ServiceNow went public at a price of $18 and early investors are benefitting from strong share price appreciation. The company’s stock has increased sharply on strong revenue growth (with sales up from $28 million in 2009 to over $1 billion annualized at the current quarterly run rate). Revenue growth has been tied to strong billings growth, which underscores market acceptance of the company’s products. Analysts anticipate sales growth of 40% in 2016 and 34% in 2017 as ServiceNow taps into an unpenetrated addressable cloud market of $45 billion. Management expects annual revenue to grow to $4 billion by 2020, up 300% from estimated revenue of $1 billion for FY2015, but investors should focus on the company’s scalable business model and impressive margins. For 4Q15, the company expects a gross margin of 73% and an operating margin of 9%. Analysts at Morgan Stanley project that the company will have operating margins of 13% in FY2016, up from 1% in FY2015. Wider margins will help ServiceNow become profitable sooner and that could further support and boost shares.


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