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Morningstar | NOW Updated Forecasts and Estimates from 19 Mar 2019

ServiceNow’s IT workflow offerings are continuing to drive increased cash flow. The company met the high end of subscription revenue expectations for the last quarter of 2018 and saw profitability for the second quarter in a row--though slightly less than what we expected. While the year still yielded GAAP unprofitability, we think this will be the last as ServiceNow maintains its expense discipline and average contract value proves to be on the rise. We are maintaining our $221 fair value estimate for this wide moat name. With shares up about 5% during the day’s trade and approximately 7% after hours, this once 4-star medium uncertainty stock is now in 3-star territory.

The firm reported fourth-quarter subscription revenue of $666 million (surpassing the high end of guidance by $1 million) and professional services and other revenue of $49 million. This totaled $715 million total revenue for the quarter, with fiscal 2018 revenue totaling $2.6 billion. On-track revenue came from 51 new transactions over $1 million in value. Additionally, ServiceNow’s core offering, ITSM, surprisingly experienced reaccelerated growth during 2018. Management believes the reacceleration came from the end of an informal testing period for some companies, in which ServiceNow’s IT service management was initially adopted only within a division of a company and only later crept into other divisions under one enterprise.

In terms of profitability, ServiceNow improved collectables and days sales outstanding, which drove better margins to ultimately yield non-GAAP earnings per share of $2.49, compared with last year’s $1.35. We think ServiceNow’s margin expansion is a function of the company’s switching costs for its high-quality customer pool, which continues to expand. The firm reported that they’ve captured roughly 75% of Fortune 500 companies and have 5,400 customers overall--a 23% increase from last year.

For the quarter ahead, management expects revenue to grow 35% to 36% year over year, totaling $736 million to $741 million, and a non-GAAP operating margin of 16%. We like that ServiceNow is in no rush for M&A--at least, not before testing out in-house product development via NowX. Most of all, our confidence in our moat outlook for the company is solidified by ServiceNow’s recent focus on verticalization, which we believe will only make its switching costs greater.