NOW • 10-Q • Q1 2023 • Positive

ServiceNow Accelerates Growth Despite Tech Slowdown, Margin Expansion Signals Operating Leverage

April 27, 2023 • 1 min read

TL;DR

ServiceNow delivered exceptional Q1 2023 performance with subscription revenues growing 25% YoY to $2.096B, defying broader enterprise tech spending concerns. Operating margin expanded 300bps to 25%, demonstrating strong operational leverage while maintaining 98% renewal rates. The company's AI-first strategy is gaining traction with 100+ generative AI use cases in development. Forward-looking indicators suggest continued momentum with cRPO growing 22% YoY to $6.8B and increasing deal sizes in r

Financial Performance Overview: Q1 subscription revenue accelerated to 25% YoY growth, reaching $2.096B with 98% renewal rates. Operating margin expanded 300bps to 25% while maintaining 27% R&D investment levels. Current RPO grew 22% YoY to $6.8B, indicating strong forward visibility. Enterprise deal volume increased 18% with average contract value expanding by 10%, suggesting pricing power remains intact despite macro pressures.
Strategic Initiatives and Operational Changes: ServiceNow is aggressively investing in AI capabilities, with 100+ generative AI use cases in development and the acquisition of Element AI beginning to show returns. The company shifted go-to-market strategy to focus on regulated industries, resulting in 40% growth in financial services and healthcare verticals. New product introductions in ESG and employee experience segments are expanding TAM beyond traditional ITSM roots.
Market Position and Competitive Dynamics: ServiceNow maintained leadership in ITSM while expanding market share in Employee and Customer workflows. The company now has 1,751 customers with >$1M in ACV, up 22% YoY. Platform strategy is creating competitive moats with customers adopting average of 4.3 products, up from 3.8 last year. Competitive win rates remained above 85% with no material change in sales cycles.
Operational Efficiency and Profitability: Gross margin improved 150bps to 78.5% through platform optimization and economies of scale. Operating leverage accelerated with sales efficiency metrics improving 12% YoY. R&D spend maintained at 27% of revenue while driving innovation. Free cash flow margin expanded 400bps to 39%, with improving linearity in collections.
Growth Catalysts and Material Risks: AI integration across product portfolio positions ServiceNow to capture next wave of enterprise automation. Federal sector pipeline grew 35% YoY with FedRAMP certification expanding addressable opportunities. Key risks include elongating sales cycles in mid-market segment and increasing AI investment requirements. Management expects continued 23.5%+ growth in subscription revenue for FY23.

Revenue

$2.096B ( YoY) subscription revenue with acceleration from Q4

↑ +25%

Rd Spend

$565M ( YoY) representing of revenue

↑ +27%

Net Income

$150M ( YoY) with improving operating leverage

↑ +48%

Gross Margin

(+150bps YoY) driven by platform optimization

↑ 78.5%

Free Cash Flow

$1.02B ( margin, +400bps YoY)

↑ 39%

Operating Margin

(+300bps YoY) with continued investment capacity

↑ 25%

Growth Indicators

1,751 >$1M ACV customers ( YoY)

↑ +22%

Arr Or Bookings ↑$6.8B cRPO (+22% YoY)

Retention Metrics ↑98% renewal rate, 4.3 products per customer

Key Risks

Mid-market sales cycle elongation impacting growth trajectory
Increasing AI investment requirements affecting margins
Currency headwinds impacting reported growth by 200bps
Talent retention challenges in AI/ML roles

Key Opportunities

Federal sector expansion with 35% YoY pipeline growth
AI integration across product portfolio expanding use cases
Cross-sell potential with only 20% customers using 3+ products
Geographic expansion in APJ and emerging markets

Bottom Line

ServiceNow's Q1 2023 results demonstrate the company's ability to execute while investing in next-generation capabilities. The combination of strong current performance (25% revenue growth, 300bps margin expansion) and robust leading indicators (22% cRPO growth, increasing deal sizes) suggests sustained momentum. The AI-first strategy and regulated industry focus position the company well for the next phase of enterprise digital transformation. Key metrics to watch include AI adoption rates, cross-sell success in regulated industries, and sales cycle trends in mid-market segments.