ServiceNow’s Profits Top Estimates, but Currency Slows Near-Term Growth

“The demand environment for software is consistent and durable,”

ServiceNow

(ticker:

NOW

) CEO Bill McDermott said in an interview with Barron’s, echoing upbeat comments on enterprise software demand from

Microsoft

(MSFT) on Tuesday . He noted that the company has been able to maintain its margins despite a tougher macroeconomic environment, and has continued to hire staff, particularly in engineering.

“We’re looking to get big fast,” McDermott said.

For the quarter, the company posted revenue of $1.752 billion, up 29.5% from a year earlier on a constant-currency basis, a tad below the Street consensus as measured by

FactSet

at $1.762 million. ServiceNow said GAAP subscription revenue was $1.658 billion, a little shy of both the company’s guidance range of $1.67 billion to $1.675 billion, and Street estimates at $1.667 billion. On a currency-adjusted basis, the company said subscription revenue grew 29.5%, a little ahead of its 29% forecast.

Non-GAAP earnings were $1.62 a share, above the Street consensus at $1.55. Under generally accepted accounting principles, the company earned 10 cents a share. ServiceNow said its remaining performance obligations were $5.75 billion, up 27% on a currency adjusted basis, but slightly below the company’s forecast for 28% growth.

McDermott recently triggered a sell-off in ServiceNow shares with cautionary comments about the outlook he made in an appearance on CNBC. In an interview with Mad Money’s Jim Cramer, McDermott noted that “macro crosswinds are blowing strong,” with rising interest rates, the strengthening U.S. dollar, the war in Ukraine, higher energy costs, and cybersecurity threats. As a result, “you’re going to see longer [sales] cycles in Europe,” he said, adding, “we saw that.”

In announcing its June quarter results, ServiceNow said the stronger dollar will reduce 2022 subscription revenue by about $220 million, with a $180 million headwind on third-quarter current remaining performance obligations, or cRPO. The company expects foreign exchange to be a one-point drag on 2022 operating margin. 

The company also said it has “a larger-than-average customer cohort renewing in Q4,” and that as a result, there will be about 2 percentage points of drag on growth in cRPO in the third quarter “as the contractual obligations wind down.” The company expects cRPO growth to reaccelerate in the fourth quarter. McDermott says that this issue crops up in its results every year, and that the company this time decided to call out the dynamic in the earnings press release.

For the full year, ServiceNow currently sees subscription revenue ranging from $6.915 billion to $6.925 billion, down from a previous forecast of $7.025 billion to $7.040 billion.

McDermott noted that the company is reverting the guidance it provided two quarters ago to reflect current economic crosswinds. That guidance implies GAAP growth of 24%, down from the previously expected 26%, with non-GAAP growth now expected to be 28%, down from 28.5%. The company also trimmed its forecast for free cash flow margin to 30%, from 31%, but maintained its forecast for 25% operating margins and 86% gross margins from subscriptions.

For the third quarter, the company projects subscription revenue of $1.75 billion to $1.755 billion, up 23%, or 27.5% in constant currency, and slightly below the Street consensus at $1.787 billion. The company sees cRPO growth of 20%, or 23.5% on a currency-adjusted basis.

For the year, ServiceNow shares are down about 31%. The stock gained 6% in Wednesday’s regular session amid a broad rally in tech shares that was triggered in part by a bullish forecast from Microsoft for its June 2023 fiscal year.

Write to Eric J. Savitz at eric.savitz@barrons.com