If you’re a regular reader of this publication, chances are you know that it hasn’t been a great year for many tech company stocks — one in which giants like Meta, Amazon, and Alphabet have been mauled by the markets after less than stellar earnings reports.
Even an enterprise stalwart like Salesforce is behind hounded by activist investors.
The fact is that few have been spared, whether startups or established public companies. We’ve seen a litany of stories on hiring freezes, layoff announcements, and tech stocks taking bigger hits than an NFL quarterback behind a bad offensive line — in other words, getting crushed.
SaaS stocks in particular are having a rough year, so when a SaaS stock does well, well, that’s news. And that’s what happened to ServiceNow this week when it reported Q32022 earnings.
It bucked the odds with a mostly positive earnings report — good revenue, good guidance, the whole nine yards — and believe it or not, Wall Street rewarded the company, with the stock up over 13% at the bell on Thursday, a number that held steady throughout the day. (It was down around 1% so far in trading today.)
Maybe we’re not the only ones looking for some good news. Perhaps investors are, too. But what led to this positive 2022 earnings anomaly? To find out, let’s explore the earnings report and the impact of hiring former SAP CEO Bill McDermott to lead the company.
A look at the numbers
Given the general carnage we’ve seen in the public markets for tech earnings this quarterly cycle — Snap kicked things off with a raspberry, followed quickly by other leading tech shops failing to meet Wall Street’s stringent expectations — the ServiceNow share-price boomlet caught our eye and made us curious what the company had managed that was so worthy of investor praise.
First, expectations. Analysts had expected ServiceNow to report $1.84 worth of adjusted profit per share in the third quarter off of revenues of $1.85 billion. Instead, the company turned in $1.83 billion in total top line and $1.96 worth of adjusted profit (non-GAAP net income) per share.
If ServiceNow had a mixed quarter — beating on profit, missing on revenues — why did its share price shoot higher? Even more, how did ServiceNow cut its full-year subscription revenue targets, falling from a range of $6.915 billion to $6.925 billion at the end of Q2 2022 to $6.865 billion to $6.870 billion at the end of the third quarter, and still gain value?
We can answer that. Sparing you complex charting, ServiceNow’s revenue in the third quarter was heavily impacted by changing currency exchange rates. However, the company managed to partially combat that performance headwind by recording higher revenues than it expected. So, while ServiceNow didn’t actually meet revenue targets, the cause of that miss was not its own fault; and even more, it did better than it had anticipated (when compared to midpoint guidance) in the period.
Looking at the rest of the year, ServiceNow expects a little bit more revenue in the fourth quarter than it had, meaning that its Q4 2022 guidance, while still currency-impacted, is built on the back of strong business results that are being masked by a very strong dollar.
Finally, looking forward, the company has a lot to be content with. Per a Fool transcript of the company’s latest earnings call, observe the following (from Gina Mastantuono, the company’s CFO):
Current [remaining performance obligations] was approximately $5.87 billion, representing 25% year-over-year constant currency growth, a 150 basis points beat versus our [foreign-exchange]-adjusted guidance. Fifty basis points of the beat was driven by early renewals from Q4 as the team looks to get ahead of our large renewal cohort. Our renewal rate was a best-in-class 98%, continuing to demonstrate the stickiness of our business as the Now Platform remains a mission-critical part of our customers’ operations. We finished the quarter with 1,530 customers paying us over $1 million in ACV [annual contract value], up 22% year over year. The number of customers paying us over $10 million in ACV grew 60% year over year as our cohort expansion remained healthy.
Early Q4 renewals? Nearly 100% gross renewals? Big growth in big customers, the stickiest and most likely to buy more from ServiceNow? Investors were stoked by that combination of results, even if the company reported a modestly mixed Q3 2022 in top- and bottom-line terms and cut guidance modestly.
Investors, instead, looked inside the figures and saw a business that appears to be firing on all cylinders — recall that companies doing billions in yearly revenue do not grow at startup-like rates — and saw a pretty picture of the coming year. And so they bid its shares higher.
The McDermott effect
ServiceNow has a broad business, but its core founding purpose was to manage internal IT service and operations. That has expanded greatly over the years to include service fleet management, HR help desk functionality, customer service, customer experience, security, and broader enterprise workflows, among other things.
When CEO Bill McDermott left SAP four years ago this month, he quickly landed at ServiceNow with big plans. We would be remiss if we didn’t point out that when his appointment was announced, Wall Street wasn’t exactly thrilled. As we wrote at the time:
It’s worth noting that the company made the announcement after the market closed and it announced its latest quarterly earnings. Wall Street did not appear to like the news, as the stock was down $13.34, or 5.84%, in early after-hours trading.
On October 24, 2018, the very day McDermott’s hiring was announced, Q3 2018 earnings came in at $673 million. Since then, the company has nearly doubled quarterly revenue to the $1.8 billion it reported the other day. It’s currently on a run rate close to $6 billion, and earlier this year, McDermott predicted the company would reach $11 billion by 2024. It’s an ambitious target
Is that $11 billion target possible? Perhaps. If we consider two years’ growth at 30% from the top end of ServiceNow’s most recent full-year revenue guidance, the company would turn in $11.6 billion worth of 2024 revenue. So it will need to run close to that growth rate for the next two years. Hard? Yes. Impossible? No.
That’s the kind of growth that should get investor attention. Perhaps it explains why McDermott was willing to leave the comfort of the position he had at SAP after 16 years to take over a much smaller company. He saw potential, and his instinct appears to have been correct.
As he told analysts in the call after the earnings report, customers are responding to ServiceNow’s broad platform strategy and it’s paying off in big wins:
We see the growth across multiple buyer personas as customers consume more of our expanding solution portfolio. In Q3, both ITSM (IT service management) and ITOM (IT operations management) were in 17 of our top 20 deals, with six deals each over $1 million. Security and risk were in 15 of the top 20, with five deals over $1 million. Customer and employee workflows were each in 12 of the top 20. Once again, we saw creator workflows in all the top 20 deals, with nine deals over $1 million.
McDermott certainly has formidable goals beyond revenue. “The stated ambition of ServiceNow remains. We will be the defining enterprise software company of the 21st century. We are firmly committed to that journey,” he said during the call.
Goals and lofty statements like this one are one thing. Execution is another. But if the company can meet McDermott’s challenging revenue goals, the future could be very bright indeed.
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