SUN VALLEY, IDAHO – JULY 07: ServiceNow CEO Bill McDermott waves as he walks to lunch at … [+]
Strong dollar puts brakes on revenue growth for companies selling outside the US Investors aren’t happy with companies trying to normalize them into thinking they don’t matter.
This comes to mind when considering the stock of “digital workflow company” ServiceNow whose stock fell 7.5% after it reported second quarter results on July 27.
The company said it “beat expectations on the top and bottom line, exceeding the high end of continued currency subscription revenue growth and operating margin guidance.”
So why did its stock fall after the report? While maintaining its revenue guidance for 2024 and 2026 and beating adjusted earnings per share expectations, ServiceNow’s earnings for the quarter slightly missed consensus and it lowered its subscription revenue guidance for third quarter and all of 2022.
On the plus side, the company seems to be maintaining very fast growth at a time when other big tech companies – for example, Microsoft
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Furthermore, CEO Bill McDermott told me that its services are invaluable to its corporate customers because they help them quickly adapt to change and generate a quick return on investment.
(I have no financial interest in the securities mentioned in this post).
Trying To Normalize A Strong Dollar
Earlier this month, McDermott spoke with Jim Cramer on CNBC in an effort to reassure investors that a strong dollar will hurt the earnings of all companies that make significant profits in markets outside the US
In retrospect, I see that as a risky move. That’s because after the interview aired on July 12, ServiceNow stock fell 12%. McDermott told Cramer that “No one is going to outrun the money right now.”
That’s because when US-based companies convert their earnings from, say, Euros to Dollars — where the exchange rate dropped from 1.2 to 1.0 last year, earnings don’t increase as much as the company has. hedged its currency risk.
Although CNBC reported that he did not specifically address how the strong dollar would affect ServiceNow’s earnings, the July 12 plunge in its stock leads me to believe that investors thought his comments applies to ServiceNow.
To that end, when ServiceNow shared highlights of its second quarter results, it referred to them as adjusted “for constant currency.” Its earnings press release, explained that constant currency earnings are a “non-GAAP financial measure” where ServiceNow used the average exchange rate in second quarter of 2021 rather than the actual second quarter 2022 exchange rates.
ServiceNow told me it “exceeded expectations on the top and bottom line, exceeding the high end of constant currency subscription revenue growth and operating margin guidance.”
ServiceNow also said that “total GAAP revenue of $1.752 billion in Q2 2022, represents 29.5% year-over-year growth adjusted for constant currency.” When I asked McDermott on July 27 to share earnings that weren’t adjusted for constant currency, he declined to provide a number.
In April, ServiceNow reported first-quarter subscription revenues of $1,631 million that were up 26% — beating consensus estimates of $1,621 million.
ServiceNow expects second quarter 2022 “subscription revenues to increase 26% to a range of $1.67 billion and $1.675 billion.”
On July 27. ServiceNow issued an email saying “Q2 GAAP subscription revenues of $1.658 billion, representing 29.5% year-over-year growth adjusted for constant currency.”
I asked the company if the April forecast for the second quarter was adjusted for constant currency — though I suspect not. I will update this post if I receive a comment from ServiceNow.
ServiceNow Performance and Prospects
The more important question for investors is whether ServiceNow’s financial performance and prospects are better or worse than investors expected. By that standard, ServiceNow’s report is mixed.
What if? While McDermott told me ServiceNow is sticking to its goal of generating $11 billion in subscription revenue by 2024 and $16 billion by 2026.
ServiceNow reported better-than-expected adjusted earnings per share. However, its revenue fell short of expectations and forecast lower-than-expected revenue for the quarter and year.
More specifically, its adjusted earnings of $1.62 per share were seven cents higher than Wall Street’s target.
Revenue for the period rose 24% from the second quarter of 2021 to $1.752 billion — $10 million below expectations, according to SiliconAngle. ServiceNow’s subscription revenue of $1.658 billion was $9 million short of the Street estimate.
More significantly for investors, ServiceNow lowered its forecast for the third quarter and all of 2022.
More specifically, the midpoint of its new 2022 subscription revenue forecast — $6.92 billion — is 1.6% below its previous forecast and the midpoint of its new Q3 subscription revenue forecast — $1.753 billion — is 1.9% below Wall’s consensus estimate Street of $1.787 billion, according to SiliconAngle.
Earnings before certain expenses such as stock compensation, came in at $1.62 per share, ahead of Wall Street’s target of $1.55 per share. Revenue for the period rose 29% from a year ago, to $1.752 billion, but that was just below Wall Street’s forecast of $1.762 billion. The company also reported subscription revenue of $1.658 billion, just shy of its own guidance of $1.67 billion and below the Street estimate of $1.667 billion.
How ServiceNow Creates Value For Customers
ServiceNow is optimistic about its future. As McDermott told me, “Digital transformation tailwinds are stronger than macroeconomic crosswinds. Companies are iterating which platforms they’ll use over the next decade. ServiceNow is one of the top five that matters at scale.”
The reason companies are enthusiastic about ServiceNow products is because companies still need to do the same or more work during economic downturns even if they cut back on hiring or layoffs.
ServiceNow helps companies rethink their business models. “To be more productive, companies must provide better direct to customer experiences, they must offer better employee experiences. Global 2000 enterprises know that ServiceNow provides- enable them to create better experiences for customers and employees They choose us because we enable them to do more with a faster return on investment [than competing products do],” McDermott said.
He gave examples of specific customers getting value from ServiceNow. As he said, “Adobe
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Is ServiceNow Stock a Buy?
ServiceNow is trading nearly 41% below its $708 high. Although its revenue growth has slowed and it’s taking hits due to currency translation — for example, they’ll cost it $220 million in full-year subscription revenue, ServiceNow is likely to survive the downturn.
One analyst thinks the key to being able to prevail is to continue to provide customer value. Constellation Research analyst Holger Mueller said that despite falling below 30% growth, its reported growth [24% second quarter GAAP revenue increase] is a positive sign. He challenged ServiceNow to demonstrate customer value as well during the downturn as it did during the economic upturn of the pandemic.
Morningstar lowered its price target for ServiceNow by 3.6% to $675. As senior analyst Dan Romanoff wrote, he lowered the price to reflect its larger-than-expected headwinds from currency exchange, a lower outlook for subscription revenue growth, and slowing guidance for its deferred revenue and order backlog — called the current outstanding performance obligation.
For a long time, he sees the upside because of “[ServiceNow’s] workflow automation strength to bring its existing customers deeper into IT, and more broadly into human resources and customer service-specific products, as well as its continued push for special versions in the industry segment.”
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