ServiceNow softens short-term guidance due to macro headwinds, but is bullish on future success

Derek du Preez Profile picture for user ddpreez July 28, 2022 Audio mode
Summary:
ServiceNow CEO Bill McDermott said that the demand environment for software is durable and consistent, but some deal cycles are taking longer in the current macro environment.

An image of ServiceNow CEO Bill McDermott on stage at the Knowledge event in The Hague
(Image sourced via ServiceNow)

Digital workflow vendor ServiceNow has delivered an upbeat quarter, beating its guidance for both the company’s revenue growth and operating margin. However, CEO Bill McDermott did marginally soften ServiceNow’s annual subscription revenue forecasts as macro headwinds will continue to play a role throughout 2022. 

That being said, McDermott was keen to emphasise that these are short-term adjustments and looking further ahead, the company’s ambitions remain strong. He said: 

Looking beyond 2022, our confidence in our midterm aspirations, which we raised earlier this year to $11 billion plus by 2024 and $16 billion plus by 2026, is rock solid. In short, ServiceNow's iron-clad fundamentals will not waver.

The key Q2 2022 numbers are: 

  • Subscription revenues of $1.658 billion, representing 25% year‑over‑year growth, 29.5% adjusted for constant currency

  • Total revenues of $1.752 billion, representing 24% year‑over‑year growth, 29.5% adjusted for constant currency

  • Current remaining performance obligations of $5.75 billion as of Q2 2022, representing 21% year‑over‑year growth, 27% adjusted for constant currency

  • ServiceNow now has 100 customers paying over $10 million in annual contract value in Q2 2022, representing more than 50% year‑over‑year growth

The company said that its annual subscription revenue will increase 24% to a midpoint of $6.92 billion, which is down from the 26% growth to $7.03 billion it predicted in April. The company said that currency fluctuations were the biggest facto, which would cost ServiceNow $220 million in 2022 revenue. 

Commenting on the results this quarter, McDermott said: 

Like other premier technology companies we are managing through the current macro…we're simply returning to the outlook we originally set for you in January of this year on a constant currency basis.

Unlike others, while the currency effect also applies pressure on our margin, ServiceNow will maintain our full year margin guidance of 25%. We will absorb the impact through disciplined cost management, as we run more efficiently on the ServiceNow platform.

Gina Mastantuono, ServiceNow’s Chief Financial Officer, pointed to the company’s 99% renewal rate as evidence of the company’s resilience and said that it finished Q2 with 1,463 customers paying over $1 million in ACV, up 22% year-over-year. However, as well as currency headwinds, the company is also experiencing longer deal cycles. Mastantuono explained: 

While our business remains resilient, we do expect the elongated deal cycles that we experienced in the last couple of weeks of June to persist for the remainder of the year. We have factored that into our updated guidance.

We have a well-diversified customer base with over 80% of our business in large global enterprises. As a result, we expect to sustain our best-in-class renewal rates. Over 85% of our new business comes from existing customers, which drives our robust net expansion and predictable growth. We also continue to see a very strong pipeline at our recent Knowledge event, which some of you attended in Q2, we drove a 40% increase in pipeline year-over-year.

We're confident that we're appropriately factoring in the macro trends as we see them today and will continue to be transparent as the remainder of the year unfolds. 

Demand for digital is strong

Taking a bigger picture view of what’s happening in the market, McDermott emphasised that whilst there’s volatility in a number of areas across economies, the demand from buyers for digital is consistent. This is what gives the company confidence in its ambitions beyond this year. McDermott said: 

The secular digital transformation tailwinds are blowing stronger than the macro crosswinds. ServiceNow generates an unmatched combination of organic growth and profitability at scale. We believe there is a generational value creation opportunity here on every level of our company. Therefore, we are hiring, expanding and investing for the future. Growth companies don't get stronger than this one.

Let me offer some additional color to underscore the state of the business. Enterprise software is an all-weather industry. Some businesses out there are prioritizing enhanced productivity to lower costs. Others are evolving business models to stimulate growth. All of them know full well that digital technology is the only answer. That's why the demand environment for software is consistent and durable.

And all of our businesses are performing extremely well. In Q2 ITSM was in 12 of the top 20 deals with seven deals over $1 million. ITOM was in 13 of the top 20 nine deals over $1 million. Customer Workflows was in 14 of the top 20. Employee Workflows 13 of the top 20. And Creator Workflows was in a remarkable 20 of the top 20.

In closing, we are confronting reality, but not conforming to it. Our Q2 beat on the top line and the bottom line reinforces who we are. The digital transformation imperative will not shift to the sidelines. We will continue full speed on our growth journey to be the defining enterprise software company of the 21st century. We are resolute because now as ever the world works with ServiceNow.

My take

The markets won’t react favorably to companies softening their guidance, but as I’ve said before, thinking quarter to quarter doesn’t make a successful strategy. What’s important is looking at the long-term indicators. Deal sizes increasing. Existing customers expanding their footprint. Strong renewal rates. On these metrics, ServiceNow is looking good for tackling any disruption in the short-term. And McDermott is right, whilst some companies may be being cautious this year, what they also know is that reducing investments in digital and technology isn’t the solution. 

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