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Why Is ServiceNow (NOW) Down 1.5% Since Last Earnings Report?

It has been about a month since the last earnings report for ServiceNow (NOW). Shares have lost about 1.5% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is ServiceNow due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

ServiceNow Q3 Earnings Beat Estimates, Revenues Up Y/Y

ServiceNow reported third-quarter 2022 adjusted earnings of $1.96 per share, which beat the Zacks Consensus Estimate by 5.95% and improved 26.5% year over year.

Our earnings estimate was pegged at $1.86 per share.

Revenues of $1.83 billion lagged the consensus mark by 1.2% but increased 21.1% year over year. After adjusting for forex, revenues of $1.93 billion jumped 27.5% year over year.

Subscription revenues improved 22.1% year over year to $1.74 billion. After adjusting for forex, subscription revenues increased 28.5% year over year to $1.83 billion, surpassing management’s guidance range of $1.750-$1.755 billion.

Professional services and other revenues increased 4.7% year over year to $89 million. After adjusting for forex, professional services and other revenues increased 12% on a year-over-year basis to $95 million.
 
ServiceNow has been benefiting from the rising adoption of its workflows by enterprises undergoing digital transformation. The company now has 1,530 total customers with more than $1 million in annual contract value, representing 22% year-over-year growth in customers.

Customers with contract value worth $10 million grew 60% year over year in the reported quarter. The renewal rate was 98% in the reported quarter, flat year over year.

During the reported quarter, ServiceNow closed 69 transactions with more than $1 million in new annual contract value.

As of Sep 30, 2022, current remaining performance obligations (cRPO) were $5.87 billion, up 18% year over year. On a constant currency basis, cRPO increased 25%.

Remaining performance obligations, on a constant currency basis, rose 24.5% year over year to $12.1 billion after adjusting for forex.

Operating Details

In the third quarter, the non-GAAP gross margin was 82.4%, which expanded 130 basis points (bps) on a year-over-year basis.

Subscription gross margin of 86.2% expanded 120 bps year over year. Professional services and other gross margins were 7% compared with the year-ago quarter’s figure of 16.5%.

Total operating expenses, on a non-GAAP basis, were $1.03 billion in the reported quarter, up 23.1% year over year. As a percentage of revenues, operating expenses increased 90 bps on a year-over-year basis.

ServiceNow’s non-GAAP operating margin expanded 40 bps on a year-over-year basis to 26.2%.

Balance Sheet & Cash Flow

As of Sep 30, 2022, ServiceNow had cash and cash equivalents and short-term investments of $3.96 billion compared with $3.83 billion as of Jun 30, 2022.

During the reported quarter, cash from operations was $265 million compared with $433 million in the previous quarter.

ServiceNow generated a free cash flow of $103 million in the reported quarter, down from $287 million reported in the prior quarter.

Guidance

For fourth-quarter 2022, subscription revenues are projected between $1.834 billion and $1.839 billion, suggesting an improvement in the range of 20-21% year over year on a GAAP basis. At constant currency, subscription revenues are expected to grow in the 26-27% range.

cRPO is expected to grow 26% year over year on a non-GAAP basis and 20% on a GAAP basis. Unfavorable forex is expected to hurt subscription revenues by $330 million.

ServiceNow expects the non-GAAP operating margin to be 26%.

For 2022, ServiceNow expects subscription revenues to be $6.865-$6.870 billion, which suggests a rise of 23% over 2021 on a GAAP basis. At constant currency, subscription revenues are expected to grow 28.5% over 2021.

Unfavorable forex is expected to hurt subscription revenues by $290 million in 2022.

ServiceNow expects the non-GAAP subscription gross margin to be 86% and the non-GAAP operating margin to be 25%. Moreover, the non-GAAP free cash flow margin is expected to be 29%.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended downward during the past month.

The consensus estimate has shifted -7.02% due to these changes.

VGM Scores

At this time, ServiceNow has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with a D. Following the exact same course, the stock was allocated a grade of D on the value side, putting it in the bottom 40% for this investment strategy.

Overall, the stock has an aggregate VGM Score of D. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, ServiceNow has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.

Performance of an Industry Player

ServiceNow belongs to the Zacks Computers - IT Services industry. Another stock from the same industry, Infosys (INFY), has gained 5.5% over the past month. More than a month has passed since the company reported results for the quarter ended September 2022.

Infosys reported revenues of $4.56 billion in the last reported quarter, representing a year-over-year change of +13.9%. EPS of $0.18 for the same period compares with $0.17 a year ago.

For the current quarter, Infosys is expected to post earnings of $0.19 per share, indicating a change of +5.6% from the year-ago quarter. The Zacks Consensus Estimate remained unchanged over the last 30 days.

Infosys has a Zacks Rank #4 (Sell) based on the overall direction and magnitude of estimate revisions. Additionally, the stock has a VGM Score of C.

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