Bernstein: ServiceNow subscription revenue beats guidance. Why is growth metric guidance slowing?

Revenue beat guidance. Why are forward-looking metrics in focus?

ServiceNow's third-quarter 2026 subscription revenue at constant currency was 3.99 billion dollars, 31 million dollars above company guidance. Product and service adjustments reduced growth by about 25 basis points; Bernstein estimates that without this change, the beat would have been about 40 million dollars.
The market is focused on signals of future revenue: constant-currency current remaining performance obligations (cRPO, the contract balance expected to be recognized within one year) rose 20.9% year over year in the third quarter, while company guidance for the fourth quarter is 18.5%. Excluding acquisition contributions, the metric exceeded guidance by about 90 basis points in the third quarter, near the lower end of the 50 to 240 basis point range seen over the past few years.

Some acquired contracts contain termination-for-convenience clauses, so their future revenue cannot be included in cRPO. Management said the impact on fourth-quarter guidance was about 50 basis points, compared with about 25 basis points in the third quarter; including these orders that will contribute revenue, the 18.5% guidance would be equivalent to nearly 19%.
A higher proportion of on-premises deployments and AI deployment services also weigh on the metric, while the incremental contribution from the Moveworks acquisition enters the year-over-year comparison. After adjusting for the relevant factors, Bernstein estimates that fourth-quarter guidance implies growth about 90 basis points below the actual third-quarter rate; if the actual result exceeds guidance by at least 90 basis points, adjusted growth will be flat or higher.

The company provides dedicated implementation support for some complex, high-value AI projects, shifting part of the value of AI add-on purchases from subscription revenue to professional services revenue, with no change to the total contract value paid by customers. Management expects the impact of this reclassification on subscription revenue growth to widen from 25 basis points in the third quarter to 50 basis points in the fourth quarter and about 100 basis points in 2027.
Management said customers receiving dedicated support adopt AI about twice as fast, and their Assist consumption and product usage are also several times higher; the company plans to hand more work back to partners as implementation experience and automation capabilities improve.
For usage growth to translate into incremental revenue, customers must cross their package thresholds: most AI consumption remains within customers' initial allowances, with usage-based revenue generated only after those allowances are exceeded. Management said the number of customers exceeding their initial allowances is rising rapidly.

Third-quarter total revenue rose 21% year over year to 4.106 billion dollars, but operating profit under US generally accepted accounting principles fell 33% year over year to 385 million dollars, and net profit fell 45% to 277 million dollars. Adjusted free cash flow was 822 million dollars, up 39% year over year but below the market consensus of 923 million dollars.
Management believes subscription gross margin will bottom at about 80%; recent pressure has come from greater use of infrastructure provided by major cloud providers, geographic expansion and AI deployments in the company's own data centers. The company expects scale efficiencies to gradually offset the pressure and maintains its outlook for operating margin expansion.
Bernstein adjusted the mix of subscription and professional services revenue, kept its total revenue forecast largely unchanged, and raised its 2026 adjusted earnings per share forecast from 3.93 dollars to 3.97 dollars; the firm maintained its outperform rating and 266-dollar price target.