ServiceNow, Inc. (NOW) Earnings Call Transcript & Summary

Okay. Good afternoon, everybody. Welcome to the fireside chat here with ServiceNow. We're -- I'm delighted to welcome ServiceNow to the conference. Very fortunate to have CFO, Gina Mastantuono, join us. Thank you, Gina, for joining us. Very much looking forward to this conversation.

Likewise, Brad. Thanks so much for having me.

Absolutely, absolutely. So you guys all know the format here. I have some prepared questions that I'll go through with Gina. [Operator Instructions]

So with that, again, welcome, Gina. Thank you for being here. Great to have you here at the conference. Why don't we just start with a quick recap of the Q1 earnings. What are some of the key highlights that you'd like to call out here that you reported in late April.

Sure. Well, we delivered a strong Q1, beating high-end guidance metrics across all top line. Subscription revenue growth of 30% year-over-year, cRPO grew 30%, and the top line beat carried through to a robust operating margin and strong free cash flow generation. So Q1, we saw strong bookings driven by a combination across the portfolio. Our core IT workflows remain healthy with ITOM and security showing a strong uptake. We continue to see strong growth from our customer and employee workflows with our newer products showing great traction, telco, workplace service delivery and legal service delivery, for example. And we saw particular strength in our creator workflows as our App Engine and IntegrationHub both outperformed, and this is our low-code platform, which we're seeing great traction on. From a regional perspective, strong performance from EMEA and APJ, and these are regions and areas that we've been investing heavily in the past few years. So our investments made in 2020 are really gaining traction. And EMEA closed one of its largest deals ever in Q1, really helping to drive very strong year-over-year net new ACV growth. And 4 of our top 20 deals actually came from EMEA which was great. Improving trends we're seeing in APJ. Japan and Australia and New Zealand performing very well. And we continue to see that momentum carry on through 2021. Americas also had good growth. And as part of our Q1 earnings call, we also talked about our pipeline coverage for the remainder of the year, Q1 and beyond being better than a year ago, and that remains true. So really excited about the opportunity for '21 and beyond.

Great. Why don't we shift gears to one of the key items you addressed at the Analyst Day recently, which was that long-term revenue target. The goal of $15 billion by fiscal '26 implies a very solid 6-year CAGR, about 22%. How do you sustain that kind of growth over that period? What are some of the products that need to come in more over this next 5, 6 years in order to sustain that kind of growth? We could start at the product level or if you want, you could talk about land versus expand deals. I'd be curious to get your thoughts on both, please.

Yes. I think -- well, first of all, it's important to emphasize that the 15-in-5 framework was a $15 billion-plus target, and it's meant to set a minimum threshold of where we want to be in 5 years. So it's actually a tighter CAGR range to the upside if you do the math. But it's important also that it's operating with the same discipline that you've seen us operating at today. So organic and balancing growth and profitability. For a company to grow organically by that much at scale is pretty impressive. So we feel really good about that, especially while delivering the profitability. When we talk about the growth, the strength of our top line is really made possible because we have multiple levers to grow within the $175 billion total addressable market that we see. And to start with, it's about continuing to land more new logos with a tremendous opportunity remaining in our current markets as well as new countries and geographies that we enter. And then we have significant opportunity to continue to expand our relationships with existing customers. And as you know, Brad, right, over 80% of our new business comes from existing customers, so it's a great foundation to build off of. And because they're existing customers whom we have a great relationship with, we have great visibility into the growth opportunities within the enterprise. And a lot of that has to do with expanding product deployments wall-to-wall across departments, divisions and countries. Then it also could be cross-selling the new products that we talked about, whether it's human resources or customer service or creator workflows. And with the constant innovation that CJ and our product teams are driving, we're adding new capabilities to new SKUs all the time that really allow us to get even more capabilities in the hands of our customers, really helping to drive that value. And finally, we're introducing new solutions to new personas, so our HR product to CHROs, for example, and more recently, legal service delivery to GCs, which present new buying centers. So really multiple drivers to fuel that organic growth engine. And then if you think about the partner ecosystem, in addition to our incredible direct sales force, our global partner ecosystem is a critical enabler of that path to $15 billion. And we're really well aligned with them. 7 of the top 10 systems integrators and advisory firms have committed to build $1 billion-plus ServiceNow technology practices. And so they're a huge part of that growth trajectory as well.

That's great. And then as part of that, Gina, you talked about how you could see 40-plus customers with spend of $20 million annual with ServiceNow. What gives you the confidence that you can see that type of pervasive use of the ServiceNow platform over that period of time? And do you have customers already in that kind of category? How do you get more into that level of expansion and broader use of ServiceNow?

Yes. We absolutely see customers at that level today. And so we see the path. And it's very clear. It's a land and expand. It's one of the reasons why we talk so much about the engineering pride of this company, and it's really about the innovation on the product portfolio. I mean, you see that expansion and you see more of our customers with -- buying more than 3-plus products. And then you see the renewal rates of those customers that have more than 3 products even higher at 99%. It's pretty incredible to see the opportunity there. And so we feel really good about these customers really driving and understanding the power of the platform and the fact that it's one platform unified across the enterprise that can really automate workflows end-to-end no matter where you're sitting in the organization. And so we feel really strongly that our customers understand the value and getting them to continue to grow with us is really just driving that value from -- for them. And so yes, we're really excited about that growth opportunity.

That's great, Gina. And you mentioned also global SI is a key part of that, I would assume. How much of these types of deals, where you're getting into this type of usage of ServiceNow more pervasively through your organization, is reliant on those global SIs delivering on that pipeline that we're hearing from is very strong? I know this has been a key focus for Bill. How do the global SIs plan to get into that is my question.

They're a huge part of it, right? And as I talked about earlier, the fact that they have leaned in -- and Bill will tell you, they started with thinking that the business would be $250 million to $500 million. And so quickly, they're building and committing to building more than $1 billion-plus types of business investment. So as you think about those larger customers and those larger wall-to-wall deployments and thinking about customers of ACV of $20 million-plus, they're definitely a huge part of that. They're helping the customers drive to value faster than ever before. And so we are -- we have an incredible partner ecosystem and a partner organization within our company run by Lara Caimi that's just doing incredible work with them. And so they are critical and remain ever so critical to the path to growth for us.

Great. And at the Analyst Day, you had also outlined how you'd simplified the buying process for customers. Could you elaborate a bit on that, please? And how -- what are some of the changes you've made to kind of reduce friction, if you will, to really drive those meaningful expand deals?

Sure. So in 2019, we formed a pricing team that was really focused on developing a 3-year strategy around a few simple things. So first of all, simplified buying for our customers, improve deal velocity and future-proofing our pricing model. And so first, it was about focusing on portfolio simplification and evolving the go-to-market to -- from selling just point products to solution suites, right? And as our product innovation broadened, so really thinking about holistically selling the product outcomes, right, and the suites of outcomes. Next, we simplified our license meters from 20-plus variations to just 4, right? And so how can we really help simplify the buying process and really help the ease of doing business with us as we get larger? And so that was a key focus for us. And then next, we launched recently the Now Buying Program, which really simplifies pricing by moving away from fulfillers, more to unrestricted users. So if you think about the ELA, right? And this Buying Program really allows customers to expand faster through these ELAs with solution suites. It helps simplify buying and provides greater usage flexibility. And we're hoping that, that drives a strong value alignment, right, which is really important as we think about ensuring that our pricing structure is built to last. We want to really make sure our models can grow with us and match the customer buying preferences. So you'll always hear us talk about customer first. And so we've listened to the feedback. And we're just very focused on driving a customer-centric approach to pricing that makes it easy for customers to grow with us and achieve quick time to value, which we know is so important. And at the end of the day, the hope is that, that's going to continue to drive strong NPS, and the great retention, renewal and expansion rates that you've been seeing from us historically.

Great to hear. And Bill called out APJ and EMEA as particular areas of strengthen geographies this past quarter. What's going on there? Is this just a renewed focus on the regions? Is it more of a cloud laggard catch-up kind of that's driving that activity? Why international so strong now?

Well, I think it's a couple of things. So first of all, we're underpenetrated in EMEA and APJ. And you'll see us continue to invest in our opportunities in those regions, for sure. And similar to what we've done in the U.S., we are now elevating our discussions to the C-suite, right? And that's really helping create a halo in awareness of what our platform can do. Other regions are definitely behind the curve with digital transformation, but they're very quickly coming right back and getting up to speed there. And so we're really focused on helping customers understand the power of the Now Platform and what the product portfolio can do for them. And as we move into these new geographies and as they start to scale, we add more and more resources to ensure that we're able to really have a deeper connection with the customers. And as we scale, we build a library of reference customers. And as the opportunities grow, we bring in experienced hires like Paul Smith in EMEA. So he's our new President for EMEA. He's been with us about 9 months and really driving incredible things within the organization. But regardless of the geography, and we will continue to do this globally, we're focused on scaling our go-to-market best practices and focused on really ensuring the value that we deliver to the customers. And this is about aligning the presale, especially on the value drivers that are important to a customer, especially in the specific industry and in their specific persona. And from an outside-in perspective, we're studying very carefully, especially in the COVID environment, what we can do to help them. And so it's all about value. And we're really focused on helping drive that outside of the U.S. as well as within the U.S. as well.

Great to hear. And also, I guess, one of the topics on the earnings call was more back-end-loaded seasonality, linearity in the business. I'm sure you've been talking a lot about that. But what's going on there? And can you explain to us what's driving that more back-end-loaded trend that you had cited on the earnings call?

Sure, sure. And this is a trend that we've been seeing for a number of years, so it's not new. We've been on this journey for a while. And it's about really ensuring that we are customer-centric, first and foremost, and making sure that we're providing much better account coverage, and meeting our customers where they are and giving them the choice to decide the timing of renewal and upsell. 80% of our customers are enterprise. And as the product suite is expanding and we shift the focus to solution sales and you see the number of products increasing and the ACV dollars increasing as we talked about, you see these larger multiproduct deals. As the customers continue to buy and expand, they're following a more traditional enterprise buying behavior, which is typically more Q4 weighted. And any of our peers who are --have reached this level of scale, you would have seen that with them as well. So it's nothing new, and it's not specific to ServiceNow, but it is a trend that we continue to see and that we expect to see. And they're really based on the customer preference and nothing to do with the underlying health of the business. And so you will continue to see a little bit more Q4 weighted every year. And that's just the nature of software as -- especially as we scale.

Understood. Understood. And why don't we shift gears to acquisitions. A couple of interesting ones, recently, Intellibot for RPA, Lightstep for observability. What was the decision-making process behind these acquisitions? What was the rationale for those -- in those categories now? And what are your thoughts on just the -- how you think ServiceNow can compete uniquely in those markets?

Sure. So I'll start with Intellibot. Many of our customers are really trying to drive automation across a mix of legacy and modern applications. And RPA is particularly important for integration, with legacy applications that don't support API-based integrations, right? So Intellibot has strong experience in developing these RPA solutions and had great existing product capabilities and technical talent that will really help us accelerate and enhance the automation efforts. And again, we're very customer-centric, and this is what the customer is asking for. And so our focus is really on delivering world-class automation platform that accelerates digital transformation. And RPA is just a piece of the strategy, right? It's going to extend our core ServiceNow workflows by enabling automation of certain repetitive tasks and integrating with the legacy systems. And it strengthens our existing technologies such as the AI and machine learning that's already inherent in the platform. And so it's just a way to give customers more of what they want within one platform end-to-end workflow solution. With Lightstep and the addition of Lightstep, we add advanced observability platform to our portfolio. And Lightstep's key benefit is all about allowing developers and site reliability engineers to quickly and easily understand the root cause of any digital service performance or user experience degradations in a modern DevOps world, right, where you have distributed teams and microservices architecture. And so if you think about our core IT and really remaining relevant with the Mode 2 developer side of the house, it just was a fantastic opportunity for us. And with ServiceNow's proven service management, AIOps and workflow automation capabilities combined with Lightstep's observability technology, it really enables actions to be taken to resolve the root cause of the issues orchestrated throughout the platform and really enabling quick resolution to any issues that come out. And so it's really about going a bit deeper into IT, but allowing us to really have end-to-end capabilities across the board. And so -- and what you see with that is the type of acquisitions that we're doing are talent -- I won't say tuck-ins, talent and technology that we can add capabilities to our platform. We're not doing enormous type of M&A. It's really about how do we enable customer first and really allowing our platform to give our customers what they need. And with respect to competition, we've been saying it from the get-go, and we really believe this, that no one has to lose for us to win. And we're not interested in being a pure-play RPA vendor. We will absolutely continue to partner with all of them, and we'll continue to enhance our integrations and drive integrations with all of them. And so we feel really good about those acquisitions and really excited about the capabilities that it brings to us.

Great. Excellent. And why don't we shift gears to just the core IT business, ITSM and ITOM. How do you think about the ability or opportunity to continue to consolidate those markets? How well penetrated are you today? This is obviously where ServiceNow got started, and it's had tremendous success. But where is the opportunity from here? How well penetrated are you? And what does the runway look like just in ITSM and ITOM?

Sure. Sure. So according to Gartner, we're currently about 50% penetrated in IT for existing customer base on ACV. But in terms of penetration within those customers, what we're seeing is that we can more than double the existing IT business with current customers. We're largely replacing legacy systems or homegrown solutions. So we don't see any reason why we can't penetrate the other 50% of the market as well. And from a Magic Quadrant perspective, we're top of the market there. So on top of that, we also see us expanding the overall addressable market with our innovation that we've been talking about. And so the new capabilities with AI and machine learning that are in the pro SKU, the virtual agents, for example, we talked about we're currently penetrated at just 20% of our customer base is in the pro SKU. And we think that we can penetrate approximately up to 50 -- between 50% and 60% in the pro SKU. And the pro SKU carries about a 25% realized uplift. And then we just launched in Quebec the enterprise SKU, which we absolutely believe can penetrate, over time, of course, about 20% of the existing base. So it's still early days, but there's a lot of potential upside still within IT given -- even though we're already so well penetrated based upon the things that we just talked about. So a lot of opportunities still even within our core.

Absolutely. That's great. That's great. And then if -- drilling into that a little bit, with the traction you've seen in pro and now you have enterprise, what is incremental in pro? What's incremental in enterprise? Enterprise is a new release, and obviously, you've added a lot to it with the Quebec release that you referred to. So what are some of the things you're hearing from customers in terms of interest in the added features that you're getting in those 2 SKUs?

Yes. Well, so the pro SKU has been out for a couple of years, and as I said, we're currently at 20% penetrated. And we actually got to 20% faster than we thought we would. And the incremental functionality in the pro SKU is all about AI and machine learning. If you think about virtual agent capabilities, really about automating many employee requests that can be solved through a chatbot do not require a conversation with an agent. So it drives real productivity and real quick time to value. But it does take a bit of time to get all of the learnings, right? AI is about learning, right? And so that's obviously been very well received. The enterprise SKU, which was just introduced with Quebec about 1.5 months ago, introduces process optimization and workforce optimization to ITSM. And process optimization really is about enabling IT and customer service organizations to improve the underlying processes driving the workflows to enable them to proactively identify any process bottlenecks so they can speed issue resolution. So if you think about just overall optimizing the process, workforce optimization allows customers to optimize their most important asset, which is the people, right? It provides a work space for IT and customer service managers to really help optimize productivity. A lot of this is all being done in Excel now, if you can imagine that, in many of the largest organizations. And so this really allows real-time agent productivity, balancing workloads among the employees, and really resulting in increased and improved employee and customer experiences. And so again, the great thing about the innovation that CJ does, it's all about customer and market fit. And what the customers are asking for and what the customers are using, that's how our HR products were built, that's how our customer service products were built, and that's no different here as well. And so really a good reaction from the customers in the marketplace because very often, we are creating with them.

Makes sense. And then outside of the core ITSM and ITOM, is the company planning to launch pro and enterprise SKUs for other workflow, other applications, customer employee workflows?

Yes. We actually have seen strong demand for AI power within our entire portfolio, including CSM and HR. There's already CSM Pro. So when we launched CSM, we actually launched with the good, better, best. So pro penetration is actually about 30% already for CSM because most customers are looking to automate as much as possible, right, really allowing their customer service reps to focus on more complex issues. And so enterprise SKU is also launched not only for IT but also CSM, which carries the same process optimization and workforce optimization capabilities that I talked about for ITSM. And so if you think about the acquisitions that we've made with AI and machine learning with Element AI, you'll absolutely see that in the enterprise and pro SKUs for HR and CSM.

Great. Excellent. And why don't we shift gears to the creator workflows. Big development here with the Quebec release that was recently launched. Can you talk about what that brings to the creator offering? And how can that accelerate ServiceNow's move into this vast market of custom application?

Yes. It's so exciting, Brad. So creator workflows, which includes our App Engine and IntegrationHub, had a really strong Q1 and was in 19 of the top 20 deals. And with Quebec, we're delivering even more new low-code tools that really move the app development beyond the borders of the engineering organization and into the hands of citizen developers. And I keep hearing that within a year, more than 70% of applications and businesses are going to be created by citizen developers. And we've actually started in-house at ServiceNow a citizen developer program for anyone who wants to learn to build apps, right? And so the great thing is that ServiceNow is really the innovator that can provide these low-code tools that lines of business users are looking for in logs, and it really makes them very productive. And the great thing, it's built on the platform that's already in the business, right, that's already strategic to IT, that's trusted, that's scalable and secure. And it's the platform that IT continues to build mission-critical applications on. And so what we've seen over the past few quarters is more market awareness for low-code tools and automating manual processes. And the fact that we were so able to quickly release our emergency response apps when COVID hit, fast followed by safe workplace return and vaccine administration management, it really has shown the power of the platform and the ease of building these really essential tools to help automate processes end-to-end. And so on this single platform, if you think about -- you have 3 things: the speed, the power and trust that IT needs to deliver these business-critical apps to the business faster than ever. And then the lines of business are fully empowered to build their own app applications in a simple and powerful tool set. So we're really excited about it. Clearly, it's resonating. And we've seen great growth in Q1 and expect to have a strong 2021 and beyond.

Excellent. Great to hear. And the company is now starting to focus more on cRPO versus billings. Why is cRPO a better metric to gauge performance in the business? And how should we think about that change? And then what are some of the limitations still on cRPO as well?

Yes. I mean, subscription billings has live fluctuation and just often requires so much explanation and adjustments for timing-related noise such as customer co-terming, which really can change the timing of renewals from 1 quarter to another. And I showed a graph back at Financial Analyst Day that really showed that cRPO, and if you look at it moving with -- it literally moves exactly with revenue, whereas billings quarter-over-quarter, you just have these massive swings up and down, right? And so if you look at billings from a 4-quarter rolling basis, that absolutely helps normalize for some of those quarterly timing swings, really, because that metric is much more correlated to cRPO and revenue. It's why we introduced it as -- in the guidance this year and why you'll see us focus more on that going forward. It definitely provides better visibility. It's just a more consistent indicator of business performance because it normalizes for most of the timing and duration noise that impacts quarterly billings. And while cRPO is definitely a better leading indicator than billings, there's still some noise there. It's not perfect, right? So you still have some timing of renewals and contracted upsells that can have an impact to cRPO. Additionally, self-hosted deals are excluded from cRPO. And you know we have about 5-ish percent of our business, and that fluctuates in each quarter. It could get up to 7% in some quarters. So that definitely also has some noise. But if you look at the trends over time, it's much more correlated to revenue than quarterly billings. Billings, if you normalize it by using the rolling 4 quarters, is a better sense. And we'll, as always, continue to consider ways to be more transparent about the overall health of the business. It's important that we do the right thing for the business as well.

Sure. Makes a ton of sense. And then also at the recent Analyst Day, you set a target for 26.5% operating margin in fiscal '24 at about $10 billion of subscription revenue, which implies about 100 basis points expansion annually. How are you thinking about balancing growth and margin? What are some of the key areas of investment that we should be thinking about going forward?

Yes. We were really -- we -- hopefully, we were transparent about the fact that we will be utilizing the same playbook that you've seen us use to date when we get to $10 billion and $15 billion. And that's about disciplined investment that drives a strong balance of strong growth and profitability. And in the world where the Rule of 40 is considered good, and we've been operating at the Rule of 60, we expect to be able to continue to operate around 55. And so it's the great thing about our model is that it really allows us to continue to invest aggressively in growth while still driving margin expansion because we have this beautiful one platform, one model, one architecture, all the innovation that we build into it. It's not always a conversation about who's starving and who's getting the investment because most of the investment actually benefits the whole product portfolio. And so because we were able to achieve this scale organically, we have a really efficient business model that allows us to drive incremental leverage even as we continue to invest in R&D and sales and marketing. And so you'll see us continue to invest in the same areas where you've seen us. So it's on R&D and on product innovation. It's on feet on the street sales. It's really making sure that we will be continuing to do all the great things that you've seen us really engaging in a world-class go-to-market as well as innovation on the product side.

Sure. Sure. That's great. And then I always need to ask a question on the pandemic. As we're getting into reopening, as you look forward to reopening, how does that change the environment for ServiceNow relative to kind of the environment we've been in with the pandemic, now the tail end of it, obviously?

Yes. I mean, we're seeing strong demand, Brad. I think the tailwinds of digital transformation, business model innovation and cloud computing that you hear us talk about are really showing up. Our pipeline looks strong. And I think at the end of the day, what the customers are looking at is quick time to value. And we've been able to prove time and time again with our platform that we're able to drive that. And so we feel good about the economy, we feel good about the demand environment right now. And we feel great about the opportunity for growth that we see in front of us and that we outlined at our Analyst Day.

That's great, Gina. And then last one, I think we're out of time here after this. And thank you so much. This has been great. When you look out over the course of this year, what are you most excited about across the product portfolio or even geographies?

I got that question a lot today, and I can't pick one. Like the great thing about this model is that we have so many different levers for growth, whether it's cross product, IT core, enterprise SKU coming out in Quebec, the penetration that we've been seeing with our ITSM Pro. The risk product has been doing phenomenally well. And then if you think about the continued success that we've been having with customer service and with HR and then creator. I mean, I'm just bullish across the board. And then back to the comment that we talked about earlier from a geography perspective, the fact that we are really starting to see the upswing that we knew would come in EMEA and APJ happening now is just super exciting. And at the end of the day, I'm most excited for getting back to the office, seeing people, right, and really working with customers face to face again, right, as opposed to always being digital. Super exciting. The demand environment looks good. I'm just -- I'm excited about it all. So we're in a privileged position, and we don't take it for granted at any moment, right? And we have an incredible culture here of people who just really want to make the world of work, work better for people. And it's such a purpose-led company. It's just -- every day, I feel like I'm in my dream job and just really excited. So it's hard to pick just one.

Absolutely. No, understood, Gina. There are a lot of coals in the fire at ServiceNow. And thank you so much. We're out of time here. It's been a pleasure hosting you on this session and at the conference. And really learned a lot. Thank you so much.

Thank you, Brad, for having me. It's been a pleasure as well. You have a great day.

You, too. Thanks again.

Bye-bye.