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

Again, my name is Alex Zukin. I run the enterprise software practice here at Wolfe Research. I am thrilled to be joined by our afternoon keynote, CJ Desai from ServiceNow. CJ, thank you so much for joining.

It is an absolute pleasure to be with you, Alex, again.

Well, look, we've now met each other a few times, and I am -- I guess I'm honored to have you keynoting the afternoon session for us. You are a very unique executive at ServiceNow. You've been through multiple executive teams and regimes, if you will, at the company.

If you think about stepping back -- the first question I've been opening with, the first few are scripted questions, and I'll remind everybody in the audience feel free to ask a question. I will ask it. Just know that they know who's asking the questions, so be mindful. The first question I'd ask you, CJ, how do you -- when you think about the value proposition of ServiceNow today, if I ask you for kind of a brief intro, and when I say brief, I mean fairly brief, so -- because it's a short fireside, but a brief intro on ServiceNow, the value prop, what you're delivering to companies today and where you're going in the future.

Yes. So I would say, first of all, I always start every single even customer meeting that we are a platform company. We are a platform company, and the platform enables many use cases that our customers can leverage. And our roots are in IT. But even within IT, Alex, we have now grown. We have security incident management capabilities that were started a few years ago, risk solution, asset management solution. So even within IT, we have expanded our portfolio where customers truly use us as a platform rather than a point solution vendor. Then we went after employee experience, and not only just starting with workflows related to employees onboarding, off-boarding, all of that good stuff, but expanded to facility solution, legal service delivery, procurement service delivery, types of things that makes employees life easier in how they interact with the organization. And then, as you know, in 2016, we started customer service journey and field service journey and really, really excited about how well that product line is doing. Kudos to the innovations and our amazing go-to-market teams. And then we have local tools for people to be able to create applications. So when I look at ServiceNow and I'm presenting to our largest customers, midsized customers, sometimes prospects, it is an enterprise-wide platform play. Once you have us, regardless of which use case you started from, you can expand enterprise-wide. We are not just on IT. You can do line of business. Alex, one last thing I would say, in the last couple of years, we have added industry solutions for telco, banking and others where we are really going in and say, here is what we do for you in loan operations at a bank, for example.

I'm going to ask you a lot of follow-ups on that. But the first question -- the second question I've asked everybody today is, what's the demand environment feel like right now? How does it compare to, I don't know, a quarter ago, 2 quarters ago? And what does it feel like through the rest of the year?

So I would say, I am definitely seeing that large projects -- for example, last year, if you're speaking to me last year this time, I would say, products like ITOM and others tend to be something that customers like, hey, I'm dealing with COVID, this, that, whatever. I'm not sure how to leverage some of your larger product lines because that would require a couple of years of transformation to get product together and use your product. I have seen, beginning of this year, products like ITOM, products like our customer service management, field service management, our enterprise or IT asset management product. We are seeing very strong demand. And you saw our Q2 numbers, not only it was a balanced performance across geographies that every geography hit the number, which help us accelerate the net new ACV, but also across balanced performance across our product lines, whether it's creator, workflow, customer employee or IT workflows. So I feel pretty good when I saw the performance across geographies and across product lines. So I would say the demand environment seems healthy to me. I'm not -- and I didn't feel like we were pandemic-related acceleration last year and now it's this and that. Actually, I'm saying, okay, companies are like, hey, what do I need to digitize? And if I can digitize using ServiceNow, let's talk about it, and does your product provide value? But I'm not seeing people shying away even in some of the impacted industries like travel and entertainment. I just spoke to a few customers this quarter, and they are speaking, yes, they are dealing with all the pandemic-related stuff. But demand-wise, it's pretty healthy.

And then the third question I'm asking everybody, particularly very senior level executives or founders, if -- as you look at the metrics inside the company and you feel you get enthusiasm, excitement, if there was an -- if you had an investor looking at the same set of metrics that you're looking at internally, what do you think they would be most excited about?

I would say they would be most excited about how many new products we continue to create. We are a product company, platform company. And Alex, you have known this about us since your previous days and previous employer. We continue to leverage our platform for unit economics. And creating an app are so favorable, that whether it's a horizontal product that we can create or a vertical product that we can create for a telco industry, when they look at the unit economics of what it takes to create a product and seeing the traction for that product through our amazing go-to-market team, they will say, oh my God, I see now what you mean. You have a great platform company, and you can create all these products to capture TAM and grow ServiceNow's business. That's what I would say.

Now we move to the fun question. So I've got 3 questions that I specifically wrote for you, CJ, for ServiceNow. And it's -- again, a lot of these come from the questions that I get asked over and over and over. But the first question is just around this notion of an ELA cycle. It's something that one of your partners have called out. It's something that you called out. It's something that Bill called out in previous calls. Help us understand exactly what you're talking about, where we -- for those that don't know what an ELA is, where are we in that cycle? And how big -- if you had a customer that was spending $1 a year or $100 a year with you in the past, after this cycle -- after you've delivered on the new innovation, the new value proposition that you're offering to customers, what does that spend look like after that?

Yes. So Alex, for every investor, including yourself, we have been fairly transparent that we used to and still for the predominantly sell multiple products. So if we get a brand-new customer, say, a large pharma, you will find 4, 5, 6, 7 products being sold at the same time. And that motion is still pretty prevalent in a good way where we will get a brand-new customer that was using some on-prem product or other product, and they are going all in on ServiceNow. In terms of ELA cycle, I would say we are still in fairly early innings. We have done absolutely some transactions using ELA. It makes it easier for customers to purchase, and they say, okay, I have access to all of your products. I turn it on, whatever I use, and we can do a true-up. So from an enterprise license, given that we are a single platform for all products, it actually makes it easy from an adoption, turning on, turning off standpoint rather than us selling individually product. But I can tell you that we are very, very early. I look at our 7,000-plus customer installed base, and we are talking a very small fraction percent of our customers that are using ELA. And if it makes it easier for customers, given they leverage our platform, to use ELA or now buying program -- a bunch of programs we have, that's great. But we are fairly early. We are not -- I won't tell you that, okay, we have hit that stake where 20% or 30% of our customers are already on that.

And what's the magnitude of expansion dynamics that you're seeing with customers, pre and post, this type of a product -- this type of a buying cycle?

I mean I would say that customers are always supersmart. And Alex, even if we tell platform stories, knowing that all products are built on the platform, we still have to prove out that we have a good product for that use case. So you don't have this base of, hey, ServiceNow, you do all this thing for IT transformation. I'm going to give you a $12 million annual spend just because you are ServiceNow. No, we need to prove it out that this is really good product that delivers the value. And we do very systematically through our go-to-market team, BVA. So from an expansion standpoint, I -- my personal thing is when we get a brand-new customer, and we can articulate the value of our platform and products, that's when that approach is very effective versus when a customer is expanding from 4 products that we're using to 2 additional products. Yes, they could. Could they do any [ less ], sure. But I don't get that in my conversation, they are like, okay, you can simplify purchasing, but that doesn't come up as a deep thing in terms of expansion.

Understood. One thing that dovetails on to this conversation within ELA is -- and I put this in our weekly -- I put 2 articles about ServiceNow in our weekly a few weeks ago. One of them was showcasing what Accenture did, and they laid out effectively a blueprint of taking a number of CMDBs and unifying them all in one as they were progressing through a cloud migration. And I thought that was important, a, because that was effectively a blueprint and they were dogfooding a strategy that they would then be able to go to market with 4 customers on a combined basis. Walk us through am I seeing things? Am I seeing something important? Walk us through if that is, in fact, something to be mindful of as a blueprint for some of these very large potential deals.

100%. I mean 100% spot on. First of all, Accenture is a great partner, and they are a great customer of ServiceNow as well. And they use our platform in very creative ways, and I consider them as an amazing co-innovation partner. But the example you said, in December of 2020, we did a large transaction with a large firm. And when you talk to their CTO, why did you decide to do enterprise-wide ServiceNow, he said, I want all my assets -- enterprise assets, not just IT assets, to be in CMDB of ServiceNow so I can serve my customers better. And Accenture is now actually doing the implementation there, which is fantastic. And it's a much bigger deal for Accenture than it was for ServiceNow. But that, 2 weeks ago, a large Chicago-based company, exact same thing. The CIO said, listen, CJ, need your help to get CMDB right. And can you put couple of best practices or blueprint as you call it, Alex, to us so that we can go all in on ServiceNow, and we are going to make that decision in November, December time frame. So this whole idea of CMDB driving the technology transformation, having all the assets and services in one place so you can serve your end customers better is something resonating really well. Even this morning, our Head of EMEA, Paul, amazing guy, called me, and he's talking to a telco tomorrow. And we have the exact same question you had, what can I say? How long will it take? Do we have best practices? And do you recommend a couple of partners. So yes, that is something that is resonating really, really well in health care, telco, certain parts of financial services, government and so on.

And with respect to how that ties in, because the other thing that occurred to me when I heard about this was when these customers are looking at the bigger cloud migration deals that they're signing with the hyperscalers, ones that are hundreds of millions of dollars of both total and annual contract value in some cases, that migration, that megadeal is almost pulling ServiceNow as there's a component of the puzzle that you need -- that needs to be fulfilled that you can help with. And so you're being pulled into those deals, equations, et cetera. Well, talk to us about that a little bit.

I would say that's in addition to a better customer service cycle. So when we talk about centralized CMDB or asset repository, if I know where my assets are and if something happens to my services, I can serve my end customers better. So say, a telco will say, I can do B2B customer service better or direct-to-consumer customer service better. But what you said, which is different, is that hey, CJ, I have -- I am going with 0 data center strategy. Okay. Awesome. I have physical workloads, virtual workloads, bunch of other workloads that use microservices, Kubernetes. I may do lift and shift for some apps. For other apps, I may re-architect them. For other apps, I may completely decide to end-of-life them over time. ServiceNow becomes this platform that allows you to discover assets in Google Cloud. Like I have a customer who is currently migrating to GCP, and they're using ServiceNow as their transformation platform to know where all the assets are as they go from data center A to GCP. And some are still keeping their on-prem data center, maybe 20% capacity. We become that orchestration engine to really understand where your assets are and what is the health of all those assets between Google Cloud, Azure and their on-prem on whatever journey they are on. And yes, we are being pulled in, and I'm seeing that actually more and more in some of the largest enterprises who are moving at x pace to public cloud.

And then you've mentioned telco a few times. You even bought some RPA functionality, if I recall correctly, to help make that product specifically for that vertical a much more vibrant experience. So talk to us about the power of that vertical product, what you're doing around RPA there and how investors should -- if you kind of stack rank both your industry exposure from a growth driver perspective and your verticalized product strategy, where does that go? And I apologize in advance for the 5-part question.

No problem. So Alex, you and I have discussed this before. And I believe that RPA is a necessary technology, but it's not a differentiated technology. It's a necessary technology but not a differentiated technology. So going after a generic RPA use case is not something we want to do. No. We are not going to go to some back-office function and say, you have a back-office operations. Can RPA do this for you? Can ServiceNow do this for you? Absolutely not. However, as you automate your business processes, even when you're doing a cloud migration that you talked about, there are some API-based systems, some non-API-based system. Telco has them. Health care has them. Manufacturing has them. There are many industries has them. When you are using ServiceNow use cases or workflows, and now all of a sudden, you need to connect to this non-API-based system, we will provide the RPA functionality in the beginning of 2020, so 4, 5 months from now, that you can say, oh, I can stitch this together, and I get this beautiful workflow across the process that works across the system, whether they are on-prem, public cloud, API-based, non-API-based home care, that is the next game on business process automation. And given our technology, with integration built in the platform, we don't have another integration technology platform that will say, oh, my god. You look at this platform, and now look at this other platform and look at this third platform for RPA. No. We have everything in one platform, and you should be able to create a workflow across your departments and processes. So it will be a feature. And yes, for certain industries, it matters more than the other.

Got it. I guess on that notion, how far down the life cycle of integration do you need to go -- do you need to have? Like do you need to have API to API? Do you need to have ETL? Do you need to have -- I'm going to -- I used to cover MuleSoft. So I'm familiar with all the jargon. But I guess do you need to have multiple features around a life cycle of integration depending on that? Or where do you draw the line?

So we have kept it pretty simple, Alex, given that you were an investor -- you followed and tracked this space is we are very focused on ServiceNow to any integration. So we built IntegrationHub, which is a nice business for us. The engineering team did an amazing job and created that product 3 years ago, and it is now growing very nicely that when ServiceNow needs to integrate with x, you can do that API-based integration. Now we are going to add RPA for a non-API-based system, and we are going to charge for that. How much? We don't know. We are still trying to figure out. So our goal is ServiceNow to any that if you're a telco and you're using ServiceNow as the central platform, you should be able to use RPA, IntegrationHub, process mining that we have built in, or our workflow tools to be able to do everything on ServiceNow to any. But this any to any middleware that can talk to SAP to Workday, absolutely not. That is not our priority, and that's not an area we have decided to go after yet.

Perfect. I'm going to entertain a question from the audience. Guys, again, I encourage you to ask questions. I will ask them. The question is, when you think of various products across the platform, where do you see more pricing pressure? Does that show up more on the core IT services side on ITOM, probably not in creator workflows? Also, can you talk about how DevOps could end up being the biggest business you have?

Well, there's a lot of questions in that question. So from a pricing perspective, I would say, right now, I have not seen something where I feel tremendous pressure if you can show that you deliver the value using our platform. So I don't -- if somebody is trying to say, hey, ServiceNow is a premium product versus a low-cost alternative, that means they are looking at us as a product, not as a platform. We create applications, and we differentiate with our platform. So if somebody misses that point, that means they are solving for a very different type of a use case in their mind and probably misinterpreting where ServiceNow can provide value. So I do not see -- of course, there are large volume ELAs, the things that Alex, you and I talked about, but I'm not seeing, in customer service, I'm competing with XYZ. And now there is a new entrant, so I need to drop price or in IT -- or I mean ITOM is growing nicely for us this year, and there is still a lot of innovation that ITOM is delivering via Loom acquisition on log analytics and all that. So I'm not seeing that pressure specifically even on the IT side. And then we continue to innovate. So usually, people see so many features and others that -- between IT, HR employee and creator do not see that as much.

What about on the DevOps question?

On the DevOps, here is my viewpoint. My viewpoint is when people were using ITSM, one of the biggest challenges in some of the regulated industries was around change management. And we created a product, and that product is resonating really well in certain industries around that. It is 100% our ambition and a right to play that we are going to create products for the DevOps teams so that they can get their work done faster and still talk to master ServiceNow instance. So you will see announcements coming from us. Lightstep was our first step on the observability side for the DevOps team because it's mainly used by the ops team more than the dev team. So Lightstep will be our first entry, but you will see us add more and more things on the DevOps side where they can leverage our product line and innovation for the smaller teams. But that still talks to master ServiceNow instance. So yes, I agree that's an opportunity. I agree that's a long-term strategy for us, and I agree that we will play in it.

If we look -- another question that was e-mailed to me. Guys, if you don't feel comfortable submitting them in the Q&A, e-mail them to me. I will also ask them. The question is, if we look out 3 to 4 years, what do you believe will be your largest product outside of ITSM/ITOM? Does one stick out with meaningfully more potential than the others?

Customer service management and field service management. That market is still underserved. CRM is an industry, does a decent job on customer service, but there are still a lot of mid-office back-office workflows. And that's the reason we have -- we will continue to invest in that, specifically for certain vertical, and that's a massive opportunity. So I expect that we will see -- all of our product lines, fortunately, are growing, and I'm very proud of what the team has done, both our engineering and the sales teams, but that particular is a breakout category. And what is going to drive that breakout result is verticalization within that specific vector for a health care or a telco or a government, federal, state, local and others.

Perfect. I love -- the reason, CJ, I love having you as part of these channels is you answer questions directly instead of answering 6 questions I didn't ask. So I really appreciate that about you. It's very refreshing. Let me ask you this question. Obviously -- well, I'll talk about one of your competitors, who you seem to hire everybody from, Salesforce. When I talk to their ecosystem, one of the things that strikes me is their best performance year-to-date is coming out of the federal vertical and public sector. And that's even before the big quarter, which is -- and obviously, in September. How should we think about the public sector and the federal vertical for ServiceNow this year? You guys have always been strong in it, but is there anything unique and specific this year that's driving an even bigger and better demand environment than in previous periods? And how should we think about that?

Because we are in the quarter, I cannot comment on the quarter itself. But here is what I would say. When I look at U.S. federal government across Intel community, Department of Defense and federal civilian, just if we talk U.S., we definitely see that ServiceNow workflows make a lot of sense from them, from creator workflows to IT to even digital agency to citizen type of things, absolutely, there is a demand for it. But everybody else, our competition also sees the same demand, and they also want to position themselves that they can do workflows, all that stuff, fine. That's totally fine. That's how the games get played. I would say my observation, Alex, has been, besides the U.S. federal government, we are seeing demand in the state government, state as they try to digitize a lot of things with offices, not -- people not being there in person. You don't have paper processes. Julie signed this, and now it went to Joe, and Joe has to send it to [ Dane]. And oh, can you go to the next door down and get this signature? So even at a state level, we are seeing demand. And even at a city level, we are seeing demand. So cities, state and -- city, state and federal in the United States, we are seeing demand across the board for ServiceNow workflows. And I would say that when I look at just future -- quarter-to-quarter -- last quarter, we had 7 deals north of $1 million just in U.S. federal. So -- but in the U.K. federal, we have done vaccination with health services there and so on. In Australia, we did a nice job with the Australian government. So we are seeing across the board in government sector demand for ServiceNow. Everybody has their own closing different months, but I feel pretty inspired and encouraged by the demand environment in the federal sector overall globally, whether you look at German government, Australian government or a U.S. government with ServiceNow. We are very unique, and our sales team does an amazing job in that sector.

The one I'll close with -- well, I won't close this, but I'll get close to closing, second to last. Going into this year, one of the biggest, and I asked this in May, I think, when we had dinner. Going into this year, every question was when is ServiceNow going to make that big acquisition? What are they going to buy? It's going to be big. It's going to be dilutive. They're about to be like Salesforce. And that -- and to your credit, you basically said, no, that's -- and then Bill in every earnings call basically starts out the call by saying, we're not buying anything big. Walk us through, as we exit this year, as we get into 2022, as we think about the platform, where should investors think about the company being more aggressive with respect to M&A leaning in and maybe going bigger versus the strategy that you have, there I say, scaled to perfection around buying unique purpose-built assets layering them on your distribution mechanism and going for both.

So Alex, first, I would say I'm very proud of ServiceNow teams to execute at this scale and still delivering the kind of results we did in Q2. And you and I talked about -- we met in Q2, and you said, hey, CJ, how was Q1? And I said, from my perspective, Q1 was great, and I understand why there was an astrict on it. And then we put those behind us with the Q2 results across CRPO, subscription revenue growth and profitability. We are a very disciplined company, and we will always be disciplined when we do technology tuck-ins or even things like Intellibot, Lightstep. Our goal is always to create a product that our customers love and willing to pay for. And we have hit this scale that has not been done before as you are very well aware in enterprise software with this level of discipline. In terms of large M&A, transformative M&A, right now, there's nothing on the table. However, we are always looking -- of course, it is our job and our fiduciary duty, whether it's Bill, Gina, myself, Kevin, whoever, to always look at is there something that can transform us as a company, but it is the right thing to do for our shareholders and customers. Because if it's not the right thing to do long term for our shareholders and customers, what are we solving for? So I'm not trying to solve for -- or Bill is not trying to solve for something, hey, that's tactical, that will spike up the revenue growth next year and then continue to feed that engine every year by doing M&A, that's not -- we want to be disciplined about it. We are always looking to say, okay, we had this technology in-house. Can we leverage our go-to-market? Will it still provide really good operational metrics to The Street short term and long term? And it's fairly disciplined. The bar is pretty high to say what is in it for customers and what is in it for shareholders? And without that, I don't even start a conversation. Even when I meet like amazing CEOs, entrepreneurs and they're like, hey, what about us working together? And I said, that's great. What is in it for our customers and shareholders? So we will always continue to look. Nothing on the table right now, but that is not to say that we don't look -- we are always looking. We are always seeing, but we are very disciplined about it.

I guess I'll end it with this, CJ. What am I -- what is top on your list of things right now to focus on, things that I haven't maybe asked you about or you think that is important for investors to start thinking about as we get to the end of the year? Anything that kind of comes to mind to close out with?

I would say one thing. What I'm seeing, Alex, and this -- I saw that at Oracle in late '90s, but this time, I'm seeing it being more real. When you articulate the product that is more industry-oriented, and it's a real product, not a veneer, it's a real data model, real business logic, real integration for, say, a health care, customers listen. Not a veneer, a real deep product. And this is one area that you will see us invest even more as we create industry solution to open up even a bigger TAM because our platform unit economics are amazing. If I say we want to go after insurance industry, and we want to do these things that are ServiceNow like, right, related to servicing a customer, we can create that product with 24 engineers in a year, okay? And then in 3 to 5 years, we can create a decent business on it. So these -- besides our horizontal product lines that you are very well aware of, IT, employee, customer service and creator, we are putting more focus than before to say which industry we want to play, where we have a right to play and ability to win. I'm not going in and trying to say, please displace Guidewire. No. Absolutely not. That is not. Our whole thing has been around system of action. What workflows can we surround ourselves in these industries that still creates a nice deal for ServiceNow? And customer says, I could see why you have a right to play here. And here is the money I'm willing to spend. So that's on top of mind, which industries we go deep in. We are going to continue to innovate on all the vectors. I look at every product's performance up to Q2, and it really inspires me on some of the products we created recently and how well they are getting traction. And we'll just continue to stay humble and try to solve for our customers. That's our game.

CJ, sounds like somebody's going vertical. I don't know if it's the stock or the product, but hopefully, it's both. Well, thank you so much for doing this again. It's a true pleasure. It's enjoyable, insightful and, I think, impactful. So thank you.

Thank you so much, Alex. Thanks for inviting me. Appreciate it.

Thanks, guys.