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

Everybody, I'm Brad Zelnick, software analyst here at Deutsche Bank. And for this session, I'm really delighted to be joined by Gina Mastantuono, CFO of ServiceNow. Gina, thank you so much for joining us.

Hi, Brad. Thanks so much for having me. I really appreciate it.

Absolutely. So the format of this session is going to be a fireside chat. I've got a number of topics that I'd like to go over with Gina. [Operator Instructions] But maybe without further ado, Gina, again, welcome. I just wanted to maybe open up with a topic you keep hearing about. Everybody is trying to understand sort of the shift between digitization and all the exciting changes we've lived through over the last year or so. But as economies hopefully reopen and things, hopefully, one day return to normal, how do you think about the selling environment? And the pandemic, no doubt, accelerated digital transformations. But what are you now hearing from CIOs and fellow CFOs in terms of spending priorities? And just to top it off, how much of this investment cycle do you think is really a matter of a strong digital imperative versus simply a low interest rate environment?

Oh, goodness. Great questions. Listen, I think what we're hearing is digital transformation is on the top of mind for every C-suite really because digitizing these manual processes are going to be able to drive exponential increases in employee engagement, customer loyalty, better scale and, of course, higher profitability. And all of these are top of mind as CEOs and CFOs and CIOs are really reopening and getting back to the office. And so IDC is predicting that digital transformation investment spend is going to exceed $7 trillion between 2020 and 2024. That's enormous, right? And that number keeps increasing every time they release it. And so business leaders are really recognizing the need to address the new reality of distributed work. And those that make the investments now are going to emerge stronger from this health crisis. And we're in this dynamic and complex environment, volatile even at times, right? And so enterprises are really focused on innovation without disruption. Speed and agility are critical, and how can we really drive this employee engagement, customer loyalty and productivity as quick as possible. And so I've talked about this, and Bill has talked about this, the secular tailwinds between digital transformation, cloud computing and workflow have all really intersected at this incredible moment in time that we find ourselves a part of. And ServiceNow is really so well positioned to take advantage of that opportunity. And it's not about a low-interest investment cycle. These companies really are looking to reinvent their business models to stay competitive, reinvent their talent, brands and their experiences for employees to remain competitive and really engaging with employees and customers where and how they want to. And this is just more important than ever. And we're hearing it time and time again from all customers.

Yes. There's no doubt that tailwinds are quite strong, and ServiceNow is really well positioned to benefit. But at the same time, over this last 1.5 years or so, there's just been so much uncertainty in the world. And your business has proven to be quite resilient. How would you compare the visibility that you have into the business today and its diversification versus maybe 1.5 years ago?

Well, the great thing about our business, and I say all the time, I'm in my absolute dream job with this incredible company, this business model is so resilient and predictable. We have such a robust backlog. Our RPO exiting Q2 was just under $10 billion, at $9.5 billion. We generate 80% of our business from existing customers, and they really understand ServiceNow is mission-critical to their operations and their business. And our renewal rates are phenomenal at 97%, 98% depending on the quarter, and we don't expect that to change. Second half pipeline looks really strong. But visibility versus 1.5 years ago when COVID just hit, obviously, so much was uncertain and so much was unknown. I think we have really come a long way in 18 months. And as a result, we have even better visibility into our pipeline and great visibility into our billings guidance. And our revenue is even more predictable. So our net new ACV has and will continue to diversify across our strong product portfolio. You would have heard that on the last few earnings calls, these other product and portfolio lines are really growing faster than the core. Our core remains extremely strong as well. But that expanded breadth of our product suite has really allowed us to land larger deals with multiple products and with new customers. And we're also landing new customers, net new customers outside of IT, which is fantastic. I talked about our Financial Analyst Day back in May, that in 2024 we expect about 30 -- 35% of our new business to come from Customer and Employee Workflows with Creator Workflows driving at 20%. So more than 50% from these emerging workflows, which is just phenomenal. So great business model, really resilient in this environment. And our visibility is better than ever.

Awesome to hear. And Gina, I think you have previously noted that net new ACV is accelerating in 2021. And I think on your last earnings call, you mentioned the acceleration being greater than initially anticipated. What are the contributing factors driving upside to your plan?

Yes. I talked about this at the earnings call and after. We're seeing broad-based strength, which is just phenomenal. We're seeing growth across our industry categories. So financial services and manufacturing were particularly strong across the globe really driven by investments in business continuity. Industries impacted by COVID, including retail and hospitality, also showed signs of recovery with strong net new ACV growth in the quarter. So we were really pleased to see that turn. We saw healthy demand across the globe. So from a regional perspective and a geographic perspective across the globe, Americas, EMEA and APJ really showing strong growth. Our land-and-expand strategy continues to work. We see great growth in average customer spend this quarter. At the end of Q2, we had over 1,200 customers paying us over $1 million in ACV, which was up 25% year-over-year. And that included 62 customers paying us over $10 million in annual contract value. And so we're seeing robust net new ACV growth from new customers as well. And the average deal sizes are growing 50% year-over-year. And so we're really seeing that going to this solution sales approach that delivers full capabilities of our product portfolio is really continuing to drive more multiproduct deals. We talked about in Q2, 18 of our top 20 included 3 or more products. So land and expand is working well. We're really seeing this digital transformation acceleration that I know that you've been talking about as well. Pipeline continues to be strong. Coverage ratio is better this time than this time last year. From a workflow perspective, I talked about it earlier, across the board, IT remains strong. So does Customer, Employee as well as Creator. And so we're really feeling good about the breadth of our product portfolio across really the whole side of the business. So really pleased with the results to date and great pipeline for back half as well.

Awesome to hear of the breadth and diversification. It absolutely shines through in all the metrics that you've shared and the comments that you shared today as well. Maybe if I could turn to product and capabilities of the Now Platform. Can you maybe discuss the importance of AI? How are your customers benefiting from your intrinsic capabilities within the platform? And how important is AI in winning deals and driving competitive differentiation?

Yes. I mean, listen, we've been investing in AI and machine learning for a while now. And we've been talking pretty openly about that. And these AI machine learning capabilities that are embedded in our Pro SKUs are really resonating with our customers, especially during the pandemic. If you think about IT service requests growing exponentially in a remote distributed workforce, many IT organizations are really looking for ways to deflect these lower-tier cases, self-service, how they can handle and spend time working on the more difficult, complex cases. Leveraging our chat box and automation to streamline those processes are just imperative in them being able to run their businesses. So with these premium SKUs, we're really able to differentiate ourselves by providing performance analytics and predictive intelligence to really help drive further productivity and turbocharge these digital transformation efforts. And if you combine our AI with our one data model, we really provide a platform solution to our customers regardless of the buying center and the use cases. And the benefit of being a platform company is that there's no one competitor that can provide the end-to-end functionality across IT, employee and customer. And if you think about investments that we make in AI, in machine learning, in anything, because we have this one data model, one platform, those investments benefit all of our product portfolios, whether it's IT, customer or employee, which is just a phenomenal business model.

I think it's really important. And when I think about the platform, if I reflect back over the last couple of few years, I can recall investors being concerned around ITSM saturation. And I'd always believe that having ITSM at the core of ServiceNow, having a CMDB is really strategic in automating so many other types of workloads, especially when we consider every company today is becoming a technology company. So -- but with that said, how would you respond to skeptics that might fear ITSM market saturation? Is it possible that ITSM, that the market might just be much, much bigger than people realize?

There's still plenty of opportunity within the ITSM market. The TAM continues to grow. When we IPO-ed years ago, Gartner estimated the TAM was about $1 billion. We're so much higher than that already, right? And if you think about what we're doing with constantly adding new products and functionality that expand our ITSM offering, it increases that market opportunity. A decade ago, virtual chat bots were not part of the TAM. Our investments in AI and ML have really yielded incremental capabilities that are monetized in our pro and now our enterprise SKUs. So given we aren't anywhere close to being fully penetrated even within our existing accounts and the massive opportunity to really capture even more new enterprise logos, we serve about 7,000 enterprises, but there are tens of thousands of enterprises out there that can really benefit from our ITSM. It really suggests that the TAM for it is much larger. So what I'd love everyone to take away is that there's plenty of runway to go in ITSM. And we continue to show that, that TAM continues to grow.

Maybe just related to that, can you remind us of the opportunities with ITSM Pro and now enterprise, why customers are choosing those options, what the uplift is? And how far penetrated are we?

Yes. At the end of Q2, ITSM Pro is about 25% penetrated, and CSM Pro is about 35%. We believe there are Pro SKUs, and we talked about this at our Financial Analyst Day back in May. We believe the Pro SKUs can penetrate approximately 55% of our customer base in both ITSM and CSM. So still significant runway ahead. For ITSM, the Pro SKU has about a 25% realized uplift. CSM Pro has incremental capabilities and is also offered within our vertical solutions, so it's priced a bit higher than that. I'm super excited about our Enterprise SKU, which just launched in June. So it's early days. But as a reminder, it introduces process mining and workforce optimization capabilities into it, which is just phenomenal. And actually, while still very early, even in Q2, we already saw 4 customers adopt that Enterprise SKU in Q2, including Xerox. And we talked about the fact that we think enterprise can penetrate approximately 20% of our existing customer base for both workflows. We think the uplift should be roughly the same in magnitude as the standard to Pro uplift, so about 25%, but still early days. And we'll continue to be transparent about how the Enterprise SKU is doing as we get more penetration in our customer base.

Awesome. Clearly, a long way to go.

Absolutely.

While we're thinking about product and the platform, can you talk maybe about the importance of App Engine and the early traction you're seeing with it? And why the Now Platform is the best place for customers and partners to develop low-code applications because there are a number of alternatives out there.

Yes, absolutely. Well, as you know and as many know, right, every organization right now is really focused on app modernization and operational transformation. And IT and the business have got to move as quickly as possible. And they're really all focused on driving greater efficiency, being more agile. And there's just not enough developers to build the application that enterprises need to really transform their business. So you're seeing this trend, right, of this low code because there's just this huge unmet need in application delivery. And so we see a really powerful partnership emerging between IT and the lines of business around low code. And IT organizations are going to look to their trusted platform, the Now Platform and Creator Workflows and App Engine is really the foundation of that partnership. And as security is becoming more and more important than ever, IT is really looking to get a handle on the app proliferation in their organizations, right? And so that partnership between IT and the business on app development is going to just be more important than ever. And so with our Quebec launch back in June, we delivered new local to -- sorry, new low-code tools that really help to move that app development out of the developer and really beyond the borders of that engineering organization into the hands of the citizen developers. And this is a trend that I know you guys have been calling and seeing for a while. And ServiceNow really is the innovator that can help provide these low-code tools to the line of business that really helps them be productive in scale when they're building these apps. And it's on a platform that's already strategic to the IT organization. It's trusted from a security perspective. It's scalable. And clearly, it's the platform that IT continues to use to build mission-critical applications for themselves as well as for the line of businesses. So as you've seen in our numbers over the past couple of quarters, we've seen much more market awareness around ServiceNow as this low-code application tool. And one of the advantages we have is that we have this platform that's already integrated with all of their systems of records, right? Customers can build out really fast. And at the end of the day, I think what we've seen, especially as we were able to very quickly deploy emergency response applications after the COVID pandemic hit, that's followed by safe workplace return and vaccine admin. The ability to really build these applications quickly and get them into production and driving value fast has really gone a long way. And so the great thing is that, again, it's one data model, one single platform that the IT organizations and the business has the speed and power and trust that IT really needs to deliver these business-critical apps.

I think the need is intuitive. And I think from what we can see ServiceNow is clearly -- has as much right to this opportunity as anybody. So it's good to see the success that you're having there. If I can maybe turn the conversation in the direction of one of your favorite topics, I'm sure you get asked about in every conversation, is M&A. You've got such a massive TAM at this point. You guys sized it at over $175 billion, I think.

Yes.

How should we think about the future as it relates to M&A? And is it fair to say that anything you do would be more about enhancing your position in existing markets versus pursuing new ones? Because it seems you've got a lot of TAM to go after. At what point do you risk spreading yourselves too thin perhaps?

Absolutely. I think, listen, we are the only born-in-the-cloud software company to have reached $5 billion in revenue without large-scale M&A, and we're super proud of that. It really helps us when we talk about that one beautiful data architecture model of our platform. And we really have gotten here through self-grown determination and innovation of our incredible engineering team. And we expect to continue to run that same playbook. We're uniquely positioned to achieve our $15 billion revenue target organically, and our plans are really not about buying revenue to get there. We're committed to the common platform, the engineering-led, internal innovation engine. And we'll continue to do the technology and talent tuck-ins that you've seen us do in the past, really all about aligning towards our common user experience of our one platform model and really the no tech debt brand promise that we've made to our customers. So obviously, when it comes to large-scale M&A, we're always looking at the best possible opportunities that would bring tremendous value to our customers and shareholders. But it means being very disciplined about valuation. It means being very disciplined on how we think about things. We wouldn't be doing our jobs if we didn't keep our eye out for these opportunities. But you're absolutely right. We are definitely not looking at enhancing in -- outside of our current core and where we're playing so well today.

That makes perfect sense, and thanks for being very clear on that. As CFO, you have a number of medium- and long-term targets for the business that you've put out there. And one in particular that caught my attention was putting out this goal for having over 40 $20 million-plus customers by 2024. And I mean, I guess, the question around it, what -- normally, what drives your confidence when it took the company almost 20 years to have a dozen such customers that large? And maybe related to that, since you're a CFO, at what point does the line item for a given vendor gets so big that it puts a target on the back of a particular vendor? And I get maybe $20 million for a company the size of some of the largest banks and other institutions that are spending billions and billions of IT maybe it isn't that big. But I've heard the anecdotes from other vendors were, hey, we're just getting so large relative to the overall budget that it's reaching higher levels of visibility in the organization. How do you think about all this?

Yes. I think we have a significant opportunity to continue to expand our relationship with our existing customers. And there's really multiple drivers to fuel that growth, right? First, we're growing our existing product deployments wall-to-wall across departments, divisions and countries, right? And we've evolved our focus to land the right customers that have that ability to really expand with us. Second, the strategy of selling the portfolio is resonating, and we've talked about this already. We see an acceleration of the business well beyond just ITSM. We're cross-selling our new products to complement the existing ones and the constant innovation that's coming out of our NowX team. We're adding new capabilities, new SKUs that really allow us to upsell, but give our customers much more value for every dollar that they spend. And we're also introducing new solutions to new personas, right? HR product to CHROs, our Legal Service Delivery product to GCs, which really help present new buying opportunities for us. We're really focused on always listening to our customers' needs and introducing new features and products that are top of mind of our customers and the C-suite. So we're really focused on making sure that the Now Platform remains mission-critical and really relevant to our customers. And so as -- in terms of being a target, I actually think it's the opposite. As more of an enterprise's workflows move on to the Now Platform, it drives a better together story, more efficiency, more productivity, increase capabilities and with more product and wallet share. We're actually seeing higher renewal rates. So people who buy more than 3 products with us actually have a higher renewal rate. And you know our renewal rates are pretty high to start, 97%. But if you add 3 or more products, it goes up to 99%. And so I also think that there's a trend to consolidate vendors, right, and get when you talk about scalability and security, really consolidating vendors into those ones that you trust, something that ServiceNow is integral within the IT organization. I think it actually only makes that more important, right? And fragmentation due to application sprawl, I think, is a bigger problem. So to your point, we took us 20 years to have a dozen. We were very one product for many, many, many of those 20 years, right? And the fact that we are a much broader product portfolio, really looking at different ways of helping solve our customers' problems, I feel really good about those targets that we put out there. Our customers are phenomenal, and we just continue to work really well with helping them drive business value every day.

Awesome. Maybe as it relates to other targets, you've got a $15 billion revenue target out there as well. And in that context, I wanted to just think about the business as it evolves and how much demand is really being driven by the global SIs of the world. And it's natural that Bill really understands how to work with the GSIs. But what are you baking into your plan in terms of the lift that you get from them? And what do you see maybe now that supports your longer-term confidence and what could come from these relationships? Are there any leading indicators, maybe number of trained people or other types of investments that they're making right here and now?

Yes. Partners, Brad, make -- they play an incredibly important role for us, right? They are critical in driving successful implementations and really helping tailor our product to different industries. And they are absolutely very strong thought partners with us, and they are a meaningful enabler on our path to $15 billion. And they're well aligned to help us achieve our goals, right, and our corporate priorities. 7 of the top 10 global advisory and system integrators have committed to build 1 billion-plus ServiceNow technology practices and managed services offerings over the next 3 years with the remaining 3 of the top 10 expected to commit to that 1 billion-plus this year, right? And these top 10 global SIs have formally designated ServiceNow as one of their top 5 tech partners, which is a coveted designation, which really frees up significant internal partner investment in their practices, right? So if you think about internal joint go-to-market resources across multiple continents and significant mind share at the tip of the spear, where it matters most. And so we feel really great about where we're standing with them. A great example is our Accenture partnership, right? The Accenture-ServiceNow business group really brings together dedicated resources, professionals with deep expertise in ServiceNow and workflow and platform development. And this business group is going to really offer integrated consulting and technology solutions designed to help our joint customers deliver these transformational customer and employee experiences. And so being a part of us -- the Accenture-ServiceNow business group is a significant milestone in their path to achieve a $2 billion ServiceNow practice by 2025. So we're just really excited about all of the relationships that we have with all of our global SIs. They are incredibly important, and those relationships are really strong.

Wow, that's some serious commitment. Just to be clear, when you say $1 billion, $2 billion, you're talking about all of the professional services from strategy and implementation and ongoing maintenance support things that they provide away from what it is that ServiceNow provides, but what complements and wraps around a given solution or...

That's right.

Awesome. That is really impressive. Turning to a different topic, Gina, the Now Buying Program, can you talk a bit about the benefits? And just how investors can be comfortable that your pricing of these agreements is done with discipline? And maybe even an example could be helpful of how it's enabling a more strategic customer dialogue?

Yes. I mean the Now Buying Program was really created to help our larger enterprises digitally transform and really help them engage with us in a much more simplified way, right? And so the Now Buying Program enterprise license agreement really simplifies the buying process, providing greater usage flexibility, investment protection and really improves the value alignment. It also allows them to expand faster, which is fantastic. And so if you think about the combined capabilities of the platform being better together, they really deliver more than the sum of the parts. And so it's all about making it easier for our larger, rapidly expanding customers to grow with us through simplified, flexible and value-aligned ELAs, right? And so what I'll tell you is that deals are typically multiyear and multiproduct larger. And we are super focused on making sure that we are pricing it correctly. It's still small now. And many of folks who are helping drive this understand kind of some of the pitfalls that have come before with pricing on ELAs. And so we're really focused. There's a good amount of governance to make sure that we are driving value for our customers, but also making sure that we are pricing it at the right spot for us as well.

Not to get too deep into the weeds, but are any of these ever self-managed, self-hosted, where you would recognize upfront revenue? Or do they all tend to be ratable revenue recognition?

Yes. These are -- yes. They're all ratably over the life of the contract. So they haven't been on-prem to date.

Okay. Got it.

And I would imagine that they would be materially at all.

Awesome. Maybe in the respect for time, 1 or 2 more questions. We've heard really good things about Intellibot, which you acquired earlier this year. What was it that finally got the company into the RPA space directly versus prior always looking to partner?

Listen, I think it's -- we see RPA as part of a complete workflow automation platform, right? And it was becoming more relevant to us, and we really had spent years building the leading workflow automation platform. And so it made sense for us to kind of think about the RPA piece. But the digital transformation, what's really needed is much broader than just RPA, right? It includes workflow, API-based integrations, AI as we talked before as well as process mining, process analytics and conversational interfaces, right? So there's a lot more to really doing workflow and integrated workflow automation than RPA. But it was important, right? Many of our customers really were trying to drive this automation amongst the mix of legacy and modern applications. And RPA is particularly important for integrating with legacy applications that don't really support the API-based integration. And so we've been really pleased with the Intellibot acquisition. The folks have been fantastic. And really, RPA is an important addition to our platform, and it's going to help us extend those core ServiceNow workflows by really being able to automate certain repetitive tasks and integrating with those legacy systems for our customers to really drive intelligent end-to-end automation, which I think really complements our existing technology stack.

It certainly seems complementary. And Gina, just on the topic of M&A and which directions you might go, you also recently acquired Lightstep, another area where you've always interoperated with competing alternatives. And just as we think about market ServiceNow might enter into the future, I appreciate this wasn't meant to be a road map discussion or somewhere a venue where you're going to show us your full shopping list. But maybe it's easier to ask, where can we be very comfortable you might not look to go? Where -- what direction absolutely makes no sense for ServiceNow?

We're going to continue to enhance the Now Platform and continue to innovate to build new solutions that really focus on our customers' needs always. We're such a customer-centric company, and that customer-centric approach really guides us through our product road map. We're focused on C-suite priorities. So generally, you're probably not going to see us go down the path of targeting a small niche point solution market, right, with limited appeal. There's no specific market where I would definitely say no because we're obviously going to examine each opportunity closely. But markets further away from our core competencies would need to have substantial opportunity to really enhance the customer experience for us to consider it at all.

Makes sense. Listen, Gina, with that, we are out of time. There's so much to talk about, and it's always so great to see you, even virtually over by camera here. But thank you once again, and thanks to all who tuned in to listen. This has really been informative. It's been a great session. So thank you.

Thanks, Brad. So nice to see you. Be safe, and see you soon.

Likewise.

Have a good one.