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

All right. Good afternoon. Good morning, everybody. My name is Tyler Radke. I co-head the U.S. software sector here at Citi, and welcome to today's mid-afternoon keynote for those of us on the East Coast. We're really happy to have ServiceNow. We have Gina Mastantuono, the CFO, and really looking forward to this discussion around digital transformation. So thank you, Gina, for joining us.

Thank you, Tyler. I'm really excited to be here. Thanks for having me.

Absolutely. Well, we'd love to do this in person, but I think we'll look forward to maybe doing that next year. But I thought maybe we could just start off at a high level. I mean, there has been no shortage of buzzwords in the software industry around digital transformation. I think ServiceNow has historically sold into IT professionals. You're kind of increasingly targeting line of business folks. But could you just help frame for us, for these digital transformation conversations, what are kind of the big catalysts driving them now versus what you've seen in the past at ServiceNow?

Yes. Great question, Tyler. Thanks so much. Listen, I think digital transformation was a buzzword before. But without a doubt, it's top of mind for everyone in the C-suite now because digitizing these manual processes can really drive exponential increases in employee engagement, fierce customer loyalty, better scale and, of course, higher profitability. And so IDC predicts digital transformation investment spend will exceed $7 trillion between 2020 and 2024. And that number keeps increasing every time they put it out. And so most of our customers now recognize that we are not just an IT service management tool anymore but rather a workflow engine that really can enable many different aspects of their businesses and improve their productivity across the board, right? And they see that our workflows are better together, and the combined power of our products really exceeds the sum of the parts. And if you think about CIOs, they continue to be our champions as most every other function within a modern enterprise is really enabled and supported by the IT backbone. So they continue to be our champions. And IT is no longer just supporting the business. In many cases, it actually is the business. And so that CIO sponsorship opens doors for us in other buying centers outside of IT. And a good example, if you marry ITOM with customer service management, right, it unlocks a ton of value. And customers that use us for CSM and ITOM are better able to break down the silos between the IT organization and customer service organization, which allows them to utilize the insights coming from ITOM and their IT assets to provide better, more efficient customer support, right? So I mean, what's better than that? CSM, we think, is going to be the largest growth driver for us in the future outside of IT, just given the sheer volume of the market and our headroom. If you think about HR then, the employee experience is more relevant than ever for us, and C-suite budgets are shifting to really drive better employee experiences. So with COVID, there's been the focus on distributed work, employee well-being and employee learning in a remote environment, all of which needs to be enabled remotely. And so in the current environment and as we talked about, every other article you see is about the future of work and hybrid's here to stay, that distributed work environment is really here to stay. That's not going away. And then last of our workflows, of course, is our creative workflows. And that really enables enterprises to quickly build applications, powerful applications that seamlessly connect across people and processes, really delivering unique solutions for employees and customers, right? And it's really fast time to development. There aren't enough developers within an enterprise to meet the demand right now of all the applications being requested. So our low-code offering within creative workflows really helps to democratize application development and really move it into the hands of citizen developers. And so you're absolutely right that this digital imperative and the digitization that we're seeing is really across the board and really exciting for us, and ServiceNow is so well positioned to really help our customers right now more than ever before.

Great. So related to that topic, one of the questions we often get from investors is kind of which office is digitizing faster, the back office or the front office, right? There's definitely different catalysts for both. I guess what is ServiceNow's perspective in terms of which office is seeing the fastest digitization trend? And where do you see Now better positioned between those 2?

Yes, it's so funny. In my meetings earlier today, I got this question a lot, too. And so from a value proposition perspective, we talk about the fact that we're a platform company, first and foremost. And the benefit of that is that there's no 1 competitor that really can provide the end-to-end functionality across the enterprise, within IT, employee and customers. So the front, middle and back office is enabled by the Now Platform. And most -- if you think about our differentiation, like the ability to manage those end-to-end processes of creating a ticket and carrying it through the resolution all in 1 system on 1 platform is really impactful. And so I think that the answer to the question on back, middle, front, I think the front office was the first to get the focus of the digital transformation. I think COVID has accelerated the focus not only on the front office but also back and middle. And we're seeing it across the board. And if you think about the interconnectivity, right, and the ability of having productive employees, productive customer service, having productive processes that help define the answer for the customer and help drive this fierce customer loyalty and fierce customer engagement, it's across the board and it's all connected. You can't have one without the other. So I actually think that you're going to continue to see expansion in all areas, front, back and middle.

Got you, got you. So shifting back to the conversation around IT, which, again, you have very strong relationships there. I think one area that has probably been also underestimated when we talk about digital transformation is just how much runway is left in the core ITSM business. I guess, how do you think about that from a customer share perspective and just where we are in terms of the, I don't know if you want to use baseball innings or percentage of market penetration, like how far through that opportunity are we?

Yes, I get this question a lot as well, as you can imagine. There is still plenty of opportunity in the ITSM market. The TAM continues to grow. When we IPO'd years ago, Gartner estimated the TAM for ITSM was about $1 billion. Now it's significantly more than that and continues to grow. On top of that, we're constantly adding new products and functionality that expands our offering and really increases that market opportunity. For instance, a decade ago, things like virtual chatbots were not part of the addressable market. And our investments in AI and machine learning have really driven those capabilities within the platform, and we're able to monetize them in our Pro SKU, which generates approximately 25% realized price uplift. In addition, we weren't anywhere close -- we aren't anywhere close to being fully penetrated even within our existing accounts. And there's a massive opportunity to capture more enterprise logos. While we serve about 7,000 enterprises today, there's tens of thousands out there. So it actually suggests that the actual TAM for ITSM is much larger than even what they're saying it is today at about $5 billion. And so I keep talking about runway. We keep building in new capabilities. Our Pro SKU penetration has hit 25%, and we've talked about that going up to 55%. Our new enterprise SKU, which was just launched back in June and brings workforce and process optimization into the platform, very new but great traction and great customer understanding of what the capabilities are. So there's a lot of runway even left within IT for us, for sure.

I see. And related to that, how do you view kind of low-end competition in the market? It seems like offerings such as Jira Service Desk from Atlassian is -- seems to be having some success, maybe not directly against ServiceNow but certainly in terms of adding new logos. So how do you kind of look at the low end of the market in the competitive environment?

Yes. Our primary focus has been and will continue to be enterprise customers with 5,000-plus employees that really need scalable and reliable platforms. And we're not seeing Jira very often in that end of the market. When we have seen them and Atlassian in the past, it's typically been at the team level or the smaller end of the market, where the customers aren't looking for really robust workflow capabilities but a ticketing solution, for example. And Atlassian is a great company, but we differentiate ourselves by providing really robust out-of-the-box functionality that helps IT organizations manage these complex workflows and quickly respond to incidences. And so ITSM Pro, which I talked about a few minutes ago, with that SKU, we're able to further differentiate ourselves with our strong AI and machine learning capabilities that really enable teams to deflect lower-priority cases and improve an IT organization's productivity, especially around the higher-priority cases. And so as I talked about earlier, we're a platform company, first and foremost. And the benefit of that is really that there's no one competitor that can provide the end-to-end functionality across IT, employee and customer workflows all on a single platform, one data model, one architecture. The simplicity there is a real differentiator for us.

Yes. And I think one interesting thing that we saw in the Q2 results was as a percentage of your workflows, IT kind of had a nice tick-up relative to Q1, which may have surprised folks just given how much success you've had beyond IT. I guess, what would you attribute the strength to -- in IT? I mean, is that kind of a recovery from challenged industries or pent-up demand that you're seeing coming out of the pandemic?

Yes. The actual fluctuation in net new ACV mix in Q2 wasn't so much driven by a change in the IT demand environment but more a function of the strength in our creative workflows, especially in Q1. And so from a net new ACV standpoint, the mix coming from IT workflows decreased in Q1, and creators increased pretty significantly because we closed some 7-figure Creator Workload deals, which were unusually large in 1 quarter, and that really drove that business to be 20% of the net new. And in Q2, Creator went back to the more normalized run rate of about 14%, which is consistent with what we saw in the back half of 2020. That said, our core IT business remains very strong. And to your point earlier about people who think that the market is saturated, clearly, it's not, right? And relative to a post-COVID recovery, for example, ITOM in Q2 showed particular strength after a sluggish 2020, that was definitely a result of COVID. And so we also mentioned on the earnings call the impacted industries represented 20% of our total net new ACV in the past. And although we're still in a pandemic environment, we're definitely seeing signs of recovery in those challenged industries. For example, retail and hospitality and transportation and logistics delivered strong net new ACV growth in the past quarter. So I think it's a combination of both, but the core remains strong and we're really pleased with the results there.

Yes. And Gina, I wanted to go back to some of the earlier comments you made around HCM and CSM and just talking about the opportunity there. I guess how are you kind of sizing that opportunity maybe relative to what you see in IT? And I think the natural question that you probably get a lot is just how should we think about long-term overlap with the offerings that Workday and Salesforce provide in those markets?

Sure, sure. Well, Employee Workflows has about a $13 billion total addressable market, and it's growing at a CAGR of about 12% over the next few years, such that it's expected to be a $20 billion opportunity by 2024. And the key trends really there are about employee first, right? Because of the pandemic, C-suites are so focused on the health and well-being, first and foremost, of their employees, but also on the productivity, right, and the ability for them to do their jobs effectively in the digital environment. And so remote hybrid work has really reinforced the necessity of these digital employee experiences more than ever, and the distributed workforce is not going away anytime soon. So post pandemic, employees are going to continue to want to digitally engage across the enterprise. And so that remains a tailwind for sure. And competitive offerings here are largely systems of record and not systems of action where employee services are managed, orchestrated and delivered across different organizations, whether you need something from the IT, whether you need something from HR, if you need something from the legal department, right? And we don't really compete against the HCM systems here but are a layer on top of them really with great integrations. And so with our Employee Workflows, employees can get help across all of those functions I just talked about, whether it's HR, legal, finance and IT, just to name a few. And we hide all the complexity so employees just see the simple. I have a question, I go here. I ask it, it gets answered. From a customer side of things, we talk about, that's a $20 billion total addressable market now growing at a CAGR of 13% over the next few years. So the opportunity by 2024 is about $33 billion. And the key trends that we're seeing here are about direct-to-consumer, everything-as-a-service, work from anywhere and the real need to automate mid- and back-office workflows so that the customer is getting the best experience possible. And certainly, in CSM, we definitely overlap a bit more with Salesforce, given we also provide the customer engagement layer. Salesforce is really focused on the front end, also an incredible company, but we're differentiated in our ability to manage the end-to-end process of really creating the ticket and carrying it through resolution all in one system, right? So the customer service agent can do all of their work, understanding the issue, the problem and resolve it all in one system. And they're able to do that because our platform is really built to manage these complex workflows, orchestrating work across different parts of the organization. And if you think about customers using CSM and ITOM together, they're much better able to break down these silos between the IT organization and customer service, really allowing them to utilize those insights from the IT assets to provide much better and efficient customer support and resolution to any of the customer issues. And so we talk a lot about not needing systems of records to lose for us to win. Our differentiation is that we're the software company, the only software company at our size with one platform, one data model and one architecture that can really drive these robust workflows across the enterprise.

Got you, got you. And I think one of the things that we heard over the last year is just the different ways within HR on how ServiceNow is being used to help companies manage through the pandemic, everything from remote onboarding to just dealing with unique workforce management, I think even vaccine and testing requirement. How much of a tailwind was kind of these COVID-related-driven businesses? And how much of that is durable because certainly, I think some of these workforce things, to your point, the new normal of a hybrid workforce are going to be here for some time?

Yes. I think it's -- I think employee experience is more relevant than ever. And you're absolutely correct, this new distributed work environment isn't going away, so the ability to onboard talent remotely, right? Even if you're in person, the ability -- pre COVID, I've onboarded everything before I even walked in the door. I started January in 2020. I had my laptop, I had all my forms filled out, I did everything remotely. It's a beautiful experience. That's not going to go away. So I think it's very durable. And certainly, while there's been a huge focus during COVID on distributed work, employee well-being and employee learning, the ability to provide all of that in a single platform on the Now Platform and be the single source to kick off any employee request, that's not going away. And I think workplace service delivery is an area that we've been investing in. And it will provide a nice chapter, too, to our safe workplace apps, right? Because safety and workplace, employee safety and workplace safety remain top of mind. And we're the only ones with the complete suite to be able to do that really effectively. And again, it's all about connecting services across the enterprise. And you're right, vaccine management is also helping to connect workflows across organizations. And so the problems that these applications are addressing are top of mind for C-suites. And they facilitate discussions that really allow us to pull through the rest of the product portfolio in the sales motion. And so I think it's extremely durable, health and safety, well-being in a post-COVID environment is more important than ever.

Yes, makes sense. So talking a little bit about where I think you're investing in terms of products. We often get asked around one of the recent acquisitions of Lightstep, which kind of put you more into the observability market, which I thought was pretty interesting. I guess, how do you think that ServiceNow can uniquely compete in this market? And maybe talk about your aspirations and where you want to take it.

Sure. So Lightstep, super exciting acquisition for us, and we really saw a unique opportunity here to move fast in this highly technical and very emerging observability space, right? And so Lightstep provides specific insights into what changed within a dev environment, which allows customers to get to the root cause of any issues really quickly. And if you think about combining that together with the Now Platform to take action upon those insights, that's a pretty compelling differentiator, right? And so with Lightstep, ServiceNow is going to be able to help the DevOps engineers build, deploy, run and monitor these state-of-the-art cloud-native applications. Together with ServiceNow and Lightstep, it's going to extend the benefits of observability across the enterprise and really allow customers to convert those real-time insights into action across all the technologies, people or processes that enable the digital business. And so that's super compelling and a real differentiator for us. And moreover, the Lightstep team has deep roots in the open source community and the developer ecosystem, really giving us relevance with that channel to engage with developers, which is also exciting. And if you think about enterprises really focused on creating new revenue-generating applications, innovating and driving high reliability, observability really helps provide the developers with the insights that they need to make sure that these digital assets are performing well. And so it's really exciting and we're super excited to have that amazing team of folks on board with us today.

Yes. And just a clarification on kind of the strategy here. So obviously, there are a number of successful vendors in the observability market. We just had Datadog present earlier today, Dynatrace, Elastic, a number of folks out there. So is Lightstep, obviously, a much smaller scale player prior to the acquisition. Is the ambition here to actively compete with the Datadogs of the world? Are you going to be taking kind of the telemetry and all the data that some of the observability players already have and use that with the ServiceNow platform to kind of drive these remediations and responses?

It's more of the latter. We will continue to partner very effectively with all of the other observability tools out there. And they are amazing companies as well and they will continue to be good partners for us going forward.

Okay, okay. Got you. So you touched on this a little bit earlier, but with some of the new offerings such as the Pro and Enterprise versions, could you just elaborate on the strategy here? And maybe help us understand kind of what's incremental in the Pro SKUs within each of your various workflows?

Absolutely. So the Pro SKU really introduces AI and machine learning capabilities. And that includes everything from virtual agents, performance analytics and predictive intelligence. And so ITSM Pro really increases productivity so the agents can focus on the work with the highest impact to customer satisfaction. So if you think about the virtual agents, they're really able to automate conversations across any incident or problem and deflect any of the lower-tier issues so that the customer service representatives are really focusing on the harder-to-fix issues, right? Predictive intelligence about actively learning and predicting outcomes in advance and recommending solutions before issues happen. And then predictive analytics, it's all about solutions to create management dashboards, report on KPIs and metrics and really answer key business questions to help increase the quality and reduce the cost of service delivery there. So really, if you think about AI and machine learning and those incremental capabilities, that's the Pro SKU. And then our Enterprise SKUs include everything in Pro and adds process optimization, which really enables visualization, right, and analysis of process flows, gathering insights to really help identify bottlenecks and weaknesses that denigrate the KPIs, right? So that's process optimization. And then workforce optimization, which really is about allowing users to really effectively manage their team's skills and their team's time in the right places and manage work assignments accordingly. And so if you think about people being a company's greatest asset and really managing their time efficiently and effectively, that's what workforce optimization is all about. And then as of the end of Q2, our ITSM Pro SKU was about 25% penetrated. And we talk about -- I'm sorry, and CSM Pro is 35% penetrated. And we talked about the fact that we believe that both those Pro SKUs should really penetrate about 55% of our total customer base. There's still a lot of runway in front of them there. And then we think the Enterprise SKUs could get upwards of about 20% of our existing customer base for both workflows. And the uplift is about 25% from a pricing perspective on the Pro SKU. Enterprise is brand new, just launched in June so we expect it to be similar, but it's still early days.

Okay, okay. And you talked about Enterprise, I think, reaching, over the long run, 20%, 25%. Remind us, that's single-digit percentage today or where we are in terms of that penetration currently?

Enterprise just launched in June so we just -- literally, just this past June. So it's early days, but in Q2, we already saw 4 customers adopt it, including Xerox. So we're definitely getting some real interest in the customer base but literally just launched less than a quarter ago.

Right, got you. And as we think about the target that you laid out of $15 billion in subscription revenue by 2026, which implies 20% kind of growth CAGR over that period, how should we think about the kind of the 3 biggest factors to reach that target, maybe between land versus expand, new products? Just help us frame that.

Sure, sure. So the strength of our top line is really made possible because we have multiple levers to drive growth within that existing total addressable market, which we calculate at about $175 billion and continues to expand. So to start with, you're exactly right. Our strategy has always been land and expand, and we continue to land more new logos with a tremendous opportunity remaining in our current markets as well as new countries that we enter. Next, we talk about a significant opportunity to continue to expand our relationships with our existing customers. Over 80% of our business comes from existing customers, so it's a great foundation for us to build off of. And because they're existing customers and we have a great relationship with, we have great visibility into the growth opportunities within that organization, really understanding how we can help them continue to drive and add value, right? And so that's been fantastic. And that gives us the confidence in our ability to model our cohort curve over time, and we show that on a regular basis. And you see within the existing customer base, there continues to be multiple levers to really drive that growth. And if you talk -- if you think about it, it's about expanding deployments within a company, wall-to-wall across departments, divisions and countries. Secondly, it's about cross-selling, right? So we're no longer just the IT company anymore, right? And cross-selling our new products in HR and Creator Workflows and customer workflows to really complement the existing ones. And with the constant innovation that CJ is driving, we continue to add new capabilities to new SKUs that we just talked about with Enterprise and Pro, for example. And then, of course, we continue to introduce new solutions to new personas, right? So HR within CHRO, and more recently, our legal service delivery to general counsels across our customers, these present all new buying centers for us. So these kind of in combination are going to be the key to that growth to $15 billion-plus in revenues by 2026, which we're really excited about.

Yes, got you. And kind of related to that, how should we think about just kind of the NowX platform and particularly some of the new vertical solutions that have been released there? I mean, are those going to be kind of meaningful contributors longer term?

Absolutely. We talked about the verticalization, our financial services model as well as our telecom, which were already launched and doing quite well. CJ, back at our Financial Analyst Day back in May, talked about new verticals that we'll be entering, including insurance, health care and manufacturing. And so they will continue to be areas for us to focus on. And really, that's about delving deep with our customers, understanding their use cases, understanding where our platform can really help them create value very quickly. And so that will remain part of our strategy, for sure, on the innovation side of things.

Yes. And we had a question come in, and I know I think we've gone about 30 minutes without talking about your favorite topic of billings. But just as we think about the seasonality this year, and I know coming out of Q1, there was a little bit of adjustments to kind of the folks' financial forecast as it relates to billings, but how are you just seeing kind of seasonality shape through the year? And there was also a related question around just impact from the Delta variant. Anything you're seeing on pipeline build?

Yes. So I'll take the first question first on billings and seasonality. I talk about it all the time. Quarterly billings is just not the best indicator of the health of the business. There's too much noise that clearly comes out in the numbers. And so this is why we've been trying to focus people more on cRPO. Everything has a little bit of noise but it's much more stable and much more predictive of future revenue. If you want to use billings, 4-quarter rolling gets rid of some of that noise a lot more than quarterly. And so I always push people to kind of look more longer term because the quarterly numbers have a ton of noise in it. But from a seasonality perspective, we absolutely continue to see Q4 getting bigger and bigger, very similar to our peers who are larger than us, when they kind of got around this scale, saw it as well. And so Q4 remains big and continues to grow in size, and we expect to continue to see that going forward. With respect to the Delta variant and certainly, it's not ideal, but I think what's going to happen right now is we're going to just -- this is a new norm that we need to operate under. And we were able to close deals really effectively and efficiently even within a total lockdown. And at least now, things are opening up. While they're not open completely, people are more comfortable that they understand kind of what's happening in the world. And so we remain really confident, pipe remains strong, our linearity even within Q3, is good. And so we feel very good about the back half of the year and into 2022.

Got you. That's helpful. And I think earlier this year, coming out of Q1, there was really noticeable booking strength, at least in terms of the commentary that we saw internationally. And I think that was a big focus area for the company in terms of go-to-market investments. How have you just kind of seen international demand kind of trend through the year?

Yes. We've been really pleased with the results internationally. EMEA and APJ feel like they're hitting an inflection point right now. We've talked especially about EMEA being sluggish the past couple of years and bringing in new leadership there. As we scale that business, it hit $1 billion in revenue run rate last year. And what's necessary when you're at $1 billion is different than what was necessary at $100 million. And so the leadership there has been doing a phenomenal job. Growth trends remain strong. And APJ as well, really good growth. If you think about our penetration in both of those markets, it's much lower. And the value proposition remains the same, whether you're a European-based customer or an Asia-based customer. And so there's a great continued opportunity for us internationally, and we feel really good about the growth trends that we've seen to date in 2021 and the expectations going forward as well. Strong leadership matters and they're doing a great job.

Great, great. And then just lastly, on the federal business, we get a lot of questions on that with the federal fiscal year-end coming up. But just an update on the positioning there and what you're seeing from a demand perspective.

Yes. We knew that the first half of the year was going to be a bit slower with the new administration, and we had planned for that. Q2, we had good performance and we were happy with that. We saw 7 Fed deals over $1 million and so that was great. Q3 pipe and back half remain strong and we feel really good about where we are within Q3. I think there's some really big opportunities with the new administration and their initiatives, which I think will really help drive future growth for us as well, right? If you think about their focus on resiliency and business continuity, on cybersecurity, top of list as well. And vaccine management, right? It's the greatest workflow that a lot of the federal and state and local governments are dealing with right now, and we've been able to help. And so some real good opportunity there. It's an area of -- that we've invested in for years now and continues to remain strong. But the new administration and their initiatives are definitely helping to drive some larger opportunities in that space as well.

Okay, great. And we had 1 question come in just kind of related to some of the Analyst Day takeaways. So I think one of the interesting charts that you had at the Analyst Day was kind of showing the composition of the, I think it was the $15 billion of subscription revenue and how much of that was coming from, I think, 8-figure deals. And I guess the question is, how are you thinking about kind of the investments and evolution of your go-to-market that may need to be made to enable those transactions? I mean, are those different personas that are kind of buying the Now Platform? Is it CEO level versus IT or HR or CSM? Just how are you thinking about investing in that from a go-to-market perspective to kind of enable those $10 million-plus deals?

Yes. I mean, I think if you think about the larger deals, they're multi-product, cross-portfolio, big customer deals, right? And so as we've been scaling up already, that's been an area of focus for us in investment in kind of big deal type of folks. Also on our solution sales and really how we've been structured is that AE is kind of the quarterback and the solution sales experts who have domain expertise within HR or Customer or Creator really help drive that conversation. And so we'll continue to scale that. I think you've seen pretty amazing growth in those areas for us outside -- in HR, in Customer, in Creator already. And so we'll just scale that model up as we continue to grow. But it's -- the plan has been working thus far. The playbook that you've seen us play to get us to where we are today is the very similar playbook that we'll be using to get us to $15 billion and beyond. And so you'll see more of that for sure.

Great. Well, I think we are right at the end of time here. Gina, thank you so much for this great discussion, and thanks for participating in the conference today.

Thank you, Tyler, so much for having me. I really appreciate it. It's nice to see you, hopefully, next time in person.

Absolutely. Thank you so much, and thanks, everyone, for joining and for the questions. And we'll talk to everyone soon.