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

Okay. Are we live? Can you guys hear me? Yes? Excellent. Welcome back, everybody. I'm Brad Zelnick with the Deutsche Bank software team and delighted that we can be joined for this morning's keynote with none other than the Chief Financial Officer of ServiceNow, Gina Mastantuono. Gina, thank you so much.

Thanks, Brad. I'm really happy to be here.

Awesome. Thank you for coming. Format of this session is a fireside chat, minus the fire.

Thank God.

It's warm enough outside. We've got a number of questions that I'm going to go through with Gina. And if time permits, maybe towards the end, we'll take 1 or 2 from the room. But with that, Gina, welcome. Maybe we dive right in.

Sure. Absolutely.

Cool. So let's get some of the most obvious questions right out of the way. For better or worse, macro environment just remains top of mind for investors. And on your recent earnings call, you called out greater scrutiny, new deal approvals at the end of June. How have these trends progressed through August? What are customers telling you? And how successful have you been in closing deals that pushed out of the quarter?

Yes. So we've been successful in closing deals that pushed out of the quarter for sure. We have solid July and August, and I remain as confident today in the back half guide as when we started the quarter. So we feel really good about that. We thought it was prudent. We saw those elongated deal cycles happening towards the very back half of Q2 and really assumed that we would see similar levels of -- and it's not deals going away. It's really just more approval levels coming into the deal such that it's just elongating the cycle between close. We're seeing similar trends, no worse. And so far, from a July, August perspective, we feel good. Pipeline remains strong. Deals are not going away. In fact, we came out of our Knowledge, our big user conference in May, with 40% more pipeline generated than we had before. And even the pipe of open deals of customers who are at our events was much higher than in previous times. So we feel really good about the pipeline remains strong. Demand remains strong, which is great. But obviously, uncertain macro. We remain vigilant in spending time with the customers, making sure that we understand what the process is so that we can really help drive that value prop and that value message so the approval process runs as smoothly as possible. So really feel good about where we are positioned given the macro. And if you think about what ServiceNow is all about, right, it's about driving greater productivity, greater efficiency, cost savings in this environment, while at the same time, really allowing for business model innovation and growth, employee experience, customer experience. We're very well positioned given all of the secular trends as well as the macro that we're seeing.

The message out of ServiceNow, secular trends, secular tailwinds, meeting with macro crosscurrents and what that means, I think, has been very clear. And along those lines, I think during these times, you'll see a trend towards consolidation where larger platforms win. And you guys have called that out in recent calls and whatnot. Can you see this yet in win rates? And what's been the competitive response from some of the more point solutions that you might come up against in deals? Have they maybe gotten more aggressive in response as customers maybe look to put more eggs into the ServiceNow basket?

Yes. What I would say is, are we seeing it in win rates? Absolutely. I can reference a particular deal that just closed this week, where the company is consolidating all of their disparate risk point solutions into ServiceNow across the entire enterprise, right? And so there's definitely an uptick in win rates as a result of the platform consolidation that we're seeing. And while certainly, competitors are competitive, right, and they don't want to lose out, and that hasn't changed. That environment hasn't changed. What you are seeing is the IT organizations really focused on driving that consolidation for a number of reasons. Number one, lower cost, right? It's much lower cost to manage one platform than it is to multiple product solutions. If you think about risk, security, point product solutions, you have a lot of cost in having to manage that. So there's lots of secular tailwinds that make this platform consolidation right now, especially today, given many different trends that you are all seeing in the market.

Great. Great to hear that you're seeing that. Maybe just in terms of business trends, if we can dig in a little bit by workflow. It's still early days for adoption of ITSM Pro and enterprise SKUs. But I think you've thrown out the goal of getting 3/4 of customers to these better and best SKUs. For more back-office tasks like ITSM, why is good not good enough? And what are the driving forces pushing customers up the curve to more premium SKUs?

Oh, my gosh, so several. Number one, think about what happened in 2020, right? Think about on a dime in 24 hours, the entire organization going remote. Imagine the level of incidents that came up for IT, right? Huge increases, right? But the IT organizations didn't have huge increases in bodies. So the incremental capabilities of the AI and machine learning to help IT organization deflect those lower-level incidences and all fix them automated so that the IT organization can focus on more complex and difficult issues, that is not changing, especially in a distributed workforce that you continue to see. And so it's all about the increased capabilities there. And so we are now at 35% penetration for ITSM Pro and continue to see -- and that 35% we got to a lot more quickly than we had originally anticipated. And so if you think about those incremental capabilities and what you're seeing in the workplace, right? And now if you think about an uncertain economic environment, I spoke to someone earlier today, who was at our user conference, Knowledge, back in May talking to some customers. And they were like increasing their spend with ServiceNow, thinking that maybe they might have to do some layoffs because of those incremental capabilities. So there's a lot in the innovation that we've been continuing to pour into the platform that is really driving an uptick in demand given the current environment.

Makes sense. Maybe if we could turn to Customer Workflows. I can recall several years ago hearing about CSM and thinking this company, ServiceNow, as an IT company. They've got to be kidding themselves. Meanwhile, you've absolutely crushed it in the front office along the way since then despite being so well known for technology workloads. Can you maybe talk to us a bit more about your ambitions in the front office and whether or not there are any boundaries or limits that we should think of in terms of where you'll go next?

Yes. I think that if you think about the TAM for Customer Workflows, it's very large, right? And so the opportunity we talked about at our Investor Day, the Customer Workflows are over 550 in ACV right now. So we've gotten there fairly quickly. And a lot of it is about really being able to solve complex workflows from the customer side, especially if the assets are digital, right? And so being able to fix and resolve customer issues all in one platform from a customer service agent perspective is really valuable. And so we've seen strong uptick, great pipeline, solid demand. Front office is always going to remain a #1 priority for investment. So we're excited about the opportunity that we continue to have in front of us, and demand and pipeline remains strong.

Excellent. And maybe just following on that comment on Customer Workflows, we're increasingly hearing really good things about your newer industry vertical solutions in CSM.

Yes.

Why are vertical-specific offerings so important here? Which ones are doing the best? And are there anywhere maybe question the investment in going vertical?

Absolutely do not question the investment in going vertical. We need to be able to talk the language of our customers. And if you know ServiceNow, we are a hugely customer-centric organization. And so really focusing on the use cases that help solve the most pressing issues for our customers is exactly how we've expanded outside of IT into HR into customer because that's where our customers were asking us to go. And so if you think about the vertical solutions that we've invested in most heavily, our first and foremost was Fed, and I know we'll talk about that in a few minutes. But the federal opportunity remains enormous, and we started investing in that a long time ago and has been extremely fruitful. Financial services and telco were like our next big verticals and where we're also investing not only on the go-to-market side but on the product side, really making sure that the use cases and the conversations are really helping our telco partners and our banking partners. So telco has been doing phenomenally well. Financial services also really well. The newer ones, manufacturing, health care, if you think about the ability to really help automate mid- and back office in each of these verticals, the platform ServiceNow is just perfectly positioned. And so you'll continue to see more vertical investment. You'll continue to see, I think, really strong ROI on that as well.

Yes. We continue to hear really, really great things. So...

Awesome.

All very consistent. Maybe if I could pivot back towards IT a bit and specifically around Lightstep, just can you give us an update where are you in the integration of Lightstep from both a product and go-to-market perspective? And what's the integrated advantage that you see in this market versus some of the pure-play options that are out there?

Yes. So Lightstep is -- we're really excited about that platform. The tech around it is best-in-class. And so it's still relatively small. And we've just kind of started to build the integrated go-to-market. And so it's early days, and it's small for us. But if you think about gaining relevancy in the DevOps side of things, it's a natural adjacency for ServiceNow. And where Lightstep plays really well is in the modern architecture, cloud-native. And so with more and more businesses really moving some of their architecture to microservices and more modern architecture, there's a real play for Lightstep because it's the best-in-class technology. And we talked about it as an and, and not an or. We're not looking to displace. But where customers have hybrid environments, Lightstep can really add significant value on those cloud-native, more modern architecture stacks. And so really excited about the opportunity, an incredible management and innovation team there. And so you'll hear us talk a little bit more about it, but it's small right now, and it's just really driving that relevancy for us in DevOps and just makes so much sense considering our history in IT.

Huge opportunity, and it would seem huge in sort of connecting that feedback loop, right, between service management and observability and what's actually coming to life in the cloud and -- or across multiple clouds.

And as more and more customers and companies are morphing their architectures to more modern, you can see where Lightstep could really -- is really well positioned to help our customers in that environment.

Got it. Gina, I want to talk about ERP workflows, which I think coming out of Knowledge was one of the more exciting announcements that you guys have made. And in the recent push into ERP, you've talked about serving as a system of action layer on top of and within traditional ERP systems. Can you talk about why ServiceNow is better positioned than the ERP vendors themselves perhaps to play this role?

Well, we have the workflow tools, right? And so if you think about what we're talking about with our ERP workflows, it's about innovating around the core and how do we pull out some of that customization and automation so that when they need to do upgrades and when they need to do the big project, you take some of the risk out and you drive real added value. And so we're really excited about the opportunity here. And certainly, it's one of the areas where our customers are leaning in really heavily. And if you think, going back to the conversation about secular tailwinds and supply chain, what's happened over the last 3 years with supply chain, with ESG and scope emissions in Scope 3 and most companies really having to have a real increased focus on procurement end to end. So much of it is manual right now, right? And so we're not looking to take out those ERPs. But how can we automate that process end-to-end so as that procurement organizations have a real way to drive value, drive automation and productivity? It's really exciting. We're getting a lot of really strong feedback on the customer side but also the partner side about where this can go. And so again, very, very aligned and adjacent to our core and where we're successful. But it's really all about the workflow piece. And the ERP players don't have that workflow. So it's about sitting on top, system of action and really making the investments that they've made in the ERPs work better, harder and faster for them.

There's somebody working at ServiceNow that you'll say nobody knows more about ERP than he does.

A little bit, right? A little bit.

He might know a little something.

Exactly.

So it's going to be really interesting to hear how this evolves.

We're very excited about the opportunity here. I think that this is an area that's ripe for growth and a ton of greenfield, and ServiceNow is so well positioned and I think has first mover advantage.

I think there's a lot of potential. I'm excited to see it unfold. Maybe just you had good intuition that I was going to ask you about the federal business. We're well into the third quarter, traditionally a big quarter for federal into the U.S. federal government's fiscal year-end. This vertical has always been a strength for ServiceNow, tends to be less economically sensitive. Just the U.S. federal IT budget this year, we all know is really strong in terms of year-on-year growth. How does the federal pipeline look? What type of opportunities are you seeing there? And maybe just if you could weave into that, remind us in terms of FedRAMP progression, like has anything changed that would help drive the opportunity even more so this year versus others?

I mean, I think you hit the head on the donkey, right? We've always been really strong in Fed, and a lot of that is about really driving productivity and efficiency in governments for organizations, which I think we all can agree is an area that is ripe for advancement and focus right now, right? And so the budget is large. There's a lot of demand for really updating the technology for governments. And so the pipeline remains strong. We feel really good about where we are in the quarter. Q3 is our biggest Fed quarter, and that's going well. We also got IL5 clearance this year as well, which is updated security clearance. Only a few technology vendors have that. And we've been building towards it for several years. And so demand is -- and pipe is already built there. And so really excited about the opportunity. But not only in federal, right? So IL5 is specific to federal. But if you think about state and local, if you think about public sector outside of the U.S., all the same trends remain. And so we feel really bullish about the opportunity there, potentially less economically sensitive in most markets. And so demand remains strong, pipe is good, and we feel really good about where we're landing for Q3.

That's awesome. Great. Great to hear. I've got some financial questions. You are the CFO after all.

Really? Surprising.

So maybe just in terms of the longer-term outlook, Bill has talked about being able to hit your $16 billion target. And that's $16 billion-plus, correct? Just to make sure.

2026, yes.

With just your top 2,000 customers alone, which implies an ACV of about $8 million per customer. You now have slightly over 100 customers paying you $10 million-plus in ACV. Can you talk about the typical journey to get $1 million-plus ACV customers up into the $10 million-plus cohort? And how much of your targeted growth is expected to come from TAM expansion versus increased penetration of existing workflows versus adoption of higher-tier SKUs?

Yes. Yes. If you rewind a little bit, and for those who didn't see the presentation at Investor Day back in May, we actually talked and showed a couple of slides about the typical customer journey today versus even just 5 years ago. And so we're landing with bigger deals, more products, and a lot of it has to do with the breadth of the product portfolio. So we're landing bigger, we're landing with more products, and then we're expanding even faster. And so we talked about the fact that in just our cut -- if we just look at where we kind of are focused on our customer, 1,000 to 5,000 and larger employees, there's 50,000 of those businesses with more than 1,000 employees and more than $100 million in revenue, which is our sweet spot. We're currently at 7,000 employees. So not only is there an expand motion with our customers, but the land opportunity is still great. And so if you think about the innovation that we've been building and the continued increase in our product portfolio, there's so much opportunity within our customer -- our current customer base and then even outside of our current customer base if you think about new logos. And so when we talk about expansion, it's about expanding wall-to-wall. So we have some customers, yes, our penetration and our customer base for ITSM is really large. But they might only have ITSM in one country, right? How do we expand wall-to-wall? And then how do we upsell with the product portfolio, platform consolidation that we continue to see and then continue to expand? There's a lot of levers that we can continue to move even within our current existing base. In our net new ACV, we talk about 85% being with existing customers and 15% with new logos. And if we can just continue that trend with the green space and the white space that we see open, we feel really confident in that guide, especially with this new innovation that we continue to bring out.

For sure. I mean that's the magic, at least I see it, the story is the pace of innovation within our platform and how quickly you're able to respond to the market need.

That's exactly what we've been doing since we've been born. So that's why I say I'm in my dream job because the opportunity is pretty incredible.

For sure. Maybe just on to my next question, how are you thinking about pricing as a lever beyond the organic mix shift as you move products up to more -- or customers up to more premium SKU adoption, just especially as you continue to add innovation to the various modules? And in particular, with San Diego and Tokyo platform releases, should we expect? And do you embed in your model a natural progression on price?

We haven't really been taking price in that way. How we usually take price is about adding innovation and upselling to the premium SKUs, right? And so you'll continue to see us do that similarly. Yes, we do have clauses in our contracts to increase pricing. We haven't typically taken advantage of that. The upsells are about driving more product adoption. It's about more seats. That being said, we are seeing some FX headwinds. And we talked about potentially taking some price in markets where FX has hit us, and that's just about keeping U.S. dollar pricing similar as opposed to really raising prices. And you'll continue to see us do that and really take pricing on innovation with the premium SKUs.

Got it.

We haven't built anything different into our models to $11 billion and $16 billion.

Got it. And I'm looking down at my own questions, and I'm glad that what came to my next for me is actually right there, which is the large renewal cohort coming in Q4.

Yes.

What are you seeing in terms of expansion trends right now, generally speaking, as contracts come up for renewal? Is there greater resistance to upgrading SKUs and/or adding modules given the current environment?

So we talked about expansion rates for 2021 at 125%. And given the scale and breadth of ServiceNow to have that level of expansion even still is pretty incredible and best-in-class. What I would say -- we don't disclose expansion rates on a quarterly basis. But what I would say is throughout 2022, expansion rates remain robust even in Q2. And so we feel really good about where that renewal cohort will land in Q4 even in the current environment. And you saw that in Q2 even with our renewal rates. Even in Q2, 99% renewal rates in every single region across the board, pretty remarkable.

No. I think it's a testament to the need-to-have versus nice-to-have nature of ServiceNow.

Mission-critical and continuing to evolve.

Cool. Just maybe on margins. For the last 3 years, Margins have remained right around 25%. You're now guiding for expansion to 27% by 2024. I have that right?

You have that right.

Excellent. What are the biggest levers that are expected to begin driving margin expansion? And how should we think about any trade-offs of margin for growth or vice versa?

Yes. Well, I think it's really important. So you say they've stabilized around 25% Think about what we've been able to manage within that 25% and the headwind. So we're keeping the margin guide at 25% this year despite almost a 1-point negative impact of FX. We're keeping it at 25%, same as last year, despite the fact that we're now back in person, doing big in-person events and traveling again. And so we've been able to do that because of the inherent leverage in the platform, right? And so because we have one data model, one architecture, all of the investment in innovation impacts all of the products across the board, right? That really helps us when we talk about leverage. If you think about we're customer 0 for everything that we do, right? So we drive significant efficiencies within our own 4 walls, which helps offset some of those tailwinds -- sorry, headwinds that we've seen. So you'll continue to see that type of leverage as we move towards continuing to expand and accrete on margins over time. You've seen us really be very disciplined about not only growth and profitability, and you'll continue to see us do that as we always have.

Cool. We've got several minutes left. I'm going to jump around to a couple of different topics.

Okay.

You're ready?

I'm ready.

I'm going to -- we can go anywhere. Just as we think about the impact of a macro slowdown that -- what it can mean for your business, can you help us square some of the delays on new deals that you're seeing versus your commentary that in the current environment digitization remains a top sweet priority? And your solutions serve as a key deflationary force. Is it really just timing of deals being signed off on? And what's the risk that these opportunities keep pushing out indefinitely? Or I mean, is that something that, in some cases, you're seeing as well?

We're not seeing any deals go away. We've seen added approval levels in cost commits, and we've been able to manage that. Listen, the value proposition that we have has not changed and in an uncertain macro environment actually becomes more important than ever. So pipeline is growing. I think I talked earlier about 40% increase in pipe generated in Knowledge. Demand remains robust. We absolutely levels and deals, right, which just elongate things slightly in the back half. We haven't seen any difference happening so far. But as you will always know about ServiceNow, I believe we remain best-in-class in transparency in our metrics and what's going on. You'll continue to hear from us trends as we see them. But I feel as good today about our guide for the remainder of the year than I did when I gave it.

Can I throw you a curveball. You ready?

Okay.

You and Bill are as much in sync as any CEO and CFO that I've ever come across. But if Bill were here today, is there any message you think that he would share with us? If I gave it -- if I left it open-ended and I said, "Bill, what do you think investors might be missing and what do we need to know about ServiceNow in this environment today?"

Yes. I think that he would likely say that despite the macro crosswinds that we see in front of us, ServiceNow -- the opportunity in front of ServiceNow midterm and long term are stronger than ever. The ability to drive value, not only in business model innovation and help our customers grow top line, but really drive productivity efficiencies, cost savings in this environment, remains stronger than ever. And so that opportunity, midterm and long term, is greater than ever. And I know Bill would say he's more excited today than ever before about the opportunity in front of us.

That's, I guess, in line with what I would expect, which is good -- which is very, very good. We're almost out of time. Maybe I'll ask you a final question. Is there anything that I haven't asked or any message that you want to make sure that investors take away from this conversation?

Yes. I think it's in line with what I just said, right? I think the -- we'll stay close and we'll be very transparent, as we always have, about what we're seeing in the macro. Demand remains strong. The need for customers to continue to innovate, to digitize, to drive efficiency and productivity is stronger than ever. Any potential recession is not happening in isolation. It's actually happening amidst the very unique labor market, a very unique distributed workforce, right, where employee engagement, productivity, efficiency, so important. The opportunity remains strong. And so you'll continue to see us operate the way we always have with a balance of focus on top line growth as well as bottom line profitability and continue to be best-in-class in not only the growth trajectory at $7 billion and beyond, but even on the bottom line as well.

Gina, a very clear message, a very strong message and upbeat message and really glad to have you here today.

Thank you, Brad.

Thank you so much.

Great to be here.

Great to see you, even better here at the Deutsche Bank Tech Conference.

Perfect. Thank you so much. Thank you.