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

All right. Welcome everyone to the 26th Annual Credit Suisse Technology Conference. My name is Phil Winslow, one of the software analysts here. Excited to have longtime friend CJ Desai from ServiceNow joining us, also one of my long-time favorite stocks. So this is going to be a great session.

Thank you. Thank you. Thanks for inviting us.

And then like I was saying, I know it's a super busy time of the year, Q4. So I know everybody here particularly appreciates you taking the time out to fly down. So I guess we'll start with the question that I think has been on everybody's mind. I'm sure it's come up in every one-on-one you've had before this, but in light of the macroeconomic environment and certainly sort of the various headwinds, you obviously spent a lot of time, I remember we were talking about this back in May at the conference, with customers speaking with them. How have priorities changed? And where are you seeing strength and resiliency compared to, let's say, the beginning of the year? And why are people saying, hey, look, I need to invest in ServiceNow now?

Makes sense. So I would say at the highest level, it is absolutely true that I do spend a lot of time with our customers. And in fact, before coming to Arizona, I spent 2 days in Florida, various parts of Florida, with some large and midsized corporations. One of them is not an existing ServiceNow customer and others are ServiceNow customers. I would say, that first, at the highest level, what is resonating for ServiceNow, and as you saw in our Q3 results, is workflow automation. I know it's a simple concept, but what you find is when you go in and you talk about ServiceNow platform's value and what it does for the technology foundation, whether technology workflows or for customer service workflows, whatever the case might be, the automation, productivity and trying to get more things done with less is actually resonating really well. And specifically, Phil, I would give an example of something like we have this great product called Asset Management. In 2017, it came out, which was Software Asset Management. Then we upped the ante with Hardware Asset Management in 2020. Then we just launched Enterprise Asset Management. With Enterprise Asset Management, Software Asset Management, Hardware Asset Management, there is a hard dollar savings. So whenever we can articulate hard dollar savings, it doesn't matter what the industry or geography is, that automation and productivity is what is resonating for ServiceNow.

Yes. Got it. Well, let's break this down. And I really want to spend time focusing on product. Let me start first with platform, then we'll go into the other areas. Thinking about your, call it, core ITSM workflows, HR workflows, Creator Workflows, et cetera, how has the platform approach really been resonating with customers, particularly, as to your point, in light of this macroeconomic environment?

Yes. So one of the things that is a consistent theme this year, as things got tough in the environment with customers, one of the first things even -- we had dinner in Sarasota with a customer on Monday night. And the customer said, "Do you know, CJ, why I'm doing this meeting with you?" I said, "Okay, maybe it's because of me." That's not the case. He basically said, "I'm only meeting our strat platforms. I'm only meeting the companies where the platform is critical to our business." And this company has 250,000 employees, a large, large organization. And he said, "I have basically cut down every vendor meeting and only my 7 strategic platforms, I meet with them. And hence, I'm meeting you and figure out how we can do more with you in certain areas," specific to that customer. So this platform message will, in terms of enterprise-wide platform that is focused on automation and rather than doing point solution, how can we do more with ServiceNow, is resonating. That's number one. And number two, with our products, if you are using our security product and if you are using our risk product, which are built on the same platform, so once you have a center of excellence for ServiceNow platform, it is easier to get incremental value and also faster, and that is also resonating really well. But if I'm using ITOM in addition to ITSM, now I get even more value out of ITSM because ITSM and ITOM are 2 sides of the same coin from a technology or service operation standpoint.

That makes sense. And one more question just on the platform, just high level, before we drill in. But to what extent do you think we're starting to reach a tipping point where customers are coming to ServiceNow for the platform versus maybe in the past, it was for a specific product?

I would say -- if you remember, Fred Luddy, when he created this company, he actually said I built a platform. And most investors and customers do not know that ITSM was actually the first demo that we did on the platform. So we are still the platform at the core of it, it's still a great platform. Yes, we have added machine learning, process mining and many other capabilities in the platform, but right now, I would say, finally, customers are understanding that it's the same horizontal platform but for a particular use case. So I would tell you that it is still not a platform sale for us. We still have to show that the outcomes that the customers will get -- and I think ServiceNow does a really nice job, and customers tell me that. Here is the outcomes you're going to get and here is how fast you're going to get this outcome. The days of multiyear implementation cycles are gone. And especially in this environment, hey, CJ, can I get the value in 4 months from now or 6 months from now, so that's resonating more for a particular use case rather than here is a platform, let me sign an ELA. We are seeing that customers do not want to do that. Customers still want to know, I need to automate these 3 things, how fast can I do it and how fast can I get the value?

I remember during the IPO process, when we were on the deal, when Fred Luddy was up there telling the history and the story, he was like, "I built this PaaS," but he was like, "It's really hard to sell a PaaS, especially when there's nothing else on that PaaS. So what did I know how to build? I had to build helpdesk tools. And so I did that. And the next thing you know, it became the company."

And that's still true. We cannot sell PaaS.

Yes, you can't sell it. You have to sell a use cases, you have to sell value, but it helps because it's all on one platform.

Correct.

So let's talk about ITSM. I mean at the Investor Day earlier this year, you talked about 30% ITSM Pro SKU penetration. So in other words, there's still innovation even in the core product. It's been around for a long time. So what is driving this increased adoption? Can you help us understand maybe the longer-term vision of ITSM Pro, Pro+, Enterprise, et cetera?

So if you remember, Phil, ITSM was our first use case on the platform and, of course, the bread-and-butter of the company. And many folks thought when we went public 10 years ago, as you know, that, that market was $1 billion to $1.5 billion tops, and we may get 20%, 25% share of it. Well, that's not true. It hasn't played out that way. What is encouraging to me is, one, in 2018 fall, when we came up with ITSM Pro, I said we will put virtual agent or automation, machine learning-driven automation, performance analytics, continuous improvement, those type of added features in ITSM, and that will drive the Pro adoption. So what we saw with our sales team is when they land a new logo or a new customer, they now almost always land with ITSM Pro. And for existing customer cohort, which is typically over 3.5 years you turn over the entire cohort, you find if they get enough sales cycle time, they try to sell Pro to existing customers, right? So we are on a good track. We showed every year 10 additional points in terms of the penetration. And I would want it by 2024 to be around 50%. But now with ITSM Enterprise coming in, which has both workforce and process optimization, just recently, we did a nice size transaction with a large company for ITSM Enterprise. So that has started getting traction as well. So the strategy is very simple for existing customer base, ITSM Standard, ITSM Pro, ITSM Enterprise. And there is a lot of innovation. And still, the engineering team on ITSM is pretty large because we want it to be a world-class product. One last thing I would say that you heard me say at the Investor Day, $100 million in revenue and 1,000 employees plus, that's our target market for ITSM. And if you exclude China where we do not do business, we are currently penetrated 15% on ITSM. Now you'll say, okay, CJ, 15%, so why is that traction not higher given that this is a market-leading product, Gartner Magic Quadrant, all that. The thing is because of our portfolio, as you have seen from Gina, that when a sales rep has a choice to upsell additional modules like HR customer service versus go and hunt for new logo, especially during the pandemic, they went for upsell. So we are now trying to change some incentive beginning in 2023 so that they will go after the new logos as well.

Yes. I would say you did your job too well, too much product. I'm joking, but I'm serious in terms of the portfolio has gotten so big and the velocity of it, to your point, you can just sell that expanded portfolio into existing customers.

Correct. And there is enough to sell and the bag is always full, yes.

Exactly. And getting fuller. And so let's stay in the IT world, but we'll shift gears a little bit, ITOM observability. Now you may have had obviously a significant amount of success in ITOM. That was sort of the first thing outside of ITSM that you got into. Can you talk about some of the dynamics here that made ServiceNow successful in making this move over? What's resonating with customers versus, let's say, computing solutions here?

Yes. So I would say if you ask Fred, our founder, why did he create ITOM, he would say it was a really good moat around ITSM. And some of the competitors that Fred was competing with in the early part of this century needed both ITSM and ITOM. ITOM is doing really well for us. And I am really, really proud of what the team has done from an innovation perspective. But what is driving ITOM growth? Every single CIO has 3 simple questions: where are my assets, compute network storage; how are they doing; and what applications are built on those assets. That simplicity of message on ITOM, whether you have gone with Azure or AWS or a GCP or Oracle Cloud. And you would not believe this, Phil, if you asked me this 6 years ago when I joined ServiceNow, I would have not guessed it, right now, 1,400 ITSM customers are using ITOM specifically for public cloud discovery. So some people have just one public cloud, whatever it is, their preference, choice, say, it's Microsoft. Some will have multiple. Some are saying, for Oracle workload, I'm going to go to OCI. We are the only game in town, which will allow you to discover these assets across this multiple cloud environment, so the CIO to the regulators to whoever for audit can say where my assets are. So the discovery portion of ITOM in this multi-cloud world has just accelerated ITOM business. And number two then, event correlation, making sure that digital services are resilient. And that specific second vector where we work with all other observability players or Splunks of the world and so on has driven the second part of it. But this cloud transformation has been a tailwind. I'll tell you one last example, a bank that has a very aggressive plan to move to public cloud over 5 years. Then they realized it's a lot harder than they thought; in the second year, the CTO told me, and they're already 1 year behind. So in that case, ITOM is still a beneficiary because we are still going to provide you all the asset and the orchestration across your multiple cloud. So that's why ITOM, whether you have a public cloud tailwind, public cloud headwind, it's still a beneficiary.

Those are amazing anecdotes and data points. Let's pivot a little bit to observability. Obviously, you acquired Lightstep last year. More recently, you acquired Era into your log capabilities. Can you walk us through the challenges that customers are coming to you with that you're addressing. Can you walk us through sort of just the broader ITOM and observability plans?

Okay. So for observability, when you look at this market, the specific observability market, all of you will say, it's a crowded market. We get it. It's a crowded market. But the market has been around for a long time, right, in '80s, '90s. And Phil, you covered some of those stocks, it has gone through multiple transitions. This is our conviction that every 10 years, application architecture shifts. And if you now talk to banks, they are building a lot more things on cloud native. So what we liked about Lightstep is Lightstep was for cloud-native architectures at Spotify. And those kind of leading brands, they were the tracing solution. Then they added metrics last year. And the reason we did this recent acquisition is that now it adds logs. So you have metrics, traces and logs for cloud-native architecture. And over the next few years, as the application architecture shift, we will be the beneficiary of it. So we are in the early innings of it right now. But I will tell you, just recently, we had a technical win at a very large bank that uses 7 levers of observability. And they said for cloud native, we beat every single one of them, and they gave the business to Lightstep. And then Lightstep integrates well into ITOM that they were already using. So that's basically the play.

Yes, it all comes together. Okay, let's switch gears a little bit and get into Creator Workflows. Obviously, once again, a significant amount of traction, in fact, actually just this last quarter, it was in all 20 of your top 20 deals. And so can you walk us through a similar thing, what's driving this sort of level of customer uptake amongst your biggest customer?

Yes. So I think one of the biggest takeaway we had a few years ago, I want to say 3, 4 years ago, was our primary buyer is still IT. And line of business, all this talk about low code, democratizing app dev, we found in regulated industry like financial services, health care, even government, CIOs did not like it. CIOs didn't like a department creating an app and have a PII data or a customer data in that app. So we basically said, let's create a great low-code platform that is -- Fred's always vision was to create a low-code platform, but we made it even simpler to create apps. But what we built in because we were solving for the CIO and these regulated industries is governance-related features. And then very easy for you to integrate with system X or system Y. We are an automation engine. And by the way, we built-in even RPA in it. So overall, now you have a low-code platform where you create a low-code app pretty fast and integrate with other systems in your environment, while IT can still govern it. So we are not confused in trying to sell to a line of business buyer, we are actually relying on our champion, the CIO, and she's going to make sure it has the right governance features, but it also has amazing low-code features that she can take to line of business said, "Hey, if you really want to build an app for investment banking, great, but build it on ServiceNow." And here is why it makes sense.

Got it. That makes a lot of sense. Now when you think about sort of just the vision now going forward, when you think about sort of new product development in Creator Workflows, what are you most focused on in terms of sort of related to R&D spending?

So overall, R&D spending, as you have seen over the last couple of years, we are creating a lot of additional products. So one of the things that we created in 2018, which was NowX, has been a phenomenal success where we ring fenced that team. And Phil, our unit cost economics are so good on R&D that even when we created the first telco product -- and that's why you see our free cash flow margins and despite our revenue growth, our R&D cost is pretty reasonable. With 2 scrum teams, I can create a minimum viable product in 6 to 9 months because the platform provides user interface, machine learning, workflow, integration, all those services. So NowX was a massive success where we created all these industry vertical products. We created some of the asset management product and recently, ERP area, where we created procurement operations management. I have never seen a pipeline built that fast on that product that just came out in September. So from an R&D perspective, we are just trying to -- we don't want to replace system of action. That's too many calories to get $1. But can we do something? We are a platform from a workflow perspective, on a source to pay, procure to pay, that's where we want to play. So that's where the R&D focus is besides the core of the core, whether it's in IT or HR or so on.

Yes, that makes a ton of sense. Okay, let's talk about our customer employee workflows. I keep saying it, another area of success, a lot of successes here. But let's start with CSM first. Maybe unpack the competitive dynamics here because, like you talked about, observability, people say, hey, look, this is a very competitive market, lots of strong incumbents, but you continue to win big customers, big deals here. So like what's giving sort of ServiceNow sort of the right to win, so to speak?

Yes. So I would say, first of all, Customer Service Management is a massive TAM. And even though there are existing players with large businesses, there are still a lot of homegrown tools and systems in the largest of the largest enterprise. We started first seeing traction in tech. And tech is where people said, okay, ServiceNow was used by a CIO. And I'm head of customer support, and I'm going to use it too because I need to deal with a lot of complex workflows, depending on the type of the customer. So B2B tech, we did really well. Then we found out telco is on the B2B side and now also on B2C, they said, oh, CIO is using it. We should use for customer service. Especially B2B, if you look at top 10 telcos, they have significant business on the B2B side. So we started getting a lot of traction. And right now, I would say, top 10 telcos use some form of CSM for a certain side of their customer service, which is just phenomenal. And then we started getting traction in government, state, city and federal government to citizen services, my unemployment check, this and that. So for these kind of opportunities, we are typically replacing a legacy system. Now if you go to financial services or bank, a bank may say I already have a massive investment in company X. Then we say what about the workflows for customer service, for mid-office and back office. And they say, yes, I think ServiceNow can help us there. So we are an end to an existing incumbent in those financial services. And we have won a few deals where we end up with an existing CRM provider. And when you go to the commercial segment of ServiceNow, which is 1,000 to 5,000 employees, and they want to have a brand-new solution for customer service, we go head on, fierce competition, dogfight against some of the current players, and we win for those kind of use cases. But we don't run the play, hey, you have invested 6 years into this solution, you should replace that with ServiceNow. That's not worth it. And as Gina shared on the Investor Day, all these businesses were Employee and Customer Workflow, including Creator, but like $10-ish million in 2017, and they all crossed $0.5 billion last year.

Incredible, absolutely incredible. Well, you touched on sort of employees, so HR service delivery. What about how you sort of, call it, attack HR service delivery that's made ServiceNow so successful? The HCM market as a whole has a lot of core players, to your point, system of records. But a similar thing, why are you winning in this space? What are you delivering that's different?

I would say what we are delivering different, it still boils down to our automation or workflow, right? So a large services company has 700,000 employees and 15% turnover, let's just say, so you have 100,000 people joining and leaving at the same time. If your SLA is as simple as day 1, you want to be 98% ready with all systems access, security access, the laptop is provided or a desktop, whatever the case might be, legal checks are done, these are a lot of cross-departmental workflows. So we will make sure your Okta provisioning is done. We will make sure that you get credential tokens from whoever. And so IT, security, facilities, those workflows, HCM's going to do it. That's it. Literally, that's it. And then the manager has a to-do list for the employee, and those requires also complicated workflow. I will tell you today, Phil, in one of the most advanced technical companies in Silicon Valley, when I was talking to them, their people operations aspect of it, when an employee moves from office A to office B, it is still a lot of manual process that touches multiple departments, and that's where ServiceNow shines.

Exactly. Yes, I remember just talking to people, the tie between IT, HR, particularly on onboarding, okay, did I get provisioned, did the laptop show up, was able to sign into this office, set it up. And sort of like when I heard you talking to some of your customers at the conference, it was like I did a bake-off in the idea of HR service delivery, and ServiceNow is the best. And the fact that we're using it on the IT side which is great, but it won sort of on its stand-alone merits because sort of like there was nothing else out there that did this.

Exactly. And I would tell you that between most of the large American banks and European banks, we are always an end, the HRSD with the HCM. And now everybody realizes, okay, we understand what HCM does, but we see this.

And what it doesn't do. That's the only thing.

But it still comes out every time.

I'm sure. Okay. We're going to do one more product area before we sort of actually step back a little bit, automation, obviously. This is something actually you and I talked about in Las Vegas. Obviously, you launched your native RPA product early this year, your ServiceNow RPA. What areas within RPA are you seeing the most traction? What are the areas for further investment?

So we bought a small company. My highest thesis, and this is my personal conviction, that RPA is not a differentiated technology, full stop, that it's not very hard to create an RPA solution. The approach that we wanted to take is that you are a Fortune 6 company, real example, a Fortune 6 company, you are using ServiceNow for workflow automation, we are fully API-driven, but you have these 10 legacy systems that are non-API-based. So for those ServiceNow use cases, say, on customer service, how do I integrate with those legacy systems? So we wanted to provide RPA in the platform that I can do that. Our CIO, who's phenomenal, Chris Bedi, he took the platform and, in Gina's finance department, he saw there were opportunities to create bots using ServiceNow Platform. The team created 30-plus bots on ServiceNow Platform and automated things related to non-API-based system. So we are still going to do RPA in the context of ServiceNow use cases where you need to integrate with a non-API-based system or even if API integration is just really hard.

All right. That makes sense. All right, now I joked before that you've been almost too successful at your own job, bringing on so much product for the salespeople to sell into new and existing customers. But coming from your position, you're a Chief Product Officer, how do you decide sort of what areas to focus in on? Because, to your point, it's like the applicability of the platform is so broad. When you sit in your role, how do you say this is this crease to go after, this is this new platform and this is the workflow to go after? How are you thinking from your seat?

So one of the things that we always want to do is, at the highest level, I still look at white space in every area. Whether we pick Creator or ITSM even and so on, we still want best-in-class product, period, full stop. So we will continue to invest in R&D for those products. The one word that is not allowed in my team is cash cow because we don't have a cash cow. We have every product line that is growing nicely, and we still have a lot of white space, right? All jokes aside, we do. So we continue to invest to make sure. One of the things, Phil, that we have really focused on over the last 2 to 3 years is time to value, how fast can we get time to value and how much functionality we provide in the cloud itself. So the implementation cycles are very fast. Sometimes, customers really, really focus on that aspect and time to value. Now in terms of your question on where things are going, like cloud transformation, everybody is dealing with some kind of cloud transformation. So our ITSM and ITOM team, how do we make that easy in this multi-cloud world, not just saying at a superficial level, really thinking about the pain point and doing that hard dollar savings via asset management. The 2 products that have just done a phenomenal job this year despite the market environment is our security operations and risk products. We are replacing a lot of legacy risk solution and doing wall-to-wall enterprise risk in tech, in financial services and in health care. And 5 years ago, I had 10 engineers on it. Now I have 60, and the business is growing. It is the second fastest-growing product line after our asset management product line business. So that's an area that we are going to continue to invest to make sure that -- when we started that product, of course, everybody told me, hey, CJ, it's only a few hundred million dollar product market, blah, blah, spreadsheet has the share. That changed. We've changed that. And then ERP is another area. And then on the core platform with machine learning, process mining, we'll continue to always invest in it.

Now on the flip side of this, obviously, you said, hey, your development engine is running at such high speeds right now. I'm not sure if anybody brings as much product to market as efficiently as ServiceNow does. But let's talk about M&A, sort of the flip side of organic. How do you go through the process of buy versus build? Do you and the management team think about it? Do you think, frankly, just the macro and what's happening and then sort of the markets, public, private valuations, changed at all or created maybe opportunities in the context of M&A versus maybe that it might change that equation?

So I always first start with the customer. And our customers are asking me to look at something that ServiceNow should have. And that is North Star for us. And the customer has not come and say, CJ, you should buy X or you should buy Y. And I am very cognizant of not putting the complexity on the customer that, hey, here is platform, here is another technical debt we are going to take on. So first, the customer bar is very high. So can I build it fast enough given platform provides all the features? Or do I need to really buy something for a particular functionality? And the second bar for us, which is even higher is our shareholders that are here. If you look at revenue and free cash flow numbers that we have, which is closer to 60, I mean, that bar is really, really high. So what is in it for our shareholders besides what is in it for our customers? Once you put those 2 lens, I would rather build and buy, but we always do that analysis and look at everything.

Exactly. You don't have any cash cows, but you definitely have a few cash machines. But okay, so I always like to ask this -- I can't believe our time's already up, I had to skip over a couple of questions. But CJ, let's say you and I are sent up here 2, 3 years and having the same kind of conversation, what do you think you're going to look back on and say, hey, this technology, this product, this trend, was more transformative for ServiceNow's customers than people give it credit for back in 2022?

I would come back to most of the time both our customers and others, even our employees for some part, underestimate how complex the technology landscape that our customers are dealing with and how ServiceNow truly, even in these economic times, is helping them simplify that landscape and create that technology foundation so that they can transform their business. And that's why our demand remains robust. You saw our Q3 results that most folks thought that, okay, maybe ServiceNow will struggle. And the diversity of our product lines, Phil, and diversity of our customer base like public sector, strong customer base across the world, not just United States, that is what is resonating really well with ServiceNow in our customer base. And 3 years from now, hey, I knew I needed to transform cloud at this level for my technology, public, private, whatever, ServiceNow was always there and help us on that journey along. Most folks under estimate how much ServiceNow helps.

How much it can do that?

Yes.

Awesome. Well, my friend, I always learn so much whenever I get a chance to have time with you. I'm sure everybody in the audience did as well. Thank you for coming down. And like I said, I appreciate you making the time as always.

Thank you.