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

Thank you, everyone, for joining us. My name is Keith Weiss. I run the U.S. software research franchise here at Morgan Stanley. And really pleased to have with us CEO of ServiceNow, Bill McDermott. Bill, thank you for joining.

Thank you, Keith.

Before we get started, for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. So as we were just chatting about really fascinating time in software right now. And not to give you any pressure, but we had a Best Ideas panel on Monday, and I think ServiceNow is my best idea. So you got to help me out here to make sure that we have some follow-through on that. I started out saying like, I've been -- this is my 20th TMT conference, and I've never been more excited about software. And it seems like you showed the same views.

So maybe you could talk to us about that big picture, what's getting you excited about this moment in time in software and maybe bring us down to what you're seeing in the IT spending environment today and sort of the outlook for 2023?

Yes. I think the big picture is software is the only way forward. It's the deflationary force. It's the only way to retool the company and do so in an environment where you're expected to have less headcount, not more. And it's the only way to rethink experiences whether those experiences are with your employees or your customers, this is the elixir for getting there. The one big change that I would just tell you is the move is not so much for operating systems or databases or obviously, on-premise software, even if it's being co-located in someone else's cloud, I think it's really time for end-to-end digital transformation. And if we were your big idea, Keith, I think that's probably because you know it's a platform game now. And to have an intelligent platform for end-to-end digital transformation is the big idea. We built it organically. It's one platform, one architecture, one data model. And so the productivity and the speed and the complex things we can handle are pretty unique.

Right. So there's multiple reasons is my best idea. And we're going to go through some of them. And part of it is the business model at ServiceNow has been great. Part of it is you've been able to sustain demand really well even through a tough environment. But there's definitely a part of it that I think there's an interesting play for AI and regenerative AI. And you guys have made some significant investments here. You've made some acquisitions. Can you just talk to us about how AI is playing out in your portfolio today? And then as we sort of look forward to sort of what's going on in generative AI and some of these large language models, how that's going to further extend what you're doing?

We're big on AI. We're big on generative AI. We do think this is a transformational moment. I know the hype cycle is high right now, but it's absolutely a transformational moment. And when you think about Netflix, as an example, getting its first million users in 3.5 years and Twitter doing in 2 years and ChatGPT doing it in 5 days, something is going on out there. So the question is what can we do at ServiceNow in the enterprise to completely rethink the enterprise? We're making a release on March 22, we call it our Utah release. And already, we're big innovators in AI. So if you think about process optimization built into the platform, if you think about search, if you think about Virtual Agent, if you think about transforming the employee experience or the customer experience or even the creator experience where you can go from text to code or text to workflow, these are all areas in which ServiceNow intends to completely transform enterprise business.

Right. One of the concerns I hear from investors when it comes to generative AI is, as more and more of this gets automated, ServiceNow has traditionally been a seat-based business. So if the process of IT help desk and ITSM becomes more and more automated, is that going to mean less seats to make it harder for you guys to monetize?

Not at all. I mean, first of all, you have to deal with everything as it relates to the cycle of innovation. We're in the early days. So the CEO meeting now with the CTO right next to her is all about how do I get more margin performance and more leverage out of my business model because my shareholders are expecting me to perform well even though I might be depending on the industry in an environment with scarce revenue or difficulties in supply chains and you know all the capital market structures they're dealing with. So they're looking for answers. That's why our business is so exciting right now. They need us. So right now, they're basically saying, how do I not add headcount or how do I reduce headcount, but still get more productivity out of my human capital. And in there lies the power of the Now Platform, it also drives AI. So for a long time, you're not going to have any issues on a seat-based pricing basis. But also don't forget, you can look at this as a Pro SKU. So the more AI innovation that you put into the platform -- and keep in mind, this platform has RPA. It has process mining. It has machine learning. It has AI. So the more you put into the platform, the more pricing power that you have, especially when you think about our Pro SKUs. Now together, we're thinking about new innovations and new pricing models, and it might be an entirely different SKU, which gives you yet a net new opportunity to make even more money for the shareholders. That is all on the table as we speak.

Got it. And I think that's one of the concerns for investors that particularly in terms of the hype cycle that AI has been infusing application floor for a long time. And I would say, the bear case is almost like Einstein from Salesforce or a Sensei from Adobe where it's just part of the functionality. It doesn't get priced separately, but you guys have been successful of actually being able to monetize those AI innovations.

Yes. I think the reason is, again, I go back to the platform. What is the big story with the platform. If you look at the era of, let's say, 2008, you'll all remember that financial crisis. That is when the SaaS platform rage took off because now people had to do more with less and they were optimizing at a line of business level. And the CEO basically said, if you're the HR -- the head of HR, just take care of the people. And if you can rent it in the cloud, do it because OpEx was plentiful and CapEx is real tight. The environment that we're in now is IT spending is predicted to go up 5% this year, but software spending -- software-as-a-service spending is predicted to go up 15%. But within the realm of SaaS players, there's only one that has an end-to-end platform that's intelligent for digital transformation end to end. What does that mean? That means the IT backbone has now become the driver of the company's strategy. Why is that? Because you have to manage your assets, you have to manage your operations, you have to think about risk, you have to think about security and you have to basically service the business. Well, what is the business? The business is composed of a lot of people, and they're working in a hybrid world. And by the way, that's not a debate on whether you come back to the office or you don't. You have to service the employee no matter where they are under any conditions. And especially coming out of a 3-year COVID cycle, companies have to be digitized with the employee experience. So they're all fighting for that. And look, if you're the employee, you want to be able to search things, you want to be able to work with a virtual agent, you want all your services on the mobile. You don't have to call the HR department and wait on an 800 line, those days gone. So the employee experience is something from recruiting, onboarding, training, providing all the services and doing it at an exemplar level that we're world class at, that's a platform game. I took the IT backbone and now I transformed the employee relationship. But let's not stop there. Let's now talk about the customer and how you're going to service the customer. If you look at any large retailer today, anyone, their direct-to-consumer business is all that's on their mind. That's where the margins are, that's where the customer sat is, that's where the best buying behavior is, that's where they want to be. We do that at an exemplary level. But then you think about wait a minute man. What about the mid-office and the back office because I got to get a right product at the right price and the right form factor. And if something goes right, I have to in the workflow be able to automate returns or all the things that drive customer satisfaction and loyalty. Well, who's going to do that? People, and they're in call centers, and they're working in the phones and they're doing a lot to make sure that promise that was made at the point of sale is kept. You have to transform that. And the way to do that is to fully automate it. Why? So we competitively advantaged because we know the whole life cycle of that customer relationship because we have the IT backbone. And now I can go into not only the front office but I can go into the mid-office and the back office to create customer satisfaction, loyalty and growth. And finally, and keep this in mind. Yesterday, I was working with one of the largest logistics companies in the world. And in this conversation, we got into all the complexities of that business. And so the places where ServiceNow was with ITSM, we're already optimizing the process. We're already doing the things I just said. But there's other parts of their core business where we're not. I can take the Now Platform throw it at non-ServiceNow places, use the process optimization and the AI today to basically tell them, this is where the process is broken. This is where we can automate the workflow. This is where you can take cost out and we're ready to hit the ground running. We don't need 6 months of a consultant study to figure it out. It takes about 6 minutes with a business analyst. That's the difference. And it's all on the same platform.

It's an amazing expanse of sort of the opportunity that has been built out of ServiceNow. And what's so fascinating to me is that I remember like over a decade ago, sitting in Fred Luddy's office. And he's talking to me about, "Listen, this isn't ITSM. This is a broader kind of workflow solution. We're going to automate the entire enterprise." And I'm looking at my nose, "What's he talking about? It isn't like an ITSM play." What was it about that core technology? What was it about that platform that gives you entree across the entire organization?

Yes. Fred, first of all, you got to give it to Fred. We're so proud to have our great founder also on our board and such a great friend of mine personally and our companies. It's just an honor to work with him. And his broad vision was there day 1. It just so happened that the technical people understood it and the business people didn't yet because it's not easy to explain that you can completely reinvent the business processes of an enterprise on 1 platform. And you can do it seamlessly by composing workflows that enable people to do their job better, make their life a little bit easier, give them a little bit more productivity. And back in that day, you are coming off of like the heavy enterprise resource planning kind of apps and to have something with so light weight in the cloud, so easy to use at a consumer grade, it took a while for people to digest it. I can actually remember working for another software company, being in a boardroom once and someone saying, "Is it CRM? I don't know if it's CRM. Is it like HR? I don't know if it's HR. We know it's IT. I heard people writing apps on it. No kidding. It does all up." And it was like this thing that just got into these enterprises and people started building on it. They were reinventing the employee experience. They were doing different things for the customer relationship. The IT was well known and obviously expanded, but it was just growing because it's a platform that people love to use and innovate on and it was a well-kept secret for a long time. But in my former job, it wasn't a well-kept secret to me because I knew I needed to transform the way I was running my IT operations across an entire 100,000-person company, and I used it. And I paid for it because I knew it was going to give me a big ROI. So it really works.

And you got a great advocate in the CIO in these organizations. And that's one of the things that always came through in the ServiceNow story is how strong of an advocate the CIO was and their ability to expand you out. I want to dig into some of the individual kind of product categories and starting with IT workflows. And really from I would say, day 1, like after the IPO, people were worried about, is ITSM fully penetrated? Is there still more room to go? And you guys have been able to expand that category. And now you've really expanded the vision of what you're looking to do in IT workflows. Can you talk a little bit about sort of what the acquisitions of like Lightstep and Era Software bring to the equation and really expanding out what you guys can do in those IT workflows?

Yes, sure. If you look at IT workflows, first of all, there's huge growth left in IT workflows. And I think a lot of people didn't realize when they first looked at ServiceNow and it first went public that the TAM was a $200 billion TAM. Nobody would have told you that then. They would have told you it was a substantially smaller TAM. But again, the IT strategy has become the business strategy and the expansion of IT is amazing. If you look at asset management, operations management, security, risk, governance, all the things that we do on an end-to-end basis play also in this observability space. So what we did with Lightstep and obviously, the tuck-in that we did into Lightstep was always designed to take metric, traces and logs and compose it into the workflow automation platform of ServiceNow so you could have an end-to-end experience. And if there is an issue that a customer needs to be mindful of, they have one user experience across the whole platform, and you can use AI and all the trigger points of our workflow automation to immediately zero in on what the problem is. And what's cool about it is you have our platform as the control tower for digital transformation. It doesn't mean you don't have other solutions in the enterprise, but there's so much clunkiness, data challenges and user experience problems that 1 dashboard with 1 control tower is now becoming a prevailing theme, and that's stretching IT to totally new dimensions. But keep one thing, if I may, if you think about the ERP space, there's many companies now using ServiceNow to conquer some of the problems that have really been problematic in the ERP space for a long time. Think about procurement, think about accounting, think about financial management, think about risk and security and controls and governance and ESG. These are all things we're doing on the platform. We have one very large manufacturing company that is actually using ServiceNow as the front end for all their accounting globally. And that doesn't mean they're never going to upgrade their ERP And even if they do upgrade the ERP, they're still going to use us as that standard user interface for all their accounting procedures, and they've taken huge cost out of the business. Same thing could be true with supply chain, reorienting supply chains on the fly in 100 days instead of 5 years. All this is happening in ServiceNow. And people are like, "I didn't know you did that. You do that?" I was at an unbelievable conference in Laguna Beach, California, where I was on stage with another executive who runs a huge pharmaceutical company, and we were speaking at the Black Corporate Conference in Laguna Beach. And I explained that we are very intentional with our procurement procedures. And we think minority and women-owned businesses are extremely important to the sustenance of a great company. And we moved our spend to 16% of our entire spend almost overnight. How did you do that? The average company is 2% to 3%. How do you go to 16%? We did it with the Now Platform. Because if I tried to change all that messy complexity, I would have never got anything done. That's why we run the whole company on ServiceNow. And I can then tailor the ecosystem I want to do business with and the procurement rules that I put into the workflow, the way I want to do it because of the outcome I'm trying to get. And that's the way well-run businesses are moving now. They don't have time for the drawn out long, time-consuming, risky expensive game anymore.

Okay. And it kind of comes down to the principle. If you want to manage something, if you want to optimize something, you have to have the data about and that data now exists in the Now Platform.

Exactly. And if the data exists somewhere else, you can put it into the Now Platform and utilize that for the purpose that you intend the data to be used for. So it's your data. It's the customer's data.

Got it. Two more tactical questions on IT workflows. One on the premium SKU. Can you remind us where we are in terms of penetration of premium SKUs? And kind of where can that go over time? How much of a latent opportunity could you just -- further opportunity is there?

Yes. I mean, if you look at the IT world alone, you're probably 25% penetrated in the IT world on it. So you got another 75% there. But on the employee, the customer, the creator, we're just getting started. It's de minimis what we have compared to what we will have. And then the more innovation you put into the platform, the more value you bring to the customer, the more value-based outcome you drive, the more legitimate pricing power that you have because you've just taken a piece of the action, there's plenty of action.

right. And then the focus of ServiceNow for a long time has been large enterprises, G2K-type customers. How do you think about the opportunity in the mid-market? Does the value proposition of ServiceNow resonate as well in the mid-market? Is it as differentiators -- you compete as effectively in that mid-market space?

Yes, I think that's a real opportunity for us because we haven't really focused outside the top 2,000 companies in the world, the way we can. And I would say there's 2 things that we're doing about that. One, we're actually doubling down on the Global 2000 because there's so much left to go for ServiceNow in all the domains that I explained today. By the way, that's geographically, that's by industry, that's by persona, so much room to run. In the lower on mid-market, I wouldn't spend too much time on that. But the upper mid-market, where you have, let's say, 500, 1,000 employees to 5,000, we're working on lightweight models, also initiating our partners, especially by industry to compose ready-to-run solutions where you can actually use inside sales, self-service and you can really make it easy for customers to consume the innovation and the value of the Now Platform. So it's not like the platform doesn't serve mid-market customers, it does. It's just that we didn't have to dig deep in the past. And still, we wouldn't have to, to achieve our goals, but it's upside.

Right. Got it. I want to switch gears to customer employee workflows and really a go-to-market question for you. You have a tremendously effective sales motion and sales force that sells into the IT department -- has tremendous domain expertise on organizing that IT department. How do you -- like isn't it an add-on sales force to get into customer workflows and another sales force to get into GRC? Or is it leverageable? Like how do you expand and be able to sell effectively into all these different parts of the business?

Yes. It's absolutely expandable. And the reason it's expandable is because we're a platform company. And we didn't have one thing, and then we bought a whole bunch of companies to compose different things, and those things are so specialized that the generalist would never get it. So we're not that. And we can be very lightweight on the specialization of these high-value employee customer service or creator kinds of things because they're not that complicated on the Now Platform. So the ratios that we would have of experts to generalists is much lower than any other company. And as we more and more educate and teach and role model and certify our own workforce and our customers and our partners, I think the lightweight nature of our sales force will be a sensation. We came out with this concept of RiseUp with ServiceNow to initiate 1 million fully trained, capable, certified people in the ecosystem of ServiceNow. We're up to 225,000 since we announced it, by the way. And the idea here is to expand the brand and the platform worldwide with people that are beholden to the platform and can make their livelihood on the platform because they're experts. And that education is the key to unlocking productivity and the upside of less labor in the sales and marketing cost line to get you more revenue, and we're working on it.

Got to push you a little bit on that one because one of the concerns is within sort of the IT workflows, you went after some legacy vendors who're just really flat footed, right? And they didn't respond very effectively. But now you're going into CRM, right? And Salesforce is a cloud-based company and they're effective and you're going into HR onboarding. And Workday, they're pretty effective in that space. Like it would seem like the cost of book has got to be higher, like the margin profile of going into these adjacencies that are more competitive has got to put some pressure on operating margins.

Well, first of all, we have no quarrel with any of these companies that you mentioned, Keith. On the contrary, these systems of record will all work a lot better, and their sales, customer satisfaction and loyalty will increase by a factor of a lot by just partnering with ServiceNow and recognizing that you're not going to stop ServiceNow because the experience ServiceNow gives is the one the customer wants. So we can team up with any of these systems of record. We are not trying to replace them. On the contrary, we understand them, we integrate well with them, and we can make them look good. And our go-in position is not to replace any of them. And that's the unique part of ServiceNow. We're not against anybody. We're for the customer and that experience at a consumer-grade level is what differentiates us. So you're still going to need to do payroll on one of those HR systems. Cool, you should do it. But when you want to recruit higher onboard training, provide all the services at the touch of a button, have virtual agents and search that's AI-enabled at a GPT level, you're going to want ServiceNow. And on the customer service side, maybe if you want to upsell and cross-sell and do Marketing 360 on an existing customer, that game has already been played and maybe there's somebody you'd rather do business with or you've already done business with them, that's great. Your big problem is your mid-office and your back office, we just had 1 customer go live with 55,000 agents. Who would have thought that ServiceNow is running call centers with 55,000 agents? I saw the CEO at one of the conferences in New York City last week, and I said, "Hey, we were in the board room a couple of weeks ago when you went live with 55,000 of your agents on our platform. And I was watching it as the Board meeting was going on, and I was like, you guys better get this right," text and calls and everything and they go light, everything is green. CEO goes to me, "Bill, I didn't even know it." I said, "That's right. You should never know it."

So you could go after these opportunities without any compressive impacts to margins.

Absolutely.

Got it.

And the reason for that is, if you look at our customer service management in one respect, the competitor that you mentioned that's well known in that category, their former platform leader is at ServiceNow. Their top apps guy is in ServiceNow. Their top AI guy is at ServiceNow. So we knew we had a good thing. But what you learn is the best technical people in the world that understand the winning formula, they're ServiceNow. And we didn't have to recruit them. And that's super cool for our customers because they can come to an EBC and meet with executives or engineers. They don't have to wait for the AE to come in with the busload specialists to tell them about 40 different things that we picked up, whether we paid too much for them or not, we bought them because we built it all. And if we did do a tuck-in, we recoded it to the Now Platform, so there was never any tech debt in the first place. And that's our brand promise.

Got it. I want to shift gears and talk a little bit about go-to-market and particularly sort of the partner build that's happened. I remember, this is pretty clear, probably 2019, I was at a competitor's conference and talking to Accenture, right? And you guys who is in charge of this big cloud bets. And you said we have 5 cloud bets, the Microsoft, SAP and Oracle, Workday and Salesforce. And I asked, "Where's ServiceNow." Like why ServiceNow not on that list? And he said, "They're an IT play. It's not an enterprise-wide play." And then you came in...

Is he still...

You came in and changed that. And from the get-go, you pointed that out as one of the opportunities to get the global systems integrators more on board. So you could talk about like, one, how you did that? And two, what are the impacts of sort of that initiative?

Yes. I mean it was really easy because when I'm here 4 years now, I don't know where that went. But in the year 4, I first came in and wanted to meet the top 100 customers globally, so i went on a 100-day roadshow, and I met 100 different customers globally. I met every single employee in the company face-to-face and met every partner. And every big partner was very kind. They mostly came to Santa Clara, where we're headquartered, and they would come in the room with a whole bunch of people and they'd sit down at the table and they'd say, "Yes, we're going to go get them, Tiger. And we think we can get like an incremental $100 million over the next 20 years." And I am like, "I just want to help you out here, like just lose those slides because they don't have enough zeros on them." And what we're going to do is be the defining enterprise software company in the 21st century. And we're not going to do it at the expense of any of your other practices. You're entitled to all those good relationships, and they should make money on all those relationships and those customers do need to be serviced, and I hope those practices grow too. We're talking about an entirely different concept of intelligent end-to-end digital transformation. And it starts with IT, but it expands to all these other personas. And it goes across all these industries. And there are so many untapped geographies for ServiceNow that I kindly ask you to rethink this and come back with a $1 billion plan because we want to make big bets with big partners that want to talk billions, not millions. Now we have 9 out of 10 of the biggest partners in the world with $1 billion or more planned and some of them up to $5 billion. And that's what I mean about the breadth and depth of the defining enterprise software company in the 21st century. We can't do it all alone. And I don't want to waste my time telling people they didn't do a good decision with the participants in the marketplace. I want to make those decisions to work better for them. And that's why we don't compete against them. I don't want to replace them, and I don't even want to say bad things or get into the old skirmishes of the '90s because it doesn't matter anymore. Intelligent digital transformation has superseded the importance of what those things are doing. We need to be talking about helping these companies to new frontiers.

Outstanding. Unfortunately, that takes us to the end lot of allowed time slot. But Bill, thank you so much for joining.

That went fast.

It went super-fast.

Wow, I love being with you. I hope you learned a little bit about ServiceNow. Thank you very much.

Thank you.