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

Welcome to our next session. I see this year, we do like more the [ BFA ] style, which basically means there's going to be more movement than in the previous years, but I hope we are still okay. Gina, thanks for joining me.

Thanks for having me.

The -- let's start -- it's funny because the -- so much has changed or has -- in the last few weeks and months. So it's like -- it's almost -- I want to kind of take like the pulse from you as well to see like, okay, how the last few weeks kind of played out for you guys. And there's like the typical questions like postelection and what happened, et cetera, like maybe just frame us a little bit like what have you seen?

Yes, great question. Not surprising. From our perspective, the quarter has been shaping as we had expected, and we feel good about our guide that we gave in last quarter. Postelection -- and by the way, our pipelines are strong, we had a really solid knowledge pipeline generation. Q4 for us also, we do a lot of our world forums, which are kind of smaller customer events and building pipeline has been good there. What I'd say postelection, and I said this last week at 1 of the conferences, and I think you're hearing it a lot online in the news as well. I think yesterday, they talked about small business sentiment being the highest in 3 years. Certainly, the conversations that I'm having with industry analysts, whether it's Gartner or IDC, expectations for IT spending into 2025 seem stronger than last year. All of the CIO surveys are also talking about as we're going into '25 a better IT spend environment. So I'd say from that perspective and the conversations that I'm having with customers, I'd say, cautiously optimistic versus same time last year as we were entering into '24. And some of that, I think, is postelection. So as we're thinking about '25, I'd say cautiously optimistic vis-a-vis where we were same time last year. Demand environment remains stable. At the end of the day, ServiceNow's platform and the ability to drive really strong productivity and efficiency gains has enabled us to do well even in an uncertain macro and with cautious optimism heading into 2025, I feel pretty good.

And then the -- I mean, if you think about it, there is the optimism when you're talking with clients, is there -- do you also see it already for you guys? And I don't want like Q4 specific or whatever commentary. But as you look out like -- is there like better pipeline generation or anything like that? Or is it that's too early, like we shouldn't really think about it?

I mean postelection, it's a little bit too early to talk about pipeline build. But I will say, in general, and we've talked about this externally in the past, our pipeline generation from knowledge back in May and the word forums in Q3 and Q4 have been strong. The attendance at these events have been really strong as well. And so from a pipeline perspective, heading into '25, we talked about heading into Q4 and '25, we feel really good about where we are.

Okay. Perfect. And then the -- a big part of our conversation, we probably have to spend on GenAI.

No.

Yes, I know, another one. If you think about it though, how do you -- like -- the world is changing so quickly at the moment. And I don't know how you, on the corporate side kind of want to kind of keep track on it kind of see all this kind of evolving? But from your perspective, so we started off with the copilots, then now we have like the agents, et cetera. You guys are -- we're always kind of -- you're starting from much more holistic actually, which is kind of nice like, but how do you see that playing out from your perspective?

Well, I think Bill and I and the leadership team at ServiceNow have been pretty consistent in our messaging. That we truly believe that Gen AI is going to fundamentally shift how work gets done in the enterprise. And we've been investing in AI for years and years, one of the first acquisitions that we did in 2020 after Bill and I arrived at ServiceNow was a company called Element AI. And that was a company that brought in incredible talent in the space. And so the ability to invest in innovation and kind of be ahead of the curve, I think, has allowed us to take an approach where we're seeing monetization better than expected. Our Pro Plus SKUs I talked about in Q3, continues to be the fastest-growing new product introduction in our history. We talked about 3.5 quarters out, and we have 44 customers paying us more than $1 million, which includes 6 customers paying us over $5 million and 2 customers paying us over $10 million. And so monetization looks good. Pricing, we talked initially when we launched that the expectation about price uplift from our Pro Plus SKU would be around 30%, and that has been holding true. And so from our perspective, AI is absolutely going to fundamentally shift how work gets done. And ServiceNow's platform is uniquely positioned because we can sit on top of the application sprawl or data sprawl and really drive exponential productivity. And the differentiation that we have in that it's 1 platform across the enterprise, whether you're working in HR, IT, customer service, legal, finance and that ability to harness the power of the Better Together story. I think really differentiates us in an AI-enabled world.

And if you have the customer conversations, how does that whole dynamic of PxQ playing out. And you remember at the Analyst Day, I think it was like 2 years ago, and we were like, okay, PxQ, PxQ. Like in reality, like how are customers thinking about it?

Well, when the conversation first came up, we talked about when we first launched our Pro SKUs back in 2018, which was our initial foray into AI and machine learning capabilities in the platform, we actually saw a seat expansion. Because the productivity gains were so great, people wanted to go more broader in the enterprise. And so the conversations that we had initially about PxQ, we felt pretty strongly that regardless, as long as we're providing value for our customers, we will be able to monetize such that the value that we give to customers, we keep a small piece of it. And that has remained. And so a year out, we haven't seen any seat compression. The pricing uplift of 30% that we had expected a year ago is holding true. And at the end of the day, we've been really focused always at ServiceNow's history of driving conversations about pricing, it's all about value. So we're a value seller play and the conversations with customers have gone really well when we can say the lion's share of the value is going to you, and we're taking a slice of it because we're investing in all the innovation that's allowing that value. And so those conversations continue to go well. And we continue to see, I think, really strong results as a result.

And have you -- when you rolled this out, is that kind of like something where you kind of had a little bit of guardrails on to make sure that you're delivering the value with this kind of available for all the clients straight away?

Well, when we talked about pricing and our perspective of how we wanted to price, we did it very similarly to when we launched our Pro SKUs, really understanding that value proposition and giving 90-ish percent to the customers and keeping 10 for us. And so that was kind of the guardrails. We did a lot of studies on the value creation, and that's been holding true. Now we've been pretty firm on not over discounting because we truly believe we're driving very significant incremental value, and that has helped us ensure that the pricing remains strong.

Yes. And then the -- if you think about it now, the other big debate and it's more like a -- it's not a ServiceNow question, it's like a bigger picture CFO question that comes up now a lot is outcome-based pricing. Because I am adding so much value to you and so what I need to do. I want to kind of participate, I don't know how I measure it for every client, et cetera. Like how do you think about that? Is that like to me, it feels like the holy dream, it's software all the time. And every kind of few years, it comes back up again. And yes, you could monetize even more. But how do you How's the discussion for you guys going. I'm sure you talk about that?

Yes. Of course, we talk about that, and I certainly get a lot of questions on it as well. In our current Pro Plus Now Assist, so that's our GenAI SKUs. We actually have a hybrid model, right? It's seat-based and you get a certain number of tokens. And then if you're overconsuming you need to buy more tokens. And so, this is the way that we have initially thought about monetization and customers really like that because to switch automatically the outcome-base and consumption base, to figure out how to measure that is really complex and complicated. And it's also hard to predict and budget and forecast for customers. And so the hybrid approach right now has made a lot of sense and customers have leaned in and really, I think, appreciate that. As we think about where the market is going on outcome-based pricing. As you say, that's a conversation that comes up every several years. You can imagine that we're always focused on how we're monetizing and pricing for our customers. How do we simplify and make it less complex, but at the same time, allow some predictability and forecastability for our customers as well as ourselves. And so with Amit coming on as Chief Product Officer and COO, he has dearth and wealth of pricing and packaging experience. And so his perspective is going to be helpful and unique as we evolve the model, and you can expect that ServiceNow as we always have been, have been really focused on value for customers. And as long as we're driving value for customers, I'm not worried about how the pricing models will continue to evolve.

Yes. Okay. And another kind of it's more a CFO question, but also kind of very relevant for you. You started a few years ago with that journey of more price differentiation with the different -- with the Pro SKU, Enterprise SKU, et cetera. How do you think this will evolve for you in terms of like what is over differentiating on the price versus like what's the right mix for you? Like where are you on that journey?

Well, I'd say it's continuing to evolve, right? I think one of the ways that we've continued to grow our top line is the differentiation in the incremental capabilities. I think a couple of years ago at Financial Analyst Day, it might have been too, we talked about before Pro Plus was even in production. We talked about standard pro and enterprise and the expected penetration and the fact that we expected at that point that standard, about 20% to 25% of folks would still be on standard. That hypothesis is shifting in an AI [ infused ] world. And so as we think about the number of SKUs and how we price and the product uplift that we're getting, I come back to value. As long as we're providing and driving value for our customers, we're going to continue to evolve how we think about our product portfolio, our pricing. But what I come back to always is that ServiceNow is so well positioned because of the innovation that we've been driving for years and years to take advantage and to really help customers drive exponential value as they think about how work is going to happen in the enterprise 2, 3, 5 and 10 years from now.

Yes. Okay. And then the -- I wanted to shift gear a little bit. So I was I'm kind of updating myself, but I was kind of part of the IPO for ServiceNow. And back then, it was like, "Oh, yes, ITSM and ITOM and stuff." Now it's a much broader platform game. How do you think about the next opportunity for you guys? We've done -- we're doing HR. It's like a very big element of the offering, customer platform is coming. How do you think -- where are you going from here?

Yes. I think one of the things that has been unique about ServiceNow and has been part of the reason why we've been able to be so successful is that innovation has come from where customers have pulled us, right? So we started out in IT. It actually started -- if you go back to Fred's initial pitches, he was building a platform that could help anyone in the enterprise drive automation and get their work done better, faster and more efficiently. But back then, no one really understood what the platform was. And so they said, what's the use case? How do we use this platform? He was in IT, so he built an incredible use case in IT. And then we brought in outside of ITSM and into ITOM, but then customers are looking at this incredible platform saying, what we're doing here in IT is replicable in HR, can you build me custom out-of-the-box applications for HR? So we went into HR. Same thing with customer. And then, of course, oh my gosh, this platform can be utilized to drive and build applications anywhere within the enterprise, and that's where a Creator and Platform came from. And so the continuation of that platform and 1 Better Together story has, I think, really been a differentiator for us. And so if I think about -- I get the question a lot about our core, our core continues to remain really strong because we continue to innovate. So we have risk and security that are big businesses within IT. We have customer. We have HR continuing to do extremely well. Creator, we've talked in Financial Analyst Day about the continued opportunity in front office, right? So we've been really successful. We talked about customer being greater than $1 billion in ACV about a year ago now. And so we've got a right to play in that space. And those customers that have been with us along the way are pulling us into front office, right? So we introduced sales and order management 3 quarters ago, doing very well. And so the ability for us to continue to innovate in customer is a large TAM for us. And we've demonstrated a right to play there. So that's an exciting continued opportunity. Back at Financial Analyst Day, we talked about OT. The landscape for OT is about 3x the size of IT, and they're about 15 years behind in digitization there. And so that's a great opportunity that we've sized at billions of dollars, ERP workflows, we've talked about as well. And so again, it's all about the uniqueness of the 1 platform that really can drive that productivity and automation across the enterprise. So there's lots of opportunities that we continue to remain focused on. Those are probably the big ones.

Yes. And then we haven't even talked about industries. Like can you talk a little bit what you do there in terms of more verticalizing the solution? Because that's another big step.

Well, I think especially as you think about use cases specific to industries like financial services, telco, manufacturing, so many of them are similar. And so how can we build robust bundling of solutions that really help address use cases specific to industries. Our public market SKU has been really successful for us. And so again, it's all about how can we understand what is priority for our customer, how can we understand the best way to get them to value for automating processes throughout their organizations. And the more we are able to be very specific in industries and how we can help them, the more successful we continue to be.

Yes. I mean in that respect also, if you think about the new administration and the drive for more efficiency. I mean they are land of opportunities for you guys there?

Well, I've gotten that question a few times in the last couple of weeks, as you would imagine. Our public sector total business, not just federal, public sector, we've talked about being at about 10% of our revenues. And federal being a majority of that, we've been very successful in the federal space in the last several years. It's one of our fastest-growing verticals. And the reason we've been successful is because we really helped many of these federal agencies drive better productivity, efficiency and digitization. So if there's even more focus on efficiency and digitization, who are they going to trust. The ones that they've been working with or brand-new folks? And so we actually think it's a great opportunity for us. Our federal business is extremely strong, run by one of the best teams in the company. And so we're really excited about the opportunity that continues for federal. And that's before you even talk about state and local and public sector, which as I talked about, federal is the largest piece of the public sector. There's a lot of opportunity, state and local and public sector outside of the U.S. that we're just scratching the surface on. And everything that we've done in federal is replicable outside of federal space in state and local and public sector internationally. And so federal is 1 piece of it, but public sector more broadly, certainly remains a really strong opportunity for us.

And is that like from we always think, like, "Oh, yes, but you should have been there like a long time ago." Is that -- how is that -- how should we think about like having the resources or the focus to kind of go there? Like it feels like local is something that hasn't really been like in the focus areas. It's like more federal -- fixed federal...

It's bigger. So people talk more about the things that are bigger, but our state and local business is very strong and doing very well. It's just on a smaller scale right now. And then public sector outside everything we've kind of start big in the U.S. and then go broader. And so as you would imagine, a public sector outside of the U.S. right now and certainly over the last several years has been a key focus area.

Yes, yes. Okay. I can imagine that, yes. And so shifting gear a little bit. So as the CFO, when you took over, the thing was like, okay, this is a well-run company and you kept delivering -- well run -- well, kept delivering on this with kind of better margins, better cash flow margins, et cetera. Can you talk a little bit about that, how you kind of get that mix right between growth and margins?

Well, I think ServiceNow has been really disciplined in how we think about growth and profitability forever. And so best-in-class top line at our scale, with best-in-class margins has been a key focus area for Bill and I since day one. There's inherent leverage in the platform because we are 1 platform, 1 data model, 1 architecture. So when you're innovating and spending R&D dollars, that innovation, that -- those incremental capabilities go across platform. So there's unique leverage built in there. 85% of our new business comes from existing customers. So there's inherent leverage in the sales model, which allows me as we go into new markets like federal, public sector, Japan, India, allows me to take some of that leverage, reinvest it back, while at the same time, accreting margins to the bottom line as well. And so we've always been focused on that balance. It's not growth at all cost but profitable growth. Part of it is because the inherent leverage in the model. And part of it is discipline that the company has always had. Just adding more resources doesn't always make for a better company. So the ability to really scale without getting overly complex, and without losing that agility has been a real key focus for Bill and I.

Okay. Perfect. And then -- I mean how much of that -- you came from a different business in a way? Like that wasn't -- sorry to -- if I insult your previous company, like it wasn't like this high-margin software business, but you always had to be more disciplined. Did it help you as you came over?

Well, I think it's one of the reasons why they wanted me for the role, right? And so yes, my previous job, 7% gross margin, $50 billion top line. There's huge risk, talk about a complex model and that ability to scale and be really smart about disciplined investment, I think, that's part of it. But I think inherently that has been in the DNA of the company because the company was always built like that. Just making sure that we were continuing to be disciplined as we scale and really understanding what scale means and what it takes to scale profitably and smartly. I think my background certainly served that purpose.

Yes, yes, yes. And then last question on that topic. So now if we are maybe kind of getting into better times, and there's obviously then kind of things that you need to think about almost pre-invest, like sales capacity because, the sales guys takes like 9 to 12 months to get productive, et cetera. How do you think about that as we maybe are thinking about recovery in terms of that mixture. And does it need to change? How do you kind of tune that?

Yes. Well, we talked about that in Q3. We talked about the fact that sales and marketing head count growth was reaccelerating in back half of '24. And you saw that in Q3, and I talked about that continuing into Q4. And yes, I think one of the great things about the ability to continue to be agile is that the plan we put in place in January is never the same come February and March. And so the ability to, when market dynamics are shifting to dynamically shift the hiring model and the go-to-market leverage, I think, is really important. And so you'll continue to see us do it. It's why I think we were able to not do layoffs in a time when many, many were because we were able to quickly pivot once we saw dynamic shifting the other way. And so what I'll tell you is that if opportunity is there, you'll continue to see us invest smartly and disciplined and the opportunities that we see in front of us, whether it's 6 months or 12 -- 5, 10 years from now, we will position ourselves well to take advantage of that.

Yes. Okay. Perfect. And then in the interest of time, last question for me is like it's more as you think about growth and the market expanding, you think about more about M&A as well. Now Bill surprised us all because like the expectation was when he joined while we knew him from SAP, he bought like a lot of businesses. But he's been driving that organic message for quite a few years now. A lot of things happening in the industry. How do you think about this M&A dynamic?

Yes. I mean, Bill was pretty transparent about how he is thinking about M&A as I have been from the get-go. And we've been very focused on driving customer value. And we've been able to drive significant customer and shareholder value organically for a number of years. We've also done a number of tuck-in acquisitions, talent acquisitions. I talked about Element AI earlier, many each and every year. You'll continue to see us do that. We've also continuously said we wouldn't be doing our jobs if we weren't looking at other larger transformational types of M&A, but our hurdle rates are high because we've been able to really drive such strong organic growth. Our focus, first and foremost, is always if we do any acquisition, how is that going to drive customer value. Because if you're not driving customer value, you're not going to drive shareholder value. So what I'd say, our strategy hasn't changed. We don't need M&A to hit the targets that we've put out there in front of us. But if there's the ability to accelerate top line growth smartly by driving real customer value and shareholder value, we wouldn't be doing our jobs if we weren't looking at it. So in a nutshell, no change in how we've been thinking about things.

Perfect. And I think our time is up as well. So that's actually a very good closing statement.

Thanks so much, Raimo.

Thanks for coming. Thank you.

Thanks very much.

Good to see you again. Yes.