ServiceNow, Inc. (NYSE:NOW) Q3 2023 Earnings Call Transcript

ServiceNow, Inc. (NYSE:NOW) Q3 2023 Earnings Call Transcript October 25, 2023

ServiceNow, Inc. beats earnings expectations. Reported EPS is $2.92, expectations were $2.54.

Operator: Good day everyone and welcome to the Third Quarter 2023 ServiceNow Earnings Call. Today’s call is being recorded. All lines have been placed on mute to prevent any background noise and after the speaker’s remarks there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Darren Yip, Vice President of Investor Relations. Please go ahead, sir.

Darren Yip: Good afternoon and thank you for joining ServiceNow third quarter 2023 earnings conference call. Joining me are Bill McDermott, our Chairman and Chief Executive Officer; Gina Mastantuono, our Chief Financial Officer; and CJ Desai, our President and Chief Operating Officer. During today’s call, we will review our third quarter 2023 results and discuss our guidance for the fourth quarter and full year 2023. Before we get started, we want to emphasize that the information discussed on this call, including our guidance, is based on information as of today, and contains forward-looking statements that involve risks, uncertainties, and assumptions. We undertake no duty or obligation to update such statements as a result of new information, or future events.

Please refer to today’s earnings press release and our SEC filings, including our most recent 10-Q and 2022 10-K for factors that may cause actual results to differ materially from our forward-looking statements. We’d also like to point out that we present non-GAAP measures in addition to, and not as a substitute for financial measures calculated in accordance with GAAP. Unless otherwise noted, all financial measures, and related growth rates we discuss today are non-GAAP, except for revenues, remaining performance obligation or RPO, current RPO, and cash and investments. To see the reconciliation between these non-GAAP and GAAP measures, please refer to today’s earnings press release and investor presentation which are both posted on our website at investors.servicenow.com.

A replay of today’s call will also be posted on our website. With that I’ll turn the call over to Bill.

Bill McDermott: Thank you, Darren, and thank you everyone for joining us today. On behalf of Gina, CJ, and our entire company, I’d like to first make a brief statement about recent events. ServiceNow has a very special team in Israel. One of our own colleagues Shlomi Sividia was at the Supernova Music Festival. He was murdered in the unprecedented and heinous attack. Shlomi was highly respected, admired, and a good friend to many. We stand in solidarity with our team and with their families. Terrorism has caused the unfathomable humanitarian crisis and now engulfs millions of people in Israel and Gaza. Our hearts pray for the innocent on all sides. Even with optimism in short supply, we choose to honor the dream of a peaceful and prosperous future for the Middle East region.

God bless and protect all those in harm’s way. Now for business. Of course, that’s the reason we’re here to discuss ServiceNow’s Q3 results. We’re proud that our company once again delivered beyond expectation. ServiceNow has delivered subscription revenue that grew by 24.5% in constant currency, over one point above our guidance. cRPO grew a strong 24%. That’s 2.5 points above our guidance. Operating margin was 30%, more than 2.5 points above our guidance. We had 83 deals greater than 1 million in net new ACV, up from 69 a year ago, a 20% increase year-over-year. Our focus on landing the right new customers, continued to deliver. Large new logo growth accelerated for the third consecutive quarter. ServiceNow’s traction as the intelligent platform for end-to-end digital transformation has intensified.

All of our workflow businesses were in 14 or more of the top 20 deals, ITSM, ITOM, ITAM, security and risk, customer, employee, and creator. Within our technology workflows, security and risk had a very strong quarter, with 10 deals over 1 million. Employee workflows had a stellar quarter with seven deals over 1 million and one deal over 10 million. From an industry perspective, this was the best US Federal quarter in ServiceNow’s history. NNACV was up over 75% year-over-year. US Federal agencies are standardizing on a single platform with a core set of end-to-end solutions. We had 19 federal deals over 1 million, including three deals over 10 million. Our top deal in the quarter, the United States Air Force was the third largest deal in the company’s history.

You’ll hear from Gina that this performance has heightened our confidence for a strong Q4. We’re increasing the full year guidance on the top line and the bottom line and here is the key takeaway. AI has strengthened the market dynamics for enterprise software. ServiceNow is the fastest-growing company in this market at relative scale. We have the highest rule of 50 plus across our peer set with the highest growth of any other large-cap software company. We are the best performing enterprise software company to IPO. This is a unique, highly differentiated company that is rewriting the benchmarks to be best-in-class in the SaaS industry. Looking beyond the quarterly results, while the world’s challenges are sobering, the digitization imperative is stronger than ever.

Gartner forecasts that $3 trillion will be spent on AI and GenAI between 2023 and 2027. GenAI represents 36% of AI spending overall. We believe every dollar of global GDP will be impacted by AI over the next several years. This isn’t a hype cycle. It is a generational movement. In the last year, ServiceNow has doubled down on our AI investments. Our Vancouver release includes generative AI-powered Now Assist for every workflow. Others issued press releases. We released product. At ServiceNow, our strategy isn’t about exuberance. It’s about execution. We carefully laid the groundwork for success and talent and resources and technology. This investment is accelerating our already robust pipeline with customers lining up to be first-movers in this next wave of business transformation.

The question we’ve been asked repeatedly, does AI drive growth? The definitive answer is, yes, it does. GenAI represents a tailwind of growth for ServiceNow. We have over 300 customers in our pipeline from every industry, every buying center and every stage of testing. Our GenAI SKU drove the highest number of customer requests for a pre-release product in our history. We launched Vancouver on September 29th. That left us one day in Q3 to sign deals, and we signed four large deals. A US government agency selected our premium SKU offerings, to be an early adopter of GenAI. Real estate leader, CBRE is harnessing generative AI with ServiceNow to deliver superior service to customers and employees, while reducing costs. NVIDIA is accelerating its own ServiceNow journey with generative AI.

Among other leading companies, Teleperformance joined ServiceNow’s AI Lighthouse program. They will collaborate on new generative AI use cases that boost productivity while increasing customer and employee satisfaction in key industries. We have a wide range of other customer wins in the quarter as well. FedEx is using ServiceNow to simplify their IT workflows, while building a universal employee portal to improve employee experience for a 0.5 million global employees. One of the world’s largest automakers selected ServiceNow to help consolidate dozens of applications into a new modern platform to accelerate their push into the EV market. Philips, Mars, Bank of California, Cleveland Clinic, the US Department of Defense, Fujitsu, Asahi Mutual Insurance, and the State of California are among many others.

We see a meaningful path for all customers to recognize value from generative AI, in the quarters to come. Our innovation velocity is very high. Pipeline is growing fast and capacity to execute is well proven and this is just the beginning. Looking holistically at our business, we see progress everywhere. We have an aspiration to significantly increase the percentage of net new revenue, sourced by our partners in the coming years. This is about partners making the ServiceNow platform the core of their emerging business models. One exciting example is our customer Trane Technologies. They are a global climate innovator, which recently announced plans to acquire ServiceNow partner Nuvolo. With Nuvolo, Trane Technologies can bring world-class digital solutions, engineered on the ServiceNow platform to their global customer base.

This creates a flywheel effect to ServiceNow, more use cases, drive more workflow automation. And today, we’re excited to share that Deloitte and ServiceNow announced an expansion to our alliance. Deloitte will become a pioneering partner, integrating our generative AI capabilities into their leading operate services globally. This addition underscores Deloitte’s commitment to enhance performance with cross-industry solutions built on the ServiceNow platform. We’re also scaling our ecosystem globally, with today’s announcement of a co-investment in ANSR, a market leader in enabling companies to scale technology centers. Another area that we expect to fuel long-term sustainable growth is industry verticalization. Our product development roadmap is expanding with use cases and telecommunications, financial services, retail and the public sector.

And beyond any one industry, we increasingly see both intra and inter-enterprise workflow opportunities on the ServiceNow platform. This new generation of business networks is creating value chains that transcend traditional business boundaries. Our rapid pace of workflow innovation creates an even greater demand for our training and skills initiative, RiseUp with ServiceNow. As one example, FutureSkills Prime, a digital skilling initiatives of the Indian government will train thousands of learners across India in new digital skills. This partnership offers clear pathways to build careers as businesses worldwide grow at ServiceNow workforce. Bottom line this all points to grow at ServiceNow. In closing, we are building a company for the ages, by concentrating on customer value, we are creating immense shareholder value.

At a strategic level, we chose to set the bar high, to be the defining enterprise software company of the 21st Century. We have an inspired team that is committed to our exponential dream. A company is only as great as each member of the team and the team is only as great as the company. That is what culture is all about. Our employee engagement scores increased across the board this year, so did our retention rates, which are already best-in class. We never went for layoffs. We went for thoughtful, careful expansion. When you look at the ongoing momentum from Knowledge ’23, it’s clear the approach is working. A profitable growth profile of this company speaks for itself. The market is there for us and now we’re focused on Q4, delivering a strong full year and a fast start in 2024 as well.

Thank you for your time today. I look forward to your questions. Now, I’ll turn it over to our outstanding CFO, Gina Mastantuono. Gina, over to you.

Gina Mastantuono: Thank you, Bill. Q3 marks another quarter of strong execution, as we once again significantly surpassed the high end of our topline growth and profitability guidance metrics. ServiceNow continues to demonstrate its resilience as the intelligent platform for end-to-end digital transformation. Customers are seeking enhanced productivity solutions in the current macroenvironment and ServiceNow is delivering. In Q3, subscription revenues of $2.216 billion, growing 24.5% year-over-year in constant-currency, exceeding the high end of our guidance range by over 100 basis points, amazing organic growth at massive scale. RPO ended the quarter at approximately $14.4 billion, representing 23.5% year-over-year constant-currency growth.

Current RPO was approximately $7.43 billion, representing 24% year-over-year constant-currency growth, and a 250 basis point beat versus our guidance. As Bill highlighted, Federal has best net new ACV quarter ever, growing over 75% year-over-year. I want to give a quick shout out to the Federal team, who has just been crushing it. Among the other industries, transportation and logistics was very strong, growing over a 100% year-over-year, followed by education, which grew over 75%. Manufacturing and CMC also saw robust growth. We had some outstanding achievements from a workflow standpoint as well. I’m pleased to announce that Creator Workflows crossed 1 billion in ACV in Q3, a monumental milestone, and our Employee Pro SKU saw over 100% growth in net new ACV year-over-year.

Retention remained exceptional with the renewal rate of 98% in Q3 reaffirming the essential role the Now Platform plays in our customers’ operations. Our customer cohorts displayed solid expansion as the quarter closed with 1,789 customers contributing over 1 million in ACV, with 58% year-over-year growth in those contributing over $20 million. In Q3, we successfully closed 83 deals greater than 1 million in net new ACV, with four deals greater than 10 million. Notably, 18 of our top 20 net new ACV deals included eight or more products. By launching at the end of the quarter we have already — we have also already closed four GenAI-related enterprise deals and we’re seeing strong pipeline build for our plus SKUs. Turning to profitability, non-GAAP operating margin was 30%, over 250 basis points above our guidance, driven by disciplined spend management, and the top-line outperformance.

Our free cash flow margin was 9%, up 300 basis points year-over-year. We ended the quarter with a robust balance sheet, including $7 billion in cash and investments. In Q3 we repurchased, 0.5 million shares as part of our first-ever share repurchase program, with the primary objective of managing the impact of dilution. As of the end of the quarter, we have approximately $1.2 billion remaining of the original $1.5 billion authorization. Together, these results continue to demonstrate our ability to drive a strong balance of world-class growth, profitability and shareholder value. Moving to our guidance. We are raising the full-year outlook to reflect the strength of Q3. As we have done all year, we continue to prudently factor the macro cross-wins into our guidance.

This includes incremental FX headwind from a strengthening US dollar. For 2023, we are raising our subscription revenues outlook by $48 million at the midpoint to a range of $8.635 billion to $8.640 billion, representing 25% year-over-year growth or 25% on a constant-currency basis. We’re also raising our full year operating margin target from 26.5% to 27%. And we continue to expect subscription gross margin of 84%, free cash flow margin of 30%, and GAAP-diluted weighted average outstanding shares of 206 million. For Q4, we expect subscription revenues between $2.320 billion and $2.325 billion, representing 24.5% to 25% year-over-year growth or 23% to 23.5% on a constant currency basis. We expect cRPO growth of 20.5% or 21% on a constant currency basis.

Notably, the strength of our federal business has resulted in a higher mix of 12-month contracts that will create a one point headwind to Q4 cRPO growth and remain a headwind into 2024. We expect that these contracts will renew in 2024 as ServiceNow’s federal contract renewal rate are 99%. We expect an operating margin of 27.5% and we expect 206 million GAAP-diluted weighted average outstanding shares for the quarter. In conclusion, our team delivered an exceptional performance across the board. With a culture focused on customer success, our people have worked relentlessly to provide solutions to meet enterprise’s needs, and it’s showing in our robust results. Businesses are looking to consolidate vendors and standardize on a platform with a core set of products, so they can build a predictable and reliable roadmap to drive digital transformation.

ServiceNow is that strategic platform. With the addition of our Vancouver release, and the capabilities presented by GenAI, the window of opportunity is even more expansive than ever before. The result is a more powerful, and intelligent platform, that enables customers to ignite end-to-end action, across the enterprise in ways not seen before. It’s an exciting opportunity to further improve productivity, and employee satisfaction, optimize processes, reduce costs, and create organizational agility. The possibilities are endless. Bill and I extent our gratitude to all our employees worldwide for their unwavering dedication and commitment that puts us at the forefront of this opportunity, and further driving ServiceNow towards its ambition of becoming the defining enterprise software company of the 21st Century.

With that, I’ll open it up for Q&A.

See also Top 20 Sex Tourism Countries in the World in 2023 and 16 Countries Where Population Will Fall by 2030.

Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Raimo Lenschow with Barclays. Please go ahead.

Raimo Lenschow: Thank you. If I look at the mix in product — on the product side, it looks like ITSM and ITOM was very strong this quarter. Can you little bit speak to that? I sense it’s probably the big Federal deals, but maybe more broadly what you see in the different product categories. Many thanks and congrats from me.

CJ Desai: Hey, Raimo, thank you so much, this is CJ, for the question. Great to hear from you. ITSM and ITOM which we define from a solution perspective as service operation is code of our core. So, as Bill outlined that we had very strong new logo business, and new logos that matter, where we almost always plan with ITSM and ITOM, and in general, we are seeing that ITSM continues to have expansion rates, whether it’s via Pro SKUs, or just recently added Pro Plus, and with ITOM and our AIOps strategy, we continue to execute on not only the product roadmap, but how our customers are leveraging those innovations from visibility all the way to health in that digital real estate.

Raimo Lenschow: Thank you.

CJ Desai: Thanks.

Operator: We’ll take our next question from Kash Rangan with Goldman Sachs.

Kash Rangan: Hello. Thank you very much. Congratulations, Bill, CJ, and Gina. Outstanding results. Bill, we’ve — we’ve all been waiting for this recession. Some houses have been calling for a hard landing, and some others aren’t. It looks like we’ve been waiting for ever since the recession to happen, it’s not happening. And I’m sure that CEOs that you do business with are — have been somewhat cautious the last three to four quarters, but it looks like things are stable, and with the tailwind of potentially a soft landing, if I could use that expression, a software landing and AI, as wind — as wind in your sales, what does the company’s growth prospects look like in ’24 versus the last couple of years that we’ve all been slogging through this, granted that you have been executing really well outperforming your peer group. What does the growth curve look like with all these tailwinds ahead of you? Thank you so much and congrats.

Bill McDermott: Well, Kash, thank you. I think that’s the reason why we’ve raised our guidance on top of an outstanding quarter like this because we have great confidence in the core business. All CEOs right now are either in a move to increase productivity because of the crosswinds that you referenced in the macro or take costs out. And obviously, while doing so, they also have the added challenge of new business model innovation, such as the auto industry, now dealing with the transition to EV. What’s unique about ServiceNow is digital transformation can deflect so many of the cost, and hence the labor-intensive procedures that companies have to deal with to properly serve their market. On top of that, you have one-third of the productivity of knowledge workers getting torn apart by swivel chairing between on average 13 individual applications a day.

Now you add the productivity tailwind of generative AI on this once-in-a-generation ServiceNow platform, and you have achieved a very important business transformation. And I think right now, CEOs are focused on business transformation, and when you can give them one common UX that is consumer-grade, that integrates with a half-a-century-old legacy mess that they have to contend with, and we can get the actions that they need done, done, done to achieve cost-out productivity and growth on, they’re all about ServiceNow now, and that’s why you’re seeing these results, and they are sustainable.

Kash Rangan: Amazing. Thank you so much. Very inspired.

Bill McDermott: Thank you, Kash.

Operator: We’ll take our next question from Tyler Radke with Citi.