ServiceNow, Inc. (NYSE:NOW) Q4 2022 Earnings Call Transcript

ServiceNow, Inc. (NYSE:NOW) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Good afternoon, ladies and gentlemen, and welcome to the ServiceNow Q4 2022 Earnings Conference Call. . At the time, I’ll turn things over to Darren Yip, Vice President, Investor Relations. Darren, please go ahead.

Darren Yip: Good afternoon, and thank you for joining ServiceNow’s Fourth Quarter and Full Year 2022 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 fourth quarter 2022 results and discuss our guidance for the first quarter and full year 2023. Before we get started, we want to emphasize that some of the information discussed on this call, such as 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 the most recent 10-Q and 2021 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 revenue, remaining performance obligations, 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 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?

William McDermott: Thank you, Darren, and thank you, ladies and gentlemen, for joining us today. ServiceNow continues to perform as-the-beyond expectations company. For Q4, we beat guidance with subscription revenue growth of 27.5% in constant currency. Operating margin was 28%, 2 points above our guidance. Our free cash flow margin was 30%, 1 point above our guidance. We had 126 deals greater than $1 million in Q4, including our largest deals ever worldwide in EMEA and in Latin America. Our 98% renewal rate remains the industry benchmark. With 25.5% constant currency cRPO growth, we actually had better-than-expected new business in Q4 with less reliance on early renewals. Based on this new business surge, we are giving a very strong guidance for 2023.

Our guidance reflects a disciplined forecast that appropriately balances our well-founded optimism for ServiceNow’s business. We’ll work hard to go beyond it, and we’ll begin that march in Q1. Here is the main takeaway. Even in a complex operating environment, ServiceNow is executing at the rule of 58.5%. We are driving net new innovation, fast growth and operating leverage. ServiceNow is the proverbial safe harbor in all weather conditions. Let me unpack the current environment for you. The secular tailwinds of digital transformation aren’t going anywhere. IDC’s research makes a clear that technology budgets are growing. They forecast IT spend will grow 5% in 2023, software spend at 8% and Software-as-a-Service spend at 15%. So as businesses increase spend, the only question then is where will all that investment go?

And this answer has everything to do with the great reprioritization. The theme in Davos this year was cooperation in a fragmented world. It all begins with a fragmented enterprise. C-level buyers don’t want long-term road maps to clean up a siloed mess of point solutions. They want integration, speed, automation, great experiences and business impact. A CEO told me, “We can’t afford 1,000 points of We need a cohesive plan with a trusted platform.” So this is now without any doubt, a platform economy. And only a few platforms will be relevant in this shift, and none are as well positioned at ServiceNow. This begins with our business model. ServiceNow with born in the cloud, established itself in IT and expanded from that core. It accelerates with the realities of the multi-cloud world.

Many enterprises are struggling to use public cloud capacity that they have already procured into ServiceNow, which directly enables cloud workload migration. We are the control tower for any architecture, public, hybrid or multi-cloud. And with open telemetry, we help business build and monitor cloud-native applications. This all extends to driving automation. ServiceNow has natively embedded the complete tool set from AI to RPA to process mining in our platform. Now professional developers and the rest of us, real people like you and me, can build mission-critical applications to automate the world of work. Everything culminates with real business outcomes. ServiceNow integrates the enterprise to deliver better customer service, employee experiences, security, risk management and next-generation business processes like Procure to Pay, technology foundation, hyper automation, process orchestration.

With this completeness of vision, ServiceNow is the end-to-end platform for digital transformation. If all we did was help existing customers consume everything this platform can do, we would stay a fast-growth company. But of course, our strategy goes well beyond this as does our proven ability to execute. Right now, many technology companies are working to shift resources from bad businesses to good ones. ServiceNow only has good businesses. Our products and engineering team is building organic net new innovation with an unmatched level of speed and quality. When we started to sense noise in the macro early in 2022, we shifted immediately to a conservative cost management posture in running the company. This allowed us to focus on execution with our team rather than look to workforce actions to leverage.

It also allowed us to continue hiring, especially in engineering and quota-carrying roles. The results tell the story. ITSM was in 14 of our top 20 deals, with 15 deals over $1 million. ITOM was in 16 of the top 20, with 14 deals over $1 million. Security and Risk Solutions were at 13 of the top 20, with 9 deals over $1 million. Customer workflows were in 13 of the top 20, with 13 deals over $1 million. Employee workflows were 13 of the top 20, with 11 deals over $1 million. And create workloads were in 19 of the top 20, with 11 deals over $1 million. We saw new business growth, new logos and major expansions with some of our existing customers. The United States Army expanded its ServiceNow road map well beyond IT. ServiceNow will improve the Army’s ability to consolidate service management for its over 1 million active military contractor and civilian population.

The Schwark Group, one of the world’s top retailers will digitize its 11,000 stores from retail locations to logistics on ServiceNow as its digital business platform. This transition is a transformation and it will position the Schwartz Group at the forefront of the next-generation retail industry. From Banco do Brasil, to AT&T, to Sumitomo, we have countless stories that span ServiceNow’s workflows, Lightstep, geographic regions and industries across the board, we’re winning. And as you’ll hear from Gina, we grew new business 100% year-over-year across retail, hospitality, transportation and logistics. That’s only one example. And with the expansion of ServiceNow’s impact, we are setting the standard for speed of deployment and business value for our customers.

One of 3 years ago, I stated our ambition to be the defining enterprise software company in the 21st century. And this is an ambition I will see through to its full completion. Following my elevation of Chairman and CEO, I’m delighted to announce that CJ Desai has been promoted to President and Chief Operating Officer. CJ is the leader of consequence, well known in the industry. His track record and ServiceNow speaks for itself from strengthening our platform to driving our customer experience. This is exactly how we are orchestrating our company to perform on an end-to-end basis from innovation to execution with our customers. And I’d like to personally congratulate CJ for his latest well-deserved endorsement of his leadership. Congratulations, CJ.

In other news, we proudly welcome Masatoshi Suzuki as the new President of ServiceNow Japan. He brings a long history of successful leadership with some of the industries most respected brands. We will elevate ServiceNow Japan to a fourth geographic region reporting directly to our proven Chief Commercial Officer, Paul Smith. And to add fuel to the growth buyer, we rolled out a new partner program to help our ecosystem drive full platform adoption of ServiceNow. We’re also getting an enthusiastic reception for the company’s premier global initiative rides up with ServiceNow. And under the thoughtful leadership of we will continue to rise up. We offer the training and certification to help people build a lifelong career working on this platform.

We have never seen so much interest in the ServiceNow franchise around the world as we are seeing right now. And from an ongoing operating perspective, we entered 2023 with much stronger sales coverage on a year-over-year basis. We have the feet on the street. We also see stronger pipeline coverage and the maturity of that pipeline, much more so than we did a year ago. The latest ratings feature ServiceNow as the 9th best place to work in the United States, 2nd best in the United Kingdom. The company is fully invested in all of our stated ESG objectives with our global impact report coming later this year. All this is a reflection of our proud culture built on Fred Luddy’s founding vision for our company. I was just in Las Vegas last week for our sales kick-off of them.

And I can tell you, our team is fired up and ready to go for the year ahead. Really fired up. I can only reiterate that we have said consistently, there is only one way forward, and that is innovation. IDC says that by 2027, the number of digital businesses on the S&P 500 would double. Every industry is being reframed by a new paradigm or several. The participants that lean in will lead, the others will fall behind and quickly. For ServiceNow, we are committed to make the world work better for everyone. Our fundamentals are operating at peak performance, net new innovation for our customers, business impact, driving long-term stickiness of our platform and network effects, giving us a competitive moat with multiple avenues for market expansion and profitable growth with a pristine balance sheet.

All in all, when people talk about cloud economics, ServiceNow is the blue chip standard. Whatever the world lacks in stability, we will more than offset with relentless execution. Our customers need to automate for cost reduction and to innovate for growth. Yes, ServiceNow helps them do both. The world works with ServiceNow as the end-to-end platform for digital transformation. I’d like to personally thank our customers, partners and shareholders for their steadfast trust in ServiceNow. You can count on us. We’re in your service, hungry and humble as ever. I’d like to now hand the call over to our CFO, Gina Mastantuono. Gina, over to you.

Gina Mastantuono: Thank you, Bill, and happy New Year to all of you who are listening in. Q4 was another great quarter of execution. We exceeded our subscription revenue guidance and drove strong renewal and expansion rates. Our operating and free cash flow margins also exceeded our outlook as disciplined cost management drove tailwinds to profitability. In Q4, subscription revenues were $1.86 billion, growing 27.5% year-over-year in constant currency, exceeding the high end of our guidance range by 50 basis points. RPO ended the year at approximately $14 billion, representing 25% year-over-year constant currency growth. Current RPO was approximately $6.94 billion, representing 22% year-over-year growth and a versus our guidance, primarily driven by favorable FX movements in the quarter.

On a constant currency basis, growth was 25.5%. While constant currency cRPO growth came in just shy of our guidance of 26%, we actually outperformed our target for net new ACV and renewal ACV for contracts expiring in the quarter. The delta came from fewer early 2023 renewals than is typical in the fourth quarter. Given our strong renewal rates, which remain the best-in-class 98% in Q4, this is only a timing issue. We expect these customers to ultimately renew upon contract expirations, providing opportunities to drive further expansion throughout 2020 rate. The timing of early renewals does not impact 2023 subscription revenue growth, only RPO. Net new ACV would drives incremental revenue growth, and there, we exceeded our forecast. Our larger-than-average Q4 customer cohort not only renewed at a very strong rate, net expansion also remained robust.

What’s more, the strength in net new ACV was added to existing customers. New customer net new ACV grew over 30%. We ended the quarter with 1,637 customers paying us over $1 million in ACV, up 20% year-over-year. From an industry perspective, retail and hospitality and transportation and logistics saw net new ACV growth of well over 100% year-over-year. Government remained strong, growing more than 50% year-over-year. Manufacturing and financial services also saw healthy double-digit growth. We closed 126 deals greater than $1 million in net new ACV in the quarter, including 2 of our top 5 largest ever. In addition, we saw 100% increases in the number of both $5 million plus and 10 million-plus net new ACV deals. More and more customers are seeing the true power of the ServiceNow portfolio as a unified platform.

That’s leading to more multiproduct deals in Q4, 5 of our top 10 deals contain 10 or more products. Turning to profitability. Operating margin was 28%, 200 basis points above our guidance, driven by disciplined spend management and less-than-expected FX headwinds. The cash flow margin was 53%, up 650 basis points year-over-year. For full year 2022, operating margin was 26%, 100 basis points above our guidance and free cash flow margin was 30%, also 100 basis points above our guidance. Total free cash flow for 2022 was a robust $2.2 billion. We ended the year with a healthy balance sheet, including $6.4 billion in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of world-class growth and profitability.

Before I move to guidance, I want to give a brief update on the trends we are seeing. Heading into 2023, we believe we have prudently factored in the evolving macro crosswinds into our guidance. Overall, the demand environment remains healthy, deals getting done, the market opportunity is growing, the ecosystem is expanding, our renewal and net expansion rates ended the year strong, our pipeline is robust. With that in mind, let’s turn to our 2023 outlook. We expect subscription revenues between $8.44 billion and $8.5 billion, representing 22.5% to 23.5% year-over-year growth on both a reported and constant currency basis. We expect subscription gross margin of 84%, reflecting the expected diminishing impact of the change in useful life of our data center equipment as well as investments to accelerate customer time to value as part of our impact offering and higher inflation.

We expect operating margin of 26% as sales and marketing efficiencies are offsetting headwinds from gross margins. We expect free cash flow margin of 30%. And we expect GAAP diluted weighted average outstanding shares of 206 million. For Q1, we expect subscription revenues between $1.99 billion and $2 billion, representing 25% to 25.5% year-over-year growth on a constant currency basis, excluding a 300 basis point FX headwind. We expect cRPO growth of 24% on a constant currency basis, excluding 300 basis points of FX headwind. We expect an operating margin of 24%, and we expect 204 million GAAP diluted weighted average outstanding shares for the quarter. In conclusion, we had a strong Q4, capping a resilient year. As we enter 2023, the macro challenges many enterprises face underscore a point we have made consistently.

The technology strategy has become the business strategy. Digital technologies are growth-stimulating deflationary force. They power new business models, accelerating productivity while reducing costs. Our unique ability to drive business model transformation while delivering efficiency gains has created durable demand for the Now Platform. Our investment strategy is a laser focus on our customers’ most pressing issues, and that continuous net new innovation translates into net new business for ServiceNow. We are well positioned for 2023 and remain on our way to becoming the defining enterprise software company of the 21st century. Finally, I’m extremely proud of our team’s performance this year. Bill and I can’t thank our employees enough for their continued hard work and dedication.

With that, I’ll open it up for Q&A.

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Q&A Session

Operator: . We’ll take our first question this afternoon from Brad Zelnick of Deutsche Bank.

Brad Zelnick: And congratulations, everybody. Bill, we continue to hear from some of your largest partners of the great opportunity ahead in the middle office for which ServiceNow platform just seems to be ideally suited. How are customers prioritizing these opportunities right now and into this year? And how do you position yourselves particularly with partners and vertical industry solutions to best capture it? And I’ve got a follow-up for Gina.

William McDermott: Yes. Thank you very much, Brad. And before I answer the first question, ladies and gentlemen, I just wanted to officially welcome CJ Desai as our newly President and COO, who is joining me here today. and I will have him continue to join me on these calls. And I’d also like to acknowledge Gina for powering through while she’s a bit under the weather, so please her voice might be a little scratchy, but her passion is on fire. So she’s in good shape, but losing a voice a little bit. We’ve been all over the world from Davos to Vegas to here. So that’s what happens when you travel a little bit. Brad, the partners and the largest partners are really doubling down on their investment with ServiceNow. And I look at it as a multifaceted situation.

First, on this RiseUp with ServiceNow, we’re going to train 1 million people in the ecosystem to be fully certified on the platform to ensure that we globally scale. Second, partners are teaming up with us on an industry domain basis also based on persona and mapping that back to our solution road map and naturally, everybody is all in on the platform. So the big ones are really doubling down on the platform. What’s interesting, and you bring up a good point, this is for the front, the mid and the back office. And there’s a next-generation ERP evolving here with things like procure-to-pay, optimizing supply chains and other things that definitely impact the middle office. But I would also say we have a great opportunity. And if you saw our new business surge in Q4, you’re seeing it play out, where we’re going to net new logos and drawing net new business.

And I think that will be a big part of it. CJ, you may want to build on it from what you’re seeing in the middle office.

CJ Desai: But is, I would say, when we look at the engagement layer, engagement layer has been around for a long time, say, for a customer service require. So for a large financial services organization, moving the workflow from the engagement layer on, say, customer complain to the mid office where we really shine because of our interoperability of the platform and our ability to integrate the systems and to different clouds all the way to the back office. And that’s what is driving the middle office acceleration, whether that’s for a financial services organization, telecommunications or a health care organization.

William McDermott: Excellent. And I know, Brad, do you have the second question, I think, for Gina.

Brad Zelnick: And congrats. I was remiss in not congratulating you, CJ. For you Gina, I appreciate the additional disclosure on net new ACV. You guys clearly had a really strong quarter for new business, which is what matters most to investors. But as we think about cRPO and what you shared with us, I mean, we’re all trying to understand the customer mindset during these uncertain times. Is it fair to conclude that perhaps there was less of a traditional Q4 IT budget flush in 2023? And if not, what else would be the rationale as to why you would see that phenomenon?

Gina Mastantuono: Yes, of course, Brad. Thanks for the question and apologies for my throat. So I think what you’re seeing is early renewals were always correlated and still always correlated to net new ACV. And when people really renew, it’s really about co-terming multiple contracts. And certainly, in the current environment, when — I don’t know if you want to say it’s just budget flush or just more tightening of budgets, the need or the desire to co-term the contract is a little bit less than what we’ve seen historically. Not altogether surprising given the current macro. It’s why I wanted to be really clear about the fact that early renewals have no impact on future revenue, right? And in the quarter, our target forecast for net new ACV as well as renewal ACV within the quarter actually overachieved, which is why we were able to come out with a strong 2023 revenue guide and why we feel good about not only the Q4 results, but also the position that we stand in the market as well entering 2023.

Operator: We go next now to Raimo Lenschow at Barclays.

Raimo Lenschow: Congrats from me as well, and Gina, I hope you feel better soon. A quick question. If you think about the different pockets of growth, you saw this quarter that the HR and CRM part was a little bit stronger for Q4. Can you talk a little bit about the drivers? Because like ITSM, ITOM, you’re kind of the #1 player. And the other ones you’re expanding. So it’s nice to see the expansion in them. And then I had one follow-up for Gina.

William McDermott: Yes, I’ll make the first point, Raimo. And then I think CJ can actually even give you some customer examples that might be helpful. We have become the platform for digital transformation, and that’s an end-to-end platform for digital transformation. So what you’re seeing now is a company that has evolved from IT to the employee experience to customer service management. And obviously, the low code platform and how the creative workflow is exploding is demonstrated in our outstanding results and our very strong guide. So we’re really now a platform company with a multiproduct approach to helping every customer in the industry they operate in, based on the persona we’re discussing business with and ultimately, it’s that completeness of vision now that has made us one of — about a handful of companies in the entire world that really matter in the enterprise. CJ, you’ve got some examples you want to talk about?