ServiceNow, Inc. (NYSE:NOW) Q1 2023 Earnings Call Transcript

ServiceNow, Inc. (NYSE:NOW) Q1 2023 Earnings Call Transcript April 26, 2023

ServiceNow, Inc. beats earnings expectations. Reported EPS is $2.37, expectations were $2.04.

Operator: Ladies and gentlemen thank you for standing by and welcome to the ServiceNow, Inc. Q1 2023 Earnings Conference Call. I would now like to turn the call over to Darren Yip, Vice President of Investor Relations. Please go ahead.

Darren Yip: Good afternoon. And thank you for joining ServiceNow’s first 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’ll review our first quarter 2023 results and discuss our guidance for the second quarter and full year 2023. Before we get started, we want to emphasize that 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 the 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 revenue, remaining performance obligations, or RPOs, current RPOs 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 very much Darren. And thank you everyone for joining us today. ServiceNow had an outstanding first quarter. Subscription revenue grew 27% in constant currency, which was 150 basis points above the high end of our guidance. cRPO grew 25% in constant currency, a 100 basis points above our guidance. Operating margin was 26%, two full points above our guidance. We have 66 deals greater than a $1 million in net new ACV. We saw a strong, sustained demand to ServiceNow’s platform. In January, we committed the company to performing beyond expectations. We said it, we did it. Our Q2 guidance reflects our strong conviction in the fundamentals of this business. We remain laser-focused on net new innovation, new business growth and profitability.

ServiceNow is a growth company that consistently executes in any environment, and we will continue to do exactly that, execute. Looking at the big picture, there is no question this remains a complicated macro environment, C-Level leaders are managing an endless array of headlines and mixed signals. When you filter all that noise, it comes down to one simple reality, there is an app for everything, but nobody wants every app. This consolidation is a tailwind for ServiceNow as the intelligent platform for end-to-end digital transformation. We are now seeing conversations up level to business transformation. This is bringing CEOs directly into the process as principal executive sponsors. Nearly 40% of CEOs think their company will no longer be economically viable in a decade if they continue on the current path.

They aren’t interested in turf battles between departments, they want enterprise level investments to drive business impact. This isn’t merely an inspection of what historically has been a big call center, this is CEOs engaging on a strategic level, insisting on a clear roster of technology partners to drive very specific business outcomes. For example, when it comes to technology in the age of generative AI, it’s a build, buy, operate conversation. They are looking for a single platform that can orchestrate the entire technology value chain. ServiceNow does just that. Businesses are also working hard to transform their customer experience. The AI opportunity here is when you integrate the front, middle, and back offices to better serve that customer.

This is a ServiceNow core competency. On the internal side, it’s about reducing the number of touchpoints for employees to get work done. People can’t maximize their potential by juggling multiple systems with different user experiences. Our customers use ServiceNow as the one-stop digital hub to create a consumer grade experience at work. Whether it’s efficiency, productivity, cost takeout, or business model innovation, ServiceNow has never been more relevant. This is a message I hear directly from CEOs who know they need to shake things up and they want our help to do it. Once again, these secular trends are fueling ServiceNow. About 70% of global tech equity value comes from firms that rely on network effects, and we see growing platform adoption across all of our businesses.

ITSM was in 18 of our top 20 deals with three deals over $1 million. ITOM was in 14 of the top 20 with five deals over a $1 million. With increased focus on cost takeout, ITAM had a very strong quarter in 14 of our top 20 with three deals over $1 million. Security and Risk were in 12 of the top 20 with three deals over $1 million. Customer workflows was hot in Q1 in 18 of the top 20 with nine deals over $1 million. And this is worth emphasizing because ServiceNow is more relevant than ever as businesses invest in a differentiated experience for their end consumers. Very exciting indeed what we’re doing with customer service management. Employee workflows was in 10 of the top 20 with four deals over a $1 million. Creator workflows was in 18 of the top 20 with three deals over a $1 million.

Major global brands continue to accelerate their own transformation by working with ServiceNow, Marriott, Grupo Bimbo, Navy Federal Credit Union, Travelers, the U.S. Air Force and Schneider Electric, just to name a few. Look at banking as one example. PNC works with ServiceNow to modernize the way it manages disputes, which will reduce losses and improve case closures. We also saw major co-innovation milestones in the quarter. For example, ServiceNow and AT&T have created a global telecom product to help communication service providers manage 5G and fiber network inventory. Q1 was also the latest step forward for our organic innovation machine. The ServiceNow Utah release was engineered to drive faster business outcomes for our customers. The release includes AI-powered process mining, with robotic process automation capabilities, additional search enhancements, expanded workforce optimization and health and safety incident management.

These are all designed to help increase automation, simplify experiences and offer greater organizational agility. It bears repeating that while customers are aware of market excitement for individual technologies like generative AI, they expect a platform strategy to integrate the various tools. ServiceNow has AI, process mining, RPA, low-code and many other technologies built natively into a single workflow automation platform. Of course, we will have much more to say about all of this at our Knowledge event in Las Vegas on May 16. I hope you can join us. I’d also like to extend a warm welcome to Deborah Black, Vice President, Engineering at Netflix, who is the newest member of ServiceNow’s Board of Directors. We’re so proud to have Debbie’s leadership on our journey to be the defining enterprise software company of the 21st century.

In closing, I’ll simply reiterate things we’ve said consistently. First, businesses need ServiceNow. Enterprise software is mission-critical, the demand environment is robust. Second, ServiceNow is a unique company performing at a very high level. We are delivering strong growth, aggressively managing costs and creating immense shareholder value. The company has momentum everywhere. We’re performing very well across the best places to work scorecards including Glassdoor. Our brand recognition is increasing as we rise on lists like Fortune’s Most Admired Companies, our market opportunity is expanding, and this is the early days of a truly generational growth story. Finally, we know the trust is the ultimate human currency. What we have here is a platform, a culture and a company that is built entirely on trust.

The results tell that story. We just eclipsed the $2 billion threshold in a single quarter, and we were the fastest ever to do that on an organic basis. This is about a fast growth, durable, predictable cloud business model. This will be the red thread at our Financial Analyst Day in a few weeks. We look forward to seeing you all there. Businesses work with ServiceNow, people work with ServiceNow, the world works with ServiceNow, and we’re only getting started. I’d like to thank you very much for your time today. I’m looking forward to your questions. And for now, I’ll hand things over to Gina.

Gina Mastantuono: Thank you, Bill. Q1 was a tremendous quarter with strong beats across our top line and profitability guidance metrics. We saw resilient demand as the Now Platform continues to deliver the productivity improvements enterprises are looking for in the current macro environment. The quarter was yet another example of consistent execution from our team. In Q1, subscription revenues were $2.02 billion, growing 27% year-over-year in constant currency, exceeding the high end of our guidance range by 150 basis points. RPO ended the quarter at approximately $14 billion, representing 24% year-over-year constant currency growth. Current RPO was approximately $7.01 billion, representing 25% year-over-year constant currency growth, a 100-basis-point beat versus our guidance.

From an industry perspective, energy and utilities, government and transportation and logistics led the way, followed by strong growth in education. Financial services net new ACV also continued to grow despite a tough comp and volatility in the banking sector. New customer ACV growth remained an area of strength, and the average deal size was up significantly year-over-year. Our renewal rate was a best-in-class 98% in Q1, continuing to demonstrate the stickiness of our business as the Now Platform remains a mission-critical part of our customers’ operations. Our customer cohorts have also continued to show solid expansion. We ended the quarter with 1,682 customers paying us over $1 million in ACV, up 20% year-over-year. We’re continuing to see healthy customer engagement with enterprise buying patterns demonstrating the extensibility of the Now Platform.

We closed 66 deals greater than $1 million in net new ACV in the quarter, up from 52% a year ago. In Q1, 18 of our top 20 deals contained five or more products, showcasing how ServiceNow is providing customers the single platform they need to orchestrate their technology value chain. Turning to profitability. Non-GAAP operating margin was 26% and 200 basis points above our guidance, driven by continued disciplined spend management. Our free cash flow margin was 35%. We ended the quarter with a robust balance sheet, including $7.2 billion in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of world-class growth and profitability. Moving to our outlook. Our pipeline continues to look robust for the remainder of the year, and we’re excited about what the Utah release and Now’s 2023 can further contribute to those opportunities.

While we’ve seen market resiliency, we continue to prudently factor in the evolving macro cost with each of our guidance. As Bill mentioned, we remain laser-focused on balancing net new innovation and new business growth with cost management and profitability. With that in mind, let’s turn to our 2023 guidance. We are raising our subscription revenue outlook by $25 million at the midpoint to a range of $8.47 billion and $8.52 billion, representing 23% to 23.5% year-over-year growth on both a reported and constant currency basis. We expect subscription gross margin of 84%, operating margin of 26%, a free cash flow of 30%. And we continue to expect GAAP diluted weighted average outstanding shares of 206 million. For Q2, we expect subscription revenues between $2.04 billion and $2.045 billion, representing 23.5% to 24% year-over-year growth on a constant currency basis, excluding a 50 basis point FX headwind.

We expect CRPO growth of 22.5% on a constant currency basis, excluding a 50 basis point FX tailwind or 23% on a reported basis. We expect an operating margin of 23%, and we expect $205 million GAAP diluted weighted average outstanding shares for the quarter. In summary, Q1 was a very strong quarter. We’re extremely proud of our team’s performance, and we can’t thank our employees enough for their continued hard work and dedication. It’s their collective commitment to our culture that has enabled us to be named one of Fortune 100 Best Companies to Work For, yet again in 2023. The consistency of our results exemplifies the strength of our platform and our people. We’re delivering great experiences that drive powerful employee engagement, fierce customer loyalty and significant productivity gains.

ServiceNow’s intelligent automation is a deflationary force that helps enterprises retool their business to get more done with less. And since we use the Now Platform ourselves extensively, we continue to see the benefit from those efficiencies, generating incremental opportunities for further operational leverage. That’s why ServiceNow is so well positioned to become the defining enterprise software company of the 21st century. You can hear more about that momentum in our new products and long-term opportunities at our upcoming Investor Day on May 16 in Las Vegas. We look forward to seeing you there. And with that, I’ll open it up for Q&A.

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Q&A Session

Operator: The floor is now open for your questions. Our first question comes from the line of Mark Murphy from JPMorgan. Please proceed.

Mark Murphy: Thank you very much and congratulations on another excellent quarter. So I wanted to ask CJ or Bill. You seem to be in a great position to embed AI into your Pro SKUs and try to unlock new efficiencies. Can you speak to how you see that opportunity playing out? And as chat bots become more powerful, do you see that affecting the headcount or seat count of a typical IT helpdesk or a contact center if you try to project that forward a few years down the road?

CJ Desai: Mark, first of all, thanks for the question. Here is what I would say. When we started the ITSM Pro journey in 2018 Q4, the exact question was asked because we embedded machine learning and AI into ITSM Pro. And that was a game changer, both for our customers and our shareholders. When I look at specifically generative AI, we absolutely believe that besides our core machine learning and AI features that are in platform today, it is a clear ‘and’. And this particular and versus an or provides more productivity not only for the employees of our customers, but for the customer service agent or IT agents as you asked. And wherever we can capture that additional value, we will monetize that further via additional SKUs that we offer on top of our current offerings.

So overall, I feel very good about generative AI and what it does for our business. And we have learned a lot through our ITSM Pro traction over last – four years now, four-plus years, and I feel very optimistic for next three to five years related to it is an accretive to our top line.

Mark Murphy: Excellent. Thank you very much and I’ll stick to the one question limit.

Operator: Our next question comes from the line of Brad Sills from Bank of America. Please proceed.

Brad Sills: Wonderful, thank you and great to see a nice start to the fiscal year here, I wanted to ask a question around the non-IT mix. If you take customer and employee, plus creator combined, it’s 43% of new ACV this quarter, which is the highest I can remember. The question is, what is it about Now that you’re seeing success kind of taking ServiceNow outside of the IT department? Obviously, you have these great products to address more workflow automation. But is there something about the go-to-market, whether it’s direct or in the channel that you’d call out here where you’re seeing that real traction outside of IT?

Bill McDermott: Yes. Thank you very much for the question, Brad. And I think it underscores the importance of ServiceNow becoming the intelligent platform for end-to-end digital transformation. As I said, the C-level decision-makers now, CEO, the CFO, obviously the Head of Technology, along with the Head of HR and the various other departments in the company are aligning their business strategy on technology platforms that truly matter and can impact business results, and they’re moving away from the app of the day and platforms that don’t matter. They’re also taking antiquated platforms and building our innovation on top of them. So if you want to think about our unfair advantage, we actually started in IT and have extended that beautifully into HR, into the customer service management and into creator.

Think about the importance of creator. 75% of the app development that will take place in the next two years will be done by the customers themselves on a low-code platform like ServiceNow. We feel we have a pole position. Customer service management, everybody is trying to align the front, mid and back office to give a seamless, self-service, direct-to-consumer experience on the mobile. It’s our core competency. And when you think about the employee experience, there’s wonderful systems of record out there that do what they’re supposed to do, but our expertise is really taking a technology view of recruiting, hiring, onboarding, providing all the services and with generative AI actually giving the employee next best action and fundamentally changing the game on the productivity curve.

All of this is aligning the executive team around platform strategy, and our teammates here at ServiceNow are proud and confident in that platform. They can tell the story by industry, by persona, and they can bring countless examples to the first meeting now, and they’re aligning the executives. One of the biggest requests we get is, hey, can we have an off-site with our entire management team with your team so we can figure out the best next step for the relationship? That’s a very different outcome than we were doing four years ago, where it was a more land-and-expand kind of approach.

Brad Sills: Great to hear. Thanks so much, Bill.

Bill McDermott: Thank you very much, Brad.

Operator: Our next question comes from the line of Keith Weiss from Morgan Stanley. Please proceed.

Keith Weiss: Excellent. Thank you guys for the question. Congratulations on a really nice start of the year. I want to dig in a little bit on the thread that Mark Murphy started pulling out in terms of the impacts of generative AI. And the question that I get a lot from investors is, does it necessitate that ServiceNow has to change their pricing model? And is there an ability to do that? So maybe if you could kind of walk us through, like as this functionality creates more automation and it’s more just the workflows in the platform, the data in the platform that’s driving the value, is there a necessity or a potential of changing the pricing model to be more consumption or volume-oriented versus like a seat-based model?