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ServiceNow, Inc. (NYSE:NOW) Morgan Stanley Technology, Media and Telecom Conference 2022 March 9, 2022 6:00 PM ET

Company Participants

Gina Mastantuono - Chief Financial Officer

Conference Call Participants

Keith Weiss - Morgan Stanley

Keith Weiss

Excellent. Thank you, everyone, for joining us. My name is Keith Weiss. I run the US equity research effort around software at Morgan Stanley. I'm very pleased to have with us from ServiceNow, CFO, Gina Mastantuono.

Gina Mastantuono

Thank you. You did well.

Keith Weiss

I've got them both right this time. Before we get started, for important research disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.comresearchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

Excellent. So with that out of the way, again, thank you for joining us, Gina, and welcome back to the TMT Conference.

Gina Mastantuono

Thank you.

Keith Weiss

The last time we held this in person, you were kind enough to join us with Bill. And I think you're about three months onto the job at that point.

Gina Mastantuono

Not even. I think it was a-month-and-a-half onto the --

Question-and-Answer Session

Q - Keith Weiss

A month onto the job. Yes. So how has it been going?

Gina Mastantuono

It's been going pretty well, considering the crazy environment that we've been in, in the last two years. And so I often say, I started in January of 2020 and 60 days in, COVID happened. So quite an interesting journey the last two years, but incredible progress that we've seen at the company.

And I think it's a testament to the capabilities of the platform and really the ability to help drive incredible employee and customer engagement, as well as productivity and efficiency, which today seems more relevant than ever.

Keith Weiss

I want to dig into one of the points you made there, the platform story. I think that's one of the elements that both you and Bill often highlight. It's that ServiceNow is transitioning from an ITSM solution or a IT-focused set of products to now as a platform play. Can you talk to us about kind of what that means to be more of a platform strategy and where we are in that transition?

Gina Mastantuono

Yes. It's a great question, but unique in that, if you ever have the opportunity to speak to Fred Luddy, who is the founder of ServiceNow, he'll tell you that the vision from day one was about platform, right? But no one understood what it meant. And so, he had to drive use cases.

And the first use case, that made a lot of sense -- he was a developer, right? So IT use cases came natural. And so, we started out that way and have evolved really naturally and organically, because of the platform approach and the customer-centricity. And so, we've actually evolved our product portfolio based on what the customers were asking for and what the customers were using.

And so, yes, we lean very heavily into IT, which I think has served us really well, because we're the trusted ERP of IT. And as we are really evolving this digital transformation trend that we're seeing, the ability to be that trusted adviser to the IT organization, but be able to expand now more broadly across the enterprise into employee, customer, front and mid-back office has been really unique.

And so, I'd say, the journey is early stages still, but we have absolutely morphed our go-to-market from product point selling to solution selling. And so, you'll hear Bill talk about it, you'll hear me talk about.

But you'll hear, more importantly, our sales folks talking about, how it's a better-together story and how IT with CSM or IT with employee really helps drive greater efficiency, greater engagement. And you'll continue to see us do that and lean into that, because that's really where I think the value of ServiceNow is for all of our customers.

Keith Weiss

Got it. And where do you think we are in sort of the customer recession side of the equation? Its one thing to sort of broaden out the solution portfolio and have the CSM solutions and HR onboarding solutions. It's another thing to get customers to understand that there's a broader product portfolio and to understand the extensibility of what you could do on top of that platform. So how has that side of the equation been evolving?

Gina Mastantuono

Yeah. It's a great question. It's been evolving really well. And if you think about -- Bill is just an incredible orator of our capabilities, and his Rolodex is enormous. And so, really maintaining and managing and getting C-suite to understand the capabilities of the platform has been phenomenal. And it's not just about customers.

Our partners are leaning in …

Keith Weiss

Yeah.

Gina Mastantuono

… really extensively with us and heavily. Seven out of the 10 large providers -- partners, sorry, have really leaned in and committed to $1 billion businesses with us over the next few years with the three remaining planning to commit this year. And so partners play an enormous part of the story for us.

And then, if you think about the inflection point that we've been seeing in EMEA and APJ, they're a little bit behind the trajectory on the platform story, but you've seen the acceleration there as a result of really understanding the capabilities of the platform.

And I think customers are leaning into platforms more and more. I'm sure you're seeing it throughout these last three days and really understanding that the value of the trusted platform that you're using multi-functionally across the enterprise is going to continue to add productivity and efficiency throughout the organization.

So early days but great traction and great understanding, I think, it's why you were able to see our net new ACV acceleration in 2021. We feel really good about the trajectory that the business has been on as well as pipeline into 2022.

Keith Weiss

Got it. Two-part question here, so I was -- the other is on Monday afternoon. And I was looking at reports we wrote coming out of the TMT Conference in March 2020. And it was really sort of how to frame the risk exposure to sort of COVID on a go-forward basis because, we're all worried about the sort of follow-on effect or second derivative effects.

And there's a little bit of a mimicking there now with the Ukrainian conflict. And we're worried about the second derivative impacts from higher resource costs and a potential slowdown in Europe and even in the U.S.

So the two-part question there. One, how are you feeling about the demand environment? Are you seeing any impacts on your pipeline? Or do you think you're seeing anything on the ability to close? And then, I'll come back with a second question.

Gina Mastantuono

Okay. So with respect to current demand and current pipeline, its early days but we've seen no slowdown. Pipeline remains strong. Demand remains strong, but it's early. But what I would say -- and I think, COVID kind of helped us think through and helped customers think through, if there were knock-on recessionary impacts, for example, it's not going to be in isolation. It's going to be in the backdrop of return to work, distributed work environment, more so than ever. It's about, war for talent and Great Resignation that we've been seeing.

Keith Weiss

Right.

Gina Mastantuono

And so, most customers and companies that are thinking ahead are really leaning into efficiency, productivity. If you think about distributed workforce, I think during 2020, when people were thinking about return to work, they thought it would be more business as usual the way it looked before. I think, we've really come to the conclusion that that's going to look very different.

So how do we keep employees engaged, productive and efficient in a distributed work environment? The platform is so well positioned to take advantage of that. And to help customers really drive productivity.

And so I think that what you would have seen two years ago is very similar to what could potentially be happening if we were to see some knock-on effects of the unfortunate crisis that we're seeing in Ukraine and Russia play out.

Keith Weiss

Got it. The second part of the question was -- so one of the things that we did, like a four-by-four table where you see potential risk, and one of the things we were worried about was software companies that have high value, high ticket price solutions that depended strongly on direct sales forces that go to the customer site and assess, they had a bunch of people getting in the room and deciding this is how we're going to move forward with the strategic objective. And that was the ServiceNow model. That's how you guys sold. But you guys sustained growth well in 2020. You've seen accelerating growth through 2021 without getting back on planes.

So I guess the question is, how do you do it? How do you guys evolve that sales model to work as efficiently in the current environment as it did prior? And does that help you guys be more efficient on a go-forward basis from here when we are going to get back on planes?

Gina Mastantuono

Yeah. I think -- so there's two pieces of the answer there. So first and foremost, we invested heavily in digital sales and marketing initiatives that have been really effective in this environment. And that will help us as we think about return to work and what that looks like going forward. And I think there's absolutely opportunity there.

That being said, we're coming from a period of zero travel, zero really in-person events. And so there will be an increase versus the baseline of zero. There's going to be real opportunity though because it's going to look different. You're not going to have to be on a plane as much. In-person events are going to look differently. And so there's a real opportunity to utilize some of those savings to continue to reinvest back into the business on R&D, go-to-market, feet on the street and growth.

And so I think there's a real opportunity to continue to lean into what's been working well. But at the end of the day, there is nothing to -- and you will see it today. I'm so excited to be back in-person. It's a different interaction with investors when you're meeting face-to-face. It's the same with customers, right? So I think there's an opportunity for some efficiencies, but there's nothing that takes the place of in-person.

The other piece that I think we were fortunate of and it's part of the business model that 80% of our business comes from existing customers. So they know the value that the platform provides. And so really being able to sell to customers who know you, who've experienced your value-add is a much easier sell than a new land, right? And so we've been leaning in, continuing on new lands, but our expansion rates even at our scale have been pretty impressive, and that's all about the value-add of the platform.

Keith Weiss

Got it, got it. I want to shift gears and talk about the goal that you guys laid out at Analyst Day. ServiceNow wants to be the defining enterprise software company of the 21st century. And the revenue targets on that is $10 billion in subscription revenues by 2024, $15 billion by 2026. Can you help us understand, the current solution portfolio, where is the legs of growth, if you will, that can get you to that $15 billion, kind of, trajectory over a really fairly short period of time in just five years?

Gina Mastantuono

Yeah. It's a great question and one that I think is pretty incredible at our scale to be able to say that all organically. And I think there's -- the thing about it is that there's multiple vectors of that growth. So it's not one particular area. And so if you think about our current product portfolio and our current customer base, we talked about in May that just with our current customers and current products, there's the ability to grow 5x our ACV. And that's all about the platform, right? It's all about really leaning into customers who only have one or two workflows and really being able to help accelerate time to value, help accelerate productivity and efficiency. Less than 20% of our customers today have three or more workflows, right? So, the white space for up-sell and cross-sell remains phenomenal. So that's one vector.

If you think about our penetration in the US, which is by far our largest penetration, I think Gartner says IT is like 50% penetrated. We're taking out legacy homegrown systems. There's no reason why that 50% is not 80% and 100%, so a lot of continued white space on IT. And then if you think about outside the US, where penetration is quite low comparatively, there's such opportunity in both Europe and APJ.

And then if you think about the innovation that we've been pulling through the platform, if you think about AI, machine learning, you think about our enterprise and pro SKUs, there's continued upside and penetration that we can continue to drive there. So those are three levers that I would say are pretty meaningful in our path to $10 billion by 2024 and $15 billion plus in 2026.

Keith Weiss

Excellent. Thank you for that correction there; helps my model. You and Bill have both been very vocal about the organic growth imperative and how important it is to grow that business, grow the platform organically. Can you talk to us about why? We've seen other companies use M&A as a strategic tool to quickly enter new markets and get time to market value. You guys have not done that, by and large, at all. Why is organic so important?

Gina Mastantuono

Well, I think that we've been -- one of the reasons for our success has really been our approach to M&A in that we've been doing these tuck-in talent and technology acquisitions, re-platforming on our platform, which really allows much less complexity for the customer, right? The cleanliness of the platform is definitely a value-add that our customers really appreciate. And so first and foremost, the ability to get to $7 billion, which is our guide for this year in revenue almost all organically, is testament to the success of that strategy.

That being said, and I get this question all the time, is there a place for large M&A in the future? We never say no, right? But it would have to really drive incremental customer value. It would have to make sense from a financial perspective on the investor side and shareholder side. And we just haven't found anything that ticks all that boxes to-date. And so it doesn't mean we won't in the future, but it's certainly not the focus for our strategy at the moment.

Keith Weiss

Got it. Got it. On the other side of the coin, you guys have been very aggressive in partnering, right, and having partnerships to create that ecosystem and to create and extend the workflows in terms of what you're doing around some of your core systems. In that vein, can you talk to us a little bit about the Celonis partnership that you announced last October. Both -- I think it's a fascinating partnership. And I'm talking to Celonis tomorrow. So I could use some notes on what I should be asking them about.

Gina Mastantuono

Perfect. So yeah, I think we've had a really disciplined approach to M&A. And that really means that we're focused not only on M&A, but right, it's the build versus buy versus partner. And so we've had real success in technology partnerships. And Celonis is a great example. It's a global partnership. And if you think about the opportunity to really drive value from investments in IT, right, many, many customers are not realizing the full value because they don't understand and they can't see the bottlenecks and the processes, right?

And so Celonis is purpose-built to identify the bottlenecks and the issues. But then what? And I speak to people all the time and people are like, "I know a lot of customers. They have all this great data about the process inefficiencies and problems, but they don't know how to solve it." So you combine Celonis' process mining, identifying the issues with ServiceNow system of action to help resolve it, then you have an end-to-end that really drives value for the customer in a way that it's pretty compelling.

And so it's early days. It's just started. I know the Celonis team is really excited about it as are we. And I think that it's a unique way to think about really accessing new buying centers. Like Celonis is really big in the office of the CFO, we're really big in the office of the CIO, and how can we continue to drive value for our customers across the board. Partnership is a unique area of focus for us that, I think, we're able to really lean into well.

Keith Weiss

Yes. And so from like a high-level perspective, Celonis takes the X-ray, understands where there's blockages, and then Bill McDermott is the heart surgeon who comes in there and fixes it and makes everything work.

Gina Mastantuono

ServiceNow is the heart...

Keith Weiss

ServiceNow is the heart surgeon.

Gina Mastantuono

That fixes it. Exactly.

Keith Weiss

Got it. So digging into -- more into the -- now the platform workflows. I want to start on platforms with -- it's showing up in a lot of your big deals, 19 out of the 20 top deals in Q4 2021. And I think you sort of mentioned that. This is where you can put the ad hoc workflows. This is where you can create efficiencies and process improvements and stuff that you have and particularly targeted.

On the other side of the equation, is it like it's easier to show someone sort of and sell someone a solution of like ITSM is for your ticketing workflow and getting someone to understand sort of the potential of the platform is harder. How have you guys been able to do that and get that platform into so many of these large deals?

Gina Mastantuono

Well, I think first of all, the fact that we're so strong in IT is a huge differentiator for us, right? So we are the trusted, secure, scalable platform that IT organizations are using. And so if you think about the application proliferation that has happened in many customers, you speak to CIOs, like that's such a headache for them, to secure, to manage. And so being able to be the platform that's the trusted platform of the IT organization, and today, more than ever, with security at such an important stage of where we are, really having a secure platform, the businesses are really looking more to IT to help them really in this than ever before.

And so we put a goal out there back in May at Financial Analyst Day that the percentage of our net new ACV that comes from our creative workflows going from 13% in 2021 to 20% in 2024. You're seeing that evolving and happening actually a bit more rapidly than we had originally assumed and estimated. And so, it's really a function of -- and all the thought leadership articles are out there around the number of applications that are planned to be developed in the next three to five years. There's not enough developers, real developers to do that. So citizen development is becoming more and more important than ever before.

And so I think you're seeing that in the value proposition. And the fact that -- again, it goes back to the platform story, that it's the same platform that you're using for IT, for employees, for customer, that you're able to use to really solve any of your workflow issues, whether it's front office, mid-office or back office.

Keith Weiss

Right. Can you talk to us a little bit about the competitive environment? Because we hear companies like Salesforce and Pegasystems or Appian and even Microsoft with Power Platform talking about those low-code/no-code platforms and really enabling more efficient app development. Who do you guys actually see in the marketplace?

Gina Mastantuono

Yes. I think we're seeing all of them in the marketplace. I mean they all have platform capabilities and low-code capabilities. Where I think we differentiate is we're able to build complex applications in days as opposed to months, right? Simple applications are easier to do. But the more complex ones, I think we're winning where the more complex applications are what they're trying to build. And so again, it's a one-platform approach. It's really being that trusted platform of the IT organization. And it's really where complex workflow orchestration is required. It's where you're seeing us win.

Keith Weiss

Okay, which is traditionally where ServiceNow wins, in the most complex and...

Gina Mastantuono

Correct.

Keith Weiss

Highest end environment. So switching gears from sort of what's the smallest part of the business today but from my perspective probably one of the biggest potential opportunities to the other side of the equation, we talk about sort of the ITSM part of the solution and biggest part of the business today, but the one where I hear the most investor concerns on sort of what's the forward opportunity there and how much is really left given ServiceNow's dominance on that side of the equation. So let me pose the question to you. What's the runway like in core ITSM? How much is left on the table?

Gina Mastantuono

Yes. I mean if you think about what we've been able to do with respect to innovation and automation, machine learning, AI, our premium SKUs with Pro And Enterprise, we talked about being 30% penetrated at the end of Q4 in a Pro SKU. Enterprise is early days, right? And so there's a lot of runway still. We talk about 7,000 customers. While there's tens of thousands more customers, commercial and larger, that we don't play -- and again, it's ripping out legacy, right, systems. And so there's continued upside even in the US market. And then look outside the US We are doing phenomenally well but very underpenetrated outside the US.

And so there remains continued opportunity. And the TAM for this business just continues to grow. When we IPO-ed, you'll remember -- I think the TAM, they said, was $1 billion. It's up to $6 billion now and I think that that's under-indexed, right, if you think about the real value add that we can provide throughout the ecosystem. So it's not going to grow at the same speed of a creator or customer, obviously, but there's still strong opportunity and runway ahead of us even in our core.

And that's just ITSM. Forget about -- add all the IT, ITOM, ITAM, security asset management. Think about security and security workflows today being more important than ever. Think about risk. All of that is part of our IT portfolio, and there's really strong growth in all of those areas.

Keith Weiss

Yes. And we've seen that pick up over the last couple of quarters?

Gina Mastantuono

We have, absolutely.

Keith Weiss

Last May, you announced the acquisition of Lightstep in the observability space, very kind of small, kind of nascent technology in the durability space. One that is fascinating to me because we hear about that integration a lot between sort of the observability vendors and almost similar to somebody said where -- this is where you identify the problem and then ServiceNow is where you solve the problem. What's the vision for Lightstep within the ServiceNow portfolio?

Gina Mastantuono

Yes. It's a great question. I get it all the time. As you would imagine, we're so excited about the acquisition of Lightstep and thinking about observability. And where they differentiate is in the distributed architecture, so born in the cloud companies and really being able to gain insights into the DevOps environment and really be able to then remediate and fix any issues in real time. And this is where it's another better-together story, Lightstep plus ServiceNow.

A great example is a customer, Zalando, which is a big e-commerce customer in Europe, was a Lightstep customer and a ServiceNow customer. In Q4, they're big at margin e-commerce, right? They need to make sure that they're on 24/7, because it's their biggest demand. Really being able to get the insights from the system if there's any issues real-time and then using ServiceNow to help resolve those issues in real-time to keep everything going in a high demand environment, just incredible. And so you'll see more of that.

We've been -- it's been a separate go-to-market machine until Q1. We're starting to co-sell together. But I think you'll see more investment coming in the DevOps space from us as we think about -- it's a great interplay similar to the Celonis on how to diagnose the problem. But diagnosis only gets you so far, you need to solve it. And so it's another better-together story, and you'll see more of us -- more investment in that area.

Keith Weiss

Basically closing that between signal and action.

Gina Mastantuono

Exactly.

Keith Weiss

And remind me, Lightstep, is that wrapped into the premium SKUs? Or is that offered as a standalone margin?

Gina Mastantuono

Standalone, not part of the…

Keith Weiss

Okay. So that's a further upsell into the…

Gina Mastantuono

Correct. Exactly.

Keith Weiss

Got it. So we're running short on time. Customer and employee workflows, we're very excited about, but I'm going to skip that for now. So can I talk to more CFO-level stuff?

Gina Mastantuono

Sure.

Keith Weiss

I want to talk to you a little bit about sort of the growth expectations into next year and the cRPO growth in particular. And one of the elements that I get a lot of investor questions for is, how we should think about the kind of duration and renewal-based dynamics around cRPO. Could you just remind us like sort of the headwinds and tailwinds, if you will, that we should be expecting in the year ahead?

Gina Mastantuono

Yes. We talked about it. It's not a huge headwind, but it is a small headwind in that we have a large renewal cohort coming up for renewal in 2022. And the fact that we're so Q4 weighted, right, it's going to impact 2022. I wouldn't say a little bit in a U shape. So if you think about a $100 deal that's coming out for renewal after Q4, right, it's $100 at Q4 cRPO, $75 in Q1, $50 in Q2 and only $25 in Q3. Now when we renew in Q4, it goes back up to $100 and higher because we usually have a high expansion rate, right?

And so you'll see kind of that little -- I won't say it's a U shape, a more of a hockey stick shape on cRPO, but it's not a huge impact. A point or so is impacting, but it is something that you should be aware of. But underlying health of the business and if you think about our renewal rates at 98% and 99%, it's just a blurb in the number and not really underlying issues with the business.

Keith Weiss

Got it. Got it. But then on a multi-year cycle, you do have a very good expiry base in 2022 compared to prior years.

Gina Mastantuono

That's right.

Keith Weiss

Right.

Gina Mastantuono

That's right.

Keith Weiss

Got it. And then I want to wrap up on operating margins. We like ServiceNow for a really long time, and part of the reason is the big market opportunity. Part of the reason is just how efficiently you guys have been able to grow in this marketplace. And we've always cited ServiceNow as having the best kind of underlying unit economics.

Can you just -- at the Analyst Day, you talked about consistent improvements in operating margins reaching 26.5% by FY 2024. But there's some nonlinearity in that. That's changed a little bit with some of the accounting changes around the depreciation schedules. Can you walk us through the puts and takes on how we should be thinking about, operating margins FY 2022 -- or gross margin and operating margins FY 2022, FY 2023 and FY 2024, just to make sure we're all on the right page here.

Gina Mastantuono

Yes. I mean it's a great question. And thank you because, I think the unit operating metrics here are pretty phenomenal at our scale. To be operating at the Rule of 60 is quite amazing. And part of that goes back to your first question on M&A and the cleanliness of the platform because our R&D investments really in the platform benefit all of our products. So that really allows us to continue to invest in a way that is disciplined on both top line and bottom line, right? And so, we talk about accreting margins, 300% from where we were, the guide back in 2021. That's when we thought we were reopening in 2021.

And so, let's just say 26.5% by 2024. But you're right, we had a change of accounting on our depreciable lives of our data center assets, right? So we're using them longer, so we can depreciate them a little bit longer. So it has a 100 basis point positive impact this year, which is offsetting the return of travel and in-person events. That's why our margins this year are flat. But it's what's enabling us to expect now instead of 26.5% in 2024 for our margins, 27%, because that 100 basis point improvement this year goes to 50 basis points by 2024. And it's linearity, right? So, 2022 will be 100 basis points. You can imagine about 75 in 2023 and 50 basis points by 2024.

Keith Weiss

Got it. And then at the Analyst Day, you talked about longer term or consistent 100 basis point improvement on a go-forward basis.

Gina Mastantuono

That's right. And that's the beauty of the platform, right, because the investments in innovation allow us as we scale to continue to invest and, when we're seeing leverage, put some of it to the bottom line, but also put some of it back in the business. And that investment is all around R&D, innovation and go-to-market feet on the street.

Keith Weiss

Outstanding.

Keith Weiss

Well, unfortunately, it takes us to the end of our time, but great to catch up on ServiceNow, fantastic growth story that you guys have been putting together for multiple years. I think you almost define the Rule of 60 on a go-forward basis. So congratulations on the success, and thank you for joining us.

Gina Mastantuono

Thank you. Thank you so much. It's so nice to be back in person. Thanks, everyone. Have a good one.

Keith Weiss

Thank you.

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