ServiceNow Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2022

There are 10 speakers on the call.

Operator

Good day, everyone, and welcome to the Second Quarter 2022 ServiceNow Earnings Conference Call. I would now like to turn today's call over to Darren Yip, Vice President, Head of Investor Relations. Please go ahead, sir.

Speaker 1

Thank you. Good afternoon, and thank you for joining ServiceNow's Q2 2022 earnings conference call. Joining me are Bill McDermott, our President and Chief Executive Officer and Gina Mastentuno, our Chief Financial Officer. During today's call, we who will review our Q2 2022 results and discuss our guidance for the Q3 and full year 2022.

Speaker 2

Before we get started, We

Speaker 1

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 our most recent 10 Q and 2021 10 ks 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 for non GAAP except for revenues, remaining performance obligations or RPO, current RPO and cash and investments.

Speaker 1

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.

Speaker 2

Thank you, Darren, and hello, everyone. We appreciate you joining us for today's call. ServiceNow's Q2 results once again Speed expectations on the top line and the bottom line. Revenue growth was 29.5% at constant currency. Operating margin was 23%.

Speaker 2

Both results were above our guidance for the quarter. Our 99% renewal rate Remains the industry's benchmark. We had 54 deals over $1,000,000 Our 27% Constant currency, CRPO growth is also strong. And looking forward for a moment, once you factor the large renewal cohort effect In Q3, our full year CRPO outlook is also strong. Like other premier technology companies, we are managing Through the current macro.

Speaker 2

As you'll hear from Gina, we're simply returning to the outlook we originally set for you in January of this year on a constant currency basis. Unlike others, while the currency effect also applies pressure on our margin, ServiceNow will maintain our full year margin guidance of 25%. We will absorb the impact through disciplined cost management as we run more efficiently on the ServiceNow platform. Looking beyond 2022, Our confidence in our mid term aspirations, which we raised earlier this year to $11,000,000,000 plus By 2024 $16,000,000,000 plus by 2026 is rock solid. In short, ServiceNow's ironclad fundamentals will not waver.

Speaker 2

The secular digital transformation tailwinds Are blowing stronger than the macro crosswinds. ServiceNow generates an unmatched combination Of organic growth and profitability at scale. We believe there is a generational value creation opportunity here on every level of our company. Therefore, we are hiring, expanding and investing for the future. Growth companies don't get stronger than this one.

Speaker 2

Before I hand things over to Gina, let me offer some additional color to underscore the state of the business. Enterprise software is an all weather industry. Some businesses out there are prioritizing enhanced productivity to lower costs. Others are evolving business models To stimulate growth, all of them know full well that digital technology is the only answer. That's why the demand environment for software is consistent and durable.

Speaker 2

Market research From IDC and several prestigious institutions on this call, I might add, have all affirmed the stability of technology budgets. We also see consolidation of enterprise software as buyers shift further away from experimentation with unsustainable solutions. So when you think about the technology sector, There are niche vendors, legacy leaders and platforms. ServiceNow is a platform company With strong demand in a fast changing world. And this is consistent with what we see from our customers.

Speaker 2

It's all about reprioritization. Customers are making significant investment with fewer platforms to drive faster ROI. As this process unfolds, while sales cycles can lengthen, deal sizes get bigger As more materials are negotiated into those agreements and we at ServiceNow are on the right side of the great Reprioritization. One customer summed things up well. She said, we have a capacity challenge, Not for ServiceNow, but for all the others that want to be like ServiceNow.

Speaker 2

It's time to standardize on the platforms we trust for the long haul. The current macro environment likely will ease overnight neither will the theme for automation As companies need to make money, save money and differentiate and they need to do all of that really fast. Aime has become the greatest asset of business. When you look at our results and our opportunity, it's clear evidence that digital transformation Is the only way forward. ServiceNow is helping our customers innovate to win.

Speaker 2

Our ability to execute This is another key point of confidence. This is a proven team. And what's happening here is about more than great business results. It's about honoring Fred Luddy's founding vision to change the paradigm of enterprise software. That's why from a technology perspective, ServiceNow has maintained a fully integrated workflow automation platform That gives everyone the great experiences they deserve.

Speaker 2

With artificial intelligence, robotic, process automation, Process mining and low code capabilities all embedded in our architecture, we make hyper automation about people. With 750,000,000 net new applications being built on the horizon, ServiceNow is leading the low code revolution. Our born in the cloud suite of applications stretches across the enterprise end to end. And all of our businesses Are performing extremely well. In Q2 ITSM was in 12 of the top 20 deals with 7 deals over 1,000,000 Itom was in 13 of the top 20, 9 deals over $1,000,000 customer workflows was in 14 of the top 20 Employee workflows 13 of the top 20 and creator workflows was in a remarkable 20 of the top 20.

Speaker 2

World class brands like Dun and Bradstreet, Banco Bradesco, Virgin Media Ireland and CDW Are some of the many selecting or expanding on ServiceNow. Adobe works with ServiceNow to transform the way it serves employees, Driving 30 percent Fast of Care Resolutions for everyday requests. NTT Data works with ServiceNow to generate end to end visibility of their ESG performance and they also provide ServiceNow's ESG solution to their own customers. Kings Hawaiian works with ServiceNow to streamline its end to end procurement operation. Frankly, ServiceNow has become the platform for digital business.

Speaker 2

And looking at SaaS businesses across the industry that have built $200,000,000 or greater in ACV businesses. It's important to call out that ServiceNow has actually accomplished That milestone was 11 businesses in our current portfolio and several of these businesses achieved That $200,000,000 plus figure faster than many prominent publicly traded software companies. So we see countless opportunities to build on this with expansion into additional adjacencies. And most of these adjacencies will be built on our platform, Like you're seeing with ERP Workflows, others might operate as integrated portfolio businesses that benefit from our strong installed base across the Global 2,000. And one example here is LightStep, which is delivering observability and incident response to some of the world's most innovative companies.

Speaker 2

Overall, ServiceNow is hitting its stride as a platform, As a business architecture and as a commercialization engine. And next up is our Tokyo platform release coming in September. I'm heading to Tokyo personally as this will be a major milestone in our growing commitment to the Japan market and our pursuit of our annual objectives. The final point I'd like to stretch is this fast expanding ServiceNow ecosystem. This is happening with some of our most strategic partners.

Speaker 2

Through our partnership with Microsoft, our technology workloads help customers streamline for migration of existing workloads to Azure. This is opening additional addressable market to ServiceNow by creating an expanded co sell motion with Microsoft Enterprise Sales and Public Sector Teams. This is about incremental net new revenue growth. We are not opportunity constrained. The need for digital transformation continues to grow and enterprise software remains a defining deflationary force In this marketplace, the ecosystem effect also applies to the talent marketplace.

Speaker 2

There's a massive opportunity The talented professionals who aspire to build their future on ServiceNow. And as an employer, While others in the tech industry are slowing or even stopping hiring, ServiceNow is hiring. We are hiring. We are doubling down on our talent brand and that's a reflection of our deep belief and the amazing potential of this company. Our customers and partners are also expanding their ServiceNow workforces at a record clip, which is another indication of the expansive cross enterprise adoption we are seeing for the ServiceNow platform.

Speaker 2

Finally, ServiceNow's impact solution is a critical piece of our ecosystem strategy. We are setting a new standard With respect to fast deployment and value realization, the faster we implement, the more we expand the use of the platform. It all adds up to a virtual cycle for stakeholders and for ServiceNow. In closing, We are confronting reality, but not conforming to it. Our Q2 beat on the top line and the bottom line Reinforces who we are.

Speaker 2

The digital transformation imperative will not shift to the sidelines. I would like to thank our customers, our partners and our shareholders for their continued trust and confidence in ServiceNow. We're proud to help you make the world work better for everyone. We will continue full speed on our growth journey To be the defining enterprise software company of the 21st century. We are resolute because now as ever the world works with ServiceNow.

Speaker 2

With that, I'll hand things over to Gina. Gina, over to you.

Speaker 3

Thank you, Bill. In Q2, we beat the high end of both our Constant currency subscription revenue growth and operating margin guidance, while maintaining our best in class renewal rate at 99%. Our business remains strong. Our opportunity is greater than ever. However, as Bill highlighted, our customers are feeling the effects Yip.

Speaker 3

So what are we doing? What ServiceNow always does, we're putting our customers front and center to deliver a great experience so they can retain their customers, to drive productivity so they can bend the curve on the bottom line, to reinvent their business model, so they can innovate to win and come out of this moment stronger than ever. We're continuing to invest in our powerful go to market and incredible R and D organization to drive future growth, While keeping both hands on the wheel and being disciplined with spend, we're leaning into our people path, Our commitment to our amazing employees, so they can do their best work and we can fulfill our purpose together. This is what the ServiceNow culture is all about. Turning to our Q2 results.

Speaker 3

Subscription revenues were $1,658,000,000 growing 29.5% year over year in constant currency. This reflects in over 300 basis points acceleration in growth year over year. RPO ended the quarter at approximately 11,500,000,000 representing 27% year over year constant currency growth. Current RPO is approximately $5,750,000,000 representing 27% year over year constant currency growth. At the end of June, We started to see customers elevate larger spend decisions to the C suite, resulting in elongated deal cycles.

Speaker 3

We've already closed several of those deals in July. And as Bill noted, this access to the C Suite has resulted in even greater exposure to the capabilities of the NOW platform. Our renewal and net expansion rates Remains very strong. Our renewal rate was 99% in Q2 for all regions, demonstrating the resilience of our business. The NOW platform remains a mission critical part of our customers' operations.

Speaker 3

We finished the quarter with 1463 Yip. Paying us over $1,000,000 in ACV, up 22% year over year and our largest customers continue to expand with us. We have now more than 100 customers paying us over $10,000,000 in ACV, up more than 50% year over year. From an industry perspective, technology, media and telecom led all other verticals growing net New ACV 100 percent year over year and our Better Together go to market positioning continue to resonate as we closed 54 deals greater than $1,000,000 in net new ACV with 16 of our top 20 deals containing 5 or more products. Turning to profitability.

Speaker 3

Operating margin was 23%, one point above our guidance, driven by operating efficiencies, partially offset by FX headwinds. Our free cash flow margin was 16%. We ended the quarter with a healthy balance sheet, including $5,400,000,000 in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of growth and profitability. Before I move to guidance, let me give you some context as to how we're thinking about the months ahead.

Speaker 3

While our business remains resilient, we do expect the elongated deal cycles that we experienced in the last couple of weeks of June to persist for the remainder of the year. We have factored that into our updated guidance. Additionally, Which I know is no surprise to any of you, we've continued to see an incremental strengthening of the U. S. Dollar resulting in further FX headwinds for the second half of the year.

Speaker 3

We expect the total FX impact to be a $220,000,000 headwind for 2022 subscription revenues and a $180,000,000 headwind for Q3 CRPL. We have a well diversified customer base With over 80% of our business in large global enterprises. As a result, we expect to sustain our best in class renewal rate. Over 85% of our new business comes from existing customers, which drives our robust net expansion and predictable growth. We also continue to see a very strong pipeline.

Speaker 3

At our recent Knowledge event, which some of you attended in Q2, We drove a 40% increase in pipeline year over year. We're confident that we're appropriately factoring in the macro trends as we see them today and will continue to be transparent as the remainder of the year unfolds. With that in mind, let's turn to our 2022 outlook. Primarily to reflect the incremental $87,000,000 headwind we've seen from FX since the end of March, we now expect subscription revenues We've seen $6,915,000,000 $6,925,000,000 representing 24% year over year growth, That's 28% growth on a constant currency basis, in line with the original outlook that we provided in January. We continue to expect subscription gross margin of 86%, up 100 basis points year over year.

Speaker 3

We continue to expect an operating margin of 25% as we currently plan to offset an approximate one point impact from FX with operational efficiencies and disciplined spend management. We will continue to monitor FX rates over the next couple of quarters. We now expect free cash flow margin of 30%, reflecting slightly lower collection as we expect to provide greater payment flexibility to support our customers when they need us most in this current environment. Finally, we expect diluted weighted average outstanding shares of $203,000,000 For Q3, we expect subscription revenues between $1,750,000,000 and $1,755,000 representing 23% year over year growth inclusive of a 4 50 basis points FX headwind. On a constant currency basis, we expect subscription revenue growth to be approximately 27.5%.

Speaker 3

We expect CRPO growth of 20% year over year or 23.5% on a constant currency basis. As I've discussed in prior quarters, this reflects about 2 points of headwinds due to our larger than average customer cohort that renews in Q4. Excluding this headwind, our constant currency CRPO growth would be 25.5%. We expect an operating margin of 25% and we expect 203,000,000 GAAP diluted weighted average outstanding shares for the quarter. Finally, we remain very confident in achieving our 2024 and 2026 Subscription revenue targets of $11,000,000,000 plus $16,000,000,000 plus that we provided at our Analyst Day in May.

Speaker 3

Our long term trajectory has not changed. In conclusion, ServiceNow has established itself as an enduring platform. Our execution is proven and we continue to lean into our great opportunity with operational rigor. We're accelerating our development cycles with our September Tokyo release to launch the powerful new products that our customers need now. We're doubling down and expanding our go to market programs for customers, including our top 250 marquee accounts to help them recognize value with greater business agility.

Speaker 3

We're being prudent with OpEx, but remain bullish on hiring go to market resources and the critical innovation roles necessary for future growth. And as always, we will remain disciplined as we evaluate our investments to ensure we generate the greatest ROI possible. These actions will enable ServiceNow to continue delivering strong growth and profitability on our way towards our future targets. We remain ever confident in our journey towards becoming the defining enterprise software company of the 21st century. Before moving on to Q and A, I just want to thank all of our employees around the world for their incredible dedication and commitment.

Speaker 3

It's your relentless focus on our customers' needs that makes us ServiceNow strong. With that, I'll open it up for Q and A.

Operator

Thank you. Today's question and answer session will be conducted electronically. Yip. Our first question comes from Kash Rangan with Goldman Sachs.

Speaker 4

Hi. Thank you very much for the question.

Speaker 5

I had a question for Bill. Bill, you talked about how deal sizes are becoming Larger, although there's some delays in sales cycles in certain segments of the market. Can you talk about the flip side coming out of these elongated deal cycles? What are the positive consequences for ServiceNow as these deals become potentially larger and one for you, Gina. Gina, you said that While the Q3 CRPO growth expectations have been reined in, it does look like the burden of CRPO performance shifts to Q4.

Speaker 5

Can you talk a little bit about how you sort of implied that you're keeping the year's ERPO relatively unchanged, which means that Q4 Is when we see the reacceleration. Can you talk about the dynamics there from the quarter to quarter perspective? Thank you so much.

Speaker 3

Sure, Kash. I'll take the CRPO question first. And if you remember, we've been talking about this several quarters now that with the renewal cohort that Q3 was going to be the bottom, right? So if you think about A renewal of $1,000,000 at the end of Q4. At the end of Q1, it becomes $750,000,000 end of Q2 $500,000 end of Q3 3, only 250, it will pop back up in Q4.

Speaker 3

And so Q3 is absolutely the bottom of that renewal cohort and we'll see that reacceleration as we move into Q4.

Speaker 2

And Kash, on the deal sizes, what you're seeing in certain cases Is lengthening deal cycles because I call this the great reprioritization where C level executives Are now looking at their business and they're saying, what are the platforms that we will team up with for the next decade? And they are prioritizing that list along the lines of which platforms make me more productive Where I can do a lot more with less because the work isn't going away even though you might have less people doing it. The second aspect is how do I grow and what channels will I need to innovate in to grow my business? And then finally, how do I differentiate against competition? Every industry has that marquee Company that seems to be out in front and lots of times companies either playing catch up or they simply want to have Yip.

Speaker 2

So they can do something their competitor isn't doing. On all those dimensions, we're now seeing the ServiceNow platform Chosen by especially the Global 2,000 as that differentiation platform to really get Business going either to save money or make money or compete better. And that is Big, because now we're not talking about a nice to have on the employee experience or better customer service management or even low code. We're talking about making that amazing platform the business platform for digital transformation for the world's largest companies. And I think Gina pointed out the $10,000,000 and above growing at 50% year over year.

Speaker 2

So even as You might need to wait a little bit longer in certain cases. When you do, it just gets bigger. And cash, I think this is now the moment With ServiceNow really gets a big, big tailwind from a macro that forces customers to really think deeply about where they're spending their money. And they're not interested in long drawn out projects that might take multiyear to get there. They have to perform for the capital markets

Speaker 6

now.

Speaker 2

So we are bringing a calling card. We bring a calling card with the fastest ROI in the enterprise, hard stop.

Speaker 5

Wonderful. Thanks so much, Bill, for the bold and confident message. Thanks so much.

Speaker 2

Thank you very much, Kash.

Speaker 3

Thanks, Kash.

Operator

We'll take our next question from Brad Zelnick with Deutsche Bank.

Speaker 7

Great. Thank you so much for taking the question. Gina, with the large Q4 renewal cohort coming up, is there any argument To try and get some of these deals done early, perhaps before the backdrop deteriorates further. And I imagine where inflation stands right now, customers might Be only too glad to lock in pricing. Is that part of the strategy?

Speaker 7

And just maybe a follow-up as well for Bill. Bill, everyone knows the environment has changed and I think we appreciate Why ServiceNow is only more important, but how do you distinguish environment first execution at times like these? And how do you feel your field organization is performing during these uncertain times. Thank you.

Speaker 3

Yes, Brad. I'll take that, the renewal cohort. So What I'll point to is our continued best in class renewal rates. Q3 at 99% Across the board in every geography during this macro environment gives me much confidence That the renewal cohort is solid, right? And so sometimes we renew early, sometimes we don't.

Speaker 3

We're having conversations Always with our customers to lean in to what they're trying to do and how we can help them back. I really tried to bring that together in the script by talking Yip. About how ServiceNow is focused always on the customer first and we will absolutely continue to do that and we'll meet our customers where they are always.

Speaker 2

Brad, it's a great question and I'll give you a little feel for How confident I am in the field organization. First of all, Kevin Haverty, who ran the field organization for over a decade as you know, He's still on the executive management team and putting special focus on public sector. Paul Smith, who is an industry veteran running global sales And he has a very experienced team and a tenured team in Europe, in Asia Pacific And Japan. And of course, in the Americas with our most tenured sales executive who hits Every quarter. So we have a really, really excellent team on the field.

Speaker 2

We also have a very diligent Attention to detail. As we run the business on the ServiceNow platform, that's why we can run so efficiently. And I actually have something we call the CEO of Digital Dashboard and I have a complete purview on the pipelines across the world. And if you look at them year over year, our coverage is better now than it was last year geographically and by industry and by persona. I'm very comfortable with where we're at and of course, I'm very comfortable with our ability to execute.

Speaker 2

Furthermore, I just want to give you Some transparency on the coverage model. We're doubling down on hiring as I mentioned. We will have a full capacity To achieve our 2023 objectives at the Q4 mark. So please know that we're covered and that actually intensifies Along the lines of each month in this year to actually expand. Furthermore, in our indirect For our digital sales effort, we're doing some very unique things there to not only cover existing, but also to get net new logos.

Speaker 2

And I did in the midst of the script did mention the Microsoft Azure arrangement Where we can actually take advantage of customers that are moving to the cloud and taking advantage of a hyperscaler That's doing very well in the enterprise that's also teaming their sales force up with our sales force to cover net new Revenue growth opportunity. This can happen at the IL-five level. It can happen at the sovereign government level And it can also just happen in net new logos where our strong market leading ITSM solution can get many new customers for ServiceNow. It's good for Microsoft, it's good for ServiceNow and I think it's also a tailwind that isn't really factored into our numbers.

Speaker 7

Excellent. Thank you so much.

Speaker 2

Thank you.

Operator

We'll take our next question from Raimo Lenschow with Barclays.

Speaker 2

Hey, thank you. Can you Bill, I guess the platform message and that's what we hear in the market as well. Can you speak a little bit to the components? And I'm specifically wondering, if I look at your slides, the customer and employee workflow this quarter In terms of contribution, it was slightly lower than in other quarters. Is that a thing that is not quite as strategic or build out as Yip.

Speaker 2

And that's why there's something going on there or maybe speak to there if something else was happened there. Thank you. Yes. Thank you very much, Liam. I appreciate it.

Speaker 2

Yes, don't read anything into, the perhaps Somewhat lumpy details on one workflow versus another in any given quarter. Employee experience is actually gaining momentum And we have a fantastic General Manager of that business who's been with us for many years along with our well known great Our leader of engineering, CJ. This is Blake McConnell I'm talking about. And he's got a great team. We just leveled all of our product Yip.

Speaker 2

About 10 days ago and the prospects and employee and customer is fantastic. We have John Ball, John Sigler, 2 industry veterans at the Yip. All those businesses are going to do absolutely fantastic. So don't look for 1 quarter or another To make any inferences, I think the employee experience in a world where headcount is going to be incredibly important as companies decide on their hiring case. They're going to need to create great experiences.

Speaker 2

They're going to need to aggregate all the services in one portal to give those employees the most productive Futuristic user experience possible to give them all their training and needs and make sure that they're serviced properly. On the customer service side, I just think what we're doing there on the mid and the back office to make the engagement layer come to life is extraordinary. So I am really pumped up about us as a platform company. And I think the bigger thing you should read into it is companies now as they go through the great REIT prioritization Looking at things they used to do in the 20th century, which is to double click, saying that's a lot And how quickly do I realize the benefits from that? And is there a way using the ServiceNow Enterprise workflow automation platform that I can leverage my processes, give people a great UI, Would also get business outcomes faster.

Speaker 2

And when I say faster, I mean some of the conversations are in quarter over than a half a year. And therefore, I think a lot of pressure will be on companies that tend to take a long time to get the value. The other thing which is new That came up very recently, but it's happening. It is companies that are in point solution where the customer said, I like RPA or I might like Process This or AI That, they're basically saying, look, are they going to be on my team 10 years from now as a Platform. And a lot of them are starting to consolidate those point solutions into the NOW platform saying you guys got that covered.

Speaker 2

And they're getting good economies of scale from ServiceNow when they do that. So again, all of that is new developments where I actually think the macro Could lean to a tailwind that's not in the numbers.

Speaker 4

Thank you.

Speaker 2

Welcome, Ringo.

Operator

We'll take our next question from Tyler Radke with Citi.

Speaker 6

Yes. Thanks for taking the question. Maybe we just go back to the specifics in terms of the deal slippage in the quarter. Was it A handful of large customers are these deals just now taking place in Q4? And then, Gina, just help us understand Your assumptions you've made around close rates and the overall environment, are you assuming that kind of the operating environment in Q2 holds for Q3 and Q4.

Speaker 6

Thank you.

Speaker 3

Sure, Todd. Sorry about that. So yes, If you think about the elongated deal cycles, I want to be really clear and transparent as I always try to be with you on how we're thinking about the back half. And so we're assuming that we'll have similar trends through Q3 and Q4 on close rates and elongated deal cycles. What we also are trying to emphasize is that the deals aren't going away, Right.

Speaker 3

They're elongated, but many of the deals that were elongated in Q2 have already closed in July. And so those Digital transformation tailwinds that we talked about, the platform relevancy that we continue to talk about is very relevant and as relevant as ever, Which is why we felt very confident and reasserting our mid and long term guide of $11,000,000,000 by 2024 and $16,000,000,000 by 2026. And so close rate, we are taking into account the macro environment that we see in place today. Our customers, we're leaning in more than ever with our customers and we feel good about our revised guidance that we're taking into account Everything that we're seeing in the marketplace today.

Speaker 2

Yes. And I think if you really look at it, Tyler, I mean, FX aside, We always said no one's outrunning the strength of the dollar in this environment and that was pressured of

Speaker 6

course because you've seen that

Speaker 2

play out in the market. And we also acknowledge that especially in theaters of operation that are more affected by the macro, You'll see a lengthening of the cycle because especially in markets that have grown accustomed to doing things a certain way, now they're in the great reprioritization. There is a time equation there, but there's also an expansion of the power of our platform that's not factored into the numbers and we'll have to see how that plays out in the back half. But what I can tell you is we have a plan. We have a very carefully thought through plan To actually not only get the deals that may not have come in at the time we wanted them, but they come in.

Speaker 2

But we also have a plan To expedite the ROI conversation at the point of discussion versus the point of proposal to get to the close earlier, So companies can factor a larger scale relationship with ServiceNow in. Many of them can't even believe How quickly we can get them to value because they may not be as aware, for example, of ServiceNow in Frankfurt as they might be in New York City. So we're making sure that we're bringing all dimensions of fast ROI, critical thinking and industry, Solution based by Persona and dynamite execution in Aegis GEO, not only with ServiceNow, but also with our partners to deliver that business impact. And what's changed in the environment? You didn't have to have so much on business impact when digital transformation was all the rage, You could land and just expand.

Speaker 2

Now I think you have to have that conversation, especially in the larger transaction and we're very, very well equipped to do that.

Speaker 6

All right. Sounds like you'll be busy on the road. Thanks a lot.

Speaker 2

Thank you, Tyler. Thanks, Tyler.

Operator

We'll take our next question from Phil Winslow with Credit Suisse.

Speaker 8

Hi, thanks for taking my question. One for you, Bill and one for Gina. Bill, obviously, you've operated in the software industry for multiple years and seen multiple different sort of global crises. I wonder if you can compare and contrast what you're hearing from executives that

Speaker 4

you speak to year to

Speaker 8

date versus, let's say, the beginning of COVID, European debt crisis, global financial crisis. What are you going to compare and contrast What you heard from executives during those periods versus now, maybe even sort of the KPIs that you're seeing in this business versus past businesses? And then Gina, Just to follow-up on the sales productivity side. Obviously, sales productivity, to your point, remains high. You also grew sales and marketing headcount 26%.

Speaker 8

Last quarter, you expected to grow headcount in the high 20s. Does that still hold? Thanks.

Speaker 3

So I'll take the second part, first and then I'll pass it over to Bill. So sales productivity remains strong and is better this year than even last year. And so we expect that to hold still and feel really good about where We're leading. We certainly have continued to hire feet on the street go to market. We're continuing to invest.

Speaker 3

We're not pulling back at all on Speed on the Street hiring. And so we absolutely expect to continue to see similar pace in the back half as we continue to hire quota bearing sales.

Speaker 2

And Phil, just on the idea of the global financial crisis and COVID Comparing that to this current environment, they're all a little bit different. But the one thing that they all have in common They were absolutely an elixir for cloud computing. So if you think about the global financial crisis, Phil, you remember I was working with a different software company at that time. And I tell the story in that September quarter how I saw €1,000,000,000 disappear in a day. That was very sudden.

Speaker 2

This hasn't been as sudden. And actually COVID evolved a little less suddenly as well. But that was the moment When everything moved to the cloud, remember, everything became OpEx, all budgets were controlled by the line of business executive. Well, now as you got through the global financial crisis and cloud computing became the pervasive computing theme of the 21st century, Cloud is what got you through COVID, because everybody had to work virtually and you had to enable productivity in a completely digital world, Because nobody was doing business in person. Again, cloud got you through it.

Speaker 2

In this one here, what you're going to see is cloud just gets reinforced. And I've always said that the infrastructure move to the cloud, the hyperscalers will all do great in this environment. And then there's only a couple of other SaaS platforms that matter. And while it may be a little bit lumpier in a macro that's reprioritizing things, those 5 platforms That have been defined by the marketplace will, I believe, do extremely well in this environment and it will be yet another proof point That is all about the cloud. Awesome.

Speaker 2

Thanks guys. Best of luck.

Speaker 3

Thank you, Phil. Thanks, Phil.

Operator

Our next question comes from Michael Turrin with Wells Fargo Securities.

Speaker 6

Hey, thanks. Good afternoon. Appreciate you taking the question. Gina, on the free cash flow side, clearly, you have the luxury of leaning into margin if growth is seeing impacts. You did mention just a minor step down on the margin you're expecting there tied to collections.

Speaker 6

Somewhat of a similar question to what you've been Getting on the other metrics, just wondering if there's anything you can add to put some context behind that, whether it's a certain industry or something you're seeing and then Confidence you have in the ability to use free cash flow to offset any moderation you're seeing for the rest of the year, I think is very top of mind for investors. Thank you.

Speaker 3

Yes, sure. So listen, I think you're absolutely right and we have the flexibility and the ability given our best in class margin structure to be able to lean in with our customers here, right. And so I want to be clear, it's slightly lower collections as we think about assisting our customers. And if you think about in industries that probably have a little bit of cash flow Or build up working capital given the supply chain constraints, right. Those are the industries that you would Thanks to see us leaning in with here.

Speaker 3

But again, it's a small impact to our free cash flow margin that From our perspective makes complete sense and it's really purely just timing. There's no concerns with respect To any bad debt assumptions or anything like that. It's just about allowing for and leading into a little bit longer Payment terms given the current macro environment. And so real strength here, it's all about being proactive and working with our customers.

Speaker 5

Helpful. Thank you.

Speaker 3

Thank you.

Operator

We'll take our next question from Keith Weiss with Morgan Stanley.

Speaker 9

Excellent. Thank you guys for taking the question. Gina, I think this one is For you and 2 for you. I think Kash was trying to put some words in your mouth and talking about sort of no change in the CRPO outlook for Q4. I wanted to ask you that question directly.

Speaker 9

Like are you guys adjusting your view on sort of the CRPO growth that you're exiting Q4 with? And Any chance that you give us that number so we have more of a sort of a perspective on sort of how we're entering calendar year 2023?

Speaker 3

Sure. Thank you. Listen, I'm not guiding to Q4 now, but what I wanted to make the point and I think What Kash was trying to allude to as well is, is Q3 the bottom when we think about that renewal cohort and how do we think about the back Right. And so you could imagine from our slight return to our January revenue guide That we are absolutely continuing and I was very explicit in my script that we're factoring in throughout the back half of the year Slightly longer deal cycles. And so that will impact Q4 CRPL.

Speaker 3

But again, Just the timing perspective, right? Why we are also very confident in reiterating our mid and long term goals of $11,000,000,000 by $24,000,000,000 $16,000,000,000 by 2026. So I know you love to hear a Q4 guide, give us a few more months and we'll give it to you then.

Speaker 4

I think all the investors

Speaker 9

would love to hear it. Q4 guide, it's not just me. The other question I have for you, Gina, was on the operational efficiencies. It sounds like it's not coming from headcount. It's not coming from slowing down hiring.

Speaker 9

Can you give us some visibility into where the additional operational efficiencies are going to come from in the back half?

Speaker 3

Yes. So a couple of things. So we talked pretty explicitly about not slowing down hiring on feet on the street go to market And on critical R and D resources, but we are being much more mindful and planful of other kind of support types of roles, As well as if you think about T and E expense, event expense, Marketing things, we're not touching anything that's driving demand. Just being really smart and disciplined, keeping You know the hands on the steering wheel, making sure that we're being disciplined about cost, while really not touching our feet on the street or critical fingers on keyboards engineers.

Speaker 2

Okay. Sorry, I cut you off. Go with your last question. Go ahead.

Speaker 9

No, I was just apologizing for cutting you off before.

Speaker 2

No, no, no, Keith. I don't want to miss your opportunity to get something. I just wanted to offer something to build on what Gene is saying. Like we never talk about this, Well, we run the company on the ServiceNow platform. There's not an employee out of almost 20,000 people that know that we have anything but the ServiceNow platform.

Speaker 2

So for example, when you're hiring, it's pretty nice to know in real time where the money is moving in terms of the market And what it takes to hire the best in class talent and how you can adjust the ratios of salary versus Equity in these kinds of things that for a large company could be 1,000,000 and 1,000,000 of dollars. It's pretty nice to run on a platform that's the leanest in terms of The G and A component of it in the industry. So there are many aspects of the ServiceNow platform that we're actually putting to work on the agility side for the savings that we're putting forward in managing operational excellence to hold our margin rate And a lot of companies could never do that on the fly. So that's a very interesting observation. The second thing I just wanted to say like, just add all respect for all shareholders like As we love and respect our shareholders, you have no issues with this company on renewals and the cohort from Q3 to Q4 It follows the historical path.

Speaker 2

It's just that we've never outlook that way, so why start now. But I think we should give you every confidence that the company is in great shape and you don't need to lose any fleet.

Speaker 4

Thanks Andy. Thank you guys.

Speaker 2

Thank you.

Operator

Our next question comes from Keith Bachman with Bank of Montreal.

Speaker 4

Hi. Thank you very much. I wanted to ask a clarification and then a question. Gina, the clarification is for you and I agree with The other key's comment that I think investors are candidly disappointed with the CRPO guide for September. And so when you say there'll be an increase For the December quarter, do you mean from the 25.5 adjusted number or the 23.5?

Speaker 4

You could just clarify what an increase the base level is. And then my question for Bill is, something we've talked about a few times over the last year. As sales cycles elongate, the valuations of tech companies are declining, continue to decline. And so How do you think about the ability to make M and A work on behalf of ServiceNow? Does it Increase your interest, no change in strategy.

Speaker 4

If you could just update us on how you're thinking about The M and A opportunities as you look at the deal pipeline. Many thanks.

Speaker 3

Thanks, Keith. On the clarification and I know everyone's wanting to get a Q4 guide from me on CRPO. What I will say is that we expect It's reaccelerate from Q3 and we expect it to reaccelerate by at least 2 points, Because that's what the renewal cohort is impacting in Q3.

Speaker 4

Yes, sorry, Jean. Just to push you, but accelerate from what? What number are you referring to is what I'm trying to

Speaker 3

call it? The $23,500,000 that is the constant currency guide for Q2 sorry, for Q3. We expect Q4 to increase by at least 2 points from there.

Speaker 4

Okay. Okay. Many thanks. And then Bill for you.

Speaker 2

Yes. So, first of all, on our capital allocation strategy, there is no change to the strategy At this time, the $11,000,000,000 plus and the $16,000,000,000 plus with regard to 2024 and 2026 respectively, As Gina said, we reinforce that that's based upon our current strategy and no change to it. I also would say That we have done tuck ins and that's business as usual. One of them that has caught fire really is HitchWorks And we did that because the employee experience now matters more than ever and managing employees And their capabilities to the productivity needs and the project needs that different companies are managing A really, really important priority now. So it's those kinds of things where it makes sense to one of our core platforms.

Speaker 2

It's what the customer wants to tuck in. That's the kind of thing that we would look to do. I do acknowledge that you bring up a good point. We're in a very strong position. When Gina gave me the CRPO with the RPO at $11,500,000,000 and the cash at $5,400,000,000 we know That's only going to grow over time.

Speaker 2

So we're watching everything. But right now, there's absolutely no change to the strategy.

Speaker 4

Okay. Thank you very much. You're welcome.

Operator

We'll take our next question from Alex Zukin with Wolfe Research.

Speaker 2

Hey, guys. Thanks for taking

Speaker 6

the question. So kind of going on this path, I think One of the other things that candidly surprised people was just the rate of change and the pace of change in Q2. So maybe just help us understand when did these issues start showing up. I think you've alluded to certain verticals and certain geographies that may have been more impacted than others. And to the question, I guess, that was asked earlier, Gina, if you think about the assumptions that you're making In terms of what you're seeing now in July for the rest of the year versus maybe what you saw in the quarter, are you Assuming in some of the guide, particularly for CRPO in the back half, a worsening of trends as you start to see Longer sales cycles on a larger cohort of bookings come to bear.

Speaker 6

And then Just on the cash flow portion, I guess, is there an assumption in that 30% that there is Further deterioration or further, I would say, flexibility in terms of collections with certain clients? Or Are you already embedding some conservatism there?

Speaker 3

So I'll start with the forecast, Right. And so we're not assuming a worsening trend in our CRPO guide from what we saw in the last couple of weeks of June. And so the rate of change when the issue starts showing up, it was very late in the quarter, and we are assuming Similar assumptions in Q3 and Q4, so no worsening trends. In fact, July looks strong. A lot of those deals have closed.

Speaker 3

And as Bill articulated, some actually closed at a higher bill of materials than initially assumed. And so Similar assumptions for Q3 and Q4 and this is after, Alex, rigorous analysis of pipeline trends, Rigorous analysis by industry, coverage rate ratios look strong. And so very similar to what we saw in the last couple of weeks of June is our assumption and what we're seeing through July. On the free cash flow, the 30% includes the flexibility that I'm talking about. I do not expect Further deterioration from that point.

Speaker 2

And Alex, in our customer relationships, the relationship with the customers Couldn't be better. If you look at customer side, you look at net promoter score, you look at the retention rate that GINA took you through at 99 plus It's absolutely the standard in the industry. And if you look at Q2 specifically and you say, where did you see what, as Gina said, Last couple of weeks of June, you saw some deals elongate their cycles Based upon higher levels of authority having to approve them and you saw that more in Europe than you saw in other geographies. So that's it in a nutshell. And as it relates to the guide, the guide like Gina said, assumed A continuation of that to ensure we have this level based on our customers dealing with their macro, That's what enterprise companies do.

Speaker 2

We serve them so they can serve their customers and we factored that into the guide. Again, It's restoring the 2022 guide. We all know FX is an issue across the industry and we all know That we've heard our customers are dealing with a tougher macro that's in the numbers. I'm not worried at all about Gina's guide on the Q3 With the cohort conversation going into Q4, we're in great shape. We really are in great shape.

Speaker 2

So don't take You know, waiting for a little bit longer as any lack of strength. On the contrary, we're seeing signs that it's making us even stronger.

Speaker 6

Super clear. Thank you, Bill. Thank you, Gina.

Speaker 3

Thank you, Alan.

Operator

We'll take our next question from Brad Sills with Bank of America Securities.

Speaker 6

Great. Thanks for taking my question. ServiceNow has such a Unique perspective across such a broad swath of different IT categories. I'm curious with the changing macro, if You're seeing any reprioritization within the categories, whether it's IT or customer, employee, custom apps, anything you've noticed there?

Speaker 2

Well, thank you very much, Brad. There's no question that all of those dimensions are really super important. But this low code revolution, if you think about companies having to build $750,000,000 net new applications in the next 2 years, You have to say that that's one that we should do a call out on, especially since we have the best low code platform in the business. There's nobody that's going to back off on taking care of their customers and having a predictive way Of managing their relationships with their customers and to make sure the promise that's made in the engagement layer Can be kept in the full value chain of mid and back office operations. So you deliver the right product at the right Price point and configuration to the right place at the right time and then you service that customer and that account very carefully.

Speaker 2

Every company wants to do that. And I can tell you the employee experiences piece is super, super important because you have to make every employee you have more productive. And then if you're not going to have the employee number that you expected because you have to deal with the macro, you're going to have to apply automation. So I think this experience of the knowledge worker and how you enable them to work from any place And be extremely happy and productive because you don't want them to turn over. And certainly, you got to get more out of each one, so you owe them automation.

Speaker 2

And I don't think any company will argue with that. And then on the IT side, I mean, it is the marquee jewel of our company. And it just keeps chugging along and growing and growing and growing. And one of the areas that has really taken off is asset management, Because companies have to be very careful on how they manage their assets. They have to get all the value out of their assets.

Speaker 2

So they have to bring their asset in and they have to retire their asset and they have to do that in a highly sustainable way, which is something that Gina has championed along with CJ For the company on ESG and that's a really fast growing business for us. And security operations, if you look at Having all security operations on one pane of glass, because security is an issue at the C level at every company

Speaker 1

And it's not because they

Speaker 2

haven't invested. They've invested so much in so many different things that they need one thing that can pull it all together, so they have visibility On an end to end basis to secure their operations and that's been just growing so, so fast for us. And I do want to give a shout out to Ben and LightStep. I mean the logos that they win is just unreal. So when you think of observability And the areas that LightStep and Ben are driving in the best brands in the world, the most innovative brands in the world is pretty compelling.

Speaker 2

Again, that's all part of our IT category. So they're all doing very, very well.

Speaker 6

Great to hear. Thanks, Bill.

Speaker 2

Thank you very much for the question, Brad.

Operator

Our next question comes from Derrick Wood with Cowen.

Speaker 6

Great. Thanks for taking my question. So there's clearly been a lot of questions on what's causing the Sales cycle and kind of where it's coming from. Maybe I'd ask it a different way. When you look at your 3 core cohorts, the G2K, the government and the commercial,

Speaker 4

Could you just kind of give us

Speaker 6

a little compare, contrasting across those three areas? And then since we're heading into the big government flush Quarter in Q3, how do you feel about pipelines and close rates and spending behavior out of the Fed looking into the upcoming quarter?

Speaker 2

Yes. Thank you very much, Derek. As you know, this is the time of the year for the government business. Couldn't be more confident. I can tell you couldn't possibly be more confident in what we're seeing in federal, state and local.

Speaker 2

In terms of our commercial business, very, very good. And you look at our industries, we're very bullish on all of them. Yip. I'm also very happy that we put industries as a priority for CJ and the whole engineering team to link the industry domain expertise of great development and cloud services to the solution experts That actually interface with the account executive in comporting the best possible road mapping An account plan for every customer we have, including how our partners in ServiceNow deliver that impact Of business value. That value chain has fully been realized in its structure And its execution and we actually expect now to start getting some real returns out of that in the back half and beyond.

Speaker 2

So we're real strong on all the dimensions that you mentioned. Really, really can't be more confident.

Speaker 3

And I would just add to that. The largest industries we play in, if you think about financial services, industry, Energy, sorry, public sector, federal, telco. These are all industries that hold up and are most resilient In these environments. And so feel really good about the industry perspective. Said Q3 going into Q3 feel really strong.

Speaker 3

In We had great results and impact even in Q2 in the Fed business. We saw a really strong demand for that new solution. So As we're going into Q3, the federal team has ramped up and very excited. And so really across the board from an industry perspective, federal, as well as the G2 ks, very strong.

Speaker 4

Thank you.

Speaker 3

Thank you, Darren.

Operator

We'll take our next question from Peter Reed with Bernstein.

Speaker 4

Thank you for taking my call. One of the things that I think that business has been built on For so long has been a consistency in the ability to expand and you've talked about the elongating sales cycle and you might be able to interpret that as putting a damper on expansion. But what I observe looking at your Yip. Cohort chart is that you've been able to attain right around 130% net expansion with some of your oldest cohorts Actually growing quite strongly in a well into the mid-120s. What are you seeing that is enabling even your cohorts that are A decade or longer old to continue to have such consistency, particularly In a situation like this where they may be incredibly built out and it might be easier for them to push out or see less strategic Yip.

Speaker 4

What is enabling that consistency?

Speaker 3

Yes, a few things there. So first of all, you're Completely correct, right. We talked about 99% renewal rates across the board in every geo in Q2. We're also seeing exactly what you're seeing on expansion rates remain extremely high even at our scale, even with our customers who have been with us for so long. The reason for that, Peter, is exactly what we're talking about.

Speaker 3

It's the The breadth and scope of our incredible product portfolio, right. It's the expansion out of IT into HR, Into customer, into creator. It's about the platform evolution story and that is more powerful today Than ever before. And so you'll continue to see similar levels of renewal, expansion rates, as we continue to innovate, as we continue to make our Stronger and better and more capable as we continue to innovate where customers need us and want us to go.

Speaker 2

And Peter, one stat that may be interesting to you, even where we have, as Gina said, great customer relationship And we're expanding along the lines of that platform. We're only 15% penetrated. So if you look at the product portfolio And the innovation that's come out of our engineering team. We in every account have so far to go against our bill and materials of that roadmap And all of that is upside in the Global 2,000. And it also gives us permission to take it way beyond the Global 2,000 as well In our commercial business and in our kind of inside selling business and some of the partnerships that we've built, Taking advantage of co selling with some of the bigger companies in the world will also be an interesting thing to keep an eye on.

Speaker 2

Thank you.

Speaker 4

You're welcome. Thank you.

Speaker 3

Thanks, Peter.

Operator

We have time for one last question. Our last question comes from Pat Walravens with JMP Securities.

Speaker 7

Great. Thank you. So Bill, maybe to sum it all up

Speaker 6

here, how

Speaker 9

are you going to allocate your time over the rest

Speaker 6

of this year? What are your top 1 or 2

Speaker 2

priorities. Yes. Thank you very much, Pat. One of the things I said is, I'll be in Japan As we do our Tokyo release and I'm doing that because Japan is a major market and we intend To treat Japan as one of the most important regions in our company, and that's the world's 3rd largest Market as measured by GDP and we intend to do extremely well there. I'll also spend 2.5 weeks going across APJ, I'll be in Europe, and obviously across the Americas.

Speaker 2

So I think the most important thing and I've made this very clear to our management team is To take you to the street. So I will be taking it to the streets. After we're done with this, we have an all hands meeting We will talk to 19,000 plus of our closest friends around our great board meeting and now our Wonderful opportunity to talk to our investors and now it's all about the customers. So when we take this level of passion to the street, usually very good things happen.

Speaker 9

Great. Thank you very much both of you.

Speaker 2

Thank you very much, Pat.

Operator

And that does conclude today's presentation.

Speaker 3

Thank you

Operator

for your participation. You may now disconnect.

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Earnings Conference Call
ServiceNow Q2 2022
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