ServiceNow, Inc. (NOW) Management presents at J.P. Morgan Global Technology, Media and Communications Conference (Transcript)

ServiceNow, Inc. (NYSE:NOW) J.P. Morgan Global Technology, Media and Communications Conference May 21, 2024 2:25 PM ET

Company Participants

CJ Desai – President and COO

Conference Call Participants

Mark Murphy – JPMorgan

Mark Murphy

Okay. Welcome, everyone. Good afternoon. I’m Mark Murphy, software analyst with JPMorgan. And it is a great pleasure to be here with CJ Desai, President and COO of ServiceNow. CJ, welcome to the conference.

CJ Desai

Good to be here. Thank you.

Mark Murphy

A pleasure to have you. So maybe you could just give us a quick 30-second introduction of yourself and ServiceNow just for the benefit. In case there’s anyone else — anyone out here in this audience who’s not totally familiar.

CJ Desai

Absolutely, I’m responsible overall for ServiceNow R&D, our innovation factory, new product introduction, cloud operations, customer success, among other things at ServiceNow. Been with ServiceNow seven-plus years. And ServiceNow continues to be a workflow automation company, a platform company that serves a multitude of use cases across the enterprise.

Question-and-Answer Session

Q – Mark Murphy

So, CJ, my team here covers 25 large and mid-cap software companies. And we took a look at this back in March. And we commented on — so we were at the end of the Q4 earnings cycle. Only one company guided above the consensus growth rate for 2024, and that was ServiceNow. And that was just barely the case. But we were in an environment where most companies were guiding a few points below consensus. And when we look at it for companies that have over $10 billion in revenue at this point, ServiceNow is the only one that is growing 20% plus. And then we look at the rest in that category, and on average, they’re growing actually below 10%. So how can you explain the phenomenon to this audience. Why is ServiceNow is seeing so much prioritization?

CJ Desai

So first of all, at the highest level, being a workflow automation company and being a platform company is definitely something that is resonating with our customers. And when you’re a platform company that provides many core services via a single platform, whether it’s for IT or whether it’s for customer operations or whether it’s for employee experience, what is happening Mark is we are also a consolidator of many point solutions. So when somebody chooses ServiceNow initially, we may replace a few point solutions on ServiceNow Platform. But as they expand their use cases on ServiceNow, we see more and more point solutions being consolidated or sometimes it’s an additional spend where we become a system of action on top of multiple systems or multiple clouds that a customer may be using. And that phenomena in itself has allowed us to grow consistently north of 20% for the past few years.

Mark Murphy

So extending that trend line a little further, we have always noticed there is just this constant feedback about the pace of innovation that comes out of ServiceNow. We hosted an event a couple of weeks ago. And this comment that came out was ServiceNow is, first and foremost, an App Dev platform. It is the most secure and sophisticated platform, and it’s really easy for them to build new apps and customize them. So — and this — it feels like a bit of a secret sauce to us because if you can innovate faster, no one is going to catch up with you. How do you think about that pace of innovation? And then how do you draw a boundary on all the vectors that you could go out and pursue?

CJ Desai

Yeah. So when Fred Luddy, our founder, created the company, he actually did not want to create an ITSM company, if that makes sense, because he said, I’ve been in this space for a long time, and I want to create a core platform that can be used to create not only application that ServiceNow will build for use cases, but that our customers can build to your point, whichever applications they want on ServiceNow platform. So the company was created with a very simple mindset that you should be able to create the app economy on top of ServiceNow platform by not only ServiceNow, but by ServiceNow’s customers as well. So we started, obviously, our first killer use case was ITSM back in 2005. And then we expanded to multiple use cases within the technology department or for the CIO, and we begin the system of record for the CIO. And around 2015, we made the pivot to say, now we will do security operations, we will do HR case management. We’ll also do customer service. So that’s 2015. And as the time proceeded, we have added use cases for finance department, for supply chain department, for procurement department. So our perimeter on what we can do for an enterprise has continued to increase with workflow automation.

Mark Murphy

So, CJ, one of my favorite quotes came from actually one of your trustworthy partners recently. And this person was saying there’s quite a long runway to upsell to the Fortune 500. And we said why. And he said, its ability to serve as a front-end resolution to customers’ wonky back-office apps. So it feels — to me, it feels akin to — if you’re going to renovate an old house, you keep the foundation, keep the plumbing, but you kind of breathe in some new life, right? Can you speak to that? Why is this something that’s resonating so well in the current macro?

CJ Desai

So one of the things in speaking to many, many customers across industries, the technology landscape, if you think about Fortune 500 or Global 2000, the technology landscape is massively complex because our customers have invested everything all the way from mainframe to client server to web architecture to mobile in so many technologies and solutions. ServiceNow platform, first of all, has a very simple but powerful concept on how it integrates with all these existing systems, whether it’s a bank or a government or a healthcare organization. Number two, it also provides a great experience layer that you can leverage with the platform and where it makes sense, we have also enabled via AI multiple use cases. So when you think of that and when we go and say this story and the advantages of ServiceNow platform is almost very unarming for our customers to say, okay, I know I have a complex landscape in Mark, then nowadays, a lot of our customers have also multiple clouds, and we say, okay, whether you have a private cloud, whether you have a public cloud, you have multiple public cloud and multiple private clouds, we will integrate across all those clouds. And that just gives them a peace of mind that ServiceNow becomes this truly a platform of platform.

Mark Murphy

So CJ, thinking back about a minute or two ago, you did use this term system of record, right? And so within the realm of ITSM, if you think about the core IT function, many people do see ServiceNow as the core system of record. And so you’ve got the core functions, you’ve got the data management. What — as you spread the platform out, you — generally, you’re not using that term, right? So the platform expands, it goes into HR and ERP and CRM. And then you call it a system of engagement, right? So then the customers, they keep Workday or Salesforce, right? They don’t rip them out. Can you help us understand why is that the chosen strategy? Why do you want to be a system of record in one area, system of engagement in the other areas? And how do you determine which layer you want to be at?

CJ Desai

It’s a great product strategy question. So first of all, let me start with IT. So when we talk about technology workflows, like you said, with ITSM or IT operations management, IT asset management, what we have done in security risk, our competitive moat and key advantage is that we have the asset repository within the IT landscape, including the assets that our customers have in public cloud or private cloud, and that’s why we are truly a system of record. We have chosen that — to get the most value out of ServiceNow platform in the technology operations team as in the CIO or CTO, we need to be system of record, okay? Now when you think about some of the space you talked about like HCM and ERP, we said, okay, for those areas, where the technologies are very sticky that they may have invested a lot in SAP financials or SAP supply chain or whatever the case might be, we connect as an amazing system of engagement layer that easily integrates with SAP ECC or S/4HANA and still provide value to our customers for their procurement department or for supplier onboarding. So we have been very selective because the platform allows us to be system of record if we want to be, but we choose only to participate in the areas where we want to be a system of record versus a system of engagement. We have to tell somebody that, hey, go and replace your ERP system, why do that? Leverage, whatever you’re doing on the ERP investment side, but we will provide this beautiful system of engagement as you move from SAP ECC to S/4HANA, and we will allow you to become more efficient in procurement or supply chain department.

Mark Murphy

So is it inaccurate if we think about what’s been happening in the last year or so, we try to predict it forward. Is it inaccurate to think that ServiceNow is, in some ways, kind of picking away at the edges of the core? If we look at HCM or the core CRM system because — and I think it’s hard to tell externally, right, because we’re not hands-on practitioners. But you keep track of employee locations and higher dates, right? You handle employee onboarding, you — and then recently, you launched sales and order management. Do we still think of that as being on the periphery as a system of engagement?

CJ Desai

More than periphery, I would say, there are use cases which are very workflow-centric. So even in HCM, right, there are multiple HCM systems even where you are employed, they have an HCM system that they like. But there are so many workflows that the HCM system does not provide. There are workflows that an ERP system does not provide. So we really shine because one, we will integrate with your HCM system or your ERP system, but then we will provide the system of engagement layer to get work done faster like a typical onboarding of an employee, whether it’s a government agency, a financial institution or a healthcare institution can have anywhere from 40 to 90 steps, okay? Sometimes more than 100 steps to onboard an employee across multiple departments, multiple laws that you need to comply with local laws, immigration laws, whatever the case might be. And given that we integrate with multiple systems that exist inside, like I would give you an example of — even to do an address change, if I’m a customer of a bank and one of the large banks I spoke to recently. If you want to change your address and you move from location A to location B, it touches 140 systems on the back end for that particular bank. And that’s where we really shine because that’s a workflow that we initiate when somebody makes an address change request. Like have you wonder why when sometimes you try to change an address and after five days, you get an answer that your address has been changed officially and you get a letter in the mail?

Mark Murphy

Yeah. Because it’s in 140 systems.

CJ Desai

Yeah. That’s right.

Mark Murphy

Okay. That’s very helpful. So let’s talk about — thinking back then a couple a few weeks ago, you laid out a path to 20%-plus subscription revenue growth basically for the next three years. And if that happens, it’s going to land you at $15 billion in 2026. So clearly, it’s a more ambitious multiyear glide path than we’re seeing elsewhere. What do you think is going to be required, CJ, to get there? And what do you think might surprise us along the way?

CJ Desai

So I would say the first thing always, it starts with innovation that we need to stay and we have stayed on a rapid pace of innovation, but we need to stay on that pace of innovation whether creating new products, Mark. In 2018, we told our investors that we created this unit called Navex, and Navex will release at least 2 to 5 new products every year, okay? Which was a very ambitious goal at that point in time. But we said two to five products every year, we will release it. So that pace of innovation of additional products that deliver value for our customers is foremost required. So that’s number one. Number two, I would say when AI becomes a complement to those products where customers get value because of AI versus not using AI, we will absolutely monetize that. If customers are getting value, we have our Pro Plus offering. So that’s the second thing, I would say, besides the portfolio expansion. And then number three at the highest level is just leveraging more and more platform capabilities that our customers can use with the technology, could be something like an RPA or a process mining that we can add on. So it’s not a product portfolio but it’s a platform capability. A combination of these three is required for us to innovate and help maintain that growth rate. So that’s number one. And number two, obviously, go-to-market execution across every industry. ServiceNow right now is 8,000-plus customers, and if we look at our TAM — and currently, we do not do business in China, as you’re aware, but if you look at our TAM, we are still 1/4 to 1/5 penetrated just from a pure land perspective.

Mark Murphy

From a customer account standpoint.

CJ Desai

From a customer account standpoint, and we look at customer headquarters, we don’t look at subsidiaries and others. So customer count is 8,000 plus, and we still have a long, long runway to go, whether we land with ITSM or whether we land with customer service product or any other product portfolio.

Mark Murphy

So along the way, that helps us understand the product vectors and the execution and the number of customers that are addressable for you. What do you think is going to be the next $1 billion product line? And I mean after Employee Workflows because we know that, that’s getting close. But you have several that are $1 billion-plus, you have IT workflows, you have Creator and then you have Customer. As I said, Employee is getting close. If we’re trying to think out here three years, five years, could it be ERP workflows? Could it be the SecOps? Could it be the Pro Plus products themselves?

CJ Desai

Yes. We obviously have projections based on our ability to execute across geographies and our amazing go-to-market engine. Not only technology workflow has crossed $1 billion, but within technology workflow besides ITSM, ITOM has also crossed $1 billion. So when you think about it, technology workflow has crossed $1 billion, but within technology workflow, both ITSM and ITOM individually has crossed $1 billion. Customer Workflow, $1 billion-plus. Creator Workflow, $1 billion-plus. Employee would be next, you’re correct. And then when I think in the broader scope, the next one most likely is going to be IT asset management, which is — the team has done a phenomenal job between software asset management, hardware asset management and enterprise asset management. So that’s going to become a $1 billion-plus. Security and risk is on its path to become $1 billion-plus. And then Pro Plus and ERP workflow are also the two big candidates or $1 billion-plus. So we have enough growth vectors, which is why there is confidence internally that the innovations that we have delivered and the path that it has charted on will result in $1 billion-plus businesses across this.

Mark Murphy

Okay. So it’s not that you’ve run out of these $1 billion targets, you can rattle off a bunch. And do you think it’s reasonable to kind of put them in that order as you laid them out?

CJ Desai

Sequencing wise, I would say, asset management, security-risk, Pro Plus and also ERP workflow, yeah, I would put it in that order.

Mark Murphy

So can we talk about…

CJ Desai

Pro Plus is only eight months old so…

Mark Murphy

Right, right, very early. Regarding macro demand, we — I think the sense at this conference is, it is still tough out there. But when we do our work in the ServiceNow ecosystem, we keep being told companies have their budget, they draw a line, ServiceNow is kind of landing above the line. So they’ll deprioritize what is below. And then above that line, they’ll continue to invest, disproportionate resilience was one of the terms that we have. But there’s also — I think there’s some hope that this year macro wise, could be a little more manageable than what happened last year remains to be seen. How do you sum up the macro demand picture here heading into June?

CJ Desai

So I think in the earnings call in April, we shared with investment community, it is still tough out there. So 2023 was tough and 2024 continues to be tough. We are executing really well, as in ServiceNow is executing really well. We published $2.5 billion, $2 billion subscription revenue growing at 25%. That’s definitely from my perspective, a clear outlier and all that has been done organically, right? So we have a clear outlier. Now your question about coming into June, I would say it’s pretty much more of the same, like we are still saying it’s tough out there. We are executing with the platform play, consolidation play, generative AI, very specific offering that are driven around productivity advancement and so on. So we continue to stay very paranoid at the same time on execution, but we are absolutely executing.

Mark Murphy

So as we think through that environment and these targets that you have to perpetuate growth 20% plus on a huge base. And then we think about, again, all these product categories that you laid out that there’s a sense that these are going to become all individually $1 billion product lines. What I keep getting stuck on is — and this is true, CJ, across the entire software landscape is the headcount growth has really moderated. This is true at essentially every software company. When we look at it for ServiceNow, top line is growing in the 20s, you’ve got 11% total headcount growth. I think the sales and marketing headcount growth was 6%. And typically, those are going to grow kind of at the same rate. Is it not going to be the case in the cycle that you would kind of hire into the rep quota attainment or hire into the pipeline? Is there something different going on? Or how do you see getting through this for the industry without headcount growth being kind of a rate limiter?

CJ Desai

Yeah, I would say it has been all about efficiency in the headcount growth, specifically in the software sector for the last couple of years. We are continuing to invest in our software engineering. So we are hiring still talent for both AI as well as core software engineers to keep up with the innovation pace that we just talked about. And at the same time, from go-to-market expansion perspective, we continue to hire quota-carrying sales teams in very specific areas, right, whether we are trying to expand internationally in certain regions with large GDP countries, whether it’s Europe or whether it’s Asia or whether it’s Americas, we are being very intentional. Paul Smith and the team have done a great job of being intentional on going after certain markets, including public sector.

Mark Murphy

Okay. So it’s about efficiency, but you’re keeping these focus — concentrated investments and headcount growth in these areas that are…

CJ Desai

Just two like software engineers and quota-carrying sales reps.

Mark Murphy

Right, right, right. Okay. Understood. So let’s talk about Generative AI for a moment because we were — we touched on a couple of times the Pro Plus SKU. And I’m thinking back, CJ, to about a year ago, we ran our generative AI CIO survey, we looked at specific spending intentions. And when you look in there, Microsoft and OpenAI were positioned at the very top, clearly for a good reason. When we look among the SaaS providers, ServiceNow was number one in spending intentions. And recently, we were talking to one of the ultra-massive SI firms. They said ServiceNow has the best application of Generative AI in the field thus far. So there seems to be pretty good alignment. How would you describe what is setting your GenAI apart? You’ve got these domain-specific models. Is it more thoughtful packaging? There’s the team you acquired from Montreal, et cetera. What do you think is different here?

CJ Desai

I would always say it starts with the team. So I’ve shared this consistently that we were very fortunate to hire or acquire this team in Canada, which gave us a lot of expertise in AI during the peak of COVID, which would be end of 2020. And that gave us the head start on AI. And these folks have written some seminal papers on AI, including the transfer models and so on. So we learned a lot from them. That allowed us to be one of the first ones to truly create a product, as you know, Mark, in September of last year, September of 2023. And we have been eight months in the market. Our customers are going live very fast. Those who have bought Pro Plus products, they are going live very fast. And they are able to articulate the value they are getting, whether it’s for their employees, whether it’s for their IT department or customer service department or whether it is for their ServiceNow developers. So we have been on the forefront of innovation on AI with real product. And because of this team, we focused on correctly, I want to say now a couple of years ago to create use case-specific small models. Why does that matter? Absolutely, it matters because the performance is faster when the models are smaller from an end user experience perspective. But the cost to run inferences on this model is also lower, which protects our gross margin. So while we are trying to generate revenue on Pro Plus, we are doing it in a very cost-effective way because these models are smaller. So a great team that we had a head start in the end of 2020, combine that with keeping up on the innovation pace and we have released multiple Pro Plus product lines already in the last eight months, and there is still a very aggressive road map throughout 2024 and 2025.

Mark Murphy

Congrats on having the forward vision of having picked up that — this — that incredible AI development team and all the PhDs that they have out of Montreal, it was incredible. So CJ, let’s assume now that ServiceNow is doing the best job among SaaS providers of embedding generative AI and creating something that’s going to resonate. It still feels as though in our field work, it’s going to take time to monetize this at the application layer. It’s different when we look way down to the infrastructure layer. What I mean by that is we think it’s going to take time before a lot of these application companies have a 1% type of a tailwind coming from these products. How do you think about this topic of monetization and sort of rolling that forward a couple of years?

CJ Desai

I’m actually optimistic.

Mark Murphy

You are?

CJ Desai

Yeah. Based on what we have seen in the past 8 months is once we are able to articulate the value that our customers will get by infusing AI into ITSM or into HR, then the purchases have been made, and that’s why we shared that it is the fastest-growing product in ServiceNow history. And listen, I mean, we had some of the products like IT asset management and other, which went super-fast to $100 million in annual contract values or ARR really fast, and this is even faster than that. So, so far, what we have seen is once we are able to articulate clearly the value that we show with real product and demos, customers are like, hey, I’m going to try this out, because ServiceNow was always about efficiency and with AI we even have higher efficiency. So that’s number one. Number two, whether it’s 1%, 2%, I understand your point. You will — we are eight months in the journey. The journey so far has exceeded our internal expectation. We launched ITSM Pro in 2018 September and what I saw in the first eight months compared to Pro Plus, and Pro Plus is only applicable to our 45% of installed base because if you think about ITSM Pro, it was applicable to the entire installed base at that point in time. But Pro Plus runs on Pro and enterprise. So it’s only at 45%, and we are seeing 30% premium. So I am actually very optimistic. And once we finish a full year then how the bookings translate to the revenue, and you will start seeing the impact on the top line revenue.

Mark Murphy

So there could be a traction point here in 2025, 2026?

CJ Desai

That’s absolutely correct.

Mark Murphy

And do you think this is going to be — you’re optimistic, I think this could be as fast or faster to $100 million compared to the other products you mentioned?

CJ Desai

Faster.

Mark Murphy

Faster to $100 million, okay. So, CJ, it’s great to hear — it’s great to hear the bullishness on that. There was a bit of a shocker, at least in my mind, it was day two or day three of the keynote there the other week.

CJ Desai

Thank you for attending.

Mark Murphy

And you were — yes, I was — I stayed around for quite a while there. And it was a heck of a show. But you were on stage with this company Teleperformance. And they came out and announced that they have rolled out an AI product called Now Assist to 0.5 million employees. I had no idea. I haven’t heard anything about that. And I don’t think we’re aware of anything that is comparable to that. Then they went in, they talked about 100% increase in deflection rates. They’re saving agents 25 to 30 minutes for incident management. What is important for us to know about that? I mean I’m not — we weren’t sure anyone was really ready to roll it out to 0.5 million.

CJ Desai

Yes. I mean, first of all, it’s an impressive organization that became a customer of ServiceNow, I still remember, in 2022 March. It was a new logo, and we’re really excited that it’s a large company headquartered in Paris, became a customer of ServiceNow in 2022 just with ITSM. They have — besides 0.5 million employees, they have operations in 170-plus countries and multiple languages and so on. So they are very global in nature with headquarters in Paris. So that was exciting. They went live with ITSM in 2023, so about a year ago. And in September, when we launched the Pro Plus product, given their experience with ServiceNow Platform, they said, “Given our scale, CJ, we want to be the first one to not only buy Pro Plus, but we are going to roll it out right away because any impact to 500 to 0.5 million employees or 5,000-plus IT staff. Even if it’s a 2%, 3% impact, it is worth every dollar.” And they rolled it out, by December, they were live. So they purchased on September 29. I still remember the CIO letting me know that they are excited about their Pro Plus journey. They go live in December. And then we have been working with them on their feedback, where we can do better. But the biggest thing is what are the KPIs that matter to them is, one, employee productivity. Number two, the IT staff productivity and the ServiceNow developers. And the numbers have been stunning the CIO shared that in public forum, and they can even do better. So they have become one of the world-class customers of ours who are really trying out every use case that can be AI-enabled on ServiceNow. And still, they will see even more improvements moving forward.

Mark Murphy

So we — in the last couple of minutes, CJ, we — there’s kind of a debate raging that we have with investors. And we talk about if these bots become — as they become smarter and they advance, there’s this concept of the lights out help desk, right? And you get — you could have changes in the ratio, right, of how many human beings you have that are in there. But we have also — we’ve heard some chatter about the possibility of something called unrestricted licensing, right, where it’s not necessarily priced per agent. It’s going to be priced per total employee, total employees in the organization. Can you clarify that kind of thought process? And what do you think about this? What’s the right way to license this?

CJ Desai

Yes. So I’m going to resist analogy of when calculator was created, whether we would need accountants or not. So I’m going to stay away from that. And what we have seen with our customers is the actual workload on the technology staff continues to increase, right? We wanted to provide the flexibility. There was a concern, Mark, you were there about a year ago, hey, what does this mean for seat count for ServiceNow and so on. So our pricing model right now is a combination of seats plus tokens. So you get certain tokens when you buy for your staff. And then as you use more Generative AI capabilities, there is a different pricing meter that is consumption based. So that’s on the Pro Plus side. But in general, we have been giving this flexibility to our customers, I think, now for almost three-plus years where do you want to go based on your employee count because any company that is more productive hires more employees, right? If you’re more productive, you have more employee or you may get it done more fast — more faster, which is bad English, sorry, if you can get things done faster. So we have been giving this flexibility on unrestricted user versus the seat-based count for the technology staff. And right now, it really depends on the customers on how they — but that flexibility has been there. And the unrestricted user is growing but not growing as much as I thought it would grow because people still prefer the predictable seat-based license model.

Mark Murphy

Okay. Well, that’s a great note to end on, and thank you for not making the analogy to calculators and accountants, really appreciate that. CJ, really appreciate you taking the time to be with us here.

CJ Desai

Thank you. Thank you very much.