ServiceNow Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 24, 2024

There are 14 speakers on the call.

Operator

Thank you for standing by. My name is JL and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2024 ServiceNow Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

I would now like to turn the conference over to Darren Yip, Groove's Vice President of Investor Relations. You may begin.

Speaker 1

Good afternoon, and thank you for joining ServiceNow's Q2 2024 earnings conference call. Joining me are Bill McDermott, our Chairman and Chief Executive Officer and Gina Masantuno, our Chief Financial Officer. During today's call, we will review our Q2 2024 results and discuss our guidance for the Q3 and full year 2024. Before we get started, we want to emphasize that the information discussed on this call, including our guidance, is based on information as of today and contains forward looking statements that involve risks, uncertainties and assumptions. We undertake no duty or obligation to update such statements as a result of new information or future events.

Speaker 1

Please refer to today's earnings press release and our SEC filings, including our most recent 10 Q and 2023 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 are non GAAP except for revenues, remaining performance obligations or RPO, current RPO and cash and investments. To see the reconciliation between these non GAAP and GAAP measures, please refer to today's earnings press release and investor presentation, which are both posted on our website at investors.servicenow.com. A replay of today's call will also be posted on our website.

Speaker 1

With that, I'll turn the call over to Bill.

Speaker 2

Thank you, Darren, and thank you, everyone, for joining us today. By now, you've all seen the press release. You know we crushed the quarter. We raised the full year guidance and we've never been more excited about the future of ServiceNow. But before we get into all the details, I just want to comment on the leadership announcements we made today.

Speaker 2

The company received an internal As you would expect, we took the complaint very seriously. The Board of Directors conducted a thorough internal investigation with the assistance of outside counsel and determined that our company policy was violated. Acting with total transparency, the company proactively disclosed the findings of the investigation to the proper government entities. And as a result, today we're announcing the departure of the individual whose hiring was the subject of the original complaint. We also came to a mutual agreement that CJ Desai, our President and COO, would offer his resignation from the company effective immediately.

Speaker 2

While we believe this was an isolated incident, we are further sharpening our hiring policies and procedures as a result of this situation. And when it comes to compliance, let me be perfectly clear, we are fully committed to doing the right thing. And from a continuity standpoint, I'm extremely proud that our team has the incredible depth of talent and expertise to lead forward without any disruption. In fact, Chris Betty, a respected ServiceNow executive for the past decade who was recently named the MIT Sloan CIO Leadership Award winner for 2024, he'll serve as the interim Chief Product Officer while I consider internal and external candidates alike. Our entire products and engineering team is the best in the enterprise software industry and they're focused on delivering our Xanadu release in a few weeks' time.

Speaker 2

In fact, I just got done talking with them and they're in great shape. And we wanted to give you the facts as clearly and succinctly as possible because we have so much else to cover today. So as I said at the start, ServiceNow is once again in a beat and raise situation. Our Q2 results prove that we are delivering elite level execution. Subscription revenue grew 23% year over year at constant currency, which is 100 basis points above the high end of our guidance.

Speaker 2

CRPO grew 22.5% at constant currency, which is 200 basis points above our guidance. Operating margin was over 27%, nearly 2 50 basis points above our guidance. And we had 88 deals greater than $1,000,000 in net new ACV, up from 70 a year ago, a 26% year over year increase. A year ago, Q2 had one deal greater than $1,000,000 from a net new logo perspective. This year, we had 6 of them that were net new logos.

Speaker 2

Our first federal customer actually crossed the $100,000,000 plus ACV threshold and we signed our 3rd largest net new AC deal ever. All of our workflow businesses were in more than one half of our top twenty deals. Security and risk, ITSM and ITOM had 8, 9 and 10 deals over 1,000,000 respectively. Customer workflows had a big Q2 with 14 deals over $1,000,000 employee workflows had 12 deals over $1,000,000 and creator had 10 deals over $1,000,000 What's the headline? ServiceNow's relevance is the AI platform for business transformation is soaring.

Speaker 2

This is a growth company on an unprecedented trajectory. Moving to the topic of AI, Now Assist net new ACV doubled quarter over quarter, significantly overachieving our expectations and it became the fastest growing new product in the company's history. We signed 11 Now Assist deals with $1,000,000 plus NNACV in Q2, 2 of which were over $5,000,000 We had impressive wins across industries from banking, healthcare and manufacturing to semis, tech and many others. As an AI Lighthouse customer, Stellantis is using ServiceNow as its strategic AI platform to manage operations across HR, finance and supply chain. American Honda selected Now Assist as their GenAI solution of choice to improve deflection and efficiency of service, delivering a world class experience to their employees.

Speaker 2

Merck is using the ServiceNow platform to streamline operations across IT and cybersecurity to advance its global biopharmaceutical business. Adobe will leverage Now Assist to optimize routine tasks for employees, which will increase efficiency across the entire organization. Dell will integrate Now Assist with its service capabilities to deliver a seamless customer and employee experience. And with Now Assist, STMicroelectronics plans to enhance productivity and user experiences across their entire organization. LTI Mindtree is using Now Assist for ITSM to increase developer productivity by 30% with code and flow generation.

Speaker 2

We're also collaborating together to grow and expand offerings in finance and supply chain workflows. So why are so many enterprises rapidly adopting ServiceNow's JENI AI strategy? Think about this in the context of design thinking and innovation. The first pillar is always desirability. Do we have the big idea?

Speaker 2

ServiceNow is putting AI to work for people. Our GenAI strategy is focused on infusing intelligence into the flow of work end to end across the enterprise, every department, every persona. With our native integrations, we already help people orchestrate across different systems and data sources. Now we can train the machines to do the low value work so the people can up level to the knowledge work. The second pillar is viability.

Speaker 2

Does our approach to Gen AI make business sense? We set the tone on innovating with domain specific multimodal language models. This approach is more accurate. It doesn't have the hallucinations of the large models from the Internet. It's faster to train and it's faster to deploy these models.

Speaker 2

It's more cost effective and sustainable because these models are less GPU hungry than public models. The final pillar is feasibility. Can we actually do it? This is the best pillar of all for ServiceNow because we've actually done it. When you look at our own deployment of Now Assist, the initial results are staggering.

Speaker 2

With better deflection, our IT help desk is saving 45 minutes per avoided case. In customer service, our colleagues are saving 30 minutes every time the computer generates the knowledge based article for them. Our employees will save 21,000 hours with faster self-service and our developers are completing non complex scripts in half the time. This is a moment where business leaders are looking for the role model. What does it look like to run a business with GenAI at the core?

Speaker 2

ServiceNow, thanks to our engineering and our Now on Now teams is leading the way. It's an excitement for GenAI and it's one reason Gartner forecasts global IT spending will be up 8.9% in 2024 and that's even higher than originally forecasted, by the way, more than 3 times GDP. Within software spend, according to IDC, software as a service will grow 17%. So the trend line is clear. Enterprise software buyers are moving away from consolidating the past into building for the AI future.

Speaker 2

ServiceNow has been the modernizer at many points on this journey, creating a single pane of glass into the IT estate, expanding our core from IT to employee service to customer service, now making it easy to build new consumer grade applications on a single data model. The AI moment is the culmination of this journey. CIOs don't want 1,000 points of dim light. They're betting on a few market leading platforms working together as the great unlock. They see ServiceNow as the intelligent action platform spanning the entire enterprise.

Speaker 2

And that is why our pipeline has built from knowledge over 50% year over year improvement. It's why CIO surveys continue to show ServiceNow's relevance rising to the top of the charts. It's why more IT and line of business buyers alike are looking at long term blueprints for ServiceNow and planning out the future with us. It's why Jensen Huang hit it on the head when he said ServiceNow is the AI operating system for the enterprise. Customers are seeing us like Jensen sees us.

Speaker 2

While our performance has been consistently strong, we take nothing for granted. Every aspect of our innovation engine and our go to market machine is moving up to the next level. We're tracking and tackling more of the automation and market opportunities every day with both our customers and our engineers. Our new creator studio available with ServiceNow App Engine is extending our existing low code leadership to no code, so every employee can now build applications. Other updates to our automation engine help simplify RPA deployments.

Speaker 2

We see a great opportunity for ServiceNow there. We're moving even faster on co innovation partnerships with major global brands. An expanded multi year agreement will extend ServiceNow capabilities to all BT Group units. Bell Canada will develop new capabilities within the business service experience while accelerating their own internal transformation as a tech services and digital media leader. This is the largest telecommunications collaboration for ServiceNow and the first of its kind in Canada.

Speaker 2

Boomi is expanding from a small ServiceNow footprint to replace existing competitor implementations. Boomi will use all Now Assist solutions and work with us on joint product development. Deloitte is leveraging the ServiceNow platform to drive industry specific managed services to bring AI based innovations to clients around the world. We are accelerating our growth in key geographic markets and verticals. ServiceNow will help the U.

Speaker 2

S. Air Force adopt new best in class technology. The federal government's National Science Foundation is utilizing ServiceNow's new Gen AI solutions to support their mission to promote research, expanding knowledge in science, engineering and education. In Germany, Bayer is using Now Assist to empower their employees with GenAI and Hyper Automation as they create a culture where every employee has the potential to innovate. Our momentum in Japan continues with major wins this quarter including Nomura, Panasonic Information Systems and Natori Holdings.

Speaker 2

We announced plans to launch a ServiceNow UAE Cloud hosted on Microsoft Azure so we can meet the business transformation investments in our partner ecosystem in India. In Morphis, we'll extend our presence in India and across Southeast Asia through the development of new gen AI offerings, solutions and digital skills training. ProDAPT will further develop digital business transformation through AI enabled solutions and the Now platform skills expansion. We're also expanding into new categories, further increasing ServiceNow's total addressable market yet again. Industry analysts have reported that the number one priority for CIOs is getting their data house in order.

Speaker 2

And that's why at Knowledge, we shared our plans for a powerful new database offering, Raptor DB. It's built for enterprises looking for speed and scale to support new AI use cases. Raptor DB gives ServiceNow customers the capability to ingest data at massive scale from multiple data sources so they can analyze it much faster to feed our domain specific models. We're already achieving 12x transactional throughput and 27x improvement in response time for analytic inquiries in our Pro Plus version of the platform. Today, we're launching the Raptor DB Lighthouse program.

Speaker 2

This is similar to our highly successful Gen AI Lighthouse program. This new offering is designed for a select group of top customers at the forefront of this new AI world. We already have many signing up. We also completed a tuck in acquisition of Raizen, an industry leading data company based in Germany. In combination with NowAssist, Raishin will further accelerate our GenAI powered search and knowledge management capabilities.

Speaker 2

This is only the beginning. The data opportunity is massive and we intend to make some additional announcements on September 10 regarding our growing data ambition. As you can see, ServiceNow is not opportunity constrained. New buying centers, new industries, new geographic markets and we're fielding more inbound interest for new partnerships at any point in our history. There's a sense of excitement here in the community, in our company and it's all for good reason.

Speaker 2

In closing, our focus is exactly where it should be, expanding this differentiated platform, scaling this business and delivering great results for our stakeholders. I got a few questions about the second half with a rare speculation out there that elections or other macro factors will challenge the business environment. Are our customers mindful of the unknowns in the broader macro? Of course. That's exactly why they are leaning in to ServiceNow because AI is the elixir that drives productivity, cost efficiency and new business models.

Speaker 2

Simply put, enterprises are investing in business transformation. They are investing in AI. They are building a new reference architecture for the decades to come. This is the largest, most compelling business opportunity in the world. We are bullish on what's ahead.

Speaker 2

That's why we have not only confirmed but also raised our full year guidance. Our brand represents an optimistic view of the world's future. It's why we're putting AI to work for people and ultimately why. As we celebrate the 20th anniversary of Fred Luddy's original dream, we believe the next 20 years will be even more exciting. I personally have never been more convinced that ServiceNow will be the defining enterprise software company of the 21st century.

Speaker 2

Thank you for your time and attention. I look forward to your questions. I'll now turn you over to Gina. Gina, over to you.

Speaker 3

Thank you, Bill. Q2 was another fantastic quarter with tremendous beats across all of our top line and profitability metrics. ServiceNow's business remains resilient with net new ACV and GenAI contributions exceeding expectations. Once again, the team demonstrated exceptional execution as we continue to see strong demand for the NOW platform and our NOW Assist offerings. Q2 subscription revenues were $2,544,000,000 growing 23% year over year in constant currency, exceeding the high end of our guidance range by 100 basis points.

Speaker 3

RPO ended the quarter at approximately $18,600,000,000 representing 31.5 percent year over year constant currency growth. We continue to see average contract terms increase with TCV from 5 plus year deals more than tripling year over year. Current RPO was $8,780,000,000 representing 22.5 percent year over year constant currency growth, a 200 basis point beat versus our guidance and a 150 basis point acceleration from Q1. From an industry perspective, U. S.

Speaker 3

Federal had a great quarter, accelerating both quarter over quarter and year over year with net new ACV up well over 50% from last Q2. Manufacturing and Energy and Utilities were also areas of strength growing net new ACV over 50% year over year. Healthcare and Life Sciences and Retail and Hospitality both had a great quarter growing about 30% year over year. The NOW platform remains a mission critical part of our customers' operations reflected by a strong 98% renewal rate. The stickiness of our customer base has served as a solid foundation for us to continue to build upon.

Speaker 3

We closed 88 deals greater than $1,000,000 in net new ACV in the quarter, representing 26% growth year over year. This includes 6 new logos, 2 of which were G2K customers. We continue to see robust large deal momentum in the quarter closing 14 deals over $5,000,000 in net new ACV and 4 deals over $10,000,000 Our focus on selling a comprehensive platform continued to drive more multiproduct deals as 14 of our top 20 deals included 8 or more products. We now have 1988 customers paying us over $1,000,000 in ACV. In addition, the number of customers paying us $20,000,000 or more grew nearly 40% year over year.

Speaker 3

As Bill highlighted, our Gen AI net new ACV to date continues to trend ahead of any new product family launch for the comparable period. Our Plus SKUs saw more than a 30% price uplift over Pro in Q2. Furthermore, since launch, we're seeing a greater than 3x increase in average deal size versus the comparable Pro upgrade. Now Assist cogeneration capabilities within creator workflows remain a powerful productivity tool of choice as well, appearing in over 70% of our Gen A ideals. Best of all, customers are going live fast.

Speaker 3

We're learning with them, releasing innovations based on their feedback at a very fast clip to get them to value. In July, BT Group announced that its Now Assist pilot helped agents write case summaries and review complex notes faster, cutting both times by 55%. This helped drive down the average time to resolve cases by a third. We are just scratching the surface of the opportunity as the vast majority of Gen AI sales are direct. We're working to onboard partners, arming them with the tools to sell now assist and further extend our go to market reach.

Speaker 3

Turning to profitability. Non GAAP operating margin was over 27%, approximately 2 50 basis points above our guidance, driven by OpEx efficiencies, top line outperformance and timing of marketing spend. Our free cash flow margin was 14%. We ended the quarter with a robust balance sheet including $8,900,000,000 in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of world class growth, profitability and shareholder value.

Speaker 3

Moving to our guidance. Given our Q2 outperformance, we are raising our 2024 outlook. For 2024, we are raising subscription revenues by $33,000,000 at the midpoint of the range to more than offset an incremental $20,000,000 FX headwind. This raise yields a net increase of $13,000,000 on a narrowed range of $10,575,000,000 to $10,585,000,000 representing 22% year over year growth on both a reported and constant currency basis. We're also raising our full year operating margin target from 29% to 29.5%.

Speaker 3

We continue to expect subscription gross margin of 84.5%, free cash flow margin of 31% and GAAP diluted weighted average outstanding shares of 208,000,000. For Q3, we expect subscription revenues between $2,660,000,000 $2,665,000,000 representing 20% to 20.5 percent year over year growth or 20.5% on a constant currency basis. We expect CRPO growth of 22.5% on a reported basis or 22% on a constant currency basis. We expect an operating margin of 29.5 percent. Finally, we expect 209,000,000 GAAP diluted weighted average outstanding shares for the quarter.

Speaker 3

In summary, Q2 was a strong quarter and we continue to see strength heading into the second half of the year. Our Knowledge in Bet! In May was an incredible 3 days of inspiring keynotes, amazing demos, intriguing breakout sessions and plenty of discussions around AI as it was woven into every aspect of the event. ServiceNow's focus on putting AI to work for people was a consistent theme for the over 20,000 participants, including 5,000,000,000 of pipeline in the room. The response from customers around our latest innovations has been incredible.

Speaker 3

As Bill mentioned, newly created pipeline after only 60 days was up 50% year over year and that has since grown to over $1,000,000,000 Our second half pipeline combined with our net 4 gives us very good visibility into our top line guide and further confidence in our journey to $15,000,000,000 plus in revenue. We are well on our way to becoming the defining enterprise software company of the 21st century. I'm extremely proud of our team's performance this quarter, and Bill and I can't thank our employees enough for their hard work and dedication. Bill and I couldn't be prouder of this incredible team. With that, I'll open it up for Q and A.

Operator

Thank you. The floor is now open for questions. Your first question comes from the line of Keith Weiss of Morgan Stanley. Your line is open.

Speaker 1

Excellent. Thank you guys for taking

Speaker 4

the question and congratulations on a really strong quarter. In an environment that as you guys noted a lot

Speaker 1

of people are concerned

Speaker 4

about, Bill, can you talk to us a little bit more about what is it that enabled you guys to get these contracts closed, if you will?

Speaker 2

What we're hearing from a

Speaker 4

lot of CIOs is excitement about the opportunity, but tentativeness in pulling the trigger, but you guys seem to be able to get people to pull the trigger. What is it that enables you to pull the trigger? And then a follow-up for Gena, Was there any unusual activity in terms of like deals slipping from Q1 to Q2? Or was this just fundamentally the strength of Q2?

Speaker 2

Thank you very much for the question, Keith. I would first of all begin by discussing this incredible platform and the difference that it makes. If you take all the complexity that's out there and you think about what CEOs today want, they're looking for new vectors of growth. They have to radically simplify their companies and digitization is really the only way out. But the difficult thing is most people are selling into a department where they have a narrow threaded solution.

Speaker 2

And that doesn't necessarily change the way work flows and the way business processes get executed. So we're able, especially with our Gen AI built into this incredible platform, we're able to demonstrate real value. And that ROI is undeniable and we have a culture built to deliver value. We have a team that knows how to describe value And obviously, we're very market connected. I do give the culture here credit for what I call an elite level of execution.

Speaker 2

So that's just built into the fabric of our DNA, great innovation, great execution, great integration between what we build, how we take it to market and how in the post sale world we care for that value to be ultimately delivered quickly and provable ROI.

Speaker 3

And then Keith, on your question about any unusual activity of deals slipping from Q1 to Q2, no. Actually, we just saw pretty incredible great execution across the board in Q2. From a revenue perspective, net new ACV outperformance that we talked about, strong execution of the ServiceNow, incredible go to market team, as you would expect. On prem did come in a little bit ahead of expectations, but the net new ACV outperformance was more was much more impactful. With respect to the CRPO beat, also again primarily driven by net new ACV outperformance, a little bit higher early renewals.

Speaker 3

As you know, I've been pretty prudent in how I've been guiding for early renewals and continue to do so. But the beat was really a function of incredible execution by this team once again.

Operator

Your next Your next question comes from the line of Raimo Lenschow of Barclays. Your line is open.

Speaker 2

Perfect. Thank you. Congrats from me as well. Bill, you talked about some of the use cases like BT where you kind of with your slightly smaller, more efficient fast language model achieving very good results. Is that like a blueprint of the way we think we should think about AI going forward in terms of like rather than these very large models that you as a smaller and more nimbleness AI actually can do achieve a lot more because you're more specialized?

Speaker 2

Thank you and congrats. Yes. Raimo, thank you very much for the question. And I think the key to our domain specific or smaller models as you mentioned it, they're lightning quick, there's no latency because we're working with the customer's data. They're highly secure again because it's the customer's data and they're inexpensive to run.

Speaker 2

And when companies see the bandwidth of a platform that goes end to end, so everywhere from the entire IT estate for digital transformation or recreating an employee experience where employees actually get excited to come to work and do their job because we take the busy work out of their life or the customer experience can be totally reimagined and then inspiring developers to do what they do best, which is dream about net new innovation and building new business models. You see this obviously you mentioned BT. I could have easily said London Stock Exchange where they deployed us for a core business transformation and they unified 15 siloed platforms and 14 lines of business on the ServiceNow platform. And they actually saw deflection rates increase to 85% of the cases and 35 percent time improved in summarizing incidents. And by the way, now Assist does this in seconds.

Speaker 2

So we're talking about 2 days per employee improvement in productivity. I could have gone to TriMetics, a biotech company and basically what they're doing with now Assist is they're enhancing developer productivity, which has increased for them, 22% and they saw 50% of their developers actively using Now Assist in just 3 months. I could have also mentioned KANOS, a digital technology solutions provider. They created 600 knowledge articles with NowAssist and they were able to improve access to their knowledge content for their customers and employees. Their satisfaction from a customer standpoint went from 80 to 99.

Speaker 2

And this is just amazing stuff. We just went general availability with our GenAI SKUs for our government community cloud. This was June 28, by the way. One customer had a go live and implementation schedule for Q3, but their pilot went so well that they decided they needed it immediately activated in Q2. So you're into a whole different program here with rapid time to value a product that people love to use and the executives get excited because their people are so happy, their customers are so happy, their innovators are so happy and we're so market connected that we know what's going on in every one of these instances.

Speaker 2

They know we're not mailing it in from a desk. Perfect. That's amazing. Thank you. Thank you.

Speaker 2

Thanks, Amel.

Operator

Your next question comes from the line of Kash Rangan of Goldman Sachs. Your line is open.

Speaker 5

Bill, you'd be the last person to mail it in from the desk. That's for sure. Well, congratulations teams for amazing results. And Gino, I couldn't help but notice that RPO growth overall hit 30% plus for the first time in 8 years. So certainly, kudos on that front.

Speaker 5

Bill, one for you. You've been through multiple macro cycles. If there is a rate reduction and there's a regime change to more pro business, if you want to call it that way and count the 25, have there been certain things that have been holding back so to the extent that you guys have done really, really well? What could be the bigger macro unlocks as we head towards more rate cuts ahead? And also on the AI front, it's remarkable how much productivity improvement you've been able to give your clients with just 3 quarters of shipping the product.

Speaker 5

Where do you see now as this go forward, I mean, is it going to follow the path created by employee workflows, customer service workflows, creator workflows? I mean, are we going to go deeper into each of these domains and unveil more and

Speaker 4

more AI unlocks there?

Speaker 5

Thank you so much and congratulations.

Speaker 2

Thank you very much, Kash. I really appreciate your thoughtful comments and your question. I think the bottom line is consolidating the past is really not moving the ball forward and innovating the future is. I think we have a dream for the company. I think we know how to describe that dream to the C suite.

Speaker 2

I think we're now toggling across the entire C suite where we've expanded the perimeter and the relationship plan and the solution roadmap. And obviously, internally, we've scaled the company where it's ready to make a bold move now and be the defining one in the enterprise. So I think all that's coming together at once for us. In terms of the broader macro, you saw the investment in hardware obviously for the AI world. You saw the incredible success of the great NVIDIA company and the work that they're doing.

Speaker 2

You see great companies like Microsoft doing incredibly well, with Office and Dynamics and Teams and CoPilot. So they're a standard. And then you see the hyperscalers all doing well. Whether it's Azure, it's AWS or it's GCP, they're all doing well. And good news is we integrate with all of them.

Speaker 2

So we know the hyperscaler trend, okay. We built our Gen AI strategy with NVIDIA. We knew they were going to be the winner. We had no doubt about that. And we knew that the world of the 20th century would eventually get the picture that you can't upgrade the past and expect it to give you a different result.

Speaker 2

And any time we get a chance to tell that story and prove it with a great demo and great success cases, we blow people away with innovation. But to answer your question in terms of where are we headed, where we're headed is we're going to transform entire industries. And if I give you an example of that, take the utility industry for example, they have to maximize the power grid uptime. They're trying to detect and mitigate vulnerabilities of critical assets and they need to do everything in real time, whether it's repairing things, taking care of equipment, skills, parts, field service technicians, equipment suppliers. There's a whole distributed value chain.

Speaker 2

We're going to reinvent the whole industry and we're going to put it on the ServiceNow platform. And we're going to take the data and we're going to connect all the disparate parts that are suffocating companies and we're going to move it into the NOW platform and we're going to reimagine the way work flows. And I could say that for manufacturing, think about predictive maintenance across multiple sites combining IoT data with advanced analytics to optimize profitability, improve operational efficiency. Think about consumer goods. They want AI powered chatbots to deliver personalized shopping experiences.

Speaker 2

And just think about your own shopping experience. You can buy a great product, but if you can't return it in a streamlined way, you drop the brand. You're not doing business with them anymore. So it's a virtuous cycle to think about the quality of the product, the service experience of the customer and ultimately advocating for the customer and giving them what they want. That's all workflow and we're going to automate that entire industry.

Speaker 2

And so rethink healthcare, rethink manufacturing, rethink utilities, you rethink consumer goods, we're going for it all.

Operator

Thank you. Your next question comes from the line of Peter Weed of Bernstein. Your line is open.

Speaker 4

Thank you and congratulations on

Speaker 5

the continued momentum. I think the big surprise news of

Speaker 4

the day was obviously some of the changes in leadership. CJ, obviously, is a really important part of

Speaker 5

the senior leadership team.

Operator

He's one

Speaker 4

of the people that I often pointed out to clients about the success and leadership there. Beyond naming Chris as the Chief Product Officer, what do you see the key operational steps to ensure a smooth transition? And what additional actions are you taking to kind of ensure continuity? And what are those keys to success? And I guess it's probably not just operationally with the team, but also probably with the public sector business, given that was a bit of where this work came from?

Speaker 2

Thank you very much, Peter. I appreciate your question. We have an unbelievable team. And actually, we've already been in execution mode on where we're taking the company and the leadership team. I met with all of them today, including Pat Casey, who is one of the co founders of the company and he actually runs the cloud for the company and all of the line of business development leaders.

Speaker 2

Chris Betty is in there on an acting capacity because he knows my decision making style and he can integrate beautifully with the great engineers that we have and the great grow to market people we have. So we don't drop a single step in our march to be the defining one. So everybody's fired up. They understand the mission and they're ready to go. And I will hire a Chief Product Officer.

Speaker 2

It could come from the inside of the company or the outside of the company on a more permanent basis, but we're not going to miss a step in execution. We're already on the move. So very, very, very confident in our company. And by the way, very, very confident that our business is in great shape. And I do want to mention, the U.

Speaker 2

S. Public sector remains a substantially important industry vertical to our company. And we continue to believe that that is poised for further growth, especially in Q3 because that's when a lot of the decisions get made. And we have our arms around that. Our great public service companies love us.

Speaker 2

We love them. We're doing a great job for them. And we don't intend to miss a beat here, Peter.

Operator

Thank you.

Speaker 2

Thank you very much.

Speaker 1

Operator, did we lose you there?

Operator

Your next question comes from the line of Samad Samana of Jefferies. Your line is open.

Speaker 6

Hi, good evening. Thanks for taking my question and just an exceptional quarter guys. Thanks for making our evening easier. So maybe Bill, first question for you. Just as I think through AI, clearly, you're one of the few companies that's seeing significant demand upfront and strong early traction.

Speaker 6

Guess what I'm trying to figure out is for the companies that you're talking to about AI that haven't attached it, what do you think is causing them to hold out? And what do you think is the trigger that makes them join the party?

Speaker 2

Yes. In terms of the companies that are buying AI products and the companies that aren't?

Speaker 6

Correct. For the ones that haven't adopted it yet that you're still having that conversation with, how do you get them to join the party?

Speaker 2

Yes, it's a really important question, Samad, because I think what's happened is they've heard so many whitewashed AI stories from pretenders that they are a little jaded. So we have to get in there and show them all the use cases, show them the demos, show them the customer success stories, give them the handful of references that are already doing it. And before you know it, we're off to the races. And then we show them our roadmap for where we're taking the company and they realize they don't want 2nd mover advantage because if other participants in their industry move out and they don't, they could lose. And also, if you think about employees, soon employees won't tolerate the nonsense that's going on with 800 numbers, busy work, silly work that doesn't make a difference and they'll go work somewhere else.

Speaker 2

So the same thing is true with customers. So I think that it's an education, it's a demonstration and it's having the validity of success where you have permission to go into the C suite and they're interested in listening to your story. Once they hear our story and once they see us in action, it's an order And then it's a quick install and then it's a go live and then it's amazing productivity. That's what's happening.

Speaker 3

And Samad, I would just add and I talked about this in my script that we're just scratching the surface of that opportunity and the vast majority of our current sales are direct, right? So we're working now really strongly with our partners and the ecosystem to arm them with the tools to sell and that's going to extend our go to market reach even broader. Those partners are so critical and so important and they are leaning in very heavily with us. And so that's going to be another part of kind of the continued acceleration here.

Speaker 2

I think Gina makes a great point there. And I did hear one analyst once say, yes, I've been talking to the partner checks and the channel and I'm not hearing a lot from the partners. Yes, that's because as Gina said, they're still getting activated. But can you imagine when they do? If you see these results when we're doing it on our own and then you get 1,000 and 1,000 and 1,000 more feet on the street telling the same story, it's a wow factor.

Operator

Your next question comes from the line of Karl Keirstead of UBS. Your line is open.

Speaker 7

Well, thanks. Maybe I'll direct this one to Gina. Gina, 3 months ago, you had signaled an expected pretty solid sequential acceleration in CRPO in 3Q. I know things change. So I'm just wondering if you might revisit that second half outlook.

Speaker 7

And specifically, given the second half election uncertainty that Bill flagged, I'm wondering if you're being a shade more conservative on the 3Q CRPO guide given how big 3Q is in the public sector. Thank you.

Speaker 3

Yes, Karl, it's a great question. I think that as expected and I talked a little bit earlier that part of the beat, most of the beat for Q2 was all about execution in net new ACV, but there was part of the beat that was early renewals. I'm continuing to be prudent in how I'm factoring in early renewals because they are so customer by customer specific. And so what I would say is that I continue to be prudent in how we think about guide for Q3 and the full year, but I remain extremely confident in that pipeline that I talked about. So pipeline coverage ratios are strong.

Speaker 3

Maturity is better than same time last year. We came out of knowledge with 50% more pipe generated in the 1st 60 days and that number I spoke earlier has surpassed $1,000,000,000 And so pipe remains strong. Opportunity, as you've heard Bill and I talk about so far today, is fantastic. Demand seems healthy. But you're right, there's definitely a little bit of uncertainty in the back half of the year and we continue to be prudent in some of our assumptions.

Operator

Thank you. Your next question comes from the line of Brad Sills of Bank of America Securities. Your line is open.

Speaker 8

Great. Thank you so much. I wanted to ask a question around that on that same note there on pipeline with 50% increase since knowledge. Sounds impressive, sounds exciting. Would love to get some color as to where the where that you're seeing that strength, maybe a glimpse into what that pipeline looks like across the stack.

Speaker 8

Are there any standouts, whether it's in IT or customer, employee, creator? Obviously, now assist, I'm sure has a large part to do with that as well. So just would love to get a little color there. Thank you.

Speaker 3

Yes, Brad, I would say it's very much across the board. Similar to the results that you saw in Q3, it's really strength across the platform, whether it's IT, customer, employee, creator as well as NowAssist. And so what I would say is we're operating on all cylinders here and pipeline being generated is really very across the board. But as you would imagine, with respect to Gen AI, there is such excitement and such attention there that we absolutely see very strong pipeline as we think about GenAI in the back half and then moving into 2025 beyond.

Operator

Your next question comes from the line of Kirk Materne of Evercore ISI. Your line is open.

Speaker 9

Yes, thanks very much and I'll echo the congrats on a really nice quarter. Bill, you alluded to this a little bit earlier in one of your answers, but I was just wondering if you could expand a little bit on the opportunity around operational technology for you all. Where are you in terms of starting to have those conversations with customers? And could you expand a little bit on your thoughts and hopes for that product set as we look out over the next 6, 12 months? Thanks.

Speaker 2

Yes. Thank you very much, Kirk, for the question. I really do appreciate it. It's really amazing. The initial demand for this product and this offering as you saw from the Washington DC release and what we saw at Knowledge 24 has really surprised us on the upside how quickly it's taken off.

Speaker 2

In Q2 as an example, we had a large biopharmaceutical company go for OT. They mix it with IT. We had a huge biotech and pharma company and a large Japanese auto company. And what we're already seeing is partners like Boomi, STMicro, and a multinational electronics company also based in Japan go for it. So we think that there's a big opportunity here for both of these products.

Speaker 2

OT has increased our technology workflow TAM by about 5,000,000,000 dollars In addition, we see sales and order management. This is helping us address a $68,000,000,000 customer workflow TAM. So it's still early days, but we are super encouraged by the traction that we see so far. And we'll continue to monitor and update you guys on this, but it's a meaningful part of our portfolio now. And again, one of the beauties of this company is the beauty of linking the engineering development effort with the feet on the street and having that high touch intimacy with the customer and the virtuous cycle back into development where the customer feels that they are the developers developing their dreams and our great engineers are capable of doing things so quickly here.

Speaker 2

And this is yet another example. Thanks.

Operator

Your next question comes from the line of Alex Zukin of Wolfe Research. Your line is open.

Speaker 4

Hey, guys. Thanks for taking the questions. Maybe just the first one. This was like, I think, by far the strongest RPO quarter that you've had in, I think, 3 years since 2021. And I guess the question is, if I look at if I think about the inverse of that you may be pulled in any deals?

Speaker 4

Because the confidence, Gina, that that you may be pulled in any deals? Because the confidence, Gina, that you're referring to on the pipeline, help us just give us a sense for that? And then I've got a quick follow-up.

Speaker 3

Yes. So you're absolutely right. RPO growing at 31% year over year is pretty incredible, especially at our scale. We continue to see average contract terms increase, right? And so Q2 has the largest quarterly average contract term for Q2 since 2018.

Speaker 3

And so, we're seeing TCV from 5 plus year deals more than tripling. I said that in my script. And so we're really seeing a meaningful uptick in multiyear duration contracts as customers are really seeing the power of the NOW platform and just making longer, more strategic deals, which is resulting in that. And so no big differences in kind of any pull forwards of deals, a slight uptick in early renewals, as I talked about, but that was only against a pretty prudent guide. So again, it's really about the power of the platform, customers really understanding how we're abusing GenAI into that platform and really becoming the AI platform also

Speaker 5

if

Speaker 4

also if AI conversations are already driving just much larger, more strategic engagements that are leading to some of this RPO growth?

Speaker 3

Yes. So linearity in Q2 was good. Feel really good about what we saw. And absolutely, AI is AI conversations are driving very strategic engagements and obviously driving larger average contract terms, right? Again, it's customers really leaning into a longer strategic partnership and getting in now.

Speaker 3

And so I think all

Speaker 2

of that is a big part of what you're seeing in our results. And Alex, I would build on what Gina said by just thinking about the timeline that you mentioned. We became a platform company. That's what happened. We've gone from a product company with a land and expand mentality to an AI platform for business transformation that's looking at industry that we're looking at the complete bandwidth of what a company is trying to pull off.

Speaker 2

And then to give you a piece of the brand, I think we differentiated ourselves by putting AI to work for people. And people includes people like us and includes employees and includes customers and includes people that build the software and includes people that keep the place secure. So all these things were taken into account in the strategic direction of how we would build a strategic platform company. And when Gina tells you the deal sizes are expanding, the duration of the agreements are expanding, it's consistent with a company that is scaling right before your eyes.

Operator

Your next question comes from the line of Mark Murphy of JPMorgan. Your line is open.

Speaker 9

Thank you very much. Amazing quarter. Bill, I'm wondering what did you experience and what type of opportunity do you see perhaps in response to the CrowdStrike issues and outages? Is it reasonable to think that you could have some large companies that would want more telemetry across the IT estate, more ability to monitor and detect outages and improve incident response. It would seem like that could play directly into your ITOM and SecOps capabilities.

Speaker 9

And then Gina, I saw the sales and marketing headcount growth picked up. And I'm wondering if you've just reached a point where something is signaling to you to move into a more aggressive kind of a hiring posture?

Operator

Okay.

Speaker 2

Well, I'll start off and then Gina can talk about our hiring strategy. And thank you for your kind remarks, Mark. There was 0 impact on customer systems from CrowdStrike outage on July 18 as it relates to ServiceNow. There was 0 impact to data integrity financial systems and the integrity of the operations of the companies as it relates to ServiceNow. And thanks to our CMDB, I think you're on to a very good marketing and sales idea and the service mapping of the CMDB.

Speaker 2

We had instant visibility into which systems, which business services and infrastructure were impacted in our customers' environment. And our automated workflows sped up the remediation and the employees were kept up to date via our ServiceNow portal. So I think this could actually lead to more sales opportunities once non ServiceNow customers see what's possible with a platform like this.

Speaker 3

And on your question on sales and marketing, I highlighted that it would be picking up even in Q1, right? So Q1 was a little bit lower because last year Q1 was a big hiring quarter. But yes, we absolutely are focused on ensuring that we're hiring feet on the street, quota bearing sales to go and drive these opportunities that we keep talking about. So we do expect hiring and sales and marketing to kind of continue to tick up a bit, very much in line with our original plans. And obviously, the more we over exceed and the opportunity grows, we will continue to hire to ensure that we have those feet on the street driving and closing those deals.

Operator

Your next question comes from the line of Joel Fishbein of Trish Securities. Your line is open.

Speaker 10

Thanks for taking the question and congrats on the fantastic quarter. Bill, for you, you acknowledge you announced a further strategic partnership with Microsoft now assisting CoPilot integration. Just love to hear from you how that's actually proceeding and if you're driving deals together and to those co solutions. Thanks.

Speaker 2

Thank you very much, Joel. We have a really fantastic partnership with and I think that has actually opened additional addressable market for ServiceNow. And there is a co sell motion with Microsoft's enterprise sales team. We do work together very closely with them. And we're good teammates and we're good partners.

Speaker 2

And we know that both of us working together is what the customer wants. So that's why we do it. And ServiceNow is really helping customers streamline their migrations to Azure. And while Azure exposes us to a much wider spectrum of customers, I think we also help the relevance of Azure because we're getting big and we're expanding in multiple industries and geographies and we're really thinking strategically about how we can win net new logos together. And we've had some examples of them.

Speaker 2

We closed $71,000,000 plus now on Azure deals in Q2, with 2 of them as new logo wins. And one deal in fact was over $30,000,000 in net new ACV. So we're quite confident that the partnership and synergy will enable us to bring value to more customers and we'll do it at unprecedented speed and scale. And have been very straight up with everybody. I don't go anyplace without acknowledging Microsoft as a standard And I recognize that Copilot does very important things.

Speaker 2

And it gets even more interesting when all the capability of Now Assist and the things that we built our platform to do is complementary and fully integrated into Microsoft. And that's really the winning formula and it has been from day 1.

Operator

Your next question comes from the line of Rob Owens of Piper Sandler. Your line is open.

Speaker 11

Great. Thank you very much for taking my question. Bill, somewhat curious just where customer conversations are around data governance as we think about these modern architectures, as you're thinking about Raptor DB. Is that an area that we should expect ServiceNow to play in directly or play in via partnership? Thanks.

Speaker 2

Thank you very much for the question, Rob. I would say at this point, I want you to think about workflow automation, GenAI on our platform and our ability to take Raptor DB and gather any data source regardless of who's governing it or where it is and activating that in a workflow to automate the way things get done. And as an example, this lighthouse program that we have has a group right now of design partners and early adapters of Raptor DB. And I think it will further accelerate our pro version of the ServiceNow platform in addition to entering us into a whole new TAM to complement the Now platform, Pro Plus, Now Assist and then the Raptor DB Pro. And we're going to use the learnings from this program to further develop our offering.

Speaker 2

And we do see our role as integrating, as opposed to competing with other data providers because the customer wants to activate our platform to do good work with all of the data estates that they have because we have the only AI platform for business transformation in the enterprise. And if we can go everywhere, it just extends our reach and the bandwidth of our TAM and the executional excellence that we can bring to stakeholders. So it's all part of our thinking big and activating all this in industry specific use cases. So when we show up, we're not fumbling through a brochure, we got a demo in our hands and we're showing you how you can transform a business process.

Operator

Your next question comes from the line of Brad Zelnick of Deutsche Bank. Your line is open.

Speaker 12

Great. Thank you so much and congrats on the elite level execution and the great results. Gina, I just got a couple of quick ones for you. You had a big step up in CapEx this quarter. Can you comment on what drove that and the cadence we should expect going forward?

Speaker 12

And then also just a point of clarification, is there any federal business you foresee having to unwind as a result of the investigation you conducted? And should we assume that, that would all be factored into guidance? Thanks.

Speaker 3

Yes. So I'll take that second question first. So no, there's no federal business that we foresee we will need to unwind, full stop. And then with respect to the step up in CapEx, it's more quarterly timing than anything else. Expectation for full year has not changed.

Speaker 3

And as you would imagine, a focus of our CapEx is on AI and Gen AI. But as we talked about at Financial Analyst Day, it's all already baked into any guidance that I would have given you. So I wouldn't take into account any quarterly kind of timing related stuff.

Speaker 12

Awesome. Very helpful and congrats again.

Speaker 2

Thanks, Brett. Thank you, Brett.

Operator

Your next question comes from the line of Mike Sicos of Needham and Company. Your line is open.

Speaker 13

Great. Thanks for getting me on guys. I just had a couple of quick questions. The first, I think that you guys had expected, call it, about 200 basis points of headwind to 2Q CRPL in relation to the public sector. Did that play out as expected?

Speaker 13

And then can you remind us that off the top of my head, I want to say that normalizes as we lap those contracts in Q3, But does that federal headwind go away now in Q3?

Speaker 3

So yes, that headwind to Q2 CRPO did play out as expected. And yes, it will normalize in Q3. But remember, depending on the size of our Fed business in Q3, it could pop up again as we play out Q4 and beyond. Obviously, we'll let you know as that comes to fruition or not. But yes, it should normalize now in Q3 as expected.

Speaker 13

Understood. Thank you very much and congrats on the strong quarter.

Speaker 3

Thanks Mike. Thanks Mike.

Operator

We have time for one last question. Your last question comes from the line of Matt Hedberg of RBC Capital Markets. Your line is open.

Speaker 4

Great. Thanks for taking my questions. Maybe just a quick one for Gene and kind of following up on the last few questions. Subscription revenue has been decelerating here, CRPO has been accelerating and obviously even part of

Speaker 5

the guide. Is that just a

Speaker 4

function, Gene, of the renewals that we're seeing, whether it's Q2 or Q3? Just maybe a little bit of the divergence between subscription revenue and CRPO growth.

Speaker 3

Yes. So basically what that really is showing you is that net new ACV has reaccelerated in first half '24 versus first half 'twenty three. The other piece has nothing to do with early renewals really, but the other piece is that are expected on prem mix in Q3 of this year is lower than is a little bit lower than last year. So all good things as you think about the results for Q2 and what it means going forward.

Speaker 4

Great. Congrats on the quarter, guys.

Speaker 3

Thanks, Matt.

Speaker 2

Thank you very much, Matt.

Operator

We thank you for your participation in today's call. This concludes today's conference call. You may now disconnect.

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Earnings Conference Call
ServiceNow Q2 2024
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