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Edited Transcript of NOW earnings conference call or presentation 23-Oct-19 9:00pm GMT

Q3 2019 ServiceNow Inc Earnings Call

San Diego Oct 26, 2019 (Thomson StreetEvents) -- Edited Transcript of ServiceNow Inc earnings conference call or presentation Wednesday, October 23, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bill McDermott;Incoming President and CEO

* John J. Donahoe

ServiceNow, Inc. - President, CEO & Director

* Lisa Banks

ServiceNow, Inc. - VP of IR

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Conference Call Participants

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* Aleksandr J. Zukin

RBC Capital Markets, LLC, Research Division - Analyst

* Brad Alan Zelnick

Crédit Suisse AG, Research Division - MD

* Christopher David Merwin

Goldman Sachs Group Inc., Research Division - Research Analyst

* James Derrick Wood

Cowen and Company, LLC, Research Division - MD & Senior Software Analyst

* Karl Emil Keirstead

Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst

* Kasthuri Gopalan Rangan

BofA Merrill Lynch, Research Division - MD and Head of Software

* Matthew Melotto Parron

JP Morgan Chase & Co, Research Division - Analyst

* Rakesh Kumar

UBS Investment Bank, Research Division - Associate Director & Equity Research Associate of Software

* Sarah Emily Hindlian

Macquarie Research - Senior Analyst

* Stewart Kirk Materne

Evercore ISI Institutional Equities, Research Division - Senior MD

* Thomas Michael Roderick

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Walter H Pritchard

Citigroup Inc, Research Division - MD and U.S. Software Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the ServiceNow Q3 2019 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your speaker today, Lisa Banks, Vice President of Investor Relations. Thank you. Please go ahead, Madame.

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Lisa Banks, ServiceNow, Inc. - VP of IR [2]

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Thank you. Good afternoon, and thank you for joining us for ServiceNow's Third Quarter 2019 Earnings Conference Call. On the call with me today are John Donahoe, our President and Chief Executive Officer; and Bill McDermott, our incoming President and Chief Executive Officer.

During today's call, we will review our third quarter financial results, and discuss our financial guidance for the full year 2019. We'd like to point out that the company reports non-GAAP results in addition to and not as a substitute for or superior to financial measures calculated in accordance with GAAP. All financial figures we will discuss today are non-GAAP except for revenues and remaining performance obligation. To see the reconciliation between these non-GAAP and GAAP results, please refer to our press release filed earlier today, our investor presentation and for future -- and for prior quarters previously filed press releases, all of which including a replay of today's call are posted at investors.servicenow.com.

We may make forward-looking statements on this conference call, which are subject to risks, uncertainties and assumptions. Please refer to the press release and risk factors in our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such forward-looking statements.

I would now like to turn the call over to John.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [3]

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Thanks, Lisa. Good afternoon, everyone, and thank you for joining us on today's call. Given our announcement yesterday, here's how we're approaching our call today.

First, I'll give a brief overview of Q3 results and our 2019 annual guidance. Second, I'll provide a little more insight on my decision to leave ServiceNow, and accept an opportunity to lead a company that I have been associated with and admired for a very long time. And finally, before taking questions, you'll hear from Bill, who'll provide a little more context on why he chose ServiceNow and the opportunities he sees ahead.

So let's start first with our third quarter results. We delivered another strong quarter, continuing our focus on driving customer success. Subscription revenues were $835 million, representing 35% year-over-year adjusted growth. This exceeded the midpoint of our previous guidance by $9 million, including the impact of FX. Subscription billings were $864 million, representing 29% year-over-year adjusted growth. These exceeded the midpoint of our previous guidance by $10 million, excluding the impacts of FX and duration.

Our remaining performance obligations ended the third quarter at approximately $5.6 billion, representing 36% year-over-year adjusted growth. Current RPO was approximately $2.8 billion, once again representing 36% year-over-year adjusted growth.

Our operating margin in Q3 was 26% driven by hiring linearity and a shift in expenses that will be realized in Q4, and our free cash flow margin was 14%.

Now for a peek under the hood. We closed 46 deals in the third quarter with ACV greater than $1 million, representing 84% year-over-year growth. And we now have more than 800 customers doing more than $1 million in business with us annually, which represents 32% growth year-over-year, and our renewal rate for the quarter remained strong at 99%.

Our IT portfolio continues to have strong momentum. This quarter we, again, saw 18 of our top 20 deals include 3 or more products. As you recall, we launched ITSM Pro late last fall, and we're seeing strong traction. Customers are upgrading from ITSM to ITSM Pro, and we're landing new customers that see the value in starting with ITSM Pro. Simply what's happening is customers who are pursuing digital transformation are investing at ServiceNow's full suite of IT products. They see the value of better together and of leveraging our entire product suite and unique platform. This is a clear trend.

A leading company in financial services is one example. They enabled world-class IT, security and risk via automated workflows natively on our single strategic platform, the Now Platform.

Our HR business also had a strong quarter, and we closed one of our largest employee experience deals ever with a global distribution company. ServiceNow's employee service delivery solutions hide the complexity across functional work, making it easy for employees to get the services they need. This is making work, work better for people.

In Q3, our New York release became generally available. New York extends new desktop and native mobile capabilities across the workplace at scale. This enables companies to make their employees' lives at work as simple, easy and mobile friendly as their lives at home. The New York release of the Now Platform includes more than 650 innovations across IT, employee and customer workflows.

As you know, I am personally very excited about the native out-of-the-box mobile capabilities. For the first time, we have created consumer grade mobile experiences for the enterprise removing friction in everyday work. Employees can now easily find answers and seamlessly get stuff done across IT, HR, facilities, legal and other departments, and they can do so from a modern mobile app powered by the Now Platform. As a reminder, you can download a demo of this great mobile app from the App Store.

Mobile technology was at the epicenter of the digital transformation and our lives at home, and we believe mobile technology will be at the very center of great experiences at work.

Now let me turn to full year 2019 guidance. As a reminder, for several years, we've used a very consistent methodology to manage FX. We simply take FX rates on the last day of the quarter and use those rates for the subsequent quarter. So for example, the guidance we provided on our Q2 earnings call were based on FX rates as of June 30, 2019. Now during this quarter, those rates changed impacting our Q2 results and annual guidance. So the guidance on today's call is based on FX rates as of September 30, 2019. We provide complete transparency and the impact of FX in our Q3 results and 2019 annual guidance in the Investor Relations presentation.

So for the full year 2019, we're carrying forward the $9 million in subscription revenue and the $10 million in subscription billings that exceed our previous midpoint guidance for the third quarter. So for the full year 2019, we expect subscription revenues between $3.240 billion and $3.245 billion, representing 36% to 37% year-over-year adjusted growth.

We expect subscription billings between $3.740 billion and $3.745 billion, representing 32% to 33% year-over-year adjusted growth. We're maintaining our full year 2019 margin guidance as follows: subscription gross margins of 86%, operating margin of 21%, and free cash flow margin of 28%.

Now before closing out our review of the quarter, let me just take a moment to update you on our CFO search. As you know, over the past several months, we've done a global search for a world-class CFO. And I'm delighted to say we've narrowed that search to a small group of exceptional finalist candidates. Now obviously because of our CEO succession, I slowed the final interviewing process to enable Bill to be able to pick his preferred candidate, and the good news is what Bill is doing now is meeting those candidates, and he expects to name our next CFO shortly.

Now I'd like to just take a couple of minutes to explain my decision. Let me just say upfront that I believe deeply in ServiceNow, and I believe deeply in ServiceNow's opportunity. As I've said before, there's a clear cloud tailwind. This is a beautiful, as Bill called it, clean, strategic technology platform. Customers are leaning in and want to partner with our platform, and we have the ability to extend and expand across the enterprise. And I believe, as much today as anytime I've been here, we're very well positioned to get to $10 billion and move on our way to becoming a great enduring company. And to be honest, I fully intended to be part of that journey. However, a unique situation with what is a unique company for me has emerged.

Some of you may know that I have a 20-year history with Nike. I met Phil Knight and Mark Parker 20 years ago. And over the last 5 years, I've had the privilege of serving on their Board. I deeply resonate with Nike's purpose. And as everyone at ServiceNow knows, I regularly use them as the gold standard of what a great company looks like. And I love sports.

So when the Nike Board reached out to me to ask me to become their next CEO, it was a calling I felt I had to pursue. But I will say it again, it has not in any way changed my belief in ServiceNow and the opportunity ahead.

And so the Board and I have spent the last couple of months trying to identify the best successor in the world for ServiceNow. And let me just review the criteria we used and think about it, these are criteria that will enable us to get to $10 billion and beyond. We need to continue to elevate our relationships into the C-suite. We need to expand from IT across the enterprise. As a company, we need to continue to expand globally and build more industry relevance as we expand the number of industries we serve. We need to expand our go-to-market function and scale our entire organization. And most importantly, ServiceNow needs an authentic leader who is purpose-based, values-driven and experienced. And I think you would share my enthusiasm and excitement that the Board and I have that Bill McDermott has agreed to join as our next CEO. I will tell you I've gotten to know Bill personally over the last 3 years. I consider him as excellent CEO that I've learned from and a good friend.

So with no further ado, Bill, let me turn it over to you to talk a little bit about your decision to join ServiceNow.

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Bill McDermott;Incoming President and CEO, [4]

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Well, thank you very much, John, and hello, everyone. First and foremost, allow me to congratulate John Donahoe, a great friend and an enormously successful CEO, on his personal accomplishment to become the CEO of Nike, an iconic brand. No one is more deserving than you, John. And it's an honor to follow in your footsteps.

I made my decision to open the next chapter of my career with ServiceNow. By way of background, I was with SAP for 17 years. I was CEO for 10 years. In that 10-year time horizon, we moved the market cap from $39 billion to $163 billion. We either doubled or tripled or quadrupled revenue profits, the number of customers that we served around the world. Our last count was in the order of 450,000 customers around 193 countries.

I believe strongly that at this particular time rather than renew for another 5 years, it was proper to say 10 years is good principal, and I pass the baton to 2 excellent leaders that are now the co-CEOs of SAP, and I'm very proud of them, and I'm looking forward to their continued success of SAP, a really wonderful company, a great experience. And to my friends at SAP, thanks so much, and we'll continue to do a great job in the next couple of months.

As it relates to ServiceNow, why ServiceNow? First and foremost, the culture of ServiceNow is truly special. As I think about John Donahoe and what he's been able to accomplish, and the amazing legacy of Fred Luddy, and how he has set the tempo for really humble and hungry employees serving customers in the absolute best way possible and this idea of making work, work better for people is so human and so necessary in today's enterprise where customers more and more are looking for a true partner that really deeply cares.

With that to ServiceNow, John continued that proud tradition, and it's an honor for me to be humble and hungry and truly honored by this opportunity. I will give it everything I have.

I'd also like to thank Jeff Miller, the Lead Director and the Board of Directors for their support, what a Board of Directors ServiceNow has as well. I met the management team, John was kind enough to have us over his home. I met each one of them, also the VPs across the company. And as John said, we're well on our way to closing the CFO search, and I think you'll be very pleased with the outcome. Outstanding candidates indeed.

Now if I was in your shoes, what would I want to hear from Bill McDermott? I would want to hear, Bill, what about this $10 billion path that John Donahoe and the ServiceNow management team have been discussing? Well, let me answer that very simply. I completely buy in, stand by it, and I'm looking forward to achieving it.

What about all the commitments including the financial commitments of the company on the revenue as well as the margin expansion story? Are you in on that, too? 100%. That, the customer commitments and the bright future of ServiceNow could not possibly be more in focus for me. I have already sold houses, bought houses, enough land to move from my family, and I am 100% in and I am looking forward to doing things that have never been accomplished before because I'm doing it off of a base that is just truly incredible. So we're going to set the standard and be the most admired business software company in the world, and I'm fired up, and I can't wait to get started.

Thank you, John.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [5]

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Great, Bill. Thank you. So let's just -- I need to say one more thing before we turn it over to questions. Bill and I want to be crystal clear. We get it's Q4. We get, we want a strong end of the year. We are both fully committed to ensuring a high-quality and smooth transition. I don't start my new role till mid-January, so I am committed to be fully accountable in this role at ServiceNow until Bill completes his transition at SAP, and is fully in the job. So in the meantime, you can assure that both of us have a deeper sense of responsibility and accountability on behalf of our customers, partners and employees to ensure a smooth handoff and a strong Q4.

So with that, operator, you can now open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Sarah Hindlian with Macquarie.

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Sarah Emily Hindlian, Macquarie Research - Senior Analyst [2]

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John, thank you for all of your time and service, and Bill, I'm really looking forward to working with you. By the way, I think we all really appreciate the depth of color you gave us around your decisions and your views on how important making Q4 is. So thank you for that as well. One thing I think would be really great to hear from you guys about is how you're feeling and thinking about the general global macro environment, especially in light of some of the issues that are going on in Europe. And I think it would be helpful for us to just hear how you feel about your positioning in the global economy overall. And any color you can give us around what you're seeing out there outside of the really strong large deal activity?

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [3]

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Yes, Sarah. Thank you. And maybe what we'll do, Bill, I'll get from -- this is kind of an easy question. I'll give it from a ServiceNow perspective. You've been out in the same market from an SAP perspective or maybe even broader. So Sarah, let me just tell you what I see. I was actually in Europe all last week. We had our Now At Work forum in Amsterdam, where we had 1,500 customers. We had 2 days later the Now At Work forum in London, where we had, I think it was close to 3,000 customers, highly engaged. I had several customer meetings, several partner meetings. And I will tell you on the front lines with customers and partners, I hear no conversation around macroeconomic. Frankly, I didn't even hear about Brexit last week. One thing I want to talk about is digital transformation and how do they use technology to drive productivity and better user experience. And so I hear them leaning in. And so we can't predict -- at least I can't predict what macroeconomic outlook is. But we're very focused on ensuring that under any macroeconomic scenario, number one in that investment queue is an investment in the ServiceNow Platform because it drives productivity, it drives user experience and it drives digital transformation. Bill, what are you seeing from an SAP standpoint?

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Bill McDermott;Incoming President and CEO, [4]

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John, I see exactly the same thing as you're seeing. And you're absolutely right. The tailwind behind digital transformation and the cloud in particular is evident in strong companies. So if there was going to be any setback anywhere, it will be in commodity, hardware players or commodity players in tech, high-value digital transformation companies that are adding real business value will continue to prosper. Because without the digital transformation part, it's a little hard to compete and win in this digital economy. So if I look at the pipelines, they look strong and they look ever consistent, which is why we strongly reiterated guidance today.

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Sarah Emily Hindlian, Macquarie Research - Senior Analyst [5]

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So much congratulations to you both on your move.

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Bill McDermott;Incoming President and CEO, [6]

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Thank you very much.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [7]

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Thank you, Sarah.

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Operator [8]

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Your next question comes from the line of Alex Zukin with RBC Capital.

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Aleksandr J. Zukin, RBC Capital Markets, LLC, Research Division - Analyst [9]

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And I echo Sarah's congratulations wholeheartedly and looking forward to -- we're going to miss you, John. Looking forward to working with you, Bill. My question maybe is just around the strategic direction to the $10 billion target. Clearly, you have an organic framework and an inorganic opportunity to accelerate that track. I'm curious if -- when you think about the inorganic component, as you think about broadening the buying centers within your -- and broadening the strategic proposition of ServiceNow continually, what's the right way for us to think about the direction whether it's within IT or outside of IT? And then just as a follow-up, I wanted to ask around just sales execution in the EMEA region. There were -- we talked about some issues last quarter. I'm just wondering if there are any kind of follow-ups on that.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [10]

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So Bill, I mean I think it's appropriate for you to comment on the first.

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Bill McDermott;Incoming President and CEO, [11]

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Sure. I mean I think first and foremost, Alex, you have a great organic growth story here. The pristine nature of this platform and the revenue that this platform alone can begin to drive is a real growth story in and of itself. And then when you think about the solution set that ServiceNow has, there's plenty of room within the context of these solutions to grow them in different geographies. Obviously, same account revenue growth as you get more and more customers to buy the complete solution set, and of course, putting an industry flavor to things will also be quite helpful. And that flavor can then be personalized to different buying centers, and you can use different channels to get at that in the marketplace. So lots of room to grow organically.

I really believe, and I said this to John many times, I believe ServiceNow is in the privileged position of being a platform of the platforms because when you look at the business process and the workflow that goes on in enterprises today, everybody has this deep need to get the data aggregated in a workflow that creates simplicity for the users. And the more we can reinvent business processes in the image of the actual users themselves, the more we can become the defining platform of the platform for the modern enterprise. So I think the organic growth story here is just amazing, and it's only just begun. I would also say I've learned a lot and I've seen a lot of different business models and the company I work for very hard, had a very different business model than ServiceNow. This is a pure-play cloud, and when you do a tuck-in, if that's necessary because it adds extreme value to the customer, then you would certainly make sure that it's integrated beautifully into the Now Platform. So you make sure it stays very simple and extremely easy to use so more and more extensibility can be realized by the developer community, the customers themselves and our great engineers. One of the things that's been blown away by is just how strong the engineering talent and leadership is at ServiceNow. So when I see that kind of talent, I start to feel really strong about organic growth. And I do want to underscore the go-to-market machine is equally up to the task. This is an outstanding leadership team here. I'm really impressed.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [12]

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And Alex, I'll just add that you asked about Europe in specific. It's so funny because we have to remind ourselves every now and then, we have the challenge that everyone else wants to have. Scaling 30% a year while growing. So you've got to scale and grow a go-to-market team that has a growing number of account reps, product line specialists, solution architects and consultants in some industry overlay. And then you do it across multiple countries in Europe. And as I said, I was in Europe last week and that team is really, really coming together and humming. We have a new leader in the U.K. who -- quite strong from VMware. All across Europe, I think our team is really coming together. So we had a lot of change in the first half of the year just as we layered in a lot of new people, but those teams are coming together and on several customer calls, those teammates are working seamlessly on behalf of our customers.

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Operator [13]

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Your next question comes from the line of Brad Zelnick with Crédit Suisse.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [14]

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John, congrats to you. It sounds like your next chapter aligns perfectly with your destiny. Many people work their entire lives and never get a chance for something like that. So I truly wish you the best. But as it relates to ServiceNow...

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [15]

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Thank you, Brad.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [16]

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You're quite welcome. As it relates to ServiceNow, and you may see my question as a bit shortsighted but it's a conversation I've been having with several investors that are just trying to get comparable with what's ahead of us. And we're now seeing significant changes with some strong leaders exiting, some really strong executives entering, and what sounds like at least some mid-level folks being hired away or, at a minimum, distracted by all the excitement. And Bill, I appreciate your commentary earlier today and the kind of following that you have, but is there anything, Bill, perhaps that you've experienced in the past that can serve as a guide for the potential disruption that we might be in for during this transition? And perhaps even -- and I know it's early days. You're not really even in the seat just yet, but how you're thinking about it relative to the company's own internal model as you look out to next year?

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [17]

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So Bill, why don't I maybe just give a quick context because Brad, I think there have been a couple of things written recently that are a little bit misleading. So it is actually true that Mike Scarpelli did leave, the only member of our senior leadership team. Our overall attrition rate as a company is I think -- is an industry low and it's the same this year as it was last year. On sales leadership, we have had -- of our top 100 sales leaders, 3 have left. So yes, 3 sales leaders have left to go to Snowflake, 97 have not, and we have a strong deep sales bench, and it was not the Head of North America. It was -- some are working, running our commercial business and another North American role. And so we have a strong team. There's not a lot of departures. By the way, some were saying, all the others have joined Snowflake, they had all left ServiceNow well before 18 months ago. And so we are very focused, as a lot of people are very excited to hear about the momentum, about the prospects and the opportunity. And so I think that's sort of a starting point. And then, Bill, you can talk about scaling and adding to that.

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Bill McDermott;Incoming President and CEO, [18]

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Yes. Sure, John. So I think the disruption is obviously, very well in hand. Thank you, John. And regarding the internal models and the things that have been built here, they're doing things very well. I mean when I look at the org chart or I look at the way the sales force is set up, or the way the channel management strategy is done, it's very good. The question becomes, can we do more and can we make it even better? And the answer is, of course. That's why I'm here. Because I see a great opportunity. But I see innovation without disruption. I see a way that we can layer in some added focus to give these solutions a richer context around the buying centers or around the scientific methodology to deliver the value. So we can have even new hires look like they've been on the job for a long time. But this is systemic. It's something that's been done before, and we'll do it the ServiceNow way. But all in all, I am very, very pleased with everything I have seen from the management team, and it's just about a continuous evolution. We do not need to disrupt this place. We do not need to revamp territory coverage. We do not need to break customer relationships. This is going to be very smooth transition. And John and I are very similar in terms of how we look at the world, the value set that we have, the way we treat people, the way we value customers, the way we think about running companies. So you're not going to see a big change here. You're going to see a continuous evolution of a great thing.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [19]

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And Bill, I have to imagine you've had your pick of the litter of just about any software company that you'd want to run, and we see a phenomenal opportunity as well here at ServiceNow.

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Bill McDermott;Incoming President and CEO, [20]

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Brad, I just want to underscore how smart you are to say that. I looked at quite a few different things in quite a few different sectors. This was, by far, the most interesting, exciting opportunity of a lifetime. And so I'm glad to see we're on the same sheet of music, and I look forward to being great friends going forward.

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Operator [21]

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

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Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD [22]

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I'll add my congrats to you both. Pretty phenomenal opportunities for both of you. So best wishes, John. And Bill, nice to see you. Again, I guess, just first, John, a big quarter for your government business. Wondering if you could just give us an update on that. And then Bill, one of the things I think John's done really well over the last couple of years has been lifting ServiceNow's profile with CEOs, not just CIOs. And I was wondering if you have some thoughts on how do you continue to make ServiceNow your brand that's not only trusted and well respected by the CIO suite, but really take it up to be a key and critical platform for CEOs as they go through their digital transformations.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [23]

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I'm going to answer your first question on the federal in a second -- the second here, but I have to say -- we'll let Bill [answer second], but I have said repeatedly internally in the last few days. Bill McDermott makes my Rolodex look paltry in terms of his relationship with CEOs all over the world. But I'll let him comment on that in a minute. On federal, look, federal, very strong business for us, very strong third quarter. Again, what's driving it? Governments are embracing cloud because they're under pressure to deliver better experiences for their citizens and employees, and drive productivity. So we're seeing that in the U.S. federal business and we're seeing that in other public sector markets around the world. So in Q3, we had 13 deals in U.S. federal over $1 million compared with 5 in Q3 of last year. We had a nice mix of federal and civilian agencies. And we had a nice milestone in Q3 that will give good prospects going forward and that we received our FedRAMP High and IL4 certifications. What's interesting, Kirk, is that federal is starting to behave as federal has embraced cloud, it's beginning to have a little bit more like enterprise in that it's less a only Q3 scenario, and it's more a continuous scenario. So year-to-date, we've got 22 deals greater than $1 million compared to 14 in all of 2018. So we had good federal first quarter, second quarter and third quarter. And our pipeline looks strong in Q4 as well. So feel very good about U.S. federal. I'll also note, as I mentioned, we're seeing nice demand for public sector globally. So we saw large deals in public sector customers in the U.K. In that case, it would be U.K. equivalent of the IRS, the HM revenue and customs agency and big public sector new customers in Germany and Australia as well. So strong business. I think that's going to continue to be a strong business. Again, an area that Bill brings a lot of experience in. So you want to talk about CEO stuff?

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Bill McDermott;Incoming President and CEO, [24]

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Sure, John. As John said, I am very like-minded with John. We're very similar executives in the sense that we recognize the power of power. And last year, I think we had something like 34 heads of state type of meetings around the world. And on the CEO front, one of the things that brought John and I together over the years is the CEO meetings that I host, and I was very fortunate to have John join me. And as an example, we have one coming up in November, where there'll be 100 CEOs from around the world and some of the biggest business cards in the world. And we do this -- SAP does this not only in the United States but also in Europe and Asia. So the Rolodex is really strong. And I believe that John and I are the kind of executives that work our heart out to help hard-working CEOs solve mission-critical business problems so they can help their customers be successful. And that's the attitude we kind of bring to those relationships. When we make promises, we keep promises. So it's really been an honor to operate at that level. And the altitude up there is nice and clear, and it helps the conversations down below to take place faster, better and bigger. So that's kind of the way we run it.

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Operator [25]

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Your next question comes from the line of Sterling Auty with JPMorgan.

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Matthew Melotto Parron, JP Morgan Chase & Co, Research Division - Analyst [26]

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This is Matt on for Sterling. So I know you guys talked about the -- on the macro side, but specifically, have you seen any impacts on Brexit or any impact on demand from the FX changes that you guys were talking about previously?

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [27]

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Yes. The short answer is no.

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Operator [28]

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Your next question comes from the line of Karl Keirstead with Deutsche Bank.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [29]

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Congrats to you both. Maybe my question to you, John. You mentioned that you want a strong fourth quarter. We all do, too. So maybe I'll press you a little bit there because as you're well aware, the implied growth rate for your subscription billings is much stronger in 4Q than the quarter that you just put up. So I'm just wondering if you could help us get comfortable with that expected fourth quarter acceleration. What gives you that confidence? That would be helpful.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [30]

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Yes, Karl. So we've been saying all year long that we continue to see increased seasonality in the business. And so Q4 is increasingly important. Frankly, we've had visibility into this all year long that the Q4 pipeline looks strong. And part of that, I think, frankly, is as we become more strategic and have larger deals, I think customers have a little bit of an inclination that the larger deals tend to get done more in their last quarter of their year because they're confident they can fund it. And I'd just remind you from a billing standpoint, 50% of Q4 billings is contracted backlog. The second next biggest piece is renewals. So we know we have great visibility into renewals coming into Q4, and given our very high renewal rate, that gives us confidence. And frankly, the smallest portion of our Q4 pipeline -- or a small portion of our overall billings is net new ACV. Now we've got a strong pipeline. We think we're going to have a strong net new ACV quarter. But it's -- remember, the foundation of the contracted backlog and the renewals, we have great visibility into -- going into the quarter. So that said, in every quarter, heads down, focused, working at our customers.

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Operator [31]

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Your next question comes from the line of Jennifer Lowe with UBS.

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Rakesh Kumar, UBS Investment Bank, Research Division - Associate Director & Equity Research Associate of Software [32]

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This is Rakesh Kumar sitting in for Jen Lowe. My question is for Bill. SAP has very well served large enterprises as well as mid- and small businesses, whereas ServiceNow is largely focused on large enterprises so far. Do you see an opportunity to take the product down market? And what should we expect there?

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Bill McDermott;Incoming President and CEO, [33]

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Yes. Well, I mean first of all, it's really a privileged position to be focused on large and still have so much room to grow. And there's nothing wrong with being very focused and segmented on large when you're putting up these kind of numbers. So let me first in high respect, say, good for ServiceNow and good for those engineers making products that those big companies need to complete their digital transformation. I really mean that. It's a focused company. It's a really good thing. Now can you take this down market? Absolutely. And the question then becomes between spreading your wings in the large space, and taking it down a little bit and the channel strategy that you approach that with and the cost of sales that you go after that with are all items that we'll be discussing in the coming weeks. And of course, we'll talk about it at the annual guidance as we go into next year. But theoretically, it looks like another big opportunity for ServiceNow.

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Operator [34]

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Your next question comes from the line of Walter Pritchard with Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [35]

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Bill, I didn't think I'd talk to you so quickly but good to have you back. I'm curious just on 2 markets in your adjacencies on the CSM side and the HCM side. I guess probably a question for John. Are you starting to see -- we're starting to hear some of the competition, I guess, wake up a little bit, realize there's these opportunities you're pursuing and I'm wondering if you're seeing any change in the field and competitively and how you're responding and how you're taking the product direction, given what's going on in CSM and HCM.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [36]

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Yes. Well, Walter, I think you're right in that what we're seeing is validation of the need and the demand. I was with one of our top 5. In fact, I've been with 3 of our top 5 SIs partners in the last 3 weeks. And employee service delivery is on the lead of all 3 because companies know they have to improve their employee experience, and they need to drive healthy sources of automation and productivity. And an end-to-end cross-functional employee service delivery is part of that. Customers -- or employees don't really care if the issue is HR or IT or finance or facilities, they just want to get it dealt with. And that's what we do. We are the only platform out there architected to do cross-functional workflow. And so it's a very different thing when that's your starting point versus having a functional platform and hoping you can do a little process or workflow around it. And so I just think our platform is architected from day 1 to address that market.

By the way, in partnership with a lot of other platforms, right? We are not a system of record in many of these functions. And so what our sweet spot is, is that ability to integrate in with the other platforms, and Bill talked about platform of platforms, the enterprise -- or the employee service delivery, some people call it enterprise service delivery. Our role of integrating the multiple systems of record and the other systems so that the complexity is hidden for the employee, and they have a great experience. And by the way, we don't put our brand on it. We have a different point of view than others do on that. We think that employees want to have the brand of the company they're working for on their mobile app or on their desktop.

Similarly, at CSM, I said this before so this is probably the last time I'll be able to say it. CSM is a $20 billion market, big market. There are different segments in that market. There are some segments that are more CRM-based where you want your customer service agent to be connected and tightly integrated in with the CRM system. There's another segment of the market, which is our sweet spot, where you want that customer service representative has to be connected into the operating system of that business. So that when a customer calls or reaches in, you can't just say, oh, you've been a customer for 8 years. We'd like to be on the phone with you for a long time. You say, no, we understand what the root cause of the issue you have is. We're getting it addressed. We're giving you regular real-time updates on how it's getting addressed. And by the way, next time it happens, you're going to be able to do it on an automated fashion and there may not be a next time because we understand the cross-functional workflow, the cross-functional root cause so that we can fix the problem and prevent it from happening again. That's our sweet spot. That's what our cross-functional platform does. In essence, it's the same concept of ITSM or many of the other things we do. And so we're seeing very good success in that segment of the market. It tends to be B2B, services, technology, really high-value situations where the customer -- for instance, I was in Europe last week, 2 large telcos, I met the President and CEO of the business side of 2 large telcos, who were saying, they are increasingly driving software as a service to their customers. And when their customers contact them, they need to see inside the network. They need to be able to see have great transparency, and that's what ServiceNow does. So I think you will see multiple winners in the CSM space. It is not a zero-sum game. It's an opportunity to apply technology in ways that hasn't been done before. We think it's a big opportunity for us. Right, Bill?

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Bill McDermott;Incoming President and CEO, [37]

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Absolutely, John. I'm 100% with you.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [38]

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Bill, by the way, brings a lot of experience in that space and will bring additional perspective and insight. And frankly, both of those spaces [can build] almost unique to anybody in the industry has played for years in almost all the major buying centers inside of the company. And I've been so struck in our conversation, he sees seams I didn't even know exist. He knows where all the seams in between the software is, where there's unmet need and opportunity because of his broad experience across all the buying centers in each of these areas. And so I think ServiceNow is going to -- he's going to bring even additional insight and energy to these new areas.

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Operator [39]

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Your next question comes from the line of Chris Merwin with Goldman Sachs.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [40]

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Let me add my congrats to John and Bill on the incredible opportunities ahead. And Bill, when you look at the opportunity for ServiceNow, there's obviously an enormous TAM here, and it seems to be one that grows every year as the company keeps adding more and more new products. So if you think about having to go after that opportunity, can you maybe just talk to us a bit about your philosophy on balancing investment and growth? And more recently for ServiceNow, the commitment's been 100 basis points of margin per year. And I'm sure we'll hear more about this at Q4, but maybe you could just share your initial thoughts there.

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Bill McDermott;Incoming President and CEO, [41]

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Yes, Chris. It's a great question, right? Because one of the power pieces of this whole equation is that this is a native born in the cloud company. And it's a company with a great platform and enormously successful products and very, very happy customers. The loyal employees part is also significant, as John mentioned. If you put all that together, this is an organic growth story. And when you have an organic growth story and you can evolve that over time, there's plenty of growth from the core on an organic basis, where you cannot only grow the revenue at a rate that's pleasing to the capital markets, but also you can expand the margins. And we can be very discerning as to what tuck-in we may or may not choose to do on that basis because we want to do both. We want to both grow the top line and we want to evolve the margin expansion story of the company because we can. So you should expect me to stay very in concert with John's strategy. You should expect a tremendous amount of continuity between everything that John has told you. It's one of the reasons I'm here by the way because I believe in John and I believe in the management team and what they've been doing, and we're going to evolve that. But I also learned a lot of lessons too because other companies that don't have such a pleasing business model have to do perhaps more M&A that would be negative to the operating margin expansion at least to some period of time. Here, I think we can balance this out pretty nicely.

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Operator [42]

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Your next question comes from the line of Kash Rangan with Bank of America.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [43]

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John, you get to do it. So just do it. Congratulations. And Bill, congratulations, an exciting chapter in your journey. I'm curious to get your perspective from your SAP days, you had a tremendous playbook at SAP that drove significant organic growth rate coupled with innovation. What about that experience? And what about that playbook can you bring to the ServiceNow chapter of your life? And congrats again. I'm really excited about this.

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Bill McDermott;Incoming President and CEO, [44]

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Well, thank you very much, Kash. I am really, really excited. Also, I'm very excited for John. And I think it's so nice that you all recognize what a great man he is and how deserving he is of an iconic brand like Nike and vice versa. So that's really great. What have I seen that might be transferable here? First of all, they're doing a lot of the things extremely well. It's really more a matter of scale and some of the things that we had to do to scale there. For example, a value-engineering methodology where you could have a proven science around the value you create for an enterprise, and the manner in which you personalize that to buying centers in a way that's compelling and highly repeatable and differentiated by industry. So that's one clear example. Another clear example is the way you broaden the perimeter. Right now, I believe that the TAM of ServiceNow is limitless in the sense that if you really think about how broken most enterprises are and how messed up the workflow and business processes are in most companies, and how unpleasant using these old systems are to the users, we literally could can create a revolution where the business users and the enterprise demand ServiceNow get the story straight by aggregating the workflow of these various platforms. I'm not sure that any work has actually been done on identifying the size of that TAM, but I believe it's only limited by one's imagination. We heard also earlier today the idea of how we could expand in Europe, and John talked about how many million-dollar deals are now happening in the European theater. Perhaps there's a few plays within Germany and France and certain areas of Europe where the root relationship plans can be appreciated in a positive way for ServiceNow. But that certainly isn't limited there. You have Korea. You have other parts of Asia where we could be very interesting based on international business and global companies and prior history. And then I think one of the colleagues also brought up how you can move the company into different markets based on the dynamics of the size of the customer, the size we established. I think we're focused on 5,000 employees and better now. When you go to 4,000 to 3,000, that creates yet another opportunity. And finally, I think the team has done a great job here of expanding the ecosystem, but if you look at the ecosystem and the relationships that I have in the ecosystem, there may be a value play here or there with some of the partners, not just the biggest ones but also the mid-sized ones around the world. So all in all, I mean, Kash, this is like one of those "dream of a lifetime kind of" opportunities, and the only problem is my feet just haven't touched the ground. I'm just walking on air.

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Operator [45]

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Your next question comes from the line of Derrick Wood with Cowen and Company.

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James Derrick Wood, Cowen and Company, LLC, Research Division - MD & Senior Software Analyst [46]

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Congratulations, and Bill, look forward to working with you. First, I guess, John, your finance operations product went [GA] in Q3. Could you just -- can you talk about the initial interest and what you're seeing in terms of pipeline build as you go into Q4 next year? And then Bill, I mean you know the ERP space better than anyone and this product integrates directly with SAP's ERP system. And so it would be great to get your take on what you're hearing in terms of early interest and kind of how big of an opportunity you see this market being for ServiceNow over the next several years.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [47]

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Derrick, you had general availability. We're still working on the next-generation implementations of our existing customers. So those, I think, come along well. And here's what's interesting. The biggest initial interest is from some of our SIs. And so as I think you know, we have an explicit partnership with Deloitte, for instance, around -- because they see how many of their clients need this capability. In many ways, it's a -- it's one of those themes I was talking about earlier. There is great software in the finance world. Bill knows it. Bill's forgotten more about it than I know. But from everything we hear, there'd be seams that are -- where there's unstructured workflow like closing the books. And so our SIs have given us very strong indication they want to be part of the go-to-market solution, and that's great because we don't have long-deep relationships to date in the finance department. And so, Bill, you've got a lot of experience in that world. So...

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Bill McDermott;Incoming President and CEO, [48]

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Yes, John. I think you said it beautifully. I mean the idea is within the context of these systems, be it financial systems, human capital management systems, even if you think about supply chain systems and manufacturing systems, there are areas of the workflow that are not meeting the modern needs of the modern user. And we are in a full position to architect that workflow in a way that's highly pleasing to lighthouse customers and then that is transferable from that lighthouse customer at the high end to many other customers around the world. And you could certainly segment that by industry. And then you really start to think about that by buying center. And if I've learned anything along the journey, it's the empathy that goes into the initial meeting because it's preprogrammed, it's outside and manufactured and it's choreographed in such a way where even people that might be fairly new at the company or people that are looking to up their game have the tools in their hands to do a great job for the customer. And the more we can do that in a way that doesn't require somebody of John's caliber, but somebody that's just carrying a bag, to the extent they can do that, you start to get mass scale. Furthermore, I just want to say I have spoken with the co-CEOs of SAP, whom I'm working with in friendship, by the way, and achievement of their goal as well. It's really a beautiful situation where everybody really does care genuinely about the other, and we have an affinity for SAP from ServiceNow's perspective, and ServiceNow has -- I mean SAP has a very strong relationship and affinity for ServiceNow. They told me that. So I spoke with Jennifer Morgan and Christian Klein. Christian Klein, as you may or may not know, was the lead decision-maker, and actually choosing ServiceNow to run the IT operations of SAP because there was huge value creation for SAP by doing that. And we talked about the importance of this partnership and what could be done in the open market. So I actually think that you should really take away from this. But again, it's a great foundation that's already in place that can be built upon.

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Operator [49]

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Your next question comes from the line of Tom Roderick with Stifel.

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Thomas Michael Roderick, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [50]

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I'll echo the sentiments from others in saying congratulations to you both. My question here is for Bill. Bill, you've got a couple of questions already just on the general sentiment of M&A. I'm not going to ask you to share your playbook before you get in the seat. But as you yourself has scaled SAP over the past decade, would love to hear about your general philosophy towards M&A and particularly M&A at scale. Well, how do you think about the risks, the opportunities of doing M&A at scale? And what has worked for you and what happened as you look back at your past as you apply it to future with ServiceNow?

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Bill McDermott;Incoming President and CEO, [51]

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Thank you very much for the question. And I'm really happy you asked that question because you've given me an opportunity to kind of set the record straight. Because ServiceNow is not SAP, and SAP is not ServiceNow. These are entirely different companies at entirely different stages of their evolution, and they have very different business models. So what I believe is that SAP did a great job of taking the core and expanded the perimeter into the cloud through strategic M&A that was done very effectively. But as you know, when you do M&A, you also have to integrate M&A, and you have to put all the pieces together over time because you want to make sure that customer relationship is absolutely best-in-class. So you have to walk and chew gum, right? You have to get the revenue right, the margin profile right, but also the happy and loyal customers. And I think SAP has done a very good job with that. On the ServiceNow side, with the way we're positioned and the literally immaculate nature of this amazing platform and these solutions that the whole world needs, and it's a matter of expanding the solution set, it's a matter of getting to new customers, the new geography, expanding the industry, expanding maybe the market profiles, but it's all there. All the pieces are there. And the TAM for being the platform of the platform and really working through that workflow scenario, where we can continue to build. We have developers that can build solutions. We have customers that can build their own solutions on the platform. We can literally take customers build solutions and make them commercially viable successes all over the world. So this is a juggernaut waiting to happen on its own organic means.

Now to the extent we were to do strategic M&A. And I'm just giving you my bias. Again, this is not a decision. This is just what I honestly think coming in to the question, is that I would be very careful with it. You should do tuck-ins where it's in the best interest of the customer and, obviously, the shareholder, but it should never affect the pristine nature of this platform because I think our customers are really relying on ServiceNow for that simple, beautiful, gorgeous user experience and they really expect us to be so perfect with the workflow, and so pleasing that they just walk away from the relationship after the transaction that I can't wait to do another one, keep making me happy, keep me loyal. And that is the culture here that is super powerful, and I would never want to do anything to jeopardize that.

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John J. Donahoe, ServiceNow, Inc. - President, CEO & Director [52]

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All right. Well, everyone, I hope you got a good flavor of why I'm personally, the Board and the organization is so excited to have Bill onboard, rest assured, heads down focusing on Q4 and a lot of momentum into 2020. So thanks for joining us in today's call.

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Operator [53]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.