ServiceNow Inc (NOW) — Q4 2022 Earnings Call Transcript

Good afternoon, and thank you for joining ServiceNow's Fourth Quarter and Full Year 2022 Earnings Conference Call. Joining me are Bill McDermott, our Chairman and Chief Executive Officer; Gina Mastantuono, our Chief Financial Officer; and CJ Desai, our President and Chief Operating Officer. During today's call, we will review our fourth quarter 2022 results and discuss our guidance for the first quarter and full year 2023. Before we get started, we want to emphasize that some of the information discussed on this call, such as our guidance, is based on information as of today and contains forward-looking statements that involve risks, uncertainties, and assumptions. We undertake no duty or obligation to update such statements as a result of new information or future events. Please refer to today's earnings press release and our SEC filings including our most recent 10-Q and 2021 10-K 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 revenue, 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 servicenow.com. A replay of today's call will also be posted on our website. With that, I'll turn the call over to Bill. Bill?

Thank you, Darren, and thank you, ladies and gentlemen, for joining us today. ServiceNow continues to perform as a company that exceeds expectations. For Q4, we beat guidance with subscription revenue growth of 27.5% in constant currency. Operating margin was 28%, 2 points above our guidance. Our free cash flow margin was 30%, 1 point above our guidance. We had 126 deals greater than $1 million in Q4, including our largest deals ever worldwide in EMEA and Latin America. Our 98% renewal rate remains the industry benchmark. With 25.5% constant currency cRPO growth, we actually had better-than-expected new business in Q4 with less reliance on early renewals. Based on this new business surge, we are giving very strong guidance for 2023. Our guidance reflects a disciplined forecast that appropriately balances our well-founded optimism for ServiceNow's business. We'll work hard to go beyond it, and we'll begin that effort in Q1. Here is the main takeaway. Even in a complex operating environment, ServiceNow is executing at the rule of 58.5%. We are driving net new innovation, fast growth, and operating leverage. ServiceNow is the proverbial safe harbor in all weather conditions. Let me unpack the current environment for you. The secular tailwinds of digital transformation aren't going anywhere. IDC's research clearly shows that technology budgets are growing. They forecast IT spend will grow by 5% in 2023, software spend by 8%, and Software-as-a-Service spend by 15%. As businesses increase spend, the only question then is where will all that investment go? This answer has everything to do with the great reprioritization. The theme in Davos this year was cooperation in a fragmented world, which all begins with a fragmented enterprise. C-level buyers don't want long-term road maps to clean up a siloed mess of point solutions. They want integration, speed, automation, great experiences, and business impact. A CEO told me, 'We can't afford 1,000 points of dim light. We need a cohesive plan with a trusted platform.' This is now without any doubt, a platform economy, and only a few platforms will be relevant in this shift, and none are as well positioned as ServiceNow. This begins with our business model. ServiceNow was born in the cloud, established itself in IT, and expanded from that core. It accelerates with the realities of the multi-cloud world. Many enterprises are struggling to utilize the public cloud capacity that they have already procured into ServiceNow, which directly enables cloud workload migration. We are the control tower for any architecture, public, hybrid, or multi-cloud. With open telemetry, we help businesses build and monitor cloud-native applications. This all extends to driving automation. ServiceNow has natively embedded the complete toolset from AI to RPA to process mining in our platform. Now professional developers and the rest of us, real people like you and me, can build mission-critical applications to automate the world of work. Everything culminates with real business outcomes. ServiceNow integrates the enterprise to deliver better customer service, employee experiences, security, risk management, and next-generation business processes like Procure to Pay, technology foundation, hyperautomation, and process orchestration. With this completeness of vision, ServiceNow is the end-to-end platform for digital transformation. If all we did was help existing customers consume everything this platform can do, we would remain a fast-growth company. But, of course, our strategy goes well beyond this as does our proven ability to execute. Right now, many technology companies are working to shift resources from underperforming businesses to better opportunities. ServiceNow only has good businesses. Our products and engineering team is building organic net new innovation with an unmatched level of speed and quality. When we started to sense noise in the macro early in 2022, we shifted immediately to a conservative cost management posture in running the company. This allowed us to focus on execution with our team rather than look to workforce actions to leverage. It also allowed us to continue hiring, especially in engineering and quota-carrying roles. The results tell the story. ITSM was in 14 of our top 20 deals, with 15 deals over $1 million. ITOM was in 16 of the top 20, with 14 deals over $1 million. Security and Risk Solutions were at 13 of the top 20, with 9 deals over $1 million. Customer workflows were in 13 of the top 20, with 13 deals over $1 million. Employee workflows were 13 of the top 20, with 11 deals over $1 million. And create workloads were in 19 of the top 20, with 11 deals over $1 million. We saw new business growth, new logos, and major expansions with some of our existing customers. The United States Army expanded its ServiceNow roadmap well beyond IT. ServiceNow will improve the Army's ability to consolidate service management for its over 1 million active military contractors and civilian population. The Schwarz Group, one of the world's top retailers, will digitize its 11,000 stores from retail locations to logistics on ServiceNow as its digital business platform. This transition is a transformation, and it will position the Schwarz Group at the forefront of the next-generation retail industry. From Banco do Brasil to AT&T to Sumitomo, we have countless stories that span ServiceNow's workflows, Lightstep, geographic regions, and industries across the board—we're winning. And as you'll hear from Gina, we grew new business 100% year-over-year across retail, hospitality, transportation, and logistics. That's only one example. And with the expansion of ServiceNow's impact, we are setting the standard for speed of deployment and business value for our customers. More than three years ago, I stated our ambition to be the defining enterprise software company in the 21st century. And this is an ambition I am determined to see through to its full completion. Following my elevation to Chairman and CEO, I'm delighted to announce that CJ Desai has been promoted to President and Chief Operating Officer. CJ is a leader of consequence, well-known in the industry. His track record in ServiceNow speaks for itself from strengthening our platform to driving our customer experience. This is exactly how we are orchestrating our company to perform on an end-to-end basis from innovation to execution with our customers. And I'd like to personally congratulate CJ for his latest well-deserved endorsement of his leadership. Congratulations, CJ. In other news, we proudly welcome Masatoshi Suzuki as the new President of ServiceNow Japan. He brings a long history of successful leadership with some of the industry's most respected brands. We will elevate ServiceNow Japan to a fourth geographic region reporting directly to our proven Chief Commercial Officer, Paul Smith. To further fuel our growth, we rolled out a new partner program to help our ecosystem drive full platform adoption of ServiceNow. We're also receiving an enthusiastic reception for the company's premier global initiative, RiseUp with ServiceNow. Under the thoughtful leadership of Lara Caimi, we will continue to rise. We offer training and certification to help people build a lifelong career working on this platform. We have never seen so much interest in the ServiceNow franchise around the world as we are witnessing right now. From an ongoing operating perspective, we entered 2023 with much stronger sales coverage on a year-over-year basis. We have the feet on the street. We also see stronger pipeline coverage and the maturity of that pipeline, much more so than we did a year ago. The latest Glassdoor ratings feature ServiceNow as the 9th best place to work in the United States and the 2nd best in the United Kingdom. The company is fully invested in all of our stated ESG objectives, with our global impact report coming later this year. All this is a reflection of our proud culture built on Fred Luddy's founding vision for our company. I was just in Las Vegas last week for our sales kick-off. I can tell you our team is fired up and ready to go for the year ahead. Really fired up. I can only reiterate that we have said consistently, there is only one way forward, and that is innovation. IDC says that by 2027, the number of digital businesses on the S&P 500 will double. Every industry is being reframed by a new paradigm or several. The participants that lean in will lead, while the others will fall behind quickly. For ServiceNow, we are committed to making the world work better for everyone. Our fundamentals are operating at peak performance, net new innovation for our customers, business impact, driving long-term stickiness of our platform, and network effects giving us a competitive moat with multiple avenues for market expansion and profitable growth with a pristine balance sheet. All in all, when people talk about cloud economics, ServiceNow is the blue-chip standard. Whatever the world lacks in stability, we will more than offset with relentless execution. Our customers need to automate for cost reduction and innovate for growth. Yes, ServiceNow helps them do both. The world works with ServiceNow as the end-to-end platform for digital transformation. I'd like to personally thank our customers, partners, and shareholders for their steadfast trust in ServiceNow. You can count on us. We're in your service, hungry and humble as ever. I'd like to now hand the call over to our CFO, Gina Mastantuono. Gina, over to you.

Thank you, Bill, and happy New Year to all of you who are listening in. Q4 was another great quarter of execution. We exceeded our subscription revenue guidance and drove strong renewal and expansion rates. Our operating and free cash flow margins also exceeded our outlook as disciplined cost management drove tailwinds to profitability. In Q4, subscription revenues were $1.86 billion, growing 27.5% year-over-year in constant currency, exceeding the high end of our guidance range by 50 basis points. RPO ended the year at approximately $14 billion, representing 25% year-over-year constant currency growth. Current RPO was approximately $6.94 billion, representing 22% year-over-year growth versus our guidance, primarily driven by favorable FX movements in the quarter. On a constant currency basis, growth was 25.5%. While constant currency cRPO growth came in just shy of our guidance of 26%, we actually outperformed our target for net new ACV and renewal ACV for contracts expiring in the quarter. The delta came from fewer early 2023 renewals than is typical in the fourth quarter. Given our strong renewal rates, which remain the best-in-class at 98% in Q4, this is only a timing issue. We expect these customers to ultimately renew upon contract expirations, providing opportunities to drive further expansion throughout 2023. The timing of early renewals does not impact 2023 subscription revenue growth, only RPO. Net new ACV drives incremental revenue growth, and there, we exceeded our forecast. Our larger-than-average Q4 customer cohort not only renewed at a very strong rate but also net expansion remained robust. What's more, the strength in net new ACV wasn’t limited to existing customers. New customer net new ACV grew over 30%. We ended the quarter with 1,637 customers paying us over $1 million in ACV, up 22% year-over-year. From an industry perspective, retail, hospitality, and transportation and logistics saw net new ACV growth of well over 100% year-over-year. Government remained strong, growing more than 50% year-over-year. Manufacturing and financial services also saw healthy double-digit growth. We closed 126 deals greater than $1 million in net new ACV in the quarter, including 2 of our top 5 largest ever. In addition, we saw 100% increases in the number of both $5 million plus and $10 million plus net new ACV deals. More and more customers are seeing the true power of the ServiceNow portfolio as a unified platform, leading to more multiproduct deals in Q4, with 5 of our top 10 deals containing 10 or more products. Turning to profitability. Operating margin was 28%, 200 basis points above our guidance, driven by disciplined spend management and less-than-expected FX headwinds. Our free cash flow margin was 53%, up 650 basis points year-over-year. For full year 2022, operating margin was 26%, 100 basis points above our guidance, and free cash flow margin was 30%, also 100 basis points above our guidance. Total free cash flow for 2022 was a robust $2.2 billion. We ended the year with a healthy balance sheet, including $6.4 billion in cash and investments. Together, these results continue to demonstrate our ability to drive a strong balance of world-class growth and profitability. Before I move to guidance, I want to give a brief update on the trends we are seeing. Heading into 2023, we believe we have prudently factored the evolving macro crosswinds into our guidance. Overall, the demand environment remains healthy; deals getting done, the market opportunity is growing, the ecosystem is expanding, and our renewal and net expansion rates ended the year strong, with our pipeline being robust. With that in mind, let's turn to our 2023 outlook. We expect subscription revenues between $8.44 billion and $8.5 billion, representing 22.5% to 23.5% year-over-year growth on both a reported and constant currency basis. We expect subscription gross margin of 84%, reflecting the expected diminishing impact of the change in useful life of our data center equipment, as well as investments to accelerate customer time to value as part of our impact offering and higher inflation. We expect operating margin of 26%, with sales and marketing efficiencies offsetting headwinds from gross margins. We expect free cash flow margin of 30%. And we expect GAAP diluted weighted average outstanding shares of 206 million. For Q1, we expect subscription revenues between $1.99 billion and $2 billion, representing 25% to 25.5% year-over-year growth on a constant currency basis, excluding a 300 basis point FX headwind. We expect cRPO growth of 24% on a constant currency basis, excluding 300 basis points of FX headwind. We expect an operating margin of 24%, and we expect 204 million GAAP diluted weighted average outstanding shares for the quarter. In conclusion, we had a strong Q4, capping a resilient year. As we enter 2023, the macro challenges many enterprises face underscore a point we have made consistently: the technology strategy has become the business strategy. Digital technologies are growth-stimulating deflationary forces. They power new business models while accelerating productivity and reducing costs. Our unique ability to drive business model transformation while delivering efficiency gains has created durable demand for the Now Platform. Our investment strategy is laser-focused on our customers' most pressing issues, and that continuous net new innovation translates into net new business for ServiceNow. We are well-positioned for 2023 and remain on our way to becoming the defining enterprise software company of the 21st century. Finally, I'm extremely proud of our team's performance this year. Bill and I can't thank our employees enough for their continued hard work and dedication. With that, I'll open it up for Q&A.

And congratulations, everybody. Bill, we continue to hear from some of your largest partners about the great opportunity ahead in the middle office for which the ServiceNow platform just seems to be ideally suited. How are customers prioritizing these opportunities right now and into this year? How do you position yourselves, particularly with partners and vertical industry solutions, to best capture it? And I've got a follow-up for Gina.

Yes. Thank you very much, Brad. And before I answer the first question, ladies and gentlemen, I just wanted to officially welcome CJ Desai as our newly appointed President and COO, who is joining me here today. I would also like to acknowledge Gina for powering through while she's been a bit under the weather, so her voice might be a little scratchy, but her passion is on fire. We've been all over the world from Davos to Vegas to here. So that's what happens when you travel a little bit. Brad, the partners are really doubling down on their investments with ServiceNow. I look at it as a multifaceted situation. First, on this RiseUp with ServiceNow initiative, we're going to train 1 million people in the ecosystem to be fully certified on the platform to ensure that we globally scale. Second, partners are teaming up with us on an industry domain basis, also based on persona and mapping that back to our solution roadmap; naturally, everyone is all in on the platform. So the big players are really doubling down on the platform. What's interesting, and you bring up a good point, this is for the front, the mid, and the back office. There’s a next-generation ERP evolving with aspects like procure-to-pay, optimizing supply chains, and other things that definitely impact the middle office. I would also say we have a great opportunity, and if you saw our new business surge in Q4, you're seeing it play out where we're acquiring new logos and generating net new business. I think that will be a big part of it. CJ, you may want to build on it from what you're seeing in the middle office.

When we look at the engagement layer, it has been around for a long time, say, for customer service requests. For a large financial services organization, moving the workflow from the engagement layer to the mid office is where we really shine because of our interoperability of the platform and our ability to integrate the systems and different clouds all the way to the back office. That’s what is driving the middle office acceleration, whether for a financial services organization, telecommunications, or healthcare organization.

Excellent. And I know, Brad, do you have the second question, I believe, for Gina.

And congrats. I was remiss in not congratulating you, CJ. For you, Gina, I appreciate the additional disclosure on net new ACV. You guys clearly had a really strong quarter for new business, which is what matters most to investors. But as we think about cRPO and what you shared with us, I mean, we're all trying to understand the customer mindset during these uncertain times. Is it fair to conclude that perhaps there was less of a traditional Q4 IT budget flush in 2023? If not, what else would be the rationale as to why you would see that phenomenon?

Yes, of course, Brad. Thanks for the question, and apologies for my throat. What you're seeing is that early renewals were always correlated and still are correlated to net new ACV. When people early renew, it really boils down to co-term multiple contracts. In the current environment, whether you want to say it's less budget flush or just a tightening of budgets, the desire to co-term the contract is a little bit less than what we've seen historically. This isn't altogether surprising given the current macro situation. It's why I wanted to be really clear about the fact that early renewals have no impact on future revenue, right? In the quarter, our target forecast for net new ACV, as well as renewal ACV from the quarter, actually overachieved. This is why we were able to come out with a strong 2023 revenue guide and why we feel good not only about the Q4 results but also about our position in the market as we enter 2023.

Congrats from me as well, and Gina, I hope you feel better soon. A quick question. If you think about the different pockets of growth, you saw this quarter that the HR and CRM part was a little bit stronger for Q4. Can you talk a little bit about the drivers? Because like ITSM and ITOM, you're kind of the #1 player. And the other ones you're expanding. So it's nice to see the expansion in them. And then I had one follow-up for Gina.

Yes, I'll make the first point, Raimo. Then CJ can actually provide some customer examples that might be helpful. We have become the platform for digital transformation, and that's an end-to-end platform for digital transformation. So what you're seeing now is a company that has evolved from IT to employee experience to customer service management. The low code platform and how the creative workflow is exploding is demonstrated in our outstanding results and our very strong guidance. We're really now a platform company with a multiproduct approach to helping every customer in their respective industries based on the persona we're discussing business with. Ultimately, it’s that completeness of vision now that has made us one of about a handful of companies in the entire world that really matter in the enterprise. CJ, do you have some examples you want to talk about?

Absolutely. Employee experience and employee productivity are two sides of the same coin. Our HR service delivery product is resonating really well, whether in commercial markets. We had very strong public sector performance, as Gina outlined. That product is resonating. During these macroeconomic times, when you think about customer service, you want to hold on to your customers and serve them profitably. That's what is driving our customer service management product. We're witnessing that, despite the technology foundation where IT is the business, digital services impact other businesses, which is driving our ITSM and ITOM product lines. We're effectively combining the best of service management and operations management, with HR and customer service management also driving growth across various industries, from telecom to public sector and healthcare.

Okay, that was very clear. Then the Gina one for you quickly, on the margin and cash flow outperformance. Can you talk a little bit about factors we should consider in terms of timing, et cetera, that might have impacted this more? We don't want to extrapolate into next year, et cetera.

Yes, it's a great question, Raimo. I gave a strong guide for operating margin as well as free cash flow margin for 2023. What you saw in Q4 from an operating margin perspective was continued discipline on the cost side, as you have seen us do and as you will consistently see us do. On the free cash flow side, obviously, that disciplined cost management flows through, but we also observed some CapEx spend come through towards the tail end of Q4, meaning that the payments are not due until Q1 of '23. This does create a little bit of headwind on the free cash flow margin in '23, which is why you see the guide that I provided. Hopefully, that’s helpful.

Just want to circle back on the cRPO. Given the constant currency growth was 25.5%, is more of the issue that you described more prevalent internationally than in the U.S.? How should we think about the appetite to do renewals? Is there any concern about expansions from some of those international customers here in the first part of '23?

Yes. It has nothing to do with the renewal dynamics internationally versus domestically. The difference between the constant currency growth and nominal growth really just has to do with FX rates that moved within the quarter. So no real differences internationally versus those in the Americas on the renewal side. Regarding the early renewals, our strong net new ACV growth in Q4 indicates that customers are not changing their behaviors with respect to renewals—both on-time renewals and net new expansion. What you're witnessing is a slight lack of need to co-term and bring things forward in the current macro context. With 98% renewal rates across the board, we remain positive that not only will we continue to expand in '23, as you've seen us do in '22, but also continue to renew those best-in-class renewal rates.

Sorry for asking you to use your voice again. But how are you feeling about the 2024 targets? I think the consensus is that the $11 billion target might be a stretch, given that you've had to absorb a pretty heavy FX headwind. The operating margin target of 27% seems doable, but when I look at your free cash flow target of 33%, that would be a 300 basis point improvement in calendar '25. So that feels like a bit of a push. Do you mind just commenting on those targets? Much appreciated.

Great question, Karl. Overall, the underlying growth we're seeing remains healthy. FX headwinds have eased slightly but are still material. With the uncertain macro backdrop, we'll continue to monitor the market and provide an update on our long-term targets at our Analyst Day in May. Overall, underlying demand remains strong; operating margin is on trajectory to hit 27%. Regarding the top line and free cash flow, we will update those targets for you in May. But let's go back to what Bill discussed earlier. We remain very well positioned given the current macro environment. We are the platform of choice for digital transformation. That opportunity has not changed; if anything, it continues to grow.

Bill, just given your comments on the pipeline coverage and also the maturity, would you say that the macro headwinds have actually dissipated somewhat if you compare back to the summer? Or are those winds still blowing steadily, but you're navigating through them via willpower and execution rigor?

Yes, Mark, thank you very much for the question. I did call it out. I think maybe we were the first ones to highlight that there were some clouds on the horizon back then with the macro, and we all know the forces that were at play—between Ukraine, inflation, tightening monetary policies, and supply chain dislocation. Most businesses were not prepared for that market. We immediately revamped our go-to-market and the way we approached customers because we knew they would have to do more with less—automate their business, take costs out, and improve productivity per person. The work wasn’t going away; it still had to be done, which is where ServiceNow's platform fits in. We also knew that 98% of CEOs have a digital-first strategy. I’m not concerned about the remaining 2% because the 98% is significant. They won’t abandon their digital business ambitions, and they will invest to adjust their business models, as Gina’s example underscored; growth remains a priority. The good thing is, with ServiceNow's platform, you can say yes to both growth and cost reduction. What I see in the market is that commodity tech, which peaked during the pandemic hype cycle, is being dialed down or eliminated, and investment is freeing up for platforms that actually matter. I do think our circumstances are improving because of this macro situation; it’s now well-known that ServiceNow can reduce costs if that’s needed immediately. Given the layoffs we’re seeing and the stories we’re reading, I see our company rising accordingly, reflected in our pipeline and its maturity, which is crucial. This year, we came in with sales productivity at least 20% better than the start of last year, thanks to the sales force being well-trained and certified. All these forces are converging in a way that gives me the belief that the market is on our side, but our executional excellence will not depend on the weather conditions. We’re ready.

Very clear. For Gina, sorry again for using your voice. But just again, on the matter of the lower mix of early renewals from 2023, should we infer from that that customers may be a bit hesitant to renew early due to the higher cost of capital? They want to hold on to cash a little longer? Conversely, is there an element of perhaps you have enjoyed the luxury of not needing to encourage as many early renewals because you saw so much strength in the new logo side?

A great point, Mark. It's certainly a little bit of both. The fact that we’re not having to rely on early renewals as much demonstrates the resilience and strength of the Now Platform. I also believe that in this market, people are holding onto cash a little longer, which isn’t surprising.

One thing I would add to what Gina said is that for every investor out there, when you don't need to rely on early renewals, it reflects a competitive advantage with your technology. It also preserves your pricing power as you go into renewal cycles on normal terms. This is actually very healthy, which is why the guidance for 2023 was above all consensus estimates.

I would think that in a time of inflationary environments, people would want to get rid of cash and preserve purchasing power. But anyway, a little counterintuitive. That was not my question. First of all, congratulations, Bill, CJ, and Gina. I'll spare you a question so you can rest your voice. Bill, one thing that occurs to me is that you've scaled a very successful technology company before. What are the patterns you see at this point in ServiceNow's evolution? There could be many things you might consider from a go-to-market perspective, verticalizing the product, expanding distribution partnerships with resellers, etc. There's so much innovation. The number of products you have is mind-blowing—almost complex. How do you ensure this doesn’t hinder your mission of becoming the defining enterprise software company of the 21st century? How do you turn these catalysts and tailwinds to ensure nothing gets in the way, especially since you've seen similar patterns play out successfully in the past?

Yes, Kash, this narrative is nothing new to us. Here’s the situation: we're keeping it real simple for 22,000 of our closest friends within ServiceNow and for our partners. We have the end-to-end platform for digital transformation. This platform is applicable across every industry and every persona within the enterprise. We're going to expand across the world. You saw the move we made in Japan. Our ambitions will take us to India, the Middle East, and many other places. So, it's an end-to-end platform by industry, persona, and geography, and we keep it very simple for our colleagues and partners. We're focused on net new innovation; we will build the future. We have the best engineering leader and the best engineering team in the industry—hard stop. We have an incredible go-to-market process, and we're betting on ourselves. We will maintain simplicity around net new innovation and net new ACV. This is the strategy. With a loyal customer base, we will continue to see upsells, cross-sells, and same account revenue growth. If you can add new business on top of the existing clients, while building the best product in the world, you will create the defining enterprise software company in the 21st century.

Congratulations on the performance, particularly on the net new ACV. I would love to help unpack that because it's including both new logos and expansion. I think we heard last quarter that new customer acquisition had slowed compared to Q2 when perhaps 10% of growth was coming from new customers. Looking ahead, are you seeing most of that growth coming from existing customers relative to what you would have normally done with new customers? Relatedly, it seems that NRR declined by about 300 basis points quarter-over-quarter, and your guidance implies a continuing decline of about another 300 basis points to meet your guide. What is driving this weakness in renewal NRR compared to recent quarters that were consistently at or above 130%?

Peter, I'll take the first question. We're thrilled with the net new ACV growth we're experiencing. Our expansion rates remain robust within the quarter and for the entire year in 2022. We were pleased to see that new customer net new ACV grew over 30% year-over-year despite some headwinds. We've evolved to focus away from the sheer number of new customers towards landing the right ones that can grow with us over time. Strong new land growth reflects positively on the platform and the breadth of products available. For 2023 and beyond, we expect strong expansion rates and good new logo growth. It's about the quality of new logos, which is evident in our results. Concerning your comment on NRR declining by 300 basis points, that’s not what we're seeing. I’m not sure of your calculations, but I’m sure Darren can clarify that with you privately. Our net retention rate and expansion rate remain very strong in Q4 and for all of 2022.

I wanted to dig into gross margins a little bit. I'm still trying to wrap my head around a 200 basis point decline. We haven't seen 84% subscription gross margins in ServiceNow since 2016, if I remember correctly. Last year, you mentioned there was still a 50 basis point tailwind from the accounting change on useful life. So there's about a 250 basis point offset driving down gross margins heading into FY '23. Can you clarify what that expense is that had such a weight on gross margin?

Yes. Great question, Keith. To clarify your math, we had 85% gross margin in 2021, and this year we maintained 86%. That 100 basis point impact from the change in the depreciation life of our assets was anticipated. We highlighted that it would decline to 50 basis points, correct? So starting from 86%, subtracting to 50, gives us 85.5. What you're seeing is a couple of things. One is the impact of inflation. That's not surprising, and we've mentioned it before. Additionally, we are investing heavily to ensure that our customers achieve quicker implementations with our impact products. We’re balancing these investments against sales and marketing efficiencies which you've come to expect from us, explaining why the operating margin guide remains where you would have anticipated it.

Congrats, CJ. Kudos to the team on a solid quarter. I think it would be helpful to unpack two metrics from the quarter itself if you could. I apologize for the more financial-oriented questions. But Gina, can you quantify the renewal headwind from the smaller early renewals? Also, can you comment on the net retention rate itself? Was it still around 125 for the full year? Taking a step back, it seems that the cRPO guide for Q1 is much stronger than what people initially thought, implying that perhaps the renewal headwind could turn into a tailwind if you secure those renewals or maybe you've already captured them in the quarter. Furthermore, your full-year guidance seems to be stronger than some might realize. Can you help us piece together those dynamics?

I won't quantify the exact renewal headwind, but I can say that if not for the early renewals, we would have surpassed our cRPO guide. Regarding NRR, while we don't share exact figures, it was indeed consistent, relatively close to the 125 you mentioned.

Absolutely. One product we verticalized early on was in telecommunications, media, and tech. We started developing that in 2019, and it’s seen very strong traction—everything from order management to mid office to back office in telcos. This product line, tailored for that industry, is now with top 10 telcos and continues to gain market share while displacing multiple systems for both telcos and media companies. Similarly, we created products for the public sector and healthcare that are also showing strong traction. Overall, between the new products, horizontal products like our developments in ERP through procure-to-pay or supplier lifecycle management, and combined with newly launched industry products, we're securing 7-figure deals, often even larger, and making significant progress in these areas.

Thank you, Alex. Just to add, CJ had a go-live yesterday with 50,000 agents, and we were together in the board room observing, and it went flawlessly. That's an example of our customer service management for one of the most prestigious brands globally. We can count on our customer service management business to continue to excel. I don't focus too much on cRPO forecasting because it's based on prior year assumptions; it doesn't affect what actually occurred. The net new business was exceptional, and all those renewals are waiting for us in 2023. Given that we deliver business value and impact, those renewals are positioned for us at the right pricing structure. This situation is very positive from a shareholder value creation viewpoint.

Bill, last week, you spoke quite strongly about continuing to hire. Hiring dipped a little in Q4 compared to previous quarters. Could you share your plan for hiring this year?

Thank you very much, Brad. As Gina stated, we're being very intentional about how we manage headcount in the company. Protecting this organization is our primary objective. We've heavily invested for the last 3.5 years in headcount. We're in a good position now. Going forward, our primary focus will be on hiring coders—people who write the code—and also quota-carrying roles responsible for customer relationships. We're being selective, and I'm optimistic about the workforce. Our retention rates are better than ever. The Glassdoor ranking reflects this. By being intentional, we’re attracting top talent from a vast pool, ensuring that only the best join ServiceNow. This approach will strengthen the company moving forward, and our emphasis on driving innovation or net new ACV remains the focus.

If I can add, as we enter 2023, Bill mentioned earlier that we are entering the year with significantly more ramped reps than we had at the start of '22. So yes, we may have seen a mild hiring slow in Q4, but that was not among quota-bearing sales or engineering roles. We're entering 2023 with strong ramp reps which boosts our confidence not only considering the pipeline we see but also the productivity expected from those ramp-ups.

Gina, I hope you feel better. Question and a clarification. First, the impressive metric you provided on the net new customer ACV growth of 30%. Can you give us the same number for last year in the December quarter or an average over the last 2 years in the December quarter? For context, what I’m trying to get is the calibration point. My question revolves around the upsell, particularly regarding ITOMs and ITSM. In the past, you have provided updates on the SKU mix, our shift from Pro to Enterprise. Can you provide an update? Is that slowing down at all due to the economy? Are customers proceeding ahead as they have previously, and where is that transition?

Yes, Keith. That 30% net new customer ACV growth is something we’re proud of. But we've not provided those metrics in past quarters. Overall, we continue to see net new customer ACVs growing as we land larger deals and allow new customers to grow alongside us. So there is robust growth, though it isn’t a number we routinely report. In terms of ITSM Pro, our penetration is at about 35% and continues to grow.

The number continues to rise since we introduced this product. What was particularly encouraging in Q4 was that many of the new logos we brought on with ITSM also adopted ITSM Pro, alongside our existing customers upgrading to ITSM Pro. We're optimistic about the current rate of 35%. At our Financial Analyst Day, we will provide more comprehensive updates regarding ITSM Pro and Enterprise.

Maybe for Bill or CJ, given the widespread discussions regarding cloud optimizations, as we heard from Microsoft recently, could you provide insights into how you're addressing these discussions with your customers? Are there specific products you're leading with? Additionally, CJ, I would like your perspective on the ServiceNow observability strategy for 2023. What key milestones are you targeting from a product standpoint? How has the progress been since your last acquisition?

Absolutely. First, regarding the cloud optimization questions. Our product line since day one, whether you look at ITSM, ITOM, or asset management, enables our customers to discover assets across all environments, be it on-premise, private cloud, public cloud, or multi-cloud. Our portfolio is well-suited for assisting customers in optimizing their power spend. If they're looking to move to the public cloud and want to accelerate that journey, our platform can help them too. I believe our portfolio remains relevant in this multi-cloud landscape and how our various product lines can support their optimization and acceleration needs. On observability, I was encouraged in Q4 when three of the Fortune 100 companies decided to purchase the ServiceNow Observability solution and Lightstep at a substantial scale. These are real workloads being monitored by our Lightstep solution. Looking ahead to 2023, we acquired a company called Era, which provides log management solutions. Our goal is to fully integrate this into our Observability platform so that we not only have primary observability solutions but also a unified observability solution that works across multi-cloud environments. I'm optimistic as we move into '23.

Congrats to CJ, wonderful to see. Given that you're operating in what feels like rarefied air, let me flip things over and ask if there were any verticals or regions where you saw some softness or perhaps extra scrutiny on overall spending?

Overall, we feel balanced performance. Gina highlighted our success with the public sector. Typically, we expect to do well in that sector in Q3, but we also performed strongly in Q4, demonstrating over 50% growth. So whether it's in public sector, retail, healthcare, or others, our performance has been balanced and strong across the board. We are excited about our growth potential in Japan and India; with the new appointment in Japan and its focus by CCO Paul Smith, we're optimistic about those markets.