ServiceNow Inc

NYSE:NOW

Earnings Call Transcript 2023-Q3

[Operator]

Good day, everyone, and welcome to the Third Quarter 2023 ServiceNow Earnings Call. Today's call is being recorded. [Operator Instructions] I would now like to turn the conference over to Darren Yip, Vice President of Investor Relations. Please go ahead, sir.

[Darren Yip, executive]

Good afternoon, and thank you for joining ServiceNow's Third Quarter 2023 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 third quarter 2023 results and discuss our guidance for the fourth quarter and full year 2023. Before we get started, we want to emphasize that the information discussed on this call, including our guidance, is based on information as of today and contains forward-looking statements that involve risks, uncertainties and assumptions.

We undertake no duty or obligation to update such statements as a result of new information or future events. Please refer to today's earnings press release and our SEC filings, including our most recent 10-Q and 2022 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 revenues, remaining performance obligations or RPO; current RPO; and cash and investments.

To see the reconciliation between these non-GAAP and GAAP measures, please refer to today's earnings press release and investor presentation, which are both posted on our website at investors.servicenow.com. A replay of today's call will also be posted on our website. With that, I'll turn the call over to Bill.

[William McDermott, executive]

Thank you, Darren, and thank you, everyone, for joining us today. On behalf of Gina, CJ and our entire company, I'd like to first make a brief statement about recent events. ServiceNow has a very special team in Israel. One of our own colleagues, Shlomi Sividia, was at the Supernova music festival. He was murdered in the unprecedented Hamas attack. Shlomi was highly respected, admired and a good friend to many.

We stand in solidarity with our team and with their families. Terrorism has caused the unfathomable humanitarian crisis, and now engulfs millions of people in Israel and Gaza. Our hearts break for the innocent on all sides. Even with optimism in short supply, we choose to honor the dream of a peaceful and prosperous future for the Middle East region. God bless and protect all those in harm's way.

Now for business. Of course, that's the reason we're here to discuss ServiceNow's Q3 results. We're proud that our company once again delivered beyond expectations. ServiceNow has delivered subscription revenue that grew by 24.5% in constant currency, over 1 point above our guidance. cRPO grew a strong 24%. That's 2.5 points above our guidance. Operating margin was 30%, more than 2.5 points above our guidance. We had 83 deals greater than $1 million in net new ACV, up from 69 a year ago, a 20% increase year-over-year.

Our focus on landing the right new customers continue to deliver. Large new logo growth accelerated for the third consecutive quarter. ServiceNow's traction as the intelligent platform for end-to-end digital transformation has intensified. All of our workflow businesses were in 14 or more of the top 20 deals: ITSM, ITOM, ITAM, security and risk, customer, employee and creator. Within our technology workflows, security and risk had a very strong quarter with 10 deals over $1 million. Employee workflows had a stellar quarter, with 7 deals over $1 million and 1 deal over $10 million.

From an industry perspective, this was the best U.S. federal quarter in ServiceNow's history and in ACV, was up over 75% year-over-year. U.S. federal agencies are standardizing on a single platform with a core set of end-to-end solutions. We had 19 federal deals over $1 million, including 3 deals over $10 million. Our top deal in the quarter, the United States Air Force, was the third-largest deal in the company's history. You'll hear from Gina that this performance has heightened our confidence for a strong Q4.

We're increasing the full year guidance on the top line and the bottom line. And here is the key takeaway. AI has strengthened the market dynamics for enterprise software. ServiceNow is the fastest-growing company in this market at relative scale. We have the highest rule of 50 plus across our peer set, with the highest growth of any other large cap software company. We are the best-performing enterprise software company to IPO.

This is a unique, highly differentiated company that is rewriting the benchmarks to be best-in-class in the SaaS industry. Looking beyond the quarterly results, while the world's challenges are sobering, the digitization imperative is stronger than ever. Gartner forecasts that $3 trillion will be spent on AI and gen AI between 2023 and 2027. gen AI represents 36% of AI spending overall. We believe every dollar of global GDP will be impacted by AI over the next several years. This isn't a hype cycle. It is a generational movement.

In the last year, ServiceNow has doubled down on our AI investments. Our Vancouver release includes generative AI-powered Now Assist for every workflow. Others issue press releases. We release product. At ServiceNow, our strategy isn't about exuberance. It's about execution. We've carefully laid the groundwork for success and talent and resources and technology. This investment is accelerating our already robust pipeline, with customers lining up to be first movers in this next wave of business transformation.

The question we've been asked repeatedly, does AI drive growth? The definitive answer is yes, it does. gen AI represents a tailwind of growth for ServiceNow. We have over 300 customers in our pipeline from every industry, every buying center and every stage of testing. Our gen AI SKU drove the highest number of customer requests for a prereleased product in our history. We launched Vancouver on September 29. That left us 1 day in Q3 to sign deals, and we signed 4 large deals.

A U.S. government agency selected our premium SKU offering to be an early adopter of gen AI. Real estate leader CBRE is harnessing generative AI with ServiceNow to deliver superior service to customers and employees while reducing costs. NVIDIA is accelerating its own ServiceNow journey with Generative AI. Among other leading companies, Teleperformance joined ServiceNow's AI Lighthouse program. They will collaborate on new generative AI use cases that boosts productivity while increasing customer and employee satisfaction in key industries.

We have a wide range of other customer wins in the quarter as well. FedEx is using ServiceNow to simplify their IT workflows while building a universal employee portal to improve employee experience for 0.5 million global employees. One of the world's largest automakers selected ServiceNow to help consolidate dozens of applications into a new modern platform to accelerate their push into the EV market.

Philips, Mars, Banc of California, Cleveland Clinic, the U.S. Department of Defense, Fujitsu, Asahi Mutual insurance and the state of California are among many others. We see a meaningful path for all customers to recognize value from generative AI in the quarters to come. Our innovation velocity is very high. Pipeline is growing fast and capacity to execute is well proven. And this is just the beginning.

Looking holistically in our business, we see progress everywhere. We have an aspiration to significantly increase the percentage of net new revenue sourced by our partners in the coming years. This is about partners making the ServiceNow platform the core of their emerging business models. One exciting example is our customer, Trane Technologies. They are a global climate innovator, which recently announced plans to acquire ServiceNow partner, Nuvolo.

With Nuvolo, Trane Technologies can bring world-class digital solutions engineered on the ServiceNow platform to their global customer base. This creates a flywheel effect to ServiceNow. More use cases drive more workflow automation. And today, we're excited to share that Deloitte and ServiceNow announce an expansion to our alliance. Deloitte will become a pioneering partner, integrating our generative AI capabilities into their leading Operate services globally.

This addition underscores Deloitte's commitment to enhance performance with cross-industry solutions built on the ServiceNow platform. We're also scaling our ecosystem globally with today's announcement of a co-investment in ANSR, a market leader in enabling companies to scale technology centers. Another area that we expect to fuel long-term sustainable growth is industry verticalization.

Our product development road map is expanding, with use cases in telecommunications, financial services, retail and the public sector. And beyond any one industry, we increasingly see both intra and inter enterprise workflow opportunities on the ServiceNow platform. This new generation of business networks is creating value chains that transcend traditional business boundaries.

Our rapid pace of workflow innovation creates an even greater demand for our training and skills initiative, RiseUp with ServiceNow. As one example, FutureSkills Prime, a digital skilling initiative of the Indian government, will train thousands of learners across India in new digital skills. This partnership offers clear pathways to build careers as businesses worldwide grow their ServiceNow workforce. Bottom line, this all points to grow for ServiceNow.

In closing, we are building a company for the ages. By concentrating on customer value, we are creating immense shareholder value. At a strategic level, we [ show ] to set the bar high to be the defining enterprise software company of the 21st century. We have an inspired team that is committed to our exponential dream. A company is only is great as each member of the team, and the team is only as great as the company. That is what culture is all about.

Our employee engagement scores increased across the board this year. So did our retention rates, which are already best-in-class. We never went for layoffs. We went for thoughtful, careful expansion. When you look at the ongoing momentum from Knowledge 23, it's clear the approach is working. The profitable growth profile of this company speaks for itself. The market is there for us, and now we're focused on Q4, delivering a strong full year and a fast start in 2024 as well.

Thank you for your time today. I look forward to your questions. Now I'll turn it over to our outstanding CFO, Gina Mastantuono. Gina, over to you.

[Gina Mastantuono, executive]

Thank you, Bill. Q3 marks another quarter of strong execution as we once again significantly surpassed the high end of our top line growth and profitability guidance metrics. ServiceNow continues to demonstrate its resilience as the intelligent platform for end-to-end digital transformation. Customers are seeking enhanced productivity solutions in the current macro environment and ServiceNow is delivering.

In Q3, subscription revenues were $2.216 billion, growing 24.5% year-over-year in constant currency, exceeding the high end of our guidance range by over 100 basis points. Amazing organic growth at massive scale. RPO ended the quarter at approximately $14.4 billion, representing 23.5% year-over-year constant currency growth. Current RPO was approximately $7.43 billion, representing 24% year-over-year constant currency growth and a 250 basis point beat versus our guidance.

As Bill highlighted, federal had its best net new ACV quarter ever, growing over 75% year-over-year. I want to give a quick shout out to the federal team who has just been crushing it. Among the other industries, transportation and logistics was very strong, growing over 100% year-over-year, followed by education, which grew over 75%. Manufacturing and TMT also saw robust growth.

We had some outstanding achievements from a workflow standpoint as well. I'm pleased to announce that Creator Workflows crossed $1 billion in ACV in Q3, a monumental milestone. And our employee Pro SKU saw over 100% growth in net new ACV year-over-year. Retention remained exceptional, with a renewal rate of 98% in Q3, reaffirming the essential role the Now Platform plays in our customers' operations.

Our customer cohorts displayed solid expansion as the quarter closed with 1,789 customers contributing over $1 million in ACV, with 58% year-over-year growth in those contributing over $20 million. In Q3, we successfully closed 83 deals greater than $1 million in net new ACV, with 4 deals greater than $10 million. Notably, 18 of our top 20 net new ACV deals included 8 or more products. Despite launching at the end of the quarter, we have also already closed 4 gen AI-related enterprise deals, and we're seeing strong pipeline build for our Plus SKUs.

Turning to profitability. Non-GAAP operating margin was 30% over 250 basis points above our guidance, driven by disciplined spend management and the top line outperformance. Our free cash flow margin was 9%, up 300 basis points year-over-year. We ended the quarter with a robust balance sheet, including $7 billion in cash and investments.

In Q3, we repurchased 0.5 million shares as part of our first-ever share repurchase program, with the primary objective of managing the impact of dilution. As of the end of the quarter, we have approximately $1.2 billion remaining of the original $1.5 billion authorization. Together, these results continue to demonstrate our ability to drive a strong balance of world class growth, profitability and shareholder value.

Moving to our guidance. We are raising the full year outlook to reflect the strength of Q3. As we have done all year, we continue to prudently factor the macro crosswinds into our guidance. This includes incremental FX headwinds from a strengthening U.S. dollar. For 2023, we are raising our subscription revenues outlook by $48 million at the midpoint to a range of $8.635 billion to $8.640 billion, representing 25% year-over-year growth or 25% on a constant currency basis.

We're also raising our full year operating margin target from 26.5% to 27%, and we continue to expect subscription gross margin of 84%, free cash flow margin of 30% and GAAP diluted weighted average outstanding shares of $206 million. For Q4, we expect subscription revenues between $2.320 billion and $2.325 billion, representing 24.5% to 25% year-over-year growth or 23% to 23.5% on a constant currency basis.

We expect cRPO growth of 20.5% or 21% on a constant currency basis. Notably, the strength of our federal business has resulted in a higher mix of 12-month contracts that will create a 1-point headwind to Q4 cRPO growth and remain a headwind into 2024. We expect that these contracts will renew in 2024 as ServiceNow's federal contract renewal rates are 99%. We expect an operating margin of 27.5%, and we expect 206 million GAAP diluted weighted average outstanding shares for the quarter.

In conclusion, our team delivered an exceptional performance across the board. With a culture focused on customer success, our people have worked relentlessly to provide solutions to meet enterprises needs, and it's showing in our robust results. Businesses are looking to consolidate vendors and standardize on a platform with a core set of products so they can build a predictable and reliable road map to drive digital transformation.

ServiceNow is that strategic platform. With the addition of our Vancouver release and the capabilities presented by gen AI, the window of opportunity is even more expansive than ever before. The result is a more powerful and intelligent platform that enables customers to ignite end-to-end action across the enterprise in ways not seen before. It's an exciting opportunity to further improve productivity and employee satisfaction, optimize processes, reduce costs and create organizational agility.

The possibilities are endless. Bill and I extend our gratitude to all our employees worldwide for their unwavering dedication and commitment that puts us at the forefront of this opportunity, and further driving ServiceNow towards its ambition of becoming the defining enterprise software company of the 21st century. With that, I'll open it up for Q&A.

[Operator]

[Operator Instructions] We'll take our first question from Raimo Lenschow with Barclays.

[Raimo Lenschow, analyst]

If I look at the mix on the product side, it looks like ITSM, ITOM was very strong this quarter. Can you a little bit speak to that? I sense it's probably the big federal deals, but maybe more broadly, what you see in the different product categories. Many thanks and congrats from me.

[Chirantan Desai, executive]

Raimo, thank you so much. This is CJ for the question. Great to hear from you. ITSM and ITOM, which we define from a solution perspective as service operation, is core of our core, so as Bill outlined that we had very strong new logo business and new logos that matter, where we almost always land with ITSM and ITOM.

And in general, we are seeing that ITSM continues to have expansion rates, whether it's via Pro SKUs or just recently added Pro Plus. And with ITOM and our AIOps strategy, we continue to execute on not only the product road map but how our customers are leveraging those innovations from visibility all the way to health in their digital real estate.

[Operator]

We'll take our next question from Kash Rangan with Goldman Sachs.

[Kasthuri Rangan, analyst]

Congratulations Bill, CJ and Gina. Outstanding results. Bill, we've all been waiting for this recession. Some have been calling for a hard landing and some others aren't. It looks like we've been waiting forever for this recession to happen. It's not happening. And I'm sure it's serious if you do business with -- or have been somewhat cautious in the last 3 to 4 quarters.

But it looks like things are stable. And with the tailwind of potentially a soft landing, if I could use that expression, a software landing, and AI as wind in your sails, what does the company's growth prospects look like in '24 versus the last couple of years that we've all been slogging through this, granted that you have been executing really well, outperforming your peer group. What does the growth curve look like with all these tailwinds ahead of you?

[William McDermott, executive]

Well, Kash, thank you. I think that's the reason why we've raised our guidance on top of an outstanding quarter like this because we have great confidence in the core business. All CEOs right now are either in a move to increase productivity because of the crosswinds that you referenced in the macro or as I'd say, cost out.

And obviously, while doing so, they also have the added challenge of new business model innovations such as the auto industry now dealing with the transition to EV. What's unique about ServiceNow is digital transformation can deflect so many of the cost-intensive, labor-intensive procedures that companies have to deal with to properly serve their market. On top of that, you have 1/3 of the productivity of knowledge workers getting torn apart by swivel chairing between, on average, 13 individual applications a day.

Now you add the productivity tailwind of generative AI on this once-in-a-generation ServiceNow platform, and you have achieved a very important business transformation. And I think right now, CEOs are focused on business transformation. And when you can give them one common UX that is consumer grade, that integrates with the half a century of legacy mess that they have to contend with, and we can get the actions that they need done, done, done to achieve cost out productivity in and growth on, they're all about service down now. And that's why you're seeing these results, and they are sustainable.

[Operator]

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

[Tyler Radke, analyst]

So the beat on constant currency current RPO was one of the largest we've seen in quite a while. Could you just unpack? Was that mostly federal? Or was it broad-based?

And then secondly, Gina, on the current RPO outlook for Q4, can you just help us understand the dynamic with the 1 point headwind a little bit better? Did Q3 also face that headwind, given you booked so many of these large federal contracts?

[Gina Mastantuono, executive]

Tyler, thanks so much for the question. So yes, we're very excited. Q3 results were just phenomenal across the board. And the beat on constant currency cRPO was two things: specifically strong net new ACV growth, and that was primarily driven, but not entirely, primarily, not entirely driven by very strong federal business which was just fantastic and great business for us.

We also did have better early renewals. If you remember, we've been really prudent in how we've been forecasting early renewals given the current macro environment. And so the beat this quarter was two-pronged, right? So strong net new ACV growth as well as strong early renewals. To your question on the impact of Q4 cRPO and the 1-point headwind, how federal agencies usually contract is 1 year out, right?

So their contracts are only 12 months in duration. So it doesn't have a negative impact on Q3, right, because at the end of Q3, you have it in there for a full year. But at the end of Q4, when 1/4 of those contracts roll off cRPO, it means that there is a headwind to Q4. And because Q4 -- sorry, because federal was so strong and the mix of federal in Q3 was stronger than we've ever seen before, there is that headwind into Q4.

But again, as you think about the underlying business, extremely strong results. In fact, federal business has a strong renewal rate at 99%. So as you think about the underlying health of the business going into '24, it remains very strong.

[Operator]

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

[Sanjit Singh, analyst]

This is Sanjit Singh for Keith. I wanted to congratulate the team on the 24% constant -- on the current RPO growth. That was really impressive. Bill, when I looked at what you were talking about in terms of gen AI trials and landing 4 customers right at the end of the quarter, in terms of your -- the team's expectation about adoption of ITSM Pro Plus versus Pro, is there -- do you see a scenario where that adoption could potentially happen faster than the cadence of adoption that you've seen over the last 5 years with ITSM Pro? I appreciate the thoughts.

[William McDermott, executive]

Well, I can tell you that -- we, first of all, appreciate your question, Keith. You know how well we have done with the Pro version of the platform, and there's still plenty of room to expand on that. But the demand that we've seen so far for Pro Plus and the transformational nature of what customers are now able to do on the Now platform has led to the single best hype that we have seen at ServiceNow. I'll let CJ give you some color on individual customers and some of the actual stories that I think you'll find illuminating.

[Chirantan Desai, executive]

Absolutely. Thank you, Bill, and thanks for the question. So we have one data point from the last week of September, which I do not want to translate it to trend, however, we are having many, many conversations with some of the iconic companies and public sector customers around ServiceNow's generative AI offering. So when we launched in 2018 Q3 the Pro SKUs, there was a term that followed over multiple quarters now, 20 quarters, and we know what that looks like.

With Pro Plus, what I'm seeing is it is no longer about the potential of generative AI. Where they are questioning is generative AI good for us in context of ServiceNow platform, but the conversations have shifted to, CJ, how long would it take for us to implement? Does our data strategy need to be aligned? And what about security, et cetera?

So the positive side of this is that we are seeing good demand. And on the cautionary side is we will work with our customers. They are learning, like Bill said, the 4 customers who leaned in and bought our products on the last day of the quarter. But as we move forward, we'll work with these customers. And as we get a couple of quarters under the belt, we will be able to tell you how this is looking versus Pro. So Pro Plus versus Pro.

[William McDermott, executive]

And Keith (sic) [ Sanjit ], one thing to keep in mind is Pro is a necessary stepping stone to Pro Plus. So from a shareholder value creation standpoint, it's plus, plus.

[Operator]

We'll take our next question from John DiFucci with Guggenheim.

[John DiFucci, analyst]

Gina, thanks for all the detail around cRPO. That's really helpful in understanding that metric. I know we've talked about this in the past, but I mean that. It's helpful. My question is really around the federal business, which is really -- it's been really strong for at least a year, more than offsetting any commercial weakness when it happened like maybe a year ago or so.

And just adding to what -- at least what I think is surprising, commercial strength, as Kash sort of hit on that, in periods like this quarter. I guess my question is how sustainable is that federal business in regards to new ACV, which it sounds like it just continues. It's like the energizer bunny. It just sort of keeps on giving.

[William McDermott, executive]

Yes. John, I'll start it off and then let Gina give you some of her color as well. But our federal business, as I said, had the biggest quarter in ServiceNow's history with 75% year-over-year growth in ACV, and we had 19 deals that were more than $1 million, including $3 million over $10 million with the U.S. Air Force as the third-biggest deal in the history of ServiceNow.

And what we're seeing is across all areas, federal agencies are really looking to consolidate contracts, point solutions, the messy middle, and they really want to standardize on a platform with a core set of products that they can grow with. And our gen AI offerings, for example, are really reinforcing our ability to help accelerate their transformation journey, and they're seeing really tremendous opportunity in gen AI on our platform.

And we're already seeing early adopters show an interest in domain-specific models, which offer better security, as CJ said, and we're working with some agencies that I can tell you care a lot about security. So I think it's really a tribute to ServiceNow's engineering and the way ServiceNow runs our cloud and the manner in which we care for our customers at a deep technical level, and they know that they can count on that.

And every agency where we've done business is highly referenceable, and they're telling our story to other agencies for us. It's really a beautiful force multiplying situation. But I want to leave you with one thought. We're only getting started. With federal, with state, with local, the business transformation that's going to go on in the next decade across all of those categories will play beautifully into our growth agenda, and we'll continue to service it with 100% customer satisfaction. We are fired up with what we're able to do to transform government and make it run like a best run business.

[Gina Mastantuono, executive]

The only thing I would add -- and Bill, fantastic answer. The only thing I would add, John, is that this is durable demand. The federal agencies, the digitization agenda is only growing. And the success that we've had at federal we absolutely have the ability to replicate that outside of the U.S. and public sector around the world.

[Operator]

We'll take our next question from Mark Murphy with JPMorgan.

[Mark Murphy, analyst]

Bill, the level of confidence that we hear from SIs on maintaining this kind of 20% plus growth trajectory for their ServiceNow practices is truly standing out across the software landscape. One of them surveyed their customers and the top 3 topics of interest that came back were Microsoft, Azure and ServiceNow.

So just in light of that joint prioritization there, could you shed a little light on traction with your Microsoft relationship? Is that kicking in already at this stage? And are you able to go to market as a bit of a one-two punch with the Azure Copilots and Now Assist?

[William McDermott, executive]

Yes. I'll start off and then please, CJ, feel free to add your opinion on this as well. But our partnership with Microsoft is really geared to open additional addressable market for ServiceNow. And we're doing that by creating an expanding co-sell motion with Microsoft's enterprise sales team. So that would talk to you one-two punch.

And ServiceNow is really helping streamline their migrations to Azure, while Azure exposes us to a much wider spectrum of customers. So we saw the partnership influence deals across geos in Q3, including government wins in Americas and APAC, as real driving forces between both Microsoft and ServiceNow. And we really are confident that the partnership and the synergy with Microsoft does enable us to bring value to more customers and do so at an unprecedented speed.

And I do want to say that we've been friends with Satya myself on a personal level for a long time, and we've done a lot of business together, and the friendship that exists with CJ and the engineering team at Microsoft is very rock solid, and we trust each other. And we see that our mutual interest gets better by working together, but also we're doing it in the name of the customer. And I think that's the big thing.

And I just want to compliment CJ and our engineering team, not just for the 5,000 new innovations they brought to the platform this year. That would have been enough. But also for the hands-on relationship with great partners like Microsoft, because you got to remember, everything we have has been integrated into Microsoft from Office 365 to Dynamics, to Teams, to Azure, to AIOps.

It's pretty amazing when you think about the engineering work and talent that went into putting this together. So this isn't just like let's go to market, and 2 is better than 1. This is deep technical integration to serve customers at an unprecedented level.

[Chirantan Desai, executive]

Bill, you said it well. Mark, the only thing -- good to hear from you. The only thing I would add is the engineering collaboration is absolutely necessary but not sufficient when it comes to go-to-market partnership and relationship we have working with Microsoft.

So whether it's our financial services customers or health care or government customers, when they are trying to leverage ServiceNow hey, where are my assets? Are my assets healthy? Are they secure, whether they're running on-prem or in Azure? We have the best-in-class partnership with Microsoft, and that is definitely being noticed by some of our largest as well as midsized customers and brand-new customers.

[Operator]

We'll take our next question from Karl Keirstead with UBS.

[Karl Keirstead, analyst]

Okay. Great. Maybe I'll direct this one to Gina. Gina, I know from the past when you've had strong fed quarters that by virtue of those deals, they tend to have, I think, correct me if I'm wrong, a little bit more upfront rev rec.

So I'm just curious. You laid out the impact on cRPO, but how does that strong fed quarter that you saw in September impact the reported subscription revenue and margins that you put up? And if you could, in any way, maybe size that lift, given that I think there's more upfront rev rec. Much appreciated.

[Gina Mastantuono, executive]

It's a great question, Karl. Actually, quarter-over-quarter, year-over-year on-prem has remained consistent. So there hasn't been an impact. And so the strength in our revenue in the quarter was the result of extremely fantastic execution by the team.

[Operator]

We'll take our next question from Gregg Moskowitz with Mizuho.

[Gregg Moskowitz, analyst]

So it's really interesting that you signed 4 large deals on September 30, literally right after the availability of Vancouver and Now Assist. And it sounds like your gen AI tech was a clear catalyst, if not the catalyst for these transactions.

So I guess for Bill or CJ, I assume these were all existing customers, but did they all purchase Pro Plus? Did any of them purchase Enterprise Plus? Are any of them deploying your new functionality? Just curious to hear any additional color that you might be able to share.

[Chirantan Desai, executive]

Gregg, thanks for the question. I'll take this question. I would say, just to summarize, because we in the Vancouver release launched Now Assist for our 4 flagship product lines, which is ITSM, HR, customer service and creator. So we'll start with that. And those are all resonating whether our customers want text to core or text to workflow capabilities, or they want their employees to be more productive or they want their IT staff or customer service agents to be more productive.

So depending on the customer and what they're solving for, all of them are resonating really well. So this was driven mainly on Pro Plus. So these were Pro customers who also bought Pro Plus. So one example, one of the customers who did buy this on September 29 specifically said to me, hey, CJ, we had the most successful ITSM rollout. Now we want to buy Pro Plus. And they are on ITSM Pro already, and we just want our employee experience to be great.

Versus another customer that Bill mentioned, they said not only we want to solve for our employees but also our end customers. So these 4 specific transactions were across the board, resulting in very strategic and significant wins. As we move forward, I would tell you that what is still resonating with our customers is the speed to value.

This is not something where Now large language model need to be fine-tuned for one customer at a time. And the way our engineering team has implemented this solution. I can tell you generative AI is probably one of the best, if not the best, complement I have seen to ServiceNow platform where you can use generative AI to look up something, to summarize something and then you take action via ServiceNow platform.

[Operator]

We'll take our next question from Kirk Materne with Evercore ISI.

[S. Kirk Materne, analyst]

Congrats on the quarter. Bill and CJ, I was wondering if you could just talk about the concept of starting to deliver AI solutions that are more vertically oriented. How far away are you from that? How much of the verticalization do you want to take on? And how much do you want to leave to your partners to sort of take some of these use cases with gen AI into verticals with specific vertical technology?

[Chirantan Desai, executive]

So first of all, Kirk, thank you for the question. When we start -- and yesterday, we had our Board of Directors meeting and a similar question was asked. We are first prioritized on our core set of use case that cut across every single industry. We are very focused on that via ITSM, customer service, HR as well as our creator offerings. As we look forward, though, there are specific use cases within a financial services or a health care types of customers or even governments.

I'll give you an example where some of our public sector customers, they asked us, hey, CJ and the team, can you provide us a solution that can potentially run on-prem, given the nature of that agency, and our engineering team delivered that for our public sector customers. So I would consider that as a vertical solution that we had to create for our public sector customers. But as we take it to the next level, post this core set of use cases across our 4 workflows, we will definitely be prioritizing financial services and TMT moving forward.

[Operator]

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

[Aleksandr Zukin, analyst]

Congrats on another great quarter. Maybe just 2 quick ones for me. Clearly, the story of this quarter was the unbelievable federal growth that you guys posted. Maybe ex federal, to the extent of the incremental challenges or lack of thereof from the macro and pipeline, like what's the story of the quarter ex Fed?

And then some of the deals that you guys referenced either on the Pro Plus side or just a very large deal side, like maybe talk a little bit about the competitive environment? Are you taking them away from some of your front office peers? Or kind of how does that shape up as you look at the pipeline?

[Chirantan Desai, executive]

Yes, Alex, thanks for the question. It's CJ. First of all, yes, federal had a phenomenal quarter, and it has been talked about by both Bill and Gina. But we also saw strength in certain industries and certain geographies across the board. We won't be able to produce these kind of results and this kind of beat on cRPO without strength in other industries and other geographies.

So that's what I would say at the highest level that there were a lot of further strengths. And even from a use case or a workflow perspective, Bill already outlined that our employee workflow, which is now customers are asking us this question that we want our employee productivity to be high and what is ServiceNow solution, because employees waste too much time swivel chairing or looking for information. So we saw significant growth there, but the growth was across the board, even from a workflow perspective, and all 4 workflows grew very, very nicely.

And Alex, you know how much I pay attention to that. The second thing I would say on Pro and Pro Plus, what we are seeing is that customers understand ServiceNow's strategy is very specific to ServiceNow use cases. And one of the things that I realized after having this Pro Plus conversations with customers on a large sample size, that generative AI on our Pro Plus SKU is a productivity multiplier. It's not a productivity enhancer.

So when you have a productivity multiplier and you can articulate what kind of productivity gains they will get, that is when they say, "Okay, we got it. And now let's figure out what are the pricing and other things." So competitive dynamics-wise, from a generative AI standpoint for overall this Pro Plus SKU, it is still in the context of ServiceNow. How much value will they get, how fast will they get that value, and how much they're willing to pay.

[William McDermott, executive]

And Alex, if I may build on what CJ said, I can give you some additional color, if you like. One thing that might be of interest to you is in America, the number of $5 million-plus deals actually more than quadrupled year-over-year and the number of $10 million-plus deals doubled year-over-year. And I think as CJ laid out beautifully, technology and employee workflows were enormously successful.

And in EMEA, our 1 million-plus deals grew 70% year-over-year, which means that the platform and multiple components of the solutions that our great engineering team builds is resonating, and we're seeing particular uplift now in government and manufacturing. And one interesting fact, we have these world forums coming up in London, Paris, Frankfurt and Rotterdam, and we have $1 billion-plus pipeline that's registered for those events.

So we feel good about that. And APJ, when you think about it, their 1 million-plus deals increased 40% year-over-year, and Japan is continuing to impress us with the unprecedented opportunity of the world's third-largest economy as Germany is as well. So we're seeing lots of real growth opportunities on the global stage, and I think Gina pointed that out earlier as well.

[Operator]

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

[Bradley Sills, analyst]

It looks like an uptick here in head count this quarter, sales and marketing hires. Net adds looks like more than 500. R&D almost 400. Would love to get some color on some of those areas of prioritizing -- that you're prioritizing in the investment, both in sales and marketing and R&D?

[Gina Mastantuono, executive]

Yes, Brad, listen, this is a tale of continued execution. We've been very focused on adding heads and investing in our R&D resources and our quota-bearing sales. And so you will continue to see us invest in those critical areas for us. And that's been something that we've been doing for quarters now. And so we'll continue to add the quota-bearing sales, the direct sales folks.

As we enter into '24, you could expect to see similar levels of growth as we enter the following year. So I feel really good about where we've been investing in those same areas that we've been talking about, quota-bearing, direct sales heads as well as critical key engineering as we think about the great innovation that comes from our R&D and engineering teams across the world.

[Operator]

We'll take our next question from Michael Turrin with Wells Fargo Securities.

[Michael Turrin, analyst]

Fantastic job with the Q3 results. Gina, you gave us some 2024 mile markers at the Analyst Day earlier this year. It's now October. A lot has changed, but the growth profile has proven impressively durable throughout. Is there anything you're seeing that's meaningfully different here today versus where things were in May? It sounds more clear in terms of some of the initial value you're seeing from the gen AI capabilities, but are there other swing factors we should keep in mind? Understanding Q4 is very important, but anything you can add is useful.

[Gina Mastantuono, executive]

Yes, Michael, thanks for the question. We don't provide formal fiscal year guidance, right, until next quarter. That said, given our increase in revenue this year, we remain ever confident in the goals that we put forth back in May at Analyst Day for 2024 as well as 2026.

The strength of our underlying business does provide solid momentum and the potential for upside heading into '24. But as you said, Q4 is a big quarter for us. We expect great things, but it has a significant impact on next year. So we'll wait for the formal guide, but feel very, very confident in the numbers that we laid out for you back in May. And stay tuned as we head into '24.

[Operator]

We'll take our next question from Samad Samana with Jefferies.

[Samad Samana, analyst]

Gina, I actually wanted to follow up on that. I had a different version of that question, which is just more precisely on gen AI. When you gave the outlook at the time of the Analyst Day, there's obviously already a lot of discussion about AI with the products that have been rolled out, but when you gave the '24 targets, did that embed any potential impact from gen AI specifically? Or was that something that was just on the horizon or on the comm that wasn't included? Just for clarification. I've gotten the question a lot.

[Gina Mastantuono, executive]

Sure. Yes, Samad, great question. As you recall at Analyst Day, we actually showed a lot of live demos of the work that we were doing around generative AI. We talked also about the fact that we're not jumping on this AI bandwagon, but we've been investing in AI for years and years, and generative AI was part of that. So as you think about our road map and our plan, gen AI was part of that. Now that being said, the interest and the understanding and the excitement about gen AI today versus back in May is extremely exciting to us.

And so if your question is, is there a potential upside as a result of gen AI? Absolutely. But one quarter does not a trend make. So we will absolutely continue to keep you posted on the adoption rate of our gen AI SKUs, but we are extremely excited about the pipeline build that we've seen already, and it's just been out for a very short amount of time. And yes, so more to come on where gen AI goes for us. But rest assured, ServiceNow is going to be a winner in the gen AI space, and we're extremely excited about pipeline build and where we are today.

[Samad Samana, analyst]

Great. And Bill, if I could squeeze one in for you. You've talked about how much interest and buzz that's been generated and how it's increased the velocity of conversations. When you think about your Board-level conversations, are you seeing that the budget that's being carved out for spend on gen AI, is that being taken away from other parts of the overall IT budget? Or is that hey, this is a strategic imperative, and we need to find the money, whether we're growing our IT budget or not. Just how are they thinking about those dollars and where they're going to...

[William McDermott, executive]

Yes, Samad, the CEOs all have Boards of Directors, and they don't want to show up without a gen AI plan. So this is a CEO-level decision. And I think that is why we meet with so many CEOs and the C-suite is now completely embedded in the ServiceNow go-to-market plan, and it's working beautifully.

What they are doing is as follows: according to IDC, the IT budget this year would have been about 3.5% spend. And next year, it's expected to go to -- instead of incrementally increasing 3.5%, which is your typical year, it's expected, according to IDC, to incrementally go up 7%. And that's the IT budget itself.

What I believe is going to happen and based upon the CEO discussions that I'm having and also based on my own way of thinking, I would very much like to take the position of looking at the world through the customers' eyes that if I'm them, 7% may or may not get it done. I might look to G&A functions to further fuel this generative AI revolution. Because this is really about business transformation and truly transforming the way you run your company, and it's not a nice to have IT project.

And I do think that is one of the interesting question you have, because I think it's one of the reasons why I have said repeatedly the IT strategy has become the business strategy because digital transformation is an end-to-end imperative. Now generative AI across platforms that matter, and there's only a few and we're one of them. is really, to me, going to get a very nice tailwind investment in 2024, regardless of the macro.

[Operator]

We'll take our next question from Derrick Wood with TD Cowen.

[James Wood, analyst]

I guess either for Bill or CJ, but I was hoping you could expand on your new AI Lighthouse program with NVIDIA and Accenture. You guys announced this initiative a couple of months ago. It'd be great just to get a bit more color on the undertakings around this program and how these particular partners are helping to drive more kind of generative AI investments on the ServiceNow platform.

[William McDermott, executive]

Yes, Derrick. I'll start off and then CJ can build on it. I'd like to first acknowledge NVIDIA in particular to being such a great partner, really taking their fantastic GPU technology and then working hand in glove with them on fine-tuning these large language models, especially beginning in IT, but even more recognizing that one of the great brands and great companies of the world is using ServiceNow to transform their company on our platform, where generative AI is such a complement.

And so I just want to say thank you, Jensen. Thank you NVIDIA for being a great partner. And yes, with regards to Accenture and Julie and so forth, we are really doing some great things with Accenture. They're a fantastic partner. And we're building now generative AI use cases across 300 different customers with our ecosystem, and that doesn't even touch on the broader pipeline.

CJ can give you some detail on exactly what we're doing, but I really do want to say that I'm incredibly appreciative of our partners, and I want to thank our partners for recognizing that we're a good partner, and it takes a good partner to know one, and we have really built foundational trust with the ecosystem, and I appreciate them all.

And I think that is another tailwind effect that we're getting because I believe we're moving into a world of not just intra enterprise, but inter-enterprise business network opportunities, and I believe our platform in generative AI will fuel a completely new frontier of solutions and offerings in the global economy. And I think that this has only just begun. I just want to really give you that as a thought because we'll have more to say about that in the future. CJ?

[Chirantan Desai, executive]

Absolutely, Bill. Right on. And Derrick, one of the things with this Lighthouse program that we are solving for is have a great technology partner, and Jensen and the team are a great technology partner. Most of them -- most of us know NVIDIA as a great CPU provider, among other engineered systems. But in this specific program, what most do not know is that NVIDIA's software team is working very closely with ServiceNow's engineering team to really innovate on generative AI.

And that is a very important point as part of this Lighthouse program is the engineering collaboration between NVIDIA and ServiceNow and a software layer, which obviously then pushes the hardware in the right direction. And then when these customers, we talked about the 4 customers, there will be many who will start using this product, as they need to get adopted, besides Accenture, there will be other partners that we are also training, enabling so that they can implement really, really fast the solutions that come out of ServiceNow.

So overall, this is a holistic strategy, engineering collaboration, and as Bill said, ecosystem collaboration so that we can deliver the value for our customers. Customers' demands are high on the value that we will deliver, and we need a great set of friends between technology and system integrators to deliver that value.

[Operator]

One last question. We'll take that question from Matt Hedberg with RBC Capital Markets.

[Matthew Hedberg, analyst]

CJ, a question for you. A lot has changed in the observability market with the Splunk proposed acquisition. I'm curious, could you give us a sense for your positioning in the cloud observability market? With Lightstep and other advancements there, how well positioned do you feel to gain additional share there?

[Chirantan Desai, executive]

Absolutely. So I would say observability is still fundamentally a big market. It's a big market that continues to grow. We started with Lightstep. And as you are aware that they provided a great solution for tracing and with OTL as in open telemetry, they had done some phenomenal work. Then we added the metrics capability, and just end of September, we finally added logging capabilities.

So now we feel that we have a full-blown cloud observability solution that we can take to the enterprise market, and we will compete head on for the types of use cases that we need to with whoever we need to. And that's how I look at it. So I'm optimistic. We have a lot of work to do. Finally, the product is there, full-blown cloud observability product between metrics, traces and logging, and we are ready to go.

[Operator]

And that does conclude today's presentation. We thank you for your participation, and you may now disconnect. Goodbye.