ServiceNow Inc (NOW) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2012 ServiceNow earnings conference call.

My name is Kim, and I will be your operator for today.

At this time, all participants are in listen-only mode.

We will conduct a question-and-answer session toward the end of this conference.

(Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Mr. Robert Specker, General Counsel.

Please proceed.

Good afternoon, and thank you for joining us on today's conference call.

This call is also being broadcast live over the web and can be accessed at our website at investors.servicenow.com for the next 30 days.

With me on today's call are Frank Slootman, Chief Executive Officer, and Michael Scarpelli, Chief Financial Officer.

After the market closed today, ServiceNow issued a press release with results for its fourth quarter and fiscal year 2012.

If you would like a copy of the release, you can access it online at our website.

We would like to remind you that statements made on this conference call that are not historical fact may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934.

These forward-looking statements include, among other things, information concerning our possible or assumed future results of operations, business strategies, financing plans, operating model, competitive position, industry environment, potential growth opportunities, potential market opportunities, and the effect of competition.

Words such as -- may, will, expects, intends, plans, believes, targets, estimates -- and variations of these words are intended to identify forward-looking statements.

These forward-looking statements involve risks and uncertainties that could cause our results to differ materially from those expressed or implied by such forward-looking statements.

The risks and uncertainties include any weakening of general economic and market conditions and customer budgets, our ability to react to trends and challenges in our business and the markets in which we operate, our ability to anticipate market needs or develop new or enhanced products to meet those needs, our ability to scale our sales channels, our ability to recruit and retain personnel, our ability to compete in our industry, and other risks and uncertainties described more fully in our documents filed with or furnished to the Securities and Exchange Commission.

All forward-looking statements are based on information available today, and we assume no obligation to update these forward-looking statements.

Any future product feature or related specifications that may be referenced in today's call are for information purposes only and are not commitments to deliver any technology or enhancement.

ServiceNow reserves the right to modify future product plans at any time.

In addition, we will reference non-GAAP financial measures on this conference call.

The Company reports non-GAAP results for gross margins, operating margins, net income or loss, basic and diluted income or loss per share, free cash flow, and billings in addition to, and not as a substitute for or superior to, financial measures calculated in accordance with GAAP.

Management believes that this supplemental non-GAAP information is useful to investors in analyzing and assessing the Company's past and future operating performance.

To see the reconciliation between these non-GAAP results and GAAP results, please refer to our press release which was filed earlier today and, for prior quarters, previously filed press releases, all of which are posted on our website at investors.servicenow.com.

I would now like to turn the call over to ServiceNow CEO, Frank Slootman.

Thanks, Rob.

Good afternoon, and thank you for joining us on today's call.

We're pleased to announce all-time record revenues for the quarter.

Revenues grew year on year 92%, to $75.2 million, continuing a five-year trend with quarterly revenue growing by more than 80%, year on year.

Both billings and deferred revenue were marked by strong performance, with total billings of $97.6 million, up 20% sequentially and 58% year on year, and a deferred revenue balance of $170.4 million, up 15% sequentially and 63% year on year.

As of year-end, our backlog was $379 million, an 81% increase over the $209.9 million reported at the end of 2011.

As a reminder, backlog represents future amounts to be invoiced under our agreements, and it's not included in deferred revenue.

Backlog and deferred revenue combined totaled $549.4 million, coming into 2013.

Now, I'd like to update you on three key strategic priorities -- first, new customer wins; secondly, delivering best-in-class customer satisfaction to drive upsells and renewals; and, third, our platform opportunity.

In terms of new customer wins, we added 166 net new customers in the fourth quarter, ending the year with a total of 1,512 customers.

New names added to the customer base include Boeing, Nomura, Pearson, Starz, and Moody's.

We continue to focus on penetration in the Global 2000 as defined by Forbes magazine, adding 20 new Global 2000 enterprises to our customer roster during the fourth quarter.

As a result, we're now counting 265 of the Global 2000 as ServiceNow customers, representing about 13% penetration.

In the quarter, GDF Suez, a Global 2000 enterprise in the utility sector with over 200,000 employees worldwide, selected ServiceNow as its new European IT operations management solution, as part of an IT infrastructure transformation program.

We also added a Fortune 500 oil and gas operator that selected ServiceNow to drive the company-wide operational excellence strategy, both inside and outside of IT.

ServiceNow will be deployed within IT for service management and, outside of IT, [our] Cloud platform will be utilized to drive agility across the business through additional application development.

We have a presence in approximately half the countries in which the Global 2000 have corporate headquarters.

Our focus in 2013 is to expand our service area internationally.

Our addressable market extends beyond the Global 2000.

We believe that there are at least 12,000 companies globally with $500 million in revenue and greater than 1,000 employees which are potential customers for our enterprise cloud platform.

This does not include the opportunity we have in the public sector at the federal, state, local, and university levels.

Second, best-in-class customer satisfaction is key to our long-term success.

We grew our professional services revenue 35% quarter on quarter and delivered our first quarter with positive Services gross margin, excluding quarters with Knowledge, our annual users conference.

Our Professional Services team's ability to deliver quality deployments quickly is a critical driver of customer satisfaction.

As an example, during the quarter, Pacific Aluminum, a division of Rio Tinto, successfully deployed ServiceNow's enterprise service automation suite, leveraging our Professional Services organization, in under a month.

Renewals and upsells are the two key indicators we maintain to gauge customer satisfaction and our success with our cloud software platform.

Our renewal rate during the quarter was close to 98%, continuing a three-year trend of quarterly renewal rates at or above 95%.

We also saw significant contributions from upsells during the quarter and full-year 2012, representing 32% and 30% of our annual contract values signed, in each respective period.

Our upsells typically come from organic growth, where customers outgrow the number of [seat] licenses purchased, as they continue to utilize the ServiceNow cloud platform.

Upsells also include incremental sales of other ServiceNow software options.

Kohl's, a department store chain with more than 1,000 stores and 100,000 associates, is one such case.

During the quarter, Kohl's expanded their use of ServiceNow by adding our Discovery application to automate the discovery of IT assets in their stores.

By enabling assets and CMDB management, Kohl's will be able to accelerate root cause identification of in-store problems as they arise.

We think about our incremental market opportunity in terms of two key components -- increased saturation of accounts, where we already have penetration, which we refer to as upsells, and our ability to penetrate new accounts.

In the fourth quarter, our average annual revenue per customer was $190,000, up from $157,000 in the fourth quarter of 2011, a 21% increase year on year.

This increase is driven primarily by upsells and the addition of larger customers compared to previous years.

In terms of upsells, the rate of monetization within our customer base has historically been a key driver of our business and, on average, we believe we are less than one-third saturated in our customer base.

We achieve significantly higher average revenue per customer in our larger accounts compared to the overall installed base.

We recently analyzed our Global 2000 customers on a stand-alone basis and found this segment of customers is generating average annual revenue greater than $420,000 per customer.

As an indication of the potential of these Global 2000 accounts, our largest customer accounts for $5.3 million in annual contract [value] and, yet, we believe we have significant room to continue to grow this account.

Third, our growth continues to be driven by the transformation from 1990s-vintage help-desk management applications to a modern, on-demand cloud platform that enables a consumer-style online experience, sophisticated workflow automation, and a consolidated, single system of record view of IT service operations.

The key benefit of the ServiceNow platform is the unparalleled agility to evolve applications on demand, such as instant changes to data structures, forms, workflows, and reports.

The ability to rapidly deploy, evolve, and expand service-oriented applications has led to the spread of ServiceNow to global IT operations.

The ServiceNow platform is well within the purview of mainstream IT personnel and doesn't require deep technical expertise and scarce programming talent.

As a result, we've seen our platform grow virally within customer environments to other service domains, such as human resources, legal, travel, facilities, and the line of business itself.

The realization that service management is an enterprise discipline has begun to take hold, and the enterprise IT function has been leading the charge beyond its functional perimeter.

In summary, we believe we have a remarkable opportunity in front of us to continue to drive new customer adoption of our core IT [SN] product suite, to increase utilization of ServiceNow among existing customers, and to drive viral adoption of our cloud platform.

Consequently, we plan to make twice the number of new hires in sales and marketing in 2013 as we did in 2012.

Before I close, I want to highlight our upcoming annual users conference, Knowledge, in Las Vegas, May 12 through the 16.

We expect nearly 4,000 IT professionals and ServiceNow experts to converge for five days to see our IT service automation strategies and to learn how other IT pros achieve results in the cloud.

On May 13, as part of the event, we will be holding an Analyst Day for professional financial analysts.

Analyst Day registration will begin formally in early March.

We also encourage those participating in the Analyst Day to register for the Knowledge conference events.

In the meantime, please mark your calendars for May 13.

For those who cannot join our Analyst Day in person, we will hold a webcast of the event that will be accessible on our website.

With that, I will turn the call over to Mike Scarpelli, our CFO, to go over the numbers in more detail.

Thank you, Frank.

During today's call, I will review our fourth quarter financial results and discuss our financial guidance for 2013.

Before I begin reviewing the numbers, I'd like to point out that all financial figures I will discuss today are non-GAAP unless I state otherwise, with the exception of revenue numbers which are GAAP.

You can find a reconciliation of GAAP to non-GAAP results in our press releases on our website.

With that, let me take you through some of the numbers.

Total revenues for the fourth quarter were $75.2 million, representing 92% year-over-year growth and 17% sequential growth over third quarter revenues of $64.3 million.

Revenue was above our outlook, primarily due to strength in new business and renewal bookings during the quarter coupled with better-than-expected utilization within our Services business.

Subscription revenues for the quarter were $62.9 million, representing 82% year-over-year growth and 14% sequential growth.

Subscription revenue growth was driven by strong bookings in prior quarters, coupled with a retention rate of 98% in the current quarter.

32% of our annual contract value signed in the quarter came from upsells in existing customer base.

Professional Services and Other revenues were $12.3 million for the quarter, growing 166% year over year.

On a sequential basis, Professional Services and Other revenues increased 35%.

Professional Services and Other revenues are generated primarily from fees related to the implementation and configuration of our subscription service, as well as training fees.

Total revenues based on geography were $52.9 million in North America, $18.6 million in EMEA, and $3.7 million in the rest of the world, representing 70%, 25%, and 5% of total revenues, respectively.

In the fourth quarter of 2011, we recorded revenues of $27.4 million in North America, $10.3 million in EMEA, and $1.5 million in the rest of the world, representing 70%, 26%, and 4% of total revenues, respectively.

Our total billings were $97.6 million for the fourth quarter, compared to $61.9 million in the fourth quarter 2011 and $81.2 million in the prior quarter, representing 58% year-over-year growth and 20% sequential growth.

Additionally, approximately 10% of our billings in the quarter were for periods greater than one year, compared to 25% in the fourth quarter of 2011 and 12% in the prior quarter.

In the future, we expect 10% of our billings will be for periods greater than one year.

One year is our standard billings term.

Before we turn to expenses, I'd like to point out that we ended the quarter with 1,077 employees, an increase of 474 employees from the same period in the prior year and an increase of 114 employees from the prior quarter.

I would also like to note that we recorded a pretax amount of $9.3 million related to stock-based compensation expense.

This impacted our earnings per share in the fourth quarter by a tax-adjusted amount of $0.08 per diluted and basic share.

Our Subscription gross profit was $44.2 million, representing a gross margin of 70% which, as we had planned, is down compared to 76% in the same period last year and 70% in the prior quarter.

During the quarter, we added 16 employees to Subscription cost of sales, ending the quarter with 218 employees.

The year-over-year gross margin decrease is primarily attributable to the migration of customers to our new generation of datacenters and the 43% year-over-year growth in our cloud infrastructure team.

As of today, we have completed the migrations, and all of our customers are in our new generation of datacenters.

We believe we now have an enterprise class cloud better suited for the intense reliance and scale our customers require of our platform.

During the migration, we incurred double rent as we wound down our contractual obligations and accelerated depreciation for certain assets.

Starting next quarter, we will no longer incur costs related to our previous generation datacenters, and you will see the positive impact on Subscription gross margins in 2013 when we discuss guidance.

Our Professional Services and Other gross profit was $0.7 million, representing a gross margin of 5%, compared to negative 54% in the fourth quarter of 2011 and negative 1% in the prior quarter.

During the quarter, we added 24 employees to Professional Services and Other cost of sales, ending the quarter with 183 employees.

Professional Services and Other gross margin improved sequentially in each quarter of 2012, driven by the ongoing shift towards time and material contracts and away from fixed-fee contracts.

Our total gross profit was $44.9 million, representing a gross margin of 60%, compared to 61% in the prior year and 60% in the prior quarter.

Moving to operating expenses for the fourth quarter, sales and marketing expenses were $26.1 million, or 35% of revenues, compared to $17.3 million, or 44% of revenues, in the fourth quarter of 2011 and $25.2 million, or 39% of revenues, in the prior quarter.

During the quarter, we added 20 employees to sales and marketing, ending the quarter with 350 employees.

Our third quarter sales and marketing expense included $1.5 million related to our sales kickoff event for the second half of 2012.

Beginning in 2013, our comp plan will [follow] a calendar year, and we will incur sales kickoff expenses in the first quarter only.

Research and development expenses were $10.9 million, or 14% of revenues, compared to $3.8 million, or 10% of revenues, in the fourth quarter of 2011 and $8.9 million, or 14% of revenues, in the prior quarter.

During the quarter, we added 36 employees to research and development, ending the quarter with 200 employees.

We expect research and development expenses to increase on a dollar basis, as we continue to make significant investments in our services, primarily in the areas of application and platform development and cloud infrastructure.

General and administrative expenses were $8.1 million, or 11% of revenues, compared to $4.6 million, or 12% of revenues, in the fourth quarter of 2011 and $9.6 million, or 15% of revenues, in the prior quarter.

During the quarter, we added 18 employees to general and administrative, ending the quarter with 126 employees.

We expect general and administrative expenses will continue to increase as our business grows, but we expect these costs to decrease as a percent of revenue.

Our operating loss in the fourth quarter was $0.2 million, compared to an operating loss of $1.9 million in the fourth quarter of 2011 and an operating loss of $5.1 million in the prior quarter.

This equates to an operating margin of 0%, compared to negative 5% margin in the fourth quarter of 2011 and an operating margin of negative 8% in the prior quarter.

During the quarter, we reported a tax expense of $0.9 million.

Net loss for the fourth quarter was $0.6 million, or a net loss of $0 per basic and diluted share, compared to a net loss of $3.6 million, or a net loss of $0.17 per basic and diluted share, in the fourth quarter of 2011 and a net loss of $7.1 million, or a net loss of $0.06 per basic and diluted share, in the prior quarter.

Our net loss was driven by the significant investments we're making in our business.

We will continue to invest in the business to ensure we have the ability to scale and sustain growth.

This includes continued hiring and investments in systems, infrastructure, sales and marketing, and other resources.

During the fourth quarter, we generated $16.7 million in cash flows from operations.

We used approximately $9.9 million for capital expenditures, resulting in $6.8 million in free cash flows.

This compares to negative $1.9 million of free cash flow in the fourth quarter of 2011 and negative $2.9 million in the prior quarter.

We ended the quarter with approximately $314.7 million in cash and short-term investments and no debt.

Net proceeds of $50.6 million from our [follow-on] public offering which closed in November are included in our cash balance at the end of the quarter.

Our total GAAP deferred revenue balance of $170.4 million at the end of the fourth quarter, up 15% over the $147.9 million reported at the end of the prior quarter.

Our backlog was $379.0 million at the end of the fourth quarter, an 81% increase over the $209.9 million reported at the end of 2011.

As of the end of the year, backlog and deferred revenues combined totaled $549.4 million, up from the $314.5 million at December 31, 2011.

Let's turn to guidance for the first quarter of 2013 and full-year 2013.

Please note that our margin and EPS guidance is on a non-GAAP basis which excludes stock-based compensation expense and the related tax impact.

For the first quarter of 2013, we now expect total revenues between $81.5 million and $82.5 million, representing sequential growth between 8% and 10%.

Revenues are expected to consist of Subscription revenues between $69 million and $69.5 million and Professional Services and Other revenues between $12.5 million and $13 million.

We expect Subscription gross margins between 73% and 74%, up from 70% in the fourth quarter of 2012, primarily due to the completion of the migration from our previous generation datacenters.

We expect Professional Services and Other gross margin between 0% and 4%, and overall gross margins between 62% and 63%.

We expect an operating margin between negative 4% and negative 2% and a net loss per basic and diluted share between negative $0.05 and negative $0.04, with weighted average shares outstanding of approximately 129 million.

Our negative operating margin will be primarily driven by our continued rapid expansion, specifically our headcount growth.

We expect our employee count to increase by approximately 170 in the first quarter of 2013 and roughly 620 during the full year 2013.

Included in these headcount additions are sales and marketing employees of approximately 70 and 200 for the first quarter and 2013, respectively.

For the full year 2013, we expect revenues to fall within the range of $387 million to $392 million, representing year-over-year growth between 59% and 61%.

Our total annual revenues estimates consist of Subscription revenues between $325 million (sic) and $329 million and Professional Services and Other revenues between $60 million and $63 million.

We are not providing specific cash flow guidance at this time but want to call out select line items that we believe will influence cash flows in 2013.

First, in terms of cash flows from operations, we forecast deferred commissions to increase reflecting incremental annual contract value signed in 2013.

Second, we expect 2013 capital expenditures to be flat, to slightly up, on a year-over-year basis, driven in large part by ongoing investments in our cloud infrastructure and facilities build-outs to accommodate our rapidly growing organization.

Third, we anticipate some benefit from stock option exercises.

Prior to wrapping up the call, I want to make a few comments related to the share count.

At December 31, we had approximately 164 million diluted shares outstanding, consisting of approximately 126.4 million shares outstanding, 13.1 million vested and 23.0 million unvested options outstanding, and 1.5 million RSUs.

Our basic weighted average share outstanding for the quarter ended December 31, 2012, was approximately 124 million.

If we had operated a net profit in the fourth quarter, diluted weighted shares outstanding would have been approximately 146 million.

With that, Operator, you can now open up the line for questions.

(Operator Instructions) Adam Holt, Morgan Stanley.

You obviously had a very good quarter and maybe even saw an acceleration on the new billings side.

Could you just talk a little bit about what you saw that might be driving such an inflection relative to the new order business?

You know, Adam, we look at our business in terms of these three components that we always talk about -- new logos, renewals, and upsells.

And, our growth really comes from us hitting on all cylinders.

And, that's what we had this quarter.

We were really exceeding our own expectations on all of those.

New logos, those represent a very hefty part of our business, but it's really all three coming together that make the engine go.

If I could just ask a follow-up on that, about 9 to 12 months ago, you saw a real uptick in sales, capacity adds.

Where do you think you are in terms of getting your incremental capacity on line?

And, if you will, how much [final] capacity as you're looking into next year?

Well, as we said during the prepared comments, we're going to be doubling the adds in sales and marketing in 2013, from 2012.

So, if anything, you're going to see us really push the pedal down hard.

We think we have great opportunity.

We have matured enormously in terms of our field infrastructure, first line management.

We're expanding in other geographies.

So, we think the time is really right.

It took us quite a bit of time to really scale the organization and convert it to yield.

But, we're now in a place where we're more comfortable stepping harder on the pedal in terms of investment.

I will also add we are a lot more comfortable in terms of the ramp time that it's taking new reps when we add them on, now that we have more experience with this.

We're seeing in North America and EMEA, it's about a 9-month ramp for a rep, on average.

In new geographies that we're entering into, some of the Latin American countries and Asia, we're thinking it's going to be about a 15-month ramp.

So, a lot of the reps that we're adding in 2013 will really impact 2014 revenues more so than 2013.

I'd also like to correct -- I made an error in the total annual revenue estimate for our Subscription revenue.

I said $325 million to $329 million.

It's $327 million to $329 million.

Just my last question on that front, are you thinking about anything discreetly associated with platform in that number?

Or, is the platform rollout going to be gradual, and we should think about that as being upside?

For this year, it may be more of a driver in the out year?

It's really more of a driver in the out year, because we really have just begun separately pricing now that we've rolled out to the field our platform pricing this quarter.

And, because of the ratable recognition, it will be towards the end of the year that there'll be a number that we'll report.

But, it's really not going to be meaningful until 2014 and beyond.

Terrific.

Thank you.

Walter Pritchard, Citigroup.

Thanks for taking the question.

Hey, Mike, I'm wondering if you could talk a bit about on the Services side, that number is better this quarter than we expected.

And, I'm just wondering in terms of ramping partners, guys like KPMG and so forth, what do you see [netted out] and how should we expect that to trend over the course of 2013?

Well, we expect that we're going to have more partners signing on, especially some of the big system integrators.

[Be it] KPMGs and others of the world that ramp in quite quickly.

As well, there's a lot of small professional service organizations that are really dedicating their whole practice around ServiceNow we're seeing.

With that said, we think we can grow our Subscription revenues to the numbers that I gave and still create a healthy environment for our partners to grow, as well.

This is Frank, Walter.

As a follow-up, we peg the Services number at about 15% of revenue, as you'll see in the guidance, and that's where we think Services should be, so they will not start to crowd out our own ecosystems.

And, then, just to follow up on the sales capacity adds, I think, Mike, you delineated between maybe adding people in North America or existing territories versus those new territories?

I'm wondering should we think of the mix as pro-rata in terms of the adds?

Or, are you now at the point where you're saturated with territories in the existing areas and you're really pushing on the new countries at this point?

We're not saturated at all.

We're splitting territories.

We still have reps that are assigned to too many accounts and, as Frank said, one of our key drivers is really upsells into our existing accounts.

And, we need to split a lot of those territories so that we can better service our existing customers to further penetrate them.

Great.

Thanks a lot.

Phil Winslow, Credit Suisse.

Hi, guys.

This is Siti Panigrahi for Phil Winslow.

So, as you're looking into the international opportunity, just wondering if you could give us how you're planning to expand into the international market?

There is definitely a significant opportunity to expand.

This is Frank.

We're very much led by the footprint that we have in Global 2000 enterprises.

We have analyzed where they are in the world, where the concentrations are, and that's what's guiding our foray into markets that we're currently not in.

So, we've already gone into Brazil, to Mexico.

We're expanding further into southern Europe, in Spain and into Italy.

And, we're going to set up shop in southeast Asia.

We have a very strong business in Australia and New Zealand, and it's historically been great for us.

But, we've not been in southeast Asia itself.

So, these are all areas where we're going to have our own people on the ground to address the opportunity directly.

That's good.

One more question, if I may.

So, just wondering in terms of [newer] products, what you're seeing in terms of adoption rates on (inaudible) automation [distribution], and where you're seeing it going forward, what kind of traction?

So, the strongest adoption in our portfolio of apps, as you would expect, is in instant problem change configuration management.

Those are sort of the four horsemen, if you will, that make up the core drivetrain of what we do.

Now, around that, you see a lot of customers engaging in system development lifecycle, asset management, knowledge.

And, we are now making a lot of headway closer to the infrastructure.

Discovery, obviously, the technology that goes along with configuration management.

But, orchestration, what we used to refer to as [run book] automation is a very, very key technology to enable workflow automation, which is what all our customers, sooner or later, are going to get into, especially as we're going after the platform opportunities.

It's going to be very, very central to that positioning.

Great.

Thanks, Frank.

You're welcome.

Tom Ernst, Deutsche Bank.

Hi.

This is actually Jobin Mathew on behalf of Tom Ernst.

Thanks for taking my question.

So, the first question is, obviously, you guys have a large [greenfield] market out there, a lot of opportunity, but (inaudible).

Are you seeing any of your legacy competition step up in terms of tactics in new products or pricing changes?

Well, we don't see so much of that, in terms of what's actually happening in the field versus what happens in terms of marketing and just public communications.

I think our competitive reality really hasn't changed all that much.

We think it's probably BMC is the most assertive of that group of competitors, and we see less and less of HP and IBM and CA.

That said, most of the installations that we replace are still from BMC.

We also replace a very large segment of homegrown systems.

That's also a very big part of our business, and HP.

That group of three represents probably 70%, 75% of what we replace and transform.

And, has that percentage changed at all over the last couple of quarters?

Has it maintained much the same?

It has been pretty persistent, that pattern.

OK.

So, your backlog is up 89%.

Can you talk about the [moving parts] in the backlog?

Are you seeing more of platform in there?

Is it --?

Are you seeing more of the opportunity [within] the international markets?

Where should we think as the biggest changes in backlog?

What [are you recording in] billings throughout this year?

The backlog consists of our core business.

You've got to realize it's still very early innings for our business.

As we said, we have about 12%, 13% penetration within those enterprises.

We think we're less than a third penetrated.

So, all the backlog that you're seeing is very much the core business of ServiceNow.

It's not sitting in peripheral areas of our business at all.

It's very core, IT [SN] business that we're selling out there.

Thanks.

You're welcome.

Rob Owens, Pacific Crest.

Hi, guys.

Jesse Hulsing, in for Rob.

Frank, in your conversations with buyers, where do you feel that [service desk] currently sits from a budget priority perspective?

And, are you seeing in the plans, one- or two-year plans, from your customers it ticking up in priority?

And, what do you think would be driving that?

No, we are at a point where we're seeing more and more customers looking at this.

And, the reason is they're sitting on systems that are by now very, very old.

In the world of infrastructure, every three years, people seem to be sweeping the floor in datacenters and going to a new generation of product.

In the world of software, you're dealing with a much longer cycle.

It's sometimes a whole generation.

We're replacing systems that are now 15, 20, some 25 years old.

People have to move, and they're going to move.

Every single one of them is going to move.

The only question that remains is how soon are they going to do it?

Are they going to do it this week, next month, next year?

But, they're all going, because they're running out of time.

They're sitting on platforms that are literally several generations old now, and they're running out of software support, [hardware] support.

So, they've got to make a move.

These transitions are not easy for our customers.

Typically, they're heavily customized, and the people that built these systems typically are not around anymore.

They're highly integrated with other systems.

They're afraid to touch them, but they have to.

There's literally no choice.

So, we think that in the (inaudible) of time, the pressure is building to make these transitions.

Thanks.

And, looking at the platform side, given that you when you're building out your platform, the amount of domain-specific and process-specific knowledge that you have to invest into the platform versus your modules would seem to be less.

As the platform grows as a percentage of your business, do you view it as a much more profitable segment?

Or, how are you thinking about that split?

Well, I think the platform business will have a very similar profitability profile in terms of our core business.

It's a little bit inverted in terms of the pricing models.

You'll see far more end users than process users, but the price point is equally inverted.

So, it ends up being a very similar sized opportunity for us.

Now, in terms of what the platform represents, your question about domain expertise, that's really what other people bring to it.

That's not going to be ServiceNow.

We have our own applications portfolio that we market out there.

But, our customers, that's really what they do.

That's what the platform represents.

They're able to define their domain expertise around the processes that they're looking to automate to the platform.

And, also, third-party application developers, same thing.

These people possess domain expertise, and they apply that to our platform and thereby deliver solutions to the customer.

All right.

And, have you looked --?

Along those lines of the last part of your comment, have you looked at developing some sort of application store, or some way of distributing or promoting these third-party applications that, kind of, ease the selling process?

Yes, we actually are already developing a method for our customers to share content.

That's really phase one in that process.

Sharing content is really important, because it feeds the market, it teaches the market, and it just accelerates the process of people getting started on the platform and being productive on it.

So, sharing content is a strategy that we're in the middle of executing on.

Great.

Thanks, Frank.

Raimo Lenschow, Barclays.

This is actually Chris Hogan in for Raimo.

I just wanted to touch on, with the pace that you guys are going to be adding within sales and marketing next year, is there any concern around finding the right talent, given the acceleration there?

Or, do you feel comfortable with the quality of people that you've been hiring?

Well, we feel very good about the quality of people that we've been hiring, but when you're asking, is it a concern?

Yes, it's always a concern when you're hiring at the rate that we are.

Last thing we want to do is resort to substandard hiring.

The good news is the team that we have assembled is a very, very strong sales team, very well connected in the marketplace.

And, we don't really have to resort to recruiters that much, because these are people that know how to stand up a team and how to manage a team.

And, that's really why we've been able to grow at as fast as we have.

When you have good sales teams, they know how to scale themselves.

OK.

That makes sense.

And, then, just one quick follow-up.

With the renewal opportunity obviously continuing to grow, as you look back, that average contract length, that [pool is going into 2013], is there any change to managing that renewal process that needs to be made?

Obviously, the retention rate was really good this quarter, but any changes that need to be made there given that opportunity continues to grow?

Yes, we've actually made changes as of the first of the year to our sales model.

We now have a model where we have dedicated resources to existing accounts, especially our Global 2000 accounts, to be much more aggressive in terms of protecting and growing the franchise, versus a sales force that is mostly focused on new logos, which is what we historically have been.

So, we're more balanced between playing an offense and defense than we've been in prior years.

So, we've absolutely made that shift.

And, some much of our business is now caught up with existing customers that we felt we needed to do that.

Great.

Thanks a lot.

You're welcome.

Jason Maynard, Wells Fargo.

Hey, guys.

Good afternoon.

I just had a couple of questions about the new hiring plans, as well.

Was curious if the increase in headcount is going to be segmented at all by customer size?

Are you going to try and, if you will, grow your distribution footprint for some of those smaller customers?

How are you thinking about interplaying with channel-friendly or channel-focused sales reps?

And, is there any thought within that, if you will, (technical difficulty) given that you've obviously got this huge upsell opportunity with a lot of different apps?

So, lots of questions there but, just generally, how are you thinking about segmenting some of these hires into the various buckets they could potentially go?

Well, this is Frank.

I'll first take a crack at it.

There's no doubt that we have heavily gravitated towards what we refer to as Global 2000 accounts over the last two years, almost two years, that I've been here.

We feel that is an incredibly rich opportunity.

And, we've got to be able to plant the flag and get footprint in the accounts and then build them up from there.

So, we're heavily skewed and biased towards that opportunity.

We're not going to create dilution in our focus from that opportunity to go down market at this point in time.

And, I'm assuming that that focus and bias will persist for a considerable amount of time because, as you know, we have 265 out of 2000.

We've got a bit of work to do here before we fully address that opportunity.

How about on the channel side, Frank?

What are you thinking there in terms of supporting, standing up some of these big partners or even some of the small partners?

To go after the Global 2000 opportunities, you need partners at the very high end of the range.

And, you all know about KPMG.

Actually, at our sales kickoff, we had people like Accenture.

We have some of the other large ones -- Infosys, Cognizant, HCL -- that have been very instrumental in helping us accelerate sales cycles in that caliber of enterprise.

So, we're very much building up [channel] for the large enterprise.

That's what our focus is.

Obviously, we need some ecosystem as well to help with enablement and implementation.

But, it's also an access to huge opportunities.

We also recognize too, Jason, going to a lot of these international markets in South America and Japan, in particular, and some of these others, we have to have very strong partners that we work with, and we will make it so it's very friendly to those partners.

Great.

Cool.

Thank you very much.

You're welcome.

Abhey Lamba, Mizuho Securities.

Yes, thanks.

And, so, Frank, just a few other things [on the] competitive landscape for a minute.

Sometimes, when you do lose a transaction, is it primarily price?

Or, are there any other factors?

And, can you discuss what causes these customers to go the other way, if they do?

The number one loss for us is a do-nothing.

That's by far the number one thing.

It's not that somebody else beats us on a deal, but it's that the customer for a time being stays with the status quo.

And, the reason is, as I mentioned earlier, these are systems that have been around for a long time.

They're heavily customized, heavily integrated.

People are afraid to touch them.

It's a high profile transition.

They may have other priorities.

So, the answer may be, not now.

And, that's by far the most common situation that we would characterize as a loss.

Every once in a while, we get caught up in high profile politics.

That's becoming less an issue, because our company has really grown in stature and is able to withstand it a lot better than we could when we were a much younger company.

So, that's the issue, when a customer is not proceeding.

They're just hanging on to the current situation.

But, it's coming around again.

We've seen numerous, numerous times where customers have decided to proceed with a conversion or an upgrade, spent the money, spent the time and, then 18 months later, they're like -- well, we're at the end of our rope.

We need to now engage with you guys, even though we didn't do it 18 months ago.

We wish we had.

But, now, we're going to do it.

Sometimes, it just takes another year and a half of experiencing the status quo that just pushes them over the edge.

Got it.

And, Mike, can you --?

Clearly, you're doing a lot of investments this year, and that makes sense.

Can you talk a little bit about the margin for full year?

What type of profitabilities should we expect in 2013, if we should?

And, also, (inaudible) in your deferred revenue, you had pretty good maturation [effort] in the last couple of first quarters.

Should we expect similar type of returns as we go through the year?

Well, first of all, we're not expecting the first half of the year to be profitable, with all the adds that we're doing in the first half of the year.

Towards the end of the year, we are expecting on a non-GAAP basis to be at a profitable level, but we're not giving the actual guidance to that at this point in time.

And, we do expect that our deferred revenue will continue to grow quarter over quarter.

And, once again, we're not at this time giving those, other than the revenue guidance and the specific guidance we gave.

We're not giving anything beyond that right now.

Thanks.

Kirk Materne, Evercore Partners.

Thanks very much.

Frank, I might have missed this earlier, but have you guys announced the pricing for the platform as a stand-alone product yet?

Or, is that still yet to come this year?

That is still yet to come.

We have not announced that.

OK.

We are internally working through that.

But, we have not announced it externally.

OK.

I guess when you think about as that comes out, I guess is there any real change to sales quotas or anything like that?

Is that just another product in the salesperson's bag that they can sell, that they can get quota credit for?

Or, are there any, I guess, thoughts about how that --?

Does that, I guess, disrupt the process at all?

Or, is that just something that if the customer is interested in, it's a potential upsell for the salesperson?

It is a potential upsell, for those customers who have [not] licenses as part of their initial purchase or excluded it in their renewal process.

And, we definitely have a focus this year, both in terms of product as well as in our go-to-market, to make sure existing customers all have a very, very good grasp of what the platform can do for them.

But, the potential is how it works, so that we --.

Historically, this has all happened virally, without the selling, promoting, documenting, doing anything.

And, we're really moving away from letting nature take its course to basically driving adoption of the platform.

So, that is definitely a change for us, moving into 2013.

Great.

And, then, the last question for me.

Along the larger partner front, you've seen over the past couple of years that the bigger SIs or Accenture or KPMG are really -- have gone from being just sort of embracing cloud products like Workday and Salesforce to actually building practices around them and putting real significant numbers of people in terms of building up practices.

I guess, where do you guys think you are in that process?

I realize that they're helping you go to market, but are they at the process or at the point that where they're willing to start building centers of excellence around ServiceNow?

If they're not, I guess, do you think you're on the right, I guess, trend line to get there over the next 12 to 24 months?

No, we're definitely there.

That is absolutely happening.

And, these very large names that we mentioned, they're quite emphatic.

They're aggressive in hiring.

Sometimes, that actually causes issues, because they may end up hiring from our customers or other partners.

And, because the Company has been growing so fast, we're always at a deficit in terms of talent.

So, there's a ton of training going on, and our training revenue has been jumping year over year and quarter over quarter, because standing up the ecosystem and growing it to enable our growth is a big priority.

But, all these big SIs had to really have practices now around ServiceNow.

Great.

Thanks so much.

You're welcome.

Brent Thill, UBS.

Thanks.

Just on the sales build-out, you're obviously making an aggressive move and just from what you're seeing in your pipeline, can you just give us a perspective of what's changing, what the inflection point you're seeing to get that aggressive?

And, certainly, from a platform perspective, I think everyone is very excited about this.

Is this you're starting to see that inflection point, too, and adding ahead of that?

Or, is this more just on the core opportunity you see that these net adds are coming in for?

Well, this is Frank, again.

We're looking to add headcount at a rate that we can do it effectively and productively.

So, we'll stay away from the [hairy] adds where we'd be going too fast and it would be unproductive and we would have undue attrition.

So, that's sort of the threshold where you want to be careful that you don't go beyond that.

So, the numbers that we're talking about here are really dictated by what we think we can do effectively and productively.

Now, that said, the marketplace has really gotten to a point where, as I travel around and I meet with prospects, they all know us.

They've heard about us.

I can't tell you how many people have said to me -- geez, you guys seem to be the product everybody else is going to.

So, there's this awareness out there that people should be talking to us, looking at what we can do for them.

And, that simply wasn't there a year ago, or even six months ago.

So, I really feel that we're hitting a lot of critical mass in the marketplace where it's been easier for us to get a seat at the table and have the conversation.

And, we think we obviously need to have the people to be able to do that.

OK.

And, just in terms of the sales structure, Frank, in Q1 a number of companies take that opportunity to re-huddle.

And, I guess from your perspective, is there any major changes that you're expecting this year, in terms of how you're going to market, whether it's by vertical, whether it's --?

Or, is it just kind of the same playbook that you've been using the last -- since you and Mike came in?

Yes, so I referenced earlier a fairly substantial change in our sales model, where we now have dedicated resources on existing accounts, which we historically have not had.

Our sales organization was very much focused on new logos almost exclusively, and they sort of treated existing accounts as something that they also have to do.

We've really evolved, because our existing customer business is not just big in terms of renewals, but it's big in terms of the upsell opportunity.

And, it's a different talent and salesperson profile that we need to have on existing accounts, much more of a farmer profile versus hunter profile.

So, we made that split.

So, we're allocating resources now along those two lines very deliberately.

So, that's a pretty good evolution of our model from last year.

Geographically, we are a geographically laid out organization.

We do have organization split between global accounts and what we call territory managers, people that really have a geographic definition as opposed to a set of accounts behind their names.

Great.

Thanks.

Nice job on the quarter.

Thank you.

There are no further questions at this time.

Thank you for your participation in today's conference.

This concludes the presentation.

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Good day.