ServiceNow Inc (NOW) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2013 ServiceNow earnings conference call.

My name is Allyson, 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 towards 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, sir.

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

We would like to apologize for the late start.

Management has been on the line waiting for the bridge to open as well.

So we will get right to it now.

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 first quarter of 2013.

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 facts may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities 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 effects of competition.

Words such as may, will, expects, intends, plans, beliefs, 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; 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 enhancements.

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 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's CEO Frank Slootman.

Thanks, Rob, good afternoon and thank you for joining us on today's call.

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

Revenues grew year-on-year 81% to $86 million.

Both billings and deferred revenue were marked by strong growth, with total billings of $110 million up 13% sequentially and 88% year-on-year, and a deferred revenue balance of $195 million, up 14% sequentially and 68% year on year.

Even as we surpassed $282 million of trailing 12 months revenue, this marks the 27th consecutive quarter of 80%-plus year-on-year revenue growth.

Our billings performance in the first quarter of 2013 was the result of strong contribution from each of our three growth engines -- new customer acquisition, contract renewals and upsells.

The topline results were the benefit from a number of initiatives.

First, our sales organization is now more balanced in terms of existing account focused and new logo acquisition.

Second, our sales effort is benefiting from sustained investment in both deeper and broader service areas, both foreign and domestic.

Third, we increasingly benefited from the presence of global system integrators in our ecosystem.

And, finally, our expanding professional services organization has been a key enabler of our growth.

In terms of new customer wins, we added 128 net new customers in the first quarter, ending the quarter with a total of 1640 customers.

We continue to focus on the Global 2000 as defined by Forbes Magazine, adding 17 new Global 2000 enterprises to our customer roster during the quarter.

As result we are now counting 282 of the Global 2000 as ServiceNow customers, representing 14% penetration.

Global 2000 accounts added in the quarter include Yamana Gold, W.W. Grainger, Transocean, and Dollar General.

The results reflect the Company's focus on time to value.

According to one large financial services organization based in the Midwest, who went live with ServiceNow in the quarter, with ServiceNow we accomplished in seven weeks what took four years with HP.

In the quarter our average annual revenue per customer was $198,000, up from $164,000 in the first quarter of 2012, a 21% increase year-on-year.

This increase was driven primarily by user growth within our installed base.

Renewals and upsells are key indicators of ServiceNow increasing adoption in the enterprise.

Our renewal rate during the quarter was 96%.

We also saw significant contributions from upsells during the quarter, representing one-third of our annual contract value signed during the quarter.

One upsell example is a Global 2000 diversified manufacturing company based in the Northeast which purchased 200 user licenses in the third quarter of 2012, and returned this quarter to purchase an additional 1300 user licenses to facilitate replacement of a number of legacy applications with ServiceNow as IT single system of record.

We're replacing CA with Incident, [COL] with Change and BMC Remedy with Asset Management, as this customer takes the first step to standardize and consolidate IT globally.

We continue to make good strides on the international front.

An example is a first quarter when, with Capita Secure Information Solutions, a subsidiary of the largest professional support service provider in the UK, with over 45,000 employees serving the blue light public-service forces such as the police, firefighters, ambulance police and prison management, which each require their own secure instant response system and database.

Capita SIS was running a legacy instant response system that could not scale past 600,000 incidents per year and elected to adopt ServiceNow.

We are seeing more evidence of global system integration partners pulling us into new engagements.

For example, Chicago-based Grainger is North America's leading broadline supplier of maintenance and repair products and has been working with our partner KPMG on high-level business process transformation.

The IT organization was working on an unsupported version of a legacy vendor's product and the KPMG team introduced ServiceNow to the key decision-makers, despite the fact that they were already down the path with one of our competitors.

ServiceNow prevailed, and Grainger will be implementing Incident, Problem, Change, and Knowledge Management in its Phase I deployment.

We grew our professional services revenue 17% quarter-on-quarter and achieved 8% non-GAAP gross margins.

In the quarter we completed our largest training project to date at Carlson Wagonlit travel.

Carlson has been a ServiceNow customer since 2009 and recently added 560 new users as they replaced their legacy system with ServiceNow.

As part of this go-live, we and several SI partners trained 1200 users on Incident, Change and Configuration Management in over 50 virtual and live sessions conducted around the world in three different languages.

Our business is driven by the opportunity to fundamentally transform the enterprise IT discipline.

While IT has historically been the most text tech savvy of enterprise functions, it also has trailed in terms of management sophistication.

This is no longer tolerable with the pressure on IT budgets, and escalating demand for system support.

The ServiceNow platform is widely regarded by our enterprise IT customers as their ERP, a single system of record that massively consolidates, globalizes, and standardizes the IT processes and workflows.

IT staffs typically represents 5% to 10% of the enterprise work force worldwide, but our customers routinely aim for 100% of the IT staff to be enabled on our platform.

Everybody in IT is an actor and a participant in the workflow of IT.

The second vector of transformation is what we call the consumerization of the service experience.

Why should enterprise users be denied the online service model as popularized by for some time now by banks, retailers and other online service providers?

Younger generations joining the workforce today expect a modern service experience that is online, structured and intuitive, and includes things such as search, chat and community.

ServiceNow enables IT to deliver itself as such a service.

The third level of transformation is the automation of workflow in IT as well as throughout the enterprise.

Animation is applicable to activities that are repeatable and can be standardized.

The result is efficiency, transparency and process execution at the speed of light.

IT organizations tend to be overstaffed and under automated.

The ServiceNow platform is the enabler of workflow automation in the enterprise.

ServiceNow adoption and the IT organization typically opens doors to other enterprise service domains, either to modernize legacy applications or to develop structured workflows for activities not previously automated.

For example, a large retail customer deployed ServiceNow to help support the rebalancing of their supply chain between suppliers, distribution centers, and stores.

It does not get much more mission-critical or for a retailer to ensure the right product at the right time and place.

We continued to see encouraging growth in platform adoption.

One example, a new Global 2000 customer that is a leading services firm providing advice and solutions in risk, strategy and human capital with over 50,000 employees worldwide, was looking for a case management application to front-end their existing PeopleSoft system.

The primary users of this ServiceNow implementation will be employees within the North American HR department with a plan to expand globally.

We competed with HR solution vendors and won a contract valued in excess of $500,000 based on the ease of configuration.

In another example an existing Global 2000 customer in the pharmaceutical industry increased its commitment to ServiceNow in the first quarter by adding over 50,000 end-user seats across the enterprise.

This customer is using ServiceNow to support an employee-facing learning and certification system containing training curriculum, scheduling and certification tracking.

This is typical of how we see IT organizations extending ServiceNow into the enterprise and driving service automation as a management discipline.

In summary, we believe we have a remarkable opportunity in front of us to continue to drive new customer adoption of our IT application portfolio, what we call the ERP for IT, and expansion of our management platform into other service domains in the enterprise.

Before closing, please note our upcoming annual users' conference, Knowledge13 in Las Vegas May 12 through the 16th.

We expect 4000 IT professionals and ServiceNow experts to convene for five days to share IT service automation strategies and to learn how other IT professionals achieve the results in the cloud.

On May 13, as part of the event, we will be holding an analyst day for professional financial analysts, for which many of you on the call today are already registered.

We have a great lineup of speakers, including members of our management team that are not regular attendees at investor events, and customers who will discuss their experience with ServiceNow.

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 we will review our first quarter financial results and discuss the financial guidance for the second quarter and full year 2013.

Before we begin, we would like to point out that all financial figures we discuss today are non-GAAP unless we 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 us take you through some of the numbers.

Total revenues for the quarter were $85.9 million, representing 81% year-over-year growth and 14% sequential growth over fourth-quarter revenues of $75.2 million.

Revenue was above our outlook primarily due to strength in new business and upsell bookings during the quarter, and an acceleration of our services business.

Subscription revenues for the quarter were $71.6 million, representing 81% 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 96% in the current quarter.

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

Our average new business contract length was 32 months and our average renewal contract length was 25 months; compares to an average of 33 months and 24 months on a trailing four-quarter basis respectively.

Professional Services and other revenues were $14.4 million for the quarter, growing 82% year-over-year and 17% on a sequential basis.

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 $60.1 million in North America, $20.3 million in EMEA and $5.5 million in the rest of the world, representing 70% and 24% and 6% of total revenues respectively.

By comparison, in the first quarter of 2012 we recorded revenues of $33.9 million in North America, $11.9 million in EMEA, and $1.6 million in the rest of the world representing 72%, 25% and 3% of total revenues respectively.

Our total billings were $110.3 million for the first quarter compared to $58.6 million in the first quarter 2012 and $97.6 million in the prior quarter, representing 88% year-over-year growth and 13% sequential growth.

Additionally, approximately 7% of our billings in this quarter were for periods greater than one year, compared to 22% in the first quarter of 2012 and 10% in the prior quarter.

In the future we expect 5% to 10% of our billings will be for periods greater than one year.

One year is our typical billing term.

Before we turn to expenses, I would like to point out that we ended the quarter with 1269 employees, an increase of 541 employees for the same period in the prior year and increase of 192 employees from the prior quarter.

Please note that we recorded a pretax amount of $12.0 million related to stock-based compensation expense.

This impacted our earnings per share in the first quarter by a tax-adjusted amount of $0.09 per diluted and basic share.

Our subscription gross profit was $55 million, representing a gross margin of 77% compared to 73% in the same period last year and 70% in the prior quarter.

During the quarter we added 16 net new employees to subscription cost of sales.

This number is inclusive of 15 employees transferred out of subscription cost of sales as part of an internal reorganization, ending the quarter with 234 employees.

In the first quarter we stopped incurring costs related to the migration of customers to our new generation of data centers.

This migration spanned the majority of 2012, concluding in the fourth quarter.

The costs associated with the migration included double rent as we wound down our contractual obligations and accelerated depreciation for certain assets.

In addition to the cost savings from the migrations, subscription cost of sales decreased by approximately $800,000 due to the previously mentioned employee transfers, the majority of which went to sales and marketing.

Our professional services and other gross profit was $1.2 million, representing a positive gross margin of 8% compared to negative 27% in the first quarter of 2012 and positive 5% in the prior quarter.

During the quarter we added 21 net new employees to Professional Services and other cost of sales.

This number is inclusive of 11 employees transferred to sales and marketing who will now be responsible for assisting in the Professional Services sales cycle, ending the quarter with 204 employees.

The sequential improvement in Professional Services and other gross margin was driven by improvements in billable utilization and average hourly rates, in addition to approximately $600,000 reduction in cost associated with the previously mentioned transfers.

Our total gross profit was $56.2 million, representing a gross margin of 65% compared to 57% in the prior quarter -- or prior year, sorry -- and 60% in the prior quarter.

Moving to operating expenses for the first quarter, sales and marketing expenses were $34.2 million or 40% of revenues, compared to $17.8 million or 38% of revenues in the first quarter of 2012, and $26.1 million or 35% of revenues in the prior quarter.

In the first quarter we incurred $1.3 million in expenses associated with our annual sales kickoff event, which was previously held in July.

During the quarter we added 102 employees to sales and marketing, ending the quarter with 452 employees.

It is important to note that in the second quarter of 2013, we expect to incur expenses in sales and marketing of approximately $8 million to $9 million related to our Knowledge conference next month, compared to $3.6 million incurred for the event in the second quarter of 2012 due to a significant increase in the size of the event.

Research and development expenses were $12.9 million or 15% of revenues, compared to $6.1 million or 13% of revenues in the first quarter of 2012, and $10.9 million or 14% of revenues in the prior quarter.

During the quarter we added 31 employees to research and development, ending the quarter with 231 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, platform and cloud development.

General and administrative expenses were $9.9 million or 12% of revenues compared to $5.4 million or 11% of revenues in the first quarter of 2012 and $8.1 million or 11% of revenues in the prior quarter.

During the quarter we added 22 employees to general and administrative, ending the quarter with 148 employees.

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

Our operating loss in the first quarter was $0.9 million compared to an operating loss of $2.4 million in the first quarter of 2012, and an operating loss of $0.2 million in the prior quarter.

This equates to a negative operating margin of 1% compared to a negative 5% margin in the first quarter of 2012 and an operating margin of 0% in the prior quarter.

During the quarter we reported a non-GAAP tax expense of $1.1 million.

Net loss for the first quarter was $1.9 million or a net loss of $0.01 per basic and diluted share, compared to a net loss of $2.5 million or a net loss of $0.11 per basic and diluted share in the first quarter of 2012, and a net loss of $0.6 million or a net loss of $0.00 per basic and diluted share in the prior quarter.

Our basic weighted average shares outstanding for the quarter were approximately 130 million.

If we had operated at a net profit in the quarter our diluted weighted shares outstanding would have been approximately 155 million.

Fully diluted shares at the end of the quarter were approximately 167 million.

Our net loss was driven by significant investments we are making in our business.

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

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

During the first quarter we generated $15 million in cash flows from operations.

We used approximately $10.4 million for capital expenditures, resulting in $4.6 million in free cash flow.

This compares to $7.5 million of free cash flow in the first quarter of 2012 and $6.8 million in the prior quarter.

We ended the quarter with $338.9 million in cash and short-term investments and no debt, an increase of $242 million (sic) over the prior quarter -- sorry, $24.2 million over the prior quarter.

Our total GAAP deferred revenue balance was $194.8 million at the end of the first quarter, up 14% over the $170.4 million reported at the end of the prior quarter.

Let's turn to guidance for the second quarter 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 income tax impact.

For the second quarter 2013, we expect total revenues between $94 million and $96 million, representing year-over-year growth between 66% and 69%.

Revenues are expected to consist of subscription revenues between $77 million and $78 million, and professional services and other revenues between $17 million and $18 million.

We expect subscription gross margins between 74% and 75%, down from 77% in the first quarter 2013, primarily due to additional investments in our data centers and Cloud Infrastructure personnel.

We expect professional services and other gross margin between 23% and 25% and overall gross margin between 64% and 65%.

Please note we expect to recognize approximately $4 million in professional services and other revenue related to our Knowledge event, with approximately $8 million to $9 million of expenses recorded in sales and marketing.

We expect an operating margin between negative 6% and negative 5%, and a net loss per basic and diluted share between negative $0.06 and negative $0.04 with weighted average shares outstanding of approximately 135 million.

Our negative operating margin will be primarily driven by our continued rapid expansion, specifically our headcount growth, and also the impact of Knowledge on sales and marketing in the second quarter.

We expect our employee count to increase by over 200 employees in the second quarter of 2013 and approximately 740 employees for the full year 2013.

Included in these headcount additions are sales and marketing employees of approximately 65 and 250 for the second quarter and 2013 respectively.

For the full year 2013 we are raising our outlook and expect revenues to fall within the range of $394 million to $398 million, representing year-over-year growth between 62% and 63%.

Our total annual revenues estimate consists of subscription revenues between $332 million and $334 million, and professional services and other revenues between $62 million and $64 million.

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

(Operator Instructions).

Tom Ernst, Deutsche Bank.

So you mentioned a couple of interesting customer anecdotes on the platform business.

I wanted to ask you -- I am sure you are not disclosing the revenue level there, but can you tell us about the nature of the platform business as you're seeing it come together this year?

Are they similar sized deals to the application product?

Are you finding they're typically upsells or new customers?

What is the makeup of what your pipeline looks like in platform, please?

Tom, this is Frank.

What is interesting about our platform business is that historically this has always been an important parcel of our -- the sale of our IT applications portfolio.

What we are starting to see more of is standalone platform deals.

And this is a direct result of our go to market cadence being much more deliberate in terms of positioning and messaging around platform.

It is still relatively early to characterize the makeup of the business.

It is all over the map.

They are certainly very substantive opportunities.

And I mentioned one during the prepared remarks.

But we signaled in prior quarters that it is going to be towards the latter end of this year before we're going to be more systemic in how we talked about our platform business and how we report on it.

Great, and maybe just one follow-up; your perspective on the market opportunity for you in platform vis-a-vis the opportunity for building out more applications.

As -- with your early experience here, how large an opportunity do you think the platform is relative to continuing to build out more applications in the IT arena?

It is hard to be very authoritative on it.

But we have historically said that we think that the platform business is at least as large as the IT business is.

But as we get further into this, many of our enterprise customers are really beginning to understand and grasp the nature of the opportunity.

And the reason is we don't just go in and automate or re-implement legacy applications that have previously been built, whatever it is -- Microsoft Access or SharePoint or Lotus Notes.

They are also starting to tackle processes that have never been automated before that are really running through e-mail and spreadsheets and so on.

So as a result of that, we think the platform opportunity is still unfolding right in front of us and potentially can be much larger than what is currently even visible to us.

All right, thanks again.

Raimo Lenschow, Barclays.

Thanks for taking my question and congrats on the great start to the year.

Looking at the other conference calls today, that is really nice surprise.

The quick question on -- related to the platform as well.

You talked a little bit about you guys working outside of the core domain that we previously talked about and you mentioned the HR example.

Can you talk a little bit about how we have to think about you addressing it?

Is this more opportunistic as customers are evolving there, or is there something that we could think about a proper strategy there?

Thank you.

This is Frank again.

This has been true historically.

Our business -- we always land in the enterprise most of the time, not always, but most of the time on the IT applications portfolio.

And as everybody knows we typically replace either home-grown or other legacy systems that have been in place for 10, 15 years or even longer.

Once IT organizations, A, get well established in terms of rolling out the new IT systems, and become familiar with what the capabilities are our platform are, this is typically when they start branching out into other service domains.

And other service domains are the other corporate support functions.

So human resources, very typical; legal case management, very typical; travel, facilities and so on.

We call those the other service domains.

But it usually doesn't take long before we start to bleed into other service areas that can be either customer-facing or more line of business oriented that support core product operations.

I mentioned the supply chain example.

Anything that is request/response, workflow oriented, typically is a very good fit, especially when IT is involved in undertaking those kinds of projects.

The question for me was more like is that something that you can do?

Or is it just a natural evolution to -- that you just rollout alongside IT and then we just have to wait and see until it gets rolled out further?

Well, no.

Historically it was very much a viral thing that happened with or without us.

With the start of this year, now first of all, we have rebalanced our sales organization that we now have dedicated people on existing accounts that get paid on this class of software and application development.

In terms of our whole go to market approach, we are now very specific in terms of demonstrating what our platform is capable of doing.

Not just in terms of modifying and configuring the existing application set, but also how you stand on brand-new applications.

So our approach to the market is much more deliberate and specific in terms of showing people, A, what the platform can do, and then B, how this actually gets done.

So we are driving this effort now, as opposed to letting it happen naturally, which has historically been the way this business has unfolded for us.

Perfect, thank you.

Rob Owens, Pacific Crest Securities.

Mike, maybe you can help us understand duration a little bit.

You gave some comments around average contract length, but I guess what I'm looking for is maybe a little more help around book to bill.

I think you gave the metric that 7% of billings were for periods greater than one year.

And just as we are trending long-term deferred, as we are thinking about billings moving forward, does this number here represent [a loan] we should base off of this, given you're in the middle of that 5% to 10% range?

Or just how should we think about that moving forward?

Good question.

As I told most of the analysts before we had changed our comp plan for our sales force, where in the past we had heavily incented them, pre- being public, to get as many years' billings in advance as possible.

And salespeople were paid quite handsomely on that.

Given we are now public Company and cash flow not as a concern with multiple year billings in advance, we change our comp plan.

And we are seeing the results of that right now, where most of our billings, you should assume, are going to be one year in advance with only a small portion being multiple years.

And it is that multiple year that goes into the long-term deferred revenue movement.

And, hence, why we say roughly 5% to 10% is what we forecast of our billings will be multiple years in advance.

And, unfortunately, that is a number that we generally don't find out about until the very end when the deal is coming in.

So it is hard to forecast, the multiple year component.

Does not change, though, the average contract length or anything, which is what we focus more on.

And, then, second, as we look at the FISMA, I guess you have a bunch of FISMA ATO GSA from the press release, but just the government opportunity, is that in your existing data centers?

Does that require a new data center being built?

And just where are you in terms of federal adoption right now?

So -- a couple of things.

First of all, we have a separate pair of data centers for the federal business.

We have that for some time.

That is not new.

FISMA data centers -- they have very different access controls than our regular commercial data centers, and they are specifically set up and run for this class of business.

We started well over a year ago in really establishing and building out our federal team, and that organization has done very well in is sort of growing in leaps and bounds.

Obviously, in the last quarter, just about every vendor was affected by sequestration.

It created a huge amount of inertia in the business.

We think that is pretty much cleared, and for the rest of the year I think we are going to have a lot more clarity on the federal business.

But everybody knows that federal business can easily represent 10% of our total revenue or better.

It is a very, very good business for us to be in.

It is hard to get in, because of the requirements in terms of compliance and security -- in security, which is why the authority to operate for us is a very significant milestone.

There aren't that many vendors in our business that have acquired that ability.

And you just cannot get to do business with the federal government until you have those kind of credentials.

Great, thanks, Frank.

Walter Pritchard, Citigroup.

Frank, I am wondering if you could talk about just on the deals you have been seeing the last couple of quarters, any metrics on what percentage of the users you are having signed are for non-Incident and Problem kind of helpdesk type functionality.

And how much of the user account are you seeing in areas like Asset and Change and Config, and some of the areas that you have introduced more recently, say over the last 12 to 24 months?

Walter, it is pretty unusual these days to find customers that are approaching our business really as a helpdesk system.

It does happen at the low end of the spectrum, and that is where a lot of this or the new competitors are coming from, that are principally trying to replace legacy helpdesk management systems with newer hosted versions.

Our classic customer has a very different perspective.

They are not trying to reinvent the helpdesk; they are trying to retire it.

They want to get to a single system of record.

And to them, the evolution of helpdesk is really the creation of the ITO framework where you have to find processes around Incident Management, Problem Management, Change Management, Configuration Management and it is almost difficult to actually even recognize the old mode of helpdesk management in those kinds of applications.

So, with our customers, we typically don't talk about helpdesk management anymore.

What Incident Management really represents is the initiation of a structured workflow, either related to a problem or to a request or some other event.

Right?

So the whole notion of helpdesk and has really a bit of a remnant of the 1990s timeframe.

So it is really not part of our nomenclature the way we go to market with ServiceNow.

And then, Mike, just on the hiring, it looks like your margins going to come in a lower then we were modeling for Q2.

I guess it seems like you are executing well in terms of getting productivity of the people you're adding.

And I'm wondering if you can talk about is relative to the plans you laid out on the Q4 call around increasing your hiring.

How have you fine-tuned or changed those plans now with another quarter under your belt?

First of all, we were very pleased with our hiring last quarter.

The 192 that we hired in the quarter was actually well above the financial plan that I had looking at historical hiring.

So we feel very good about our hiring right now.

Hence, in our original plan we were looking at more like 170 employees that we would be actually able to onboard.

Now we think we can do 200 in Q2.

And that is the big driver.

So it is simply adding people earlier that drove the lower (multiple speakers) margins in Q2.

Correct.

Got it, thank you very much.

Jennifer Lowe, Morgan Stanley.

Maybe just to follow up on Walter's question, it looks like you're pacing ahead on the sales and marketing headcount in particular.

I guess there are two questions on that.

One is how much of that is purely related to the reallocation of headcount from some other cost of goods groups into sales and marketing?

And then related to that, were those people who had been performing similar sales type roles in those -- you had mentioned some of the more people doing services, sales.

Are they doing similar roles?

It is just the reallocation?

Or are they being -- getting a whole new job and really contributing overall to the sales capacity that you have?

The people who were transferred from the subscription support line down into sales and marketing are performing a new role.

They are now performing a client account manager role and I believe that was 11 people we transferred down -- or sorry, 15 people that we transferred down out of subscription into predominantly sales and marketing.

There were some of them that actually went into engineering that were -- that used to support perform a support function that went into engineering.

And then on the professional services side, the 11 people that we transferred down are performing a new role.

In the past they performed a bit of a mixed role between pre-sales and actually doing implementations at customers.

We did a whole reorganization of our go to market from a sales standpoint January 1. We talked a little bit about that at the call then.

And those 11 people now who were in our professional service organization are only focused on the pre-sales activities of professional services.

Hence they are in sales and marketing now.

Great.

And just one more question on sales.

Now that you are moving to a calendar year-end in your comp plans versus the mid-year-end previously, and is being the first year that they have had that, is there anything we should be thinking about in terms of your ability to sign new business in Q2, just so we should be more careful about -- for modeling out deferreds and billings, and potentially having maybe a tougher comp there because of the comp year-end?

Historically June has been an extremely good quarter, because of that year-end.

But if you look at most tech companies Q4 by far is going to be your strongest quarter, and we saw that this past quarter.

We are still expecting a strong quarter in Q2.

But we expect going forward with the federal business in September Q2 to Q3 are pretty much going to be flat quarters from a bookings perspective, but still a very strong quarter relative to Q1.

Great, thank you.

Brent Thill, UBS.

Mike, I was just curious if you could just address what you are seeing in the overall environment.

There has been a wave of cold air, if you will, that has come over the software industry, including some of the subscription-based models.

And you obviously bucked the trend in Q1.

But can you just give us your sense of -- are you seeing any change in customer behavior, in terms of what you saw in the linearity of the quarter on new signings, or any other detail that you're seeing that would be helpful?

Thanks.

I will answer the first part then I will turn it over -- the last part of your question -- and turn it over.

We have -- in the last three quarters we pretty much had identical linearity between the first two months of the quarter and the third month, which we are very pleased to see.

And so there has been no change in terms of the amount of business we booked in the third month of the quarter.

And that has been consistent for three quarters.

And then I will turn it over to Frank, who is in front of the customers a lot more than I am.

I was on the road a lot in Q1, and I have seen a ton of people.

I definitely notice, as did many other vendors that have reported, that the general sentiment is a little bit more cautious than what we saw last year.

Now, I cannot determine whether that is cyclical or just seasonal.

Q1 for all companies of our type is just a difficult quarter, because you tend to really take down your mature pipeline and rebuilding it in a short period of time is always difficult.

So if you try to push business along, and you detect that you're doing -- you're pushing the customer harder than they want to get pushed, it may come across as a waning sentiment.

But the reality it might just be normal friction and we are just trying to push it harder than it wants to be pushed.

So that is why I said it might just be seasonal.

It could be cyclical.

And I think we need to have at least another quarter under our belt before we can really be more intelligent about characterizing it.

Okay.

Frank, just to follow on that, you have been doing this quite some time, and from your perspective it feels a little more seasonal.

And it feels like -- is there anything in terms of what you're seeing for Q2 or Q3 that would lead you to believe that it could be more back-end loaded this year?

No, not really.

We are much more governed by secular trends that are unique and specific to our business than anything relating to the macro.

So we are feeling really good about where we are in our business.

As a matter of fact, we are feeling better about it than we ever have.

And the reason is the Company is so much higher profile than it was a year ago.

Our ability to engage in conversation at a high level is so much better than it has ever been.

We have really opened up a huge gap to the rest of the competition and people that are vying for this kind of business.

And it is really benefiting us in the whole go to market cadence.

So I am not down at all on the rest of the year in any way, shape or form.

Okay, good to see.

Thanks.

Tim Klasell, Northland Securities.

Good afternoon and congrats on the quarter.

Just a quick question on the competition.

Clearly we know your traditional competitors.

But as you do expand into the new use cases, you did mention that you ran into some of the HR tech companies, at least was on one deal.

Do you expect that trend to continue, and how should we think about that going forward?

This is Frank again.

Yes, we absolutely expect to see and contest against nontraditional competitors.

And we have already mentioned some, and you mentioned some.

Depending on what class of applications we are getting into, we can see a completely different set of competitors.

And it is really a reordering and realignment and a re-platforming that is going on in the industry.

Where people may have historically worked with very narrow point solution vendors relative to specific requirements, they may all of a sudden look at this, hey, this can actually be addressed on a platform basis rather than using some [hardcore] application from a specific vendor.

So that dynamic is shaking up in the marketplace.

And this is not the first time this has happened in our industry.

You can go all the way back to the early 1990s when there were a lot of one-off tools out there.

And when Windows came out with Visual Basic and things like that, they completely realigned the marketplace.

We are seeing flavors of that dynamic playing out.

So I think you will see us on the platform side go up against a whole variety of different players that are out there, usually legacy customers, companies, people who have been around for a long time.

Okay, great.

And then just a follow on for Mike, the professional services gross margin came in better than we were or at least what I was looking for.

Is that a reflection of just better efficiency as you gain scale?

Or have you been tweaking your prices up or did a price increase this quarter?

Part of our whole strategy to ultimately get our professional services and other gross margins to the 13% to 15% has been to shift more of our business from fixed-price to time and material.

And we are seeing the impact of that now.

And it is still a gradual process, but also, we hired a lot of people on the management side in our professional service organization to build it for scale.

And as we add more people to actually do the implementations, you get better scale out of your management layer within your professional service organization.

So I do expect that for this quarter, it was really part of it is the timing of deals that are more profitable in terms of the hourly rate we are able to get.

As well, the utilization was very strong this quarter.

And there is always a [mix at recorder] of how much work we do ourselves versus we subcontract out to some of our professional service partners, where we just don't have the bandwidth to do all the work.

That has an impact as well on our margins.

And, as I said, I do expect our gross margins for professional services, when you back out the impact of the Knowledge revenue, that will actually come down slightly.

It is going to be 0% to 4% in Q2, standalone without the Knowledge revenue being in there.

Okay, great.

Thank you.

That is helpful.

Jason Maynard, Wells Fargo.

I just had one question, maybe a multipart, on working with partners.

And, Frank, maybe get a little bit color from what you are seeing in terms of the breadth and depth of the relationships and how that is actually translating into consumption of multiple products, partners starting to work with the platform, and then driving that into some of your big accounts?

Thanks.

Very broad question, but there are different classes of partners that we work with.

By far the largest class of partners that is very important in our ecosystems are the implementation partners, not just because they enable our business and they are able to implement for the customers that we sell, but, also, because they typically have relationships in their particular vertical or their particular locale that they can leverage very, very quickly to the benefit of our business.

We have seen a lot of partners come over from other legacy vendors and deciding they don't want to play over there anymore.

And they would rather be in our business, because of the growth and the fresh dynamic that we have around it.

We have been very deliberate in creating a really good atmosphere to develop an ecosystem.

So, one of the reasons why our professional services rates are kept up is we really want to have a pricing umbrella that other companies can operate underneath with lower tariff services.

And they appreciate that.

So that we don't crowd out our own ecosystem and that we don't compete with our partners as much as we can help that.

It does happen from time to time.

What you also see is we are developing -- and those of you who are coming to Knowledge, you will probably be amazed to see how many partners will actually be at the conference.

It is a very, very large number of companies.

There's lots of software companies now that are building tools and add-on capabilities that work in conjunction with the ServiceNow platform and are really selling.

We have become market because there is now 1600, 1700 customers out there that now is market for people that are working either on our platform or with our platform.

A lot of those are technology partners.

There is tons of people that do analytics and reporting type of applications, people that do release management.

So all these different product niches that are developing around the platform are making this a very dynamic sort of a rich place, and a lot of options for our customers to build out their use of what we do.

Phil Winslow, Credit Suisse.

Just had a question about win rates.

Obviously, you continue to have phenomenal growth.

Have you seen any change in the win rates versus any of your particular competitors?

And, also, some of your competitors have talked about their SaaS.

They are really just hosted client/server offerings.

Are you seeing any change or customer interest in those at all?

Thanks.

It is Frank again.

We always like to say that our number one class of competition we have is inertia.

In other words, customers that are just not ready or able to engage at a particular point in time, just because they're all overwhelmed with other issues or they don't have budget right now, or whatever else is going on.

It is a do-nothing, kick the can down the road type of a thing.

Now, in the end everybody is going to move, because time is our friend, because every day what they have is getting older and more unmanageable.

But it is just, very, very common.

The systems that we replace are 10 or 15 years old.

There is a reason why they're that old, because they're that difficult to -- not so much difficult to pullout but difficult to modernize.

And all the planning and project management, it is a considerable undertaking.

And that is typically the friction that we encounter out there.

Our win rates, when we come up against direct competition and the customer actually is going to make a move and actually embark on the journey, is extraordinarily high.

It is very, very unusual for us to not get the win on product.

So I'm feeling good about it, but the nature our business -- and this is oftentimes what our customers refer to as their ERP, is because it has a lot of the characteristics of the ERP.

It is a very serious undertaking.

These are also systems -- when you replace them it is like changing the engines on a plane that is in the air.

It is a delicate undertaking.

It takes a lot of planning, and it is something that people really have to be ready for to undertake.

They have got a lot of other things going on in their lives.

They may want to say, well, I'm going to take another six months or nine months or 12 months before I'm ready to do this.

So, we -- obviously customers talk to us.

Then they back off for a period time, come back and then finally they will bite the bullet and they embark on the journey.

And then that goes on and on and on.

This is a very dynamic business.

Our customers are always evolving their applications, expanding their use, developing new things.

This is not a one-time, I build it and then I run it type of business at all.

That is the way that in the past these systems were being run.

It is not the way it is with ServiceNow.

Thanks, guys.

Kirk Materne, Evercore Partners.

I guess, Frank, just a quick question on the platform.

Sorry if this was answered -- or asked and answered already -- but I was just curious what you guys are thinking in terms of setting up templates, in terms of different types of business processes that might make sense, that are sort of best practices that you all have seen, versus leaving that open for partners to build upon themselves -- what salesforce has done with their own AppExchange.

How are you guys going back and forth to try to make sure you get people on the platform, having success, versus also leaving some opportunity for app partners to show up?

This is Frank.

Yes, we have left that core capability of building templates of apps very much to our partners at this juncture.

Doesn't mean that we will always have that kind of a posture.

We have focused much more on enabling the platform to have better and better capabilities to reduce the friction that customers might encounter in terms of using it for application development.

So we are investing huge amount in mobile support, scalability, the approachability of the development platform itself, to really allow people to have a better and better experience in terms of standing up applications for the first time in our platform and grow their involvement with us that way, rather than having the application readymade to be put at them.

We do see a lot of our partners moving down this path, and we think that is a very positive thing.

The whole notion of ecosystem is very important.

We start doing everything, that creates a lot of friction and angst in our ecosystem and we don't want that.

We really want to create ample room for our partners to do what they want to do and bring their bit of value added to our marketplace.

And, again, coming to Knowledge in Vegas next month is an incredible display of what all those capabilities are.

Thanks.

Abhey Lamba, Mizuho Securities.

Frank, I just want to dig a little bit deeper into your platform offering.

Can you talk a little bit about the sweet spot of the types of applications where you see the most success?

And who are the key competitors that you expect to see the most in that space?

The most important thing for people to realize is that we are not a generic application development environment.

Or we are not suitable as a generic application development environment you can build any type of app on.

The reason that our platform is a highly abstracted and so approachable by people without programming skills is because it is designed to build a certain class of applications.

And we typically refer to that class of apps as service oriented apps.

And these are apps that typically initiate structured workflow, structured workflow in response to requests.

It could be a request for a product, request for a service, request for information, all kinds of different things, right?

This is much more common in the world than most people realize, because most business processes in the enterprise are actually executed through e-mail with a little bit of Excel thrown in.

So we have this incredible opportunity to start chipping away at a lot of business process that have never been automated before in the enterprise, and we are just ideally suitable to stand up applications.

We typically teach our solution consultants, our pre-sales people to really show our customers how to build applications in minutes, not in days or weeks, but really minutes and hours.

So it is an order of magnitude different, the speed at which we can stand up fully operable database, record keeping applications.

That is really our sweet spot.

Now, when you start peeling away the onion, instant management systems exist in IT, but they exist in all kinds of line of businesses.

They exist in other service domains.

They exist in relationships to customers, to partners, to investors.

That is really is what has led to the proliferation and the viral adoption of ServiceNow, because people are starting to understand that a lot of the work that previously was done on e-mail and on the phone, and in spreadsheets and one-off local databases actually now capture-able in full-blown ERP industrial grade systems.

And that is what IT organizations like about ServiceNow.

Thanks, and competitors-wise in that space, who do you think -- who do you expect to see the most in that space?

There really is no pure play competitor the way I just characterized it.

And we are the only one.

What you see out there are platforms like Microsoft with Azure.

But that is really .NET hosted, which is very much a programming platform evolution of the former Visual Basic, Visual Studio.

And you have got VMWare really for the Java crowd.

You've got force.com also with proprietary procedural line, which is also really for a programming audience.

We really exist for the highest level audience and also the largest audience.

These are the people that have good grasp of relational concepts, people that can use Excel pretty well or Microsoft Access, but do not have programming skills.

And in that class of platform, ServiceNow is really the only thing that is really out there with an industrial grade type of system.

Thanks.

Brad Sills, Maxim Group.

Just a quick question on where you are seeing the most traction cross-selling.

You mentioned good strength there cross-selling to more users.

I assume customers are starting with Incident and Problem for support personnel, and then expanding into operations with asset developers for Configuration, Release Management.

Maybe just a little bit of color on where you are seeing the most strength on -- just within IT, the viral adoption that you're talking about of more users.

This is Frank again.

You pretty much characterized it the right way.

It is most common for people to go after the core drivetrain of IT workflow.

And that really is the Incident, Problem, Change, Config.

Those are the four Horsemen of IT service management.

And those four go together.

Incident has the highest penetration in our customer base.

Config or the CMDB and related discovery technologies is a close second.

Request management, really turning the IT organization into a self-service delivery vehicle, those things are typically top priority.

After that, we see people going to SLDC.

You mentioned ACV; that is another big one -- compliance, governance, applications.

And then what we are starting to see a lot of as well is people going after automation, really looking for workflows that are being conducted right now in a predominantly manual manner that are automatable.

Right?

It's all about disintermediating workflows where, right now, lots of different people are inserted and touching different parts of the infrastructure and applications to figure out how software can take that over.

So those are typical progressions.

It also happens that we start somewhere else.

I mentioned earlier we're starting to do standalone platform deals now whereas -- in other words that are completely outside the realm of IT, whereas previously that was always downstream business.

And that is really a function of our go to market cadence, now really focusing on opportunities like that were previously we would just go after the IT opportunity and then let the other opportunity unfold from there.

Got it, thanks, Frank.

I have no further questions for you.

So I would now like to turn the call back over to management for closing remarks.

Thanks for joining us on the call today.

This concludes our call, and we look forward to our next update in July following the close of our second quarter.

Ladies and gentlemen, thank you for your participation and today's conference.

This concludes the presentation.

You may now disconnect and good day.