ServiceNow Inc (NOW) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to today's Q2 2013 ServiceNow earnings conference call.

This call is being hosted by Mr. Robert Specker, General Counsel.

My name is Shalane and I will be your event manager today.

During the presentation your lines will remain on listening only.

(Operator Instructions).

And now I would like to hand the call over to Mr. Robert Specker.

Please go ahead.

Good afternoon.

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 second 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 fact may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21-E 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 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 Committee 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.

2Q was another strong quarter for us with significant growth on all fronts.

Revenues grew year on year 80% to $102.2 million.

Op billings and deferred revenue were marked by strong growth with total billings of $117.5 million, up 6% sequentially and 63% year on year and deferred revenue balance of $202 million, up 8% sequentially and 60% year on year.

In the quarter, our average annual revenue per customer was $209,000, up from $173,000 in the second quarter of 2012, a 21% increase year on year.

This increase is primarily driven by user growth within our customer base.

One of the highlights of our quarter was our annual users' conference, Knowledge13.

Almost 4,000 attendees converged on Las Vegas for a few days to learn, share and network.

The event more than doubled its attendance year on year and its growth has certainly kept pace with the Company.

Knowledge is a convention where customers and prospects come to learn and share their experiences with ServiceNow.

93% of breakout sessions during the four-day event were delivered by our customers and the program included the CIO track with 70 senior IT executives in attendance.

Some of the largest companies in the world joined us on the keynote stage including AIG, Coca-Cola, Bristol-Myers Squibb, GE Energy, Eli Lilly, Intel, the New York Stock Exchange and the premier conference sponsor, KPMG.

The attendance numbers are now such that we view it as an industry event more so than just an event or conference.

For those of you planning to attend next year, Knowledge14 will take place April 27 through May 1, 2014, at the Moscone Center in San Francisco.

In May, we announced our latest software release delivering new capabilities to our customers.

The four key areas to focus were as follows.

First the new App Creator enables custom application development on the ServiceNow platform without the need for any programming skills.

Customers have long been able to create applications on our platform, but App Creator makes it even more intuitive.

This is especially important as companies use ServiceNow to (technical difficulty) [augment] workflows outside of IT.

And second, we have introduced a new tablet user experience optimized for a mobile touch base interface with no additional administrative demands.

Everything created in ServiceNow is instantly mobile.

Third, we introduced a new Cloud Provisioning application to manage the complete lifecycle of cloud resources from initial request to retirement.

And fourth, we introduced enhanced governance functionality in our CMDB with a new data certification capability giving organizations auditable control of the service assets under management.

All of these product additions help expand the role that ServiceNow plays in the enterprise.

And finally we acquired a performance analytics company called Mirror42 which enhances all ServiceNow applications with rich analytical capabilities.

Starting in August we will be offering performance analytics as a separate SKU.

We believe this new business intelligence functionality is especially important for executive users of our platform.

Early indications suggest strong interest in our customer base.

As we grow our business, we are deepening and broadening our position in core markets and expanding into new geographic regions.

We landed our first new customer with our partner, Hitachi Solutions, in Japan and opened our regional headquarters in Singapore.

In Brazil we won B2W, a leading online retailer in Brazil.

We also began to build out of a Brazilian cloud infrastructure, expected to go online later this year.

Our recent investments in the state and local vertical continued to fuel additional growth.

For example the Commonwealth of Pennsylvania chose ServiceNow to enable service delivery across all state agencies.

In terms of new customer wins, we added 138 net new customers ending the quarter with a total of 1,778 customers.

We are not counting 335 of the Global 2000 of ServiceNow customers, representing 17% penetration.

Global 2000 accounts added include Zürich Insurance Group, Seagate Technology, The Nielsen Company, Clorox and [Deloitte's].

During the quarter we recorded four new customer deals, each with an annual subscription contract value in excess of $1 million, a record for ServiceNow.

We view these larger transactions as further indication of ServiceNow's expansion beyond traditional ITSM.

Manulife Financial, the third-largest insurer in North America and number 156 in the Global 2000 lists [just] ServiceNow to enable more than 2,000 process users and 30,000 end-users consolidating 30 separate tools into ServiceNow's single system of record.

Statoil, a Norwegian enterprise and one of the world's leading energy producers with approximately 45,000 employees and currently number 38 on the Global 2000 list, is replacing its legacy systems with ServiceNow.

Another success story is dairy giant Land O Lakes, which received a 2013 CIO 100 award for its use of ServiceNow to manage more than 1,000 applications with a single system of record.

The resulting transparency sharpened IT's priorities along with the IT organization to track service performance by business and application type and to reduce failure rates and resolution times by 90%.

We saw increased utilization of every ServiceNow application as measured on the so-called same-store basis compared to last quarter.

But the biggest jumps in the use of service catalog in Knowledge Management which often involves use outside the traditional ITSM service model.

We are also seeing higher rates of adoption of our project and portfolio management product.

Platform utilization continues to grow.

Across the ServiceNow install base 76% now have deployed custom applications and on average built 3.9 applications compared to 64% and 3.7 apps in the prior quarter.

Market surveys further highlight the momentum behind ServiceNow platform adoption.

KPMG surveyed 275 ServiceNow customers at our recent Knowledge13 conference and concluded that 87% already used the ServiceNow platform for non-ITSM applications.

Morgan Stanley's recent quarterly survey of CIOs showed that 12% of CIOs surveyed are planning to use the ServiceNow platform for custom application development by the end of calendar year 2014 versus 1% who reported using it today.

The survey populations represented a broad cross-section of industry CIOs not limited to ServiceNow customers.

We continue to see adoption of the ServiceNow platform for service domains outside of enterprise IT.

For example, European Railway with over 200,000 end-users was looking to consolidate its purchasing procurement and other organizational processes.

ServiceNow was awarded the business due to our ability to tightly link the online services experience with the underlying IT backbone.

Another example, Service Stream, a trailing utility and networking provider, selected ServiceNow for service automation.

Service Stream's CIO was quoted as saying, we looked at ServiceNow and concluded it wasn't just an IT service management tool; it was a business automation platform that we could also leverage for IT service management.

Service Stream now supports resource allocation for 4,000 technicians and installers with our service catalog asset management and other applications delivered via tablet for easy to use in the field.

And another example MetroPCS, an operator of one of the largest telecommunication networks in the United States, selected ServiceNow to consolidate workflows from Microsoft Access, SharePoint and Exchange.

The implemented incident changed service catalog requests in CMBD as well as 15 custom applications to improve governance and to automate workflows across HR, engineering, network operations, legal and other service domains.

Human resources is one service model that we are often seeing customers develop in ServiceNow.

In many instances the IT service model is actually repurposed and adapted for HR.

Employee onboarding and outboarding is another long-standing use case for ServiceNow due to extensive process integration between HR, IT facilities and other service domains.

One example is a large Global 2000 investment bank which rebuilt its global HR request system on ServiceNow.

Our platform enabled HR case management that displaced existing line of business systems and provided self-service case management and workforce administration recruiting employee outboarding, leave of absence, management/employer relations and records management.

This type of adoption is common as a follow-on to ITSM deployments.

But we also see customers tackling the HR service model first.

For example, Envision Healthcare, a leading provider of emergency medical services in the US, decided to go with ServiceNow to support their 17,000 employees with HR case management.

To win this, ServiceNow beat a specialized provider of HR case management software as well as a prominent platform as a service vendor.

In summary, we believe there is a remarkable opportunity in enterprise software not limited to refreshing legacy systems, but also in automating business processes, never captured in systems before.

At the core, ServiceNow offers what we call Service Relationship Management or SRM -- the ability to automate and manage service relationships across the enterprise.

In general, all service relationships involve requesters of a service and providers of those services.

These services include a defined request for product, service, information, the change or assistance with the problems.

In enterprise IT the service model is quite mature but often lacking or nonexistent in other service domains.

Initial deployments of ServiceNow tend to focus on replacing legacy systems with a modern service model.

However, because the ServiceNow platform was built to be highly configurable, approachable and extensible, applying it to other service relationships has become a widely adopted strategy in our customer base.

Enterprises have come to understand that service relationships need to be managed.

This is quite evident in the realm of outsourcing because of their contracts, [SLAs] and compliance requirements that need to be managed and providers must be held to account.

While having defined structured service relationships with outsourcers has gained acceptance, it is equally relevant to internally source services such as procurement, legal aid, charter, travel facilities and so on.

Our customers are realizing from their IT experience that ServiceNow is ideally suited as a platform for implementing these service relationships, allowing the IT service model to be easily adapted for other service domains inside and outside the enterprise.

We believe this is a large opportunity which today seems obscured by legacy products such as Lotus Notes and the Microsoft personal productivity suite of Exchange, Excel, SharePoint and Project.

These products have done much over the past 20 years to boost personal productivity, but we believe are now holding organizations back from managing global enterprise-grade service relationships.

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 second-quarter financial results and discuss our financial guidance for the third quarter and full-year 2013.

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

You can find the 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 second quarter were $102.2 million representing 80% year over year growth and 19% sequential growth over the first quarter revenues of $85.9 million.

Subscription revenues for the quarter were $80.4 million representing 72% year over year growth and 12% sequential growth.

Subscription revenue growth was driven by strong bookings in prior quarters coupled with a renewal rate of 94.2% in the current quarter.

Our average new business contract length was 33 months and our average renewal contract length was 26 months, compared to an average of 32 and 24 months on a trailing four-quarter basis, respectively.

Professional services and other revenues were $21.8 million for the quarter drawing 119% year over year and 52% 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.

In the second quarter it also includes $5 million and registration and sponsorship revenue from Knowledge, our annual users' conference.

This compares to $2 million in revenue from Knowledge in the second quarter of 2012.

Total revenues based on geography were $71.8 million in North America, $24.5 million in EMEA and $5.9 million in the rest of the world, representing 70%, 24% and 6% of total revenues respectively.

By comparison, in the second quarter of 2012, we recorded revenues of $40.7 million in North America, $14.0 million in EMEA and $2.1 million in the rest of the world, representing 72%, 25% and 3% total revenues, respectively.

Our total billings were $117.5 million in the second quarter compared to $72.1 million in the second-quarter 2012 and $110.3 million in the prior quarter, representing 63% year-over-year growth and 6% sequential growth.

Additionally, approximately 12% of our billings in the quarter were for periods greater than one year compared to 16% in the second quarter of 2012 and 7% 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 turn.

Before we turn to expenses, I would like to point out that we ended the quarter with 1,443 employees, an increase of 561 employees from the same period in the prior year and an increase of 174 employees from the prior quarter.

Please note that we recorded a pretax amount of $14.8 million related to stock-based compensation expense.

This impacted our earnings per share in the second quarter by a tax-adjusted amount of $0.10 per diluted and basic share.

Our subscription gross profit was $62.2 million, representing a gross margin of 77% compared to 71% in the same period last year and 77% in the prior quarter.

During the quarter, we added 32 employees to subscription cost of sales ending the quarter with 266 employees.

Our professional services and other gross profit was $7.1 million, representing a positive gross margin of 33% compared to a positive 16% in the second quarter of 2012.

It is important to note that professional services and other revenues includes $5 million from our Knowledge event with all of the expenses related to the event running through sales and marketing, providing a boost to gross margins that we will see once a year in the quarter we hold the event.

Excluding Knowledge, our non-GAAP professional services margins were 13% compared to 8% in the prior quarter.

During the quarter, we added 35 employees to professional services and other cost of sales ending the quarter with 239 employees.

Our total gross profit was $69.3 million, representing a gross margin of 68% compared to 61% in the prior year and 65% in the prior quarter.

Excluding the $5 million in revenue from our Knowledge event, non-GAAP gross margin was 66%.

Moving to operating expenses for the second quarter.

Sales and marketing expenses were $47.5 million or 46% of revenues compared to $24.4 million or 43% of revenues in the second quarter of 2012 and $34.2 million or 40% of revenues in the prior quarter.

Sales and marketing expenses also included $8.3 million related to our Knowledge event, an expense we expect to incur only in the second quarter of each year.

Excluding Knowledge sales and marketing expenses were 38% of revenues.

During the quarter, we added 60 employees to sales and marketing, ending the quarter with 512 employees.

Research and development expenses were $14.2 million or 14% of revenues compared to $7 million or 12% of revenues in the second quarter of 2012 and $12.9 million or 15% of revenues in the prior quarter.

During the quarter, we added 20 employees to research and development, ending the quarter with 251 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 $12.1 million or 12% of revenues, compared to $5.4 million or 9% of revenues in the second quarter of 2012, and $9.9 million or 12% of revenues in the prior quarter.

Second-quarter 2013 expenses include $577,000 of acquisition-related expenses associated with the purchase of Mirror42, which closed on July 1, 2013.

During the quarter, we added 27 employees to general and administrative ending the quarter with 175 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 second quarter was $4.5 million compared to an operating loss of $1.9 million in the second quarter of 2012, and an operating loss of $0.9 million in the prior quarter.

This equates to a negative operating margin of 4% compared to a negative 3% margin in the second quarter of 2012, and an operating margin of negative 1% in the prior quarter.

During the quarter we reported a non-GAAP tax expense of $2 million.

Net loss for the second quarter was $7.8 million or a net loss of $0.06 per basic and diluted share compared to a net loss of $1.6 million or a net loss of $0.06 per basic and diluted share in the second quarter of 2012 and a net loss of $1.9 million or a net loss of $0.01 per basic and diluted share in the prior quarter.

Our basic weighted average shares outstanding for the quarter were approximately [134.5 million].

If we had operated at a net profit in the second quarter, diluted weighted shares outstanding would have been approximately [156.5 million].

Fully diluted shares at the end of the quarter were approximately [167.9 million].

Our net loss was driven by significant investments we are 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 sales and marketing, infrastructure, systems, and other resources.

During the second quarter we generated $9.7 million in cash flows from operations.

We used $11.8 million from cash -- for capital expenditures resulting in a negative $2.1 million of free cash flow.

This compares to negative $4.7 million of free cash flow in the second quarter of 2012 and positive $4.6 million in the prior quarter.

We ended the quarter with $346.1 million in cash, short-term and long-term investments and no debt, an increase of $7.3 million over the prior quarter.

In July we paid $13.3 million in cash to acquire Mirror42.

We are currently working through the purchase accounting and will provide more information when we report our third-quarter results.

Our total GAAP deferred revenue balance was $210 million at the end of the second quarter, up 8% over the $194.8 million reported at the end of the prior quarter.

Before turning to guidance, I want to provide some insight into our change in Global 2000 customer account.

At the end of the second quarter, we were counting 335 of the Global 2000 as customers based on the 2013 list published by Forbes in April.

During the quarter, we added 24 new Global 2000 customers.

In addition to these adds, we increased our Global 2000 listing by 29 customers, due to an internal review of our customer listing during which we discovered customers that are subsidiaries of Global 2000 Enterprises which were not previously counted as Global 2000 and adjustments related to changes in the recently published Global 2000 listing.

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

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

We completed the acquisition of Mirror42 on July 1, 2013, and incorporated the expected revenues and operating expenses associated with the acquisition in our guidance.

The accounting treatment for the acquisition is pending completion and therefore we have excluded the related amortization of acquired intangible assets, acquisition-related expenses and income tax expense from our guidance for the third quarter.

In the future, we will include these acquisition-related expenses in our non-GAAP results.

For the third-quarter 2013, we expect total revenues between $104 million and $106 million, representing year-over-year growth between 62% and 65%.

Revenues are expected to consist of subscription revenues between $88 million and $89 million and professional services and other revenues between $16 million and $17 million.

We expect subscription gross margin of approximately 75%, professional services and other gross margins between 7% and 9%, and overall gross margins of approximately 65%.

We expect an operating margin between negative 3% and negative 2% and a net loss per basic and diluted share between negative $0.03 and negative $0.02 with weighted average shares outstanding of approximately 137.5 million.

For the full year 2013, we are raising our outlook and expect revenues to land within the range of $406 million to $410 million representing year-over-year growth between 67% and 68%.

Our total annual revenues estimate consists of subscription revenues between $337 million and $339 million, and professional services and other revenues between $69 million and $71 million.

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

(Operator Instructions).

Walter Pritchard.

Two questions here.

One on the analytics side.

Could you talk about how we should think about how much you could charge for such a solution there and how broadly you think something like that could be adopted within your install base?

And then secondarily, you guys had talked about front end loading the hiring this year and you have obviously had two good quarters here and it sounds like the pipeline is good.

And I am wondering how you are thinking about your hiring into the second half given what you have seen here now for two quarters in 2013.

Well, Mirror42, the way we are going to charge for it is as an uplift to our standard process user license fee.

We haven't determined the exact amount yet.

We are not quite ready to talk about that.

But just view it as an uplift on the core pricing that we have.

We do believe that the applicability of Mirror42 is extremely broad in our customer base.

What Mirror42 really does is really adds time dimensionality to our reporting.

It does key performance indicators predictive analysis especially for the executive audiences in our customer base.

We think this is going to be incredibly important functionality.

We have been wanting to have this for some time.

This really allows us to move up the timetable on having it.

On hiring, we are going to continue to hire according to our plan as we did during the first half.

I would say that we are incrementally more confident about our ability to hire and convert by hiring to yield as we have established in our plan.

So it is all systems go in the second half.

Should we assume then that you would be -- I know last year you did slow down that hiring and you said all along that we shouldn't expect you to slow it down in the same way, but you still would moderate especially your sales hiring in the second half.

Should we now expect that you don't moderate your sales hiring or maybe give us some color on how should we think about versus what you were telling us three and six months ago there?

No, it is exactly what I said.

You should not expect us to moderate.

We are going to hire according to plan as I said.

You know, we are incrementally more confident about our ability to convert our hiring to yield which is something that held us back a year ago and gave us a little bit of pause.

And we are not going to do that again.

So, Walter, our plan, request for hires are north of 200 employees this quarter.

We have never had a quarter that we have hired 200 employees.

But we did just add 174 and we feel pretty confident we will most likely add close to 200 employees this quarter with a focus on sales and marketing and R&D.

Great.

Thanks for that clarification.

And that is reflected in the numbers by the way.

Got it.

Jennifer Lowe.

I wanted to drill into the platform business a bit and it is great to hear some of these encouraging data points around the uptick there.

The question has been through the ability to monetize some of those interest levels.

So as you continue to see some of this traction in new customers, are you starting to get more comfort that customers are willing to pay for that functionality and getting more confidence around the revenue models there?

Customers have been paying for platform all along.

A process user is a process user is a process user whether they are a process user in our standard application portfolio or they are in custom applications on the platform side.

So they have always been paying.

What we haven't been able to do historically is quantify the contribution of that part of our business.

So we have been charging for it all along and that has been a normal accepted practice.

But obviously we have gotten more aggressive in terms of singling that out from the core license.

So that people are not just paying for incremental users, but also are paying for the incremental functionality.

And that is the part that obviously is new and different.

And we feel that our new customers are taking this in stride quite well.

The conversation is obviously harder when you are dealing with existing customers who feel they were grandfathered into a licensing model that was there from the early days.

But that is a smaller set than the set going forward obviously.

One more quick one for me.

Looking at Q2 results versus the guidance that we had coming in, obviously the revenue result was incredibly strong versus the guidance.

But it looks like EPS, it was a little closer to the low end of the guidance there.

Can you comment a little bit about spending in the quarter and where maybe the spending came in a little bit higher than expected?

Was that purely related to Knowledge and the acquisition or were there other expenses in the quarter that you hadn't anticipated initially as well?

The biggest impact on the operating margin line, we are fine on the EPS, I agree we did come in at the low end of the guidance.

That was really driven by the unexpected strength in the US dollar creating a $1 million FX loss, that flow through the other income expense line.

You'll see as well the non-GAAP numbers with the income taxes because we don't get the benefit of the stock options flowing through.

There is an artificially high non-cash tax number flowing through higher than what anyone expected, the P&L, but on the operating expenses we were below on those.

Thank you.

Raimo Lenschow.

Frank, can you talk a little bit about the Cloud Provisioning that you launched or started to talk about in the business this quarter?

And how deep do you want to go there and how do you see the competitive field around that one?

Yes, Cloud Provisioning is one of the applications that we built on our orchestration platform.

We view our orchestration platform sort of in a similar vein as we have our core ServiceNow platform in the sense that we feel we have to build applications to really show customers really what the full scope and power is of that platform.

What Cloud Provisioning really allows our customers to do is really provide an end to end service experience where end-users can request virtual machines to be provisioned either through a VMware environment or in Amazon Web Services environment and have that fully manage through a ServiceNow service experience.

Are we trying to go compete against pure play vendors in that space?

Not really.

That would really be distracting for us.

It is really for customers that have really built their service experience around ServiceNow and want to have that functionality to be part of that.

And that works really well.

And it is also a priming the pump thing for us where we can really show people what the possibilities are with the orchestration platform.

They can see how it is built and obviously be inspired to embark on other types of automation projects.

Perfect.

And one quick one on if you talk about Service Relationship Management as kind of almost like a new category and you mentioned a few very interesting HR wins, could we think about in the long term that you almost need specialized sales forces as you are going through the different submarkets there?

Or how do you want to tackle that?

I don't think that is on the horizon at this point.

One thing to always remember about ServiceNow, we typically end up in other service domains through the enterprise IT organization.

Whatever we do outside of IT typically, not always, but typically we get there through the IT organization itself as being the implements provider to other service areas within the enterprise.

I think it will be long days off before we really broaden our go to market cadence beyond the IT organizations.

It has been working exceedingly well for us that we get to other dimensions of the enterprise through IT.

So we want to strengthen that ability rather than water that down and let people go to different parts of the organization.

We don't really know how to speak HR all that well, but we do talk to our key people very well.

Perfect.

Thank you.

Michael Turits.

Obviously, a really strong quarter and pretty much lower space.

Can you talk a little bit about seasonality on billings?

This quarter you had the mid-single-digit growth in June -- in the June quarter.

As we go into the third quarter any thoughts on how that billing seasonality should play out?

Should that be mid-single digits or even -- I mean it's been double digits but I am wondering what kind of seasonality that we might see.

Sure in general, in our business Q4 is such a strong quarter and we have so many of our contracts that start January 1, you always see a big uptick in billings in Q1, which is contrary to the actual bookings.

But from a billings perspective Q1 is always strong.

Going into Q3 and Q2 they are pretty much flat from a bookings perspective with one of those.

So you would expect booking or billings are going to be pretty much flat this quarter.

And then you see an uptick in Q4.

And once again you will see another uptick in Q1 2014.

So flat pretty much year over year.

I'm sorry, quarter over quarter.

Quarter over quarter from 2 to 3.

And one clarification.

You guys were talking about headcount before.

You had actually talked on the last call about getting to doing around 740 headcount adds total and 250 in sales and marketing.

I just want to clarify, so, we are still on track to that?

Yes.

Great.

Perfect.

Thanks a lot.

Brent Thill.

Frank, you mentioned that there are a number of large transactions this quarter.

I was curious if you could just drill in a little bit more and talk maybe about how the platforms played into that.

And did you have any outside transactions in that over 1 million count?

We are -- in general, the deals are getting larger.

We have also deals that were pushing the $1 million mark fairly closer to that that we didn't count.

So in general the deals are getting larger.

One of the key drivers for deals getting larger is that the populations that we license are going much beyond the typical ITSM crowd.

We typically said the ITSM audience if you will is a multiple [IT] historical helpdesk audiences.

But we now really go for that whole notion of ERP for IT whether we are really licensing everybody in IT and not that subset that typically is associated with the ITSM model.

This is really why you see deals getting larger because everybody in IT is getting involved with ServiceNow on our platform.

It becomes their system of record.

All the work of IT gets managed through ServiceNow.

So there's more and more people involved.

Actors and participants in the workflow in ServiceNow.

That is why that is.

Jason Maynard.

I just had a couple of questions.

First with all the stuff around BMC, does that cause customers or have you seen any customer behavior modified given basically what is happening there?

Do they accelerate?

Do they change planning assumptions and how does that benefit you?

And the second part on the SRM opportunity, how much of that right now is customers effectively being smart enough to pull you through into these new service opportunities where they are building these apps in various domains versus, say, the reps at ServiceNow are articulating, hey, I think, you guys, we got this project that you are trying to solve over there, use our stuff to go take care of that.

Yes.

I think the BMC dynamic is a little bit overblown.

I don't think that we could -- no one attributes a whole lot to BMC being public or private.

I think as time goes on I think that BMC situation becomes more untenable because the software is aging more and more and more, and is becoming less more as acceptable to the contemporary audiences that we address.

But we don't really have seen a real step function in dynamic from BMC a quarter ago versus what it is now.

And so we don't want to pin too much on that.

In terms of SRM, you are actually correct.

We wish we could take credit for it and our brilliant salespeople driving all these initiatives and sometimes that is true.

But on the whole, our customers have really recognized that the IT service model can be repurposed for these other service domains and typically that happens.

Because once they roll out an IT service management system, other areas very quickly recognize, hey, we could use that exact same Incident Problem and change cadence for our service area.

And of course the IT organizations are really happy to oblige and help them implement a service model that is exactly analogous to what they have done on the IT side.

So it is really interesting because in some of these other service domains, there are specialized vendors that try and do that sort of thing.

But the IT organization is now really driving a much more standard service model really across the enterprise to all these different service areas.

And some of our customers, and this is why we always encourage people to attend our Knowledge conference, you get a real sense of how broad and deep and widespread the adoption of these service models really is.

Maybe a follow-up on that.

How much have you seen from your SI partners expanding into some of these new service domains?

Have they started to grok that opportunity yet or are they still doing maybe call it the more traditional limitations?

Thanks.

Yes, we have some specialized partners that really focus on taking ServiceNow into these new service models.

But I would say on the whole, especially our larger SI partners, very much focused on IT transformation.

That is really the conversation that they are driving with our customers and their customers.

Nandan Amladi.

Two questions, both related to Mirror42.

The guide -- the guidance is [losing more than it would meet] in the quarter.

Should there soon be additional revenues are coming from Mirror42?

And then the second part of the question is they are reported to have a pretty large number of partners and both in profit and several other products.

So where do you see that going?

With regards to the revenue raise, the revenue attributable for the second half of the year associated with Mirror42 is going to -- is not going to mean material at all right now.

It is more the expenses that we are picking up associated with the people that we assumed and that acquisition and the incremental investments we are going to be making into the Mirror42 product is what is incorporated into the model.

What was the second question again?

The second question was the partnerships that Mirror42 had with a whole bunch of other products or interworking with other products with the EMCCA, salesforce.com, various other product platforms.

Do you plan to continue those partnerships or should we expect some sort of a change?

Yes.

What we are going to do is we are going to continue to honor our customer commitments for one year associated with those, and then going forward it is going to be purely just the Mirror42 with the ServiceNow platform.

We are not making any additional investments into any of those other third-party partners they had.

Thank you.

We have already notified most of those customers already.

Rob Owens.

You mentioned in the prepared remarks 17% penetrated into the Global 2000.

And, Frank, you talked about these new populations that you are licensing.

Can you give us a sense within those large customers just how penetrated you are?

Yes, we have historically said that conservatively speaking we are less than half penetrated if not below even 30% or 40%.

So there's a long way for us to go and usurp the opportunity in the large enterprises.

And the irony is we upped account of Global 2000 Enterprises and we didn't even realize that these customers actually belong to a much larger entity.

So that shows you how much incremental upside there still is in those opportunities.

We have continually come to realize is that we just not related to some of the other service relationships that we have been talking about, even directly in the IT sphere, we have just so much room still to -- so much runway and so much room to expand our business in these large accounts.

And that is one of the reasons, by the way, why we changed our sales model or modified our sales model going into January is to have a much more directed focus in our sales organization to be able to pursue that business.

Because we were historically strictly a new account selling organization.

And we have come to realize that we need to have much more balance to make sure that we don't underinvest in these opportunities.

And then circling around the platform, realizing it is still early, but customers that you are actually charging, can you give us any kind of sense as to what kind of lift or how it is augmenting [HCD]?

Yes, as we said before we are going to be reporting that in Q4 when we report our Q4 results.

I will just say we are starting to see more and more deals and we are being a lot more diligent as we go into renewal opportunities with customers with bifurcating the piece associated with platform and the traditional IT service management.

And Mike, last just around the DSO, was this kind of that new normal and the low to mid 80s here and as we think about that up on a year-over-year basis, is that really a function of either linearity or just the size of transactions you are seeing?

Thanks.

No, that has to do with some operational issues within my own finance organization that we have got fixed and subsequent to July we have seen the cash collection.

The last couple quarters in there I've been very disappointed with that.

There are no issues we have been collecting and we have now collected a fair chunk of that subsequent to July 1.

Great.

Thanks.

And expect it to come down next quarter, the DSOs.

Kirk Materne.

Frank, along the lines of the platform a lot of the partners we talked to are very excited about the opportunity longer term and to your comments they are really focused more on IT transformation right now.

But I guess the thing holding them back to go bigger into the platform is just a shortage of skills around it.

I was just wondering, coming away from Knowledge can you talk about the training efforts you have going on to get more people trained up on the platform?

And secondly, on the new customer count this quarter, obviously not quite as up sequentially as much as we have seen in the last couple of years.

I was just curious if that had to do more with shifting the fiscal year to December and that is just we are going to see a bigger lift in that perhaps at the back of the year.

I realize average deal size is up, but I was just curious on that as well.

Thanks.

Yes, actually we weren't all that thrilled with the new customer count, our sales organization.

It is always easier to sell an existing account than it is a new account and salespeople are always going to go in the line of least resistance.

And that is typical for SaaS Enterprises in general, but they become very focused on their existing accounts because it is such good hunting grounds.

So we have to redouble our efforts that we don't get undue influence on our install base.

Which by the way it's a whole market unto itself.

Because that is the fastest way to the revenue.

So I sort of agree with your observation and we have already had that observation ourselves inside here.

But, yes we think we have a ton of opportunity.

We are going to make sure that we are disciplined, that we are providing proper incentive to people to do the harder deals as well as the ones that are not as hard.

On platform, you actually put your finger on one of the more strategic issues for ServiceNow and that is for us to be able to raise the roof on the overall capacity and professional services resources in our ecosystem.

It is not just about what ServiceNow has in the way of professional services resources, but what the entire ecosystem can provide.

The reality is that all our professional service capacity is consumed continually and that is why that business is growing as rapidly as it is.

It is not such that new customers consume a portion of it and then it rolls out to the next account.

Typically we get in and we stay in.

There is an ongoing services relationship with our large customers.

So that puts more and more pressure on continually expanding the ecosystem.

This is a very big priority for us.

We have started to provide incentives for our ecosystem to be trained and certified that is actually quite far along, that process, but we viewed it as a very, very critical aspect because it is going to slow us down if we do not continually get ahead of the curve here.

We even see a lot of our customers' technicians in our customers, I mean actually moving into professional services organizations which also is not necessarily a healthy dynamic.

So we have got to go new bodies with -- that are newly qualified, newly skilled to tackle these opportunities.

It is a good problem to have, but it is certainly something that we have our eye on.

Great.

Thank you.

Abhey Lamba.

Frank, you discussed the expansion of your footprint to all IT employees within your customer base.

Can you talk about your ability to expand the on IT to other areas?

And what other areas do you think your customers can expand your usage to?

Yes.

So from a -- the expansion from IT has really sort of a full-blown system of record for all IT operations.

And some of the key applications there are project portfolio managements, asset management.

Everything governance risk compliance and then there are typically and this is really, really important for the strategy, IT organizations use our platform and to build the applications that we do not stand and provide.

Many of them are related to vendor management, procurement, sourcing, licensing.

There are literally lots and lots of things that IT organizations built themselves that sort of fills in the gaps that they have in their organization, relative to everything that they need to have a full-blown system of record.

So we have a whole bunch more applications that we stand to provide beyond our core ITSM model, but then our customers are adding on to that themselves to really build a very complete ERP grade system if you will.

So, that is the typical dynamic and that allows us to license a lot more people than you normally would expect through ITSM.

As I said during the prepared remarks, the expansion beyond the IT organization really come from the observation that the IT service model can be very quickly repurposed and adapted to other areas.

So it's not terribly hard for HR organizations to build a service model on the ServiceNow platform because it is so analogous to what goes on in IT organizations.

The same for travel, and legal and procurement and finance facilities.

You name it.

All of those service relationships exist in the enterprise are suitable for the ServiceNow platform.

Often, also going external as well, either customer facing, partner facing or facing audiences outside of the perimeter of the enterprise itself.

Got it.

Very quickly on the international opportunity can you talk about what investments you are making?

You talked about one big customer in Japan with what are the other investments you are making and when should we start seeing more meaningful bookings from that front?

Thanks.

We are opening up our Mexico data center.

We were actually expecting it to be open last quarter, but it got delayed.

That is one of the reasons why our subscription margins came in a bit higher.

We will be opening a data center in Singapore in the beginning of 2014.

We have now opened up in Hong Kong, Japan and Singapore.

We are looking at some other countries in that region such as South Korea.

And we are putting a lot of infrastructure in place in terms of people there to support the sales organization.

As well, we continue to grow in certain geographies within EMEA and some of the more emerging markets in EMEA.

Phil Winslow.

Congratulations on a good quarter.

Just wanted to touch on some of your newer products beyond just the platform via discovery, your run books automation I think you are calling it, putting it as a part of orchestration now.

Just curious what you are seeing from an uptake of the install base of those.

Thanks.

As we said earlier during the prepared remarks, those products are gradually gaining acceptance and adoption in our customer base.

And by the way, this is also the effect of having a sales organization that is now in part focused on existing accounts.

Because when they have purchased the core set of applications, it is only natural that the sales organization starts to focus on these other products as incremental sales opportunities.

We have seen -- so, we see this growing quarter over quarter.

It is a good thing we are investing in these technologies as well.

Talked about Cloud Provisioning, things of that sort.

We do think that CMBD is very foundational for ITSM and in general for running IT system, system of record.

And it is just essential to have that foundation in place.

So we expect that to be very important in our future.

We have talked about project portfolio management.

That is actually an area that has languished historically, but that we have focused on in recent times as it has taken on -- we fixed some key gaps that we perceive product and we are now gaining traction in that area as well.

This is a lot of blocking and tackling.

ServiceNow has a fairly broad product portfolio.

We can't focus on everything at the same time, but as we deepen and broaden functionality in some of these areas, we see the effects of that in our business.

I will also say that discovering orchestration and now accounting for this quarter just above 8% of our net new ACV.

So we are very pleased with how that has come around.

And if you remember before, I was saying, historically, it was accounting for less than 5% of our revenue.

So we do have high hope for those two products.

Great.

Thanks.

Tim Klasell.

Congratulations on the quarter as well for me.

But just a quick question on App Creator.

Historically, I have always thought of ServiceNow being used by the IT department and then extending into the IT department extending into other departments.

Does App Creator change the dynamics here where people can start from other departments to create their own applications and are you seeing that in your customer base?

That is absolutely the intent.

We sort of glommed on to a concept that Gartner Group, I think, invented which is referred to as the Citizen Developer.

Addressing the Citizen Developer it's really a model where IT [bosses], say, a development platform but then brings that into the end-user environment for end-users to develop them.

People that really do not have programming skills, but have fairly good understanding of relational concepts, tables, rows and columns and so on.

So sort of the same level of skills that you would have for Microsoft Access or Excel, things of that sort.

So App Creator really brings another level of abstraction to our development environment and makes the platform even more approachable for that class of user than it was for the typical IT user that has historically always used ServiceNow.

We are still at early stages of that, but I am just giving you what our aspirations are and what we are aiming for with the strategy.

Great.

And I think at Knowledge they mentioned that this increases the developer community by about 25%.

Do you guys believe in that as well?

Well, we think that is one of the great things about ServiceNow is that as we dramatically expand the population of people, that can actually build meaningful applications on our platform because we do not require programming skills for people to be successful.

So we are going after the entire Excel crowd out there which is literally hundreds of millions of people.

That is really the innovation around ServiceNow is that we have really lowered the bar and democratized access to a platform where you can build real record-keeping data entry reporting workflow applications.

That is really what it is all about.

Great.

Thank you very much.

Brad Sills.

Congratulations as well on a great quarter.

Following on your point, Frank, on the Citizen Developer.

Are you finding that the platform is being used more for new custom applications or more so for replacements?

And if replacements where are you seeing platforms which platforms are you seeing most often replaced?

The replacement cycle is really the legacy helpdesk applications.

Those systems are 10, 15, 20 years old.

That is really the hardcore replacement.

And they are not replacing it with same, they are replacing it with a much more modern service model, a real [itel] set of processes.

So it is not a straight replacement, sort of a snazzier version of what people were doing before.

We are using service portals now.

We are using automation.

These are Internet systems, they are single systems.

There is no redundancy, no fragmentation.

So that part of the business.

But what is going on in our customer base is that they are automating workflows that have never been automated before.

They typically have lived in the realm of messaging.

In other words email.

Email, text, voice.

People were executing service relationships through communications but they weren't managing them.

So they are moving them from the realm of messaging to the realm of record-keeping.

And that is a great opportunity.

Because once you have a service relationship in a record-keeping systems, now we can aggregate the records.

We get real dashboarding, real reporting, real insight.

We can structure the service relationships.

We can define them and they can now become repeatable, out of the [bowl].

They can be optimized.

So this is what our customers are after.

And once they have a record-keeping system for a particular service relationship the amount of insight that they gain, literally overnight once the system is live, is simply amazing.

They have got control.

They are able to hold people accountable and they get insights that they have never had before.

So this is what makes a platform like ServiceNow so interesting to pursue some of the service relationships that before just lived in the world of email.

That's great.

Thanks.

And then, just one on Mirror42.

I know it's early but can you assess the impact that that acquisition has had on the install base or the pipeline just in terms of customer reaction on the analytics front?

I made one comment during the prepared remarks.

We got a very strong response out of our customer base and in part I think our customers have felt that we could have done better and more in this area.

So they were incredibly happy that we made this move.

Secondly, Mirror42 was already known to a very good part of our customer base because they have been coming to all of our user groups and our user conferences and so on.

So it is a very, very natural addition to our portfolio.

It can deliver value to our existing customers very, very quickly.

So that is what makes it such a good addition to our family, we think.

Great.

Thanks.

Shebly Seyrafi.

Can you talk about where you might want to expand through M&A going forward?

I think Mirror42 is your first major acquisition in a while.

That is one question.

Another one is your subscription gross margin is guided to decline sequentially.

It has been around 77% the last few quarters, but you are guiding for higher revenues.

So maybe you can talk about the drivers, explaining that decline.

I will talk about the subscription.

So the real issue with subscriptions is we have been behind in our expenses.

A, we were behind in opening up our Brazilian data center which comes online this quarter as well.

We were expecting to add a lot more capacity into some of our data centers and take on some additional space which is happening this quarter and in Q4.

Hence why we are guiding down in our subscription model and have gotten a little bit ahead of ourselves.

As a reminder, our long-term margin is 78% to 80%.

I don't think the 77% is sustainable in the short term with some of the plans that we have within our cloud infrastructure.

As well we have been a little bit behind in the hiring in that group as well.

And then I will turn it over to Frank for the M&A question.

Yes, I can't comment on those specific categories of acquisitions.

But what I will tell you that our strategy for doing acquisitions is very much based on acquiring talent and technology.

We are not interested in buying businesses, per se.

We just want to see enough evidence that we are dealing with viable count and viable technology.

The second thing I will say is when we do acquisitions, we look for capabilities that really strengthen our overall platform.

What we are not interested in is building a really big PowerPoint slide that has a lot of boxes and arrows on it.

For us it is not about the amount of stuff that we have in our portfolio.

It is really about filling in critical capabilities that really make our overall platform more compelling to our customers.

So I think Mirror42 is a very good example of how we would like to do acquisitions on a going-forward basis.

One more for me, if I can.

You disclose your backlog every so often and I think the last time you disclosed it was up 81% in Q4.

Can you talk generally about backlog growth, how it compared to your revenue growth this year of this quarter of 80%, your billings growth of 63% just in comparison.

Yes, we will disclose backlog annually in our K and if we ever do any registration statements, we will file -- we will disclose our backlog as well.

Those are the only times we have ever disclosed it.

What we have disclosed is our contract term in both the initial licensing renewals has been increasing.

So we are very pleased with the growth in our deferred revenue and backlog combined.

And you'll just have to wait until January when we disclose our December backlog.

Great.

Thank you very much.

Okay, operator, you can turn it back or I will finish it off right now.

As a reminder, a replay of this call will be available as a webcast and the investor section of our website as well as to the dial-in instructions contained in today's earnings release.

Thanks for joining today's call.

This concludes our call and we look for to our next update in October following the close of the third quarter.

Thank you very much for joining, ladies and gentlemen.

This concludes your conference call for today.

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