ServiceNow Inc (NOW) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ServiceNow Q2 2015 earnings conference call.

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

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

I would now like to introduce your host for today, Mr. Michael Scarpelli, Chief Financial Officer.

Please proceed.

Good afternoon, and thank you for joining us.

On the call with me today is Frank Slootman, our Chief Executive Officer.

Our press release, our quarterly IR deck, and the simultaneous broadcast of this call can be accessed at investors.

ServiceNow.com.

We may make forward-looking statements on this conference call, such of those using the words may, will, expects, believes, pipeline, prospects, or similar phrases to convey that this information is not historical fact.

The statements are subject to risks, uncertainties, and assumptions.

Please refer to the press release and risk factors in documents filed with the Securities and Exchange Commission, including our most recent annual report on form 10K, for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements.

I would now like to turn the call over to Frank.

Thanks, Mike, and good afternoon.

Total revenues for the second quarter were $247 million, up 48% over the same period last year.

During the quarter, we saw strong renewals at 97%, and healthy up-sells at 43%.

We recorded nine new transactions with ACV above $1 million.

The Company now has 186 customers with ACV in excess of a $1 million, a 68% increase from last year.

This reflects both new customers with larger initial contracts, as well as customers who expanded their use of ServiceNow.

We also landed 21 new global 2000 customers, including Caterpillar, Novo Nordisk, and Alliant Energy.

One of our existing global 2000 customers, a financial institution, signed our largest up-sell transaction ever, with ACV in excess of $6 million.

They are focused on modernizing service by providing employees with an online user experience and structured workflow for managing requests across the entire bank.

This initiative is driven by the CEO, with a vision to transform the entire organization.

During Q2 we saw strong performance of the emerging products that are outside our core service management offerings.

Our performance analytics solution set a quarterly record for new customers and ACV, including its largest single transaction ever.

The ACV for our IT operations management portfolio nearly doubled year-over-year, driven by 21 deals larger than $100,000.

The ServiceWatch solution had a record quarter, and was our best performing product in the [ITOM] portfolio, with strong interest from our existing customer base.

On the heels of our acquisition of Intreis, our GRC solution recorded its largest transaction, with ACV of nearly $2 million, and growing interest from our existing customers.

During the quarter, our ServiceNow Express product landed 74 new customers, including its largest.

Seven of our existing express customers upgraded to our enterprise version in Q2.

We also booked the first transactions for our new financial management application, with six customers and a robust pipeline of pilots and prospects.

Finally, we set new attendance records at our Knowlege15 conference in Las Vegas, with more than 30% growth.

Our conference is branching out beyond the boundaries of IT, with 25% of the breakout sessions focused on topics outside of IT.

Our inaugural developer conference, CreatorCon, exceeded our expectations, with nearly 1500 registered professional developers and application architects.

We certified more than 400 developers at the event.

Since we have launched our CreateNow developer program, we have nearly 10,000 sign-ups, and provision more than 4,000 developer instances, an essential resource to help developers learn and build market applications on the ServiceNow platform.

To help these developers monetize their applications, we also launched the ServiceNow store.

We now have 96 applications and integrations published on the store, with almost as many in the pipeline going through certification.

With that, I'll now turn the call over to Mike.

Thank you Frank.

During today's call, we will review our second quarter financial results and discuss our financial guidance for Q3 and full-year 2015.

We would like to point out that the Company reports non-GAAP results in addition to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP.

All financial figures we will discuss today are non-GAAP, unless stated otherwise.

To see the reconciliation between these non-GAAP 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 at investors.

ServiceNow.com.

Our total revenues for the second quarter were $247 million, increasing 48% year-over-year and 59% in constant currency, an $18 million FX impact.

We now have 186 customers that pay us more than $1 million in annualized contract value, an increase of 18 customers or 11% quarter over quarter, and 75 customers or 68% year-over-year.

Our average contract terms for new customers, up-sells, and renewals were 31.1, 26, and 22.6 months, respectively.

Our annualized contract value for global 2000 customer, as of Q2, was $804,000, up 34% from the prior year, and up 7% from the prior quarter.

Total revenues, based on geography, were $174 million in North America, $56 million in EMEA, and $17 million in Asia-Pacific and other, representing 71%, 22%, and 7% of total revenues, respectively.

Our calculated billings, using the change in deferred revenue from the same of cash flows, was $281 million in the quarter, increasing 50% year-over-year and 62% in constant currency, a $23 million FX impact.

We also noted that several analysts and investors continue to calculate our billings using the change in deferred revenue from the balance sheet.

As we previously mentioned, calculated billings derived from the statement of cash flows better aligns with our actual billings.

Our foreign currency statement of cash flows translate into US dollars using the average quarterly FX rate, where our foreign-currency balance sheets translate into US dollars using the spot rate at the end of the quarter.

We bill throughout the quarter, so the calculated billings using an average FX rate for the statement of cash flows better represents, and is consistently closer to, our actual billings.

Our weighted-average subscription billings term was 12.2 months for the second quarter, compared to 11.7 months in the prior year.

Subscription gross margin in the quarter was 82%, compared to 78% in the prior year.

Professional services and other gross margin was 38%, compared to 34% in the prior year.

This includes $11 million of revenue related to Knowledge, while all related expenses run through sales and marketing.

Excluding the Knowledge revenue, our professional services and other gross margin was 19%, compared to 13% in the prior year.

Our overall gross margin was 74%, compared to 69% in the prior year.

Excluding the Knowledge revenue, overall gross margin was 72%, compared to 67% in the prior year.

Operating margin was 6% compared to negative 3% in the prior year, including net expenses of $10 million related to Knowledge.

We ended the quarter with 3,187 total employees, a net increase of 140 from the prior quarter.

We continue to expect between 850 and 900 net employee additions in 2015.

Net income for the second quarter was $7 million, or $0.05 per basic and $0.04 per diluted share, compared to a net loss of $9 million or negative $0.07 per basic and diluted share in the prior year.

Our basic weighted average shares outstanding was 154 million, and our diluted weighted average shares outstanding was 168 million.

During the second quarter, we generated $79 million in cash flow from operations, and we used $15 million for capital expenditures, resulting in $64 million in free cash flow.

This compares to $26 million of free cash flow in the prior year.

We ended the quarter with $1.1 billion in cash, short-term, and long-term investments.

Let's turn to guidance for the third quarter and full year 2015, based on FX rates as of the end of Q2.

For the third quarter 2015, we expect total revenues between $252 million and $257 million, representing year-over-year growth between 41% and 44%, and between 49% and 52% in constant currency, an approximately $14 million FX impact.

We expect subscription revenues between $216 million and $220 million, and professional services and other revenues between $36 million and $37 million.

We expect billings between $280 million and $285 million, representing year-over-year growth between 35% and 37%, and between 42% and 45% in constant currency, an approximately $15 million FX impact.

We expect subscription gross margins of approximately 80%, professional services and other gross margin of approximately 14%, and overall gross margin of approximately 71%.

We expect an operating margin of approximately 8%, and free cash flow of approximately $35 million.

For full-year 2015, we expect total revenues between $985 million and $1 billion, representing year-over-year growth of between 44% and 47%, and between 52% and 55% in constant currency, an approximately $54 million FX impact.

Our total annual revenue estimates consist of subscription revenues between $830 million and $840 million, and professional services and other revenues between $155 million and $160 million.

We expect full year 2015 billings of approximately $1.2 billion, representing year-over-year growth of approximately 41% and approximately 49% in constant currency, an approximately $70 million FX impact.

We expect approximately 6% operating margin for the full-year, and to end of the year with approximately 180 million fully diluted gross shares outstanding, which includes all basic shares, stock options, and our issues outstanding, before applying the treasury stock method.

As a final reminder, we've included a high-level reconciliation of constant currency for Q2 results and guidance in the appendix of our quarterly investor deck posted at investors.

ServiceNow.com.

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

(Operator Instructions)

Brent Thill, UBS.

Mike, on the billings guide, I'm curious -- obviously the constant currency you gave was a healthy metric, but anything else that you are looking at that is having an impact, as it relates to how you look at billings and -- realizing you've got the FX headwinds and the bigger comp from last year?

No, a lot of it has to do with timing of renewals and other things in billing our backlog.

Remember the biggest chunk of our billings is actually billing our contracted backlog, and based upon the historical billings terms that they had.

As well as new renewals that we do, and that does get impacted.

There is potential upside in any quarter in billings if you're able to pull some renewals into a current quarter with up-sells, and we just do not forecast that.

And maybe for Frank, as it relates to the traction among the Global 2000, you continue to make very good progress there.

I'm curious if you could just shed what you are seeing as it relates to some of the larger Enterprise contracts, and how you think about the pipeline in the back half of the year?

Feeling good about it, Brent.

We've consistently been skewed toward the very large Enterprise business more and more so over the last several years, and we continue to do well there.

It's not just the new logos that we're landing, it is also that our footprint in the Global 2000 logos that we already have continues to expand very nicely.

It's really key part of our strategy to land in those Enterprises and then grow our footprint in them.

It's one of the reasons why we highlighted the traction that we are having with our emerging products, because that all flows into those large institutions as well.

It is really an ongoing opportunity for the Company to sell new and existing products.

Raimo Lenschow, Barclays.

Frank, you obviously launched the store at the customer conference.

Can you give us an initial feedback you have seen from customers and partners?

People are pretty happy with the fact that we have a monetization feature in our community.

At this point, as you know, we had our share facility -- allowed people to upload and share content, but what's new of course is the ability to monetize.

It really becomes a route to market for professional software developers, people that not just build software for a living, but also have to sell it for a living.

It's really opened things up.

It really goes hand-in-hand with a bigger program that we have to attract professional developers to our platform.

So that is why we have made a whole bunch of other announcements around it, as well.

So, we signed up 10,000 developers to the program, we're now provisioning developer instances to developers for free, all we need is an email address.

So we've really lowered the bar to allow people to come in, stay a while, learn, really explore and experience what it's like to be on our platform.

I think the store is one aspect of that overall strategy for us, and so far it's been well received.

One quick one for Mike.

Your gross margins are trending obviously in the right direction.

Can you talk about the puts and takes you see there for the second half?

The second half is really just as we continue to expand within some of our data centers.

There is some new capacity coming online that is going to hit us with depreciation, and that is reflected.

And also, we plan on stepping up some of our hiring in the second half of the year, within both our support and our cloud infrastructure, that will negatively impact the subscription margin line.

Hence why we guided to 80% from the 82% that we achieved last quarter, but long-term, I will reiterate the guidance we gave at our analyst day, long-term we see the leverage we'll be able to get out of our subscription line.

Keith Weiss, Morgan Stanley.

In terms of the sales re-org at the beginning of the year, it looks like any issues in terms of getting people online have been solved.

Can we just get an update there?

Do you guys feel comfortable that those issues have been smoothed over and the sales force is operating as expected or as you'd planned on a go-forward basis?

Related to that, on the hiring front, given that you haven't changed your targets for the full-year, it seems like you have a lot of work to do in terms of hiring for the back half of the year.

To what extent are you having issues or having trouble meeting the target for sales hiring, in particular?

Are you on target there?

And does that have any impact?

Is there any kind of supply constraint, if you will, or capacity constraint on the business based upon hiring?

Keith, this is Frank.

On the re-org, as we emphasized during the quarter, this is something that straightens itself out in the normal course of business.

For example, in the big re-org was to really split our organization between enterprise business and commercial business, and we saw our commercial business between Q1 and Q2 grow sequentially about 72%, which really is fairly healthy indicator that things are normalizing and straightening themselves out.

We think that is really behind us.

In terms of your other question, hiring obviously is an enormous responsibility, and a huge task that we have every quarter to bring so many people on, all different categories that we are hiring.

We are certainly under where we would have liked to have been in Q2, but we reiterated our guidance for the full year, so we have not backed off of our intentions to hire in all of the categories.

Obviously, having things like the conferences like Knowledge in the mix doesn't help, but we had a good start on hiring coming into Q3, and we will have to peddle down for the rest of the year.

Kirk Materne, Evercore ISI.

Frank, I was just wondering, along with the launch of the store -- obviously, you guys are trying to build a more of an ISV community on top of your platform.

I was wondering if you can give us an update on how that is going, and what we should maybe be thinking about, in terms of seeing some ISV's sign-up to build that more discrete solutions on top of the platform?

And then Mike, I was wondering if you can talk about the government business?

Last year, you guys had a really strong third quarter.

Just what are your expectations heading into what is obviously a strong seasonal time for the government?

Kirk, there's really no update beyond what I talked about in the prepared remarks.

Very early going.

This sort of thing has a slow fuse on it, and we've really started seeding the marketplace with developer programs, with free developer instances.

As I said, we are approaching 100 apps and integrations on the store.

There is another number like that in the pipeline.

So we are at the very beginning, I feel, in terms of that entire process.

And before people fully sign-up, build applications, are ready to go market, quite a bit of time goes.

But you've got to get started, and that is what we have done here.

So we will be updating you in future calls on where we are with this.

On the federal government, Kirk, as you know, Q3 generally is one of the stronger quarters for the federal government.

And as of right now, it looks like we will have a good quarter, but we really do not talk about individual lines of business, in terms of segmentation, how they do.

But as you know, we've had a big investment in our federal organization, not just on the sale side, but our data center, so we're very hopeful long-term that will be very meaningful for us.

Justin Furby, William Blair and Company.

I wanted to ask about rep productivity.

Frank, you talked about it a bit, sequentially.

But on a year on year basis, within the entire sales team, what did you see from a productivity standpoint?

And then, on the hiring side of things, it sounds like no change.

Is that the same with the sales rep side of things in terms of your expectations for full-year?

In terms of our reps and our sales, and when we talk about head count, we always talk about sales and marketing headcounts in total, and we are continuing to add with what we've said before, and that is not changing.

In terms of productivity, we did see an increase in productivity sequentially from Q1 to Q2, which we are very pleased with.

And it was pretty much flat from the year ago quarter.

What about -- you called out the revenue side from geography, but from a new business standpoint, was there anything that was strictly strong, weak across Europe, US, APAC, that stood out?

From a geography standpoint?

No, it was pretty much consistent, as you saw on our revenue side.

Some of our big deals, I will say, that big financial institution we talked about was a European one.

So, up-sells were very strong in EMEA and we were pleased with our results in Asia-Pacific as well, last quarter.

One last one on free cash flow.

I think at your analyst day, you put up $160 million as sort of a proxy for this year.

It seems like you're tracking well above that.

I know you're not getting to it, but what is the right way to think about growth in free cash flow, looking out in the back half of this year and over the next few years, relative to your P&L or anything else?

Stay tuned for long-term guidance on free cash flow in January for 2016.

We really don't give long-term guidance there, and as we said earlier, we're expecting about $35 million in free cash flow in Q3.

And one of the reasons it's down quite a bit from the $65 million we just did is, as we mentioned at our analyst day, we're off to a very strong start in Q2, and as a result we did a lot of billing early in the quarter and collected.

Where historically we would have done the billing in the quarter and collected in Q3, for instance.

That is one of the reasons why our free cash flow is there, but we are very pleased, and we're tracking well ahead of where we thought we would be at this time in the year and for the full year.

Michael Turits, Raymond James.

Mike, during the re-org, there was some changes I think in the way that you rolled up the pipe and looked at visibility, and adjustments that had to be made there.

Where are we, and do you feel like you have got visibility back where we want it?

As Frank mentioned, we're very pleased with what we saw.

The growth in our commercial business, and we think it is back to where it needs to be right now, and we think that is behind is now, but obviously time will tell.

I'm not sure if it was in the prepared remarks, Frank, but did you mention platform licenses and where you are with those?

What progress you made on getting those going?

No, it was not in the prepared remarks.

The thing that I keep emphasizing is all of the ServiceNow business is platform business.

It is only one thing.

You're referring specifically to the licenses for custom Bespoke applications, which is something separate.

And we did not disclose the data, I do not have that on me, either.

But that continues to do very well.

We have -- 85% of our customers have on average 6.5, 7 applications deployed on our platform.

It's just something that is very part and parcel on virtually all of our customers.

The way they use our platform, and they have a lot of services on there that are standard that they buy from us, and then there are a lot of services that they either built themselves or they had partners build for them.

That continues very well.

Phillip Winslow, Credit Suisse.

Wonder if you can give us -- I know you have (technical difficulties) single SKU now, but some color on -- feedback from both existing and potential customers on field service management, HR, the newer functionality to the platform?

This is Frank, you are correct.

We really have made a strong push to SKU ourselves around service management, to allow customers to really embrace that enterprise-wide, and not for us -- for them to have to keep track of licenses that they use for IT versus human resources versus facilities and so on.

The downside of that, of course, is we do not necessarily know what people are using it for, or how they are moving it around.

We just know anecdotally that human resources is still by far the area outside of IT that has the most traction, and that is -- we're putting a lot of resources behind that, as well.

We are very optimistic about the momentum that we have in those areas.

Some of the others are trailing behind that in terms of procurement: facilities, legal, marketing, you mentioned field management.

There's obviously a lot of other areas, and one of the things that we released in the current release of our software is a set of templated capabilities to allow people to stand up their own service management applications, because it's a very, very fragmented business in sense of there's all kinds of service domains that people can build service management capabilities for.

It's not always as discrete and big bucketed as it is with things like human resources and facilities, which is the bigger go-to items, if you will, after the IT category.

Matt Hedberg, RBC Capital Markets.

Mike, you alluded to in the last quarter, Q2 got off to a very strong start.

I'm wondering if you can talk about the linearity in the quarter?

Certainly, as deals get larger and cross sell increases, is it becoming more backend loaded?

And maybe as a follow up, has Q3 gotten off to a similar strong start that you saw in Q2?

I apologize Matt, you cut out a little bit.

So if I do not answer your question properly, I couldn't really hear the first part.

I think you were asking the linearity in Q2, how was that?

Yes, it was one of our fastest starts to the quarter as we had mentioned before, hence one of beats in our subscription, because the revenue came in -- or the deals closed sooner, so we were able to recognize more of that revenue in the current quarter.

In terms of Q3, we're pleased with the start, where we are today.

It's not as fast as last quarter, but we were not expecting that to be.

I would say it is slightly ahead of where we have normally been in the past in Q3.

Can you talk about the competitive landscape, be it the legacy vendors or more your emerging competitors like Salesforce.com on the platform or services side?

The competitive dynamic is not really changing that much.

We look at our top five brands that we replace, that mix has consistently been the same.

Most of the energy, if you will, in the marketplace is at the low end, especially the extreme low end, all the way down on the [SMB] side.

One of the reasons we stood up the whole commercial sales organization alongside our Enterprise sales organization is because we're going to become much stronger in that marketplace.

That is also why we launched the express product, to be very active in that opportunity.

That is where that all stands.

I forgot what the other half of the question was.

Maybe more on Salesforce.com.

Salesforce obviously is -- they show up in platform situations.

There aren't that many head-on collisions, where people go out to bid on platform opportunities.

The ServiceNow platform is something that happens as an extension of the deployment that they already have.

They typically are not brand-new procurements.

It does happen.

In those cases, it tends to be competitive with people like Salesforce, but most of the time they're really follow-on contracts and opportunities that are not competitively contested, which is actually a great advantage for us.

It isn't really a marketplace where you are out and out contesting platform opportunities.

It is really growth from existing deployments.

That is probably something that people really need to appreciate and understand more, because if you go to Gartner group, they always wonder why they do not get more questions about it.

And the reason is, the questions have already been answered, as a byproduct of people already buying into ServiceNow.

They already own it, they're already using it, they are just buying incremental licenses to be able to do more things with it.

Rob Owens, Pacific Crest.

If I look at the first half of the year, you guys have either hit or exceeded the high end of your revenue range.

So, as you guide for the remainder of year, what keeps you from increasing the high end of the range, at this point?

Because it is not like you guys, with your subscription-based model can pull things forward.

I would just say, Rob, we are comfortable with the guidance that we gave for Q3 on the revenue side and the balance of the year -- (multiple speakers)

But you're not foreshadowing anything happening with the pipeline?

No, I'm not foreshadowing anything happening with the pipeline.

I'm sorry to cut you off, Mike.

You were saying something about FX?

You also see were FX rates are today as well.

Sure, but they've been pretty consistent through the last couple of quarters.

Second on the free cash flow side.

If I look at the trailing 12 months, you've had a free cash flow margin of roughly 15%, I think.

Is there any reason to think, as the business continues to grow, especially at this rate and the scale, why that might decline?

Again, I'm looking at a twelve-month basis, just to take out some of the one time things that can happen with cash flow.

For quite some time, our free cash flow margin will exceed our operating cash flow margin, as we continue to grow here.

I don't see us, long-term, coming down below that number, where it's at, because obviously we're showing margin expansion on the operating margin line on a non-GAAP basis.

There is nothing -- you wouldn't expect it to go down from there.

Sarah Hindlian, Brean Capital.

Thanks for providing all of the constant currency numbers and reconciliations.

I think we all appreciate that.

A couple of questions for you.

You talk a little bit more about your sales cycles, and any dynamics you have seen there that are different versus Q1?

Mike, I think you recently noted it was about a nine-month sales cycle, and I'm wondering if that is still what you are seeing there?

My second question is for Frank.

I think the mid-market opportunity is really interesting, and I'm wondering if you can talk a little bit more about the demand you're seeing there, and where you think that can trend?

On the sales cycles, obviously commercial accounts can have a much shorter sales cycle.

On average though, we're still seeing nine months-plus sales cycle.

Large Global 2000 accounts, you can have two year-plus sales cycles.

It does vary quite a bit by the type of customer we're selling into, and I really do not expect that initial sales cycle is going to change anytime soon, especially on large accounts, because remember, there are no green-field opportunities in the initial sale when we're selling into many of these people on an ITSM replacement.

Up-sales tend to happen much quicker within accounts, but once again, it varies by customer.

This is Frank.

The only other thing I will say about it is -- it is not always as neat as the sales cycle is X number of months.

Sometimes transactions can just disappear because there is turnover in the executive ranks, there are other priorities, and they literally go dormant or even just go away for a period of time, and then they get hot again.

That is just the world we live in.

These are like ERP grade type undertakings, and they have a bit of an unpredictable character to them.

It is really incumbent upon us to have the volume of business to be able to absorb the ebbs and flows of the business.

So it is very hard to say it is exactly this number, they are really averages, and there's a huge range.

We have seen very large transactions happen very quickly, and we've seen all kinds of transactions come wax and wane and not happen.

We had one transaction close this quarter I think got pushed, like, five or six quarters in a row.

That is the kind of crazy stuff that happens in our business, but the good news is they always happen.

Time is our friend, and typically for a customer time is not their friend, because things are getting older every day and more painful.

Your question on the mid-market, that is the reason why we pull through that entire sales re-org that has been talked about so much, to have a full on commercial sales organization that operates completely separately from our Enterprise organization.

And we are also following that up with different approaches, different types of people, and different product, quite frankly.

A product that is often simpler, that is more aggressively priced, and it really goes after a customer that looks very different than the large Enterprise customer, where we've been very successful.

So we're very specifically taking aim at that commercial mid-market with our products and our sales organization.

Walter Pritchard, Citi.

Mike, you've seen some pretty good leverage in the business at this point, I know you have always talked about that, that would come through.

I am wondering as we look at the type of leverage that your guidance implies into Q3, and presumably into Q4, is there anything that we should expect that would work against that?

That might not let that continue, for example, into Q4 and into next year, as we model forward?

No, I think on a quarter over quarter basis, you will not always see that type of leverage, but you should expect to see it year-over-year, quarter.

We will continue to show leverage in our model.

Just the nature of the revenues growing faster than our costs.

Frank, you sound like you are seeing -- I would characterize it as a little bit of an inflection on the non-IT apps this quarter.

And I'm wondering if that has caused you to do anything mid-year, reprioritize some of your development efforts, or put incremental investment into some of those areas, like the financial management app, the HR on-boarding app, and other areas that you may be developing apps that you haven't talked about at this point?

We've been in the mode for some time to really evolve the business from being predominantly one product, one market, to multiple products, multiple markets, and we've completely reorganized ourselves on the product side to be able to execute that way.

We are following through in all of the other functions: sales, pre-sales, service, and so on, to be able to support that so that we have multiple growth engines executing simultaneously in the business, and what we highlighted this quarter is that we are seeing some really good traction within the businesses that are not in the core service management area.

That is very much part of our vision, it is very strategic to move us from that $1 billion run rate to the $4 billion run rate, that Mike characterized at the financial analyst day back in April, in 2020 timeframe.

So we have to make that transition successfully to really fully take advantage of our total adjustable market opportunity, and we are seeing some evidence of that.

That is beginning to contribute to the overall business.

Steve Ashley, Robert W Baird.

I would just like to ask a little bit, following onto Walters question about the ITOM business specifically.

You've now baked in ServiceWatch.

Has that helped change the trajectory of that business?

Has that allowed you to have conversations you haven't had before?

Maybe we could just get an update on what is going on there?

This is Frank.

ServiceWatch has been a very hot product for us.

It's become the lead product for the ITOM portfolio in the sense that that's what the sales organization tee's up first and likes to talk about.

It attracts the attention of the entire organization.

That is something that we feel everybody has to have.

It is really understanding the impacts of all kinds of incidents and how it affects the services and the users that are supported by those physical assets.

It is a component everybody has to have, we are having a lot of traction with ServiceWatch.

Had a great quarter, we have a tremendous pipeline for that product.

We're very excited to have it, and it is the tip of the spear at the entire ITOM portfolio, because it then drags the other components right along with it.

Notably Discovery -- as Discovery and ServiceWatch go hand-in-hand.

But also event management had a very strong quarter, orchestration and so on.

We're finding in general that selling ITOM is a very natural sales motion after service management, and the sales organization is really lining up worldwide in that way.

So we are excited with the momentum that we are seeing in that way.

I would just like to ask about your developer program.

If we were to juxtapose your platform and development program against some of your competitors like Salesforce1.

Are there any key differences you might point out to us?

One key difference that I would point out is that our platform caters to a much broader set of skill sets.

We cater to professional developers, sometimes refer to them as code developers.

That is actually a relatively small group.

Secondly, we cater to what we call low code developers, which is a much larger group.

That has been the traditional ServiceNow group.

These are people that are mostly people that understand data, that know how to handle declarative constructs but have very light scripting skills.

They are not hard-core programmers.

That is a group of people that ServiceNow has stood out with, and sort of what put us on the map.

Then we also cater to no code developers at all.

In other words, people that just have to define and publish services, and have absolutely no procedural skills whatsoever.

So we -- and by the way, we outlined at our conference that, that is really the big difference between ServiceNow and everybody else out there, that we have a very broad spectrum of developers that our platform can cater to, and that is absolutely not the case with the competition.

Derrick Wood, Susquehanna.

Frank, exciting to hear about the largest up-sell ACP deal ever.

Just be curious to hear a bit more about this transaction.

How it came to fruition, why you won, who you displaced?

The breadth of product adoption?

A little bit more color on this would be great.

As we said, it's a large financial institution in Europe, and just by the very scale of that institution, it ended up being a very large deal.

But alongside of that, we sold virtually everything we have in that transaction, as well.

Including performance analytics and GRC, and so on.

So, it was a very successful platform seller.

It was the entire enchilada, if you will, which is our favorite way to sell.

Our people really embraced the entire platform, and sort of are now picking and choosing a few components or a few services.

That is really what made it big.

It was a replacement of one of our large legacy people that we typically displace.

What was interesting about this account is it wasn't just driven from the IT side, which is sort of traditionally where our bigger deals come from, but we had a lot of stakeholders all the way up to the CEO office, as well as the CTO.

So a very broad-based executive involvement in this transaction.

They were looking for a big transformation on how they were doing things inside that institution.

It is nice to see transactions of that magnitude, where its becoming that strategic for that large of an organization.

And we are looking for a lot more of those.

That is great.

And as a follow-up, as customers are looking to adopt a platform, a breath of modules, it would seem that there would be more of a need to help bring in best practices and more focus on ITIL frameworks and such.

And how do you weigh the need to have that internal consulting expertise, versus leaning on partners?

And maybe if you could just give an update on the partner front, that would be great.

Our general posture is we're very partner friendly.

We're not driving scale on our services business for the sake of it.

Because we all know it is a drag on margins.

So we are basically running our services business at the pace that we feel is appropriate for the strategic need that it serves.

And that is, we have to be able to step up when a customer says to us, you have to lead the engagement.

Then we have to have the ability to do it, and that requires a certain level of mass for us to have that, and also have all the skill sets that you mentioned, that we can bring those to the table.

For a Services organization it's becoming a little bit more challenging, because now they also need to know about project management, they need to know about ITOM, the whole operations out of the house.

The need to be specialist on ServiceWatch, so we have a much greater diversity of skills now that we are asking for from our own services organization, as well as from our ecosystem.

But our first order of business is always we do not want to crowd out our partners.

We want them to be heavily invested in our business, and we always make room for our partners when we have an opportunity to do so.

It is a balance, it is a mix, and we will continue down that path.

Karl Keirstead, Deutsche Bank.

I just wanted to return, Mike, to the operating margins.

I think on the Q1 call, you had guided to full year non-GAAP operating margins of 5%.

I might have missed it on this call, but did you update that guide?

It feels like you are tracking well above that, so I would love an update.

Secondly, related question, you materially outperformed against your operating margin guide for 2Q.

Just so I understand that, was that primarily because you under hired?

Thanks, Karl.

Full year guidance we gave was 6% for operating margin.

In terms of the Q2 beat, there was a combination.

One was we came under quite a bit in our expenses around our K-15 event, which we were, we managed that very well.

The other thing is hiring, as you did mention.

And thirdly, there were just some expenses, particularly around some of our legal expenses, and it was the timing of those where we were expecting we're going to come in Q2 and they pushed into Q3.

If I could follow up on that second one, Mike or Frank, just on the hiring front.

In terms of why it might be a little bit more back-end loaded, is that because it is a pretty tough competitive hiring market out there?

And if that is the case, we're certainly hearing that from plenty of other technology companies.

Or is it a little bit more internal, where you feel like you need to fine tune the funneling and recruiting process?

This is Frank.

It is mostly internal.

Hiring is always hard; it is never easy.

Hasn't been easy for all the time that we have been in here.

We have been very good at it.

We do have, from time to time -- we have stronger quarters, we have weaker quarters.

That is why we always focus you back on what the annual commitment is, because whatever we lose in one quarter, we make it up in the next.

I would not read that much into it.

It is an internal execution issue for us.

We don't think the external conditions have materially changed.

Alex Zukin, Stephens.

First question on renewals.

Just being a bit of a variable with respect to the billings guidance, I wanted to ask about the effect of this greater renewal activity in the back half on maybe sales rep productivity with respect to new business?

Are they having to spend more and more time on that aspect, is there a separate team handling that?

Any color would be good.

There is a separate team that handles renewals, but the salespeople are actively involved in those renewals.

Especially on our larger accounts, and what I was referring to on the billings around renewals -- many times, our salespeople are negotiating up-sells with customers, and we end up doing the renewal early with those up-sells that relate in billings.

That is very hard to forecast, is what I was referring to.

That has been something that we have been dealing with for years, as a Company.

Can you maybe talk a little bit more about the traction with the Express product?

And the fact that you have some customers that actually in the Enterprise, you get up-sold or convert to the Enterprise version of that product.

Is that more of a strategy that you are building out, and then maybe the competitive environment in that segment, as well?

This is Frank.

We really built Express because we felt there was a section at the lower end of the marketplace where we weren't as good a fit with our Enterprise product, both in terms of the feature set, user experience, pricing, the contractual model, how automated the provisioning was, the low touch nature of the whole marketing and sales model.

People typically don't go on site for those kinds of things.

We've been off to a very strong start with the Express product.

The sequential growth is very fast, and it's also a product that we're focusing very much on the commercial markets.

Probably more so than the SMB side of it, the SMB side is very low end, whereas in the commercial market it really becomes a product where that sales organization can be much more aggressive with their product than they can be with the Enterprise product.

It's a different model altogether, in terms of the user experience, the feature set that it has, the pricing model, the contractual model, all of those types of things.

We're excited to have that.

The competitive dynamic is different; there are different people that show up in that space.

Interestingly enough, we do see people graduate from -- and we highlighted that in the prepared remarks.

They graduate from the Express product to the Enterprise product.

And before we had that product, we might have just never seen those people and lost them altogether, so this is really grown a core capability to the overall product line that we think is super helpful.

Abhey Lamba, Mizuho Securities.

Frank, I think you mentioned 96 applications in the store.

Can you describe what type of functionality they are addressing?

What is the common thread in those applications, and how do you expect your momentum in that area to progress from here?

A lot of those applications are not brand-new, they have come over from the previous share capabilities.

A lot of our partners have been with us for a long time.

A lot of them are integrations.

In other words, capabilities that really help ServiceNow work with other products.

The traction that we are having -- yes, we had about 96 of those in the system.

There is another number in that order of magnitude of people that are going through various phases of certification.

It is a little bit too early to give a good characterization.

We may do that in a future call and give you little bit more color on exactly what that is, and alternatively if you feel a getting on the site and looking at it, you are welcome to do that as well.

Mike, your sequential billing growth rate expectations of roughly flat in Q3 seemed conservative as you normally experience growth in the third quarter.

Was there any pull forward of deals from third quarter to second quarter, or any other factors in play here that could result in below normal seasonality in third and fourth quarters?

What I would say, in Q2, as we mentioned, our weighted average billing term was 12.2 months versus 11.7 months in the previous quarter, and as a result, that was about a $10 million pickup we had because we had some multi-year billings in the quarter.

We don't forecast multi-year billings in our billings guidance.

Greg McDowell, JMP Securities.

You had mentioned that new customers are starting with larger initial transactions.

I was hoping you could give a little color on whether that is more a function of adopting a lot more users up-front versus adoption of some of the emerging products you had mentioned?

This is Frank.

We are selling broader and higher these days than we ever have.

It was a key thrust for us coming in 2015, to not sell tactically in narrow categories, but really position the Company broadly and widely, and that does drive bigger transactions up-front.

So this is what we expect to see happen.

It doesn't always happen that way.

We talked about our largest up-sell project we've ever seen, that was an up-sell, that was not an initial deal.

So it's happened many times that we may have an ACV contract for somebody for a couple hundred thousand and then we have an up-sell that is worth millions.

It doesn't really matter all that much whether we land with a small transaction first and do a much bigger transaction afterwards.

Because what we really look at is -- and what we really track and measure is really, how many customers?

What do we have in that ACV range?

And I think we said we had 168 customers now that are over $1 million in ACV.

That is really what matters.

How they got there and in how many transactions is really not as important, because we will campaign the customer for the entire product line regardless of whether they get started with a small, or whether they bite off the whole thing up-front.

Kash Rangan, Merrill Lynch.

I was curious, to drill into the ACV of 6 million in the financial services sector.

Can you talk about what -- when you look at companies like Salesforce.com that have been through your phase, they are a comparable size, I think a little bit larger.

They signed a big deal with HP, some $10 million, $15 million in ACV per year or something like that.

Could this be the beginning of a turn in the way big deals are done by ServiceNow?

In other words, is a one-off, or do you see validation for what could be building in the pipeline for more of these megadeals?

My second follow-up was if you were to look at new ACV, that's renewal -- [back of renewal] -- new ACV's, was there a change in the composition of new ACV's by the core ITSM versus the non-core?

This is Frank.

I always take the position that if I can do one, I can do more than one, if not hundreds.

I'm not just saying that in regards to this particular transaction, but we saw an almost $2 million transaction with our GRC product.

If we can do one, we can do more.

The same thing on the ITOM side, with ServiceWatch.

If we do a handful, we can do a lot more.

It is really proving to yourself that you can do it, and we will scale it broadly and deeply.

So the answer generally to your question is yes.

We can do it once and we believe that becomes evidence that we can do it many, many more times.

As a follow up to the other part of your question, initial deals still tend to have a bigger service management component, and the follow-on deals tend to be more skewed toward products outside of service management.

That doesn't surprise us, because our land-and-expand strategy all along has been: we sell into IT, it's generally an ITSM replacement.

We are starting to do more beyond that in initial deals, but remember because we have so many old customers that started with ITSM, a big portion of up-sells tends to be outside of service management.

When you look at the up-sells specifically, is there a change in the composition of the new products versus existing ITSM add-on?

(Multiple speakers)

I would generally say yes.

I will add to that, what Mike's saying absolutely correct, that has been our historical go-to market motion.

It still very much dominates in how we do things, but as we fully transition to a multi-product, multi-market model, I would not be surprised to see us lead with transactions are not service management at all.

That is going to happen.

We've already seen, we've done human resource deals, for example, in accounts where we've done absolutely nothing on the IT side, and that is going to happen as a byproduct of how we are organized and multiple prongs that we have going into our sales campaigns.

Tim Klasell, Northland Securities.

Two quick questions, here.

On the Express customers who migrated to the Enterprise, what features or capabilities were they looking for?

And I know it is a small sample size, and how did that effect their ACV?

This is Frank.

It effects their ACV immediately.

That is a much bigger bill.

The features that make them graduate -- usually, it has to do with client or server side scripting, and the of ability to really take advantage of the platform.

As you recall, Express was very much designed as a product that can deploy in hours and days, not weeks and months.

And we do that because there is really nothing to do other than loading in your users and their credentials, and you hit the button and you go.

All the processes are predefined.

That is the concept behind Express, that is why it is called Express.

When customers get into that, then they all of a sudden are starting to develop all kinds of requirements that don't fit that standard -- that highly standardized model.

Now we're going into the Enterprise model, that cost more money, and it is a much more powerful product.

That is typically what happens.

People often think going into the process that, that product will suit their needs very well, and then they get into the process and they develop requirements that they did not originally envision.

It is not a bait and switch.

It is just that, as people learn what it is that they really want to do, sometimes that triggers an upgrade, and the great thing about the way the product is architected is -- it is a pushbutton upgrade.

So we can take people's instances from Express to Enterprise in a very simple, straightforward manner.

So there is no painful conversion migration associated with that process.

Can you give us a percentage on the ACV increase?

Generally our minimum deal on the Enterprise is $42,000 a year.

The average ACV on Express is somewhere between $10,000 to $15,000.

So you can see the up [lift].

In the past, you guys used to give a cohort analysis on the number of apps that were used on the platform?

I think you mentioned that earlier, Frank.

Do you still track that and can you share it with us?

We do track that.

I do not have the latest and greatest data on me, but I think we said the average is about 6.5 apps right now -- 85% of our customers have on average 6.5 apps on the platform.

We will update that again, that data, we look at that every six months on a cohort basis, to see how that is progressing.

John Rizzuto, SunTrust.

Question about platform-as-a-service, not yours in particular, but the movement toward it.

It has been very slow for enterprise adoption, but that seems to be accelerating.

As that changes, the face of the IT industry changes.

So I'm really looking for two indications: A, if you think it's going make a change, good, bad or indifferent to your business?

And then B, has anything happened as more enterprises, perhaps even your own customers, starting to go toward the cloud for their own development needs and their own IT needs?

This is Frank.

I find that delineation between platform-as-a-service and software-as-a-service is to too stark a contrast, because the reality is that people would love to have standard services that they do not have to build.

Because it's obviously a lot quicker and easier to take things off the shelf.

You configure, modifying for your needs, and you go.

We typically see that people get standard -- get started with standard services, and then as they learn how things work and they develop new requirements, they start to add custom services, where they are now using the platform as a platform, and they add that to it.

So it is a very fluid mix of using platform and standard services.

That to us is typical.

It is not typical to see pure platform deals, where people are not using any standard services and everything is from scratch.

We have those customers, they exist.

But that is not the main mode of our business.

The main mode of our business is very much mix use between standard and custom.

What I was asking about was -- if the Proctor and Gamble, one of your customers, starts to do some of its own custom application on Microsoft's Azure, certainly the service desk component's different.

Components of the IT that it may have as a customer of yours, it can still use.

I'm just wondering if that is a catalyst as some of your existing customers or potential customers go to another [past] service, again migrating to cloud adoption, more broadly, how that might have an effect?

Or you do not think -- or it might not.

Our use cases on the platform are much more associated with the service model in general, so we have not ventured into the very broad world of custom application development where any type of project can be attempted.

That is a totally different market, so our platform applications are always downstream from where we already are, with the domains that we are serving.

We're not a general purpose infrastructure-as-a-service capability like an Azure or Amazon Web services, where it is the infrastructure and then some ancillary services to help people along.

Our platform orientation is very different from those kinds of offerings.

There are no more questions in the Queue.

I will now turn the call back to you, Michael, for any closing remarks.

Thank you.

As a reminder, a replay of this call will be available in the Investor section of our website.

Thank you for joining us today.

Ladies and gentlemen thank you for joining today's conference.

This concludes the presentation.

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