ServiceNow Inc (NOW) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the ServiceNow Q3 2016 earnings conference call.

(Operator Instructions)

It is now my pleasure to hand the conference over to Michael Scarpelli, Chief Financial Officer. Sir?

Good afternoon and thank you for joining us. On the call with me today is Frank Slootman, our Chief Executive Officer. Our press release and investor presentation and broadcast of this call can be accessed at investors.servicenow.com.

We may make forward-looking statements on this conference call such as those using the words may, will, expects, believes, or similar phrases to convey that information is not historical fact. These statements are subject to risks, uncertainties, and assumptions. Please refer to the press release and risk factors and documents filed with the Securities and Exchange Commission including our most recent annual report on Form 10-K 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. Good afternoon. Thank you for joining us on today's call. We are pleased to announce an exceptional third quarter. Total revenues grew 37% year on year to $358 million driven by record metrics across the board.

First, we closed 16 new deals with net new ACV greater than $1 million. Second, we posted the 99% renewal rate. Third, 301 customers now pay us more than $1 million in ACV an increase of 31 in the quarter. Lastly, 18 customers now pay us more than $5 million in ACV, an increase of six in the quarter.

We also continued to see great uptick in Global 2000 accounts adding 23 new logos in the quarter including Prada, Hilton and Constellation Brands. Our average ACV for Global 2000 is now approximately $1 million, a 6% sequential increase and a 20% year-over-year increase.

Large deals in IT emerging products and the federal business highlighted the quarter. IT continues to be our strength and primary landing strategy. Eighteen of our top 20 deals and 22 of our 23 new Global 2000 logos include ITSM and we see tremendous new business opportunities in this market.

The quarter was punctuated by an upsell to a North American global 100 financial institution. This represented our largest contract value ever and included more than $5 million in net new ACV.

The CIO was tasked for driving significant cost savings, increasing employee productivity and improving the velocity of service delivery. We successfully demonstrated a comprehensive service management solution and the ability to unify processes in a single system of engagement.

The deal was led by ITSM to consolidate 66 disparate tools and are commended by ITOM to deliver lights-out automation. This initiative will result in more than $150 million in savings over five years.

Beyond IT emerging products continue to drive larger deals, as customers increase adoption of service management throughout the enterprise. These products represented 41% of our net new ACV in the quarter, up from 28% in the prior year. Fifteen of our top 20 deals included three or more products and 69% of our customers now license more than one product. Emerging products were highlighted by our largest HR deal ever at $2 million upsell to a European Global 100 financial institution.

As part of their global transformation, this customer replaced the legacy solution that supported 19 disparate document management tools. We won this RFP against 10 other vendors who had a comprehensive platform approach including case management, orchestration to integrate key systems, and in platform analytics. ServiceNow will improve employee engagement for more than 250,000 employees and deliver productivity for more than one million cases per year.

We also saw large deals in industry verticals. The federal government represented 11% of our net new ACV compared to 9% a year ago, including two new deals with ACV greater than $1 million.

The civilian sector represented the majority of our wins, but defense net new ACV grew 40% year on year and represents a large opportunity going forward. We landed our largest Federal deal ever, a $2 million upsell to an agency within the Department of Health and Human Services. This customer contracted ITSM to consolidate 10 legacy systems, performance analytics to be an inside to key trends and discovery to effectively manage assets. Additionally our FedRAMP Certification led to us becoming their first enterprisewide cloud platform.

Finally, our Chairman, Paul Barber of JMI is retiring from our Board of Directors after 11 years of service. Paul was our first venture investor and we appreciate his support all these years. Going forward I will serve as Chairman and Charles Giancarlo will serve as lead independent director.

We also welcome two new members to our board, Jonathan Chadwick, most recently CFO of the VMware, and Paul Chamberlain, most recently head of technology investment banking at Morgan Stanley. Both bring significant corporate leadership, industry and management experience to our board.

With that I will now turn the call over to Mike.

Thank you, Frank. During today's call we will review our third-quarter financial results and discuss our financial guidance for Q4 and full-year 2016. 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 except for revenues. 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.

Total revenues for the third quarter were $358 million, increasing 37% year over year. Subscription revenues were $319 million, increasing 43% year over year and professional services and other revenues were $39 million increasing 2% year over year. Billings were $404 million in the quarter, increasing 41% year over year compared to 38% in the prior year.

Subscription billings were $363 million increasing 47% year over year compared to 39% in the prior year. Professional services and other billings were $42 million, increasing 3% year over year. Our average billings duration was 11.8 months for the third quarter, compared to 11.7 months in the same period last year. Subscription gross margin in the quarter was 84%, professional services and other gross margin was 12%, overall gross margin was 76%, and operating margin was 16%. We ended the quarter with 4,501 total employees a net increase of 260 in the quarter.

Free cash flow margin was 18% and we ended the quarter with $1.1 billion in cash short-term and long-term investments. Let's turn to guidance for the fourth-quarter and full-year 2016, based on foreign exchange rates at the end of the third quarter. For the fourth quarter we expect total revenues between $376 million and $381 million representing year-over-year growth between 32% and 33%. We expect subscription revenues between $335 million and $340 million, representing year-over-year growth between 37% and 39%, and professional services and other revenues of approximately $41 million representing flat year-over-year growth.

We expect total billings between $474 million and $479 million representing year-over-year growth between 30% and 31%. We expect subscription billings between $427 million and $431 million representing year-over-year growth between 34 and 36% and professional services and other billings between $47 million and $48 million presenting year-over-year growth between -2% and 0%.

We expect subscription gross margin of approximately 84%, professional services and other gross margin of approximately 16% and overall gross margin of approximately 77%. We expect an operating margin of approximately 16%, and a free cash flow margin of approximately 30%. We expect diluted weighted average shares outstanding to be approximately $176 million and we expect to hire 275 net new employees in the quarter.

Based on Q4 guidance and implied full-year 2016 guidance for total revenue is between $1.381 billion and $1.386 billion representing year-over-year growth between 37% and 38%. We expect subscription revenues between $1.212 billion and $1.217 billion representing year-over-year growth of approximately 43% and professional services and other revenues of approximately $169 million representing year-over-year growth of approximately 7%. Implied full-year 2016 guidance for total billings is between $1.630 billion and $1.635 billion representing year-over-year growth of 36%.

We expect subscription billings between $1.454 billion and $1.458 billion, representing year-over-year growth of approximately 40% and professional services and other billings between $176 million and $177 million representing year-over-year growth between 8% and 9%. Implied full-year 2016 operating margin and free cash flow margin guidance is approximately 13% and 24% respectively, and the implied full-year diluted weighted average shares outstanding is approximately 173 million.

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

Thank you.

(Operator Instructions)

Matt Hedberg, RBC Capital Markets.

Hey, thanks guys. Congrats on the quarter. I love to see the billings accelerate. Also the non-ITSM business continues to do extremely well.

Mike, I know on the last call, you guys talked about accelerating some hiring plans starting earlier in Q3. I think you were speaking to really the pipeline that you're seeing in non-ITSM deals. As you look out into 2017, I think the mix certainly improved this quarter to non-ITSM deals.

Can you talk a little bit more about some of the benefits of some of that hiring?

We're seeing the generation of pipeline, and we're very pleased with the pipeline we see, not just in Q4, but how it's building in 2017 right now. And we think those were very good investments.

And then one question, I don't think we've touched on this in the Q&A session in a while. But in terms of the ServiceNow store, I'm curious, is any update on the number of developers or apps, number of customer deploying third-party apps, just curious on that initiative?

That's not really a key metric that I've been looking at, because it's not a big piece of our business. As we said before, the ServiceNow store, what it really does is it drives more user licenses, not necessarily revenue coming from the apps themselves.

But we have about 56,000 developers in our developer program. Obviously, not all of those have posted things to our app store. There's I think, a little over 200 apps that you can now download for purchase in our app store.

We did do three deals that were just over $0.5 million in the quarter. Our biggest one, we talked about before, we did do a $1 million deal in the past, but this past quarter, there were just three. So as you can see, it's not that big a piece of our business.

All right. Thanks a lot, guys.

Brent Thill, UBS.

Good afternoon. Frank, can you just talk a little about the commercial business versus the enterprise business, and what you are seeing in that business? And then, I have a quick follow-up for Mike.

Yes, the commercial business is actually on an ACV basis, the fastest growing business that we have worldwide. It was growing, it was up, I think somewhere around 44%, and in the North American organization, it was like close to 70%. So the investments that we made almost two years ago to create a dedicated commercial sales organization has paid off in spades for us, and we will continue to invest there. It's an outstanding market. So that balance that we have between commercial and enterprise is really a very key part that drives the overall growth of the Company.

Great. And Mike, just judging from some of the price comments about financial services upsell. It sounds like there were some really large deals. Can you just give us a sense how you're thinking about that, as you go into Q4 and the pipeline? I think many of us believe that financial services may have not been as strong as it was, but maybe I'm reading too deeply into that. Can you just give us a little more color there? Thank you.

Financial services was very strong for us. We actually did one of our largest HR deal ever, $2 million a year, and that was with a financial service company, and we continue to do a number of upsells in our pipeline. In Q4, we continue to see more in there as well, as well as our pipeline for 2017. So we just have strength across the board, where we really feel we're hitting on all cylinders across all of our product lines right now.

Great. Thank you.

Kirk Materne, Evercore ISI.

Hi, thanks very much, and congrats on the quarter. Mike, I guess, maybe just to follow-up on your comment around the HR deal, it sounded like a financial services customer. Obviously, the other products continue to really expand, as a percent of new ACV. Can you just talk about what was in there, and may be driving some of the strength this quarter? Or Frank, if you want to take this, in addition maybe to HR platform. I'd imagined it's a pretty good product for the government in particular. Could you just give a little more color on some of the other product outside of ITSM or ITOM? Sorry.

Like Mike said, we had strength across the board. So we had a very strong quarter on performance analytics. We had a record quarter on human resources. Our brand-new businesses around security and customer service management were really, really strong.

Platform was strong as well. So there literally was no weak -- we just did really well, across our theaters, across our channels, and across all our product segments. And that's when you get very strong results.

And maybe one follow-up for Mike, just Mike, when you look at your sales productivity year to date versus what you're thinking at the start of the year, are you on plan in that respect? Or are you are little bit of ahead of plan? It seems like the cross-selling is going really well, so I was just curious to how that's evolving to date?

I will just say through the first nine months, we're well ahead of our internal plan in terms of bookings, and we're very pleased with that. And that's reflected in the productivity per rep that we're seeing. So I don't think we could be happier there.

Okay, great. Thanks, guys.

Walter Pritchard, Citi.

Hi, thanks Mike. I'm wondering if you could talk about, just as we look at next year, seasonality I think has been somewhat tricky sometimes, Q4, Q1 and Q2. If you could just help us understand how you might be thinking about that, and is that similar to what it has been in past years, or is there anything new going on?

The seasonality is really from the billings perspective, is what you really see, and that's because we have such a big growth down at the end of a quarter, and especially Q4. So you don't see the seasonality as much in billings. But as we get bigger, you will see some seasonality going from Q4 to Q1.

So obviously, Q4 is our biggest quarter with our end of our commission year for our reps, and they try to do everything they can to close every deal. So I don't expect anything different this quarter.

And then just relative to the sales organization going into next year, can you talk about any changes that you may be looking at making? Or how should we think about, in years you've done that, there has been more impact on seasonality, for example in Q4 billings.

So the sales -- this is Frank, Walter. The sales organization is going to be rapidly expanding. And one of the areas that we've been investing in is product specialization, which is working well for us, and we are really accelerating demand generation by having that product specialization focus into the organization. But going to 2017, we are going to layer in another vector of specialization, and that's going to be by my solution and by industry vertical.

So this is going to be an evolution of our selling motion, is going to be more refined by industry, and by type of solution. So it's really normal evolution. We're becoming just more sophisticated in our ability to sell more broadly, and more deeply into our large enterprises and institutions. So, that's definitely, how the sales organization is going to take shape in 2017.

Thank you.

Michael Turits, Raymond James.

Hey, guys, it's Michael Turits, thanks. Frank, can you give a little drill down on the non-ITOM, non-ITSM piece? Can you drill down a little bit more on the ITOM piece; what were the use cases, are they broadening and deepening? And maybe, Mike if you could talk about what the ACV is doing on a year-over-year basis for growth?

Yes this is Frank. On the ITOM side, we very much lead with a very comprehensive total suite approach to allow our customers a full cycle experience, where we can take an event from various monitoring capabilities, map that to critical services, and have the ability through orchestration to act on those events.

Service Watch which is the ability to dynamically map infrastructure to critical services is a key part of our strategy. That's how we lead, and that's going to continue for a long period of time, because this is the marketplace that is yet to begin to develop for us. And then the other aspect, orchestration is going to be a very big part going forward. And it's under the influence of really IoT-oriented thinking, where people are really looking at service models in terms of machine-to-machine messaging and communications, versus heavily mediated people service processes. And obviously, the orchestration aspect is what drives various frameworks.

So, those are areas that where, a lot of our conversations with our large customers are going. But ITOM is such a natural partner to ITSM, they are just two peas in a pod, two sides of the same coin. So, we really believe that over time, that the penetration that you'll see on ITOM, will rival that of what we have on ITSM.

And your question with regards to the growth of net new ACV, we're really not disclosing net new ACV. So we're not going to give you the overall growth. As you can see our business has been very strong, and it's reflected in our billings, and that's what causing the billings beat.

Okay, great. Thanks, guys.

Sarah Hindlian, Macquarie.

Yes, hi, can you hear me?

Yes.

All right, great. Hey, Frank and Mike, a couple of questions for you guys. Congratulations on the quarter too.

First, what's driving CapEx spend right now, Mike? And Frank, one for you also, so it looks like we're seeing some really nice adoption of the security operations modules; it's been four, roughly five logos for the past couple of quarters, and relatively new product. It sounds like the pipeline is strong there, and it certainly backs what we're hearing. And I know you talked about it briefly the analyst day, but are you going to think about having an independent sales force behind this product given the SISO selling motion there, and is this from customers?

So on the CapEx, I will answer that question first. Obviously, there's two components to our CapEx. The biggest component is our data centers. As you add more customers you have to add more capacity within your data centers. We're also building out two new data centers because we're in North America, which is a thing that will take some time. That's been planned for quite a while, as we are at capacity at our other data centers.

The other thing is you are adding 1,000 employees a year. That takes facilities and we're building facilities, but the vast majority is hardware within our data centers, and you do have to refresh that equipment every three years, and we are into our normal refresh, as well there.

This is Frank, Sarah. Security has been strong for all the reasons that were mentioned, it's a very logical add-on. Typically, the chief security officer reports into the CIO. They are often in the same meetings that we're in anyway. So it's a very natural selling motion for us.

But we did start a quarter ago, with really loading in dedicated field headcount, both for security as well as for customer service management. And the reason we're doing that, is because we're going to drive demand faster than if we just have reps sort of twos and threes try our quota anyway they see fit.

And we have the evidence now, that strategy is building demand faster than if we stay in the generalized mode. So we will continue to do that. That doesn't mean that there's just one group that just sells security, I mean, the overall sales force, obviously, will sell it as well. We just have more dedicated focus on these products. Especially in the early going, we thought it was really important that we have that extra level of resource and focus applied to it.

All right. That's very helpful. Thank you, guys. Appreciate it.

Rob Owens, Pacific Crest Securities.

Great, and thanks for taking my question. I want to reflect more broadly on the inflection you guys saw here in the quarter. And was that just a function of how the pipeline stacked up, or sales cycle is compressing at this point? Just curious as you saw your billings -- your subscription billings, everything accelerate sequentially?

Rob, it's Frank. What's really going on here is that our sales staff worldwide, just has more clubs in the bag. So as they approach accounts, they have more opportunities to pursue, and they can really -- and sometimes multiple opportunities at the same time.

So the acceleration really comes from being able to operate on a broader product front. In years past, if we would strike out in one area, we would have to go to another account, or wait out the situation or whatever it would be.

Now we have a second, a third or fourth the fifth way to go and pursue. Once we land an account, then the upsell opportunity starts playing out for us, as well. So the sales productivity really goes up, when you have the ability to run multiple plays. And so, we have a much broader selling motion than we've ever had before, and that's what's driving it.

And then with regard to your Global 2000 penetration, you've talked about how you're in the early innings, especially in regards to international opportunities. Talk about some of the infrastructure that's in place to help capture those deals, because we haven't seen a huge mix shift, I guess, towards revenue internationally. I think it's been relatively consistent international versus domestic. So as we look forward, where should our expectations be? Thanks.

I will say one thing Rob, last quarter 32% of our net new ACV came internationally. And remember, international has been suffering from the FX over the last year plus. So I do -- we are very pleased, and we're seeing great growth internationally. Just happens that North America continues to do well, as well. Both EMEA and APAC are well ahead of their plan for the full-year right now so.

Thanks, Mike.

Justin Furby, William Blair.

Thanks, Frank. I wanted to ask about the Inspire program, how that's going a few quarters in. I guess, just curious how long the sales cycles are there, when would that might start to impact billings? And then, are there any learnings to extract from what you're seeing with that, in terms of informing your broader go to market strategy. And then, I got a quick follow-up for Mike, thanks. Thanks.

Yes, we're actually, I am personally super pleased with how Inspire has evolved over the last year. The level of engagement that we have with our, really our top enterprise customers through that solution consulting staff has really elevated our standing in those key accounts. We often work on Tier 1 systems that are very innovative, very transformative, and they really show where the business can go, when you bring that quality of resource to a selling motion.

What we're really trying to do, down the line is, okay, how do we develop lighter versions of that selling motion for the entire sales organization? Because it's a relatively small team. We have about 40 some people in the Inspire program, and the trick is, how do we standardize and scale down across the organization?

Well, we have a lighter version of what we've learned, that we know how to do, and that it'll be available to the broader organization. So going very well, and we're looking forward to, probably at our Knowledge conference next year, that we get to showcase some of those key Inspire accounts, and the work that's been done there.

Got it. And then Michael or Frank, either of you, if you look at some of the customers who are more advanced in terms of adopting ITOM, can you give us a sense of how much they are spending there, relative to ITSM? Is a one-to-one, or are they spending more or less, and just any sense there would be super helpful? Thanks.

There is no set pattern. We have some customers that are actually spending more on ITOM than they are in ITSM. But I would say in general customers spend more on a per customer basis, because ITSM is more developed. They're paying more for ITSM than ITOM, but ITOM is quickly catching up. We're seeing some very big deals in ITOM. We've actually this quarter to date, seen a nice deal that's a standalone ITOM, which they're not an ITSM customer.

Got it. Thanks, guys.

Steven Ashley, Robert W Baird.

I would just like to go back to the large upsell you had some color on what was driving that new business. Was that extending ITSM globally or geographically? Was it new use cases? Just some color on that.

This is Frank, the big thing there, and by the way this is a pattern that plays out over and over, is just massive modernization. They are replacing dozens and dozens of legacy systems, and have a complete overhaul, complete redesign, complete refresh and really putting brand-new systems, brand-new infrastructure in place. And that is just typical of our business in these large enterprise accounts where they're turning off a lot of old stuff and a lot of fragmentation and sprawl, big cleanup and going in with a single platform approach. That's, as I said, that typical for what we do.

Right. With getting such strong traction in HR, can you foresee a future where you may land with some major accounts with HR before you land with ITSM?

It's not just the future we have been doing that for years. As I said earlier, sometimes we just can't go through the front door because there is encumbancies or contractual issues and we do lead with HR and that has worked very well for us.

I think HR is a very, very key service domain, as I think most people will appreciate from their own day-to-day work experience, and over the years they really have -- they have been underinvested in service models and really managing service, as opposed to just delivering service. And there's a lot of efficiencies to be had there in terms of staffing and there's a huge opportunity to improve the service experience itself. So we are very bullish on the HR opportunity.

Thanks.

Karl Keirstead, Deutsche Bank.

Thanks. Hi Mike, I've got two questions about the 4Q Billings guide of $474 million to $479 million. First is, the third quarter was so strong, $20 million above the high end of guide. Was there any pull forward from 4Q? And then secondly, FX rates have been pretty volatile of late. Are there any FX hits to that 4Q Billings guide that's worth calling out? Thank you.

So every quarter, as I mentioned on the last quarter, you have, especially on the renewal side, you have deals that get pulled in and pushed out, and I saw nothing unusual this quarter. I'll just say our renewals were extremely strong and in Q4 we think our guidance appropriately reflects what we see in the business today and I'm assuming we're going to have a normal quarter exiting Q4 with deals getting pushed and pulled on the renewal side.

In terms of FX, yes FX rates have moved, as a reminder. 30% plus of our revenue is converted from euros and a big chunk of our businesses is in pounds, as well too, they get converted into euros and then dollars. And so, it does have an impact. But we've reflected that in our guidance.

Okay. And if I could follow up Mike, on the free cash flow margins, they've been in the 23%, 24% range in each of last year and this year. I'm not asking you for guidance, but as we look into 2017, are there any variables that you could callout that would enable perhaps you guys to post something higher than that in 2017 outside of normal margin expansion?

We will be giving guidance for 2017 in January. We've given you guys a framework for kind of how we see over time how we will get free cash flow expansion, as well as operating margin expansion based upon our growth rates and where we sit today we think that's appropriate still, and obviously we'll revisit that in January when we give guidance for the full year.

Okay. Helpful, Mike, thanks.

Keith Weiss with Morgan Stanley.

I just want to thank you guys for taking the question and very nice quarter. I wanted to dig into sales capacity a little bit, both in terms of how we should be thinking about adding internal sales capacity into the back half of 2016, and also what type of expansion you're seeing in terms of contributions to [disincentigrative] pace, if you will, that they are kind of expanding their practices around some of these new solutions and how that's helping your go to market strategy?

So in terms of headcount, as we mentioned, we're going to add about 275 people in Q4. The bulk of that is going into our engineering and sales organization. I will say in our sales organization we've been hiring a lot of these product specialists that aren't necessarily quota carrying, but they're helping generate pipeline for our quota carrying reps.

And we will continue to add at roughly that pace through 2017 based upon what we're seeing in terms of pipeline and the way we are converting that pipeline to maturity and closing that these guys have been able to do. So, that's where we are thinking about headcount and sorry, what was your last question?

On the [disincentigrative] side of the equation, what you're seeing in terms of them ramping up their investments around the new products coming out?

This is Frank. We are actually really pleased with the progress that we've made with this year, especially with some of the larger ones like CSC and Accenture, both their internal uptake, as well as their use as practitioners and as MSPs. So we see -- [Dave], we are really a very significant part of their plans and their growth objectives and it's very well cemented in. There was no longer --

Historically a lot of these relationships were opportunistic, something comes up they kind of raised their hand, we'll do it. Now these businesses are so big for these large DSI's that this is now a really managed resource and driven like any other business.

Pleased where is sits, but we still have more room to cover. We'd like to make more progress that IBM for example and there's others out there, but on the whole, one of the reasons that we've driven our own professional services business down as a percentage of your overall mix is to make sure that we really, really create room for a very dynamic ecosystem, because that is what enables the growth of the business.

Thank you guys.

Ramio Lenschow, Barclays.

Hey thanks and great quarter, congratulations.

Two quick questions, first of all on the HR side, you are showing up a lot more on like HR related to consulting work. Can you talk a little bit about how your approach to what's partnering with pure play HR vendors like Workday or Cornerstone will drive you deeper into that vertical?

And then the other thing is on the large accounts side, we hear from some big financial services over [in the middle, also other guides] and when we talk with the consultant, that people see you so strategic that they almost restart the implementaion to kind of get it right, to get all the value out of it. Does that kind of impact your spending habits for while or will it just keep buying new (inaudible) during that process. Thank you.

I wasn't following what the second part of your question was, but let me try to answer the first part on HR. We've had long-standing relationships with Workday and the reason is we're both cloud companies, there's often similar customers that will adopt both Workday and ServiceNow at the same time. There's really good value-added integration between our respective platforms.

We're starting to see more opportunities now with SAP as well. I think we're more on their radar and I see certainly a relationship developing -- a go to market relationship developing there, as well. In general, I think you are correct. We are starting to spike to radar on the HR side much more than we historically have and I really expect that to continue. If you could reiterate the second part of your question now, I will try to address that.

Hey Frank, what I'm trying to see, if I look at the bigger accounts and you might suspect which one I talk about as well, what you do see is that we realize when we put in ServiceNow the first time, we probably took some shortcuts and didn't get the full value out of it. And I've heard from a few accounts that are reimplimenting ServiceNow to just get this full value out of it, does that impact the spending of those customers or are these isolated cases? Thank you.

I understand what you're talking about now. We certainly have customers that have implemented in years past and have come to the conclusion years later that hey, now that we really understand the capabilities of the platform we would have done a whole bunch of things different, and instead of forward engineering themselves, they do a reset and completely get a fresh instance and reimplement right out of the box. It's much faster is much cleaner, and people are much happier with that approach.

This is one of the great things about ServiceNow that you can bootstrap and resurrect a new system in a very short period of time. One thing that I always tell customers is that PowerPoint does not make you a better presenter. And people always laugh when I say that, but what it really means is the software itself can be implemented very well, very poorly, and everything in between. And if on the first attempt to haven't gotten everything out of that you would've envisioned, then there's room up to do better.

One of the key challenges that we have when we work with our ecosystem of integrators in our own professional service organizations is to really drive people very hard towards outcomes. Because if we don't a lot of organizations will implement ServiceNow, and they're very happy. But in reality what they've done is they have modernized, they have put their old system in a new jacket, and it looks different and it feels different. But fundamentally they have not transformed. Everybody is still having the same jobs and they have to preserve the status quo in their existing systems.

That's missed opportunity. So it's very much incumbent upon us to really inspire, there's that word again, to drive our customers to higher outcomes. And really started that in 2016, to be much more aggressive, much more proactive, to get customers to implement with much higher expectations than they historically might have.

IT is a conservative profession. People have a tendency to be very incremental in their approaches, and we as a provider, we try to break people out of that and embolden them in their objectives and their expectation. The software can do it; the question is whether the organization can.

Perfect. Thank you.

Greg McDowell, JMP Securities.

Hello thank you. Just one question, and I know this tends to be a sensitive topic, but we are getting lots of questions from investors about the leaked salesforce.com Board presentation that showed it was conducting some due diligence on a number of cloud companies including ServiceNow. And obviously there's a lot you cannot comment on, but are there any key points at least that you'd like to make for investors around future M&A?

Well, it's Frank, I'm sure you guys know that everybody and his mother maintains presentations like that. Everybody reviews their lists with their Boards that has a conversation about that. We have lists like that as well. You have been able to observe our M&A strategy over the years.

Vendors talk all the time, especially in Silicon Valley. We don't necessarily talk about M&A, but we talk about many different aspects of our business. So, we didn't think this was as eventful as a lot of the industry observers thought that it was.

Thank you.

Derrick Wood, Cowen and Company.

Thanks, I wanted to hit back on sales productivity, which seems to be tracking quite nicely. And I'm just curious if your go to market and pushing outside of ITSM has changed. Is it still kind of a land with ITSM, use that as a springboard to enter a different department our buyer? Or are you finding more success in bringing multiple constituents earlier engagement cycle to sell this broader platform out of the gate?

It's Frank, one thing that's really important to understand about ServiceNow is there is not a hard-line that says it's either ITSM or this other stuff, because a lot of the things that we refer to as emerging products are in effect products that get used with ITSM. ITOM is obvious, but also our analytics process could use with ITSM.

All our business IT business management products are used with ITSM, so in other words, these are value-added software capabilities that people use to enhance their use of the core ITSM applications. The only application that we have that's really distinctively different from our ITSM platform and really has no relationship to the ITSM business is customer service management.

Everything else really falls in the realm of IT management, so you can't draw the hard-line through it and stable this is ITSM and the other stuff is a totally different business. That's not how our customers view it, not the way we view it. We just highlight it, because there's a lot of traction in the revenue in these modules, but ServiceNow is one application, let's not forget that. It's one cloud, it's one database, we just turn on and off different modules, different services and different options.

That's how it works. That's the reason why the selling motion work so well for us, gets this is very low friction to allow customers to take advantage of incremental capabilities.

That may make my next question less relevant, but I was going to ask now with a couple of quarters of new ACV and emerging products at 40% of new ACV, just curious if you are seeing anything different in terms of who your pitted against in the competitive landscape? Anything that you'd call out?

It's not that different from what we've seen before. It's the same legacy group that is trying to slow down their own attrition. On the platform side there's people like salesforce, it really hasn't fundamentally changed. On the customer service side we see a lot of very old legacy systems that we're replacing. We're learning that business now in terms of the type of incumbency that is there an we're seeing really similar things what we saw in the ITSM side, very old software.

Which is a good thing for us, because that means the pressure to modernize and transform is going to be building. On the security side it is a completely greenfield type of situation. People do not have these kind of systems today. So depending on exactly what capability we're talking about it is a different dynamic, but it's really hasn't moved on from where it's historically been.

Got it. Thanks for the color and congrats again.

Kash Rangan, Bank of America Merrill Lynch.

Hello, I wondered what your prediction as to which analyst on this call is going to experience much better IT support quality service in their bank? That's not a serious question. (laughter)

It could be if you choose to answer it. You could say Brent or Keith our Kash or whoever it is. We will do the guessing between each other.

It's not Kash.

It's still in the pipeline, that's good to know. My serious question was, it looks like ITSM had a good quarter based on your percentage of net UACB split. It looks like sequentially it was up very nicely, that had not been the case Q3 this last year. It's also up modestly on a year-over-year basis.

As you look at this bounce back in the ITSM business, what is the right way to think about 2017? Because obviously the percentage of net -- the percentage of your net new ACV coming from non-ITSM will probably likely continue to expand. Is it even fair to expected net new ACV from ITSM system to continue to grow or is it going to sort of flatten out?

And my follow-up question is if it continues to compress, how are you going to be positioning your sales force to sell the HR product? As Frank pointed out, is a completely different sale, by exploring partnerships with the likes of Workday, other HR companies that are complimentary. Are you going to be creating a new separate swat sales organization? Along those lines? Thank you.

A year and a half ago, almost 2 years ago now we created a product line organization to really be able to drive our core focus on different business segments, and obviously that focus has rippled through the entire oil Company, inter professional services into solution consulting.

Our whole Company now drives these individual product lines as separate business, even though our selling missions are altogether for the most part. We are really going to continue to do that, security is going to grow into a full-blown standalone business in the sense that it have its own business development function, its own set of partners in its own unique capabilities. The same is true for HR, certainly is true for customer service. We like that, and we think that the math is there for us to invest at considerable scale. I mean all those businesses can grow to considerable size.

On ITSM, I'm actually bullish on the opportunity that we have there. I think you correctly characterized the growth dynamic this quarter for ITSM, there's a lot of things that are going on that marketplace that I believe will revitalize that opportunity. One of the things that we suffered from as a company is that we had a lot of shiny new toys, and sometimes been hard for us to maintain the vigorous focus on a business like ITSM, which quite honestly, a lot of our people didn't view as sexy as some of the new stuff.

But we have a lot of compelling new capabilities coming out in terms of machine learning and AI, we are going to be releasing comparative benchmarks, people can see how they are doing against their peer group and the rest of the industry. There's a lot going on. The service models are really evolving to heavily machine to machine lights out light speed touch] service models from where people historically have been with ServiceDesk, which are very heavily people-mediated processes. There is an enormous amount of room for innovation and expansion in the world of ITSM, and I think it's been more of an execution issue on our part than it has been a market issue.

I would add to that too, Kash, that if you look at our global 2000 adds in the quarter, 22 of those out of the 23 had ITSM. That's one of the main selling features. If you look at 18 of our top 20 deals, that includes both upsells, as well as new customers. They all had ITSM in them, so it is key to our business.

Abhey Lamba, Mizuho Securities.

As you are adding these product specialists, is it helping with the adoption of some of these new products? And should be expect that trend to accelerate in 2017, as many of these new hires will become fully productive?

I sure hope so, otherwise I will stop doing it (laughter). That is the point, right? We do everything within eye towards how quickly it is developing demand. The demand development is the cyclical metric for our business. We have very good capabilities in terms of converting demand to sales. We have very good abilities in terms of building and deploying capacity, but building demand is the hard part in our business. That's always the critical metric, so everything we do has a focus on that. The specialist allocations, that is completely done to accelerate demand development.

Got it. Mike, can you help us to understand how should we think about your plans to expand gross margins and if single tenant architecture makes it tough to achieve significantly higher margins? As part of that, if you can also discuss what are the advantages of the single tenant architecture that's tough to replicate on a multi tenant environment? Thanks.

I am the finance guy and you're going to want me to talk about the technical differences of our data center architecture?

The margins.

Let me answer the first question is, compute is compute, it's all automated the way we do things. And whether you are a single tenant or multi tenant, you're still going to need the same amount of compute power, and so it's not going to make it difference from a hardware standpoint.

One of the big things though that adds to our cost is, we truly have mirrored data centers where we are on a regular basis failing our customers over from one data center to another to do the maintenance on our databases, which keeps us higher uptime. You've seen the margin expansion we've had -- 84% on a subscription right now, which includes the support organization, and we truly have an enterprise class support organization, that adds a lot of cost.

We've given you our longer term target model there, which you've seen, and we're comfortable with that subscription margin there. I don't think there's really any difference in because of our architecture.

Got it. Thank you.

Keith Bachman, BMO.

Hello, thank you. I was wondering if you could give any general characterizations on, you have a lot of new products out there, if you've thought about attach rates achieved today? In other words if you've thought about the installed base of ITSM over the last number of years? What do you think your are attach rates are achieved in aggregate?

We certainly get some characterization of deals done in the quarter, but it would seem like they're still a long runway to go in terms of opportunity to go ahead and attach to that the installed base established over the last number of years.

Yes, roughly today about 69% of our customer base has two or more products, so there's still room there. But if you look at our corporate analysis you can continue to see our customers year after year by 50% plus their initial purchase.

A lot of that is adding to their existing products they have with more user licenses, and we're seeing more and more now that they're also buying these new products, and that was part of our whole strategy was going to a multi product company that we shifted to in 2015. So I really don't have any more data than that.

Fair enough.

This is Frank, I think that's a very important angle that you've got to keep your eye on, because our whole game is to drive attach rates up for all our products. And we have incredibly long ways to go for all of our product.

Even in our existing products just to get to attach rates where we start to rifle the penetration that we have on the core platform, it is going to take years and years and years for us to get there. So, a lot of upsell opportunity. And Mike's right, is that the core analysis shows exactly that. So this is a big opportunity that is going to play itself out for years to come.

Okay great, if I can ask a follow-up question from your Frank, just from one of the previous questions. It sounds like you think net new ACV, even on the ITSM side, as you guys look out over the next year and calendar year 2017, it sounds like you would expect, without putting numbers on it, but that can continue to grow as we look into calendar year 2017. Is that the conclusion from an answer to a previous question?

Yes.

Okay great. Thanks very much.

Alex Zukin, Piper Jaffray.

Hey guys, congrats on a great quarter. First one for Mike.

Can you categorize how you're feeling about the start of 4Q maybe how 3Q started out? And then Frank, maybe just on the macro, it's been a volatile year, how are you thinking about the macro environment today versus the beginning of the year and has the volatility actually created increased demand for this?

I will start with, we just gave guidance for Q4 and our Q4 guidance is based upon where we see our business for the quarter, and we are off to a very good start and I'm pleased with it. I don't really have much more to add to that.

This is Frank, I don't have any real color to give you on the macro either, I think it's reasonable. We're obviously much more of a secular play.

We think that we can still sell quite effectively when the macro is turning not so favorable, and the reason in we're not a transformational play, we are an optimization play. I sometimes can't determine whether I am dealing with macro or micro or secular influences, so it's hard for us to have a real intelligent commentary about what the macro is and isn't, because we sell right through that.

Thanks, guys.

Jesse Hulsing, Goldman Sachs.

Thanks for taking my question. Frank, you mentioned verticalization on the sales side as part of your plan for next year. I'm wondering what your plans for that are on the product side. You've done a good job of pivoting your platform horizontally to date. Do you plan to more heavily verticalize your platform with new products, or is that something you expect to let your integrated partners run with? Thank you.

No, we are going to do that. The verticalization, the first place you're going to see it is really on the marketing side, especially on the product marketing side because -- and then the sales enablements will follow. In other words, how are our salespeople methods position and present themselves in the contact of the industry that they are selling into?

We have such critical mass in every major vertical that there isn't a huge amount of value for us to exploit, and it's just low hanging fruit. It's just, in other words, we've just got to take our learnings across the big pharmas, across the big retail, everything that we've learned and diversified, industrials, and really use that in our selling motion.

Now as it evolves, it is quite possible that we have products that are industry specific. That we will not start off that way, but I think the deeper and better we get at this, it's quite possible that we get industry-specific products at some point. Healthcare is another one of those areas, state and local, federal. There's a ton of opportunity, I am super excited about what we're going to do in this area.

Perfect, thank you Frank.

Ladies and gentlemen, this is all the time we have are questions today. So at this time I am now going to hand the call back over to Michael Scarpelli, Chief Financial Officer for closing comments or remarks. Sir?

As a reminder, a replay of this call will be available as a webcast in the investors section of our website. Thank you for joining us today.

Ladies and gentlemen, thank you for your participation on today's conference, this does conclude the program and you may all disconnect. Everyone have a wonderful day.