ServiceNow Inc (NOW) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 ServiceNow Earnings Conference Call.

(Operator Instructions) As a reminder, today's conference is being recorded.

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

Sir, please go ahead.

Thank you.

Good afternoon, and thank you for joining us.

On the call with me today is John Donahoe, our President and Chief Executive Officer.

Our press release, 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 in documents filed with the Securities and Exchange Commission, including our most recent quarterly report on Form 10-Q, for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such forward-looking statements.

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

Thanks, Mike.

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

We reported another strong quarter today.

Our consistent performance underscores our strengths.

We have a leading cloud-based platform with innovative technology and an expanding set of product capabilities.

We have a strong customer-focused culture that our customers recognize and our employees and customers value.

And we have a global footprint and an expanding partner ecosystem.

The result is steady growth of new customers and a consistently high renewal rate.

And our strong growth in net new ACV through upsells is driving deeper enterprise integration and expansion of our capabilities.

With leading companies across diverse industries, we're becoming a more relevant strategic partner to their digital transformation.

Our top 2 accounts now exceed $15 million in ACV, and we now have more than 400 customers doing more than $1 million in ACV with us, including 32 hitting that number in Q2.

When I spoke to you last quarter, at the time, just 3 weeks into the job, I shared that my top priority was listening and learning from our customers.

That has continued to be my focus.

Customer listening and learning are constant operating motions deeply embedded in our ServiceNow culture.

We listen, build what our customers want and need and learn from their experiences.

And then we repeat that cycle over and over.

ServiceNow founder, Fred Luddy, set that tone from day 1 with his vision of enabling regular people to route work effectively through an enterprise.

And our opportunity to fulfill that vision is greater than ever.

I met with 100 customers in my first 45 days, and I then had the privilege to be with more than 15,000 customers and partners worldwide at our Knowledge17 event in May, which was our biggest Knowledge yet.

Knowledge17 was extraordinarily energizing, with companies such as GE and Novartis sharing how they are using ServiceNow to transform their businesses.

Spending the week engaging with our customers, partners and developers further elevated my excitement about being part of ServiceNow as we create our next chapter.

The world is at an inflection point of intense digital disruption, which necessitates that every company focus on digital transformation.

Every company I talked to is experiencing this.

For IT organizations, CIOs and C-suite leaders grappling with these changes and challenges, we intend to become an indispensable enterprise cloud partner and helping them create the future of work.

During my conversations with customers, I'm asking 3 simple questions.

How are we doing?

Where can we get better?

And what are your biggest priorities?

Let me quickly recap what our customers are telling me.

First, our customers absolutely love our products and platform.

And they appreciate how we work with them and do business.

ITSM has been a game changer for our customers and they want to do more with us.

That's reflected in our Q2 renewal rate of 97.7%.

We have a strong foundation.

And as I discussed in my keynote at Knowledge17, our customers want us to continue to lead and innovate with best-in-class out-of-the-box integrations and configurations and with more consumer-like end-user experiences.

And they want to hear more from us about our road map and product vision.

These are priorities for us: creating best-in-class customer experiences, improving our end-user experience and driving customer success.

We're already increasing our investment and management focus in these areas.

We are also committed to developing a robust, highly skilled partner ecosystem.

As I've said before, many of the world's largest systems integrators are rapidly investing in ServiceNow's ecosystem.

And our partners are critical to the success of our customers, and therefore, to our collective future.

Increasingly, we're being leveraged across the enterprise as customers pull our platform and multi-product capabilities into HR, Customer Service Management and Security.

In Q2, 58% of our net new ACV came outside of ITSM compared with 40% a year ago.

And today, 3 out of every 4 customers license more than 1 ServiceNow product.

Our newest products helped drive our strong Q2 results and are being recognized as best-in-class.

For example, our HR product addresses a key customer need, which is complementary to leading HCM vendors.

This product drove the acquisition of a significant new customer in Q2, a leading airline, with net new ACV of almost $3.5 million.

And our HR product also resulted in net new ACV of almost $2.8 million with one of our largest existing customers.

Our Customer Service Management product also is demonstrating great momentum.

In Q2, for example, a leading provider of health care technology became a new customer with net new ACV above $1 million, solely with Customer Service Management.

In addition, the product debuted in Gartner's Magic Quadrant in Q2 and was named by Forrester Research in its Forrester Wave for Customer Service Solutions.

That's tremendous recognition for a product in its first year.

As we continue to evolve, we also continue to innovate.

We ended Q2 with the completion of our Jakarta release, which is now generally available.

As we demonstrated at Knowledge17, Jakarta delivers significant performance and user experience enhancements.

We continue to be strongly committed to building on our leadership position in ITSM and ITOM as well as expanding our capabilities for HR, CSM and security.

Our Jakarta release also builds intelligent automation into our platform, bringing machine learning capabilities to all of our products and all of our customers for their everyday work.

We're solving real challenges for enterprises today while also enabling their transformation to a digital future.

ServiceNow facilitates new ways of working, driving greater efficiency and productivity.

And that, in turn, creates real business value and opportunity for our customers.

In closing, we see tremendous opportunity as we drive deeper engagement with CIOs and C-suite executives, increasing our relevance across the enterprise.

I'm incredibly proud to be part of this organization.

And we intend to continue to serve our customers, partners and employees.

I look forward to continuing our progress and momentum.

And with that, I'll turn the call back over to Mike.

Thank you, John.

During today's call, we will review our second quarter financial results and discuss our financial guidance for Q3 and full year 2017.

We'd 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 and revenue growth.

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.

Total revenues for the second quarter were $472 million, representing year-over-year growth of 38% and an adjusted growth of 40% or an impact of $7 million.

Total billings were $505 million, representing year-over-year growth of 35% and adjusted growth of 38% or an impact of $12 million.

Subscription gross margin was 85%.

Professional services and other gross margin was 37% and overall gross margin was 78%.

Excluding Knowledge17 revenue, our professional services and other gross margin was 12% and overall gross margin was 78%.

Operating margin was 14% and free cash flow margin was 20%.

We ended the quarter with $2 billion in cash, short-term and long-term investments.

In May, we issued $782.5 million of 0% convertible senior notes due in 2022.

The primary use of proceeds is to refinance our existing $575 million of 0% convertible notes due upon maturity in 2018.

In conjunction with this offering, we purchased a bond hedge and sold warrants to eliminate shareholder dilution up to a $203 stock price.

If the stock price increases above $203 warrant -- the $203 warrant exercise price, only the incremental value above $203 will be dilutive as we plan to settle the principal in cash.

Let's turn to guidance for the third quarter and full year 2017.

For the third quarter, we expect total revenues between $488 million and $493 million, representing 36% to 38% year-over-year growth and 36% to 37% adjusted growth or a $3 million impact.

We expect total billings between $540 million and $545 million, representing 34% to 35% year-over-year growth and 34% to 36% adjusted growth or a $3 million impact.

We expect an operating margin of approximately 17% and diluted weighted average shares outstanding to be approximately 181 million.

For full year 2017, we expect total revenues between $1.901 billion and $1.911 billion, representing 37% year-over-year growth and 37% to 38% adjusted growth or a $2 million impact.

We expect total billings between $2.271 billion and $2.281 billion, representing 34% to 35% year-over-year growth and 35% adjusted growth or an $8 million impact.

We expect subscription gross margin of 84%, professional services and other gross margin of 15%, total gross margin of 77%, operating margin of 16%, and free cash flow margin of 25%.

We expect diluted weighted average shares outstanding to be approximately 179 million for the year and now expect to add approximately 1,300 net employees in 2017.

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

(Operator Instructions) Our first question comes from the line of Matt Hedberg with RBC Capital Markets.

John, the mix of new ACV from non-ITSM and ITOM products, I believe, is a record of 39% versus, I think, what it was a record last quarter of 34%.

And in your prepared remarks, you talked about Security, HR, Customer Service deals, but it really was that $1 million plus Customer Service Management win that was really interesting to me as a new customer win.

Can you give a little bit more detail on why they chose ServiceNow versus other vendors and how they think about expanding into other areas of your platform?

Sure, Matt.

The -- well, obviously, Customer Service Management is a huge market.

And the area where our product is -- has a real sweet spot is in situations where a customer is dealing with a large volume of inbound contacts and/or that they've got to deal with root causes to reduce the human interaction.

So the kind of situations we're strong at is when you take those high inbound volumes, much like you get inbound incidents to an IT helpdesk or HR case management, you get high inbound volume and you want to automate how you respond, creating as much self-help as possible.

And the way you do that is to get to what the root cause of the -- root cause of the inbound incidents are.

And so our product is very well suited to that to help identify what the root cause is so that you can then remediate without a lot of expensive human interaction.

And so that's the kind of use case where our product plays well, and it's turning out to be an entrée point in the commercial market in many products -- in many customers and in this case, in the enterprise market.

And then as you know, once we've sort of landed an account, the opportunity to expand laterally into our other products is much easier.

So it's, in many ways, using the same functionality we have in our other products applied to a CSM use case.

That's great.

Maybe just a quick follow-up.

You guys made an acquisition of Qlue, kind of building on the DxContinuum acquisition.

Clearly, customers are asking for more machine learning capabilities, intelligent automation, predictive capabilities.

But I guess can you help define how this functionality helps with new wins and maybe the monetization effort of that?

It's -- what's interesting is what we hear from both existing customers and new customers are that there's just a -- there's a huge amount of new technologies out there.

And they're having trouble keeping up what are the ones they need to pay attention to, what are the ones they need to be building themselves.

And what we're saying is that there's a certain functionality that we will take responsibility for accessing and acquiring and make it easier for them to use.

So machine learning, we started with DxContinuum, where we bought DxContinuum and we're integrating machine learning into our platform so that all products and all customers can access it.

And therefore, the customer only has to worry about using their data.

They don't have to worry about acquiring their own machine learning capability.

Virtual Agent technology, which is the way to obviously automate and streamline a response, whether it's an IT response, an HR response or a CSM response, is another technology.

And by buying Qlue, we'll sort of repeat that same formula of replatforming it into our platform, recoding it into our platform and making it available to them so they don't have to buy their own chatbot capability or other Virtual Agent capability.

And we'll continue to do that.

We're looking at a number of other technologies, all of which I characterize as being complementary to the core thing we do, which is helping them automate their workflows, improve the ability to have self-help and provide better experiences for their employees and customers.

And our next question comes from the line of Rob Owens with KeyBanc Capital Markets.

Given some of the volatility you've seen over the past couple of quarters and your sequential ACV growth for G2K customer, can you just speak to the dynamics of customer acquisition and what it's contributing and how follow-on plays out?

Because your customer acquisitions obviously had been running well ahead over the last couple of years.

But we've seen that variability, I guess, in the ACV numbers.

So any color will be appreciated.

Yes.

So Rob, it's Mike here.

So if you recall, when we laid out our model, that 4% is an average growth quarter-over-quarter.

Obviously, it's not the reality of the world.

This is not a spreadsheet that it continues to grow through 2020 at that.

We do see seasonality.

You saw that last year.

Typically, the second half of the year is a much bigger upsell quarter.

So we do expect that the second half of this year, and we see that already with a number of contracted upsells that have closed already as well as what is sitting in our pipeline of opportunities that are heavily weighted towards upsell.

So I feel very good about that number still.

The other thing that weighs down upon that number when we came up with that 4% 3 years ago that was based upon adding 20 Global 2000 per quarter, we continue to add well above that.

And if you remember, our average Global 2000 we land typically is much lower than what people think.

If you look at last quarter, it was 300,000.

The quarter before, it was 200,000.

And that is very typical.

And it's once we land them, then they continue to grow from there.

So we feel very good about what we're seeing there.

Is there any different dynamic given your -- a lot of the incremental Global 2000, obviously, are likely to come out of APAC and other versus your penetration in North America and EMEA, which are both 50% or greater at this point.

Is there a different ACV that you experience with APAC and other geos?

No.

And I actually already closed 2 Global 2000 this quarter in APAC that are greater than the average of our Global 2000 today.

And our next question comes from the line of Keith Weiss with Morgan Stanley.

A question for John.

When you talked to us at Analyst Day, you were basically talking about [this], and my #1 job here is listening.

And you've done a lot of listening talking to a lot of customers.

Is this still too soon to be thinking about any changes that you want to make to a certain distribution or how you guys are planning on go to market from what you've learned?

Or is it just sort of you guys are operating pretty well as is so you're going to let well enough alone in the near term?

Well, Keith, I think -- I don't know if you'd characterize this as go to market.

But we are increasing our focus on the full customer life cycle, right?

We have a world-class sales force and a world-class go-to-market motion.

And I don't see any need for significant change in that.

In fact, I really admire -- I'm struck by how nicely our sales team has layered in product specialists and layered in the industry focus as well as continue to recut territories to serve customers and more deeply penetrate in our sort of presales through sales motion.

The area where we're increasing our focus is in the sort of full customer life cycle, post-sale all the way through renewal, where what I heard from customers was help me implement and help me get maximum value out of the product and then help me translate that into business value that we can demonstrate.

And the interesting thing is our products do drive real business value, right?

We automate workflows, which is the sort of at the root cause of productivity.

But what we are going to do is put a little more focus on customer success so that we're capturing and documenting and codifying the business value that gets created, which helps a CIO or an IT department within their organization demonstrate the value they are driving inside their company and frankly helps us on upsells, on price realization and on landing new accounts.

So I'd say the more focus on the full customer life cycle, particularly post-sale through renewal.

We already have a number of things going on there, but we're going to try to bring them together in a more cohesive and powerful way, both presale and post.

Excellent.

And if I can sneak in one follow-up.

We heard a lot last year about sort of increasing partner commitments, if you will, and more partners coming to the ecosystem.

Is it too soon to be seeing the results of that -- of them sort of driving more business for you guys?

Is that still in development?

Or are you starting to see those results?

Both.

I think I'd say we see some results but our partners are clearly playing a very important role in influencing deals, particularly with G2K customers.

We think roughly 2/3 of our net new ACV was influenced by partners.

Roughly 1/3 was sourced by partners.

And so we're already seeing that impact.

And certainly, our top partners are quite important partners.

That said, I see -- I was meeting with a CIO of one of our top partners this morning in our EBC.

And as we talked, it feels to me like there's still opportunity where we can more comprehensively and effectively work together to both bring our joint products to market.

Every company is struggling with digital transformation, and that takes both great software and great process reengineering support to sort of implement it.

We can -- we're talking about even tighter collaboration on product development and sharing R&D and road maps together.

And so I feel like there's still additional opportunity to get even more mutual benefit out of our top partner relationships.

And our next question comes from the line of Kirk Materne with Evercore ISI.

John, you mentioned a couple of the bigger HR wins this quarter.

And it seems to us that more of your customers and partners are talking about your HR onboarding offering.

And I noticed know you all are also a Diamond sponsor at the HR Tech show this year, which would seem to indicate you guys want to get the message out there.

So can you just talk about the opportunity you see for ServiceNow around the HR function?

And what do you think has to happen to sort of realize that opportunity?

And then just a really quick follow-up for Mike.

Mike, obviously, a really good quarter.

But you also took up guidance for the back half of the year, which would seem to indicate you feel good about the trends heading in the third quarter.

Is there anything else we should sort of read into the guidance going up for the back half of the year from a billings perspective?

Yes, Kirk, on your first question on what you described as HR, here's what I see.

And I think we're experiencing it.

The change is that virtually every company and every CEO is making modernizing the employee experience a priority, right?

Millennials are demanding that they get the same kind of experiences at work as they're getting at home.

And so almost every company is saying, how can we provide a more compelling employee experience at work?

And that's the macro trend that's creating the macro demand.

Now what's interesting when you think about it as employee experience, employee experience is a lot more than just HR.

It's their full end-to-end experience.

And that's where we excel.

So take employee onboarding.

Employee onboarding is a multidepartmental experience, right?

It touches -- you got to get your badge from facilities.

You got to get your desk -- or sorry, your badge from security, your desk from facilities.

You got to get your laptop from IT.

You got to deal with finance.

You got to deal with compliance.

You have to deal with HR.

So it's more than just an HR experience.

It's the full end-to-end experience.

And that's where our platform and our capabilities are really strong.

Same thing with HR case management.

Same thing with employee portal, which is, by definition, a multifunctional portal.

And so our sweet spot is something that can help drive end-to-end good experiences, workflows, the way we talk about it, to improve the employee experience.

And so that's what driving really strong demand for our HR products and we think that's going to continue.

And I'll note, as I have several times, that is very complementary with what the HCM providers are providing.

It's not in competition with them but very complementary to provide the best end-to-end -- working together, we provide the best end-to-end employee experiences for our customers.

And then, Kirk, on your question with regards to billings.

The uptick in our billings guidance for the full year is really a result of the overachievement in our net new ACV in the quarter coupled with the opportunity we see on the subscription side.

FX also impacted that very positively.

You see where the euro was at relative to where it was when we gave guidance last quarter.

But on top of that, there is a negative headwind that we did take down our professional services slightly by about $6 million in revenue, which directly flows through the billings.

And that's really more because, as we've talked about quiet some bit for the last couple of years, we're really shifting more of our professional services, the implementation work, to our GSIs and partners because we really want to focus more on the high-level solution architect, the deployment of our new products and training.

And our next question comes from the line of Walter Pritchard with Citi.

A question for John on -- just on M&A.

The company's been very, I'd say, measured in acquisitions that have been done.

And I'm wondering, you've been -- you have a quarter under your belt.

Is there a need in some of these markets?

It feels like your priority has to be on driving the broader opportunity.

Is there a need to extend that M&A activity as you look at some of these markets that are maybe further afield from your core and IT and you might want to jumpstart or otherwise accelerate the efforts there?

Walter, I think one of the real strengths of the company has been this practice of taking literally virtually every single acquisition and recoding it into the platform so that we do have one platform that all applications and all customers can pull from.

And the thing that's striking about this company is the organic innovation that we've been able to pull off.

And so whether it's the new products around ITOM, around HR, customer support and security, the organic innovation is what's driving our growth.

And that is enhanced by having one platform.

When you have multiple platforms, you get more complexity, you get less organic innovation.

And so I think this formula of saying let's look for acquisitions that may bring a functionality of capability such as machine learning or Virtual Agents or the iTapp capability that we're now using in Cloud Management, bring those in, recode them into our platform so they're natively available, which then drives a very high organic innovation flywheel.

And as long as that's working, there's no need to disrupt that momentum.

We feel like there's very good growth opportunity with our existing application set.

The other interesting thing is we've got a whole host of applications or a whole host of use cases where customers are already using our platform on workflows and use cases that we don't have an out-of-the-box functionality with.

And we will, over time, evaluate which of those we want to bring into our core product line.

And so I see a pretty strong innovation pipeline that's not dependent upon M&A.

And our next question comes from the line of Abhey Lamba with Mizuho Securities.

John or Mike, I have a question on customer feedback on the Jakarta release.

What type of feedback are you getting from them?

What are the kind of features that partners and customers are most excited about?

And in particular, if you can talk about the adoption.

Are you expecting the adoption of Jakarta to be faster or slower than the previous releases?

Well, the first thing we should say, it was only released, generally available last week.

So the -- but clearly, the feedback from Knowledge and since then has just been very, very strong on a number of dimensions, whether it's the enhancements that Ferrell made to ITSM to make the preconfiguration that makes integration and upgrades more easy and allows faster time to value or additional functionality like Software Asset Management or Cloud Management that's being released with Jakarta, 2 new products, great examples of organically extending our platform to address a key need in our customer software -- they're having an explosion of different software inside and managing that software.

Tracking and managing is a key need, and our software management, asset management product does that.

And then they've got multiple clouds.

And how they manage the cloud is a growing and new and emerging need, and our Cloud Management product and Cloud Management capability is helping to address that.

So there are a number of both, I'd say, refinements to existing products and new features and functionality in Jakarta.

There's a lot of excitement about it.

But they're -- to be honest, they're just now upgrading and implementing them.

And we'll be very aggressive at ensuring that our customers get real value out of those.

Anything you'd add, Mike?

No, I'll just add, remember, we deal with very large enterprise customers.

And feedback on new release is generally when they adopt a new release, they put it into a test environment to make sure they test out everything before they go live.

So it generally takes a number of months after the release before we get real feedback.

I will say, just internally, Software Asset Management is one that interests me.

We adopted that within the first couple of weeks doing -- we had a software audit.

It came in and saved us.

We're a small company, $150,000.

So I was pretty pleased with that because I -- if we weren't using it, I don't think we would have saved that at all.

We are already seeing -- in Software Asset Management, we've seen a $500,000 deal for that.

So I'm pretty excited about that, and I'm excited about what we've done with both the Security Ops with the trusted circles as well as the BrightPoint acquisition is now native, and we talked about that at our users' conference, but also what we're seeing in HR and the improvements we've done there and the fact that in our CSM product we now have communities inside there built into that.

So a lot of excitement across the board with our entire portfolio.

And our next question comes from the line of Justin Furby with Wells Fargo -- with William Blair & Company.

I guess a couple for me.

First, either for John or Mike, I was hoping you can unpack the 39% ACV a little bit.

You've got a number of products in there, HR, Security Ops, [CX] and others as well.

I'm just wondering if there's any one that dominates that in terms of what you saw in Q2.

And if you look at the pipeline, it was pretty balanced.

And then specifically for Software Asset, you just mentioned it Mike, where will that go in terms of these different buckets?

And what does the pricing look like for that?

And then I've got a follow-up.

So we continue to see strength in all of our emerging products, as John called out.

HR was a very, very strong quarter for us and I would say second followed by customer service.

ITOM was a very big quarter.

I know you're not calling out that.

We're very pleased with what we saw with ITOM.

And then I would say third was customer or Security Ops.

With third, we continue to see a lot of excitement and pipeline built within the Security Ops product.

But HR and CSM are driving bigger deals for us.

In terms of Software Asset Management, that will be disclosed as one of our emerging products, that other going forward.

And the pricing on that is really based upon the number of servers that you have out there.

And that was really -- yes.

Super helpful.

And then on the guide for Q3, it looks like -- particularly on subscription billings, it seems abnormally strong from a sequential standpoint.

I think you're guiding for something like 8% growth.

And last year, I think the guidance was more like 2%.

You talked a little bit about this.

But is that just abnormally strong start to Q3?

Is it timing of renewals?

Or what else is there to think about in terms of seasonality?

And that's it.

It's both.

It's a lot of backlog, not just renewals that is going to be built, as well as the strength that we see in our pipeline of opportunities.

And our next question comes from the line of Raimo Lenschow with Barclays.

A question for John.

Now that you had a good few months in the company, and if you look at the vendors, like it's the highest renewal rate I see in SaaS.

It's very, very strategic.

What is the feedback that you get from talking to all the guys that are in the industry that are not yet customers in terms of if you have engagement with them, like what are they thinking about you versus other guys?

And what's kind of the dialogue that you have around that one?

And a quick question for Mike then is if I look at the -- in Q2, you did beat us quite a bit on operating margins.

And then in Q3, it was slightly lighter.

Was that a timing thing in terms of cost, et cetera, that we should be aware of?

Well, Raimo, I sort of struck 90 days in on sort of 2 levels about what customers and as you say, not yet customers.

Obviously, within every IT department, ServiceNow is very well known.

And for those that are not yet customers, often, they either have a renewal of their existing provider that's coming up, and I think we'll have an at bat, if you will, on almost every one of those cases, or they haven't yet gotten to using software to structure unstructured workflows.

And the impetus is on us to demonstrate to them the business value and productivity value that they will get from using our ITSM and core IT products.

And so I think we continue to add new logos simply because where we do focus our energies and effort, we are successful at penetrating.

The other observation I'd make is outside of IT and in the C-suite.

In some way, ServiceNow is one of the best-kept secrets of the world and that our brand awareness outside of IT is not what I think it can be.

And in particular, as I said earlier, the brand awareness of how we drive business value, how we drive productivity, how we drive an enhanced and improved employee experience, how we drive improved end customer experiences where our platform is being exposed to end customers, that is, I think, an opportunity for us to raise our visibility and raise our awareness.

And it's one of those wonderful situations where the substance is ahead of the perception.

And so I think one of the things we're going to be doing is trying to bring the awareness and perception in line with the substance.

And I think we've -- we'll -- when people understand what it is we do and what it is we can do and how it can drive business value for them, the -- all it will do is enhance what is an already strong sales motion.

And Raimo, that ties in partly to the answer to your question.

So the first thing in Q2, we did have overachievement on the operating margin.

That was partially due to timing of expenses but all -- namely some of the linearity within the hiring, but there were also some expenses that got pushed out into Q2.

But we did make a decision, and this is part of the thing that John just talked about, we are going to try to elevate our brand awareness at a company level as well as at a certain product level with some of our emerging products because we see the opportunity.

And that's reflected in our operating margin, which is still within the guidance that we gave for the beginning of the year.

We're still confirming 16% operating margin for the full year.

And on top of that, we've also -- we're adding more employees, too, as we're seeing the opportunity to invest more heavily, both in our sales organization and sales and marketing, to go after these opportunities that we're seeing.

And our next question comes from the line of Sarah Hindlian with Macquarie.

John, the first one for you.

You're seeing a lot of strength in your Forbes 2000 adds.

Another 29 this quarter, which is up year-over-year and sequentially.

And it looks pretty good across the globe.

But I wanted to dig in some of the original performance and what you're seeing in the pipeline in both Europe and Asia Pac.

And then, Mike, I wanted to follow up with you on 606.

I'd love to hear where we are and what we should be expecting from you on that accounting change.

So actually, Sarah, I'm going to jump in right now kind of on the Global 2000.

But yes, we had very -- we had very good strength across the Global 2000, 29.

We continue to see in our pipeline a large pipeline of new opportunities.

But in the past quarter, Asia Pac was a little light on landing new Global 2000.

However, as I did just mentioned, we did have 2 that closed already quarter-to-date this quarter.

So you do see variability.

I can't stress enough, these Global 2000 sales are extremely long sales cycles.

We see that globally, and that's not unique to any one region.

As an example, we landed 2 Global 2000s this past quarter that were -- as new customers that were 5 plus years sales cycles.

We upsold another Global 2000 where we finally got the mothership that they're committed to land.

Once again, that was a 4 plus year upsell.

They were a very small customer and they're now continuing to grow.

So I'm not concerned about the strength in Global 2000 adds in any one geo and any particular quarter, looking at it more in an annual basis.

And we do see very good distribution, both historically and what's in our pipeline going forward.

And the thing I'd just add to that from more of a macro perspective is one of the things that we look at is cloud adoption.

Cloud adoption differs by country.

And so there are a couple of markets that are enormous markets where cloud adoption has been a little behind but is now beginning to kick in, Japan being one of them.

It's a huge market.

Cloud, a little bit more slowly adopted.

Now we're beginning to see it's more common among the large Japanese, multinationals and leading companies to be embracing cloud with some of the same fervor that's being done in the U.S. and other places.

Similarly, Germany.

Germany is a huge market for a lot of very large companies.

And cloud adoption, Germany has been just a little bit more slow for all sorts of reasons, privacy, security and others.

But we're beginning to see some early signs there, that market moving along a little bit.

So I think that's another positive indicator around the -- on the global expansion horizon as more and more countries begin embracing cloud with the same vigor that the U.S., U.K. and others have.

And then on the second part of your question, Sarah, on 606.

I did spend quite a bit of time at our Financial Analyst Day going over 606 in May.

I was not planning on getting any update right now.

We continue to move through with the adoption of that.

And in the October call, I'll update people on the impact of that.

And our next question comes from the line of Karl Keirstead with Deutsche Bank.

Mike, a question for you on free cash flow.

I remember super strong in Q1.

You warned us all that, that was a little bit of an unusual cash flow generation quarter.

But 2Q, solid as well, actually.

And through the first half, you're now running at 28% free cash flow margins.

Your full year guide is 25%.

So what would cause the free cash flow margins to compress in the second half given that your operating margins should likely be up year-over-year?

So believe it or not, Q1 is generally one of the strongest quarters.

And if you do look at our investor deck, which was posted, that we did go over with you guys at our Financial Analyst Day, Page 20, Q1 is so high because of the amount of contracts that we have that start on December 31 through January 1. So the cash flows through in Q1 when you do that billing.

Yes, Q4 is a strong quarter.

Q3 has a negative impact of the employee stock purchase plan because we use a fair bit of cash that we've collected in the previous 6 months that goes out.

That's probably the biggest impact.

And as a reminder, we did tell people for the full year, if we are on high growth, we're going to add 0% to 1% in free cash flow margin.

And we're continuing to deliver above that this year.

And our next question comes from the line of Michael Turits with Raymond James.

I'd like to drill down a little bit on Keith's question about go to market and then your need for change there.

I know that you said that you're in pretty good shape.

But there have been a really big expansion in the amount of products and in the areas in which you have products, including in areas like infrastructure where you're doing more automation.

So what makes you feel that you have the right structure, exactly what is it?

And how do you scale out and broaden the scope such that you can make sure that you deliver all those products and sell them?

Well, Michael, maybe both of us can comment on this.

Different points of view because, I'll just say, as a relative newcomer, it's not that we -- I don't think we have it all figured out.

But I'm really impressed with Dave Schneider, Kevin Haverty, our sales leadership team, of how they're continuing to evolve it each year.

And they're evolving it by, as I said earlier, adding product sales overlay, adding some of the verticals, how they're expanding geography.

And they're doing it in a way where customers don't see a lot of dislocation.

And that's not an easy thing to do.

The other thing that's striking to me is that as we get larger, it's allowing more focus on our customers.

So we have 2 huge wins.

The 2 large wins in Q2 were, as Mike said, things that took many years.

And we went back and asked the rep, 3 years ago, how many accounts were you covering?

And in both cases, they were covering 60 to 80, somewhere between 60 and 80 accounts.

And both cases, those were very same reps.

This year, we're only covering 10 accounts.

And what that allows them to do is to walk the hallways.

Even if it's a nonpaying customer, it's a potential customer.

They're walking the hallways.

They're understanding those customer's needs.

They're demonstrating our capabilities.

They're building relationships.

And so the value of scale is allowing a greater customer focus, which helps with existing customers as well as helps us penetrate new large customers because we simply have more sales time per customer.

And so I -- we will continue to evolve more in '18, '19, '20 as we grow our product portfolio and grow our scale.

So I think what I was commenting on earlier is just that dynamicability to do that in a way that deepens the relationships and does not create discontinuity is what's certainly striking to me as impressive in my early months.

I would echo what John said.

And what I would also say is that obviously, what we've been doing has been working as you see the expansion outside of ITSM and our emerging products.

We will -- obviously, we continue to look at this.

They may be more vertical focus later on down the path.

But we don't expect any changes in 2017.

And our next question comes from the line of Greg McDowell with JMP Securities.

Two quick questions.

First one is if you can provide any color on sort of commercial sales team performance versus the enterprise sales team performance.

And then one quick mechanical question, Mike.

I noticed there's an uptick in the contract term length for new customers.

And I was just wondering if there's anything behind that.

So we had very good performance of the commercial team.

The commercial team, I think, hit 106% of their number.

We had a very good quarter, as I mentioned.

The overachievement in our new net ACV is kind of what's driving billings.

So we're very pleased with what we're seeing across the board, both enterprise and commercial.

On your comment on average contract term, not that much to read into that other than we did -- it was a very strong Global 2000 quarter with 29 that we added.

The G2Ks tend to like longer-term contracts to lock in pricing for a period of time.

As a reminder, we do try to incent our sales force who sell a 3-year contract.

We've had quarters that have kind of been in that 33 before.

I don't find it that unusual, the 33.9.

And our next question comes from the line of Sterling Auty with JPMorgan.

JPMorgan.

Just one quick one.

I missed it when you said it.

But any color that you can give us in terms of the experience in demand by vertical industry in the quarter, and specifically government as we head into the government's final fiscal quarter?

We saw strength across the board, financials.

We saw it in the health care.

We did some very nice government deals this past quarter.

So no one industry to call out.

Well, I would say it was strength across all.

And our next question comes from the line of Kash Rangan with Bank of America Merrill Lynch.

Pardon the directness of the question.

With the mix of business, the way it shipped out the non-ITSM, was it as you expected going into Q2?

And if so, are you -- what does the sales pipeline of potential new business look like?

Does that reflect the change in your business mix?

Maybe if I'm overthinking this, do you expect, conversely, ITSM to rebound?

Because I think there was at least one quarter last year when ITSM was a little bit sluggish.

And if I remember, Frank said that it's going to bounce back and it did.

I'm wondering which of the 2 ways to interpret the mix of results because if it is the former, I believe that the value drivers for ITSM are very different from the value drivers for non-ITSM.

And therefore, the -- what we have come to depend upon the predictability of a replacement cycle of old Service Management systems, that gives way to a different kind of missionary sales, increasing mix of your business from missionary customer support, analytics, HR, et cetera.

So that's the case.

Sorry for the complicated question.

But if that's the case, then how are you going to be thinking about how you organize your sales force?

Because the selling skills and the motions are very, very different.

Sorry for the long-winded question.

Thanks, Kash.

So first of all, those percentages are of ACV.

We're actually not telling you what the actual ACV is.

And what I will add is of the 29 Global 2000, 28 of them were ITSM.

I can't stress enough, ITSM is what lands us in the door.

And once we get into ITSM, then we're able to upsell.

And we are continuing to see strength in ITSM.

We -- if you look at our Jakarta release, we're very focused on a lot of the enhancements we're doing within ITSM.

But I don't disagree with you on value.

The IT is a very different value than HR and customer service.

And we are seeing we can extract more value on the HR and customer service.

But if you don't have ITSM, you don't have that opportunity.

So we do see a very good pipeline of opportunity in the second half of the year across the board.

I do expect the emerging products, as you'd expect, we're investing heavily in these, will continue to grow at a bigger pace than the ITSM.

But we are seeing growth in ITSM, and ITSM is the bulk of our revenue today and will be the bulk of our revenue for quite some time.

And Kash, what I'd add to that, and it's striking to me, is that when you actually get inside these customers and talk to them, they view us as a platform.

I mean, this is where -- this is not a series of disparate products that are unrelated to one another.

They -- and many, if not most, cases have embraced our platform.

And even though the decision-maker in HR, HR product or security or CSM is not the CIO explicitly, the CIO and IT does play a role both because we've established credibility and payback in IT and IT is involved in the implementation outside of IT as well.

And so there's -- it's not quite as far afield as it may look from the outside in that is from the same platform, the products do -- there's a high degree of overlap of what the product functionality is.

And the role of IT is a real asset and our credibility with IT within the company is a real asset.

Our next question comes the line of Jesse Hulsing with Goldman Sachs.

I have a couple of questions.

But first, for John, what's your philosophy on ISVs and expanding that opportunity?

And are you doing anything to increase your investment on third parties building on ServiceNow?

And then a quick one maybe for Mike.

How are sales cycles trending year-over-year in your non-ITSM business?

I guess I'm curious, as you build up more awareness around these solutions and get some reference customers, if you're starting to see those come down.

Yes.

Our platform, as I said a minute ago, is a huge asset.

And what our customers tell us is internal developers find it easy to build on, fast to build on, extensible, quite easily.

And so that's an obvious opportunity to open that up and make that more available to ISVs and third-party developers.

And as we grow and expand, that's a natural way to grow and expand our functionality as well, whether it's more vertical, vertical-specific requirements that ISVs can develop or new markets, new use cases.

And so we're absolutely investing and making sure the platform is easy to build upon as possible.

We have our store.

It's relatively nascent.

But there is, I think, over 200 now applications in the store and that's growing.

And so it will be a continued and increasing area of focus and investment as we go forward.

I'll also add, Jesse, we did 4 investments last quarter in ISVs that are building their businesses on ServiceNow's platform.

The other thing on your other question on sales cycles, we continue to see really no change in the ITSM sales cycle.

And remember that's a replacement cycle.

I talked about earlier how long it is in a Global 2000.

It's still a 9-plus month on average initial sales cycle.

We are seeing some shorter sales cycles in some of the emerging products, in particular HR and customer service.

Don't know if that's a trend that will be going forward.

But we do see in some of the newer products shorter sales cycles.

And there are some shorter sales cycles on the upsells.

And we are very much focused, too, on having contractual upsells with customers right now as well.

And our next question comes from the line of Phil Winslow with Wells Fargo.

You all touched on a lot on HR, ITOM, customer service.

But hopefully you can give some flavor for what you're seeing in IT security management, analytics because obviously the growth in that other ACV line has been really impressive this year.

Well, the -- I think all the products are doing well.

We just chose to flag and highlight the ones that stood out.

But Security Operations is obviously a huge market where it's going through tremendous high demand.

And our product is a natural complement to many of the other products in that market and is addressing one of the most fundamental dilemmas CSOs have, which is an explosion of inbound contacts, whether it's from their existing nodes or the Internet of Things.

It's just an explosion of inbound contacts.

And the ability to address or remediate those in as an automated way as possible so that they put their human energies on the ones that really matter is a key need.

And so the Security Operations product continues to sell well.

2 of our top 5 deals in the quarter included security, and it's a natural add-on product along with ITSM and ITOM.

And similarly, analytics was -- had a strong quarter.

It was included in 17 of our top 20 deals.

So the highest -- frankly, the highest count of all products.

And it was a strong contributor to net new ACV.

It's not as big a line item, so to speak.

But it's very prevalent and most customers are buying analytics along with the other products.

Got it.

And then, Mike, just one quick housekeeping.

I think last year the net expense associated with Knowledge was $11 million.

Wondering if you can give us that for this year as well.

The net expense is somewhere in the $15 million to $17 million, I don't remember exactly the amount, going through there.

And our last question will come from the line of Richard Davis with Canaccord.

John, this may be a question for you.

It's a short question but maybe a little harder answer.

So if you kind of think about when Salesforce really kicked it into another gear is when they became kind of strategic partner to their customers on the revenue side, and you guys have touched on this on and off throughout the conversation tonight, to what extent do you think you guys are there?

And if you're not, what should we -- what do you need to do to get there?

Well, I think we have -- Richard, I think it's an excellent question.

I think my early read is we have all the potential to get there and that there's clear demand in every company that's dealing with digital transformation.

Every company needs to find productivity in their operations so that they can take that productivity savings and reinvest it in innovation with their own customers.

And fundamentally, at the end of the day, what we do is, by automating workflows, we're driving productivity, we're helping improve the employee experience.

And so I think the fundamentals are there.

I think we can do a better job of capturing the business value we're creating, codifying, capturing it and communicating it.

And interestingly, our customers are asking for that.

IT, has typically not talked about what they do inside the company in business value terms, they're increasingly being asked to do so.

And so just as I think you talked about Salesforce when that focus became unmeasurable incremental revenue, they became a more strategic partner.

In our case, driving greater productivity, driving greater employee experience, better employee experience, which as I said earlier, is a core requirement and demand for most customers and driving better end customer experience.

And P.S., you heard Ashley from GE talk about that at our Knowledge where we're being pulled to the end customers.

And so those are measurable business outcomes that we're helping to contribute toward.

Those are C-suite kind of issues, and I think we are well positioned to capture and codify what we're doing, linking it to that.

And that will continue to make us more relevant and strategic, both to IT and beyond.

And I'd now like to turn the conference back over to Michael Scarpelli for any closing remarks.

So sorry for those who weren't able to ask a question.

Unfortunately, we're at the top of the hour.

So 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.

Thanks, everybody.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.