Michael P. Scarpelli - ServiceNow, Inc. Frank Slootman - ServiceNow, Inc..

Matthew George Hedberg - RBC Capital Markets LLC Brent Thill - UBS Securities LLC Kirk Materne - Evercore ISI Sarah Hindlian - Macquarie Securities Keith Eric Weiss - Morgan Stanley & Co. LLC Michael Turits - Raymond James & Associates, Inc. Karl E. Keirstead - Deutsche Bank Securities, Inc. Steve M. Ashley - Robert W. Baird & Co., Inc.

(Broker) Alex Zukin - Piper Jaffray Companies Justin A. Furby - William Blair & Co. LLC Derrick Wood - Cowen & Co. LLC Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker) Rob Owens - Pacific Crest Securities. Kash Rangan - Bank of America Merrill Lynch Andrew Kisch - Barclays Capital, Inc. Brian Schwartz - Oppenheimer & Co., Inc.

(Broker) Jesse Hulsing - Goldman Sachs & Co. Abhey R. Lamba - Mizuho Securities USA, Inc. Ryan MacDonald - Wunderlich Securities, Inc. Tim E. Klasell - Northland Securities, Inc..

Good day, ladies and gentlemen and thank you for standing by. Welcome to the ServiceNow Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session. Our instructions will follow at that time.

And as a reminder to our audience, this call is being recorded for replay purposes. I would now like to hand the program over to Michael Scarpelli, Chief Financial Officer. Sir, you have the floor..

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 the simultaneous 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. Total revenues for the second quarter grew 38% year-over-year to $341 million driven by new customers, upsells to existing customers and a 97% renewal rate.

We added 26 Global 2000 customers and we now have 272 customers paying us more than $1 million in ACV, a record increase in the quarter. While service management continues to be our principal selling motion and the main driver of these metrics, our emerging products are growing faster and capturing more net new ACV.

Emerging products defined as, everything except ITSM, represented 40% of our net new ACV, up from 24% in Q2 2015. Additionally, 67% of our customers now license multiple products and 15 new deals of our top 20 new deals in the quarter included three or more products.

IT Operations Management, or ITOM, continues to be our second largest product suite and represented 13% of our net new ACV, up from 10% in Q2 2015. One of the biggest trends we're seeing in ITOM is customers licensing multiple products instead of one-off products. 53% of ITOM net new ACV included product bundles and 28% included the entire suite.

For example, we signed an $840,000 upsell to a state government that purchased the entire ITOM suite to improve governance, remediation and self service. Customer Service Management officially launched in May at Knowledge16. A 1,300 attendees participated and 14 break-out sessions dedicated to this new service.

We now have 40 total customers, 30% of which are new to ServiceNow and 31% of which are Global 2000s. Customer Service Management also participates in broader transactions. For example, we signed a $500,000 deal as part of a larger $1.3 million upsell to a medical equipment company.

The customer also integrated Field Service Management to drive down costs and improve service delivery. Security Operations also had another strong quarter. We landed 18 new customers, including nine Global 2000s and we landed our first net new ACV deal over $500,000. We now have 32 total customers since our December launch.

In June, we acquired BrightPoint Security to accelerate our investment in security analysis and response. BrightPoint allows customers to prioritize security threats by analyzing external threat data and by showing threat indicators with industry peers. Customers then remediate security threats using our Security Operations' structured workflow.

We expect to completely replatform BrightPoint by the first half of 2017. Q2 was our strongest quarter ever for our human resources solution in terms of new business. Average deal sizes for this product continued to increase and we're encouraged by the outlook for the rest of the year.

The strong quarter was driven by a $1.4 million HR-led deal to a new public sector customer in Australia. User experience was critical to the HR buyer and we won against an incumbent solution and two additional competitors. Q2 strength was also driven by our annual users conference, Knowledge16.

We set a new record with over 10,000 attendees, an increase of 31% from the prior year. Knowledge is our single largest customer prospecting event of the year and 87% of attendees were customers, prospects, partners. We continue to branch out beyond the boundaries of IT as 24% of attendees were in roles outside of IT compared to 10% last year.

In conjunction with Knowledge16, we hosted our second annual developer conference, CreatorCon. We saw 3,000 registered developers and application architects and hosted 51 workshop sessions, both an increase of more than 100% from last year. We expect significant growth next year as 94% of attendees indicated they will attend Knowledge17 in Orlando.

Finally, we are announcing that our founder, Fred Luddy, intends to retire from active duty before the end of the year. Fred has been writing code for some 44 years and 13 whirlwind years at ServiceNow. We are thankful for his many contributions, as without him we would not be here today.

Fred will continue to serve in an advisory capacity as well as on our board of directors going forward. With that, I will now turn the call over to Mike..

Thank you, Frank. During today's call we will review our second quarter financial results and discuss our financial guidance for Q3 and full year 2016. 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. 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 $341 million, increasing 38% year-over-year. Foreign exchange rate fluctuations did not significantly impact our actual year-over-year revenue or billings growth.

Subscription revenues were $291 million, increasing 45% year-over-year and professional services and other revenues were $51 million, increasing 9% year-over-year. Our average contract terms for new customers, upsells and renewals were 30.8 months, 27.5 months and 26.2 months respectively.

Total revenues based on geography were $234 million in North America, $82 million in EMEA and $25 million in Asia-Pacific and other, representing 69%, 24% and 7% of total revenues respectively. Approximately, 30% of our revenue is in foreign currencies.

The majority of our foreign exchange rate exposure is related to euro, however, we have approximately 6% revenue exposure to the British pound. Billings were $375 million in the quarter, increasing 33% year-over-year.

Subscription billings were $333 million, increasing 38% year-over-year and professional services and other billings were $42 million, increasing 4% year-over-year. Our average billings duration was 11.8 months for the second quarter compared to 12.2 months in the same period last year, a negative impact of $12 million year-over-year.

Subscription gross margin in the quarter was 84% compared to 82% in the prior year. Professional services and other gross margin was 33% compared to 38% in the prior year. This includes $13 million of revenue related to our Knowledge Conference, while all related expenses run through sales and marketing.

Excluding Knowledge revenue, our professional services and other gross margin was 10% compared to 19% in the prior year. Overall gross margin was 76% compared to 74% in the prior year. Excluding Knowledge revenue, overall gross margin was 76% compared to 72% in the prior year.

Operating margin was 10% compared to 7% in the prior year, including net expenses of $11 million related to Knowledge. Our operating margin included higher than expected subscription revenue and lower than expected net expenses from Knowledge. We ended the quarter with 4,241 total employees, a net increase of 250 in the quarter.

Net income for the second quarter was $26 million or $0.16 per basic share and $0.15 per diluted share, compared to a net income of $7 million or $0.05 per basic share and $0.04 per diluted share in the prior year. Our basic weighted average shares outstanding was 164 million and our diluted weighted average shares outstanding was 173 million.

Free cash flow margin was 23% compared to 26% in the prior year and we ended the quarter with $1.031 billion in cash, short term and long-term investments. Let's turn to guidance for the third quarter and full year 2016.

Based on foreign exchange rates at the end of the second quarter, we are not forecasting a significant impact to our year-over-year revenue or billings growth due to foreign exchange rate fluctuations. For the third quarter, we expect total revenues between $350 million and $354 million, representing year-over-year growth between 34% and 36%.

Our guidance was negatively impacted by approximately $2 million due to foreign exchange rate fluctuations during the quarter.

We expect subscription revenues between $312 million and $315 million, representing year-over-year growth between 40% and 41% and professional services and other revenues between $38 million and $39 million, representing year-over-year growth between 0% and 3%.

We expect billings between $380 million and $385 million, representing year-over-year growth between 33% and 34%. Our guidance was negatively impacted by approximately $3 million due to foreign exchange rate fluctuations during the quarter.

We expect subscription billings between $339 million and $343 million, representing year-over-year growth between 38% and 39%, in line with the growth rate we saw in the same period last year. We expect professional services and other billings between $41 million and $42 million, representing year-over-year growth between 2% and 4%.

Turning to gross margins, we expect subscription gross margins of approximately 84%, professional service and other gross margins of approximately 13% and overall gross margins of approximately 76%. We expect an operating margin of approximately 15% and free cash flow margin of approximately 16%.

As a reminder, Q3 is seasonally low for free cash flow as we expect to spend approximately $15 million associated with our ESPP purchase. We expect diluted weighted average shares outstanding to be approximately 174 million.

For full year 2016, we expect total revenues between $1.37 billion and $1.38 billion, representing year-over-year growth between 36% and 37%. Our guidance for the rest of the year was negatively impacted by approximately $4 million due to foreign exchange rate fluctuations during the quarter.

We expect subscription revenues between $1.203 billion and $1.211 billion, representing year-over-year growth between 42% and 43% and professional services and other revenues between $167 million and $169 million, representing year-over-year growth between 6% and 8%.

We expect total billings of between $1.605 billion and $1.615 billion, representing year-over-year growth of approximately 34%. Our guidance for the rest of the year was negatively impacted by approximately $6 million due to foreign exchange rate fluctuations during the quarter.

We expect subscription billings between $1.427 billion and $1.435 billion, representing year-over-year growth between 37% and 38% and professional services and other billings between $178 million and $180 million, representing year-over-year growth between 9% and 10%. Looking at operating margin and free cash flow guidance.

We expect to accelerate investments in sales and R&D in the second half of the year, but we are maintaining our guidance of approximately 12% and 24% respectively. We expect diluted weighted average shares outstanding to be approximately 173 million for the year and we expect to add approximately 1,000 net employees in 2016.

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

Thank you. Our first question comes from the line of Matt Hedberg with RBC Capital Markets. Please go ahead with your question..

Yeah, guys. Thanks for taking my questions. Maybe to start with, it sounds like FX didn't have a big impact on your numbers here. I'm curious there was no mention of the macros given the timing of Brexit.

Was there any impact to quarterly linearity or any thoughts on that, the potential impact on that, on the guide?.

No. We really haven't seen anything as a result of Brexit and coming into this quarter right now, too, we don't see any impact on our business today, but I think it's too early to tell..

Okay. And that's great. And then, Frank, maybe you highlighted in your prepared remarks this is a record quarter for HR deals. Are we closer to inflection point there on adoption? And I think at the conference you mentioned that 40% of your business is partner influence.

Are you getting additional leverage there on some of these HR wins?.

No. I think that we're – I don't know whether it's an inflection point or not, we probably need a quarter or more to see how that plays out.

But what we're seeing in all our emerging product lines is that the sustained focus and investment that we're making is really starting to push us over the edge as you know, or you may recall that about a year-and-a-half ago, we really changed our organizational model, how we build, how we support, how we go to market is really by product line now.

And it just takes time for us to sort of reach critical mass there and there's a sort of a tipping point where things really come together on a lot of different vectors and we're starting to see the effects of that..

I would add that to that $1.4 million HR deal was actually through Capgemini. So we are seeing the big system integrators involved in those..

That's great. Thanks a lot, guys..

Thank you. Our next question comes from the line of Brent Thill with UBS. Your question please..

Good afternoon.

Mike, I realize that billings is not the only metric health but given kind of the decel you saw from Q1 to Q3 on the billings growth, can you maybe just reconcile for everyone what's happening there? And I know you don't give out the booking number, but is there anymore color that you could just add to what is just a number of, one of many numbers we see but certainly a focus for the Street..

Yeah, I just want to remind people that one of the biggest components of billings is actually the renewals that happens in the quarter. And so, the timing of renewals has a big impact, let me give you an example.

There was a few big renewals that didn't get signed until the first day of this quarter that really should have happened last quarter that impacted our billings and there was quite a bit that dollar magnitude of that.

And I also want to remind people, too, that why Q1 in our business is relatively big relative to other companies is we do have this phenomena when a lot of our contracts start January 1; even though we booked the deals in Q4, we grossed down that AR and deferred revenue and recognize that in Q1.

That artificially inflates the Q1 billings when you look at it that way when you try to compare us with other companies..

Okay. Thanks for the clarification.

And for Frank, with Fred's departure, obviously some big shoes to fill, I realize he is going to stay on the board and continue in an advisory role, but can you maybe just talk a little bit about who will back-fill as a leader for the product group?.

Well, Fred's not a guy that can really be replaced. He's one of a kind and the company obviously has grown up around him over the last five years. When I joined we got about 250 people here, we're now at whatever we are, 4,300. So, there's a ton of talent.

Over the years, we have definitely sort of enabled Fred to sort of scale back his day to day because he's been doing some heavy lifting for a very long time. So, we're actually thankful that we've had him as long as we've had him and we're really able to take this in stride.

There's a lot of talented people at ServiceNow, a lot of different product lines in our platform. And I think the difference is Fred will be around, he'll be in an advisory capacity. The only difference is he's not going to be riding coat day in, day out and I think he's earned that break..

Okay. Thank you..

Thank you. Our next question comes from the line of Kirk Materne with Evercore ISI. Your question please..

Yes. Thanks very much. I guess first, Frank, you saw actually a really nice jump in sort of that other category in terms of the bookings contribution. And I assume most of that contribution is coming from some of the HR and the Customer Service Management modules that you're offering that you've been talking about earlier in the call.

I guess was there anything else in that bucket that we should be aware of that contributed this quarter?.

It was actually strong across the board. We highlighted HR but we highlighted Security, we highlighted Customer Service Management, but one area that was particularly strong was the whole Business Management area, where we do Project Portfolio management, combined with financials, combined with analytics.

They had an exceptional strong quarter as well. So, it was very much across the board versus having one outlier. So, the bigger theme here is that the model is working really well for us the way we built go-to market..

Okay. And then just one quick one for Mike, obviously the third quarter for you guys is a big quarter in the federal vertical. I guess do you feel like the setup for that is still pretty healthy heading into this quarter in terms of just pipeline, what you're seeing in the pipeline, just normal build into the end of their fiscal year? Thanks..

I would just say, in general, we feel very good about the third quarter where we are sitting today and looking at the pipeline across the board, not just federal..

Thank you. Our next question comes from the line of Sarah Hindlian with Macquarie. Your question please..

Yeah. Thanks for taking my questions, Frank and Mike. Frank, maybe you could start by talking a little bit about the deal mix in the quarter and particularly I'm wondering about new customers and where they're landing.

So, in ITSM and expanding into ITOM or HR services, are you landing any clients with automation beyond IT? I saw one of the top 20 appears to be landed outside of ITSM and was looking for some color beyond the top 20 deals.

And then, Mike, another question for you, maybe you can address a little bit where you're expanding partnering in Security Operations and what's driving the traction there with five of the top 20 deals, including Security Operations..

I'll go first. It's Frank, Sarah. So, in terms of how we land, the preponderance of deals we're landing with Service Management has always been true. It is still true. The vast majority of our top transactions, ITSM, Service Management is core.

That said, we have a lot more clubs in the bag now and our sales team is capable of landing with other products and I highlighted that in the prepared remarks that we have a whole bunch of brand new logos now, for example on customer service that are not ITSM customers.

So, this ability to land with different products – I mean, different accounts is a very powerful new dynamic for the customer because we have demonstrated historically that we're very good at upselling customers once we land them. We just have many more opportunities to land them.

We think that our overall performance in landing Global 2000 accounts was definitely boosted by having this portfolio of products..

So, Sarah, I apologize. I didn't quite understand your question you were asking on the security side, the partners.

Could you maybe clarify that question?.

Yeah. On the security – thanks, Mike, on the Security Operations side, I know you've announced several partnerships. I was wondering are those really what's driving uptake? Where are you getting some traction? It was pretty remarkable to see five of the top 20 deals including that Securities Operations.

And I thought that the sales team was relatively new, so I was just looking for some more color around this..

Sarah, it's Frank again. Security, I think most people don't realize but this is really a very close adjacency to our core business and it is very typical that, CSOs, Chief Security Officers report to CIOs. Many, many times when we host large customers here at our executive briefing centers, the CSO is there.

We often now these days we're actually making sure that we invite CSOs in, but the whole offering is about combine the IT and security teams into a single system, single work flow, single set of analytics and so on.

So, this is actually – this is not a completely separate market if you will where we sort of have to start up a whole new selling motion. This is actually very high leverage of our core business. We have very good access to this opportunity.

So, there's a lot of exciting aspects to that business and that's why we're also making acquisitions in this space. We think it's going to be a very strong business for us over time..

Thank you very much..

Thank you. Our next question comes from the line of Keith Weiss with Morgan Stanley. Your question please..

I just wanted to thank you guys for taking the question and nice quarter. Wanted to sort of feel you guys out in terms of what gives you confidence in the guidance in the back half of the year. When I look at Q3, at the high end of the guidance range it looks like you're seeing accelerating billings growth.

We all see stuff like Brexit because we get worried on our side of the fence.

Where do you guys garner the confidence that you could actually see growth improve as you go into Q3 potentially at the high-end of that guidance range?.

So I'll reiterate, from a billings perspective that you're looking at, the bulk of our billings is already contracted either with our contracted backlog or renewals that we know we're going to get. Remember, we have very good visibility into our renewals because if a customer is going to get off of ServiceNow, it's something we know well in advance.

Second thing is, is as I said, we're off to a very strong start to this quarter. We feel very good about what we're seeing in our pipeline that we're looking at our Q4 pipeline. Both our gross and weighted gives us that confidence. And I just want to remind you, too, this is not a short sales cycle. This is a very long sales cycle.

We have very good visibility into deals. When we're selling into Global 2000, many times this is a two-plus year sale cycle into these large accounts. So that's what gives us the confidence in these deals..

Got it. And then drilling in a little bit just on the commercial side of the business. You had a really nice quarter in terms of G2K added 26 customers. Last quarter we saw that commercial business firm up really well.

How has that been trending or how did that trend in Q2?.

Commercial business continues to be very strong for us. We have continued to do some $1 million-plus transactions in that space, so we're very pleased with what we're seeing, and we think it was definitely the right decision in 2015 to segment our sales force into commercial and enterprise..

Excellent. Thanks very much, guys..

Thank you. Our next question comes from the line of Michael Turits with Raymond James.

Your question please?.

Yes, I guess I don't feel bad with Turits as it was Keith Weiss a minute ago. So hi, guys. Thanks for taking the question. In any case, on the slipped deals, the slipped renewals, I just wanted to clarify, Mike.

Did they all get signed, already the ones that slipped?.

Yes..

And is there any reason? Was it execution, longer sales cycles, anything we should worry ourselves about?.

Once again, these were renewals that were supposed to have renewed right at the end of the quarter, and it was delays in procurement organizations who tried to renegotiate deals many times, but they've all been signed already..

Great. And then also....

Just to be clear, this happens every quarter..

Go ahead....

There's deals that get pushed and pulled every quarter on the renewal side. I would say this quarter they tended to be more that got pushed..

And that leads into why you have more confidence or strong confidence in this Q as well, right, on the billing side?.

I'll just say, we're off to a very good start for Q3 right now where we're sitting today..

Great. And then my follow up is on fed. I can't remember if Kirk mentioned this or not. I think he brought up fed next quarter, but you got FedRAMP certification.

Does that increase your confidence, your opportunity pipe likely to convert as you go into 3Q?.

This is Frank, Michael. We're not fixated on our federal business as the driver of our Q3 number. Mike's already said several times, we're off to a very, very fast start, and we have tremendous visibility in this quarter. That's really what gives us the confidence in the federal business is part and parcel of that overall view of the business..

Okay. Thanks..

Thank you. Our next question comes from the line of Karl Keirstead with Deutsche Bank. Your question please..

Thanks. I just wanted to return to the new ACV mix data. Obviously, phenomenal growth in the other category. But at the risk of looking at the glass half empty, I want to look at the service management piece. 76% a year ago, it's now 60%.

Mike, did that grow in terms of new ACV dollars? And could you just update us on how you feel about that core service management piece in terms of new ACV? Thank you..

So I'm not going to talk about growth in ACV with service management, but what I will say and what Frank said before, if you just look at our 26 Global 2000, 24 of those were they started with ITSM. That is what lands us in the door.

It is still the bulk of our revenue and will continue to be the bulk of our revenue for quite some time and it will continue to grow in our revenue. And so that business is still very strong. The fact of the matter is these new emerging products are growing faster because they're off a such smaller base..

Yes, makes sense. Okay. Thank you, Mike, for that. And if I could ask a follow up. Your margin guidance for 3Q and the full-year implies that we might see flat or slightly down margins in 4Q. And I think you touched on it, you mentioned an increase in investment in sales and R&D.

Could you elaborate a little bit on where the investment focus is? Thanks a lot..

Sure. So, as you know, we've been acquiring companies. For instance, we bought ITapp on the ITOM side. We just bought BrightPoint this quarter. We're making some additional investments in R&D and our core ITSM products.

And so we're accelerating R&D hiring and also we're pulling forward, especially around some of these new products and specialty sales from Q4 into Q3. So it's not changing the overall year, but it changes the timing of some of our salespeople as well, too, because of the opportunity we're seeing in some of these newer emerging products..

Okay. Good. Thanks a lot..

Thank you. Our next question comes from the line of Steve Ashley with Robert W. Baird. Your question please..

Terrific. I would just like to ask about the ITOM business and specifically what I'm going to refer to as new ITOM, which is ServiceWatch and Event Management and some of the newer things you're doing.

Maybe you could comment on what kind of traction you're seeing with those newer products?.

We continue to do really, really well in that business. It is the second largest revenue stream and bookings opportunity that we have next to service management. It's still very new business to us. As we highlighted during the prepared remarks, the sales teams are really learning to sell the entire suite, the entire strategy.

I think it's going really well. The harder part about ITOM for us is, is that from a deployment standpoint, in other words that is a very different motion than what we're used to on the service management side. That has certainly triggered some growing pains on the part of our organization to really become highly proficient on that.

We made a lot of investment on the services side of our organization, and we actually think that represents opportunity and upside to us. I think we are getting way, way better at the deployment aspect of that business, which we think then in turn becomes an enabler for even better growth in that business.

Because if you can't install rapidly, your follow-on deals obviously take longer. So ITOM is a different kind of a business, but because our core products have such strong value propositions, as you mentioned ServiceWatch, but it's really the entire way we do things with the CMDB being the core depository there has resonated very, very strongly.

We just need to get better at rapidly deploying it, rapidly getting the customer to value and I think that will become a further enabler for growth in the ITOM opportunity..

Perfect. Thank you..

Thank you. Our next question comes from the line of Alex Zukin with Piper Jaffray. Your question please..

Thanks for taking the question. Hey, guys. Frank, first for you. You mentioned you doubled your customer count basically on the customer service side sequentially.

And I was curious how often you're seeing Salesforce, what your win rates are, and why typically you're getting chosen over them in these competitive engagements?.

Yes. So, obviously, we're still moving from a small base, but the response we have from the marketplace suggests that what we're doing is resonating. We're not at tit for tat with Salesforce.

We really bring the holistic integrated service model to the customer, which really adds to the engagement model, to the engineering and root cause analysis aspect, to the change operational processes, all in one single integrated approach.

For people that come from that world, which is typically the IT crowd, they go like, yes, that's the right way to do things. So we often get traction where that integrated holistic model is viewed as a really, really core advantage.

So that doesn't apply to every single customer service opportunity, but in the world of IoT and expensive capital equipment type of service models, I think we have the right approach and we're seeing the traction. As you know, this is a very large business. It's probably the single largest market that we're operating in.

So we can really invest in this area for a long time to come. We are replacing a lot of legacy systems, home grown systems. It's not that different in that regard from what we're doing on the service management side and the operations management side, very similar dynamic. We typically take up stuff that's very, very old..

Got it. And then maybe one question, kind of the opposite question of what Keith was asking. If you look at your guidance for subscription billings for the year, any reason or maybe remind us why we should see the kind of growth deceleration in the 4Q period that's implied in the guidance..

You're getting into the law of large numbers, Alex, and the guidance is what we think is appropriate right now. It's still quite substantial growth over 2015..

Thank you, guys..

Thank you. Our next question comes from the line of Justin Furby with William Blair. Your question please..

Thanks, Frank and Mike. I was just wondering if you could give more detail on what you saw by geography in terms of new bookings in the quarter. And, Frank, I think I've heard you talk about in 2020 that you expect something like 50/50 mix in terms of new ACV from ESM and non-ESM.

And it seems like you might be tracking to get there sooner than you thought. And I'm just wondering if that's the case, how it impacts the model, if at all, in terms of margins or growth over the next four to five years. Thanks..

It's Frank. I'll start. I think you're correct. We're facing at least – if you meant to imply that – we are pacing a little bit ahead of where we thought we'd be, but that doesn't mean that it will continue at this blistering pace there sort of the mix substitution that we've seen over the last couple of quarters.

I think we have so many irons in the fire now, we have a lot of hot products. There's just a ton of opportunity for us to prosecute and deploying the resources to be able to do that is really what we're focused on. I don't want to get too far ahead of myself of knowing exactly how that mix is going to play out here in subsequent quarters.

We're just happy to be able to go to market with a lot of interesting value propositions that make a lot of sense together..

And I would just add, Justin, your question on the performance in different geos, EMEA and APAC had very strong quarters, about what we were expecting, and Americas came in pretty much where we were expecting, so..

Got it. And then just one more, if I may. I think in Europe I think you made some changes at the sales organization level over the last six to 12 months. I was just hoping you might be able to comment on what you're seeing from those changes. Thanks..

This is Frank. We actually made two major theatre leadership changes last year, this year both for the Americas as well as for Europe. And we believe there's been a very significant impact of that.

One of the things we're super pleased about in 2016 is that the fidelity of forecasting, our sales organization's ability to guide the business has dramatically improved from 2015. And that is in no small parts because of the leadership changes that we've made.

So we're feeling very good where we are and we're feeling very good at what we're looking at for the second half..

Got it. Thanks, guys. And congrats..

Thank you. Our next question comes from the line of Derrick Wood with Cowen & Co. Your question please..

Thanks. Mike, great job on the subscription gross margins, but had a question on the services side. Looking at your Q3 guide, it looks like PS margins are going to be under some pressure.

Is that due to just intentional slowdown on the services side? Or are there other factors at hand? And I guess with regards to your focus on driving more services from the channel, how has that been tracking relative to expectations? And what are some of the things you guys are doing to accelerate more enablement from your partners?.

Sure. So we've done a few changes within our professional service organization. A, we elevated the leadership to being a direct report into our CEO, Frank, so that it's outside of the sales organization. And we hired a real GSI leader in to run that organization who just started in the last three months.

He's making some changes in that organization, and we're working through the transition of that right now, but I feel very good. We're going to have more of a global delivery model for our professional service organization. But with that I just want to remind you, we try to have most of the services delivered by our partners.

We're really focused more on new – as we have our emerging products, we have to be the one delivering those implementations, because our partners don't know how to do them yet. Once our partners get up and running and trained, we expect they'll do more, and we're pleased with what we're seeing with the amount of business our partners are taking on..

Okay.

And if I could throw one in there, given the settlement with BMC, any change in terms of velocity of win rates or sales cycles? Or would you consider it to be immaterial in terms of what you're seeing in the field?.

This is Frank. No real change there. Nothing that we want to attribute to that..

Okay. Thanks..

Thank you. Our next question comes from the line of Walter Pritchard with Citi.

Your question please?.

Hi. Thanks. Frank, I'm wondering if you could talk about sales productivity generally? And you talked about accelerating some sales investments. It sounds like that's more of a shifting around.

But could you comment on sales productivity and how it's fairing versus a year ago? And especially as you look towards the second half of the year, where you expect to see things accelerate?.

Yes. I think you've heard me say this in prior quarters. When sales productivity is where we like it, we tend to accelerate hiring, and when it's not where we like it, we tend to take our foot off the pedal.

And since we are moving hiring up in the year, it's a clear indication that we're happy with the way things are going and the opportunity that we think our reps are having.

And the big thing about hiring and productivity is that we hire people, we've got to see our way clear that these people become productive because then we all start making money and the whole scheme works for us. So feeling good where productivity is at and we're feeling even better of what we think we can do for the balance of the year..

And then, Mike, on the deal slippage on the renewals, it sounds like those are closed. But how are you treating those in your forecast? I guess, we haven't heard actual renewal slipping impacting your forecast. It seems like that's more been of a new business thing.

And were those sort of very much one-off events, or were those the types of things that you see normally and you just saw more of it?.

So, first of all, the renewals and these things slipping one day have virtually no impact on revenue at all. The only thing they have is an impact on is billings, and as renewals become a bigger portion of our overall business, we're at the stage now where renewals is bigger than what our net new ACV we sign in a year.

This is the transition year right now that will have a bigger impact on billings, because if it slips from June 30 to July 1, we don't get that billing. So, yes, it was a pretty big number. We saw that slip. But as I said earlier, this has happened all the time. We're always pulling renewals in and renewals get pushed out.

It's just this quarter it tended to be a little bit bigger with a couple big ones. Usually they're smaller deals..

Okay. Thank you..

They are signed as of today..

Yes. Got it..

Thank you. Our next question comes from the line of Rob Owens with Pacific Crest Securities. Your question please..

Great. Thanks for taking my question. You guys have been running well ahead on new customer acquisition at Global 2000. I think you laid out a goal of 18 per quarter. Obviously ahead of it this quarter, but hadn't been for some time.

So what are the potential impacts on the model? Does this give you confidence you can start to drive upside? Are these deals typically the same size they have been, or are you seeing customers take down I guess smaller chunks upfront with higher renewals as they come back?.

So a lot of the Global 2000 that we added, we added is I think about eight of them were in APJ this quarter, and I expect that more as a percent will be in APJ because that's probably the one area where we're the most underpenetrated and we're relatively new into that market.

A lot of APJ deals start out low, but I just want to remind you some of our biggest accounts like GE, I think they started out at 80,000 a year. So it's not uncommon for customers to start small and then they grow. Just look at our cohort analysis slide that we put in our investor deck again.

That continues to be the case that once a customer buys, they very quickly grow. And so for us, it's all about quality of customers we land, and we think all those Global 2000 that bought this quarter are going to grow to be substantial customers..

Second on the security office front, who are you replacing as you're going in?.

This is Frank, Rob..

Hi, Frank..

No, we're replacing people staring at spreadsheets all day long. There's nothing there. It is the most amazing thing that in a world of cyber security, there's been so much focus, so much investment, on enforcement, on vulnerability scanning, on detection, and then what happens in the back end in terms of the analysis and response.

It's a complete dearth of solutions. And those teams, they're in typically the SOCs, the Security Operations Center, being completely separate from the NOC, Network Operations Center, where the IT guys live. The immaturity of how people respond is just incredible. And this is what presents us with this extraordinary opportunity.

And because security lives so close to IT, it doesn't take people very long to recognize the significance of what we're bringing to the security equation.

That's where our excitement comes from, it's a not a replacement market, it's the reality is there's nothing there, and I think everybody knows that we're pretty damn good in terms of detection, and validating threats, and all of that kind of stuff. Our ability to filter signal out of noise is incredibly impaired in a world of security.

And it's done by people right now, rather than by systems, and the ability to execute on the workflow, is what comes after that. Now this is really a whole back end of the cybersecurity workflow that we are addressing and investing in. And we think this is going to become a major, major market.

It is inevitable, somebody's going to get it, and it might as well be us..

Thanks, Frank. Thanks for the color..

Thank you. Our next question comes from the line of Kash Rangan with Bank of America. Your question please..

Hi, thank you very much.

If you look at the deals that slipped, Mike, not to press too much on this, but if you were to normalize it, do you think the subscription billings could have been materially higher, meaning, there was about 400 basis points of discrepancy between Q1 and Q2, do you think you could have grown your subscription billings at just about the same pace as you did in Q1, which is, I believe, about 41%, 42%, and I have a follow-up question.

Thank you..

I would say, I haven't calculated the percentages, but net-net, we probably had about $6 million that slipped from this quarter into next quarter..

Got it..

And that, you can also look at it too, for full year billings, we did take $6 million out of our forecast for FX..

Correct, correct. Also you had the duration, which is about four months shorter, I believe, right? Actually, 0.4 months shorter per your calculation, 12.2 months to 11.8 months, and the other question was when you look at the percentage of new business that's coming in, ITOM seemed to have gone down a bit.

I'm just wondering if the pipeline for ITOM has shifted into the second half of the year, how confident do you feel that this could come back and also more of a strategic longer – 2017 question.

Do you think your subscription billings growth rate is more of a reliable way to look at the growth rate of your business and then trying to help understand what could be the future growth rate of the company. Thank you very much. Because you know the professional services business particularly..

Okay. So answering your question about ITOM. We've mentioned before, and I can't stress enough, these are long sales cycles. We tend to do bigger deals in ITOM, and it's just a matter of the timing of deals. We feel very good about what we're seeing in our ITOM business.

This quarter I think it's going to be a good ITOM quarter, and so we're not concerned there at all. In terms of what's a better proxy for estimating our growth, definitely subscription billings is a much better proxy, because the professional service, it's something we want to push more of that off to our partners rather than see that business grow..

Wonderful. Thanks so much..

Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Your question please..

Hey guys. This is Andrew Kisch on for Raimo.

So obviously, as you said we're getting to pretty large numbers and we're seeing growth maybe start to slow a little bit, but with that in mind could you help us think through what you might do with the profitability and cash flow and operating margins? As that growth slows, I mean, this year we're still looking at about 150 basis point increase on cash flow margins, I'm just wondering what that might look like in the future..

So if you look at our Analyst Day deck that we put out, you will see there is the framework for growth rates and how that relates to operating margin expansion and cash flow margin expansion. You can go look at our website and you could see that in our investors' section. Clearly defines it, what we're seeing..

Thanks..

Thank you. Our next question comes from the line of Brian Schwartz with Oppenheimer. Your question please..

Yeah, hi. Thanks for taking my question. Just had one operational question, Frank, you talked a lot about the sales productivity trends that you're seeing that you're really happy with. Just wanted to ask about the hiring that you've done so far.

And just wondered if you can provide an update on the progress year-to-date of onboarding the new sales hires versus your plans. Just wondering if you hit your target here through the first half of the year for your new sales rep hires. Thanks..

We did good on hiring this quarter, attrition was also down, so I think the sales teams are where they like to be. As a result, Michael already highlighted as we're moving some of the hiring from Q4 to Q3. And obviously we're doing that with an eye towards 2017, as well as because we think we can take advantage of the opportunity.

So, we're in a good place..

Thank you..

Thank you. Our next question comes from the line of Jesse Hulsing with Goldman Sachs. Your question please..

Yeah. Thanks for taking my question, guys. A question for Frank and then a quick follow up for Mike. Frank, it seems like a lot of the newer products which you're selling are kind of, I don't know if evangelical is the right word, but you're going after new budget or trying to create budget versus ITSM, which was more of a replacement cycle sale.

How does that shift your selling approach, if it does? I was hoping you could walk us through that..

Well, that's actually for most of our products not the case, I mean as I said earlier, customer service we're always replacing something, the project management site, we're replacing something ITOM, we're definitely turning stuff off. So, the vast majority of times, we're turning stuff off.

I think where you are correct is on the security side, having this kind of a structure workflow capability that is seamlessly integrated with the Palo Alto Networks and Splunks of the world. That is an awful idea if people have not done that before.

That is a little bit more evangelical, that's the word that you used, but the good news here is it is incredibly evident to our customers that that is an idea whose time has come, and they need it in a hurry. Just the ability to be able to track and analyze security incidents is like a whole new deal to them.

That's because security and IT have lived in separate spheres and we're busting through those walls and really letting security really benefit from everything that's been learned on the IT side. So for the most part, it is a replacement process which is a good sales motion to be in..

That's helpful. And Mike, I didn't see in your investor deck this quarter, your upsell rate disclosed.

Was curious if you could provide that?.

We're not really talking about the upsell rate anymore, we really stopped doing that and the reason we're not doing that as we mentioned before, as our install base grows, upsells tends to be the bigger piece of our business than new customers. So, it's just not a metric that we're disclosing going forward..

Okay. Thank you..

Thank you. Our next question comes from the line of Abhey Lamba from Mizuho Securities. Your question please..

Yeah. Thank you.

Mike, can you talk about penetration within the Global 2000 companies? What's the average ACV from that group? And how high can it go? And how high does it need to go for you to meet your 2020 target?.

So our 2020 target was predicated on having 1000, Global 2000 at the end of 2020 and on average doing $2 million a year out of the Global 2000. You can see today where the number is – what's the actual number today, $941,000 on average we're getting out of the 681 Global 2000. So we feel very comfortable that we're tracking towards that target.

How high can it be? We're forecasting it to be $2 million on average, but there's many customers, if you look now we have 272 customers. The bulk of those are Global 2000, but they're not all Global 2000. That on average – that pay us over $1 million, and on average they're paying us about $2.2 million a year right now..

Got it. Thanks..

So clearly it can be higher than $2 million..

Got it. Thank you..

Thank you. Our next question comes from the line of Ryan MacDonald with Wunderlich Securities. Your question please..

Yes. Thanks guys. Frank, you talked earlier about the BrightPoint acquisition, and I believe that's going to be re-platformed, you said, by the first half of next year.

Can you talk a little – go a little bit more into what's going to be involved with that re-platforming? And how BrightPoint is going to be enhancing the security operations offering as well?.

Yeah. So re-platforming is something that we do with every assets that we require. At ServiceNow, we don't integrate acquisitions, we re-platform them. And what that means is we essentially take them apart and rebuild them on our cloud, on that platform. So it's really indistinguishable from something that we've built.

This is really important, because we don't want to saddle our customers with a plethora of different assets that represents the patchwork that they have to keep operable. That's sort of the bane of software existence that people have lived with over the last 20 years, 30 years. So for us it's all one cloud.

We make sure that it's all implemented the right way. And when you upgrade from one version to the next, you don't have to worry whether A works with B, with C and so on. So re-platforming is a really big commitment. It sometimes takes us a year and a year-and-a-half to do it, but we bite that bullet.

And then when we get out there with the product exactly the way it needs to be, we only want to buy assets where the team that we're bringing on is really in full agreements with us that that is the right way to do it. Otherwise we wouldn't even want to proceed with the acquisition. So yeah, it's going to be somewhere in the first half of 2017.

Hopefully there'll be in the earlier part of that, because that really triggers the beginning of the sales process. There's a lot of interest in the capabilities, also with ITapp, that's a deal that we did earlier this year, and then BrightPoint of course is such a natural draft on the security sales motion that we already have.

So we're excited about these assets coming into our fold..

And as you look at – just one quick follow-up.

As you look at the other areas of, say, the emerging products, whether it be in customer service or in some of the business management areas or segments, is there any other pockets for additional M&A that you think that you'd be interested in, in terms of additional replatforms for small tuck-in acquisitions?.

Yes. I mean, we typically look at this in the context of all the business units that we have. Our business unit leaders, all have a list of assets that they're tracking, monitoring, trying to determine what the strategic imperative is.

We have a whole bunch of other requirements when we have hot businesses like security, we're obviously going to be motivated to further enhance that, we also bring in talent that our hardcore security people, which is really what we want, what we need, because we're not a security company ourselves, we really have to build that up.

The stronger our teams in these areas, the more confident and the more we want to support them when they want to do deals. So most of our M&A activity is going to be in the context of those individual opportunities..

Thanks a lot..

Thank you. Our next question comes from the line of Tim Klasell with Northland Securities. Your question, please..

Yeah, most of mine have been asked. But if we take a look at some of the newer applications in ITOM, normally those come as sales as upsells to your ITSM customers.

Are you seeing any of those becoming the wedge or beginning to lead into an account, rather than following ITSM?.

Well, we traditionally, I mean, as we said earlier, ITSM is almost always our beachhead, it's how we start the relationship. Not always, there are numerous exceptions to that as well, but the preponderance of evidence says that ITSM is how we land, and then we evolve from there.

ITOM has so far been the most natural progression for customers once service management gets implemented. It requires a very solid implementation of the CMDB.

Without a solid implementation of the CMDB, it's very difficult to really start on an ITOM journey, so these things all need to happen before sort of the next opportunity can be triggered and pursued. So I think – it does happen. You know that ITOM leads, but most of the time it's a natural progression from service management to implementation..

The more common products that we see kind of leading potentially before ITSM is HR and customer service. We have examples of those already..

Yeah..

Okay. Great. Very helpful. Thank you..

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. I would now like to hand the call back to Michael Scarpelli for closing comments..

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

Ladies and gentlemen, this does conclude today's program. You may all disconnect. Everybody have a wonderful day..