ServiceNow Inc

NYSE:NOW

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the ServiceNow Second Quarter Earnings Conference Call. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's conference is being recorded.

I'd now like to turn the conference over to Mr. Michael Scarpelli, Chief Financial Officer. Sir, you may begin.

[Michael P. Scarpelli, ServiceNow, Inc.]

Good afternoon, and thank you for joining us. On the call with me today is John Donahoe, our President and CEO. During today's call, we will review our second quarter financial results, and will discuss our financial guidance for Q3 and full-year 2018.

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'll 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.

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 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.

[John J. Donahoe, ServiceNow, Inc.]

Thanks, Mike. Good afternoon, everyone, and thank you for joining us on today's call. We had a strong second quarter, continuing our global momentum as we head into the second half. Our teams keep executing well, with the sharp focus and commitment to customer success. We closed 28 deals with ACV greater than $1 million in Q2, up 47% over the prior year. We now have 575 customers doing more than $1 million of business with us.

We also doubled the number of customers doing more than $5 million with us to 58. And our largest customer is now doing more than $25 million, leveraging our IT and HR Service Delivery products to drive digital transformation, and enable great employee experiences.

Our Knowledge event in May was the second quarter highlight for me. This year's Knowledge was our biggest ever, with more than 18,000 registered attendees, and it was great to see many of you there. I'm always energized by spending time with our customers and partners, and this year's Knowledge was no exception. My individual customer meetings, conversations with CIOs and interactions with hundreds of attendees, reinforced our opportunity.

Digital transformation is no longer just a business buzzword. It's fast becoming an essential business priority for C-suite leaders worldwide. I hear this in virtually every customer interaction I have. And ServiceNow is becoming a strategic partner of choice to help these customers enable their digital future.

Our consistently strong renewal rate, 98.5% in Q2, and our strong expansion with existing customers underscore the increasingly strategic role that we're playing. Another highlight of the quarter was our recognition by Forbes magazine as the World's Number One Most Innovative Company. This was the first year we were eligible for the list. So debuting at Number One was gratifying validation of our commitment to innovate for our customers, to enable their success. And it was a proud moment for everyone here at ServiceNow to see our Founder and Board Chair, Fred Luddy on the cover of Forbes.

We were also excited to launch our new brand identity at Knowledge18, bringing to life our company purpose, to make the world of work, work better for people. We believe that technology should enable people by creating simpler, faster and better ways to get work done; that creates great experiences for employees and customers, and drives better business outcomes. We are uniquely positioned to be the connective tissue that streamlines and simplifies work flows across the enterprise, eliminating silos and creating more seamless interactions. We make work, work better.

And as I said earlier, product innovation is a huge priority for us. We announced several exciting new products at Knowledge, including Virtual Agent, Agent Workspace, Enterprise DevOps, Integration Hub and Flow Designer. These demonstrate our commitment to creating great products that allow our customers to build great employee and customer experiences.

In Q2, we continue to see strength across our product portfolio with our flagship IT product suite leading the way. For example, a large U.S. government agency has evolved with us over the past four years to become one of our biggest customers today. They're using our IT products to standardize their services and to map and better manage their software technology across multiple systems. And we're working closely with them to develop a longer-term digital transformation strategy, and deepen our partnership to enable their success.

Customer success is indeed an important priority for us, and we continue to make good progress. As I've mentioned previously, we have aligned all of our customer success teams into one group under the leadership of our Chief Revenue Officer, Dave Schneider. We are driving customer success to be a natural extension of our sales motion, and are committed to not only landing new customers, but also expanding existing relationships in a healthy and sustainable manner.

For example, our customer success approach enables United Airlines to better serve their customers. Our leader for United has orchestrated various initiative teams and resources in their digital transformation journey, resulting in a more focused strategy to drive business outcomes. In closing, I'm pleased, in fact, very pleased with our strong quarter and our first half performance.

We have strong momentum as we look into the rest of the year, and we're making continued progress against our strategic priorities. We look forward to helping our customers succeed and to create the future of work.

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

[Michael P. Scarpelli, ServiceNow, Inc.]

Thanks, John. Our strong momentum continued in Q2, and we delivered another quarter of outstanding performance. Before we dive into the financial results for the quarter, I want to remind everyone that we bill our customers in local currencies and are impacted by fluctuations in foreign exchange rates, primarily the euro and the British pound. The guidance we provide is based on the spot rate at the end of the prior quarter.

In Q2, the euro decreased 5% and the British pound decreased 6%, both of which impacted our reported results in Q2. In total, our Q2 subscription revenue and billings results were impacted by approximately $7 million each due to the quarterly fluctuation in FX rate. Please review the IR presentation on our website for more detail on the FX impact in the quarter.

Now, let's look at the highlights from Q2. Subscription revenues were $585 million, representing year-over-year growth of 45% and constant currency growth of 42%. Subscription billings were $617 million, representing year-over-year growth of 36% and constant currency and duration growth of 32%. The strong top-line performance was driven by all products in the quarter, especially IT.

We booked a record new seven ITOM deals with more than $1 million of ACV, including a $4 million deal to a major financial institution, our largest new customer ITOM deal ever. We also saw our first $1 million Software Asset Management deal to a top-five customer.

Outside of IT, we landed three $1 million-plus deals in HR Service Delivery, all of which were outside of North America, and our Governance, Risk, and Compliance product was named a leader in Gartner's Magic Quadrant for Integrated Risk Management. Our GRC product provides continuous monitoring and automation, while connecting business, security and IT teams with an integrated risk framework built on a single platform. Risk and compliance has never been more important to our customers, and we're very excited about the potential of this product across many different customer use cases.

Moving on to profitability. Our Q2 operating margin was 17% and our free cash flow margin was 24%, driven by strong top-line performance and a shift of expected program expenses into Q3.

Now, let's turn to guidance for the third quarter and full-year 2018 based on the spot rates at the end of the second quarter. For Q3, we expect subscription revenues between $610 million and $615 million, representing 36% to 37% year-over-year growth and constant currency growth.

We expect subscription billings between $648 million and $653 million, representing 29% to 30% year-over-year growth and 30% to 31% constant currency and duration growth. Due to the decrease in FX rates during Q2 I mentioned earlier, we removed $12 million and $13 million from Q3 subscription revenues and billings guidance, respectively. And lastly for Q3, we expect a 21% operating margin.

Now, let's turn to our full-year 2018 guidance. Coming off a strong first half in 2018, we are raising full year subscription revenue and billings guidance when adjusted for FX rate changes. We expect subscription revenues between $2.405 billion and $2.415 billion, representing 38% to 39% year-over-year growth and 36% to 37% constant currency growth. This includes a $33 million increase, offset by a $31 million decrease due to changes in FX rates from our previously issued guidance.

We expect subscription billings between $2.815 billion and $2.825 billion, representing 33% year-over-year growth and 31% constant currency and duration growth. This includes a $21 million increase, offset by a $38 million decrease due to changes in FX rates from our previously issued guidance.

Moving on to margins, we are maintaining full-year subscription margins of 85%, operating margin of 20%, and free cash flow margin of 27% as we continue to invest in future growth. Finally, we expect diluted weighted average shares outstanding of 187 million for the year.

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

[Operator]

Thank you. And our first question will come from the line of Matt Hedberg with RBC Capital Markets. Your line is now open.

[Matthew George Hedberg, RBC Capital Markets LLC]

Hey, guys. Thanks for the question, and congrats on the strong quarter. John, in regards to customers' digital transformation, I mean, that was a key focus at your user event, and you talked about on the prepared remarks. Partners we talk to refer to ServiceNow as the platform of platforms. So I guess, I'm wondering, I know initial sales cycles can be long, but conceptually how does that positioning help with the land side of the equation? And then secondarily, from an expansion perspective, do you have any idea what inning we're at in terms of penetration in your base from all your new apps?

[John J. Donahoe, ServiceNow, Inc.]

Yeah, thanks, Matt. I think, the biggest effect as I said, this digital transformation, it was just stunning to me. It's now in a multi-hundred customer meetings how consistent that's coming up. And because every industry and every company is being disrupted by software, every company is embracing digital technology. And it's now become a C-suite CEO issue. And the effect that's having on us is, it's pulling up the awareness of ServiceNow's platform in the enterprise, where CIOs, I think, increasingly the question is not, do you use ServiceNow to why are you not using ServiceNow, and how broadly can you use ServiceNow to help drive your digital transformation.

So I'd say the biggest change we see is, we're getting almost pulled up, pulled up the enterprise as we move along. Now, I think one of the strengths of this company is that, our land motion, it's not one gigantic platform play. While we're being pulled up, it's not like you've got – rip out some big old platform that's legacy, and put in ours. So you see us often land with ITSM, although increasingly as you saw, I think, it's 17 of our top 20 deals, we had three or more products in Q3.

And so, what's happening is, as this digital transformation awareness is happening, they often land us in IT, and then they'll add either ITOM or HR Service Delivery or Security Ops. And even when they don't land those things, initially we're having active dialogs in that. So I think, as I said in my remarks, we're becoming more strategic, and that word, platform of platform just something or connective tissue is something I hear frequently from our customers as well.

With regards to what inning? Matt, I would say, let me answer that, that there's a macro tailwind of cloud. And I would say, cloud is in the second or third inning of enterprises, governments and institutions embracing cloud, it reminds me of mobile may be in 2014. So I think we're in the third inning of the cloud tailwind. And therefore, when we look at our share of wallet, so to speak, a share of what we think we can grow in many of these customers, I think, we're – I don't know, a quarter of the way there, max, more like maybe 20%.

[Matthew George Hedberg, RBC Capital Markets LLC]

Thanks, John.

[Operator]

Thank you. And the next question will come from line of Raimo Lenschow with Barclay. Your line is now open.

[Raimo Lenschow, Barclays Capital, Inc.]

Hey, thanks, and congrats from me as well. And can you talk to the strength in ITOM? Mike, you've mentioned the $4 million deal in financial services. And if you look at the market size for ITOM, it's bigger than ITSM. So was that something specific at that customer or is that kind of like something that could happen kind of more often? Thank you.

[John J. Donahoe, ServiceNow, Inc.]

Yeah. Sure, Raimo. What happened at that customer, first of all, ITOM had a strong quarter. As Mike said, we had seven ITOM deals over $1 million, and 17 of our top 20 deals in the quarter included ITOM. But what's happened in this particular financial institution, I think, is emblematic of what we're seeing more broadly. This financial institution recently appointed a new CIO. And this CIO is shaping us, in this case it's a he, his strategy for IT. And he wants to run IT as a business. And because he's in financial services, he's got a lot of regulatory and compliance requirements along the way.

And so, as he shaped his strategy, ServiceNow was one of the core pillars of that strategy in a very strategic way. And so, he's using our ITOM products to replace a number of legacy tools, and replacing them with the modern ServiceNow platform to drive huge efficiencies, and to give him better data. So they had significant disaster recovery and business continuity challenges, and those had regulatory implications.

And he's now using ServiceNow to spring automation and integration of these other core systems that allows him to both streamline his work flows, to drive the automation which drives better productivity, but also gives him the data and monitoring and tracking so that he can be compliant and confident of his compliance. And so, I think it's – ITOM's a bit of a lumpy business, so we won't have $7 million deals in every quarter. But we're seeing it, increasingly our customers are seeing our ITOM suite if you will as being strategic to their ability to run IT as a business.

[Raimo Lenschow, Barclays Capital, Inc.]

Perfect. Very clear. Thank you.

[Operator]

Thank you. And the next question comes from the line of Kirk Materne with Evercore ISI. Your line is now open.

[Kirk Materne, Evercore Group LLC]

Yes. Thanks very much. I'll echo the congratulations on the quarter. I don't know who wants to take this, John or Mike, but one of the things that's come up in a lot of our discussions is clearly the excitement around ServiceNow-as-a-platform in the federal government. And I was just wondering if you guys could talk about, sort of how that maybe influenced this quarter, and sort of your thoughts obviously going into the federal government's fiscal year end and the third quarter. And just kind of how – I'm trying to get a sense, you had a big lift this quarter or is a lot of that starts to come as we head into 3Q? Thanks.

[John J. Donahoe, ServiceNow, Inc.]

Yeah. Well, Kirk, I spent a week in D.C. in the quarter. I was in Sydney, where I met the Prime Minister, I was in UK, we met federal government. So federal governments everywhere are embracing cloud. Now, in some places, they're embracing their own cloud, they're building their own cloud, so they show up as slightly on-prem for us.

But this notion of, governments are under pressure to deliver better citizen experiences, lower cost or more efficiency, and increase the speed in which they move. And so ServiceNow, whether it's the military services or the defense and other departments or other departments are increasingly embracing cloud and they're embracing ServiceNow. So we see that as a broad trend that I still think is, in its fairly early days.

And so, as I look at it quarter-to-quarter, maybe Mike, you can comment on the seasonality, but the – I think, this is a trend that you're going to see continuing. And it's not just federal governments, frankly state and local governments, some of the most creative use cases for using ServiceNow. I was in Australia and one of the regional port authorities there is using the ServiceNow Platform to drive their bus lines, to drive all sorts of the activities within the port. So very creative use cases are coming out of state and local as well. You want to comment about seasonality Mike?

[Michael P. Scarpelli, ServiceNow, Inc.]

Yeah. So we did have a good quarter in the federal in Q2. We actually did a very big upsell to a customer. But Q3, we have a very robust pipeline, and as you'd expect Q3 will be our largest quarter for federal as well as a big renewal period for federal.

And as John mentioned, many of our federal customers, they are embracing, and they are embracing the cloud, but many of them, they're in their own private clouds where they're deploying it, so that is on-prem. About 38% of our federal government business is on-prem or they're ripe to go on-prem, so that gets accounted for differently under Topic 606. And I would add, public sector in general, there's a lot of opportunity for the company as a whole, it's still less than 10% of our revenue. And that's globally when you look at the public sector. Very, very big market opportunity for us. And we are investing heavily in our sales organization to go after the public sector, globally.

[John J. Donahoe, ServiceNow, Inc.]

And as Mike said, I think at Analyst Day, it's one of the reasons why we think G2K is no longer the best indicator of our largest customers and our largest targets, because government's not included in there. And we have several...

[Michael P. Scarpelli, ServiceNow, Inc.]

Correct.

[John J. Donahoe, ServiceNow, Inc.]

...the government opportunity for us both federal, and state and local in the U.S., and globally is a significant one.

[Kirk Materne, Evercore Group LLC]

Thanks very much.

[Operator]

Thank you. And the next question will come from the line of Sarah Hindlian with Macquarie. Your line is now open.

[Sarah Hindlian, Macquarie Capital (NYSE:USA), Inc.]

All right, great. Thank you so much. And congrats on the quarter, guys. I have a lot of questions, but I think the slide that stands out to me is the top 20 deals slide in terms of the diversification you're seeing there. And inter-quarter, we had a lot of incomings questions around ServiceNow's pricing due to how much success you're having in emerging product uptake, which frankly we really couldn't find any signs of any real changes in your go-to-market. So I thought it would be useful and helpful if you could talk about how you think about pricing today? And how it evolves as you start to deal with some of these larger and bigger upsell and renewal deals? Thanks, guys, and congrats.

[Michael P. Scarpelli, ServiceNow, Inc.]

Thanks, Sarah. Let me separate pricing into two separate but minorly-related issues. Issue one is the magnitude of our pricing, right? The pricing levels. And the reality is, we do not feel a lot of downward pressure on our pricing, because our platform delivers value. And you've heard me talk about before, one of the most important foundations of our Customer Success efforts is continuing to clearly demonstrate, document business value that our platform's driving, right?

We drive productivity, in simple terms, workflow automation drives productivity. And so our platform delivers a clear return on investment, and we need to continue to document that and make that clear. That's the best way to maintain the pricing levels, is to demonstrate the clear return on investment and value that our customers are getting. And we will continue to do that.

Where we're hearing more comment and feedback is, just the complexity of pricing. And this is a relatively simple thing. What's happening, where we've gone from – we haven't changed our core pricing approach in years, but we've gone from one application, ITSM, which is priced by fulfiller, to where we now have five, six or seven different applications, each of which has a different variable on which it's driven.

So HR Service Delivery may be driven by number of employees. Or Security Operations may be driven by number of incidents, inbound incidents. And so each is optimized for what customers want. But when you're buying five, six or seven of them, it can be somewhat complex. And so, we've been talking with customers about how do we simplify that? And we've experimented with enterprise-wide licenses, and a couple of customers were looking at – some customers said, they want to only pay for what they're using; so we say great. We want to do transactional pricing. We can structure it that way.

But other customers say, no, we want the predictability of having a budget. They need an annual budget, they want predictability, and that's where you get back to our subscription pricing. So there's no simple solution to the complexity. It's not just us. It's all enterprise software or frankly all SaaS software. But one of the things we're doing is forming a Strategic Pricing Group to help work with our customers to model out what they're buying and make it in – reduce the complexity. I do not think, again, I'll end the answer with where I started. We do not feel downward pressure necessarily at all, it's more a complexity issue.

[John J. Donahoe, ServiceNow, Inc.]

And one we're trying to work on.

[Sarah Hindlian, Macquarie Capital (NYSE:USA), Inc.]

All right. That is extremely helpful. I really appreciate all the detail and color. Thanks, guys.

[Operator]

Thank you. And the next question comes from the line of Keith Bachman with Bank of Montreal. Your line is now open.

[Keith Frances Bachman, BMO Capital Markets (United States)]

Hi, thank you very much. I also wanted to refer back to Analyst Day. And the context of the question is, ServiceNow has been very successful into moving into new markets such as HR, Security, CRM, doing very well, and yet has expanded margins while also penetrating new markets. And one of the ideas put out at Analyst Day was, as you move into additional markets, your margin expansion is going be much more constrained.

And so, I'm just trying to tie together why in the past have you been able to get into new markets and expand margins. And as you just alluded to, you're not experiencing pricing pressure; CIOs in fact want to pull you up. Why would there be more margin pressure or less margin upside if you will when you've been very successful moving into new markets in the past? That's it from me. Thank you.

[John J. Donahoe, ServiceNow, Inc.]

Sure, Keith. I'll take this, and Mike, I'm sure you'll want to comment as well. Keith, from my standpoint it has to do with the opportunity in front of us. You get these windows when you're a technology company when – as you mentioned, we have three or four products or applications firing on all cylinders and opportunity to do more. I want to make sure that we're investing enough to take advantage of this opportunity while we have it.

And as I said in Analyst Day, we can't invest more this year. We're not changing what we're doing this year. But if I think about investing in innovation, and so we talked about our NowX investment, which is investing in the next-gen products and services at Analyst Day; investing in other platform extensions over time. We're going to continue to invest in technology, in our product and in our platform.

Second, we're investing in the Customer Success motion. The customers now expect us to provide end-to-end service, right? And they're looking to us to provide best practices. They're looking for us not just to sell something and show up three weeks later at renewal, because we're becoming a strategic partner. Initially, that's an investment. I believe that will lead to faster expansion or more significant expansion over time.

Third, we're growing out our global team and investing in talent. And then last, we're investing in our company brand, something we've never invested a dime in. And so, we're not doing anything radical or dramatic on that, but you saw us clarify our core purpose as a company which is foundational to any company's brand at the company level.

You saw us launch a new brand identity at Knowledge. We were very privileged and blessed to have – be named the World's Most Innovative Company by Forbes, which has given us great brand awareness as a starting point, and we'll continue to make thoughtful and selective investments in company brand, which is critical, not even so much for our business, but for the ability to attract and retain good people, and raising some awareness in the C-suite.

So the investments we're making, I'll remind you, we're still being accretive with margin. Our margins are still significantly above what our peers' are in the industry. But we want to make sure – my concern is that we – we have more of a risk of underinvesting in this opportunity than overinvesting. So we'll do it thoughtfully, we'll do it transparently, and the goal is to set us up to take full advantage of the opportunity in front of us.

[Michael P. Scarpelli, ServiceNow, Inc.]

Yeah, I will echo what John said, Keith. And I'll also add to that, as we evolve as a company, we are shifting away from equity to more cash, which will have an impact we expect in future years on our operating margin, which is something that investors have asked us to do. Also, as we roll out new products, we anticipate there will be new products that come out, that are not – the buyers are different and we expect that will cost us a little more too, and that's factored into our margin forecast and we talked about at the Financial Analyst Day.

And as John mentioned, I want to say, at the scale we are growing at, there's not too many companies that are showing the margin expansion we continue to show every year. And we will still remain very disciplined around free cash flow as well.

[Keith Frances Bachman, BMO Capital Markets (United States)]

All right. Many thanks, guys.

[Operator]

Thank you. And the next question comes from the line of Keith Weiss with Morgan Stanley. Your line is now open.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Excellent. Thank you for taking the question, guys; and a nice quarter. Maybe following along on sort of the deadline on investment, looking at this quarter, you guys had a really good hiring quarter. Typically you guys have your biggest hiring quarter in Q1; it looks like Q2 is actually a little bit ahead of that.

How should we think about that in terms of, one, cadence of hiring for the rest of the year? Did you guys just – were you able to pull forward a lot of hiring, and two, maybe if you could give us some color in terms of like, what you're able to get done this quarter with that big hiring quarter in terms of who you got in place and sort of what areas you were able to get that investment into?

[Michael P. Scarpelli, ServiceNow, Inc.]

What I would say, Keith, is first of all, I think, a lot of this is the results of the investments we started making in 2017 into our HR organization. And we are able to attract and retain people. And we will continue doing that based upon the opportunity that we saw from our success at the beginning of the year.

We've actually upped our hiring targets internally here with some pretty aggressive hiring targets as we're starting to invest for 2019 and beyond. I think, it's too early to talk about necessarily the results of those head count coming in, because it takes time to get people to being productive, whether you're engineers or salespeople. So, I think that will show up in 2019. I don't know, John, if you want to add anything?

[John J. Donahoe, ServiceNow, Inc.]

And I'd just add, Keith, that one of the things we're doing is, we're kind of building out the team that you need to compete on not just the path to $4 billion, but the path from $4 billion to $10 billion. So for instance, user experience, as you know, you've heard me, you've heard CJ talk about the importance of user experience, important to mobile.

Well, a year ago, we had 25, 30, maybe 40 user experience people. Now, we've 100, and we've hired really strong people. We took advantage of getting a group. We made one acquisition, and in Q2, we found a group of user experience professionals who were available and we moved on it.

I mentioned earlier NowX. NowX went from being one guy at the beginning of the year to where it's now 25 engineers, and they're budgeted to go up to 50 engineers going forward. Again, that's 50 engineers working on products in the future, not on this year's roadmap. Our communications and brand function, again, a function that didn't exist a year ago, I think Alan Marks, our Chief Brand Officer, is up to a whopping empire of maybe 15 people.

But we're building out functions thoughtfully. And these are the functions that we're going to need to grow into the future. And so, part of that head count growth is just coming from us. Geographic would be another one, our teams in Germany, our teams in Japan, our teams in markets that have huge upside. We want to make sure that we're, again, capitalizing on the opportunity we have, and getting the right leaders and the right teams in place.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Got you.

[Operator]

Thank you. The next question...

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Just to be clear – I'm sorry. I was just saying, just to be clear, like the 475 quarter-on-quarter increase, is that at all sort of pulling forward from the back-half of the year hiring, or is this kind of a new pace of hiring?

[John J. Donahoe, ServiceNow, Inc.]

It's a new pace of hiring.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Got it.

[John J. Donahoe, ServiceNow, Inc.]

And I can't stress enough too, it's also retaining people. Our attrition is at one of the lowest levels ever right now. People like working here.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Thank you, guys.

[Operator]

Thank you. And the next question comes from the line of Brad Zelnick with Credit Suisse. Your line is now open.

[Brad Alan Zelnick, Credit Suisse Securities (USA) LLC]

Great. Thank you very much. Really great quarter. Congrats as well from me. I wanted to ask a question about AI and machine learning, where you've acquired and developed some fantastic capabilities. And we hear a lot of enthusiasm for these features in Kingston and more to come in London. But from the partners we speak with, it sounds like the demand is there, but that most customers aren't mature enough to be able to utilize those features. How are you thinking about the adoption curve and readiness for these types of capabilities, and what you see customers are ready for?

[John J. Donahoe, ServiceNow, Inc.]

Yeah, thanks, Brad, for that question. That gets at some of the things I was talking about in my Knowledge keynote. And I'd highlight two issues, and it's around, I'm going to call it, quality. Customers, to take advantage of the latest features, need to be on the latest version, right? And we have – one of the historical strengths of ServiceNow is allowing a little bit of flexibility, multi-instance, right, that we don't mandate being on the latest instance every six months.

So, as a result, we have a variety of customers who are on some older instances and for whom upgrades take time. And so, we are working very hard, CJ designed his team, our engineering teams to do a couple of things. One, to make upgrades faster and easier so that people will upgrade more frequently and get closer to our latest instance, our latest version in each case.

Two, I talked at Knowledge about best practices. And because the two ways to take full advantage of our machine learning capabilities that are coming out and improving every release is to be on a current version and have a best practice implementation, which means you've got a robust CMDB, you've implemented in a way that you can take advantage of the full data capabilities.

And what's fascinating is, our most recent customers or customers that have re-implemented most recently are getting very fast upgrades, getting full benefits from our platform. So, one of the efforts that's sort of embedded in this customer success effort is ensuring we're getting all of our long-term customers on current versions implemented in a healthy, best practice manner. And that is going to enable them to take advantage of the innovation cycle that we're driving every six months.

And next cycle, you're going to see a lot of great mobile stuff coming out, and you're going see customers who may be two versions back, wanting to get the latest version to take advantage of the native mobile capabilities we have. So, it's an important really sub effort under the guise of customer success to get people to the best practice and current contemporary integrations.

[Brad Alan Zelnick, Credit Suisse Securities (USA) LLC]

Fantastic, John. Thank you.

[John J. Donahoe, ServiceNow, Inc.]

Operator, could you take the next question?

[Operator]

The next question comes from the line of Walter Pritchard with Citi. Your line is now open.

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Hi, thanks. Questions on ITOM, it does feel like this quarter is a bit of an inflection, at least in large deals around ITOM. Not sure if CJ is on the call there, but I'm wondering was there sort of new pocket of budget you think you got access to with the recent ITOM release? Or anything in terms of value proposition you're able to satisfy for customers that you weren't before that's leading to that ITOM inflection?

[Michael P. Scarpelli, ServiceNow, Inc.]

I will say one of the things about ITOM is, with our latest release, especially with ServiceWatch, the mapping is a lot simpler, and it's a lot easier to deploy. And so, our salespeople, I think, in the quarter, you're seeing that they've been a lot more effective and comfortable in selling that in the right use cases to customers in the quarter. I would say, that's probably one of the bigger drivers for the success in ITOM.

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Okay. Thank you.

[John J. Donahoe, ServiceNow, Inc.]

And CJ is not on in the room. So...

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Okay.

[Michael P. Scarpelli, ServiceNow, Inc.]

But to be clear too, most of our ITOM deals were the ITOM suite, which includes Discovery, and Orchestration and ServiceWatch and Event Management in there.

[John J. Donahoe, ServiceNow, Inc.]

And I think, there's a bit of an awareness thing going on too.

[Michael P. Scarpelli, ServiceNow, Inc.]

Yes.

[John J. Donahoe, ServiceNow, Inc.]

That as we become more and more on the CIO's radar screen and agenda, and the CIO is thinking about not just ITSM, but how to – I've heard one CIO say, I want to run IT like a business, I've heard a hundred say it. And our ITOM suite helps them run it as a business. And so, that combined with digital transformation, where if they're running IT as a business, then they need to be focusing on how they drive cross-functional enablement. I think, the visibility of our ITOM capabilities is just getting higher.

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Great. Thank you.

[Michael P. Scarpelli, ServiceNow, Inc.]

Next question, operator?

[Operator]

Thank you. And the next question comes from the line of Michael Turits with Raymond James. Your line is now open.

[Michael Turits, Raymond James & Associates, Inc.]

Hey, John and Mike, good evening. John, a question for you about the long-term M&A strategy. Historically, you guys have made largely tuck-in acquisitions, and then been very patient in taking a year or so to integrate them with the existing platform. If I understand it correctly, I think you talked about that changing slightly when you go from $4 billion to $10 billion, where there might be adjacent separate platforms that would be acquired, and that strategy might change a bit. I'm wondering if you could drill down on it a little for us.

[John J. Donahoe, ServiceNow, Inc.]

Yeah, Michael, it's – I'll just repeat what I said at our Investor Day, because it's – job one, two and three in the short to medium-term is to execute on the organic growth opportunities that we have, which are significant. And if a tuck-in acquisition can accelerate that progress by bringing us technology that we won't have to build ourselves or bringing us a talented team that allows us to move more quickly, then we're going to move on those.

And one of the real strengths of the company historically is having this one platform, which is one of the reasons we've become that connective tissue. It's one of the reasons they call us the, platform of platforms, because by having – reintegrating them, reimplementing them on our platform, recoding them, if you will into our platform, allows our platform – allows all applications and all customers to take advantage of those, and allows our platform to be more extensible, the ability to move more quickly, build quickly on top of it; that's a real strength.

So we're going to continue that focus, and that's our core focus for 95% of our organization. What I said at our Investor Day is, as you would want, Mike, and I, and our senior team and the board, we're beginning to say, all right, let's look out beyond just 18, 24, 36 months, and begin to say, what are the kinds of things that we need to be looking at considering and evaluating on our path to $10 billion?

We believe and we hope and we expect that path will largely be organic. It has to be on the foundation of strong organic growth, but companies of that size, and given the market opportunity, and the impact that cloud and SaaS is having on the enterprise, selective M&A of a slightly larger size will most likely be part of that. So we're just now beginning to look at that, and planning.

And so, I think over – I don't know, what 12 to 36, 48 month time horizon, you'll begin to see us be – if we see an opportunity where we think we can acquire an adjacent technology, an adjacent platform, something that will accelerate our growth down the road, we won't be hesitant to make those moves. But we want to do things in a way that does not distract our team from the core execution, that's immediately in front of us. And so, I think that's nothing imminent, but we're beginning to take a look forward. And when we find something, we'll let you know.

[Michael Turits, Raymond James & Associates, Inc.]

Thanks.

[John J. Donahoe, ServiceNow, Inc.]

Anything you'd add Mike? I mean, I think, I'm pretty straight forward.

[Michael P. Scarpelli, ServiceNow, Inc.]

No. I think, we're going to continue to be disciplined. It's not a must that it has to be written on our platform, but that has been our choice because of the ease at which we've been able to do it. Obviously, a larger acquisition that has a large installed base of customers, it will be more challenging and disruptive to try to reimplement it. So we'll see what happens.

[Michael Turits, Raymond James & Associates, Inc.]

Thanks, John. Thanks, Mike.

[Operator]

Thank you. And the next question will come from the line of Jennifer Lowe with UBS. Your line is now open.

[Jennifer Swanson Lowe, UBS Securities LLC]

Great. Thank you. There's a lot to like in this quarter, but one of the things that jumped out to me looking at some of the products that seemed to have particularly strong uptake this quarter relative to past quarters was the SecOps product. And we – in our chats, we've been hearing more and more about it. So I'm just curious if there was anything notable to call out there in terms of momentum for that product specifically?

[John J. Donahoe, ServiceNow, Inc.]

Well, I think one of the things that, again that I'm most pleased about, and our team is most pleased about, that's less about this last quarter, but it's more about the future is just GRC being named as a leader in the Gartner Magic Quadrant. And GRC is in our Security Operations suite. And so, I've been hearing – as increased compliance requirements, increased cyber, just the whole area of GRC is one that's increasingly on board agendas, therefore on CEO, CFO and CIO agendas. And so, that product, I think has enormous opportunity, enormous upside, and we had some nice wins during the quarter on that front.

[Michael P. Scarpelli, ServiceNow, Inc.]

Correct. About 24% of our Security is GRC that we're doing.

[Jennifer Swanson Lowe, UBS Securities LLC]

Great. And just one real quick housekeeping question for Mike. I know that the G2K metric is getting less focus these days, but it looks like some of the historical numbers around there moved around quite a bit. I know you recut that from time-to-time as the G2K list changes. Is that what happened this quarter or is there something else that we should be reading?

[Michael P. Scarpelli, ServiceNow, Inc.]

Yeah. No, in Q2 the list of Global 2000 companies gets rebalanced. You see a lot of movement in kind of the bottom quartile of G2K. I think, there were 60 something in the G2K itself of our customers that came out, then there were some others that came in. So we recast the prior periods as well, too, to show that like what we've done in other years, and net-net we added 21 G2K in the quarter.

[John J. Donahoe, ServiceNow, Inc.]

One thing, Jennifer, that's not – it's not directly G2K, but one of the nice things that is absolutely happening is the global nature of our company. And so, almost half of our deals greater than $1 million in the quarter were outside the U.S., in Europe and in Asia. I just want to give a recognition to our European teams, and our Asian teams. Asia in particular had just an outstanding quarter. And they're adding, global Japanese multinationals, global Australian multinationals. In Europe, we have many of the top brand names in Europe are customers that are continuing to expand. And so, the global nature of our platform is really kicking into place.

And I would highlight; Germany and Japan is two markets we're still relatively early in cloud adoption, and they're enormous markets. And so as you see cloud adoption, Japan is a little ahead of Germany. As they grow, we view it as an opportunity, and we're going to try and make sure we invest appropriately to take advantage of that opportunity.

[Jennifer Swanson Lowe, UBS Securities LLC]

Great. Thank you.

[Operator]

Thank you. And the next question comes from the line of Greg McDowell with JMP Securities. Your line is now open.

[Greg R. McDowell, JMP Securities LLC]

Great. Thank you. I want to specifically ask about the CSM, the Customer Service Management opportunity, because when I look at the top 20 deals, it was included in quite a few of your top 20 deals compared to the Q1 top 20 deals. I was just hoping you could expand a little bit on what's going on with CSM, how it's performing, commercial versus enterprise, and maybe domestically versus internationally, and any change in the competitive dynamics with the CSM. Thanks.

[Michael P. Scarpelli, ServiceNow, Inc.]

Yeah. If you look at last quarter, Greg, we had a strong international quarter for CSM. If you look at our top deals, a number of them were in Europe, as well there's some in APJ. What I would say is, the CSM product is the one product that excites our commercial sales organization the most, because you can tend to do bigger CSM deals than you can do in HR or IT, just given the size of those organizations. But CSM is applicable across our entire customer base globally. And we're very pleased with what we're seeing there.

[John J. Donahoe, ServiceNow, Inc.]

And Greg, I think it's – just adding to what Mike said, it's – and I've said this in previous calls, the thing that makes our CSM product unique, and therefore the types of circumstances and situations where it really applies is where a customer needs a platform that is not just a CS, not just a Customer Service platform.

They want the same platform driving Customer Services as is driving IT, as is driving other cross-functional departments. Because what they really want to do is, take the inbound contacts coming into the Customer Service area, and get to the root cause, right, which is often cross-functional. They want a cross-functional platform so the customer support agent doesn't have to turn into a separate action, that they can get to the root cause, fix the root cause so that, that problem doesn't happen again. And they want to use as much self-help as possible.

And our platform is very well-geared to those things. And so, smaller companies tend to want that, because they track it more closely, they aren't as big and as sprawling. And companies in certain industries, services industries, telecom industries, financial services that want to maximize the self-help that they're having their customers do, they want to get to the root cause and address them so that they actually reduce the need for inbound contacts, they're finding the fact that ServiceNow is a cross-functional platform to be one of the real advantages. So, it's not for the entire customer service market, but for that segment of the market, which is a non-trivial segment, we've got a very – I think, a very competitive and relevant product.

[Greg R. McDowell, JMP Securities LLC]

That's helpful. Thank you.

[Operator]

Thank you. And the next question comes from the line of Alex Zukin with Piper Jaffray. Your line is now open.

[Alex J. Zukin, Piper Jaffray & Co.]

Hey, guys, thanks for taking my question. I want to ask about one metric that looked like it jumped up, and that's renewal contract durations ticked up from 26 to 29 months, which is the longest we've seen. And then, if I also look at the same time at your 2010 cohort, the new ACV – or the ACV from that cohort's ticked up meaningfully to 105%. So I guess, can you talk about the – what's happening on renewals with renewal activity? What products are really resonating with those long-time customers, and if also this duration is a new normal or if that was just a blip?

[Michael P. Scarpelli, ServiceNow, Inc.]

I would say, I think that was a little bit abnormal. There were a few very large customers that skewed that. And it's not driven by any particular product. ITSM and ITOM is very big, obviously, because remember most of the renewals that are coming in are from customers that bought three years ago. Most of our HR, SecOps and Security customers are less than three years old. I will say, part of it is one of our largest customers, who signed a 55-month renewal that kind of skewed that. So, I wouldn't expect it to be that high going forward.

[Alex J. Zukin, Piper Jaffray & Co.]

Got it. That's helpful. And maybe if I could squeeze one more in, I think, Mike, last quarter you mentioned an outperformance against internal plan. I was curious if you could comment on performance versus plan this quarter? I mean, how does the pipeline look?

[Michael P. Scarpelli, ServiceNow, Inc.]

We had a very strong quarter, and our pipeline looks very good for the second half of the year.

[John J. Donahoe, ServiceNow, Inc.]

Which is why we raised guidance.

[Michael P. Scarpelli, ServiceNow, Inc.]

Correct.

[Alex J. Zukin, Piper Jaffray & Co.]

Thank you, guys.

[Operator]

Thank you. The next question will come from the line of Kash Rangan with Bank of America. Your line is now open.

[Kash Rangan, Bank of America Merrill Lynch]

As you go towards the end, all those smart questions have been taken, you've got to think really hard about some good questions. Well, I have no questions. I'm kidding, of course, I have a question. All the good questions have been asked, but I'm curious, when you look at the ITOM business, it clearly saw an inflection point this quarter. Who are you replacing? Is this the beginning of a nice replacement cycle, like ITSM has been? And if you'll permit me, a sub-question there, how much more opportunity is left ahead in ITSM, granted that the company's future is going be hinged on your emerging products, platform products, et cetera? Just curious, thoughts on these two core products. Thank you. Congratulations, again.

[Michael P. Scarpelli, ServiceNow, Inc.]

So I'll start, Kash, with ITSM first. We only have about 4,500 enterprise customers. There's over 22,000 potential customers in the world. And every one of those will need an ITSM product. In many of our Global 2000 customers in large enterprises, we've only cracked into a country or a division. There's still a huge opportunity for ITSM within those customers.

So, we truly believe we are still very much in the first half of the ballgame here with ITSM. And you'll see that ITSM actually had a very nice growth rate year-over-year. We are very pleased with that. And in terms of ITOM, generally, with ITOM, we are replacing legacy vendors. However, one of our products, ServiceWatch, which is the big piece of our ITOM suite, is solving a problem that no one else had ever been able to solve before. So, that is really more greenfield opportunity to solve a real business problem to be able to map the business service back to the IT asset so that when there's an outage, you know exactly what asset is causing that outage. So, that results in less downtime to the business service. That's what we're solving and what is resonating with customers there.

[John J. Donahoe, ServiceNow, Inc.]

And just building on that, Kash, one of the things that Mike talked about at Investor Day, that I think is fueling some of the cloud software growth is, what was it, Mike? 30% of our new business is using software where software was not being used before.

[Michael P. Scarpelli, ServiceNow, Inc.]

Correct.

[John J. Donahoe, ServiceNow, Inc.]

And you think about all the inefficiency in an enterprise, all the manual workflows, all the places you're using spreadsheets and e-mail and other inefficient tools, where software, properly applied, can drive increased automation, increased productivity, increased efficiency, better user experience, that's I think one of the real opportunities. And to be honest, secret successes of ServiceNow is that ability to apply software in places software's not been applied before. So, it's not about replacing a legacy vendor. It's about extending software and extending our platform into new use cases. And so...

[Kash Rangan, Bank of America Merrill Lynch]

That's great. Thanks, John and Mike. I'm curious, Mike when you said the 5th innings, are we implying that from a user count perspective, ITSM is sort of 50%, although from a number of customers' perspective, it's only 20% penetrated. From a user count perspective, it's close to 40%, 50% or maybe that's quite overestimated?

[Michael P. Scarpelli, ServiceNow, Inc.]

I think it's still less than that. It varies by customer. But there's still a lot of opportunity to further penetrate our existing customer base with ITSM.

[Kash Rangan, Bank of America Merrill Lynch]

And new customers like one big bank which has not chosen you guys for ITSM, right?

[Michael P. Scarpelli, ServiceNow, Inc.]

Well, I know your bank has not chosen us.

[John J. Donahoe, ServiceNow, Inc.]

Yet, yet.

[Kash Rangan, Bank of America Merrill Lynch]

All right. Thank you so much guys. Congratulations.

[Operator]

Thank you. This does conclude today's question-and-answer session.

[Michael P. Scarpelli, ServiceNow, Inc.]

Okay. And 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.

[Operator]

Ladies and gentlemen, thank you for participating on today's conference. This does conclude today's program. You may disconnect. Everyone, have a great day.