Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 ServiceNow Earnings Conference Call. At this time, all participants are in a listen only mode. 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 would like to introduce your host for today's conference, Mr.
Michael Scarpelli, Chief Financial Officer. Sir, please go ahead.
Thank you. Good afternoon and thank you for joining us. On the call with me today is John Donahoe, our President and Chief Executive Officer. Our press release, investor presentation and broadcast of this call can be accessed at investors.servicenow.com. We may make forward looking statements on this conference call such as those using the words may, will, expects, believes or similar phrases to convey that information is not historical fact.
These statements are subject to risks, uncertainties and assumptions. Please refer to the press release and documents filed with the Securities and Exchange Commission, including our most recent quarterly report on Form 10 Q for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such forward looking statements. I would now like to turn the call over to John.
Thanks, Mike. Good afternoon, everyone, and thank you for joining us on today's call. We reported another strong quarter today. Our consistent performance underscores our strengths. We have a leading cloud based platform with innovative technology and an expanding set of product capabilities.
We have a strong customer focused culture that our customers recognize and our employees and customers value. And we have a global footprint and an expanding partner ecosystem. The result is steady growth of new customers and a consistently high renewal rate. And our strong growth in net new ACV through upsells is driving deeper enterprise integration and expansion of our capabilities. With leading companies across diverse industries, we're becoming a more relevant strategic partner to their digital transformation.
Our top two accounts now exceed $15,000,000 in ACV and we now have more than 400 customers doing more than 1,000,000 in ACV with us, including 32 hitting that number in Q2. When I spoke to you last quarter, at the time just 3 weeks into the job, I shared that my top priority was listening and learning from our customers. That has continued to be my focus. Customer listening and learning are constant operating motions deeply embedded in our ServiceNow culture. We listen, build what our customers want and need and learn from their experiences.
And then we repeat that cycle over and over. ServiceNow founder, Fred Luddy, set that tone from day 1 with his vision of enabling regular people to route work effectively through an enterprise. And our opportunity to fulfill that vision is greater than ever. I met with 100 customers in my 1st 45 days and I then had the privilege to be with more than 15,000 customers and partners worldwide at our Knowledge 17 event in May, which was our biggest Knowledge yet. Knowledge 17 was extraordinarily energizing with companies such as GE and Novartis sharing how they are using ServiceNow to transform their businesses.
Spending the week engaging with our customers, partners and developers further elevated my excitement about being part of ServiceNow as we create our next chapter. The world is at an inflection point of intense digital disruption, which necessitates that every company focus on digital transformation. Every company I talk to is experiencing this. For IT organizations, CIOs and C suite leaders grappling with these changes and challenges, we intend to become an indispensable enterprise cloud partner and helping them create the future of work. During my conversations with customers, I'm asking 3 simple questions.
How are we doing? Where can we get better? And what are your biggest priorities? Let me quickly recap what our customers are telling me. First, our customers absolutely love our products and platform and they appreciate how we work with them and do business.
ITSM has been a game changer for our customers and they want to do more with us. That's reflected in our Q2 renewal rate of 97.7 percent. We have a strong foundation and as I discussed in my keynote at Knowledge 17, our customers want us to continue to lead and innovate with best in class out of the box integrations and configurations and with more consumer like end user experiences. And they want to hear more from us about our roadmap and product vision. These are priorities for us, creating best in class customer experiences, improving our end user experience and driving customer success.
We're already increasing our investment and management focus in these areas. We're also committed to developing a robust highly skilled partner ecosystem. As I've said before, many of the world's largest systems integrators are rapidly investing in ServiceNow's ecosystem and our partners are critical to the success of our customers and therefore to our collective future. Increasingly, we're being leveraged across the enterprise as customers pull our platform and multi product capabilities into HR, customer service management and security. In Q2, 58% of our net new ACV came outside of ITSM compared with 40% a year ago.
And today, 3 out of every 4 customers license more than 1 ServiceNow product. Our newest products help drive our strong Q2 results and are being recognized as best in class. For example, our HR product addresses a key customer need, which is complementary to leading HCM vendors. This product drove the acquisition of a significant new customer in Q2, a leading airline with net new ACV of almost $3,500,000 And our HR product also resulted in net new ACV of almost $2,800,000 with 1 of our largest existing customers. Our customer service management product also is demonstrating great momentum.
In Q2, for example, a leading provider of healthcare technology became a new customer with net new ACV above $1,000,000 solely with customer service management. In addition, the product debuted in Gartner's Magic Quadrant in Q2 and was named by Forrester Research in its Forrester Wave for customer service solutions. That's tremendous recognition for our product in its 1st year. As we continue to evolve, we continue to evolve, we also continue to innovate. We ended Q2 with the completion of our Jakarta release, which is now generally available.
As we demonstrated at Knowledge 17, Jakarta delivers significant performance and user experience enhancements. We continue to be strongly committed to building on our leadership position in ITSM and ITOM as well as expanding our capabilities for HR, CSM and security. Our Jakarta release also builds intelligent automation into our platform, bringing machine learning capabilities to all of our products and all of our customers for their everyday work. We're solving real challenges for enterprises today, while also enabling their transformation to a digital future. ServiceNow facilitates new ways of working, driving greater efficiency and productivity.
And that in turn creates real business value and opportunity for our customers. In closing, we see tremendous opportunity as we drive deeper engagement with CIOs and C Suite Executives, increasing our relevance across the enterprise. I'm incredibly proud to be part of this organization and we intend to continue to serve our customers, partners and employees. I look forward to continuing our progress and momentum. And with that, I'll turn the call back over to Mike.
Thank you, John. During today's call, we will review our Q2 financial results and discuss our financial guidance for Q3 and full year 2017. We'd like to point out that the company reports non GAAP results in addition to and not as a substitute for or superior to those calculated in accordance with GAAP. All financial figures we will discuss today are non GAAP except for revenues and revenue growth. To see the reconciliation between these non GAAP and GAAP results, please refer to our press release filed earlier today and for prior quarters previously filed press releases, all of which are posted at investors.servicenow.com.
Total revenues for the Q2 were $472,000,000 representing year over year growth of 38% and an adjusted growth of 40% or an impact of 7 Total billings were $505,000,000 representing year over year growth of 35% and adjusted growth of 38% or an impact of $12,000,000 Subscription gross margin was 85%, professional services and other gross margin was 37% and overall gross margin was 78%. Excluding Knowledge 17 revenue, our professional services and other gross margin was 12% and overall gross margin was 78%. Operating margin was 14% and free cash flow margin was 20%. We ended the quarter with $2,000,000,000 in cash short term and long term investments. In May, we issued 782,500,000 dollars of 0% convertible senior notes due in 2022.
The primary use of proceeds is to refinance our existing $575,000,000 of 0 percent convertible notes due upon maturity in 2018. In conjunction with this offering, we purchased a bond hedge and sold warrants to eliminate shareholder dilution up to a $203 stock price. If the stock price increases above $203 warrant the $203 warrant exercise price, only the incremental value above $203 will be diluted as we plan to settle the principal in cash. Let's turn to guidance for the Q3 and full year 2017. For the Q3, we expect total revenues between $488,000,000 $493,000,000 representing 36% to 38% year over year growth and 36% to 37% adjusted growth or a $3,000,000 impact.
We expect total billings between 540 $1,000,000 $545,000,000 representing 34% to 35% year over year growth and 34% to 36% adjusted growth or a $3,000,000 impact. We expect an operating margin of approximately 17% and diluted expect total revenues between $1,901,000,000 $1,911,000,000 representing 37% year over year growth and 37% to 38% adjusted growth or a $2,000,000 impact. We expect total billings between 2.271 $2,281,000,000 representing 34% to 35% year over year growth and 35% adjusted growth or an $8,000,000 impact. We expect subscription gross margin of 84%, professional services and other gross margin of 15%, total gross margin of 77%, operating margin of 16% and free cash flow margin of 25%. We expect diluted weighted average shares outstanding to be approximately 100 and 79,000,000 for the year and now expect to add approximately 1300 net employees in 2017.
With that, operator, you can now open up the line for questions.
Thank Our first question comes from the line of Matt Hedberg with RBC Capital Markets. Your line is open. Please go ahead.
Hey, guys. Congrats on the strong results. John, the mix of new ACV from non ITSM and ITOM products, I believe, is a record of 39% versus I think what it was a record last quarter of 34%. And in your prepared remarks, you talked about security, HR, customer service deals, but it really was that $1,000,000 plus customer service management win that was really interesting to me as a new customer win. Can you give a little bit more detail on why they chose ServiceNow versus other vendors and how they think about expanding into other areas of your platform?
Sure, Matt. Well, obviously customer service management is a huge market And the area where our product has a real sweet spot is in situations where a customer is dealing with a large volume of inbound contacts and or that they've got to deal with root causes to reduce the human interaction. So, the kind of situations we're strong at is when you take those high inbound volumes, much like you get inbound incidents to an IT help desk or HR case management, you get high inbound volume and you want to automate how you respond creating as much self help as possible. And the way you do that is to get to what the root cause of the inbound incidents are. And so our product is very well suited to that to help identify what the root cause is so that you can then remediate without a lot of expensive human interaction.
And so that's the kind of use case where our product plays well and it's turning out to be an entree point in the commercial market in many customers and in this case in the enterprise market. And then as you know, once we've sort of landed an account, the opportunity to expand laterally into our other products is much easier. So it's in many ways using the same functionality we have in our other products applied to a CSM use case. That's great. Maybe just as
a quick follow-up, you guys made an acquisition of Clue kind of building on the DX Continuum acquisition. Clearly customers are asking for more machine learning capabilities, intelligent automation, predictive capabilities. But I guess, can you help define how this functionality helps with new wins and maybe the monetization effort of that? Thank you.
What's interesting is what we hear from both existing customers and new customers are that there is just a there is a huge amount of new technologies out there and they are having trouble keeping up what are the ones they need to pay attention to, what are the ones they need to be building themselves. And what we're saying is that there's certain functionality that we will take responsibility for accessing and acquiring and make it easier for them to use. So machine learning, we started with DX Continuum where we bought DS Continuum and we're integrating machine learning into our platform so that all products and all customers can access it and therefore the customer only has to worry about using their data. They don't have to worry about acquiring their own machine learning capability. Virtual agent technology, which is a way to obviously automate and streamline our response, whether it's an IT response, an HR response or CSM response is another technology and by buying Clue, we'll sort of repeat that same formula of re platforming it into our platform, recoding it into our platform and making it available to them, so they don't have to buy their own chatbot capability or other virtual agent capability.
And we'll continue to do that. We're looking at a number of other technologies, all of which I characterize as being complementary to core thing we do, which is helping them automate their workflows, improve the ability to have self help and provide better experiences for their employees and customers.
Well done.
Thank you. And our next question comes from the line of Rob Owens with KeyBanc Capital Markets. Your line is open. Please go ahead.
Great and thanks for taking my question. Given some of the volatility you've seen over the past couple of quarters in your sequential ACV growth per G2K customer. Can you speak to the dynamics of customer acquisition and what it's contributing and how follow on plays out because your customer acquisitions obviously have been running well ahead over the last couple of years, but we've seen that variability I guess in the ACV numbers. So any color would be appreciated. Thanks.
Yes. So Rob, it's Mike here. So if you recall, when we laid out our model, that 4% is an average growth quarter over quarter. Obviously, it's not the reality of the world. This is not a spreadsheet that it continues to grow through 2020 that we do see seasonality.
You saw that last year. Typically, the second half of the year is a much bigger upsell quarter. So we do expect that the second half of this year and we see that already with a number of contracted upsells that have closed already as well as what is sitting in our pipeline of opportunities that are heavily weighted towards upsells. So I feel very good about that number still. The other thing that weighs down upon that number when we came up with that 4% 3 years ago, that was based upon adding 20 Global 2,000 per quarter.
We continue to add well above that. And if you remember, our average Global 2,000 we land typically is much lower than what people think. If you look at last quarter, it was 300,000, the quarter before it was 200,000 Is
Is there any different dynamic given your a lot of the incremental Global 2,000 obviously are likely to come out of APAC and other versus your penetration in North America and EMEA, which are both 50% or greater at this point. Is there a different ACV that you experience with APAC and other geos?
No, I've actually already closed 2 Global 2,000 this quarter in APAC that are greater than the average of our Global 2,000 today.
Great. Thanks for the color, Mike.
Thank you. And our next question comes from the line of Keith Weiss with Morgan Stanley. Your line is open. Please go ahead.
Thank you guys for taking the question and very nice quarter. A question for John. When you talked to us at Analyst Day, you were basically talking about, hey, listen, my number one job here is listening. And you've done a lot of listening, you talked to a lot of customers. Is this still too soon to be thinking about any changes that you want to make to sort of distribution or how you guys are planning on go to market from what you've learned?
Or is it just sort of you guys are operating pretty well as is, so you're going to let well enough alone in the near term?
Well, Keith, I think
I don't know if you characterize this as go to market, but we're increasing our focus on the full customer lifecycle, right. We have a world class sales force and a world class go to market motion and I don't see any need for significant change in that. In fact, I really admire, I'm struck by how nicely our sales team has layered in product specialists and layered in the industry focus as well as continue to recut territories to serve customers and more deeply penetrate in our sort of pre sales through sales motion. The area where we're increasing our focus is in the sort of full customer lifecycle post sale all the way through renewal, where what I heard from customers was help me implement and help me get maximum value out of the product and then help me translate that into business value that we can demonstrate. And the interesting thing is our products do drive real business value, right.
We automate workflows, which is the sort of which is sort of at the root cause of productivity. But what we are going to do is put a little more focus on customer success, so that we are capturing and documenting and codifying the business value that gets created, which helps a CIO or an IT department within their organization demonstrate the value they're driving inside their company and frankly helps us on up sells, on price realization and on landing new accounts. So I'd say the more focus on the full customer lifecycle, particularly post sale through renewal, we already have a number of things going on there, but we're going to try to bring them together in a more cohesive and powerful way, both presale and post.
Excellent. And maybe if I sneak in one follow-up. We heard a lot last year about sort of increasing partner commitments, if you will, and more partners coming to the ecosystem. Is it too soon to be seeing the results of that of them sort of driving more business for you guys? Is that still in development?
Are you starting to see those results?
Both. I think I'd say, we see some results that our partners are clearly playing a very important role in influencing deals, particularly with G2K customers. We think roughly 2 thirds of our net new ACV was influenced by partners, roughly a third was sourced by partners. And so, we're already seeing that impact and certainly our top partners are quite important partners. That said, I see and I was meeting with a CIO of 1 of our top partners this morning in our EBC.
And as we talk, it feels to me like there's still opportunity where we can more comprehensively and effectively work together to both bring our joint products to market, every company struggling with digital transformation and that takes both great software and great process reengineering support to sort of implement it. We can we're talking about even tighter collaboration on product development and sharing R and D and roadmaps together. And so, I feel like there's still additional opportunity to get even more mutual benefit out of our top partner relationships.
Excellent. Thank you very much guys.
Thank you. And our next question comes from the line of Curt Materne with Evercore ISI. Your line is open. Please go ahead.
Thanks very much. John, you mentioned a couple of the bigger HR wins this quarter. And it seems to us that more of your customers and partners are talking about your HR onboarding offering and I noticed you all are also a Diamond sponsor at the HR Tech Show this year, so which would seem to indicate you guys want to get the message out there. So could you just talk about the opportunity you see for ServiceNow around the HR function and what do you think has to sort of realize that opportunity? And just a really quick follow-up for Mike.
Mike, obviously a really good quarter, but you also took up guidance for the back half of the year, which would seem to indicate you feel good about the trends heading into the Q3. Is there anything else we should sort of read into the guidance going up for the Yes,
Kurt. On the first on your first question on what you described as HR, here's what I see, and I think we're experiencing it. The change is that virtually every company and every CEO is making modernizing the employee experience a priority, right? Millennials are demanding that they get the same kind of experiences at work as they're getting at home. And so almost every company is saying how can we provide a more compelling employee experience at work.
And that's the macro trend that's creating the macro demand. Now what's interesting, when you think about it as employee experience, employee experience is a lot more than just HR. It's their full end to end experience. And that's where we excel. So take employee onboarding.
Employee onboarding is a multi departmental experience, right. It touches you got to get your badge from facilities, you got to get your desk or sorry, your badge from security, your desk from facilities, you got to get your laptop from IT, you got to deal with finance, you got to deal with compliance, you have to deal with HR. So, it's more than just an HR experience, it's the full end to end experience and that's where our platform and our capabilities are really strong. Same thing with HR case management, same thing with employee portal, which is by definition a multifunctional portal. And so our sweet spot is something that can help drive end to end good experiences, workflows the way we talk about it to improve the employee experience.
And so that's what's driving really strong demand for our HR products and we think that's going to continue. And I'll note as I have several times that is very complementary with what the HCM providers are providing. It's not in competition with them, but very complementary to provide the best end to end working together, we provide the best end to end employee experiences for our customers.
And then Kurt, on your question with regards to billings, the uptick in our billings guidance for the full year is really a result of the overachievement in our net new ACV in the quarter, coupled with the opportunity we see on the subscription side, FX also impacted that very positively. You see where the euro is at relative to where it was when we gave guidance last quarter. But on top of that, there is a negative headwind that we did take down our professional services slightly by about $6,000,000 in revenue, which directly flows through the billings. And that's really more because as we've talked about quite some bit for the last couple of years, we're really shifting more of our professional services, the implementation work to our GSIs and partners because we really want to focus more on the high level solution architect, the deployment of our new products and training. Super.
Thanks very much guys.
Thank you. And our next question comes from the line of Walter Pritchard with Citi. Your line is open. Please go ahead. Thanks.
A question for John. On just on M and A, the company has been very, I'd say, measured in acquisitions that have been done. And I'm wondering you've been your quarter under your belt. Is there a need in some of these markets? It feels like your priority has to be on driving broader opportunity.
Is there a need to expand that M and A activity as you look at some of these markets that are maybe further field from your core and IT and you might want to jump start or otherwise accelerate the efforts there?
Well, Walter, I think one of the real strengths of the company has been this practice of taking literally virtually every single acquisition and recoding it into the platform, so that we do have one platform that all applications and all customers can pull from. And the thing that's striking about this company is the organic innovation that we've been able to pull off. And so whether it's the new products around ITOM, around HR, customer support and security, that organic innovation is what's driving our growth. And that is enhanced by having one platform. When you have multiple platforms, you get more complexity, you get less organic innovation.
And so I think this formula of saying, let's look for acquisitions that may bring a functionality, a capability such as machine learning or virtual agents or the ITAP capability that we're now using in cloud management, bring those in, recode them into our platform, so they're natively available, which then drives a very high organic innovation flywheel. And as long as that's working, there's no need to disrupt that momentum. We feel like there's very good growth opportunity with our existing application set. The other interesting thing is we've got a whole host of applications or a whole host of use cases where customers are already using our platform on workflows and use cases that we don't have an out of the box functionality with, and we will over time evaluate which of those we want bring into our core product line. And so I see a pretty strong innovation pipeline that's not dependent upon M and A.
Great. Thank you.
Thank you. And our next question comes from the line of Ashby Lombeau with Mizuho Securities. Your line is open. Please go ahead.
Yes. Thank you and congrats on a great quarter guys. John or Mike, I have a question on customer feedback on the Jakarta release. What type of feedback are you getting from them? What are the kind of features that partners and customers are most excited about?
And in particular, if you can talk about the adoption, are we are you expecting the adoption of Tecate to be faster or slower than the previous releases? Thank you.
Well, the first thing we should say, it was only released generally available last week. So, but clearly the feedback from knowledge and since then it's just been very, very strong on a number of dimensions, whether it's the enhancements that Ferrell made to ITSM to make the pre configuration that makes integration and upgrades more easy and allows faster time to value or additional functionality like software asset management or cloud management that's being released with Jakarta, 2 new products, great examples of organically extending our platform to address a key need in our customer software. They're having an explosion in different software inside and managing that software, tracking and managing it's a key need and our software management, asset management product does that. And then they've got multiple clouds and how they manage the cloud is a growing and new and emerging need and our cloud management product cloud management capability is helping to address that. So, there are a number of both, I'd say refinements to existing products and new features and functionality in Jakarta.
There is a lot of excitement about it, but to be honest, they are just now upgrading and implementing them and we'll be very aggressive at ensuring that our customers get real value out of those. Anything you'd add, Mike?
No, I'll just add, Abhay, remember we deal with very large enterprise customers and feedback on new releases. Generally when they adopt a new release, they put it into a test environment to make sure they test out everything before they go live. So it generally takes a number of months after the release before we get real feedback. I will say just internally software asset management is one that interests me. We adopted that within the 1st couple of weeks doing this.
We had a software audit came in and saved us. We're a small company $150,000 So I was pretty pleased with that, because if we weren't using it, I don't think we would have saved that at all. We are
already seeing in software asset
management, we've seen a with the trusted circles as well as the Brightpoint acquisition is now native and we talked about that at our users conference, but also what we're seeing in HR and the improvements we've done there and the fact that in our CSM product, we now have communities inside there built into that. So a lot of excitement across the board with our entire portfolio. Okay. Thank you.
Thank you. And our next question comes from the line of Justin Furby with William Blair and Company. Your line is open. Please go ahead.
Thanks guys and congrats on the quarter. I guess a couple for me. First, either for John or Mike, I was hoping you could unpack the 39% ACV a little bit. You've got a number of products in there, HR, Security, Ops, CX and others as well. I'm just wondering if there's any one that dominates that in terms of what you saw in Q2 and if you look at the pipeline or if it's pretty balanced?
And then specifically for software assets since you just mentioned it, Mike, where will that go in terms of these different buckets? And what does the pricing look like for that? And then I've got a follow-up. Thanks.
So we continue to see strength in all of our emerging products, as John called out. HR was a very, very strong quarter for us. And I would say 2nd followed by customer service, ITOM was a very big quarter. I know you're not calling out that. We're very pleased with what we saw in I, Tom.
And then I would say 3rd was customer or security ops was 3rd. We continue to see a lot of excitement and pipeline build within the security ops product, but HR and CSM are driving bigger deals for us. In terms of software asset management that will be disclosed as one of our emerging products that other going forward And the pricing on that is really based upon the number of servers that you have out there.
Okay. Super helpful. And then on the guide for Q3, it looks like particularly on subscription billings, it seems abnormally strong from a sequential standpoint. I think you're guiding for something like 8% growth and last year, I think the guidance was more like 2%. You talked a little bit about this, but is that just a normally strong start to Q3?
Is it timing of renewals or what else is there to think about in terms of seasonality? And that's it. Thanks.
It's both. It's a lot of backlog, not just renewals that is going to be billed, as well as the strength that we see in our pipeline of opportunities.
Got it. Thanks very much.
Thank you. And our next question comes from the line of Raimo Lenschow with Barclays. Your line is open. Please go ahead.
Hey, thanks for taking my question. Question for John. Now that you had a good few months in the company and if you look at the vendors, like it's the highest renewal rate I see in SaaS, it's very, very strategic. What is the feedback that you get from talking to all the guys that you know in industry that are not yet customers in terms of if you have engagement with them, like what are they thinking about you versus other guys? And what's kind of the dialogue that you have around that one?
And a quick question for Mike then is, if I look in Q2, you did beat us quite a bit on operating margins and then in Q3, it was slightly lighter. Was there a timing thing in terms of cost, etcetera, that we should be aware of? Thank you.
Well, Raimo, it's I've sort of struck 90 days in on sort of 2 levels about what customers and as you say, not yet customers. Obviously, within every IT department, ServiceNow is very well known. And for those that are not yet customers, often they either have a renewal of their existing provider that's coming up. And I think we'll have an at bat, if you will, in almost every one of those cases. Or they haven't yet gotten to using software to structure unstructured workflows.
And the impetus is on us to demonstrate to them the business value and productivity value that they will get from using our ITSM and core IT products. And so, I think we continue to add new logos simply because where we do focus our energies and effort, we're successful at penetrating. The other observation I'd make is outside of IT and in the C suite, in some ways ServiceNow is one of the best kept secrets in the world and that our brand awareness outside of IT is not what it I think it can be. And in particular, as I said earlier, the brand awareness of how we drive business value, how we drive productivity, how we drive an enhanced and improved employee experience, how we drive improved end customer experiences where our platform is being exposed to end customers. That is I think an opportunity for us to raise our visibility and raise our awareness.
And it's one of those wonderful situations where the substance is ahead of the perception. And so I think one of the things we're going to be doing is trying to bring the awareness and perception in line with the substance. And I think when people understand what it is we do and what it is we can do and how it can drive business value for them, the all it will do is enhance
what is an already strong sales motion. And Raimo, that ties in partly to the answer to your question. So the first thing in Q2, we did have overachievement on the operating margin. That was partially due to timing of expenses, but namely some of the linearity within the hiring. There were also some expenses that got pushed out into Q2.
But what we did make a decision and this is part of the thing which John just talked about is we are going to try to elevate our brand awareness at a company level as well as at a certain product level with some of our emerging products, because we see the opportunity and that's reflected in our operating margin, which is still within the guidance that we gave for the beginning of the year. We're still confirming 16% operating margin for the full year. And on top of that, we've also we're adding more employees to as we're seeing the opportunity to invest more heavily both in our sales organization and sales and marketing to go after these opportunities that we're seeing.
Perfect. Thank you. Congrats.
Thank you. And our next question comes from the line of Sarah Haidt Leon with Macquarie. Your line is open. Please go ahead.
All right. Thank you very much. Congratulations on the quarter guys and thanks for taking my questions. John, the first one for you. You're seeing a lot of strength in your Forbes 2000 adds, another 29 this quarter, which is up year over year and sequentially.
And it looks pretty good across the globe, but I wanted to dig into some of the regional performance and what you're seeing in the pipeline in both Europe and Asia Pac. And then Mike, I wanted to follow-up with you on 606. I'd love to hear where we are, and what we should be expecting from you on that accounting change?
Actually, Sarah, I'm going to jump in right now kind of on the Global 2,000. Yes, we had very good strength across the Global 2029. We continue to see in our pipeline a large pipeline of new opportunities, but in the past quarter, Asia was a little light on landing new Global 2,000. However, as I did just mention, we did have 2 that closed already quarter to date this quarter. So you do see variability.
I can't stress enough. These Global 2,000 sales are extremely long sales cycles. We see that globally. That's not unique to any one region. As an example, we landed 2 Global 2000s this past quarter that were as new customers that were 5 plus year sales cycles.
We up sold another Global 2,000 where we finally got the mother ship that they're committed to land, once again that was a 4 plus year upsell. They were a very small customer and are now continuing to grow. So I'm not concerned about the strength in Global 2,000 ads in any one geo in any particular quarter, looking at it more on an annual basis. And we do see very good distribution, both historically and what's in our pipeline going forward.
And the thing I'd just add to that from a more of a macro perspective is one of the things that we look at is cloud adoption. Cloud adoption differs by country. And so there are a couple of markets that are enormous markets where cloud adoption has been a little behind, but is now beginning to kick in, Japan being one of them in a huge market. Cloud a little bit more slowly adopted. Now we're beginning to see it's more common among the large Japanese multinationals and leading companies to be embracing cloud with some of the same fervor that's being done in the U.
S. And other places. Similarly, Germany. Germany is a huge market with a lot of very large companies and cloud adoption in Germany has been just a little bit more slow for all sorts of reasons, privacy, security and others, but we're beginning to see some early signs there of that market moving along a little bit. So I think that's another positive indicator on the global expansion horizon as more and more countries again embracing cloud with the same vigor that the U.
S, U. K. And others have.
And then on the second part of your question, Sarah, on 606, I did spend quite a bit of time at our Financial Analyst Day going over 606 in May, was not planning on giving any update right now. We continue to move through with, the adoption of that in October call. I'll update people on the impact of that.
All right. That's perfect. Thank you guys so much and congrats on the quarter. Appreciate it. Thanks.
Thank you. And our next question comes from the line of Karl Keirstead with Deutsche Bank. Your line is open. Please go ahead.
Great. My question for you on free cash flow. I remember super strong in Q1, you wonder, saw that, that was a little bit of an unusual cash flow generation quarter. But 2Q, solid as well actually. And through the first half, you're now running at 28% free cash flow margins.
Your full year guide is 25%. So what would cause the free cash flow margins to compress in the second half given that your operating margins should likely be up year over year? Thank you.
So believe it or not, Q1 is generally one of the strongest quarters. And if you do look on our investor deck, which is posted that we did go over with you guys at our Financial Analyst Day, Page 20, Q1 is so high because of the amount of contracts that we have that start on December 31 or January 1, so the cash flows through in Q1 when you do that billing. Yes, Q4 is a strong quarter. Q3 has a negative impact of the employee stock purchase plan because we use a fair reminder, we did tell people for the full year, if as a reminder, we did tell people for the full year, if we're in high growth, we're going to add 0% to 1% in free cash flow margin and we're continuing to deliver above that this year.
Okay.
Good. Thanks, Mike.
Thank you.
Thank you. And our next question comes from the line of Michael Turits with Raymond James. Your line is open. Please go ahead.
Hi. Can you hear me?
Yes.
I'd like to drill down a little bit on Keith's question about go to market and any change there. I know that you said that you're in pretty good shape, but there have been a really big expansion in the amount of products and in the areas in which you have products, including in areas like infrastructure where you're doing more automation. So what makes you feel that you have the right structure, exactly what it is and how do you scale out and broaden scope such that you can make sure that you deliver all those products and sell them?
Well, Michael, maybe both of us comment on this different points
of view
because I'll just say as a relative newcomer, it's not that we I don't think we have it all figured out, but I'm really impressed with Dave Snyder, Kevin Haverty, our sales leadership team of how they're continuing to evolve at each year And they're evolving it by, as I said earlier, adding product sales overlay, adding some of the vertical, how they're expanding geography. And they're doing it in a way where customers don't see a lot of dislocation and that's not an easy thing to do. The other thing that's striking to me is that as we get larger, it's allowing more focus on our customers. So we have 2 huge wins, the 2 large wins in Q2, whereas Mike said, things that took many years and we went back and asked the rep 3 years ago, how many accounts were you covering? And in both cases, they were covering 60 to 80, somewhere between 60 and 80 accounts.
And both cases, those were very same reps this year only covering 10 accounts. And what that allows them to do is to walk the hallways even if it's a non paying customer, it's a potential customer, they are walking the hallways, they are understanding those customers' needs, they are demonstrating our capabilities, they are building relationships. And so the value of scale is allowing a greater customer focus, which helps with existing customers as well as helps us penetrate new large customers, because we simply have more sales time per customer. And so we will continue to evolve We'll evolve more in 2018, 2019, 2020 as we grow our product portfolio and grow our scale. So, I think what I was commenting on earlier is just that dynamic ability to do that in a way that deepens the relationships and does not create discontinuity is what certainly striking to me is impressive in my early months.
I would echo what John said and I would also say is that obviously what we've been doing has been working
as you see the expansion outside
of ITSM in our emerging products. Later on down the path, but later on down the path, but we don't expect any changes in 2017.
Thanks, John. Thanks, Mike.
Thank you. And our next question comes from the line of Greg McGowan with JMP Securities. Your line is open. Please go ahead.
Great. Thank you very much. Two quick questions. First one is, if you could provide any color on sort of commercial sales team performance versus the enterprise sales team performance? And then one quick mechanical question, Mike, I noticed there is an uptick in the contract term length for new customers and I was just wondering if there's anything behind that.
Thanks.
So we had very good performance out of the commercial team. The commercial team, I think, hit 106% of their number. We had a very good quarter, as I mentioned. The overachievement in our net new ACV is kind of what's driving billing. So we're very pleased with what we're seeing across the board, both enterprise and commercial.
On your comment on average contract term, not that much to read into that other than we did it was a very strong Global 2000 quarter with 29 that we added. The G2Ks tend to like longer term contracts to lock in pricing for a period of time. As a reminder, we do try to incent our sales force to sell a 3 year contract. We've had quarters that have kind of been in that 33 before. I don't find it that unusual, the 33.9%.
Okay, thanks.
Thank you. And our next question comes from the line of Sterling Auty with JPMorgan. Your line is open. Please go ahead.
Thanks guys. JPMorgan, just one quick one. I missed it, you said it, but any color in terms of the experience and demand by vertical industry in the quarter and specifically government as we head into the government's final fiscal quarter?
We saw strength across the board financials. We saw it in the healthcare. We did some very nice government deals this past quarter. So no one industry to call out. I would say it was strength
across
all. Got it. Thank you.
Thank you. And our next question comes from the line of Kash Regan with Bank of America Merrill Lynch. Your line is open. Please go ahead.
Hi, congrats on the quarter and pardon the directness of the question. Was the mix of business the way it shook out the non ITSM, was it as you expected going into Q2? And if so, are you what does the sales pipeline of potential new business look like? Does that reflect a change in your business mix? And maybe if I'm overthinking this, do you expect conversely ITSM to rebound because I think there was at least 1 quarter last year when ITSM was a little bit sluggish and I remember Frank saying that it's going to bounce back and it did.
I'm wondering which of the two ways to interpret the mix of results because if it is the former, I believe that the value drivers for ITSM are very different from the value drivers for non ITSM. Therefore, what we have come to depend upon the predictability of a replacement cycle of old service management systems that gives way to a different kind of missionary sales, increasing mix of your business from missionary, customer support, analytics, HR, etcetera.
So if that's the case, sorry for
the complicated question, but if that's the case, then how are you going to be thinking about how you've organized your sales effort because the selling skills and the motions are very, very different? Sorry for the long winded question.
Thanks, Kash. So first of all, those percentages are of ACV. We're actually not telling you what the actual ACV is and what I will add is, of the 29 Global 2000, 28 of them were ITSM. I can't stress enough, ITSM is what lands us in the door. And once we get into ITSM, then we're able to upsell.
And we are continuing to see strength in ITSM. If you look at our Jakarta release, we're very focused on a lot of the enhancements we're doing within ITSM, but I don't disagree with you on value. The IT is a very different value than HR and customer we do see a very good pipeline of you don't have that opportunity. So we do see a very good pipeline of opportunity in the second half of the year across the board. I do expect the emerging products as you'd expect for investing heavily in these will continue to grow at a bigger pace than the ITSM, but we are seeing growth in ITSM and ITSM is the bulk of our revenue today and will be the bulk of our revenue for quite some time.
And Kash, what I'd add
to that is it's striking to me is that, when you actually get inside these customers and talk to them, they view us as a platform. I mean, this is where this is not a series of disparate products that are unrelated to one another. They and many if not most cases have embraced our platform. And even though the decision maker in our HR product or security or CSM is not the CIO explicitly. The CIO and IT does play a role, both because we've established credibility and payback in IT and IT is involved in the implementation outside of IT as well.
And so, there is it's not quite as far a field as it may look from the outside and that it's from the same platform, the products do there's a high degree of overlap with the product functionality is and the role of IT is a real asset and our credibility with IT within the company is a real asset.
Thank you very much, John and Mike. Congratulations again.
Thank you. Our next question comes from the line of Jesse Halsing with Goldman Sachs. Your line is open. Please go ahead. Yes.
Thank you. Hey, guys. I have a couple of questions. The first for John, what's your
I guess
what's your philosophy on ISVs and expanding that opportunity? And are you doing anything to increase your investment on 3rd party building on ServiceNow? And then a quick one maybe for Mike. How are sales cycles trending year over year in your non ITSM business? I guess I'm curious as you build up more awareness around these solutions and get some reference customers if you're starting to see those come down?
Yes. Our platform, as I said a minute ago, is a huge asset. And what our customers tell us as internal developers find it easy to build on, fast to build on, extensible quite easily. And so that's an obvious opportunity to open that up and make that more available to ISVs and 3rd party developers. And as we grow and expand, that's a natural way to grow and expand our functionality as well, whether it's more vertical specific requirements that ISVs can develop or new markets, new use cases.
And so we're absolutely investing and making sure the platform is as easy to build upon as possible. We have our store. It's relatively nascent, but there is, I think, go over 200 now applications in the store and that's growing. And so, it will be a continued and increasing area of focus and investment as we go forward.
I'll also add, Jesse, we did make 4 investments last quarter in ISVs, that are building their businesses on ServiceNow's platform. The other thing on your other question on sales cycles, we continue to see really no change in the ITSM sales cycle. Remember, a replacement cycle. I talked about earlier how long it is in the Global 2,000. It's still a 9 plus month on average initial sales cycle.
We are seeing some shorter sales cycles in some of the emerging products in particular, HR and customer service. Don't know if that's a trend that will be going forward, but we do see in some of the newer products, shorter sales cycles and there are some shorter sales cycles on upsells. And we are very much focused too on having contractual upsells with customers right now as well.
Thanks, Mike.
Thank you. And our next question comes from the line of Phil Wilfel with Wells Fargo. Your line is open. Please go ahead.
Hey, thanks guys for taking my question and congrats on a great quarter. You all touched on a lot on HR, ITOM, customer service, but I'm hoping if you could give us some flavor for what you're seeing in IT security management, analytics, because obviously the growth in that other ACV line has been really impressive
this year? Well, I think all the products are doing well. We just chose to flag and highlight the ones that stood out. But security operations is obviously a huge market where it's going through tremendous high demand and our product is a natural complement to many of the other products in that market and is addressing one of the most fundamental dilemmas CSOs have, which is an explosion of inbound contacts, whether it's from their existing nodes or if the Internet of things, it's just an explosion of inbound contacts and the ability to address and remediate those and as an automated way as possible, so that they put their human energies on the ones that really matter is a key need. And so the security operations product continues to sell well.
2 of our top 5 deals in the quarter included security and it's a natural add on product along with ITSM and ITOM. And similarly, analytics was had a strong quarter. It was included in 17 of our top 20 deals. So the highest frankly, the highest count of all products and it was a strong contributor to net new ACV. It's not as big a line item, so to speak, but it's very prevalent and most customers are buying analytics along with the other products.
Got it. And then Mike, just one quick ask, I mean, I think last year, the net expense associated with Knowledge was $11,000,000 I wonder if you could give us to that for this year
as well?
The net expense is somewhere in the $15,000,000 to $17,000,000 I don't remember exactly the amount going through there. Got it. All right. Thanks guys.
Thank you. And our last question will come from the line of Richard Davis with Canaccord. Your line is open. Please go ahead.
Thanks. John, this may be a question for you. It's a short question, but maybe a little harder to answer. So if you kind of think about when sales force really kicked it into another gear is when they became kind of strategic partner to their customers on the revenue side and you guys have touched on this on and off throughout the conversation tonight. To what extent do you think you guys are there?
And if you're not, what should we what do you need to do to get there?
Well, I think we have Richard, I think it's an excellent question. I think my early read is we have all the potential to get there and that there's clear demand in every company is dealing with digital transformation. Every company needs to find productivity in their operations, so that they can take that productivity savings and reinvest it in innovation with their own customers. And fundamentally, at the end of the day, what we do is by automating workflows, we're driving productivity, we're helping improve the employee experience. And so, I think the fundamentals are there.
I think we can do a better job of capturing the business value we're creating, codifying, capturing it and communicating it. And interestingly, our customers are asking for that. IT is typically not talked about what they do inside the company in business value terms. They're increasingly being asked to do so. And so just as I think you talked about sales force, when that focus became on measurable incremental revenue, they became a more strategic partner.
In our case, driving greater productivity, driving greater employee experience, better employee experience, which as I said earlier is a core requirement and demand for most customers and driving better end customer experience, NPS. You heard Ashley from GE talk about that at our knowledge, where we're being used, pulled to the end customers. And so, those are measurable business outcomes that we're helping to contribute toward. Those are C suite kind of issues and I think we're well positioned to capture and codify what we're doing, linking it to that. And that will continue to make us more relevant and strategic both to IT and beyond.
Perfect. Thank you very much. Appreciate it.
Thank you. And I'd now like to turn the conference back over to Michael Scarpelli for any closing remarks.
So sorry for those who were unable to ask a question. Unfortunately, we're at the top of the hour. So as a reminder, a replay of this call will be available as a webcast in the Investors section of our website. Thank you for joining us today.
Thanks, everybody.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone