Good day, ladies and gentlemen, thank you for standing by. Welcome to the ServiceNow Q3 2016 earnings conference call. At this time, all participants are in a listen-only mode. Following the prepared remarks, we will host a question answer session. Our instructions will follow at that time. If, during the conference, you do need to speak to an operator, please press star then zero on your telephone keypad. As a reminder to our audience, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Michael Scarpelli, Chief Financial Officer. Sir?
Good afternoon, thank you for joining us. On the call with me today is Frank Slootman, our Chief Executive Officer. Our press release, investor presentation, and broadcast of this call can be accessed at investors.servicenow.com. We may make forward-looking statements on this conference call, such as those using the words may, will, expects, believes, or similar phrases to convey that information is not historical fact. These statements are subject to risks, uncertainties and assumptions. Please refer to the press release and risk factors and documents filed with the Securities and Exchange Commission, including our most recent annual report on Form 10-K, for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements. I would now like to turn the call over to Frank.
Thanks, Mike. Good afternoon. Thank you for joining us on today's call. We are pleased to announce an exceptional third quarter. Total revenues grew 37% year-on-year to $358 million, driven by record metrics across the board. First, we closed 16 new deals with net new ACV greater than $1 million. Second, we posted a 99% renewal rate. Third, 301 customers now pay us more than $1 million in ACV, an increase of 31 in the quarter. Lastly, 18 customers now pay us more than $5 million in ACV, an increase of six in the quarter. We also continue to see great uptake in Global 2000 accounts, adding 23 new logos in the quarter, including Prada, Hilton, and Constellation Brands. Our average ACV per Global 2000 is now approximately $1 million, a 6% sequential increase and a 20% year-over-year increase.
Large deals in IT, emerging products, the federal business highlighted the quarter. IT continues to be our strength and primary landing strategy. 18 of our top 20 deals and 22 of our 23 new Global 2000 logos included ITSM. We see tremendous new business opportunities in this market. The quarter was punctuated by an upsell to a North American Global 100 financial institution. This represented our largest contract value ever. Included more than $5 million in net new ACV. The CIO was tasked with driving significant cost savings, increasing employee productivity, improving the velocity of service delivery. We successfully demonstrated a comprehensive service management solution. The ability to unify processes in a single system of engagement. The deal was led by ITSM to consolidate 66 disparate tools. Augmented by ITOM to deliver lights out automation.
This initiative will result in more than $150 million in savings over five years. Beyond IT, emerging products continue to drive larger deals as customers increase adoption of service management throughout the enterprise. These products represented 41% of our net new ACV in the quarter, up from 28% in the prior year. 15 of our top 20 deals included three or more products, and 69% of our customers now license more than one product. Emerging products were highlighted by our largest HR deal ever, a $2 million upsell to a European Global 100 financial institution. As part of their global transformation, this customer replaced a legacy solution that supported 19 disparate document management tools. We won this RFP against 10 other vendors with a comprehensive platform approach, including case management, orchestration to integrate key systems, and in-platform analytics.
ServiceNow will improve employee engagement for more than 250,000 employees and deliver productivity for more than 1 million cases per year. We also saw large deals in industry verticals. The federal government represented 11% of our net new ACV compared to 9% a year ago, including two new deals with ACV greater than $1 million. The civilian sector represented the majority of our wins, but defense net new ACV grew 40% year-on-year and represents a large opportunity going forward. We landed our largest federal deal ever, a $2 million upsell to an agency within the Department of Health and Human Services. This customer contracted ITSM to consolidate 10 legacy systems, Performance Analytics to gain insight into key trends, and Discovery to effectively manage assets. Additionally, our FedRAMP certification led to us becoming their first enterprise-wide cloud platform.
Finally, our Chairman, Paul Barber of JMI, is retiring from our board of directors after 11 years of service. Paul was our first venture investor, and we appreciate his support all these years. Going forward, I will serve as Chairman, and Charlie Giancarlo will serve as Lead Independent Director. We also welcome two new members to our board, Jonathan Chadwick, most recently CFO of VMware, and Paul Chamberlain, most recently head of technology investment banking at Morgan Stanley. Both bring significant corporate leadership, industry, and management experience to our board. With that, I will now turn the call over to Mike.
Thank you, Frank. During today's call, we will review our third quarter financial results and discuss our financial guidance for Q4 and full year 2016. We'd like to point out that the company reports non-GAAP results in addition to, and not as a substitute for or superior to, financial measures calculated in accordance with GAAP. All financial figures we will discuss today are non-GAAP, except for revenues. To see the reconciliation between these non-GAAP and GAAP results, please refer to our press release filed earlier today and for prior quarters previously filed press releases, all of which are posted at investors.servicenow.com. Total revenues for the third quarter were $358 million, increasing 37% year-over-year. Subscription revenues were $319 million, increasing 43% year-over-year, and professional services and other revenues were $39 million, increasing 2% year-over-year.
Billings were $404 million in the quarter, increasing 41% year-over-year, compared to 38% in the prior year. Subscription billings were $363 million, increasing 47% year-over-year, compared to 39% in the prior year. Professional services and other billings were $42 million, increasing 3% year-over-year. Our average billings duration was 11.8 months for the third quarter, compared to 11.7 months in the same period last year. Subscription gross margin in the quarter was 84%, professional services and other gross margin was 12%, overall gross margin was 76%, and operating margin was 16%. We ended the quarter with 4,501 total employees, a net increase of 260 in the quarter. Free cash flow margin was 18%, and we ended the quarter with $1.1 billion in cash, short-term, and long-term investment.
Let's turn to guidance for the fourth quarter and full year 2016, based on foreign exchange rates at the end of the third quarter. For the fourth quarter, we expect total revenues between $376 million and $381 million, representing year-over-year growth between 32% and 33%. We expect subscription revenues between $335 million and $340 million, representing year-over-year growth between 37% and 39%, and professional services and other revenues of approximately $41 million, representing flat year-over-year growth. We expect total billings between $474 million and $479 million, representing year-over-year growth between 30% and 31%. We expect subscription billings between $427 million and $431 million, representing year-over-year growth between 34% and 36%, and professional services and other billings between $47 million and $48 million, representing year-over-year growth between -2% and 0%.
We expect subscription gross margin of approximately 84%, professional services and other gross margin of approximately 16%, and overall gross margin of approximately 77%. We expect an operating margin of approximately 16% and a free cash flow margin of approximately 30%. We expect diluted weighted average shares outstanding to be approximately 176 million, and we expect to hire 275 net new employees in the quarter. Based on Q4 guidance, the implied full year 2016 guidance for total revenue is between $1.381 billion and $1.386 billion, representing year-over-year growth between 37% and 38%. We expect subscription revenues between $1.212 billion and $1.217 billion, representing year-over-year growth of approximately 43%, and professional services and other revenues of approximately $169 million, representing year-over-year growth of approximately 7%. Implied full year 2016 guidance for total billings is between $1.630 billion and $1.635 billion, representing year-over-year growth of 36%.
We expect subscription billings between $1.454 billion and $1.458 billion, representing year-over-year growth of approximately 40%, and professional services and other billings between $176 million and $177 million, representing year-over-year growth between 8% and 9%. The implied full year 2016 operating margin and free cash flow margin guidance is approximately 13% and 24% respectively, and the implied full year diluted weighted average shares outstanding is approximately 173 million. With that, operator, you can now open up the line for questions.
Thank you. Ladies and gentlemen, at this time, if you would like to ask a question, please press star and then one on your telephone keypad. We ask everyone today participating in today's Q&A session, please limit yourself to one preliminary question and one follow-up. Our first question comes from the line of Matt Hedberg with RBC Capital Markets. Questions, please.
Hey, thanks, guys. Congrats on the quarter. Love to see the billings accelerate. Also, the non-ITSM business continues to do extremely well. Mike, I know on the last call you guys talked about accelerating some hiring plans starting earlier in Q3. I think you were speaking to really the pipeline that you're seeing in non-ITSM deals as you look out into 2017. I think the mix certainly improved this quarter to non-ITSM deals. Can you talk a little bit more about some of the benefits of some of that hiring?
We're seeing the generation of pipeline, and we're very pleased with the pipeline we see, not just in Q4, but how it's building in 2017 right now, we think those were very good investments.
One question. I don't think we've touched on this in the Q&A section in a while, but in terms of the ServiceNow Store, I'm curious, any update on the number of developers or apps, number of customers deploying third-party apps? Just curious on that initiative.
That's not really a key metric that I've been looking at because it's not a big piece of our business. As we said before, the ServiceNow Store, what it really does is it drives more user licenses, not necessarily revenue coming from the apps themselves. We have about 56,000 developers in our developer program. Obviously, not all of those have posted things to our app store. There's, I think, a little over 200 apps that you can now download for purchase in our app store. We did do three deals that were just over a half a million dollars in the quarter. Our biggest one we talked about before, we did do a million-dollar deal in the past. This past quarter, there were just three. As you can see, it's not that big a piece of our business.
All right. Thanks a lot, guys.
Thank you. Our next question comes by to Brent Thill with UBS. Your questions, please.
Good afternoon. Frank, can you just talk a little bit about the commercial business versus the enterprise business and what you're seeing in that business? A quick follow-up for Mike.
Yes. The commercial business is actually, on an ACV basis, the fastest growing business that we have worldwide. It was growing. It was up, I think, somewhere around 44%, and in the North American organization was close to 70%. The investment that we made almost two years ago to create a dedicated commercial sales organization has paid off in spades for us, and we will continue to invest there. It's an outstanding market. That balance that we have between commercial and enterprise is really a very key part that drives the overall growth of the company.
Great. Mike, just judging from some of Frank's comments about financial services upsell, it sounds like there were some really large deals. Can you just give us a sense of how you're thinking about that as you go into Q4 and the pipeline? I think many of us believe that financial services may have not been as strong as it was, but maybe I'm reading too deeply into that. Can you just give us a little more color there? Thank you.
Financial services was very strong for us. We actually did one of our largest HR deal ever, $2 million a year, and that was with a financial service company, and we continue to do a number of upsells in our pipeline in Q4. We continue to see more in there as well as our pipeline for 2017. We just have strength across the board. We really feel we're hitting on all cylinders across all of our product lines right now.
Great. Thank you.
Thank you. Our next question comes by Kirk Materne with Evercore ISI. Your questions, please.
Yeah, thanks very much. Congrats on the quarter. Mike, I guess just maybe to follow up on your comment around the HR deal you signed with the financial services customer. Obviously, the other products continue to really expand as a percentage of new ACV. Can you just talk about what was in there maybe driving some of the strength this quarter, or Frank, if you want to take this, in addition maybe to HR platform, I'd imagine it's a pretty good product for the government in particular. Could you just give a little bit more color on some of the other products outside of ITSM? ITOM, sorry.
Yeah. Like Mike said, we had strength across the board. We had a very strong quarter on Performance Analytics. We had a record quarter on Human Resources. Our brand new businesses around security and Customer Service Management were really, really strong. Platform was strong as well. We just did really well across our theaters, across our channels across all our product segments. That's when you get very strong results.
Maybe one follow-up for Mike. Just Mike, when you look at sort of sales productivity year-to-date versus kind of what you were thinking at the start of the year, are you sort of on plan in that respect, or are you a little bit ahead of plan? It seems like the cross-selling's going really well. Just kind of curious how that's evolving to date.
I'll just say through the first nine months, we're well ahead of our internal plan in terms of bookings, and we're very pleased with that, and that's reflected in the productivity per rep that we're seeing. I don't think we could be happier there.
Okay, great. Thanks, guys.
Thank you. Our next question comes by to Walter Pritchard with Citi. Your questions, please.
Hi, thanks. Mike, I'm wondering if you could talk about just as we look at next year, seasonality, I think has been somewhat tricky sometimes, Q4, Q1, and Q2. If you could just help us understand how you might be thinking about that, and is that similar to what it's been in past years, or is there anything new going on?
The seasonality is really from the billing perspective is what you really see, that's because we have such a big gross down at the end of a quarter and especially Q4. You don't see the seasonality as much in billings. As we get bigger, you will see some seasonality going from Q4 to Q1. Obviously Q4 is our biggest quarter with our end of our commission year for our reps, and they try to do everything they can to close every deal. I don't expect anything different this quarter.
Just relative to sort of the sales organization going into next year, can you talk about any changes that you may be looking at making, or how should we think about in years that you've done that, there has been more impact on seasonality, for example, in Q4 billings?
This is Frank, Walter. The sales organization is going to be rapidly expanding, one of the areas that we've been investing in is product specialization, which is working well for us. We're really accelerating demand generation by having that product specialization focus into the organization. Going into 2017, we are going to layer in another vector of specialization, that's going to be by solution and by industry vertical. This is going to be an evolution of our selling motion that's going to be more refined by industry and by type of solution. It's really a normal evolution. We're becoming just more sophisticated in our ability to sell more broadly and more deeply into our large enterprises and institutions. That's definitely how the sales organization is going to take shape in 2017.
Thank you.
Thank you. Our next question comes out of Michael Turits with Raymond James. Your questions, please.
Hey, guys. Michael Turits. Thanks. Frank, you gave a little drill down on the non-ITOM, non-ITSM piece. Can you drill down a little bit more on the ITOM piece? What were the use cases? Are they broadening and deepening? Maybe, Mike, if you could talk about what the ACV is doing on a year-over-year basis growth.
This is Frank. On the ITOM side, we very much lead with a very comprehensive total suite approach to allow our customers a full cycle experience where we can take in events from various monitoring capabilities, map that to critical services, and have the ability to orchestration to act on those events. ServiceWatch, which is the ability to dynamically map infrastructure to critical services, is a key part of our strategy. That's how we lead. That's going to continue for a long period of time because this is a marketplace that is yet to begin to develop for us. Then the other aspect, orchestration is going to be a very big part going forward, and it's under the influence of really IoT-oriented thinking, where people are really looking at service models in terms of machine-to-machine messaging and communications versus heavily people-mediated service processes.
Obviously, the orchestration aspect is what drives various frameworks. Those are areas where a lot of our conversations with our large customers are going. ITOM is such a natural partner to ITSM. They are just two peas in a pod, two sides of the same coin. We really believe that over time, the penetration that you'll see on ITOM will rival that of what we have on ITSM.
Your question with regards to the growth of net new ACV, we're really not disclosing net new ACV, we're not going to give you the overall growth. Our business has been very strong, and it's reflected in our billings. It's causing the billings to be
Okay, great. Thanks, guys.
Thank you. Our next question comes the line of Sarah Hindlian with Macquarie. Your questions, please.
Yes. Hi, can you hear me?
Yes.
All right, great. Hi, Frank and Mike. A couple questions for you guys. Congrats on the quarter, too. First, what's driving CapEx then right now, Mike? Frank, one for you also. It looks like we're seeing some really nice adoption of the Security Operations module. It's been roughly four to five logos for the past couple quarters, and a relatively new product. It sounds like the pipeline is strong there, and it certainly backs what we're hearing, and I know you talked about it briefly at the analyst day, but are you going to think about having an independent sales force behind this product given the CISO selling motion there and this interest from customers?
On the CapEx, I'll answer that question first. Obviously, there's two components to our CapEx. The biggest component is our data centers. As you add more customers, you have to add more capacity within your data centers. We're also building out two new data centers because we're in North America, which is a thing that will take some time. That's been planned for quite a while as we're at capacity in our other data centers. The other thing is you're adding 1,000 employees a year. That takes facilities, and we're building facilities, but the vast majority is hardware within our data centers, and you do have to refresh that equipment every three years, and we're into our normal refresh as well there.
This is Frank, Sarah. Security has been strong for all the reasons that were mentioned. It's a very logical add-on. Typically, the chief security officer reports into the CIO. They are often in the same meetings that we're in anyway. It's a very natural selling motion for us. We did start a quarter ago with really loading in dedicated field headcount, both for Security as well as for Customer Service Management. The reason we're doing that is because we're going to drive demand faster than if we just have reps sort of choosing to retire quota any way they see fit. We have the evidence now that strategy is building demand faster than if we stay in a generalized mode. We will continue to do that. That doesn't mean that there's just one group that just sells Security.
I mean, the overall sales force obviously will sell as well. We just have more dedicated focus on these products, and especially in the early going, we thought it really important that we have that extra level of resource and focus applied to it.
All right. That's very helpful. Thank you, guys. Appreciate it.
Thank you. Our next question comes the line of Rob Owens with Pacific Crest Securities. Your questions, please.
Great. Thanks for taking my question. I wanted to reflect more broadly on the inflection you guys saw here in the quarter. Was that just a function of how the pipeline stacked up? Are sales cycles compressing at this point? Just curious, as you saw your billings, your subscription billings, everything accelerate sequentially.
Rob, it's Frank. What's really going on here is that our sales staff worldwide just has more clubs in the bag. As they approach accounts, they have more opportunities to pursue, sometimes multiple opportunities at the same time. The acceleration really comes from being able to operate on a broader product front. In years past, if we would strike out in one area, we would have to go to another account or wait out the situation or whatever it would be. Now we have a second to third to fourth to fifth play to go and pursue. Once we land in accounts, the upsell opportunity starts playing out for us as well. Sales productivity really goes up when you have the ability to run multiple plays.
We have a much broader selling motion than we've ever had before, and that's what's driving it.
With regard to your Global 2000 penetration, you've talked about how you're in the early innings, especially with regard to international opportunities. Talk about some of the infrastructure that's in place to help capture those deals. We haven't seen a huge mix shift, I guess, towards revenue internationally. I think it's been relatively consistent international versus domestic. As we look forward, where should our expectations be? Thanks.
Well, I'll say one thing, Rob. Last quarter, 32% of our net new ACV came internationally, and remember, international has been suffering from the FX over the last year plus. We are very pleased, and we're seeing great growth internationally. Just happens that North America continues to do well as well. Both EMEA and APAC are well ahead of their plan for the full year right now.
Thanks, Mike.
Thank you. Our next question comes line of Justin Furby with William Blair. Your questions, please.
Thanks. Frank, I wanted to ask about the Inspire program and how that's going a few quarters in. I guess, just curious in terms of how long the sales cycles are there and when that might start to impact billings. Then, I guess, are there any learnings to extract from what you're seeing with that team in terms of informing your broader go-to-market strategy? Then I've got one quick follow-up for Mike, I think.
Yeah, I'm personally super pleased with how Inspire has evolved over the last year. The level of engagement that we have with really our top enterprise customers through that solution consulting staff has really sort of elevated our standing in those key accounts. We often work on tier 1 systems that are very innovative, very transformative. They really show where the business can go when you bring that quality of resource to a selling motion. What we're really trying to do down the line is, okay, how do we develop lighter versions of that selling motion for the entire sales organization? Because it's a relatively small team.
We have about 40-some people in the Inspire program, and the trick is how do we standardize and scale that across your organization where we have a lighter version of what we've learned that we know how to do, and that would be available to the broader organization. Going very well, and we're looking forward to probably at our Knowledge Conference next year that we get to showcase some of those key Inspire accounts and the work that's been done there.
Got it. I guess, Mike or Frank, either of you, if you look at some of the customers who are more advanced in terms of adopting ITOM, can you give a sense of how much they're spending there relative to ITSM? Is it one to one? Are they spending more or less? Just any sort of sense there would be super helpful. Thanks.
There is no set pattern. We have some customers that are actually spending more on ITOM than they are on ITSM. I would say in general, customers spend more on a per-customer basis because ITSM is more developed. They're paying more for ITSM than ITOM, but ITOM is quickly catching up. We're seeing some very big deals in ITOM. We've actually, this quarter to date, seen a nice deal that's a standalone ITOM, which they're not an ITSM customer.
Got it. Thanks, Mike.
Thank you. Our next question comes from Steve Ashley with Robert W. Baird. Your questions, please.
Perfect. I would just like to go back to the large upsell you had in the period with financial services customer. Just some color on what was driving that new business. Was it extending ITSM globally or geographically? Was it new use cases? Just some color on that, would you please?
This is Frank. The big thing there, and by the way, this is a pattern that plays out over and over, is just massive modernization, okay? They are replacing dozens and dozens of legacy systems and have a complete overhaul, complete redesign, complete refresh, and really putting brand-new systems, brand-new infrastructure in place. That is just typical of our business in these large enterprise accounts, where they're turning off a lot of old stuff and a lot of fragmentation and sprawl, big cleanup, and going in with a single platform approach. As I said, that's typical for what we do.
Great. With getting such strong traction in HR, can you pursue a future where you may land with some maybe major accounts with HR before you land with ITSM?
Well, it's not just the future. We've been doing that for years. As I said earlier, sometimes we just can't go through the front door because there's incumbency or contractual issues, and we do lead with HR, and that has worked very well for us. I think, HR is a very key service domain, as I think most people will appreciate from their own day-to-day work experience. Over the years, they have been under-invested in service models and really managing service as opposed to just delivering service. There's a lot of efficiencies to be had there in terms of staffing, and there's a huge opportunity to improve the service experience itself. We're very bullish on the HR opportunity.
Thanks.
Thank you. Our next question comes from the line of Karl Keirstead with Deutsche Bank. Your questions, please.
Thanks. Hey, Mike, I've got two questions about the Q4 billings guide of $474 million-$479 million. First is, the third quarter was so strong, $20 million above the high end of guide. Was there any pull forward from Q4? Secondly, FX rates have been pretty volatile of late. Are there any FX hit to that Q4 billings guide that's worth calling out? Thank you.
Every quarter, as I mentioned on last quarter, especially on the renewal side, you have deals that get pulled in and pushed out, I saw nothing unusual this quarter. I'll just say our renewals were extremely strong. In Q4, we think our guidance appropriately reflects what we see in the business today. I'm assuming we're going to have a normal quarter exiting Q4 with deals getting pushed and pulled on the renewal side. In terms of FX, yes, FX rates have moved. As a reminder, 30%+ of our revenue is converted from euros, and a big chunk of our business is in pounds as well, too. They get converted into euros and then dollars. It does have an impact, but we've reflected that in our guidance.
Okay. If I could follow up, Mike, on the free cash flow margins, they've been in the 23%-24% range in each of last year and this year. I'm not asking you for guidance, but as we look into 2017, are there any variables that you could call out that would enable perhaps you guys to post something higher than that in 2017 outside of normal margin expansion?
We'll be giving guidance for 2017 in January. We've given you guys a framework for how we see over time how we will get free cash flow expansion as well as operating margin expansion based upon our growth rates. Where we sit today, we think that's appropriate still. Obviously, we'll revisit that in January when we give guidance for the full year.
Okay. Helpful, Mike. Thanks.
You're welcome.
Thank you. Our next question comes from Keith Weiss with Morgan Stanley. Your questions, please.
Excellent. Thank you guys for taking the question. Very nice quarter. I wanted to dig into sales capacity a little bit, both in terms of how we should be thinking about adding internal sales capacity into the back half of 2016, and also what type of expansion you're seeing in terms of contribution from systems integrators, the pace, if you will, that they're expanding their practices around some of these new solutions and how that's helping your go-to-market strategy.
In terms of headcount, as we mentioned, we're going to add about 275 people in Q4. The bulk of that is going into our engineering and sales organization. I will say in our sales organization, we've been hiring a lot of these product specialists that aren't necessarily quota-carrying, but they're helping generate pipeline for our quota-carrying reps. We will continue to add at roughly that pace through 2017 based upon what we're seeing in terms of pipeline and the way we're converting that pipeline to maturity, and closing that these guys have been able to do. That's where we're thinking about headcount and Sorry, what was your last question? The second half of that?
On the systems integrator side of the equation, what you're seeing in terms of them ramping up their investments around the new products coming out or the new products announcement.
This is Frank. We're actually really pleased with the progress that we've made this year, especially with some of the larger ones like CSC and Accenture, both their internal uptake as well as their use as practitioners and as MSPs. We are really a very significant part of their plans and their growth objectives, and it's very well cemented in. Historically, a lot of these relationships were opportunistic. Something comes up in a kind of a raise your hand, we'll do it. Now these businesses are so big for these large GSIs that this is now really managed and resourced and driven like any other business. We're pleased where it sits, but we still have more room to cover. We like to make more progress with IBM, for example, and there's others out there.
On the whole, one of the reasons that we've driven our own professional services business down as a % of the overall mix is to make sure that we really create room for a very dynamic ecosystem, because that is what enables the growth of the business.
Excellent. Thank you guys.
Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Your questions, please.
Yeah. Hey, thanks, great quarter. Congratulations. I have two quick questions. First of all, on the HR side, you're showing up a lot more on HR-related consulting work. Can you talk a little bit about how your approach towards partnering with kind of pure play HR vendors like Workday or Cornerstone will drive you deeper into that vertical? The other thing is on the large account side, we hear from some big financial services organizations, but also other guys, and when we talk with consultants, that people see you so strategic that they almost kind of restart the implementation and to kind of get it right to get all the value out of it. Does that kind of impact your spending patterns for a while, or will it just keep buying new things during that process? Thank you.
I wasn't following what the second part of your question was, but let me try to answer the first part on HR. We've had longstanding relationships with Workday, and the reason is we're both cloud companies. There's often similar customers that will adopt both Workday and ServiceNow at the same time. There's really good value-added integration between our respective platforms. We're starting to see more opportunities now with SAP as well. I think we're more on their radar, and I see certainly a go-to-market relationship developing there as well. In general, and I think you're correct, we're starting to spike the radar on the HR side much more than we historically have, and we really expect that to continue. If you could reiterate the second part of your question now, I'll try to address that as well also.
Yeah. Hey, Frank. What I'm trying to see is if I look at some bigger accounts, and you might suspect which one I talk about as well, what you do see is that you realize when we put in ServiceNow the first time, we probably took some shortcuts and didn't get the full value out of it. I've heard that now from a few accounts that are kind of re-implementing ServiceNow to just get the full value out. Does that impact the spending of those customers, or are these isolated cases? Thank you.
Yeah. Okay, I understand what you're talking about now. We certainly have customers that have implemented in years past and have come to the conclusion years later that, "Hey, now that we really understand the capabilities of the platform, we would have done a whole bunch of things different." Instead of sort of forward engineering themselves, they do a reset, and completely get a fresh instance and re-implement right out of the box. It's much faster, it's much cleaner, and people are much happier with that approach. This is one of the great things about ServiceNow, that you can bootstrap and resurrect a new system in a very short period of time. One thing that I always tell customers is that PowerPoint does not make you a better presenter.
The people always laugh when I say that, but what it really means is, look, the software itself can be implemented very well, very poorly, and everything in between. If on the first attempt, you sort of haven't gotten everything out of it that you would have envisioned, yeah, then there's room up to do better. One of the key challenges that we have, and we work with our ecosystem of integrators and our own professional services organizations to really drive people very hard towards outcomes. If we don't, a lot of organizations will implement ServiceNow, and they're very happy, but in reality what they've done is they've modernized, they have put their old system in a new jacket, and it looks different, and it feels different, but fundamentally, they have not transformed.
Everybody is still having the same jobs, they sort of have preserved the status quo and their existing systems. That's missed opportunity. It's very much incumbent upon us to really Inspire, there's that word again, to drive our customers to higher outcomes. We really started that in 2016 to be much more aggressive, much more proactive to get customers to implement with much higher expectations than they historically might have. IT is a conservative profession. People have a tendency to be very incremental in their approaches. We, as a provider, really try to break people out of that and embolden them in their objectives and their expectation. The software can do it. The question is whether the organization can.
Perfect. Thank you.
Thank you. Our next question comes from the line of Greg McDowell with JMP Securities. Your questions please.
Great. Hi. Thank you. Just one question, and I know this tends to be a sensitive topic, but we're getting lots of questions from investors about the leaked salesforce.com board presentation that showed it was conducting some due diligence on a number of cloud companies, including ServiceNow. Obviously there's a lot you cannot comment on, but are there any key points at least that you'd like to make for investors around future M&A?
Well, as Frank, I'm sure you guys know that everybody and his mother maintains presentations like that. Everybody reviews their lists with their boards and has a conversation about that. We have lists like that as well. You've been able to observe our M&A strategy over the years. Vendors talk all the time, especially in Silicon Valley. We don't necessarily talk about M&A, but we talk about many different aspects of our business. We didn't think this was as eventful as a lot of the industry observers thought that it was.
Thank you.
Thank you. Our next question comes to the line of Derrick Wood with Cowen and Company. Your questions please.
Thanks. I wanted to hit back on sales productivity, which seems to be tracking quite nicely. I'm just curious if your go to market and pushing outside of ITSM has changed. Is this still kind of a land with ITSM, use that as a springboard to enter a different department or buyer? Or are you finding more success in bringing multiple constituents earlier in the engagement cycle to sell this broader platform out of the gate?
It's Frank. One thing that is really important to understand about ServiceNow is, there's not a hard line that says it's either ITSM or it is other stuff. Because a lot of the things that we refer to as emerging products are, in effect, products that get used with ITSM. ITOM is obvious, but also our analytics products gets used with ITSM. All our IT Business Management products are used with ITSM. In other words, these are value-added software capabilities that people use to enhance their use of the core ITSM applications. The only application that we have that's really distinctly different from our ITSM platform and really has no relationship to the ITSM business is Customer Service Management. Everything else really falls in the realm of IT management.
You can't sort of draw that hard line through it and say, well, this is ITSM, and that other stuff is a totally different business. That's not how our customers view it. It's not the way we view it. We just highlight it because there's a lot of traction and revenue momentum in these modules. ServiceNow is one application. Do not forget that, right? It's one cloud, it's one database. We just turn on and off different modules, different services, and different options. That's how it works. That's the reason why the selling motion works so well for us, because it's just very low friction to allow customers to take advantage of incremental capabilities.
All right. That may make my next question less relevant, but I was going to ask, now with a couple quarters of new ACV and emerging products at 40% of new ACV, just curious if you're seeing anything different in terms of who you're competing against, the competitive landscape, anything you'd call out?
It's not that different from what we've seen before. It's the same sort of legacy group that is trying to slow down their own attrition. On the platform side, there's people like Salesforce. It really hasn't fundamentally changed. On the Customer Service side, we see a lot of very old legacy systems that we're replacing there. We're learning that business now in terms of the type of incumbency that is there, and we're seeing a really similar thing with what we saw on the ITSM side, very old software, which is a good thing for us because that means the pressure to modernize and transform is going to be building. On the security side, it is a completely greenfield type of situation. People do not have these kind of systems today.
Depending on exactly what capability we're talking about, it's a different dynamic, but it really hasn't moved on from where it has historically been.
Got it. Thanks for the color and congrats again.
Thank you.
Thank you. Our next question comes to the line of Kash Rangan with Bank of America Merrill Lynch. Your questions, please.
Hi, I'm wondering what your prediction is to which analyst on this call is going to experience much better IT support quality service in their bank. That's not a serious question. Well, it could be if you choose to answer it. You could say Brent or Keith or Kash or whoever it is, or one of you guys at Goldman Sachs. We'll do the guessing between ourselves.
It's not Kash yet.
Okay. All right. Good. It's still in the pipeline. That's good to know. My serious question was, it looks like ITSM had a good quarter. Based on your percentage of net new ACV split, it looks like sequentially it was up very nicely, and that had not been the case Q3, at least last year. It's also up modestly on a year-over-year basis. As you look at this bounce back in the ITSM business, what is the right way to think about 2017? Obviously, the percentage of your net new ACV coming from non-ITSM will probably likely continue to expand. Is it even fair to expect net new ACV from ITSM to continue to grow, or is it going to sort of flatten out?
My follow-up question is, if it continues to compress, how are you going to be positioning your sales force to sell the HR product? As Frank pointed out, it's a completely different sale. Are you exploring partnerships with the likes of Workday, other HR companies that are complementary, or are you going to be creating a new separate SWAT sales organization? Things along those lines. Thank you.
Yeah. A year and a half ago, almost two years ago now, we created a product line organization to really be able to drive hardcore focus on different business segments. Obviously, that focus has rippled through the entire company into professional services, into solutions consulting. Our whole company now drives these individual product lines as separate businesses, even though our selling motions are all together for the most part. We are going to continue to do that. Security is going to grow into a full-blown standalone business in the sense that it has its own business development function, its own set of partners, and its own unique capabilities. The same is true for HR, certainly is true for Customer Service. We like that. We think that the mass is there for us to invest at considerable scale.
I mean, all those businesses can grow to considerable size. Now, on ITSM, I'm actually bullish on the opportunity that we have there. I think you correctly characterized the growth dynamic this quarter for ITSM. There's a lot of things that are going on in that marketplace that I believe will revitalize that opportunity. One of the things that we've suffered from as a company is that we had a lot of shiny new toys, sometimes it's been hard for us to maintain the vigorous focus on a business like ITSM, which, quite honestly, a lot of our people didn't view it as sexy as some of the new stuff. We have a lot of compelling new capabilities coming out in terms of machine learning and AI. We're going to be releasing comparative benchmarks.
People can see how they're doing against their peer group and the rest of the industry. There's a lot going on. The service models are really evolving to heavily machine-to-machine, lights out, lightspeed type service models from where people historically have been with service desks, which are very heavily people-mediated processes. There is an enormous amount of room for innovation and expansion in the world of ITSM, I think it's been more of an execution issue on our part than it has been a market issue.
I would add to that, too, Kash, that if you look at our Global 2000 adds in the quarter, 22 of those out of the 23 had ITSM. That's one of the main selling features. If you look at 18 of our top 20 deals, that includes both upsells as well as new customers, they all had ITSM in them. It is key to our business.
Thank you. Our next question comes from the line of Abhey Lamba with Mizuho Securities. Your questions, please.
Yeah, thank you. Frank, as you're adding these product specialists, is it helping you accelerate the adoption of some of these new products? Should we expect that trend to accelerate in 2017, as many of these new hires will become fully productive?
Well, I sure hope so. Otherwise, I will stop doing it. That is the point, right? We do everything with an eye towards how quickly it is developing demand. Demand development is the critical metric for our business. We have very good capabilities in terms of converting demand to sales. We have very good abilities in terms of building and deploying capacity, but building demand is the hard part in our business. That's always the critical metric. Everything we do has a focus on that. The specialist allocations, that is completely done to accelerate demand development.
Got it. Mike, can you help us understand how should we think about your plans to expand gross margins, and if single-tenant architecture makes it tough to achieve significantly higher margins? As part of that, if you can also discuss what are the advantages of the single-tenant architecture that's tough to replicate in a multi-tenant environment? Thanks.
Okay. Well, I'm the finance guy, and you're going to want me to talk about the differences of our data center architecture.
Well, the margins then.
Let me answer your first question is, compute is compute. It's all automated the way we do things. Whether you are a single-tenant or multi-tenant, you're still going to need the same amount of compute power, so it's not going to make a difference from a hardware standpoint. One of the big things, though, that adds to our cost is we truly have mirrored data centers where we are on a regular basis failing our customers over from one data center to another to do the maintenance on our databases, which keeps us higher uptime. You've seen the margin expansion we've had, right, 84% on our subscription margin right now, which includes the support organization. We truly have an enterprise-class support organization that adds a lot of cost. We've given you our longer-term target model there, which you've seen. We're comfortable with that subscription margin there.
I don't think there's really any difference because of our architecture.
Got it. Thank you.
Thank you. Our next question comes from the line of Keith Bachman with BMO. Your questions, please.
Hi. Thank you. I was wondering if you could give any general characterizations. You have a lot of new products out there. If you thought about attach rates achieved to date, in other words, if you thought about the installed base of, call it ITSM over the last number of years, what do you think your attach rates are achieved in aggregate? We certainly get some characterization of deals done in the quarter, but it would seem like there's still a long runway to go in terms of opportunity to go ahead and attach to that installed base established over the last number of years.
Yeah. Roughly today, about 69% of our customer base has two or more products. There's still room there. If you look at our cohort analysis, you can continue to see our customers year after year buy 50% plus their initial purchase. A lot of that is adding to their existing products they have with more user licenses. We're seeing more and more now that they're also buying these new products. That was part of our whole strategy with going to a multi-product company that we shifted to in 2015. I really don't have any more data than that.
Yeah, fair enough.
This is Frank. I think that's a very important angle that you sort of got to keep your eye on because our whole game is to drive attach rates up for all our products, and we have an incredibly long ways to go for all our products. Even in our existing products, just to get to attach rates where we're starting to rival the penetration that we have on the core platform. It's going to take years and years and years for us to get there. A lot of upsell opportunity. Mike's right, is that the cohort analysis shows exactly that. This is a big opportunity that's going to play itself out for years to come.
Okay, great. If I could ask a follow-up question of you, Frank, just from one of the previous questions. It sounds like you think net new ACV, even on the ITSM side, as you guys look out over the next year in calendar year 2017, it sounds like you would expect, without putting numbers on it, that can continue to grow as we look into calendar year 2017. Is that the conclusion from an answer to a previous question?
Yes.
Okay, great. Thanks very much.
Thank you. Our next question comes from the line of Alex Zukin with Piper Jaffray. Your questions, please.
Hey, guys. Congrats on a great quarter. Maybe the first one for Mike. Mike, can you categorize how you're feeling about kind of the start of 4Q versus maybe how 3Q started out? Frank, maybe just on the macro. It's been a volatile year, maybe how are you thinking about the macro environment today versus the beginning of the year? Has the volatility actually created increased demand for the business?
I'll start out with, we just gave guidance for Q4. Our Q4 guidance is based upon where we see our business for the quarter. We are off to a very good start. I'm pleased with it. Don't really have much more to add to that.
Yes, this is Frank. I don't have any real color to give you on the macro either. I think it's reasonable. We're obviously a much more of a secular play. We think that we can still sell quite effectively when the macro is turning not too favorable. The reason is we're a transformational play, we're an optimization play. We sort of live below. I sometimes can't determine whether I'm dealing with macro or micro or secular influences. It's hard for us to sort of have a real intelligent commentary about what the macro is and isn't, because we saw right through that.
Got it. Thanks, guys.
Thank you. Our next question comes to the line of Jesse Hulsing with Goldman Sachs. Your questions, please.
Yeah, thanks for taking my question. Frank, you mentioned verticalization on the sales side as part of your plan for next year. I'm wondering what your plans for that are on the product side. You've done a good job of pivoting your platform horizontally to date. Do you plan to more heavily verticalize your platform with new products, or is that something you expect to let your integrator partners run with? Thank you.
No, we're going to do that. The verticalization, the first place you're going to see it is really on the marketing side, especially on the product marketing side, and then the sales enablement will follow. In other words, how are our salespeople message, position, and present themselves in the context of the industry that they're selling into? We have such critical mass in every major vertical that there is a huge amount of value for us to exploit. It's just low-hanging fruit. It's just, in other words, we just got to take our learnings across the big pharmas, across the big retail, everything that we learned in diversified industrials, and really, really use that in our selling motion. Now, as it evolves, it is quite possible that we will have products that are industry-specific.
We will not start off that way, I think the deeper and better we get at this, it is quite possible that we get industry-specific products at some point. Healthcare is another one of those areas. State and local, federal. There is a ton of opportunity. I am super excited about what we are going to do in this area, yeah.
Perfect. Thank you, Frank.
Yeah.
Ladies and gentlemen, this is all the time we have for questions today. At this time, I am now going to hand the call back over to Michael Scarpelli, Chief Financial Officer, for closing comments and remarks. Sir?
Thank you. As a reminder, a replay of this call will be available as a webcast in the Investors section of our website. Thank you for joining us today.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day.