Good day, ladies and gentlemen, and 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 and answer session and our instructions will follow at that time. 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, and 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 ks 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 Q3. Total revenues grew 37% year on year to $358,000,000 driven by record metrics across the board.
First, we closed 16 new deals with net new ACV greater than 1,000,000 dollars 2nd, we posted a 99% renewal rate 3rd, 301 customers now pay us more than $1,000,000 in ACV, an increase of $31,000,000 in the quarter. And lastly, 18 customers now pay us more than $5,000,000 in ACV, an increase of $6,000,000 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 $1,000,000 a 6% sequential increase and a 20% year over year increase. Large deals in IT, emerging products and 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 2,000 logos included ITSM, and 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 and included more than $5,000,000 in net new ACV. The CIO was tasked with driving significant cost savings, increasing employee productivity and improvement of velocity of service delivery.
We successfully demonstrated a comprehensive service management solution and the ability to unify processes in a single system of engagement. The deal was led by ITSM to consolidate 66 disparate tools and augmented by Itom to deliver lights out automation. This initiative will result in more than $150,000,000 in savings over 5 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 3 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 $2,000,000 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 1,000,000 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 2 new deals with ACV greater than 1,000,000. The civilian sector represented the majority of our wins, the defense net new ACV grew 40% year on year and represents a large opportunity going forward. We landed our largest federal deal ever, a $2,000,000 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 1st 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 1st 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 2 new members to our Board, Jonathan Chatwick, most recently CFO of VMware and Paul Chamberlain, most recently Head of Technology Investment Banking at Morgan Stanley.
Walt brings 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 Q3 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 Q3 were $358,000,000 increasing 37% year over year. Subscription revenues were $319,000,000 increasing 43% year over year and professional services and other revenues were $39,000,000 increasing 2% year over year. Billings were $404,000,000 in the quarter, increasing 41% year over year compared to 38% in the prior year. Subscription billings were 363,000,000 dollars increasing 47% year over year compared to 39% in the prior year. Professional services and other billings were $42,000,000 increasing 3% year over year.
Our average billings duration was 11.8 months for the 3rd 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 $1,100,000,000 in cash short term and long term investments.
Let's turn to guidance for the Q4 and full year 2016 based on foreign exchange rates at the end of the Q3. For the Q4, we expect total revenues between 3.76 $381,000,000 representing year over year growth between 32% 33%. We expect subscription revenues between 3.35 $1,000,000 $340,000,000 representing year over year growth between 37% and 39%, and professional services and other revenues of approximately 41,000,000 dollars representing flat year over year growth. We expect total billings between $474,000,000 $479,000,000 representing year over year growth between 30% 31%. We expect subscription billings between $427,000,000 $431,000,000 representing year over year growth between 34% 36% and professional services and other billings between $47,000,000 $48,000,000 representing year over year growth between negative 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 176,000,000 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 $1,381,000,000 1.38 $6,000,000,000 representing year over year growth between 37% 38%. We expect subscription revenues between 1.212 $1,217,000,000 representing year over year growth of approximately 43% and professional services and other revenues of approximately $169,000,000 representing year over year growth of approximately 7%.
Implied full year 2016 guidance for total billings is between $1,630,000,000 $1,635,000,000 dollars representing year over year growth of 36%. We expect subscription billings between $1,454,000,000 and $1,458,000,000 dollars representing year over year growth of approximately 40% and professional services and other billings between $176,000,000 $177,000,000 representing year over year growth between 8% 9%. The implied full year 2016 operating margin and free cash flow margin guidance is approximately 13% 24%, respectively, and the implied full year diluted weighted average shares outstanding is approximately 173,000,000. With that, operator, you can now open up the line for questions.
Thank you. Our first question comes from the line of Matt Hedberg with RBC Capital Markets. Your question please.
Hey, thanks guys. Congrats on the quarter. I 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 SMB 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, and we think those were very good investments.
And then one question. I don't think we've touched on this in the Q and A section in a while, but in terms of the ServiceNow store, I'm curious, is any update on the number of developers or apps, number of customers deploying third party apps? Just sort of 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. But 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 3 deals that were just over $500,000 in the quarter. Our biggest one we talked about before, we did do $1,000,000 deal in the past, but this past quarter, there were just 3. So as you can see, it's not that big a piece of our
business. Our next question comes from the line of Brent Thill with UBS. Your question 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? And a quick follow-up for Mike.
Yes. The commercial business is actually on an ACV basis worldwide. It was growing it was up I think, somewhere around 44% and the North American organization was like close to 70%. So the investment that we made almost 2 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.
So that balance that we have between commercial and enterprise is really a very key part that drives the overall growth of the company.
Great. And Mike, just touching from some of the price comments about financial services upsell, it sounds like there were some really large deals. Can you just give us a sense of kind of how you're thinking about that as you go into Q4 in the pipeline? I think many of us believe that financial services may have not been as strong as it was, but maybe I'm bringing 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, dollars 2,000,000 a year and that was with the 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. So 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 from the line of Kirk Materne with Evercore ISI. Your questions please.
Hi, thanks very much and congrats on the quarter. Mike, I guess just maybe to follow-up on your comment around the HR deal that 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? Frank, do 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 or ITOM, sorry?
Yes. So like Mike said, we had strength across the board. So 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. So, there literally was no we just did really well across our theaters, across our channels and across all our product segments and that's when you get very strong results.
And maybe one follow-up for Mike. Just Mike, when you look at sort of sales productivity year to date versus kind of what you're 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 is going really well. So I was just kind of curious how that's evolving today?
I'll just say through the 1st 9 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. So I don't think we could be happier there.
Okay, great. Thanks guys.
Thank you. Our next question comes from the line of Walter Pritchard Mid Citi. Your question
is 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 billings perspective is what you really see, and that's because we have such a big gross down at the end of a quarter and especially Q4. So you don't see the seasonality as much in billings. But as we get bigger, you will see some seasonality going from Q4 to Q1. So 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. So they don't expect anything different this quarter.
And then 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 you've done that there has been
more impact on seasonality,
for example, in Q4 billings? Yes. So sales this
Yes. So sales this is Frank, Walter. The sales organization is going to be rapidly expanding. And 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 focused into the organization.
But going into 2017, we are going to layer in another vector of specialization that's going to be by solution and by industry vertical. So 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. So 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. So that's definitely how the sales organization is going to take shape in 2017.
Thank you.
Thank you. Our next question comes from the line of Michael Turits with Raymond James. Your question is please.
Hey, guys. Michael Turits. Thanks. Frank, can you give a little bit 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? And maybe, Mike, if you could talk about what the ACV is doing on a year over year basis growth?
Yes, 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. Critical services, is a key part of our strategy. That's how we lead, and that's going to continue for a long period of time because this is a market place that is yet to begin to develop for us. And 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.
And obviously, the orchestration aspect is what drives various frameworks. So those are areas that where a lot of our conversations with our large customers are going. But ITOM is such a natural partner to ITSM. They are just 2 peas in a pot, two sides of the same coin. So we really believe that over time, the penetration that you'll see on Itom will rival that of what we have on ITSM.
And your question with regards to the growth of net new ACV, we're really not disclosing net new ACV. So we're not going to give you the overall growth. As you can see, our business has been very strong and it's reflected in our billings and what's causing the billing speed.
Thank you. Our next question comes from the line of Sarah Hilden with Macquarie. Your question please.
Yes. Hi. Can you hear me?
Yes.
All right. Great. Hi, Frank and Mike. A couple of questions for you guys. Congrats on the quarter too.
First, what's driving the CapEx spend right now, Mike? And Frank, one for you also. So it looks like we're seeing some really nice adoption of the security operations module. It's been for roughly 4, 5 logos for the past couple of quarters and relatively new products. 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 CECL selling motion there and this interest from customers?
So on the CapEx, I'll answer that question first. Obviously, there's 2 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 2 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 3 years and we're into our normal refresh as well there.
This is Frank, Sierra. 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.
So it's a very natural selling motion for us. But we did start a quarter ago with really loading in dedicated field headcount, both for security as well as for customer service management. And 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 core to NUA, they see fit. And we have the evidence now that strategy is building demand faster than if we stay in the generalized mode. So we will continue to do that.
It doesn't mean that there's just one group that just sells security. I mean the overall sales force obviously will serve as well. We just have more dedicated focus on these products and especially in the early going, we thought it's 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 from the line of Rob Owens with Pacific Crest Securities. Your question please.
Great and thanks for taking my question. I want to reflect more broadly on the inflection you guys saw here in the quarter. And is 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 accelerates sequentially.
Rob, it's Frank. What's really going on here is that our sales staff worldwide just has more clubs in the bag. So as they approach accounts, they have more opportunities to pursue and they can really sometimes multiple opportunities at the same time. So 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 a laid out the situation or whatever it would be.
Now we have a second, the third, the fourth, the fifth play to go and pursue. Once we land in accounts, then the upsell opportunity starts playing out for us as well. So, sales productivity really goes up when you have the ability to run multiple plays. And so, we have a much broader selling motion than we've ever had before and that's what's driving it.
And then with regard to your Global 2,000 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 because we haven't seen a huge mix shift, I guess, towards revenue internationally. I think it's been relatively consistent international versus domestic. So 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. Remember, international has been suffering from the FX over the last year plus. So I do we are very pleased and we're seeing great growth internationally. It 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 from the line of Justin Furby with William Blair. Your question 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 sales cycles are there and when that might start to impact billings? And then I guess are there any learning fixed track from what you're seeing with that team in terms of informing your broader go to market strategy? And then I've
got one quick follow-up for Mike.
Yes. We're actually I'm personally super pleased with how Inspire has evolved over the last year. The level of engagement that we have with our really our top enterprise customers through that solution consulting staff and has really sort of elevated our standing in those key accounts. We often work on Tier 1 systems that are very innovative, very transformative. And 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 what we know how to do and that will be available to the broader organization. So 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. And then 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 us a sense of
how much they're spending there relative to ITSM? Is it 1 to 1? Are they spending more or less? And just any sort of sense there be super helpful. Thanks.
There is no set pattern. We have some customers that are Yes.
There is no set pattern. We have some customers that are actually spending more on
ITOM than they are on ITSM. But 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 today seen a nice deal as a standalone Itom, which they're not an ITSM customer.
Got it. Thanks, Matt.
Thank you. Our next question comes from the line of Steve Ashley with Robert W. Baird. Your question, please.
Perfect. I would just like to go back to the large upflow 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 one 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. And 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. And that's as I said, that's typical for what we do.
Great. And with getting such strong traction in HR, do you foresee 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, very key service domain as I think most people will appreciate from their own day to day work experience.
And over the years, they really have they have been underinvested in service models and really managing service as opposed to just delivering service. And 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. So 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 question please.
Thanks. Hey Mike, I've got two questions about the 4Q billings guide of $474,000,000 to $479,000,000 First is the 3rd quarter was so strong, dollars 20,000,000 above the high end of guide. Was there any pull forward from 4Q? And then secondly, FX rates have been pretty volatile of late. Are there any FX hit to that 4Q billings guide that's worth calling out?
Thank you.
So every quarter, as I mentioned on last quarter, you have, especially on the renewal side, you have deals that get pulled in and pushed out, and I saw nothing unusual this quarter. I'll just say our renewals were extremely strong. And in Q4, we think our guidance appropriately reflects what we see in the business today. And 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% plus 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. And so it does have an impact, but we've reflected that in our guidance.
Okay. And if I could follow-up, Mike, the 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 kind of how we see over time how we will get free cash flow expansion as well as operating margin expansion based upon our growth rates. And where we sit today, we think that's appropriate still. And 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 the line of Keith Weiss with Morgan Stanley. Your question please.
Excellent. Thank you guys for taking
the question and 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 twenty sixteen. And also, what type of expansion you're seeing in terms of contribution from systems integrators, the pace, if you will, that they're kind of expanding their practices around some of these new solutions and how that's helping your go to market strategy?
So 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. And we will continue to add at roughly that pace through 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. So, that's kind of where we're thinking about headcount and sorry, what was your last question, the second half?
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 for the new product segment?
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 CSE and Accenture, both their internal uptake as well as their use as practitioners and as MSPs. So we see just we are really a very significant part of their plants and their growth objectives. And it's very well cemented in. There was no longer historically, a lot of these relationships were opportunistic.
Something comes up in an account of the restaurant hand, we'll do it. But now these businesses are so big for these large GSIs that this is now really managed and resource and driven like any other business. So 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. But on the whole, one of the reasons that we've driven our own professional services business down as a percentage of the overall mix is to make sure that we really, really create room for a very, 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 question is please.
Yes. Hey, thanks and great quarter. Congratulations. I have 2 quick questions. First of all, on the HR side, you're showing up a lot more on like 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? And then the other thing is on the large account side,
like 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 leads during that process? Thank
I wasn't following what your the second part of your question was, but let me try to answer the first part on HR. We've had long standing 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. I see certainly a relationship developing, 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, I'll try to address that as well also.
Yes. Frank, so I'm trying to see is like 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 it will get full value out
of it. And I've heard from
a few accounts that are kind of reimplementing ServiceNow to get the full value. Does that impact the spending of those customers or is that just are these isolated cases? Thank you.
Yes. I understand what you're talking about now. I mean, 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. And instead of sort of forward engineering themselves, they do a reset and completely get a fresh instance and we implement right out of the 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. And 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. And if on the first attempt, you sort of haven't gotten everything out of it that you would have envisioned, yes, then there's room up to do better. We have 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. Because 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 that, 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 and they sort of have preserved the status quo and their existing systems. That's missed opportunity. So it's very much incumbent upon us to really inspire and there's that word again, to drive our customers to higher outcomes and 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.
I mean IT is a conservative profession. People have a tendency to be very incremental in their approaches. And 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. And 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 and A?
Well, as Frank, I'm sure you guys know that everybody in this 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 and A strategy over the years. Vendors talk all the time, especially in Silicon Valley.
We don't necessarily talk about M and A, but we talk about many different aspects of our business. So we didn't think this was as eventful as a lot of the sort of industry observers thought that it was.
Thank you.
Thank you. Our next question comes from the line of Derrick Wood with Cowen and Company. Your question is please.
Thanks. I wanted to hit back on the non sales productivity, which seems to be tracking quite nicely. And 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 kind of bringing multiple constituents earlier in the engagement cycle to sell this broader platform out of the gate?
So 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 this other stuff because a lot of the things that we refer to as emerging products are in effect products that get used with ITSM. ITAM is obvious, but also our analytics products gets used with ITSM. All our business our IT business management products are used with ITSM. So 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 distinctively 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. So you can't sort of draw that hard line through it and say, well, this is IT assignment and 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. But ServiceNow is one database. We just turn on and off different modules, different services and different options. That's how it works. And that's the reason why the selling motion works so well for us, gives us this 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, I mean, now with a couple of 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 is 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 there's 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. So 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. Our next question comes from the line of Kash Rangan with Bank of America Merrill Lynch. Your question 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, Keith. Well It could be if you choose to answer it. You could say Brent or Keith or Cash or whoever it is or
one of you guys will do
the guessing between just it's not Cash yet. Okay. All right. Good. It's still in the pipeline.
That's good to know. My question serious question was, it looks like ITSM had a good quarter. So 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? Because obviously, the percentage of your net new ACV coming from non ITSM will probably likely continue to expand.
So is it even fair to expect net new ACV from ATIS SIM to continue to grow or is it going to sort of flatten out? And 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 by 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? Thanks along those lines. Thank you.
Yes. So, a year and a half ago, almost 2 years ago now, we created a product line organization to really be able to drive our core focus on different business segments. And obviously, that focus has rippled through the entire company into professional services, into solutions and solving. So our whole company now drives these individual product lines as separate businesses even though our selling motions are all together for the most part. So we are really 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. And 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 we've suffered from as a company is that we had a lot of shiny new toys and 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. But 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. So there's a lot going on. The service models are really evolving to heavily machine to machine, light speed, touch service models from where people historically have been with service desk, which are very heavily people mediated processes. There is an enormous amount of room for innovation and expansion in the world of ITSM.
And 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 2,000 ads 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. So it is key to our business.
Thank you. Our next question comes from the line of Abi Lamba with Mizuho Securities. Your questions please.
Yes, thank you. Frank, as you're adding these product specialists, is it helping you accelerate the adoption of some of these new products? And 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. So everything we do has a focus on that. So 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 technical differences
Well, the margins are Let me
answer your first question is, compute is compute. It's all automated the way we do things. And whether you are a single tenant or multi tenant, you're still going to need the same amount of compute power. And 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 by 84% on our subscription margin right now, which includes the support organization. And 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, and we're comfortable with that subscription margin there. I don't think there's really any difference and because of our architecture.
Got it. Thank you. Thank you. Our next question comes from the line of Keith Bachman with BMO. Your question please.
Hi, thank you. I was wondering if you could give any general characterizations on 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?
Yes. Roughly today, about 69% of our customer base has 2 or more products. So there's still room there. But if you look at our cohort analysis, you can continue to see our customers year after year by 50% plus their initial purchase. A lot of that is adding to their existing products they have with more user licenses and we're seeing more and more now that they're also buying these new products and that was part of her whole strategy with going to a multiproduct company that we shifted to in 2015.
So I really don't have any more data than that.
Yes, 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 product. So even in our existing products just to get to attach rates where we'll start to rifle the penetration that we have on the core platform, it's going to take years years and for us to get there. So a lot of upsell opportunity and Mike's right is that the cohort analysis shows exactly that. And this is a big opportunity that's going to play itself out for years to come.
Okay, great. Well, 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, but that can continue to grow as we look into calendar year 2017. Is that the conclusion from an answer to the previous question?
Yes.
Okay, great. Thanks very much.
Thank you. Our next question comes from the line of Alex Zukin with Piper Jaffray. Your question is please.
Hey, guys. Congrats on a great quarter. First one for Mike. Mike, can you categorize how you're feeling about kind of the start up 4Q versus maybe how 3Q started out? And then 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? And has the volatility actually created increased demand for the business?
So I'll start out with we just gave guidance for Q4 and our Q4 guidance is based upon where we see our business for the quarter. And we are off to a very good start and 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 for I think it's reasonable. We're obviously much more of a secular play. We think that we can still sell quite effectively when the macro is turning not too favorable.
And the reason is we're a transformational play, we're an optimization play. So we sort of live below. I past can't determine whether I'm dealing with macro or micro or secular influences. So 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 from the line of Jesse Hulsey with Goldman Sachs. Your question is please.
Yes. Thanks. Frank, you mentioned verticalization on the sales side as part of your plan for next year. I'm wondering what your plans 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?
No, we're going to do that. And it's the verticalization. The first place you're going to see it is really on the marketing side, especially on the product marketing side, because the and then the sales enablement will follow. In other words, how 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.
And 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, that we will not start off that way. But 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's a ton of opportunity. I'm super excited about what we're going to do in this area.
Perfect. Thank you, Frank. Yes.
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