Workday, Inc. — Q3 FY2015 Form 10-Q
Reporting period: Three and nine months ended October 31, 2014; comparisons are with the corresponding 2013 periods. Workday provides cloud financial management, human capital management and analytics applications. Subscription services are its primary revenue source; subscriptions typically run three years and revenue is recognized over the contract term.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $215.1m | $127.9m | $561.6m | $327.1m |
| Subscription revenue | $164.4m | $93.9m | $431.5m | $243.5m |
| Professional services revenue | $50.7m | $33.9m | $130.1m | $83.6m |
| Operating loss | $(51.5)m | $(40.4)m | $(165.3)m | $(105.3)m |
| Net loss | $(59.9)m | $(47.5)m | $(188.5)m | $(116.5)m |
| Operating cash flow | $41.0m | $7.1m | $53.7m | $11.5m |
| Free cash flow (non-GAAP) | $13.3m | $(9.7)m | $(12.3)m | $(37.0)m |
Q3 gross margin was approximately 66.6%, versus 58.9% a year earlier, calculated from reported revenue and subscription and professional-services costs. Subscription services made up 76% of Q3 revenue. Net loss per share was $0.33 for the quarter and $1.03 for the nine-month period, compared with $0.27 and $0.68, respectively, in 2013.
At October 31, 2014, cash and cash equivalents were $192.1m and marketable securities were $1.643bn, totaling approximately $1.835bn. Convertible notes had $600m principal outstanding and a $484.9m net carrying value. Unearned revenue totaled $508.1m, including $441.3m current. Total assets were $2.232bn and total liabilities $1.103bn. Cash and cash equivalents declined $389.2m from January 31; this reflects, among other items, net purchases and maturities of marketable securities.
Material changes and management commentary
- Revenue grew 68% in Q3 and 72% for the nine months, mainly from a larger number of customer contracts. Subscription revenue rose 75% and 77%, respectively.
- Losses widened despite revenue growth. Total operating expenses increased 58% in Q3 and 68% for the nine months. Management attributed higher costs largely to employee growth; headcount was approximately 3,500 versus 2,300 a year earlier.
- Share-based compensation was $47.0m in Q3 and $116.7m for nine months, compared with $19.7m and $36.9m. It represented a substantial portion of reported operating expenses.
- Management’s non-GAAP core operating margin improved to (1)% in Q3 from (16)% and to (8)% for nine months from (20)%, citing revenue growth, professional-services utilization and operating leverage. These measures exclude share-based compensation and other specified expenses.
- Management said it expects losses to continue for the foreseeable future and operating expenses to increase in absolute dollars as it invests in product development, sales and marketing, data-center capacity and customer support. No specific revenue or earnings guidance is provided.
Outlook, risks and unusual items
- Capital expenditures were $66.0m for the nine months. Management estimated FY2015 capital expenditures of approximately $100m–$110m, primarily for data-center infrastructure and office space, and expected significant additional data-center investment in Q4. Potential construction costs for a Pleasanton site were not included.
- Management expected professional-services margins to fluctuate and decline in Q4 due to normal holiday-season slowing; it also expects professional services to become a smaller share of revenue over time as partners take on more deployments.
- Key disclosed risks include security or privacy breaches, outages or inadequate capacity at third-party data centers or AWS, intense competition and pricing pressure, difficulty managing rapid growth, dependence on HCM, and uncertainty in customer adoption and renewals. International expansion adds currency, regulatory and execution risks.
- The company reported ordinary-course legal claims, including intellectual-property matters; management did not expect their resolution to have a material adverse effect, while noting outcomes are uncertain. No material loss contingency was identified in the financial-statement notes.
- Workday acquired Identified, Inc. in February 2014 for $26.4m, principally to enhance search and predictive analytics; $23.8m of goodwill was recorded. It also made a $10m cost-method investment in July.
- Convertible notes carry $350m and $250m principal, with maturities in 2018 and 2020, respectively. The notes are convertible subject to specified conditions; related note hedges and warrants may affect dilution and share-price dynamics.
- Management concluded disclosure controls were effective at a reasonable assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether subscription growth, customer additions and renewals can sustain revenue momentum, particularly given the reliance on HCM and ratable revenue recognition.
- Whether operating costs and substantial stock-based compensation grow more slowly than revenue, and how non-GAAP core margins reconcile to GAAP results.
- Whether operating cash generation can cover planned capital spending; nine-month free cash flow remained negative.
- The size and timing of future data-center and office investment, including any development costs excluded from the stated capex estimate.
- Debt repayment or conversion implications, potential dilution from warrants and equity awards, and the effect of the dual-class voting structure.
- Any material change in litigation, cybersecurity, service availability, privacy or third-party infrastructure risks.