Workday, Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months ended July 31, 2014; unaudited. Comparisons are with the corresponding 2013 periods unless noted. Amounts are in U.S. dollars.
Business context
Workday provides cloud-based enterprise applications, including human capital management (HCM), payroll, financial management and analytics. Subscription services are the main revenue source; subscriptions typically have three-year terms, are generally invoiced annually in advance, and revenue is recognized over the contract term. Workday said a substantial majority of subscription revenue continued to come from HCM.
Financial performance and liquidity
| Metric | Three months ended July 31 | Six months ended July 31 |
|---|---|---|
| Total revenue | $186.8 million, up 74% | $346.5 million, up 74% |
| Subscription revenue | $143.7 million, up 77% | $267.1 million, up 79% |
| Professional services revenue | $43.1 million, up 63% | $79.5 million, up 60% |
| Operating loss | $61.8 million (33% margin), versus $32.3 million (30% margin) | $113.9 million (33% margin), versus $64.9 million (33% margin) |
| Net loss | $69.2 million; $0.38 per share, versus $36.0 million; $0.21 per share | $128.6 million; $0.70 per share, versus $69.0 million; $0.40 per share |
| Operating cash flow | Cash used: $9.0 million, versus $12.9 million | Cash provided: $12.7 million, versus $4.4 million |
| Free cash flow (non-GAAP) | Cash used: $37.4 million, versus $42.6 million | Cash used: $25.6 million, versus $27.3 million |
Management’s non-GAAP core operating margin improved to negative 10% in the quarter from negative 20%, and to negative 12% for the six months from negative 23%. Core operating expenses exclude share-based compensation and specified other expenses; management cautioned that non-GAAP measures are not substitutes for GAAP results.
At July 31, cash and cash equivalents were $262.6 million and marketable securities were $1.560 billion, totaling approximately $1.822 billion, compared with approximately $1.887 billion at January 31. Current assets were $1.981 billion and current liabilities $489.5 million. Total liabilities were $1.056 billion. Convertible notes had $600 million principal outstanding and a $479.3 million net carrying amount: $350 million due in 2018 at 0.75% and $250 million due in 2020 at 1.50%. The notes’ estimated fair value exceeded carrying value.
Material changes versus prior periods
- Revenue rose 74% in both the quarter and six-month period, primarily reflecting more customer contracts and demand for deployment and integration services.
- Operating costs and expenses increased to $248.5 million for the quarter from $139.8 million; for the six months they rose to $460.4 million from $264.1 million. Management attributed much of the increase to headcount, product development, sales and marketing, and infrastructure investment.
- Share-based compensation increased to $40.8 million in the quarter and $69.7 million for six months, from $9.8 million and $17.2 million, respectively.
- Other expense increased, largely because the 2014 periods included a full period of interest expense on the convertible notes; note discount and issuance-cost amortization made this expense materially higher than contractual cash interest alone.
- Workday acquired Identified, Inc. in February for approximately $26.4 million, primarily to enhance search, predictive analytics and machine learning. The acquisition added $23.8 million of goodwill. The company also made a $10 million cost-method investment in a private company in July.
Outlook, commentary and risks
- Management said it did not expect profitability in the near future and planned continued investment in product development, sales and marketing, customer services, data centers and office capacity. It expects those costs to rise in absolute dollars.
- Fiscal 2015 capital expenditures were expected to be approximately $100 million to $110 million, mainly for data-center infrastructure and office space. Related potential development costs for a Pleasanton site were not included.
- Management anticipated lower professional services margins in fiscal 2015 as it invested in deployments for financial management, medium-sized enterprises, and education and government customers while partner capacity matured.
- Operating cash flow for the quarter included an approximately $18 million one-time payment of accrued, unused U.S. exempt-employee paid time off following a policy change. Workday cited increased customer cash collections as a partial offset to higher staffing and operating costs.
- Key disclosed risks include security or privacy breaches, data-center or AWS disruptions and capacity constraints, rapid-growth execution and hiring, intense competition, dependence on HCM, customer renewal and pricing uncertainty, long sales cycles, international expansion and foreign-exchange exposure, and ongoing losses. Workday began a limited foreign-currency hedging program in July.
- Workday reported ordinary-course legal proceedings and claims, including intellectual-property matters, but said it did not expect their resolution to have a material adverse effect; an unfavorable outcome in a particular quarter could still be significant. The company was under IRS examination for tax year 2011.
- Management reported disclosure controls were effective at a reasonable assurance level and no material change in internal control over financial reporting during the quarter. The filing also notes adoption of the new revenue-recognition standard was required beginning in fiscal 2018; the impact was still being evaluated.
Important facts for investors to verify
- Whether subscription growth and customer additions continue to support revenue growth, given the substantial reliance on HCM and revenue recognition over multi-year contracts.
- Whether spending growth, especially share-based compensation and data-center investment, translates into improving GAAP operating margins and sustainable cash generation.
- Progress against the $100 million to $110 million fiscal 2015 capital-expenditure expectation and the effect of infrastructure capacity on service quality and costs.
- Convertible-note repayment, conversion and potential dilution terms, including the related warrants; also consider the substantial voting control associated with Class B shares.
- Potential developments in the IRS examination, uncertain tax positions, legal matters and the preliminary purchase-price allocation for Identified.