Workday, Inc. — Q2 FY2014 Form 10-Q
Business context and period: The filing covers the three and six months ended July 31, 2013; Workday’s fiscal year ends January 31. Workday sells enterprise cloud applications, primarily HCM, under subscription contracts, typically with three-year terms. Results are unaudited.
Financial performance and position
- Revenue: Q2 revenue was $107.6 million, up 72% year over year. Subscription revenue was $81.1 million (+92%) and professional services revenue was $26.4 million (+29%). For the six months, revenue was $199.2 million (+67%); subscription revenue was $149.5 million (+89%).
- Profit and margins: Q2 operating loss was $32.3 million (30.0% of revenue) and net loss was $36.0 million; six-month operating loss was $64.9 million (32.6%) and net loss was $69.0 million. Q2 gross margin was approximately 62.1%, based on reported revenue and cost of revenue. Basic and diluted Q2 loss per share was $0.21, versus $0.78 a year earlier; the comparison is affected by the much larger post-IPO weighted-average share count.
- Cash flow and investment: Q2 operating cash flow was negative $12.9 million; six-month operating cash flow was positive $4.4 million. Six-month capital expenditures were $31.6 million. Cash used in investing activities was $184.4 million for the six months, including purchases and maturities of marketable securities.
- Liquidity and debt: At July 31, cash and cash equivalents were $437.4 million and marketable securities were $857.2 million, totaling about $1.295 billion. Workday issued $600 million principal amount of convertible notes in June: $350 million of 0.75% notes due 2018 and $250 million of 1.50% notes due 2020. Their combined balance-sheet carrying amount, net of discounts, was $457.8 million. Capital lease obligations totaled $18.4 million.
- Other indicators: Unearned revenue was $325.6 million ($247.3 million current). Total assets were $1.506 billion. Workday reported more than 500 customers and more than 2,100 employees. Subscription revenue represented 75.4% of Q2 revenue.
Material changes versus prior comparable periods
- Q2 revenue rose $44.9 million year over year, driven mainly by subscription growth from more customer contracts. Six-month revenue increased $79.7 million.
- Q2 operating loss widened from $26.4 million to $32.3 million, although operating loss as a share of revenue improved from 42.1% to 30.0%. Higher revenue and a greater subscription mix supported the margin improvement, while spending increased substantially.
- Q2 costs and expenses rose to $139.8 million from $89.1 million. R&D increased 75% and sales and marketing 49%, primarily reflecting higher headcount and growth investments. Q2 share-based compensation was $9.8 million, versus $2.3 million.
- Q2 other expense increased to $3.5 million from $0.6 million, principally because of interest and noncash debt-discount and issuance-cost amortization on the new notes.
- Cash and marketable securities increased from $790.3 million at January 31 to $1.295 billion at July 31, largely following the note financing. Six-month operating cash flow declined to $4.4 million from $14.6 million.
Outlook, commentary, risks and unusual items
- Management said Workday does not expect to be profitable in the near future and expects operating expenses to continue increasing in absolute dollars as it invests in product development, sales and marketing, personnel, and data-center infrastructure.
- Management expected fiscal-year 2014 capital expenditures of approximately $80 million. It anticipated subscription and professional-services costs could decline as a percentage of revenue over time through scale and greater partner deployment, while noting near-term fluctuations and continued investment.
- Operating cash use in Q2 included $16.5 million of payroll taxes withheld on employee stock transactions and paid in May 2013. Management attributed six-month operating cash generation partly to a $40.4 million increase in unearned revenue.
- Notes are unsecured and cannot be redeemed by Workday before maturity. Conversion is subject to specified conditions before the respective dates in 2018 and 2020. Note hedges cover approximately 7.3 million shares and are intended to offset potential conversion dilution; warrants for approximately 7.3 million shares have a $107.96 exercise price and could dilute shareholders if the stock price exceeds that level.
- Key disclosed risks include continued losses and uncertain growth, intense competition, reliance on HCM, security and service availability, data-center capacity, long enterprise sales and deployment cycles, customer renewals and pricing, international expansion and foreign exchange, and potential intellectual-property litigation. Management said ordinary-course legal matters were not expected to have a material adverse impact, while acknowledging an unfavorable matter could affect a particular period.
- Two customers each represented more than 10% of accounts receivable at quarter-end. Certain office and equipment leases are with an affiliate of co-CEO David Duffield; disclosed office rent expense was $0.3 million for the quarter.
Important facts for investors to verify
- Whether subscription growth, customer additions, renewals, and unearned-revenue trends continue to support reported revenue growth.
- Whether spending growth, data-center investment, and capital expenditures align with management’s stated plans, and how they affect operating losses and cash generation.
- The economic and potential dilution effects of the convertible notes, note hedges, and warrants, including conversion and repayment terms.
- Customer concentration in receivables, collections, and any changes in customer mix or renewal behavior.
- Progress on relying more on deployment partners, and any material changes in service quality, security, litigation, or related-party arrangements.