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WDAY > SEC Filings for WDAY > Form 10-Q on 6-Jun-2014All Recent SEC Filings

Show all filings for WORKDAY, INC.

Form 10-Q for WORKDAY, INC.


6-Jun-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, as well as in the section entitled "Risk Factors."

Overview

Workday provides enterprise cloud applications for human capital management (HCM), payroll, financial management and analytics. We offer innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. Our applications are designed for global enterprises to manage complex and dynamic operating environments. We provide our customers highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources.

We were founded in 2005 to deliver cloud applications to global enterprises. Our applications are designed around the way people work today - in an environment that is global, collaborative, fast-paced and mobile. Our cycle of frequent updates has facilitated rapid innovation and the introduction of new applications throughout our history. We began offering our Human Capital Management (HCM) application in 2006. Since then we have continued to invest in innovation and have consistently introduced new services to our customers, including our Financial Management application in 2007, our Procurement and Employee Expense Management applications in 2008, our Payroll and mobile applications in 2009, our Talent Management application in 2010, our native iPad application and Workday integration platform in 2011, Time Tracking and Grants Management applications in 2012, Big Data Analytics in 2013 and Recruiting in 2014.

We offer Workday applications to our customers on an enterprise-wide subscription basis, typically with three-year terms and with subscription fees largely based on the size of the customer's workforce. We generally recognize revenues from subscription fees ratably over the term of the contract. We currently derive a substantial majority of our subscription services revenues from subscriptions to our HCM application. We market our applications primarily through our direct sales force.

We have achieved significant growth in a relatively short period of time. Our diverse customer base includes large, global companies and our direct sales force targets organizations with more than 1,000 workers. As of April 30, 2014, we had more than 650 customers. A substantial majority of our growth comes from new customers. Our current financial focus is on growing our revenues and expanding our customer base. While we are incurring losses today, we strive to invest in a disciplined manner across all of our functional areas to sustain continued near-term revenue growth and support our long-term initiatives. Our operating expenses have increased significantly in absolute dollars in recent periods, primarily due to our significant growth in employees. We had more than 2,900 and more than 1,950 employees as of April 30, 2014 and 2013, respectively.

We intend to continue investing for long-term growth. We have invested, and expect to continue to invest, heavily in our application development efforts to deliver additional compelling applications and to address customers' evolving needs. In addition, we plan to continue to expand our sales and marketing organizations to sell our applications globally. We expect to make significant investments in our data center infrastructure in fiscal 2015 as we update our technology and plan for future customer growth. We are also investing in personnel to service our growing customer base. These investments will increase our costs on an absolute basis in the near-term. Many of these investments will occur in advance of experiencing any direct benefit from them and will make it difficult to determine if we are allocating our resources efficiently. As a result of these investments, we do not expect to be profitable in the near future. We expect our product development, sales and marketing, and general and administrative expenses as a percentage of revenues to decrease over time as we grow our revenues, and we anticipate that we will gain economies of scale by increasing our customer base without direct incremental development costs and by utilizing more of the capacity of our data centers.

Since inception, we have invested heavily in our professional services organization to help ensure that customers successfully deploy and adopt our applications. Additionally, we continue to expand our professional services partner ecosystem to further support our customers. We believe our investment in professional services, as well as partners building consulting practices around Workday, will drive additional customer subscriptions and continued growth in revenues. In addition, over time we expect professional services revenues and the cost of professional services as a percentage of total revenues to decline as we increasingly rely on our partners to deploy Workday applications and as the number of our existing customers continues to grow.


Table of Contents

Components of Results of Operations

Revenues

We primarily derive our revenues from subscription services fees and professional services fees. Subscription services revenues primarily consist of fees that give our customers access to our cloud applications, which include routine customer support at no additional cost. Professional services fees include deployment services, optimization services, and training.

Subscription services revenues accounted for over 77% of our revenues during the three months ended April 30, 2014 and represented over 94% of our total unearned revenue as of April 30, 2014. Subscription services revenues are driven primarily by the number of customers, the number of workers at each customer, the number of applications subscribed to by each customer, the price of our applications, and to a lesser extent, renewal rates. To date, revenues from renewals have not been a substantial component of revenues.

The mix of the applications to which a customer subscribes can affect our financial performance due to price differentials in our applications. Compared to our other offerings, our HCM application has been available for a longer period of time, is more established in the marketplace and has benefited from continued enhancements of the functionality over a longer period of time, all of which help us to improve our pricing for that application. However, new products or services offerings by competitors in the future could impact the mix and pricing of our offerings.

Subscription services fees are recognized ratably as revenues over the contract term beginning on the date the application is made available to the customer, which is generally within one week of contract signing. Our subscription contracts typically have a term of three years and are non-cancelable. We generally invoice our customers in advance, in annual installments. Amounts that have been invoiced are initially recorded as unearned revenue. Amounts that have not been invoiced represent backlog and are not reflected in our condensed consolidated financial statements.

Our consulting engagements are typically billed on a time and materials basis, and revenues are typically recognized as the services are performed. We offer a number of training options intended to support our customers in configuring, using and administering our services. In some cases, we supplement our consulting teams by subcontracting resources from our service partners and deploying them on customer engagements. As Workday's professional services organization and the Workday-related consulting practices of our partner firms continue to develop, we expect the partners to increasingly contract directly with our subscription customers. As a result of this trend, and the increase of our subscription services revenues, we expect professional services revenues as a percentage of total revenues to decline over time.

Costs and Expenses

Costs of subscription services revenues. Costs of subscription services revenues consist primarily of employee-related expenses related to hosting and supporting our applications, the costs of data center capacity, and depreciation of owned and leased computer equipment and software.

Costs of professional services revenues. Costs of professional services revenues consist primarily of employee-related expenses associated with these services, the cost of subcontractors and travel costs. The percentage of total revenues derived from professional services was 23% for the three months ended April 30, 2014. The cost of providing professional services is significantly higher as a percentage of the related revenues than for our subscriptions.

Product development. Product development expenses consist primarily of employee-related expenses. We continue to focus our product development efforts on adding new features and applications, increasing the functionality and enhancing the ease of use of our cloud applications.

Sales and marketing. Sales and marketing expenses consist primarily of employee-related expenses, sales commissions, marketing programs and travel related expenses. Marketing programs consist of advertising, events, corporate communications, brand building and product marketing activities. Commissions earned by our sales force that can be associated specifically with a non-cancelable subscription contract are deferred and amortized over the same period that revenues are recognized for the related non-cancelable contract.

General and administrative. General and administrative expenses consist of employee-related expenses for finance and accounting, legal, human resources and management information systems personnel, legal costs, professional fees and other corporate expenses.


Table of Contents

Results of Operations

Revenues

Our total revenues for the three months ended April 30, 2014 and 2013 were as
follows:



                                       Three Months Ended
                                            April 30,
                                        2014          2013        % Change
                                         (in thousands)
             Subscription services   $  123,407     $ 68,418             80 %
             Professional services       36,330       23,227             56

             Total revenues          $  159,737     $ 91,645             74

Total revenues were $159.7 million for the three months ended April 30, 2014, compared to $91.6 million during the prior year period, an increase of $68.1 million, or 74%. Subscription services revenues were $123.4 million for the three months ended April 30, 2014, compared to $68.4 million for the prior year period, an increase of $55.0 million, or 80%. The increase in subscription revenues was due primarily to the recognition of revenue for an increased number of customer contracts as compared to the prior year period.

Professional services revenues were $36.3 million for the three months ended April 30, 2014, compared to $23.2 million for the prior year period, an increase of $13.1 million, or 56%. The increase in professional services revenues was due primarily to the addition of new customers and a greater number of customers requesting deployment and integration services as compared to the prior year period.

Core Operating Expenses

Management uses the non-GAAP financial measure of core operating expenses to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, and to evaluate our financial performance and the ability of operations to generate cash. Management believes that core operating expenses reflects our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business, as it excludes expenses that are not reflective of ongoing operating results. Management also believes that core operating expenses provides useful information to investors and others in understanding and evaluating our operating results and future prospects in the same manner as management and in comparing financial results across accounting periods and to those of peer companies.

The following discussion of our core operating expenses and the components comprising our core operating expenses highlights the factors that our management focuses upon in evaluating our operating margin and operating expenses. The increases or decreases in operating expenses discussed in this section do not include changes relating to share-based compensation, and certain other expenses, which consist of employer payroll taxes on employee stock transactions and amortization of acquisition-related intangible assets.

Information about our operating expenses is as follows:

                                                          Three Months Ended April 30, 2014
                                         Core               Share-Based              Other              Total
                                       Operating            Compensation           Operating          Operating
                                      Expenses(1)             Expenses             Expenses            Expenses
                                                                   (in thousands)
Costs of subscription services       $      20,358         $        1,055         $        46         $   21,459
Costs of professional services              33,673                  2,198                  89             35,960
Product development                         53,621                 10,868                 682             65,171
Sales and marketing                         61,142                  6,752                 273             68,167
General and administrative                  13,471                  8,001                (409 )           21,063

Total costs and expenses             $     182,265         $       28,874         $       681         $  211,820

Operating loss                       $     (22,528 )       $      (28,874 )       $      (681 )       $  (52,083 )
Operating margin                               (14 )%                 (18 )%               (1 )%             (33 )%


Table of Contents
                                                           Three Months Ended April 30, 2013
                                          Core               Share-Based              Other              Total
                                        Operating            Compensation           Operating          Operating
                                       Expenses(1)             Expenses             Expenses            Expenses
                                                                    (in thousands)
Costs of subscription services        $      14,660         $          262         $         8         $   14,930
Costs of professional services               21,001                    475                 293             21,769
Product development                          34,143                  1,907                 232             36,282
Sales and marketing                          37,230                  1,043                  91             38,364
General and administrative                    9,142                  3,729                  53             12,924

Total costs and expenses              $     116,176         $        7,416         $       677         $  124,269

Operating loss                        $     (24,531 )       $       (7,416 )       $      (677 )       $  (32,624 )
Operating margin                                (27 )%                  (8 )%               (1 )%             (36 )%

(1) Core operating expenses is a non-GAAP financial measure that excludes share-based compensation and certain other operating expenses from our total operating expenses calculated in accordance with GAAP. The other operating expenses excluded are employer payroll taxes on employee stock transactions and amortization of acquisition-related intangible assets. See "Non-GAAP Financial Measures" below for further information.

Core operating margins

Core operating margins, calculated using GAAP revenues and core operating expenses, improved from (27)% for the three months ended April 30, 2013 to (14)% for the three months ended April 30, 2014. The improvement in our core operating margins in the current period was primarily due to higher subscription services revenues. In evaluating our results, we generally focus on core operating expenses. We believe that our core operating expenses reflect our ongoing business in a manner that allows meaningful period-to-period comparisons. Our core operating expenses are reconciled to the most comparable U.S. generally accepted accounting principles (GAAP) measure, "total operating expenses," in the table above.

Core operating expenses increased by $66.1 million, or 57% for the three months ended April 30, 2014 compared to the prior year period. As quantified below, the increase was primarily due to higher employee-related costs driven by higher headcount.

Costs of subscription services

Core operating expenses in costs of subscription services were $20.4 million for the three months ended April 30, 2014, compared to $14.7 million for the prior year period, an increase of $5.7 million, or 39%. The increase was primarily due to an increase of $2.8 million in depreciation expense related to our data centers, an increase of $1.9 million in employee-related costs driven by higher headcount and an increase of $1.4 million in service contracts expense to expand data center capacity. We expect that in the future, core operating expenses in costs of subscription services will continue to increase in absolute dollars as we improve and expand our data center capacity and operations.

Costs of professional services

Core operating expenses in costs of professional services were $33.7 million for the three months ended April 30, 2014, compared to $21.0 million for the prior year period, a $12.7 million increase, or 60%. This increase was primarily due to increases of $9.7 million to staff our deployment and integration engagements. Due to the large increase in demand for our professional services versus the prior year, we have increased both our internal professional service staff as well as third-party supplemental staff. Over time, we expect costs of professional services as a percentage of total revenues to decline as we increasingly rely on third parties to deploy our applications and as the number of our customers continues to grow. For the current fiscal year, we anticipate professional services margins to be lower than fiscal 2014 as we invest in deploying new customers in financial management applications, medium-size enterprise, and education and government categories, where the third party partner ecosystem is still maturing.

Product development

Core operating expenses in product development were $53.6 million for the three months ended April 30, 2014, compared to $34.1 million for the prior year period, an increase of $19.5 million, or 57%. The increase was primarily due to increases of $13.1 million in employee compensation costs due to higher headcount, $2.0 million in facility and IT-related expenses, $1.8 million in contracted costs and $1.3 million in depreciation expense for our development cloud data center. We expect that in the future, product development expenses will continue to increase in absolute dollars as we improve and extend our applications and develop new technologies.


Table of Contents

Sales and marketing

Core operating expenses in sales and marketing were $61.1 million for the three months ended April 30, 2014, compared to $37.2 million for the prior year period, an increase of $23.9 million, or 64%. The increase was primarily due to increases of $17.2 million in employee compensation costs due to higher headcount and higher commissionable sales volume, $3.6 million in advertising, marketing and event costs, $1.7 million in facility and IT-related expenses and $1.5 million in travel expenses. We expect that sales and marketing expenses will continue to increase in absolute dollars in the future as we continue to invest in sales and marketing by expanding our domestic and international selling and marketing activities, building brand awareness and attracting new customers.

General and administrative

Core operating expenses in general and administrative were $13.5 million for the three months ended April 30, 2014, compared to $9.1 million for the prior year period, an increase of $4.4 million, or 48%. The increase was primarily due to $3.5 million in higher employee compensation costs due to higher headcount. We expect general and administrative expenses will increase in absolute dollars as we invest in our infrastructure and incur additional employee-related costs, professional fees and insurance costs related to the growth of our business and international expansion.

Share-Based Compensation Expenses

Share-based compensation expenses were $28.9 million for the three months ended April 30, 2014, compared to $7.4 million for the prior year period. The increase in share-based compensation expenses was primarily due to grants of restricted stock units to existing and new employees during fiscal 2014 and the three months ended April 30, 2014. During the three months ended April 30, 2014, the realized excess tax benefits related to share-based compensation is immaterial.

Other Operating Expenses

Other operating expenses consisted of employer payroll tax on employee stock transactions for the three months ended April 30, 2014 and 2013 and amortization of acquisition-related intangible assets for the three months ended April 30, 2014. Other operating expenses were $0.7 million for both the three months ended April 30, 2014 and 2013.

Other Expense, Net

Other expense, net, was $7.0 million for the three months ended April 30, 2014, compared to $0.3 million for the prior year period, an increase of $6.7 million. The increase was primarily due to the interest expense related to our 0.75% convertible senior notes due July 15, 2018 (2018 Notes) and 1.50% convertible senior notes due July 15, 2020 (2020 Notes, and together with the 2018 Notes, the Notes), including the contractual cash interest expense of $1.6 million and non-cash interest expense related to amortization of the debt discount and amortization of debt issuance costs of $5.9 million.

Liquidity and Capital Resources

As of April 30, 2014, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1.9 billion, which were held for working capital purposes. Our cash equivalents and marketable securities are comprised primarily of U.S. agency obligations, U.S. treasury securities, commercial paper, money market funds, and U.S. corporate securities.

We have financed our operations primarily through sales of equity securities, customer payments, and issuance of debt. Our future capital requirements will depend on many factors, including our customer growth rate, subscription renewal activity, the timing and extent of development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced services offerings, and the continuing market acceptance of our services. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, and intellectual property rights. We may choose to seek additional equity or debt financing.


Table of Contents

Our cash flows for the three months ended April 30, 2014 and 2013 were as follows:

                                                            Three Months Ended
                                                                 April 30,
                                                            2014           2013
                                                              (in thousands)
  Net cash provided by (used in):
  Operating activities                                   $   21,697      $  17,310
  Investing activities                                     (352,366 )      117,062
  Financing activities                                       (4,695 )          820
  Effect of exchange rate changes                                39            (86 )

  Net increase (decrease) in cash and cash equivalents   $ (335,325 )    $ 135,106

In evaluating our performance internally, we focus on long-term, sustainable growth in free cash flows. We define free cash flows, a non-GAAP financial measure, as net cash provided by (used in) operating activities minus purchases of property and equipment, property and equipment acquired under capital leases and purchases of other (non-acquisition-related) intangible assets. See "Non-GAAP Financial Measures below" for further information.

Our free cash flows were as follows:

                                                                                  Trailing Twelve
                                                 Three Months Ended                Months Ended
                                                     April 30,                       April 30,
                                                2014            2013           2014            2013
                                                                   (in thousands)
Net cash provided by operating activities     $  21,697       $ 17,310       $  50,650       $  15,816
Purchases of property and equipment              (9,873 )       (1,895 )       (68,703 )       (15,596 )
Property and equipment acquired under
capital leases                                       -            (115 )            -          (18,598 )
Purchase of other intangible assets                  -              -          (15,000 )            -

Free cash flows                               $  11,824       $ 15,300       $ (33,053 )     $ (18,378 )

Operating Activities

Management uses net cash provided by operating activities as a key financial metric. For the three months ended April 30, 2014, net cash provided by operating activities was $21.7 million. The positive cash flows resulted from increased cash collections driven by growth in sales. These cash inflows were generally offset by increases in our operating expenses, which were primarily driven by increased headcount. We recently changed our paid time off (PTO) policy for US exempt employees such that we no longer track or accrue PTO. We paid out the accrued but unused PTO balances as of May 31, 2014, which will result in a one-time use in net cash provided by operating activities of approximately $18 million in the three months ended July 31, 2014.

For the three months ended April 30, 2013, net cash provided by operating activities was $17.3 million. The positive cash flows resulted from increased cash collections driven by growth in sales and a $16.5 million benefit from payroll taxes withheld on employee stock transactions in April 2013. These cash inflows were generally offset by increases in our operating expenses, which were . . .

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