Workday beats on Q1 FY2017 but some days you just can't win

Profile picture for user gonzodaddy By Den Howlett May 31, 2016
Summary:
Workday turned in another great quarter but as it enters a new period of development, attention turns to profitability, managing the workforce and growth.

Aneel Bhusri, Workday
Aneel Bhusri, CEO Workday

I've said it before and I'll say it again - Workday continues to manage financial analyst expectations well to the point where it is (almost) routine for the company to announce a beat on its quarterly earnings calls. And so it was today as the company talked to its Q1 FY2017 results.

But even then, sometimes you just can't catch a break as profit takers decided it was time to give Workday's stock price another haircut. To that extent, the earnings call was interesting, not so much for the results and forward look, but for management's commentary around profitability, employee ownership and the maturing of the market in what Workday believes is its favor. Let's start with the numbers.

If you thought Salesforce and NetSuite did well at their respective last earnings calls, then Workday handily trumped them with year over year revenue growth of 38% to $345.4 million. This was tempered by an operating loss of $73.6 million up from $53.4 million in the same quarter of 2015. If you choose to view non-GAAP measures as the ones to follow then this quarter's loss becomes a profit of $11.1 million compared to a loss in 2015 of $2 million. All eyes will be on stock based compensation (SBC) as the primary factor driving the losses, a topic that must be exercising the minds of management as it seeks to thread a pathway to profit, hinted as occurring in the 2017-18 timeframe. Looking forward, Workday gave a conservative Q2 FY2017 growth number of 31-32% or $371 to $373 million.

Growing pains

On the call, Aneel Bhusri, CEO hinted at 'growing pains' inside the company, noting that more than half the workforce have been with the company less than two and a half years and hinting that many of them are relatively inexperienced for the roles needed at the more senior levels. From what we hear, some, more seasoned managers, have been walking away as they see the company become more bureaucratic while internal promotions have not kept pace with growth. Management is aware of these challenges and is working through them:

I keep a close eye on what's being said at [recruitment site] Glassdoor

said Bhusri on the call.

In recent times, anonymous employees have been taking to Glassdoor to express frustration. This does not and should not surprise. Managing hyper growth while retaining the best parts of a company's culture is one of the hardest management challenges, made more so when the company in question is transparent about what makes for a good culture.

It is a topic Bhusri has understood from the get go and remains one of the longest ongoing talking points between Bhusri and my group of analysts and commenters. It is one of the key issues when hiring in a highly competitive market.

The good news is that none of the challenges appear to be impacting the rate at which the company is growing but then you never know when you will need to call upon the workforce to do just that little bit more. The better news is that Workday management is keenly aware that it has issues, isn't afraid to make mention while providing clues as to what it is doing to meet those challenges. Only the most churlish would fail to give kudos for that approach.

The trickier problem centers around the stock price. On the call, Bhusri mentioned that he doesn't like volatility in the stock price, the sub-text for which is that it makes planning an attractive SBC program during high growth much more difficult. This too plays into the hiring scene but then Workday management can draw comfort from the fact it is one of many companies that have felt the chill wind of financial analyst opinions that rarely reflect business reality but which, nevertheless, have led to a new reality. Facing that reality is one of the prime reasons that the company lead its earnings call with talk about profitability, a metric which is now firmly on analyst radar.

 

Despite the challenges, Bhusri was upbeat about the prospects of hiring in the right people:

We've pretty much caught up [with hiring] and I suspect we'll continue to hire well, actually I think the hiring environment is pretty attractive, the draw for the Silicon Vally startups is not what it was a year or two years ago.

HR and financials - the right combination

Turning to the more customer focused part of the story, Workday talked about how things are working out with the combined HR and financials offerings. When the company last reported numbers, it talked about the go live momentum among new financials customers. This time, Workday did not mention specific numbers, instead preferring to talk about referencability in broad terms and the advantages it has in offering a single unified platform for all its offerings:

I think we have enough customers live on financials now and that's why the pipeline is doing so well on the financials side and we've validated that with recent financial wins. It's not like it was a year or two years ago...In terms of large customers going live, customers like JB Hunt going live with the scale of transactions that they have was very helpful for other organizations looking at us from a scale and performance perspective...In terms of the competitive landscape, SAP still doesn't have a cloud offering for financials, their strategy is S/4 HANA, HANA is a database, HANA does not equal cloud, and as far as I can tell, they don't have a true, multi-tenant offering that's underway for financials so that's a big win for us and from the Oracle perspective, I think they claim Hyperion hosted as cloud, so we just see a lot of runway and opportunity. The truth comes out in the sales cycle.

From my perspective, it has been good in the last quarter to get in front of customers who talk enthusiastically about Workday's financial offerings. For me however, the bigger proofs for Workday's future will come a little later once we see the outcome of Workday's planning application development. I remain a tad skeptical as I know just how hard it is to build tools of this kind. But then Workday has a track record of attracting willing customers with which it can work to help flesh out requirements. To that point, Workday believes that on financials, it is 'pretty much on par' with competitive offerings. Yes, there are some gaps but the main part of the heavy functional lifting is done.

To the broader point about international adoption, Workday claims that growth rates in that segment are growing faster than in North America. This should not surprise. When Brian Sommer reviewed the most recent release, Workday 26, he said:

In all, release 26 goes a long ways to making the software more valuable to firms with global operations, multiple subsidiaries, and, revenue recognition compliance needs.  Workday should see financial application sales pick up short-term but once the budgeting/planning module is launched, sales could really accelerate.

My take

Workday is hitting another of those inflection points. On the one hand, the competition has yet to step up and give it any real trouble while at the same time Workday's increasing momentum with a combination of knowledgeable feet on the street and functional improvements of the kind Sommer has outlined looks healthy enough. On the other hand, growing into profit is a challenge that will require skillful handling. To date, we've not seen any pure play cloud examples where that is working as well as investors or managements might like. Sooner or later though, a compromise has to be reached. In the meantime, Workday continues to throw off plenty of operating cash and that s a very good sign.