Workday downgrades full year outlook as it cements partnerships with Microsoft and Salesforce

To no-one's surprise. Workday recorded its first $1 billion quarter one revenue for Q1 FY2021. Robynne Sisco, CFO Workday provided the detail:

...with subscription revenue of $882 million, up 26% year-over-year, and professional services revenue of $136 million, up 10%. The total revenue outside the U.S. was up 30% to $256 million. Subscription revenue backlog was $8.19 billion at the end of the first quarter, growth of 20% year-over-year. Subscription revenue backlog that will be recognized within the next 24 months was $5.52 billion, growth of 21%.

Her commentary on the downgrade is interesting. In common with just about everyone else, the early days of COVID-19 produced an environment that can best be described as chaotic. But as the quarter unfolded, Sisco claims the company got a better line of sight into where it expects to land for the year. The forecast reduction in outlook is negligible from that offered at year end to a range of $3.67-3.69 billion for subscription revenue and $500 million for services. That still represents comparatively healthy growth of 19%. Sisco offered three reasons why the model remains comparatively resilient:

First, we primarily serve the large and medium enterprise market. And although even the largest companies are not immune to the current economic environment, we believe they are better positioned than SMBs to weather this downturn. 

Second, while our licensing model is based on the number of workers within our customers' organizations, we have measures in place that help reduce near-term volatility from employment changes. As an example, our contracts are typically only trued up annually to account for increases and decreases in worker counts. 

In addition, our contracts have base minimums, which limit our downside. And it is only upon contract renewal, which is typically every 3 to 5 years, that our customers have the opportunity to reset these base levels. 

And finally, we are very strategic to our customers, which makes our products incredibly sticky. As a result, while we may see some moderation in retention rates in the near term, likely due to increased bankruptcies and reduction in base worker counts during renewals, we expect that our retention rates will remain high.

Paradoxically, Workday sees room for margin expansion through the rest of the year, largely as a result of unused establishment costs. One fly in the ointment - Workday is withdrawing from providing cashflow guidance for the remainder of the year. The reason given is that it needs to maintain flexibility among the customer base and to have the means to offer extended credit terms. How this will shape up over the year is yet to be determined, hence the withdrawal of guidance on this element of the outlook. At the quarter end, Workday held net cash of around $1.4 billion after accounting for long term debt of $1.5 billion. 

What happens to the pipeline?

In comments, Aneel Bhusri, CEO Workday likened the current environment to the 2008-09 financial crisis. Accordingly. the company is dusting off its old playbook of accelerated time to value. In addition, Bhusri notes that (some) potential customers who are using legacy on-premises systems are struggling to keep the lights on where people are needed on site to manage the IT landscape in an otherwise locked down environment. 

One question that's been top of mind for me comes in terms of deal closing which normally requires intensive in-person negotiations. Those kinds of question have left me wondering what happens to the pipeline, whether it dries up, whether closing is possible at all. Sisco dismissed those concerns, arguing that:

We have always had a pretty significant portion of our sales cycle done virtually anyhow, particularly in the presales portion and the demoing of our software. And so what has changed is that we have moved the entire process virtually. 

In terms of what we adapted, as I said on some of my remarks, we adapted our messaging and areas of focus by solution and industry. And we clearly focus more, double down on those go-to-market motions that we have more confidence that would yield best returns during these times. And obviously, you can think -- focus more on some of the surging industries or some solutions, like it could be Planning or Prism, Learning or Scout, some of the motions that we think will produce better results.

Let's see how this works out. There are enough unknowns in the general environment for us to remain skeptical for the time being. Chano Fernandez, co-President Workday confirmed that sense of volatility when he said: 

We're still below our normal engagement levels and also below our normal pipeline builds. But there has been a significant uptick in engagement and positive sentiment relative to, I would say, four weeks ago. 

As if to emphasize the point, Bhusri added in comments about the backlog:

I think what everybody needs to recognize is that no one knows how it's going to play out over the next couple of quarters. We don't know if there's going to be another outbreak. And so everything that we are saying is our best information at this point in time.

To which Sisco added:

And as you know, the backlog is tied to net new. It's also tied to renewals, and then it's tied of duration. And we really haven't seen -- we don't have enough data yet to predict those, how they could play out over the back half of the year because we just have far less visibility.

Microsoft and Salesforce partnerships

As to the partnerships, Workday also announced expanded relationships with both Microsoft and Salesforce. These are significant. The Microsoft deal builds on a relationship that goes back to 2016 but now includes the ability to host Adaptive on Azure. This is a significant stepping stone that, while not available until next year allows Microsoft shops to better manage their infrastructure costs. At the same time, Workday announced that Microsoft has become a Workday Adaptive customer.

Finally, the expanded Salesforce relationship is about helping customers get people back to work. Bhusri explained it this way:

We have all the data about employees, locations, what they're learning in terms of the learning content. And Salesforce has a whole set of things with Work.com around contact tracing, tracking skills, shifts. And we're just making sure that the two technologies are completely synced so customers don't have to reconcile between the two. And if you -- and so if you're a joint customer, hopefully, this solution is really going to help you manage your way back into the office.

My take

Workday has a history of playing down growth and then surprising the market to the extent that it's almost expected that the company will shoot past its projected outcomes. This time the company is optimistic but with enough caveats around to ensure that analysts don't get too giddy with a one time report. Sisco is right to emphasize the uncertainties and it is instructive that Q3-4 are sufficiently murky that Workday remains cautious. However, the relatively small adjustment to the full year outcome surprises me. 

SaaS firms usually do well in a downturn, in large part because they're not dependent upon blockbuster deals to meet quarterly numbers. Their revenue is largely predictable, even in a downturn. However, while we cannot know, as Bhusri states, whether there will be a second wave of infection, we equally cannot know what the upside looks like and whether as some predict, it has a bullwhip effect. 

However, I'm not as convinced as Bhusri about making comparisons between 2008-09 and 2020. To me, there is something fundamentally different and which starts with people and their relationship to the workplace. Workday is well positioned to take advantage of changes in direction on this matter and has enough by way of developed applications that add needed value to operate both a land-and-expand and net new strategies. 

The question then comes, does Workday have sufficient market credibility to stick with its numbers? Anaplan for example got whacked in after hours when, according to Albert Pang:

Anaplan stock fell 8% after issuing 2QFY21 guidance that suggested a pullback in Cloud EPM spending b/c pandemic. While Anaplan posted a 37% jump in revenues in 1QFY21, it now expects a 23% rise in 2QFY21 sales, less than half of what it did in 2QFY20.

Contrast this with Adaptive saying it saw a 30x uplift in planning usage the last quarter with no signs of a slowing down. If you believe that a flight to safety is appropriate then Workday is well positioned to take advantage of its strengths.