Workday Q2 FY2017 beat on revenue prefaces a strong outlook through to 2020

One day, Workday is going to miss on its earnings forecasts. I just don't know when that will happen. My guess is that it will be sometime after 2021. Why do I say that? Well, on today's Q2 FY2017 earnings call, an interesting question was raised. Check this exchange:

Justin Furby - William Blair & Company - Thanks and congratulations on a stunning billings number. I had two questions I guess. The first is for Aneel. And I'm wondering, Aneel, if you think about -- if you think -- whether or not you think HR can grow 30% a year for the medium term? So the next three to five years, do you think it can do that growth when you consider it as international and payroll and learning and recruiting and some of the other products and then I have got one follow up?

Aneel Bhusri - CEO Workday  I think that's a reasonable number when you do include international and new products. International business has really picked up momentum. We were very pleased with what we saw and particularly, in APJ, that was really the most exciting quarter we've had as a company in that region. So I think that that sets up for future growth. Anything else to add? Do you feel good about that number, Phil?

Mark Peek - co-President Workday - Phil has to sign for that number.

Justin Furby - Okay, I let Phil sign up for too then.

Phil Wilmington - co-President Workday -  Well, I appreciate. Let me sign up for that Justin. I think the key there is, as you touched on it, is international. But it’s also exciting the growth we're seeing in adoption rate of new products. Recruiting has been very, very solid. Payroll attach rates continue to increase. Learning management is very solid. So the increases in awareness and acceptance there, I think is another key to that establishing or continuing that performance rate.

Based upon the full year FY2017 forecast of revenue in the range $1.548 billion to $1.558 billion, that means we can expect revenue as follows at the lower end:

FY2018 - $2.01 billion

FY2019 - $2.61billion

FY2020 - $3.4 billion

FY2021 - $4.42 billion

Regardless of how you consider those numbers, to me, executive confidence in the long range (3-5 years in software IS long range) position speaks more to the solidity of the business model and position that Workday has, and continues to carve out for itself as a cloud pure play, integrated HR/Financials system for the enterprise. If anything, you have to concede that on past performance, these numbers could turn out to be conservative. Workday's Q2 FY2017 revenue for example, at $378 million was up 34% year over year, a beat of about $5 million. The company is forecasting $398-400 million for Q3 FY2017.

Equally interesting was some of the color Workday put on which logos it is winning. Bhusri said of the north American arena:

Building on its existing partnership with Workday, IBM will now use our Human Capital Management Suite to manage many of its global HR processes for more than 350,000 employees. Additionally, in anticipation of its upcoming close of the EMC acquisition, Dell has added to its existing Workday subscription bringing its total employee count to over 125,000.

These are large numbers but they're not the only stand outs. The company won Samsung in Korea as a "global customer." If all Samsung employees are taken on board the Workday train, then that is a total of 319,000 employees at the last count. Then there is Repsol with its 30,000 employees. Those unfamiliar wth Repsol should know that this Madrid, Spain based oil business has locations in 40 countries. More to the point, Spanish companies are not known for opening their clamshell wallets too easily; so to me, this is a really big deal for Workday.

The Netsuite conundrum

On the call, there was plenty of talk about Oracle's acquisition of Netsuite. Bhusri was complimentary about this deal but in the process, let another wee nugget slip that will be of particular interest to mid-market buyers:

So they (Oracle) seem to be doubling down on the mid-market with an acquisition of NetSuite. We probably see NetSuite in 20% of our opportunities that would be my best guess. They are definitely an SMB to mid-market player...

...(The opportunity is) very sizable, I think the more we've dug into it, we’re very competitive in that world and we’ve done quite well, but that market is far more sensitive to the cost of implementation than the large enterprise market is and we’ve been working on from very powerful tooling led by Annrai O’Toole, who is one of the principals at Cape Clear and has been with us since Cape Clear became part of Workday.

We’re going to showcase some of that tooling to you at the Analyst Day in September at Workday Rising. Those tools are the critical piece for us to be more successful and gain even greater market share in that mid-market, bringing down the cost and implementation by 50%, 60% with these toolings, giving those customers less configuration choices, but most of them don’t want them anyways and that’s the way NetSuite really keeps the implementation costs down.

The software costs are pretty comparable. So I think it’s a huge opportunity for us and we just have to tackle these implementation costs.

(My emphasis added.)

OK - let's peel this back a bit. Workday now believes it has an opportunity to expand into mid-sized company deals whereas in the past it has tended to go for the upper end of the mid-market and large enterprise. We have never seen an enterprise vendor successfully achieve this in both parts of the ERP market with the same application. It has always meant a cut down version for the enterprise player.

Workday seems to be saying that given the right toolset, it can succeed where others have failed, but that it will simply switch off un-needed functionality as part of the offering. The fact it is seeing Netsuite in 20% of deals is telling, especially given the fast growing strength of Workday's financial solution, compared to the maturity of that already on offer by Netsuite.

If Workday is to succeed on the mid-market, we think it will need a different go to market strategy, and one that relies much more on the channel than is the case today. It also means that Workday is signaling the potential to offer at a price point I would not have imagined in the past.

We will need to run our own health checks, but if we have understood this correctly, then Workday could have a significant impact on a segment of the market where, to be perfectly frank, Netsuite has pretty much had a clear field. That, in itself is a multi-billion dollar opportunity, made more attractive by the fact Salesforce is the de facto CRM standard in that segment.

We shall be watching that space with interest.

Still recording losses

No analysis of earnings by this curmudgeon is complete without my whining about the use of non-GAAP numbers and Workday is no different. It posted a GAAP operating loss of $86.9 million compared to $67.6 million in the same period last year.

I'm glad that Workday doesn't try and sugar coat too much but the fact it is still running at a GAAP loss remains a concern. The climate is not as favorable as it once was for racking up massive losses but again, the executive team set expectations by talking to growth over profit while ensuring that analysts understand how it is managing cash flow, which was flat after all items in the currently reported quarter. Workday holds $2.2 billion in cash reserves of one sort or another.

My take

Workday is now hitting its stride in terms of building a highly repeatable and scalable business model. My sense is that the financial product has started to do well after a year of near relentless emphasis by Bhusri on earnings calls and analyst presentations. The impact of the soon-to-be generally available planning solution augers well for ensuring that what is now morphing into a business operating system of record becomes truly mainstream.