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Workday Q2 FY2019 impresses, warns of headwinds associated with Adaptive Insights acquisition

Den Howlett Profile picture for user gonzodaddy September 4, 2018
Another solid quarter from Workday but with plenty of questions around what happens now that the Adaptive Insights acquisition has been consummated.

To no-one in particular's surprise, Workday Q2 FY2019 results crushed expectations but along the way the company cautioned about the cost impact of its Adaptive Insights acquisition which closed on August 1. These costs hit margin and cash flow. Call me an old cynic but the market used the opportunity to 'sell the news' sending the stock price down in after-hours trading. Why they hadn't factored those elements into the stock price beforehand will remain one of life's great mysteries.

From the press statement:

  • Raising Guidance: Based on second quarter results, and inclusive of the acquisition of Adaptive Insights, Workday is raising fiscal 2019 revenue outlook and now expect subscription revenue of $2.341 to $2.348 billion, or growth of 31%. Third quarter subscription revenue is expected to be between $609 and $611 million, representing 31% to 32% growth.
  • Investing in the Future with Acquisitions: Workday unveiled its plans to and announced the completion of the acquisition of Adaptive Insights, with the company operating as Adaptive Insights, a Workday company. In addition, Workday also acquired and Rallyteam to power Workday products with even more intelligence so customers can better understand and react to business needs.
  • Continued Revenue Growth: Total revenues were $671.7 Million, an increase of 27.9% year over year. Subscription revenues were $565.7 Million, an increase of 30.2% year over year.
  • Commitment to Privacy: Underscoring its ongoing commitment to privacy, Workday announced its support for comprehensive U.S. and global privacy laws based on the Organization for Economic Cooperation and Development’s Fair Information Principles.

Onto some of the more interesting details.

The Adaptive Insights quotient

Workday is clearly placing a lot of store in what Adaptive can bring to the long-term party.

Many years ago, when Workday's financial application was but a twinkle in the developers' eyes, Aneel Bhusri and I spoke at length about how the key to winning in the CFOs office wasn't just about the transaction but having solid analytics capability alongside budgeting planning and forecasting.

At the time, I counseled the company to avoid building a solution but recommended finding a partner. That is because building this class of application that works well, scales and is user-friendly presents one of the toughest development challenges in the enterprise apps space.

Over the years, Workday tried a variety of approaches but none of them really stuck as well as the company hoped and, as Bhusri discovered, customers want something now, not in 2-3-4 years time. As I said before, acquiring Adaptive is a good call. For his part, Brian Sommer provided solid advice for both Adaptive and Workday customers. Now we start to see the impact come into view with the company mentioning Adaptive no fewer than 49 times on the earnings call.

During the earnings call, Bhusri said that Tom Bogan, former CEO Adaptive is reporting directly to him adding that:

...we have decided that our single planning solution moving forward will be the Adaptive Insights business plan in cloud. This represents a huge opportunity for us to increase the speed to market on our long-term vision of companywide integrated financial workforce and operational planning for all enterprises large and small. With an improved value proposition for the office of the CFO we strongly believe that over time we will drive more sales for financials. We believe having Adaptive Insights as a single planning platform reduces the complexity for both customers and employees.

This statement plays directly to Sommer's key advisory for Workday customers:

This solution is very tightly embedded with the Financials and HR products. Would Workday want to maintain two similar product lines long-term? Which product line would survive and which one would eventually get sunsetted? How will that scenario play out?

We now know the answer but that also raises questions about line item credits for unexpired licenses or licenses coming up for renewal along with like for like product transfers. Note: those questions are already coming up following customer briefings.

Workday says that Adaptive will be accretive to the tune of $42 million during the remainder of the year with $18 million coming in the next quarter. According to the S1 filed by Adaptive before Workday swooped in and acquired, Adaptive showed a combined $50 million in subscription revenue for Q3-Q4 FY2018 with $24 million in Q3. That suggests - if I've read this correctly - that Workday anticipates a contraction in total revenue coming from Adaptive for the remainder of the year. If so then the company is being ultra cautious and with good reason.

Workday has firmly positioned itself as an upper mid-market and Fortune 500 targeted vendor. Adaptive is firmly in the mid-market but with the opportunity to ride on the back of Workday's success into the upper segments. The question comes whether the combined Adaptive/Workday sales teams can present a convincing argument to larger enterprises especially in the area of operational analytics. Bhusri sees plenty of scope, half promising integration in 12-18 months, but then those deals have still got to get done while existing customers are provided with a pathway from existing Workday planning solutions to Adaptive. It will be a non-trivial challenge.

But if the integration work can be completed in the timescale Bhusri envisages, then implementing Adaptive at the end of a typical Workday project will slot in very nicely. Here's why. Today, Workday says that it is routinely seeing implementation timeframes of 12-13 months. Allow a period of bedding down and hey presto - you've got your window to implement Adaptive. There will be some revenue dislocation because no buyer in the right mind is going to commit to Adaptive at the beginning of a financials ERP project unless they can piggyback onto an existing financials solution while the main project is underway. Even then customers will need a smooth on-ramp to the integrated Adaptive-Workday solution.

Vertical markets

As I've outlined, much of the earnings conversation was devoted to the Adaptive situation although Bhusri made extensive mention of the fact he is seeing increased demand for vertical market-specific functionality in the financials product:

With financials we started out with E&G, Education and Government, we continue to do very well in that space. Many of the largest universities use Workday Financials as well as Workday HR. That was followed on by healthcare and we continue to land some of the largest healthcare transformations as they move their financials into the cloud.

Technology continues to be a strong area for us largely now on the back of 606 and people having to go through the painful change of their RevRec and within Workday that is already built in and easy to use.

And then other business services, Professional Services, those have all been good areas for us. Financial services has been strong in pockets. Insurance has been one of our most I guess strongest markets of moving financials to the cloud. Wall Street Banks have been slower, so if I were to say where I would hope we'd see more traction, it would be in Wall Street Banks.

Wall Street Banks were also later on the HR side due to the heavy regulation and just the amount of work we have to produce for regulators. So I suspect that in the next year or two, you'll start seeing the big investment banks coming to market with financials for the cloud.

I'm particularly interested in seeing how the banking vertical pans out. As regular readers will know, banking and financial services generally are hot markets in the overhyped blockchain segment. Those buyers are not necessarily focused on ERP replacements and, in any event, there is a slew of strong competitors. That's not to say Workday can't crack that market, just that it won't be a slam dunk. But, it only takes one of the majors like a Deutsche Bank in Europe to join Bank of America as a Workday customer for that to change. ING, Santander, and Rabobank are already marquee European Workday customers.

My take

With all eyes on Adaptive we now have a clear view of the challenges that Workday faces as it beds down the acquisition. It will not be easy but I disagree with analysts who think that the Adaptive solution represents a management distraction. If anything, I agree that it provides the Trojan Horse with which Workday might persuade prospective customers to move both back-office HR and financials albeit over time.

One surprise on the call and I'm not sure if this is a blessing or a curse. There wasn't a single mention of artificial intelligence nor blockchain, neither were there questions about any potential work in those areas. Workday has some AI capability but on that we will need to wit until Workday Rising when our team will surely pepper Workday management.

Final word - watch for Tom Bogan joining Bhusro on future earnings calls.

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