Workday, Inc. (NASDAQ:WDAY) Q3 2023 Earnings Call Transcript

Workday, Inc. (NASDAQ:WDAY) Q3 2023 Earnings Call Transcript November 29, 2022

Workday, Inc. beats earnings expectations. Reported EPS is $0.99, expectations were $0.84.

Operator: Welcome to Workday’s Third Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the call. During the Q&A, please limit your questions to one. With that, I will now hand it over to Justin Furby, Vice President of Investor Relations. Thank you. Justin, you may begin.

Justin Furby: and Chano Fernandez, our co-CEOs; Barbara Larson, our CFO; Pete Schlampp, our Chief Strategy Officer; and Doug Robinson, our Co-President. Following prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Before we get started, we want to emphasize that some of our statements on this call, particularly our guidance are based on the information we have as of today and include forward-looking statements regarding our financial results, applications, customer demand, operations and other matters. These statements are subject to risks, uncertainties and assumptions, including those related to the impacts of the ongoing COVID-19 pandemic and recent macroeconomic events on our business and global economic conditions.

Please refer to the press release and the Risk Factors and documents we file with the Securities and Exchange Commission, including our 2022 Annual Report on Form 10-K and our most recent quarterly report on Form 10-Q for additional information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. In addition, during today’s call, we will discuss non-GAAP financial measures, which we believe are useful as supplemental measures of Workday’s performance. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from GAAP results. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results in our earnings press release, in our investor presentation and on the Investor Relations page of our website.

The webcast replay of this call will be available for the next 90 days on our company website under the Investor Relations link. Additionally, our quarterly investor presentation will be posted on our Investor Relations website following this call. Also, the customers’ page of our website includes a list of selected customers and is updated monthly. Our fourth quarter fiscal 2023 quiet period begins on January 15, 2023. Unless otherwise stated, all financial comparisons in this call will be to our results for the comparable period of our fiscal 2022. With that, I’ll hand the call over to Aneel.

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Aneel Bhusri: Thank you, Justin, and welcome to Workday’s third quarter fiscal 2023 earnings conference call. I’m happy to report that we had a solid Q3 as we once again outperformed across our key operating metrics. There is no question that the macro environment presents increased uncertainty. But as we’ve said before, we are well-positioned in this type of environment because our cloud finance and HR solutions are truly mission-critical. As our Q3 results showed, more and more organizations are selecting Workday as their trusted partner to help them successfully navigate today’s changing world. We remain confident in our ability to capitalize on the opportunity ahead and are pleased to announce our first ever share repurchase program and up to $500 million under authorization.

This program will help reduce the rate of our share dilution going forward and is driven by our belief that our share price is undervalued given the long-term growth opportunity ahead. Barbara will share details shortly, but know that we feel confident that we reach a scale where we can roll-out this repurchase program, while continuing to prioritize investing for long-term profitable growth. With that, I’d like to share some highlights from the quarter. In Q3, we further solidified our position as a leader in Cloud HR with notable new HCM customers, including Intermountain Health, SGS and Texas Roadhouse. In addition, we had several key HCM go-lives, including Best Buy, Canadian Tire Corporation and the State of Oklahoma. For Workday Financial Management, we continue to see strong demand and momentum in Q3.

Key new wins included a Fortune 200 provider of information technology solutions, Cincinnati Children’s Hospital Medical Center, EZCorp and Thomas Jefferson University. It’s important to note that each of these customers have also selected us for HCM, reinforcing the power of the full Workday platform providing further evidence that companies are going all in with us. Key financial management go-lives during the quarter included City of Baltimore and Medical University of South Carolina. Q3 also saw us get back in person for Workday Rising, our annual customer conference for the first time since 2019. We had nearly 16,000 in-person and virtual attendees and it was great to experience the energy and see firsthand our community is growing and evolving.

This was highlighted by the fact that this year’s event has a large percentage of senior leaders, finance and IT attendees ever. One big takeaway from Rising is that our innovation story is resonating with customers as we evolve to be more open and connected. While we’ve traditionally targeted the offices as CHRO and CFO, we have placed increased focus recently on the office of the CIO, which presents another growth opportunity for us. One solution in particular, that was a popular topic among IT attendees was where to Workday Extend. Workday Extend lets customers and partners build their own unique solutions on top of Workday, which is a huge point of emphasis for CIOs and in their eyes, positions us even more as a true platform player. While we announced several availability at Workday Extend in 2020 we’ve continued to see accelerated demand for it over the last year as the need for organizations to quickly innovate and adapt in today’s business environment increases.

We also announced new more personalized UX enhancements that meet every type of work they use and the natural flow of their work such as mobile devices, Microsoft Teams and Slack, which helps us to address another CIO priority as they are more focused than ever on driving increased employee engagement. And finally, we further reinforced our leadership in artificial intelligence and machine learning with the announcement of next-generation skills technology that allows customers to more easily and securely bring skills data in and out of Workday. This helps customers leverage the full power of machine learning to gain deeper insights into their workforce skills and deliver more personalized employee experiences. In closing, we once again delivered a solid quarter with strength across a number of key growth initiatives, showcasing why Workday is the backbone of digital business.

And while we expect that the macro uncertainty will cause our growth to moderate in the near-term, we continue to believe we are well-positioned to navigate this environment and emerge even stronger. Driving constant innovation to address our customers’ evolving needs has always been key to our success and will continue to be our focus in this environment. With that, I’ll turn it over to our co-CEO, Chano Fernandez. Chano, over to you.

Chano Fernandez: Thank you, Aneel, and thank you to everyone for joining today’s call. I want to start off by offering my sincere thanks to the more than 17,500 workmates that help us deliver another solid quarter. Your relentless focus on the customer continues to push us and the broader Workday community forward. Great job, team. I’ve been on the road a lot the last few months, including Workday Rising in Europe, which has wrapped up in Stockholm and Workday Rising in US back in September. I’ve had the opportunity to spend time with hundreds of customers and prospects, and there are a couple of key themes emerging. First, despite all the challenges that companies are facing today, they increasingly realize the present need to modernize their HR and financial systems.

The executives that I speak with have different viewpoints on what the macroeconomic climate will look like in the year ahead. But one thing they agree on is that the change is constant and it’s nearly impossible to navigate with legacy systems. Second, there is a clear desire to consolidate and prioritize spend across a new organization’s more strategic technology vendors. Given our positioning as the backbone of digital business across HR and finance, this trend has led to more and more companies going all in with Workday as they look to harness the power of their data across the enterprise. And when I look at our solid Q3 results across both the large and medium enterprise is a direct validation of these themes being seen across organizations of all sizes.

From a geographic standpoint, we saw solid results across North America, with a number of CoreHR and FINS wins that Aneel mentioned, in addition to several strategic expansions across the Fortune 500. APA also outperformed with wins at Bank of Queensland, Fletcher Building, Ono Pharmaceutical and Trip.com, to name a few. And in EMEA, we had a number of important wins and expansions, including SGS, Alliance Medical Group and Equiniti. Our customer base sales team once again saw outstanding growth, a direct reflection of the trust that customers are placing in us and a validation of our strategy. We drove very strong renewal rates in Q3, and we closed a number of strategic expansions at companies such as Accenture, University of Maryland, the state of Nebraska, Pick n Pay, Puma and VF Corporation.

As we shared at our recent Analyst Day, our customer base momentum is being driven by our broad portfolio. Solutions such as journeys, help and talent optimization, for example, are seeing strong adoption as customers look to support employee experience. While our scheduling, time tracking and payroll solutions are all resonating as customers increasingly focused on labor optimization and other products such as Planning, Extend, Accounting Center, VNDLY and our Spend Management solutions are all contributed to this quarter’s strength across the customer base. Our industry focus continues to pay off. In Q3, nowhere was this more evident than the health care vertical where we had a strong growth in new ACV and where we surpassed $0.5 billion in annual recurring revenue.

By far, the two largest costs for health care organizations are labor and materials. And by leveraging our full suite of HCM, FINS and supply chain solutions, they are able to help optimize spend across these critical areas. In fact, all of our larger Q3 health care wins were full suite, and including Workday’s supply chain management. We also saw healthy momentum within the professional services industry, highlighted by the aforementioned expansion at Accenture, as we continue to co-innovate across the quality platform, including significant new developments in the skills cloud, public cloud and accessibility. Other strategic wins in the professional services industry included KNOWSCIENCE and REIT Global , which was a full suite win. Our expanding partner ecosystem is also becoming an increasingly important driver of our growth.

Key to our strategy is driving core innovation across the platform, which increases the differentiation of our solutions, enables even faster innovation to address real-time customer challenges and allows our partners to leverage their deep industry and solution insights to differentiate in the market. Examples of recent partner-driven innovation built on the Workday platform include Accenture’s digital revenue operations solution, which integrates CPQ capabilities with Workday’s billing and revenue automation, to enable seamless quote-to-cash functionality for software and technology companies. Another great example is employee document management, built by partner Kainos on Workday Extend, which provides our customers with advanced document generation, access control storage and finally, tuned document retention rules.

These are just a few several solutions that were recently released by our partner ecosystem, and we have those and more on the road map. As we move into our fourth quarter, the environment remains uncertain, which has led to increased scrutiny and the lengthening of certain sales cycles, particularly with the net new opportunities. While we aren’t immune to these and see signs that it will persist into next year, we are confident in our diverse pipeline and are focused on executing in Q4 and laying a strong foundation for FY 2024 and beyond. With that, I will turn it over to our CFO, Barbara Larson. Over to you, Barbara.

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Barbara Larson: Thanks, Chano, and good afternoon, everyone. As Aneel and Chano mentioned, we delivered solid Q3 results in the face of continued economic uncertainty, a testament to strong execution across the company, as well as the strategic and mission-critical nature of our solutions. Subscription revenue in Q3 was $1.43 billion, up 22% year-over-year, and professional services revenue was $167 million, up 7%. Total revenue outside of the US was $394 million, representing 25% of total revenue. 24-month backlog at the end of the third quarter was $8.62 billion, growth of 21%. The result was driven by solid new business sales and strong renewals, with gross and net revenue retention rates over 95% and over 100%, respectively.

Total subscription revenue backlog at the end of Q3 was $14.10 billion, up 28%. Our non-GAAP operating income for the third quarter was $314 million, resulting in non-GAAP operating margin of 19.7%. Margin overachievement was driven by revenue outperformance, favorable cost variances across the business and the timing of certain expenses shifting into Q4. Q3 operating cash flow was $409 million, growth of 6%. Our cash flow this quarter was impacted by a $55 million semiannual interest payment associated with our Q1 debt offering. We also paid off the principal balance on our $1.15 billion convertible debt with cash in October, resulting in a reduction to our non-GAAP diluted share count of roughly 8 million shares. Given the late Q3 timing, this share count reduction will be fully reflected in our non-GAAP weighted average share count in Q4.

During the quarter, we successfully added approximately 600 net new employees, ending Q3 with a global workforce of more than 17,500. We expect a strong moderation of hiring as we move into Q4, but we’ll continue to add key talent across strategic growth areas of the business, notably go-to-market and product and technology. Overall, we’re extremely proud of the strong company-wide performance in Q3, and we’re focused on executing in Q4, our seasonally strongest quarter of the year. Now, turning to guidance, which reflects both the continued momentum in our business, while also balancing an uncertain macro environment. With that context, our guidance for FY ’23 subscription revenue is now $5.555 billion to $5.557 billion, representing 22% year-over-year growth.

We expect Q4 subscription revenue to be $1.483 billion to $1.485 billion, 21% year-over-year growth. We now expect professional services revenue to be $645 million in FY ’23, with the slight reduction driven by the delay of a large project. For Q4, we expect professional services revenue of $147 million. We expect 24-month backlog to grow approximately 19% year-over-year in Q4. We expect Q4 non-GAAP operating margin of approximately 17.5%, which includes some expenses that shifted out of Q3. Our FY ’23 non-GAAP operating margin guidance is now 19.2%. GAAP operating margins for both the fourth quarter and the full year are expected to be approximately 23 percentage points lower than the non-GAAP margins. This includes a change to our employee stock plan that will take effect in Q4 to provide more flexibility to our employees during the open trading window each quarter.

Our vesting date will move from the 15th to the 5th of each month for all outstanding grants, resulting in an acceleration of stock-based compensation expense of approximately $30 million in Q4. This change will result in reduced stock-based compensation expense by the same amount over the next few years and has no impact on our dilution. The FY ’23 non-GAAP tax rate remains at 19%. We are maintaining our FY ’23 guidance for operating cash flow of $1.64 billion, but are reducing our capital expenditures outlook to approximately $375 million, reflecting the timing of certain data center and real estate investments being pushed out to future periods. And as Aneel mentioned, we are pleased to announce a share repurchase program with authority to repurchase up to $500 million in shares over an 18-month period.

We will continue to prioritize allocating capital towards organic innovation, followed by targeted M&A, but given our strong balance sheet and free cash flow, we intend to use a portion of our capital towards the repurchase of shares, enabling us to partially offset future dilution from employee stock programs. This repurchase program is a direct reflection of our confidence in the business and our view that our shares are currently undervalued. While we are early in our planning cycle for next year and have an important Q4 ahead, we’d like to provide a preliminary view of FY 2024. As discussed at our Financial Analyst Day, we have a significant long-term opportunity and multiple growth levers that drive our goal of sustaining 20% plus subscription revenue growth on our path to $10 billion in revenue.

While this remains our multiyear goal, given the continued macro uncertainty, we believe it’s prudent to provide a preliminary FY 2024 subscription revenue range of approximately $6.5 billion to $6.6 billion or 17% to 19% year-over-year growth. This outlook takes into account the lengthening of sales cycles that we’re currently seeing impact our net new business. From a margin standpoint, we currently expect FY 2024 non-GAAP operating margin expansion of 150 to 200 basis points from FY 2023 levels, placing us firmly on track to our target of 25% non-GAAP operating margin and 35% operating cash flow margin at $10 billion in revenue. The expected margin expansion is driven by the scalability of our model, a strong moderation of hiring, and ongoing expense discipline.

We plan to operate the business with agility, and we’ll continue to appropriately balance growth investments based on what we see in the underlying market environment. And finally, I’ll close by thanking our amazing employees, customers, and partners for their continued support and hard work. With that, I’ll turn it over to the operator to begin Q&A.

Operator: Thank you. We’ll now be conducting a question-and-answer session. Our first question is from Kash Rangan with Goldman Sachs. Please proceed with your question.

Kash Rangan: Thank you so much and fabulous, fabulous quarter given the macroeconomic conditions. I was wondering if you could give us some perspective. In some sense, this is a recession that everybody has been expecting, nobody’s going to be surprised. I was wondering if you could offer some insights into how Workday has been able to execute so well during a tough time and other software companies are facing headwinds. And to the extent we get some relief next year, if the economy does improve, could you do even better considering that your results are actually quite impressive? Thank you so much.

Aneel Bhusri: Well, I don’t think we’ll comment next year just quite yet, Kash, but thank you for the kind comments. I think the value proposition of our products works in a downturn just as it does in a good market just like we did in 2008, 2009 and every other downturn. Chano, do you want to add anything?

Chano Gomez: No, I think I agree with what you said, Aneel. I believe the mission-critical applications of our solutions really resonates with our customers as they are modernized in their HR and finance solution. And as I said in my comments as well, Kash, there is a consolidation of spend across strategic vendors, and we clearly are being one of those these days.

Kash Rangan: Thank you so much.

Operator: Our next question is from Kirk Materne with Evercore. Please proceed with your question.

Kirk Materne: Yes. Thanks very much and I’ll echo the congrats on a really nice quarter in a tough environment. I guess, Chano, you talked about some deal cycles extending. I was just wondering if you could talk a little bit about what you’re seeing at the top of the funnel. Obviously, you guys sort of came out perhaps of the COVID recession a little bit later than some others. I think there’s a fear out there that once we get through this current wave of deals in your pipeline that there might be some sort of cliff in terms of net new billings. But it sounds like you guys feel pretty good about your pipeline. So I was wondering if you could just sort of expand on that? Thanks.

Chano Fernandez: Thank you for your question, Kirk. Overall, companies continue to prioritize HCM and financials transformations, and we see ongoing momentum in important growth areas like our customer base team. What is a clear market trend, as I said, towards consolidation of vendors and as well the medium enterprise. There’s good pipeline momentum, but maybe, Doug, you can add some color in terms of pipeline and deal dynamics overall?

Doug Robinson: Yes. I think well, you captured two of it, which is I described, Kirk, as — we’ve got a diversity of revenue streams. So as Chano mentioned, medium enterprise performed well. We’ve got the customer base motion. And that was a theme that I certainly heard at our customer conference is our large customers wanting to consolidate rationalize number of suppliers and expand their footprint with us. So I think that certainly helps. In terms of like top of the funnel sort of the core of your question, it’s really interesting in that our Q3 pipeline build, so the pipe we’re building now, which is largely about next year, met our internal targets. So we’re seeing project formation. At the same time, we’re seeing some projects elongate.

So I think Chano mentioned this, but they tend to be large enterprise net new. Those projects have extra steps to complete. At the same time, at the top end, the starting of projects is meeting the goals that we’ve established internally.