Workday, Inc. Q3 FY2022 Earnings Call

Welcome to Workday's Third Quarter Fiscal Year 2022 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 Mr. Justin Furby, Vice President of Investor Relations. Thank you, sir. You may begin.

Thank you, Operator. Welcome to Workday's Third Quarter Fiscal 2022 Earnings Conference Call. On the call, we have Aneel Bhusri and Chano Fernandez, our co-CEOs, Robynne Sisco, our co-President and CFO, and Pete Schlampp, our Chief Strategy Officer. Following prepared remarks, we will take questions. Our press release was issued after the 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 on our business and global economic conditions. Please refer to the press release and the risk factors in documents we file with the Securities and Exchange Commission, including our 2021 annual report on Form 10-K and 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 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. Also, the customers page of our website includes a list of selected customers and is updated monthly. Our fourth quarter quiet period begins on January 16, 2022. Unless otherwise stated, all financial comparisons in this call will be to our results for the comparable period of our fiscal 2021. With that, I'll hand the call over to Aneel.

Thank you, Justin. And good afternoon, everyone. Thank you for joining us today for our third quarter fiscal year '22 earnings call. I'm pleased to report that Workday had another strong quarter. As we highlighted at our Analyst Day in September, we continue to expand our addressable market with a broadening product portfolio and multiple go-to-market levers to drive sustainable growth on our path to $10 billion and beyond. As we've discussed throughout this year, our expectation has been for accelerating growth. While not every expectation comes to fruition, this one certainly has even faster than we expected. And we are optimistic on the momentum we see as we head into our all-important Q4 and prepare for a great year in fiscal year '23, Robynne will provide more details shortly, but we are pleased to provide a preliminary view of 20% subscription revenue growth for next year. And with continued execution, we'd like to see the opportunity grow even faster. Before I hand it off to Chano to provide details on our go-to-market success in Q3, I want to quickly touch on the highlights from the quarter. Starting out with our industry-leading Workday HCM products, we had another strong quarter as we continue to attract new customers and also have strong success growing our relationship with our existing customers. In Q3, we added AS The Stores, Ltd., ConocoPhillips, Northern Trust, Toll Brothers, and Vishay Electronic, among many other new HCM customers like the State of Iowa and Five Below to name a few. In addition to the strong growth from core HCM, our recently acquired Pecan Solutions, newly named Workday Pecan Employee Voice delivered another record quarter. We're seeing the benefits having recently rolled out Pecan globally across our own organization, and we couldn't be more excited about the long-term potential to help our customers better listen to and engage with their own employees. We also continue to see strong traction across our financial management suite of applications. Our growing product portfolio, combined with digital acceleration in the office of the CFO is driving broader adoption of our financial management applications. To that end, new Workday financial management customers in Q3 included the City of Philadelphia, the World Health Organization, Wind Trust, Memorial Health Care, and Diversified Restaurant Group. Of course, one of the big drivers behind our continued strong customer adoption is our relentless focus on innovation by staying at the forefront of large trends that are circular drivers of future growth. One trend that has been accelerated by the demands of the pandemic is the future of work, which requires new ways of thinking about workforce composition and how to manage different types of workers. We expect to accelerate our efforts in this area with the proposed acquisition of VNDLY, a leading next-generation cloud-based vendor management solution platform. Workday and VNDLY together will deliver a comprehensive total workforce optimization solution that brings an integrated approach to managing all types of workers. We'll help customers bridge the gap between internal and external workforce management while enabling a holistic workforce strategy that delivers full visibility into entire workforces and managing and planning for labor needs, while also helping to control compliance and security risks. We look forward to expanding our efforts in this area, and we'll share more information after the deal closes, which we expect to occur in our fourth quarter. Looking ahead to fiscal year '23 and beyond, we have an amazing growth opportunity in front of us, and we see a unique opportunity to accelerate our path forward by further ensuring that our purpose, strategic vision, and product roadmap are in lockstep with our go-to-market strategy. To help us do that, we've announced a series of important organizational updates. The first two in late October and two more today that I'm excited to share with you. To help chart and further articulate Workday's strategic vision, Pete Schlampp has been appointed as our first-ever Chief Strategy Officer. Pete has successfully led our industry-leading product organization for the past two years. During that time, he implemented a robust product portfolio strategy that's contributed to our current momentum, both in terms of delivered innovation and financial success. His ability to set a strategic vision and execute makes him the perfect fit for this new role, overseeing and evangelizing our growth strategy going forward. Second, we are creating tighter alignment across our product and technology organizations under the leadership of Sayan Chakraborty, who is now EVP of Product and Technology. Under Sayan's leadership the past two years, the technology team has infused Workday with game-changing innovations like machine learning, enabling customers and partners to innovate in our platform with Workday Extend, build strategic cloud partnerships, and help ensure that Workday is amongst the most reliable, scalable, and secure platforms in the industry. His long and successful track record in delivering industry-leading innovations, along with his deep understanding of customer needs, makes him the ideal leader to map out our combined product and technology path going forward. And earlier today, we announced a couple more changes. First, we're pleased to share that Doug Robinson, EVP of Global Sales, has been promoted to co-president of Workday. Doug will serve as co-president alongside Robynne Sisco. As co-president, Doug will continue to lead our global sales organization but also take on an expanded leadership role across the company, helping to spearhead cross-functional initiatives that will help Workday reach new heights. And finally, we're also happy to share that Barbara Larson, SVP of Accounting, Tax and Treasury, is being promoted to Chief Financial Officer effective February first of next year, reporting to Robynne. The transition of the CFO role from Robynne to Barbara is part of Workday's strategic succession planning, an approach that focuses on developing leaders from within. Barbara has been a rising star since joining Workday more than seven years ago. During that time, she has held several leadership positions across our finance and product organizations, providing her with the right foundation to step into the CFO role and lead our finance organization into the future. With Barbara's move to CFO, Robynne will now focus more on her co-president responsibilities. This will include an increased emphasis on engaging with some of our most strategic FINS customers and prospects to increase Workday's footprint within the office of the CFO, in addition to continuing to lead her current organization. It's an exciting time to be at Workday, and we're looking forward to the impact Pete, Sayan, Barbara, Doug, and Robynne will continue to make as we all strive to aspire a brighter Workday for all. As I look ahead, my optimism for Workday's future couldn't be higher. We have a great team in place and a significant global opportunity in front of us as companies continue to embark on their HR and finance transformation journeys. With that, I'll turn it over to our co-CEO, Chano Fernandez. Over to you, Chano.

Thank you, Aneel, and thank you to everyone for joining us today. I want to start by offering my congratulations to Pete, Sayan, Barbara, and Doug. You're all amazing leaders and fantastic colleagues who have worked tirelessly to push us forward as a company, and your promotions to these roles are incredibly well-deserved. As Aneel mentioned, we delivered a solid Q3, driven by strong execution combined with healthy demand for financial and HCM solutions. The strong conversion rates that we experienced in the first half of the year continued in Q3, driving net new business acceleration that once again outpaced our expectations. In addition, our pipeline generation remained very healthy, setting us up incredibly well to achieve our full-year acceleration targets and providing incremental confidence in our goal of sustaining 20% plus subscription revenue growth on our path to $10 billion in revenue. Strength in Q3 was once again broad-based with solid growth in landing new core HR and financial customers. Performance in North America remained strong across the large enterprise, while the medium enterprise and international markets both drove significant outperformance. EMEA was a highlight with outstanding results in the UK, Spain, and Switzerland. In addition to solid performance from our land sales team, the momentum within our customer base team continued in Q3, driving continued strength in net revenue retention. We once again saw a very strong renewal performance and our customer base team drove strength, cross-selling a number of solutions aimed at the CHRO and CFO, including planning, learning, people analytics, and spend management. We were also excited by the strength that we saw with Peakon, which has been part of Workday now for a couple of quarters, and which drove record performance, including the signing of its largest ever deal. Customer base expansions with Peakon in Q3 included Banco Santander, a new Peakon first customer, including Holland & Barrett and S3. We had another fantastic quarter with wins like Bristol Myers Squibb, Carbonell Health, and U.S. Foods. Not only does the extensibility of our platform help us go deeper with our customers, but it also allows us to engage our partner ecosystem in very meaningful ways. A great example of this is through our partnership with an organization that built an emissions planning model in Workday adaptive planning to address critical sustainability objectives related to carbon reduction for governments in the Asia-Pacific region. This ESG solution has global applicability and is one of several examples of partners adding their IP to enhance the value of the Workday platform. Our industry approach is winning the market, and strengthening our government vertical was one of the many highlights in Q3. As Aneel mentioned, we were selected by the City of Philadelphia for financial management, in addition to planning, spend management, and several other solutions. We also signed platform HCM and financial deals with the City of Worcester, Massachusetts, and the county of Mobile, Alabama. And we had wins across a number of other states, cities, and local governments, both in the U.S. and internationally. Successes such as this highlight the importance of taking an industry approach, and we expect to continue to make significant investments across key industries from both a product and go-to-market standpoint. As we've discussed throughout this year, we're investing aggressively in our go-to-market effort. And we made continued progress on this front in Q3, adding global sales capacity across both our direct and customer base teams. We're also accelerating our investment across key brand marketing initiatives. These investments, which we expect will continue in Q4 and into FY23, are focused on sustaining 20% plus subscription revenue growth. In closing, I would like to thank the more than 14,200 global workmates who have enabled us to drive such strong Q3 and year-to-date results. We are very well positioned as we enter our all-important fourth quarter. And we have our eyes set on record pipeline generation targets as we look to lay the foundation for a strong FY23. And now I will turn it over to our Co-President and CFO, Robynne Sisco. Over to you, Robynne.

Thanks, Chano, and good afternoon, everyone. First, I'd like to say that I could not be more excited about the leadership changes, and I'm incredibly proud to share the President title with Doug and to pass the CFO mantle to Barbara. I look forward to continuing to partner with both of them. As Aneel and Chano mentioned, we reported a strong third quarter, once again accelerating subscription revenue growth as organizations across the globe look to Workday as their strategic partner in driving their HR and finance digital transformations. Subscription revenue in Q3 was $1.17 billion, up 21% year-over-year, driven by healthy new business sales and strong customer renewals, with gross retention once again over 95%. Professional services revenue was $156 million, resulting in total revenue of $1.33 billion. Revenue outside the U.S. was $336 million, up 23% year-over-year, and representing 25% of the total. 24-month backlog at the end of the third quarter was $7.12 billion, growth of 20%. Total subscription revenue backlog was $10.97 billion, up 24%. Our non-GAAP operating income for the third quarter was $332 million, resulting in a non-GAAP operating margin of 25%. Margin overachievement was driven by a combination of top-line outperformance, some favorable expense variances, and significantly more back-end loaded hiring in the quarter than we anticipated. Operating cash flow in Q3 was $385 million, growth of 31%, driven by the margin strength combined with very strong collections. Our largest investments continue to be in our people and then attracting top talent to Workday. In the third quarter, we meaningfully ramped up the pace of hiring, successfully adding and integrating approximately 800 net new employees, bringing our total employee count to over 14,200 at the end of Q3. Overall, we're extremely pleased with our results and execution in Q3, and we're very well positioned as we enter our final quarter of the year. Turning now to guidance. Based on our strong Q3 and the continued momentum we're seeing in our business, we are raising our FY '22 outlook and providing Q4 guidance as follows. For subscription revenue, we're raising our full-year estimate to be in the range of $4.533 billion to $4.535 billion, approximately 20% growth. For Q4, we expect subscription revenue of $1.216 billion to $1.218 billion, 21% growth. And we project 24-month backlog growth of 19.5%. We still expect professional services revenue to be $590 million in FY22 with $145 million in Q4 as we continue to prioritize driving the highest levels of customer success. Based on our Q3 outperformance, we now expect full-year FY2022 non-GAAP operating margins of 22%. For Q4, we estimate non-GAAP operating margins of 16% as we continue the pace of hiring and growth investments and begin our new performance cash bonus program in Q4. The GAAP operating margin is expected to be lower than the non-GAAP operating margins by approximately 24 percentage points in Q4 and for the full year. We are updating our FY22 guidance for operating cash flow to $1.65 billion, growth of 30%, and we still expect $270 million of other capital investments in FY2022 to support our customer growth and continued business expansion. While we are early in our FY23 planning cycle and have an important Q4 to close, we'd like to provide a preliminary and high-level view of FY23. We currently expect subscription revenue of approximately $5.44 billion, growth of 20% year-over-year. We expect subscription revenue in Q1 of FY23 to increase approximately 2.5% sequentially from Q4, FY22. As we shared in our recent Analyst Day, we are focused on driving sustainable subscription revenue growth of 20% or higher on our path to $10 billion in revenue. Given the strength of our market position and the accelerating trends we see across HR and finance digital transformation, we expect to increase the pace of our top-line focused investments. Taking into account these investments, our expectation of COVID-related cost savings disappearing, and the full-year impact of our new bonus program, we continue to expect FY23 non-GAAP operating margins of 18%. Investing for growth will remain our focus, and we'll continuously evaluate gross margin trade-offs. But we currently expect to resume margin expansion after next year, putting us on a path to reach 25% margins at $10 billion in revenue. I'll close by thanking our amazing employees, customers, and partners for their continued support and hard work. With that, I will turn it over to the operator to begin Q&A.

At this time, we'll be conducting a question-and-answer session. Please limit yourself to one question. One moment while we poll for questions. Our first question comes from the line of Kirk Materne with Evercore ISI. You may proceed with your question.

Thanks very much and congrats on the quarter and congrats to everyone on their promotions. Aneel and Chano, first of all, thank you all for the preliminary look ahead to fiscal '23, but Aneel and Chano, could you just talk a little bit more about what you're seeing in the pipeline today that gives you confidence in that 20% plus outlook for subscription revenue growth? Just curious if it's the volume of deals you're seeing in the pipeline pick up, the size of deals, and maybe if you could just add a little color on the core financial opportunities as well, that'd be great. Thanks so much.

Chano?

Yeah. And Kirk, thanks for your question. I think not only did we see a strengthening in Q3 new business, but the pipeline momentum that we have described the last several quarters continued as well, with strength, I would say, across regions and solutions as well. And I think it's a much more balanced and predictable pipeline when compared to a few years ago, as our product portfolio has expanded, and as we have seen really healthy momentum across both motions, landing and expanding. So, we have our sights set on another record pipeline quarter in Q4 to help lay out the foundation for a solid FY23 and beyond. The trends we're seeing in our pipeline support our view that the momentum in the business is sustainable and supports our goal of sustaining 20% plus subscription revenue growth. In terms of core financials, it was really a contributor to the strong quarter. We have both core financials and the financial category as a whole, Kirk.

That's great. I guess just a quick follow-up for Robynne. Robynne, is the 24-month backlog number still being weighed down by a lower renewal cohort and can you just remind us of what that is and maybe when that normalizes, if that's still playing out right now?

Yeah, Kirk. So, as you recall, coming into this year, we discussed a couple-point headwind to 24-month backlog growth this entire year, stemming from the flattish renewal base that we saw coming into the year. For the most part, that's played out as we thought, although our really strong renewal rates throughout the year have somewhat offset that dynamic to give us the results that we've been reporting to date on this front. When we look ahead to FY23, we are expecting to return to a more normalized rate of growth in the renewal base, and therefore, expect that headwind to go away.

Hi. Thank you very much. It's great to see how you promote internal talent. Doug, it's a very long list, and it's impressive that you've helped create the next generation of management, including Chano, Barbara, and Robynne. My question pertains to net new ACV related to the base. We've been working on it for two years now, and there’s been no slowing down in that business area. Could either Chano or Aneel discuss the opportunities ahead? As the product portfolio continues to grow and you keep adding new customers, the base opportunity remains vibrant. Can you elaborate on how you plan to focus on this moving forward? Thank you, and congratulations on a very strong quarter.

I might just touch on the new products and Chano can touch on the go-to-market piece. I think one of the great things we have had, both through internal development and through acquisition, most recently Peakon, and now VNDLY, are products that we can sell back to our really broad-based financial and HR customer base. And on the finance side, we do the same thing with Scout. And we hope to do that with Zimit, and planning spans both product lines. That really has changed the game. We have these really powerful add-on products that are best in class, that are attractive to customers and maybe Chano can talk about how we're doing that.

Yeah, thank you Kash, and thank you, Aneel. I think the value proposition of the innovation and the solutions that Sayan, Pete and the team are building is just fantastic, and I would say it's no single solution that is the one driving the momentum, Kash. It is really broad-based strength across the full portfolio of HR and financial solutions. And I think that drove strengths as well in the renewal rates and our customer base, which I believe it speaks to how strategic we are for our customers. So, we are expecting this momentum to continue, and we shared with you on our Analyst Day that $10 billion opportunity that we see in our customer base and of course, expanding as we keep adding more customers. We keep planning to keep adding some of the investments that we're doing across go-to-market, which obviously is back to our customer base. As we've been highlighting, we are planning to strengthen next year the land motions clearly of solutions around Peakon, and work the extra resource planning, and credibility, going forward as well. So, we are pretty excited by the opportunity ahead in the customer base.

Yes. Thank you very much. And I'll add my congrats to everyone who is taking on a new role, Doug, Barbara, Pete, and Sayan. Much deserved. I wanted to ask Robynne, I'm looking at the sequential change in the 24 months subscription backlog for Q3. It's actually a bigger number than we've seen the last couple of years. So, I'm just curious if what we're seeing is the conversion of that pipeline build that, I think you've said was starting maybe 9 to 12 months ago, as you expected or are you seeing something that's converting faster or in period from Peakon or other products, or is it maybe something else that's driving that sequential strength?

Yeah, Mark. I will just point out a few things even though we really are seeing strength across all of our business in multiple different ways but the few things that I'll call out is our conversion rates have remained on the higher side. And so that has certainly helped us convert more pipeline. We also, as we strengthen our sales motion on some of our acquired companies or products that we can sell independently; those tend to have shorter cycles, and so we're seeing an impact there as well. And then lastly, we just have seen really strong renewals. Really strong renewals had uplift to those renewals and so that has really helped us with sequential growth in backlog as well.

Thank you very much, and I also want to congratulate everyone on a strong performance in Q3. I would like to follow up on Kirk's question regarding backlog and the flat renewal cohort this year, specifically how we should consider the growth related to renewals. Robynne, you referred to it as being more normal, but even though the numbers may not be exciting, the key aspect is the growth you can achieve through these renewal opportunities. How should we view the typical up-sell pattern? For instance, how frequently do you see customers adopting new modules and features when they become available, either in the middle of a cycle or at renewal time? Is it more common for expansions to occur at the time of renewal rather than co-terming mid-cycle? Thank you.

Yeah. We're seeing that dynamic shift a little, Brad, over the years as we focused more on building the customer base team. They're having continuous conversations with those customers outside of the renewal cycle, so where if you go back several years, I think three to four years, most of the add-on business came during the renewal cycle, and we've really seen that change with the investments in the back-to-base go-to-market. And now those conversations are continual. So, we're seeing a lot less add-on just in the renewal cycle and more add-ons just as products become available or as customer needs shift. But the renewal is still a great opportunity to engage in a conversation with those customers. So, it's still an opportunity for us to sell, but less dependent on that renewal cycle to actually get add-on business.

Great. Thanks for squeezing me in. Some companies have talked about more accentuated summer seasonality. Just curious how linearity track for you in Q3. And then you keep hearing how Q4 is such an important quarter. Any color on linearity there and just any anecdotes to give around what you're seeing in terms of larger enterprise opportunities as you head into the end of the year?

Chano.

We haven't observed any significant changes in linearity. It was a solid quarter, particularly considering that August, our first month, is typically quieter. However, it performed well compared to last year and the year before. September overall was good too, though nothing noteworthy to highlight. For Q4, there are typically large deals in the pipeline for both HCM and financials, along with a robust selection of solutions and geographies across our entire portfolio, particularly in the medium enterprise segment. Our focus remains on maintaining strong conversion rates and executing well on the substantial opportunities lined up for Q4. We are enthusiastic about these prospects but recognize the importance of effective execution by our teams.

Hey, there. Thanks. Good afternoon. Appreciate you taking the question. You mentioned 800 net new hires during the quarter. Is there any further commentary you can add just on the pace of hiring into Q4? Are you finding able to stay on pace with that 2500 target to start off the year? And is there any difference between U.S. and international there to call out? Thank you.

And we were super pleased with the hiring in the quarter. We've been really ramping our recruiting engine and our process throughout the year. It honestly took us a little longer than we had hoped given the market when we came into the year. But we're really excited to make such great progress in Q3, and it's certainly our hope and our goal to actually have similar hiring in Q4, so that we can get really close to that 2500 net new employees for the whole year. It's a challenging market, but we feel like we've got the momentum to do that, and so we're really focused on executing.

Our next question comes from the line of Brad Thill with Jefferies. You may proceed with your question.

Thanks. I was wondering if you could just drill a little bit in the planning, and I think last quarter you mentioned 50% ACV growth. Any stat or any update there? And just directionally, it seems like with all the supply chain concerns, there's a tremendous opportunity for you to help a lot of companies out at this point. Any color around that business would be greatly appreciated.

Planning continues to be a very meaningful growth driver for us. A lot of the bigger components of that planning have seen acceleration we’re seeing this quarter. While we do not call out the specific growth rate this time, our momentum remains very strong. We feel really good about how we are competing and winning in this market. And despite all the strength we have seen in planning over the last couple of years, we have significant long-term opportunity. We shared at our Analyst Day that only about 30% of our customers have attached financial planning, and about 10% attached workforce planning. So, we have a lot of opportunity ahead.

We will now take two more questions. Our next question comes from the line of Karl Keirstead with UBS. You may proceed with your question.

Thank you. Maybe a couple for Robynne. Robynne, maybe you could elaborate on the 24-month backlog guide for Q4. Really strong number, but it's a similar growth rate to 3Q, yet it's a two-point easier compare. Anything else on your mind as you thought through the inputs to that 4Q guide?

Yeah. I would just say that we're really pleased to be providing the preliminary view of 20% sub revenue growth for FY23. But keep in mind, to achieve that, we need to sustain healthy bookings growth, which we fully expect to do in Q4. Backlog is going to move around; it's not a perfect measure for several reasons, including the renewal headwind this year. But we feel really good about the momentum in our business and in our outlook. And we certainly would hope to overachieve the backlog guide, but we'll have to see how Q4 goes.

Our next question comes from the line of Derrick Wood with Cowen and Co. You may proceed with your question.

Great. Thanks for squeezing me in. Some companies have talked about more accentuated summer seasonality. Just curious how linearity track for you in Q3. And then you keep hearing how Q4 is such an important quarter. Any color on linearity there and just any anecdotes to give around what you're seeing in terms of larger enterprise opportunities as you head into the end of the year?

We haven't observed any significant changes in terms of linearity. It was a strong quarter. Our first month, August, is usually quieter, but it was solid compared to last year and the year before. September was also good overall, though there wasn't anything particularly notable. For Q4, there are typically large deals in the pipeline for both HCM and financials, along with a solid pipeline across a wide range of solutions, geographies, and our entire portfolio, particularly in volume business across medium enterprises and our customer base. For us, delivering a solid quarter depends on maintaining the same conversion ratios and successfully executing on the large opportunities lined up for Q4. We're excited about these opportunities, but we must execute effectively, as the teams are capable of doing.

Ladies and gentlemen, thank you for your participation on today's conference. This will conclude Workday's third quarter fiscal year 2022 earnings call. Thank you again for joining us today. You may disconnect your lines at this time.