Workday, Inc. (NASDAQ:WDAY) Q4 2023 Earnings Call Transcript

Workday, Inc. (NASDAQ:WDAY) Q4 2023 Earnings Call Transcript February 27, 2023

Operator: Welcome to Workday’s Fourth Quarter and 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.

Justin Furby: Thank you, operator. Welcome to Workday’s fourth quarter fiscal 2023 earnings conference call. On the call, we have Aneel Bhusri and Carl Eschenbach, our Co-CEOs; Barbara Larson, our CFO; 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 that could cause actual results to differ materially.

Please refer to the press release and the risk factors and documents we file with the Securities and Exchange Commission, including our fiscal 2023 Annual Report on Form 10-K 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 first quarter fiscal 2024 quiet period begins on April 15, 2023. We 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.

Aneel Bhusri: Thank you, Justin, and welcome to Workday’s fiscal 2023 fourth quarter and full year financial results earnings call. I’m pleased to share that we delivered solid Q4 results and once again outperformed against our key operating metrics, which include a subscription revenue growth of 22% for the quarter and for full year fiscal year 2023. While the macro environment continues to be unpredictable, Workday’s value proposition is only getting stronger as more organizations turn to us to help them adapt and manage their two most important resources, their people and their finances. As a result, our thriving customer community continues to grow and feel our path to $10 billion in revenue and beyond. In fact, we achieved a significant milestone in Q4, as we surpassed the 10,000 customer mark with more than 4,750 of those being our core HCM and finance customers, a true testament to the power of the Workday platform and our ability to address the needs for the offices of the CHRO and CFO.

Additionally, approximately 629 billion transactions were processed with Workday in fiscal year 2023, an increase of 42% year-over-year and further proof of the scale that we had reached. Before we share some Q4 highlights, I want to touch on several recent leadership moves and one organizational announcement that we made, all of which will help set us up for our next phase of growth. The first is the appointment of Carl Eschenbach as Co-CEO, which we announced in December. Carl has been a Workday Board member since 2018, and for the past 35 years, has been one of the finest sales and operational leaders in enterprise technology. With his experience and commitment to our values and culture, Carl is a perfect fit to help Workday scale and lead us forward.

At the end of our fiscal year 2024, Carl is expected to assume sole CEO responsibilities, while I will stay involved with our product and technology teams and all of our employees as a full-time Executive Chair and Chair of the Board. Carl’s transition into the Co-CEO role has been seamless and I’m excited to work alongside him going forward as we continue to grow Workday and strengthen our position as the leader in cloud HR while building on our momentum in finance. I also want to acknowledge the great work Chano Fernandez did during his nine years with Workday and for the last two years as Co-CEO. He played a significant role in helping to shape the company into who we are today, and I want to thank him for his contributions. Additionally, Sayan Chakraborty, our EVP of Product and Technology, has been elevated to Co-President alongside Doug Robinson.

Since joining Workday more than seven years ago, Sayan has been a driving force behind our evolving and expanding innovation strategy, led our efforts to scale the Workday platform to support and enable some of the world’s largest organizations, and is one of the foremost experts in artificial intelligence and machine learning as it relates to the world of enterprise offerings. Sayan will continue to lead our product and technology organization, and we are pleased to recognize his leadership role across the organization now as Co-President. With Sayan stepping into a Co-President role, Robynne Sisco, who was previously Co-President and before that CFO, will now assume the role of Vice Chair. In this role, Robynne will work closely with our global sales team to help us build on our momentum with the office of the CFO and further cement Workday as a leader in cloud finance.

The last leadership update is related to our Board of Directors. I’m pleased to share that we announced today that Mark Hawkins has been elected as the newest member of our Board. With more than 35 years of finance leadership experience at global software and technology companies, most recently at Salesforce, Mark will bring invaluable experience and perspective to Workday. Final announcement I want to highlight, which we made at the end of January, was a restructuring and realignment of some teams across Workday that led to the elimination of roles impacting about 3% of our global workforce. While it’s always difficult to see employees leave under those circumstances, we made this decision to align our resources and people against the most strategic areas of the business to help ensure that Workday is set up for continued growth for many years to come.

Throughout this process, we did our absolute best to treat the affected employees with compassion and offer them generous severance packages. This restructuring move was not a cost-cutting effort, and we will continue to hire in fiscal year 2024 for roles that support our strategic initiatives. With that, I’d like to share some product and technology highlights from the quarter. From an innovation perspective, our continued focus on uniquely embedding AI and ML into the core of our platform is enabling us to drive the future of work for HR and finance customers and there are more than 60 million employees around the world. On the HR front, the combination of our Workday Skills Cloud, which is powered by AI and ML and Workday Talent Optimization is supporting customers in their transition to a skills-first mindset.

To date, nearly 50% of all live Workday HCM customers are leveraging Workday Skills Cloud, while Talent Optimization is Workday’s fastest-growing SKU with an attach rate on new deals of more than 85% in fiscal year 2023. For Planning, we introduced new demand forecasting capabilities that leverage AI and ML to help retailers forecast business demand based on external data, such as sales and foot traffic history. Retail continues to be one of our target industries as more than 50% of the retail organizations in the Fortune 500 are Workday customers. And innovations like this will enable us to build on our momentum in this space. We’re also continuing to double down on AI and ML through our Workday Ventures Fund. We announced a $250 million expansion of the fund to focus on larger growth areas such as generative AI, all with an eye to embracing emerging technologies to help us further enable our customers in today’s changing world of work.

Finally, I want to touch on how we’re continuing to invest in our brand. Hopefully, you all saw our fun rock star-themed advertisement during the Super Bowl, which reached an estimated 110 million viewers. While finance and HR leaders are familiar with us, we saw the Super Bowl as the stage to help us become more well known to a broader audience. We firmly believe that our brand is strategic and investments in marketing drive awareness and demand for our products and services. Going forward, we feel very confident in our ability to capitalize on the long-term growth opportunity in front of us, thanks to the strategy we have in place, the mission-critical nature of our solutions and the amazing talents of our more than 17,700 Workmates around the globe.

In fact, we are hosting today’s call from our annual sales kickoff meeting and the excitement from all of our go-to-market teams here in Las Vegas about the incredible opportunity we have in front of us is palpable. With that, I’ll hand it over to our Co-CEO, my buddy, Carl Eschenbach. Carl, over to you.

Carl Eschenbach: Thank you, Aneel, for those kind words, and thank you to everyone for joining us today. Let me start by saying that I am humbled and honored by the opportunity to partner and work alongside Aneel and our Workmates across this amazing company. I’m truly energized by Workday’s unique opportunity to be one of the largest and most profitable software companies in the world. This was my first quarterly call as co-CEO and I could not be more proud of our teams for their incredible execution. Despite a macro environment that remains uncertain and that no one is immune from, we drove strong close rates in Q4 and built a healthy pipeline for the year ahead. Our team was prepared to respond to the extra scrutiny we knew would come with deals in this environment.

And because of that, we are heading into our new fiscal year in a position of strength. I can tell you the excitement for the year is all around us as we are coming to you live from our annual sales kickoff conference in Las Vegas. As a Board member for the last five years, I have been actively involved in Workday’s growth journey. Today, more than two months in as Co-CEO, I have had the privilege of spending time with hundreds of Workmates, customers, partners and prospects around the world. Those meetings have given me an even greater appreciation of how compelling Workday’s value proposition is and how differentiated we really are. I have also gotten to know Aneel and the leadership team even better. And while I already considered Aneel, a partner and a friend, our co-CEO relationship is working really well as we have very complementary skill sets.

It’s a true one plus one equals three equation. As I reflect upon my first couple of months, a few things in particular have stood out, starting with the culture and values of Workday. This, frankly, was the most important driver for me taking this role. I have long admired the culture that Dave and Aneel built and see as a true differentiator. We have six core values at Workday, and each of them are important. But to me, the one that I keep coming back to is integrity. If you do the right thing, everything else falls into place. I have been blown away by the talent that sits across this company and by how ingrained our values are in everything we do. Another observation is around our land opportunity. With net new customers, I will tell you it’s wide open.

We have a footprint with over 50% of the Fortune 500 and more than 25% of the Global 2000, but we still see plenty of room to grow. Q4 was a great validation of this, with seven new Fortune 500 and 11 new Global 2000 customers. New HCM customers we added in the quarter included Allstate, Camping World, Cracker Barrel, Delaware North Companies, Mercedes-Benz Group and Whataburger. And key go-live included Heidelberg Materials and Mitsui Chemicals. In addition, we once again added several full platform HCM and financial customers, including Fidelity National Title, Panda Restaurant Group, and the State of Georgia. And we had several FINS go live, including The New York Times and Sanford Health. One of the exciting things about our land opportunity is that it’s not limited to replacing outdated on-premises systems.

In fact, three of our new Fortune 500 wins replaced cloud solutions from our legacy ERP competitors. And the land opportunity extends well beyond the upmarket as the medium enterprise has become an increasingly important driver of net new ACV and that team drove record performance in the quarter. What’s also important is the strength of our customer relationships and the strategic nature of what we do for them. This provides us with an incredible opportunity to expand our business with our installed base of customers who rely on Workday as their intelligent digital backbone to adapt and manage their people and money. This quarter, we once again drove very strong renewals along with solid new ACV bookings, including expansions at Belk, GE, Old Dominion Freight, Prudential and Truist.

We saw momentum across our solutions portfolio, including Learning, Planning, Prism Analytics, Accounting Center and Candidate Engagement. And an increasing number of our expansion deals added core financials as we lean into our market leadership in HCM to drive increasing momentum with the office of the CFO. Our opportunity is truly global. The US, which continues to be our largest market, had a solid Q4 and has a healthy runway going forward. We also have a tremendous international opportunity, which is only about a quarter of our revenue, but more than half of our TAM. Our momentum is building in strategic markets like DACH and Nordics, where we had a number of important wins during Q4, including CCB Management Services, Mila and NorgesGruppen.

Accelerating our international business is a strategic priority and we are investing in both talent and products to help drive that. Our continued industry focus is gaining momentum, and it is a core part of our ongoing strategy. We had wins in a number of key verticals in Q4, including state and local government where in addition to the win at the State of Georgia, we had wins at the City of Boston, the City of Charlotte and New York City Housing Authority to name a few. In fact, new ACV from our state and local teams more than doubled year-over-year in Q4, and we expect our traction to continue in FY 2024. Finally, our partner ecosystem will be critical to our next phase of growth. Our partners from the global system integrators to the boutiques have been incredibly important to get us to where we are today.

They drive the vast majority of our customer deployments and serve as an important source of co-innovation. One of the ways they do this is through Workday Extend, which now has over 1,000 applications in production across our customer community. We expect our partners will play an even more important role in FY 2024 as we look for them to drive an increased number of new opportunities, while we strategically shift more customer deployments to our ecosystem. We see this as a clear win-win. We are also focusing our efforts across our broader ecosystem of ISVs and technology partners. A great example is our recent partnership with AWS, which extends our infrastructure relationship to a more formal go-to-market motion. I am excited to work alongside our Chief Customer Officer, Sheri Rhodes, and our newly appointed SVP of Global Partners, Matt Brandt, and our entire ecosystem on this journey.

Heading into FY 2024, we have a clear strategy in place, which is rooted in strengthening our HCM market leadership and winning in FINS across our key industries. We are optimizing the business to double down in strategic growth areas such as investing in our customer base, focusing on key industries, evolving and investing in our partner ecosystem and relentlessly focusing on innovation, including shaping the future of work to our application of AI and machine learning. Having the right strategy is only part of the equation, you also need the right people, which is why we plan to continue to add sales capacity in key engineering talent as we position Workday for the next wave of growth. We also made some recent changes to strengthen our leadership bench that will be critical to helping us execute on our strategy.

Doug Robinson will continue in his role as Co-President and now has full responsibility for all go-to-market functions. As Aneel mentioned, Sayan Chakraborty has also been elevated to Co-President, and I’m also excited to have Robynne Sisco serve as our Vice Chair, now squarely focused on helping us sell FINS. Patrick Blair, who joined a year ago to run North America sales, has been elevated to Head of Global Sales. His team across the regions is a talented mix of seasoned Workday veterans and proven recently added external talent, who will rally around our global opportunity. It’s an amazing time to be at Workday, and I’m so inspired and energized by the incredible journey ahead. While we continue to see certain sales cycles, primarily net new opportunities taking longer than normal to close, our FY 2024 subscription revenue guidance prudently factors this in.

And we are positioning the business to return to 20% plus subscription revenue growth when the environment improves, while simultaneously delivering margin expansion. I look forward to meeting many of you on the road in the quarter ahead, and thank you for your support. With that, I’ll turn it over to Barbara. Barbara, over to you.

Barbara Larson: Thanks, Carl, and welcome. I know I speak for the broader Workday organization when I say that I’m incredibly excited to partner with you on the next phase of our growth journey. As Aneel and Carl mentioned, we had a solid close to the year, driven by strong execution across the company, combined with durable demand for our solutions as organizations of all sizes, prioritize finance and HR modernization during these uncertain times. Subscription revenue in Q4 was $1.50 billion, up 22% year-over-year. For the full year, subscription revenue was $5.57 billion, also a growth of 22%. Professional services revenue was $151 million for Q4 and $649 million for the full year. Total revenue outside of the US was $396 million in Q4, representing 24% of total revenue.

24-month subscription revenue backlog at the end of the fourth quarter was $9.68 billion, up 21%. The result was driven by solid new ACV bookings and strong renewals, with growth in net revenue retention rates over 95% and over 100%, respectively. In addition, early renewals added roughly 1 percentage point of upside to 24-month backlog growth and roughly 2 percentage points to total backlog growth. Total subscription revenue backlog at the end of Q4 was $16.45 billion, up 28%. Our non-GAAP operating income for the fourth quarter was $305 million, resulting in non-GAAP operating margin of 18.5%. Margin overachievement was driven by revenue upside and continued cost discipline. The workforce realignment we announced at the end of January was a $34 million non-GAAP expense in the quarter, or a roughly 2 percentage point headwind to Q4 non-GAAP operating margin, most of which was factored into our guidance.

For the year, non-GAAP operating income was $1.21 billion, representing a margin of 19.5%. Q4 operating cash flow was $694 million, growth of 13%. As a reminder, the Q4 result was impacted by a roughly $70 million one-time IP transfer tax payment. Full year operating cash flow was $1.66 billion. During the quarter, we repurchased roughly $75 million in shares and have $425 million in remaining authorization under our buyback program. We ended the fourth quarter with more than 17,700 global workmates. As Anil and Karl mentioned, we will continue to add key talent across strategic growth areas of the business, notably go-to-market and product and technology, but we are planning for fewer headcount additions in FY 2024 as compared to FY 2023. Overall, we’re very proud of the strong company-wide execution in Q4, and we enter FY 2024 in a position of strength.

Now, turning to guidance, which reflects both the continued momentum in our business, while also balancing what remains an uncertain macro environment. In addition, we recently completed an assessment of our server and network equipment. And beginning in FY 2024, we are increasing the useful life assumption from three years to five years, reflecting advances in technology that we’re benefiting from. This change will have a positive impact on our FY 2024 non-GAAP operating margin, which I will cover shortly. Following a solid Q4, we are maintaining the midpoint of our preliminary FY 2024 subscription revenue guidance and narrowing the range to $6.525 billion to $6.575 billion, representing 17% to 18% year-over-year growth. We view this guidance as prudent in the context of the environment.

But as Carl mentioned, we’re positioning to return to a 20% plus subscription revenue growth when the environment improves. We expect Q1 FY 2024 subscription revenue to be $1.517 billion to $1.520 billion, representing 19% year-over-year growth. We expect subscription revenue to increase sequentially by approximately 6% in Q2 and approximately 4% in Q3. We expect FY 2024 professional services revenue to be in the range of $630 million to $650 million. As Carl mentioned, we are strategically shifting more deployments to our partner ecosystem as part of ongoing investments we are making in the channel. For Q1, we expect professional services revenue of $148 million. We expect 24-month backlog to grow approximately 20% year-over-year in Q1. We currently expect FY 2024 non-GAAP operating margin of 23%.

The expected margin expansion is primarily being driven by the scalability of our model, a moderation of hiring, and ongoing expense discipline. In addition, we estimate the change in server and network equipment useful life will result in a roughly $100 million reduction to the GAAP and non-GAAP cost of subscription revenue in FY 2024, creating a benefit to operating margin of about 150 basis points this year. Looking forward, the impact from this policy change is expected to trend down and result in an approximately $50 million reduction to GAAP and non-GAAP cost of subscription revenue in FY 2025. We estimate Q1 non-GAAP operating margin of approximately 21.5% and expect a normal seasonal sequential decline in Q2 as we invest in our people through our annual compensation process.

GAAP operating margins for the first quarter and the full year are expected to be approximately 26 and 22 percentage points lower, respectively, than the non-GAAP margins. The FY 2024 non-GAAP tax rate remains at 19%. We expect FY 2024 operating cash flow of approximately $2.05 billion, growth of 24%. On a year-over-year basis, our first quarter cash flow will be impacted by the first full year payout of our performance-based cash bonus plans, severance costs associated with the recent realignment and an interest payment that did not occur last Q1 due to the timing of our debt offering. We expect capital expenditures of approximately $340 million in FY 2024 to support our continued business expansion. 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.

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Q&A Session

Operator: At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Kirk Materne with Evercore ISI. Please proceed with your question.

Kirk Materne: Thanks. Thanks very much. And congrats on a strong finish to the year. Carl, since you have a relatively fresh pair of eyes looking at the business, I was wondering if you could just talk a little bit about what you’re seeing in the close in 4Q and the pipeline that leads you to believe that getting back to 20% growth is achievable once we get into a more sort of normalized operating environment. Just some specifics around that or what you’re seeing maybe be helpful on that front. And then I have a quick follow-up for Barbara.

Carl Eschenbach : Sure. Well, first of all, thank you, Kirk, for the question. Let me start by just saying I want to thank all of our Workmates around the world for delivering a strong close to the year and setting us up for a strong FY 20. As you know, Kirk, announcing a CEO transition in the middle of Q4, your biggest quarter, is probably not always optimal. And we talked about our priorities at that time was to finish the year strong, and we did just that. As far as what we’re seeing in the environment to think about getting back to a 20% growth, we see plenty of opportunity to continue to invest in the business, both on the go-to-market side with additional sales capacity in quota-carrying reps as well as continued investment in product and technology.

A couple of key insights early on, now, I guess, over 60 days into the role, is we see continued opportunity in our international business, both in EMEA and in APJ. Today, we have only 25% of our business coming from our international operation, yet it represents greater than 50% of our TAM. So we see a really big opportunity there. And what we did is we brought in strong leadership both in EMEA and APJ. And Doug and Patrick have actually brought in additional strength even under our top leaders in those respective markets. We also think we’re going to double down even further on our FINS opportunity, both to sell back into our customer base as well into net new. We see this as a rich opportunity. We did a nice job in Q4 selling back into our HCM base with our FINS solution, and we think that’s something we can do a lot more of.

And then the last thing, although there’s plenty more, Kirk, I’d highlight is we’re going to continue to leverage our ecosystem. Our partners around the world are doing a great job, implementing our technology and driving deployment. But we’re also going to work with them to build business plans so they can help us drive net new business, not just do implementations, but help us drive new business into the base as well as net new customers overall. And then last thing on the ecosystem, we were excited to be able to announce today a partnership with AWS that allows us, for the first time, to sell our technology platform through their marketplace, allowing their customers to leverage the spend they have with AWS on Workday solutions. So that’s an aggregate of why we think over time, depending on when the macro turns more favorable, we’ll be able to get back to 20% growth on the subscription side.

Kirk Materne: That’s super. And just a real quick one for Barbara. Barbara, just in terms of margins — thanks for the commentary on 1Q and 2Q, just we’re thinking about it correctly. I assume because risings in 3Q, we should see the rest of sort of the margin expansion in 4Q, maybe more seasonally flat or sequentially flat between 2Q and 3Q?

Barbara Larson: Yes, that sounds about right.

Kirk Materne: Okay. That’s great. Thanks, all. Appreciate it.

Operator: Our next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed with your question.