Workday Management Ratchets Up Expectations for Its Financial Platform

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Workday (NASDAQ: WDAY), which provides human capital management (HCM) and financial software, has been growing quickly over the past several years as it attracts large corporate customers with its cloud-based solutions. That momentum continued in the third quarter, with year-over-year revenue growth of 34.3% and new customer wins that included Lowe's, M&T Bank, Lloyds Banking Group, and Oshkosh, though its forward guidance for subscription revenue was a bit disappointing.

The company continues to prioritize growth at the expense of margins in the near term, but provided some key details on the conference call with analysts about where management sees margins heading in the future. Additionally, management sounded particularly upbeat about the demand they're witnessing in the company's financial products.

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The one metric to watch

Workday sells its software products (including support and updates) via subscription, so the majority of its revenue is subscription revenue. The beauty of Workday's business model is that subscription revenue is recurring in nature -- providing a reliable indicator of future revenue given the company's high customer satisfaction ratings (98% year-to-date).

While Workday tracks several different revenue metrics, when asked about the best way to gauge the strength of the business, CEO Aneel Bhusri responded:

For the quarter, subscription revenue grew even faster than overall revenue -- up 37.2% from last year -- and came in well ahead of the company's guidance. For the full year, Workday raised its subscription revenue outlook to a range of $1.780 billion to $1.782 billion, implying growth of 38% at the midpoint.

However, in its initial guidance for next year, the company expects subscription revenue of $2.25 billion, representing roughly 26% year-over-year growth -- which would be a notable deceleration from this year's increase. That may explain why the stock has seen a minor sell-off following otherwise strong results reported in late November.

Margins are improving, but don't expect profits anytime soon

Workday isn't yet profitable on a GAAP basis, but the company's non-GAAP operating margin rose by 7.1 percentage points to 9% as revenue growth outpaced growth in expenses.

On the conference call, Workday says it expects full-year non-GAAP operating margin of 9.5%, rising to 10% next year. There should be plenty of upside remaining in the years ahead as well, as CFO Robynne Cisco explained:

However, the company hasn't provided any time frame for hitting those targets -- and profits will likely remain elusive for the foreseeable future. Cisco noted:

Financial management -- a star in the making?

While Workday's HCM offering is its largest by far, its financial management product is No. 2, and its contribution to Workday's overall results continues to grow. The company added 37 new financial management customers, up more than 60% from last year, and the company was clearly enthused about the prospects for more robust gains in the near-future.

Bhusri talked about the trends Workday is seeing in the size of its financial customers:

The company should also continue to benefit from an accelerating shift to cloud-based enterprise solutions. Bhusri stated:

While Workday's subscription revenue growth remains an area to monitor closely, the company's improving margins and momentum with financial customers are two big positives as it heads into next year.

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Andy Gould has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Workday. The Motley Fool recommends Lloyds Banking Group and Lowe's. The Motley Fool has a disclosure policy.