Workday, Inc.

Much like Salesforce.com (CRM - Get Report) last week, Workday  (WDAY - Get Report) is seeing profit-taking after posting fairly good numbers that left some bulls wanting more after a big run-up.

After the bell on Tuesday, the cloud human capital and financial management software provider reported July quarter (fiscal second quarter) revenue of $671.7 million (up 28% annually) and non-GAAP EPS of $0.31, topping consensus analyst estimates of $663.1 million and $0.26. Workday's billings, defined as its revenue plus the sequential change in its unearned revenue balance, rose 35% annually to $739.8 million, topping a $735.1 million consensus.

Workday also guided for its subscription revenue, which accounts for the lion's share of its total revenue, to rise 31% to 32% in the October quarter to a range of $609 million to $611 million, and 31% in fiscal 2019 (it ends in Jan. 2019) to a range of $2.341 billion to $2.348 billion. Those guidance ranges are above consensus estimates of $587 million and $2.29 billion, respectively.

It's worth noting that the estimates respectively assume $18 million and $42 million in revenue from finance/sales planning software firm Adaptive Insights. With Workday having closed its $1.55 billion acquisition of Adaptive Insights in early August, some analyst estimates might not account for the deal's revenue impact.

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Workday's shares fell more than 2% in after-hours trading on Tuesday to $153.00 and were down 8% on Wednesday morning. They went into earnings up 54% on the year.

Here are some key takeaways from Workday's earnings report and call.

1. Backlog and Unearned Revenue Growth Is Strong

In addition to beating revenue and billings estimates, Workday saw its subscription revenue backlog rise 26% annually, and by about $300 million sequentially, to over $5.5 billion. That helped Workday's unearned revenue balance, most of which is expected to be recognized within one year, rise 21% to nearly $1.5 billion.

On the call, CFO Robynne Sisco reiterated Workday's guidance for its organic short-term unearned revenue to rise by a low-20s percentage during the October and January quarters. However, with Adaptive Insights on the books, total unearned revenue is now expected to grow up to 25%.

In addition to new customer adds, strong renewal activity is contributing to this growth. Cisco stated the July quarter featured a "record high for renewals achievement," which Workday defines as renewal revenue as a percentage of original contract value.

2. Adaptive Insights Is Set to Weigh on Margins...

Due to Adaptive Insights, Workday's non-GAAP operating margin, which was at 10.1% last quarter, is expected to drop to 4% in the October quarter. And the company is lowering its fiscal 2019 operating margin guidance to 9% from 12%.

Cisco notes the margin guidance assumes $40 million in "one-time transaction and integration costs" related to the Adaptive Insights deal.

3. ...But Workday Sounds Quite Upbeat About Adaptive's Long-Term Impact

CEO Aneel Bhusri stated on the call that Workday, which for now offers a home-grown business planning software solution in addition to Adaptive's, will rely solely on Adaptive's offering going forward. "We're committed to unifying Adaptive Insights with Workday, not bolting it on," he added.

Bhusri also argued Adaptive's products will "open more doors" for Workday's broader financial management software (FMS) offerings. And that Workday in turn will be able to sell Adaptive's software, which today is used in large part by mid-sized businesses to its large enterprise clients.

4. Financials and International Sales Are Growing Rapidly

Though its human capital management (HCM) offerings are still believed to account for a solid majority of Workday's revenue -- particularly among Fortune 500-type companies -- Bhusri disclosed new customer adds for the company's FMS products grew 60% annually last quarter, and that its total FMS customer count is now at 530.

He also insisted that HCM products only account for about 25% of Workday's long-term addressable market. And -- after an analyst noted that recent CIO surveys indicated ERP software is becoming a larger IT priority -- he suggested that cloud-based finance software has evolved to the point where it can replace on-premise offerings in much the same way that cloud apps in other fields have done so.

"I think [with] the combination of core [financials], procurement, expenses and planning all together, we can be an ERP replacement today, and it definitely seems to be the next area of focus from IT," Bhusri said. "It was CRM, then HR, IT and I think it's now I think finance is the next big one to tackle." SAP (SAP - Get Report) and Oracle (ORCL - Get Report) have long been the broader ERP market's biggest players.

Also of note: Workday's international sales grew 48% annually to $156 million, easily outpacing total revenue growth of 28%. For now, they're still only 23% of total revenue.

5. Free Cash Flow Growth Is Solid, But Will Be Slowing for Now

Like other cloud software firms that often get paid for subscriptions on an annual basis but recognize revenue a quarter at a time, Workday's free cash flow (FCF -- operating cash flow minus capital expenses) is soundly above its net income. For the trailing 12 months, FCF is up 36.5% to $337.8 million.

However, as is the case for Workday's operating profits, the Adaptive deal will pressure cash flows in the short-term. After previously guiding for operating cash flow to rise 30% in fiscal 2019, Workday now expects it to rise 18% to $550 million. With the company still forecasting capex of $200 million, that suggests FCF will rise about 8% this year to $350 million.