Workday - Despite Upbeat Comments, I Remain Bearish

| About: Workday (WDAY)

Shares of Workday (NYSE:WDAY) traded with sizable gains duringThursday's trading session. The provider of cloud-based human capital applications reported its first quarter results for its fiscal 2014 on Wednesday after the close.

Halfway during the trading session, shares traded with gains of 4%, just above the $68 mark. At these premium valuations I remain bearish on the prospects for the company due to the extremely high valuation.

First Quarter Results

Workday generated first quarter revenues of $91.6 million, up 61% on the year before. Subscription revenues came in at $68.4 million, up 85% on the year. Revenues rose 12.4% compared to fourth quarter revenues of $81.5 million. Revenues came in ahead of consensus estimates of $86.9 million

Net losses continued to increase. Workday reported a $33.0 million net loss. This compares to a loss of $20.3 million in the first quarter of last year and a $30.9 million loss in the past quarter. Net losses came in at $0.20 per share.

Adjusted losses came in at $0.15 per share, while analysts on average were looking for losses of $0.18 per share.

During the quarter, Workday added some high profile customers including Bristol-Myers Squibb (NYSE:BMY) and Levi Strauss for its human capital management applications. The company remains upbeat about its products, the pipeline and future growth.

Chairman, CEO and co-founder Aneel Bhusri commented on the first quarter developments, "Our Q1 results demonstrate that our business continues to perform well across all initiatives. Development efforts for Workday Big Data Analytics and Workday Recruiting are progressing as planned, and we see increasing customer demand for these new applications as the largest companies around the world continue to move HR and Finance to the cloud."

A Detailed Look Through The Income Statement

Despite the significant revenue growth, signs of positive operating leverage are limited. Cost of revenue rose "merely" by 46.3%, thereby falling by 410 basis points to 40.0% of total revenues.

These margin improvements were largely undone as Workday boosted its Research & Developmen spending by 74.6%, increasing investments by 300 basis points to 39.6% of total revenues.

Sales and marketing expenses fell by 190 basis points to 41.8% of total revenues. These gains were made undone by a 340 basis points increase in general and administrative expenses which rose to 14.1% of total revenues.

Workday remains committed to R&D investments to offer superior services. The relative large investments explain the net losses to a great extent.

Looking Into The Second Quarter, And Remainder Of The Year

For the current second quarter, Workday expects revenues to come in between $97 and $101 million, up 55 to 61% on the year before. At the midpoint of the range, revenues are expected to increase by 8.1% compared to the first quarter. The guidance is in line with analysts expectations for second quarter revenues of $99.0 million.

The company has raised its full year revenue target to $425-$440 million. This implies that revenues in the second half of the year could come in around $240 million, up from last year's $154 million. Workday raised its full year revenue guidance by $5 million, bringing it in line with consensus estimates of $433.2 million in annual revenues.


Workday ended its first quarter with $806 million in cash, equivalents and marketable securities. Other than a modest amount in capital lease obligations, Workday does not operate with any debt, for a solid net cash position.

Factoring in the 4% gains in Thursday's trading session, the market values Workday at $11.3 billion. This values operating assets of the firm at around $10.5 billion, the equivalent of 24 times its expected fiscal revenues for the year of 2014.

Given the lack of profitability, Workday is currently not paying a dividend.

Some Historical Perspective

Like many cloud-based names, Workday only got its public listing quite recently. Shares were eventually sold to the public at $28 per share in a highly successful offering. Shares instantly jumped to $50 per share, to trade in a $50-$60 trading range in the following months. Shares kept on rallying throughout the start of 2013 hitting upon highs of $69 at the moment.

The main reason behind the premium valuation is the incredibly high revenue growth. Revenues quadrupled between its fiscal 2010 and 2013, from merely $68.1 million to $273.7 million. At the same time net losses more than doubled to $119.8 million per annum.

Investment Thesis

Workday had a solid quarter, with revenues coming in ahead of consensus estimates. Reported revenue growth slowed down to 61%, attributed to a tough comparison last year. Adjusting for the tough comparison, revenues would have grown by 75%. As such, the midpoint of second quarter revenue growth of 58% implies quite a growth slowdown compared to the first quarter.

Unearned revenue increased by 41% on the year, implying that Workday has a pipeline of 10 months, based on today's revenue rates.

While revenue growth is still impressive, it is slightly worrying to see the growth rates coming off that rapidly. Adjusted revenue growth is expected to fall by 16 points to 59% in the current quarter. This slowdown is even more important in light of some of the company's comments during the earnings call: "Long-term profitability and cash flow generation are important goals but we believe that our focus today needs to be on market expansion, continued product innovation and growth."

This implies that despite a relentless focus on growth, rather than profitability, revenue growth is decelerating quite rapidly.

Still Workday is positioned for growth. It has some 450 customers for its Human Resource applications at the moment, while it reckons there are more than 10,000 US companies with over a 1,000 employees. This represents a large opportunity for the company.

Workday continues to compete against the likes of SAP and Oracle (NASDAQ:ORCL) which have been trying to boost their cloud-based offerings by means of acquisitions in recent years. Within the fast growing segment, Workday is well positioned. While it is smaller than these large ERP-based competitors, its growth rates are more impressive as it is growing its market share within the rapid growing segment.

While the company is stabilizing its losses at the moment, achieving break-even levels seems far fetched at the moment and will most certainly not happen this year. Even if we attach a generous growth rate of 50% for its fiscal 2015 annual revenues, shares are valued at 16 times next year's annual revenues, with at best having visibility for break-even results.

Therefore I remain on the short side, purely based on valuation concerns.

Disclosure: I am short WDAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.