The worldwide human capital management ((NASDAQ:HCM)) applications market is expected to grow at a good pace going forward. According to IDC, the market grew 9.1% in 2013 to $10.4 billion, and the momentum is expected to continue going forward. IDC forecasts that the market will grow at a CAGR of 8.2% till 2018, hitting a size of $15.4 billion.
As such, it is not surprising that cloud player Workday (NYSE:WDAY), which specializes in HCM, is growing at a good pace. In the recently-reported second-quarter, Workday delivered a substantial increase in its revenue year over year. Its numbers were better than Street expectations, leading to a sharp rise in the shares, and the company also raised its full-year revenue forecast.
In fact, Workday reported a 74% year-over-year rise in its revenue to $186.8 million, which topped analysts' expectations of $177.3 million. Revenue generated from the number of subscriptions rose 77% year over year to $143.7 million. But, this growth came at a price, as the total cost was more than its revenue, and increased 78% from a year ago period to $248 million. However, the company managed to reduce its net loss per share to $0.11 from $0.13 last year, and marginally outperformed the consensus estimate of $0.14.
More expenses ahead
HCM is a competitive space, with companies like Salesforce (NYSE:CRM) and Oracle (NASDAQ:ORCL) also operating in this market. As such, it is important for Workday to make aggressive investments in order to stay ahead of the competition, and it is doing just that. However, this has led to increased costs, but at the same time, the company is seeing strong growth in its customers.
To sustain its impressive revenue growth, Workday will continue investing in the business aggressively. It has outlined an investment plan of $100 million-$110 million in capital expenses during fiscal 2015. But, these investments will raise the total cost for the company. Most of its expenses have increased year on year, such as general and administrative expenses, sales and marketing expenses, and product development, among others.
As a result, management does not expect GAAP profits at least by the next fiscal. Although this does not come as a surprise, as analysts were expecting the same, but this does indicate that Workday will continue to invest rapidly to improve its top line at a rapid pace, while profitability will take a back seat for the time being.
Why investors shouldn't worry
However, since Workday has a decent balance sheet, it has the flexibility of investing in growth. The company has cash of $1.82 billion on the balance sheet, and its debt is $485 million. In addition, Workday has got strong liquidity, as seen by a current ratio of 4.05. The company is also cash flow positive, generating $54 million in operating cash over the past year, while levered free cash flow stands at $106 million.
Moreover, it is expected that Workday's bottom line will improve at a rapid pace in the future, and it will ultimately become profitable. According to estimates, Workday's bottom line is expected to improve at an annual rate of 42% over the next five years, double of the industry average. Hence, investors will need to hold the stock for the long run in order to see profitability. But, the good thing is that its investments are reaping results, as Workday has a solid customer base.
Investments are driving more customers
Workday, which makes software for human resources and financial management, has built up a strong portfolio of customers, and anticipates the momentum to continue going forward. Last quarter, its customers in HCM crossed the 700 mark. In addition, the company is also focusing on diversification, and it is close to signing up a total of 100 customers for its financial management application.
Hence, Workday is making good progress in new customer acquisitions. In fact, it landed Bank of America (NYSE:BAC) as a client last quarter, among others, which is its largest customer till date. Workday is also making significant strides in Europe, with a number of new global customers adding strength to its business. Further, to support its expanding customer base in Europe, Workday is adding local employees, and this is another reason behind its increasing costs.
Apart from new customers, Workday is proceeding well with its existing customer base. According to statistics, at the end of the second quarter, more than two-thirds of its total customer base was live and used the same version, Workday 23. Moreover, its existing customers, such as Hewlett-Packard (NYSE:HPQ), are doing their bit in expanding Workday's business. According to a report:
"Hewlett-Packard is turning its experience as Workday's largest customer into an integration practice, announcing on Tuesday the launch of HP Enterprise Applications Services for Workday.
HP's new practice will focus on implementing Workday Human Capital Management (HCM) applications, which HP itself uses to support its more than 300,000 employees. HP will help companies with planning and scoping projects, change management, program management, configuration and testing of applications, and integration with benefits systems, business intelligence platforms, payroll services, and more. The partnership will help Workday fulfill what has been healthy demand for new HCM deployments."
With this move, Workday will be able to sell its products to HP's customers.
The HCM space is expected to grow at a decent pace going forward as seen above. As a result, Workday seems to be doing the right thing by investing more in customer acquisition initiatives. Though its bottom line will remain under pressure as a result of such investments, things are expected to improve in the long run. Hence, investors should continue holding Workday in their portfolios as it looks primed to deliver good gains in the long run on the back of industry growth and customer acquisitions.
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