Workday, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Overview Founded in 2005, Workday delivers financial management, human resources, planning, spend management, and analytics applications designed for the world’s largest companies, educational institutions, and government agencies. We help organizations better manage their financial and human resources with one system that helps enable them to plan, execute, analyze, and extend — all powered by machine learning. Our diverse customer base includes medium and large global companies as well as smaller organizations that primarily use our planning product. Our cycle of frequent updates has facilitated rapid innovation and the introduction of new applications throughout our history. We began offering our HCM application in 2006 and our Financial Management application in 2007. Since then we have continued to invest in innovation and have consistently introduced new services to our customers. We have achieved significant growth in a relatively short period of time with a substantial amount of our growth coming from new customers. Our current financial focus is on growing our revenues and expanding our customer base. While we are incurring net losses today, we strive to invest in a disciplined manner across all of our functional areas to sustain continued near-term revenue growth and support our long-term initiatives. We offer Workday applications to our customers on an enterprise-wide subscription basis, typically with contract terms of three years or longer and with subscription fees largely based on the size of the customer’s workforce. We generally recognize revenue from subscription fees ratably over the term of the contract. We currently derive a substantial majority of our subscription services revenue from subscriptions to our HCM application. We market our applications primarily through our direct sales force. Our operating expenses have increased in absolute dollars in recent periods, primarily due to the significant growth of our employee population. We had approximately 12,400 and 11,800 employees as of October 31, 2020, and 2019, respectively. Excluding the impact of certain COVID-19 factors further described below, we expect our product development, sales and marketing, and general and administrative expenses as a percentage of total revenues to decrease over the longer term as we grow our revenues, and we anticipate that we will gain economies of scale by increasing our customer base without direct incremental development costs. 28 Table of Contents We intend to continue investing for long-term growth. We have invested and expect to continue to invest heavily in our product development efforts to deliver additional compelling applications and to address customers’ evolving needs. In addition, we plan to continue to expand our ability to sell our applications globally, particularly in Europe and Asia, by investing in product development and customer support to address the business needs of local markets, increasing our sales and marketing organizations, acquiring, building and/or leasing additional office space, and expanding our ecosystem of service partners to support local deployments. We expect to make further significant investments in our data center capacity and equipment as we plan for future growth. We are also investing in personnel to service our growing customer base. We also regularly evaluate acquisitions and investment opportunities in complementary businesses, employee teams, services, technologies, and intellectual property rights in an effort to expand our product and service offerings. We expect to continue making such acquisitions and investments in the future, and we plan to reinvest a significant portion of our incremental revenues in future periods to grow our business and continue our leadership role in the industry. While we remain focused on improving operating margins, these acquisitions and investments will increase our costs on an absolute basis in the near term. Many of these investments will occur in advance of experiencing any direct benefit from them and could make it difficult to determine if we are allocating our resources efficiently. Since inception, we have also invested heavily in our professional services organization to help ensure that customers successfully deploy and adopt our applications. Additionally, we continue to expand our professional service partner ecosystem to further support our customers. We believe our investment in professional services, as well as partners building consulting practices around Workday, will drive additional customer subscriptions and continued growth in revenues. Due to our ability to leverage the expanding partner ecosystem, we expect that the rate of professional services revenue growth will decline over time and continue to be lower than subscription revenue growth. Impact of the COVID-19 Pandemic In December 2019, a novel strain of coronavirus disease (“COVID-19”) was reported, and in March 2020, the World Health Organization characterized COVID-19 as a pandemic (“COVID-19 pandemic”). The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global societies, economies, financial markets, and business practices. In response to COVID-19, we have temporarily closed the majority of our global offices, required most of our employees to work remotely, implemented travel restrictions, postponed certain of our customer, industry, implementation partner, analyst, investor, and employee events and converted others to virtual-only experiences. Despite the economic challenges brought on by the COVID-19 pandemic, we are committed to the long-term overall health of our business, the strength of our product offerings, and our ability to continue to execute on our strategy. During the three months ended October 31, 2020, we achieved solid new subscription bookings results as demand for our products remained strong despite the uncertain environment. Our operating margins for the three months ended October 31, 2020, have been favorably impacted by our revenue growth outpacing headcount growth as well as moderation of operating expenses in response to the COVID-19 pandemic. We do not anticipate the extent of the favorable margin impact experienced for the three months ended October 31, 2020, to continue long-term as we remain committed to investing in our business to drive top line growth and to support our growing base of customers. Our near-term revenues are relatively predictable as a result of our subscription-based business model. However, if the economic uncertainty remains for a prolonged period, we may experience a further negative impact on new business, customer renewals, sales and marketing efforts, revenue growth rates, customer deployments, customer solvency, product development, or other financial metrics, any of which could harm our business, operating results, and financial condition. For further discussion of the potential impacts of the COVID-19 pandemic on our business, operating results, and financial condition, see Risk Factors included in Part II, Item 1A of this Quarterly Report on Form 10-Q. Components of Results of Operations Revenues We primarily derive our revenues from subscription services and professional services. Subscription services revenue principally consists of fees that give our customers access to our cloud applications, which include related customer support. Professional services revenue includes fees for deployment services, optimization services, and training. Subscription services revenue accounted for 88% and 87% of our total revenues for the three and nine months ended October 31, 2020, respectively, and represented 96% of our total unearned revenue as of October 31, 2020. Subscription services revenue is driven primarily by the number of customers, the number of workers at each customer, the specific applications subscribed to by each customer, and the price of our applications. 29 Table of Contents The mix of the applications to which a customer subscribes can affect our financial performance due to price differentials in our applications. Pricing for our applications varies based on many factors, including the complexity and maturity of the application and its acceptance in the marketplace. New products or services offerings by competitors in the future could also impact the mix and pricing of our offerings. Subscription services revenue is recognized over time as services are delivered and consumed concurrently over the contractual term, beginning on the date our service is made available to the customer. Our subscription contracts typically have a term of three years or longer and are generally noncancelable. We generally invoice our customers annually in advance. Amounts that have been invoiced are initially recorded as unearned revenue. Our consulting engagements are generally billed on a time and materials basis or fixed price basis. For contracts billed on a time and materials basis, revenue is recognized over time as the professional services are performed. For contracts billed on a fixed price basis, revenue is recognized over time based on the proportion of the professional services performed. In some cases, we supplement our consulting teams by subcontracting resources from our service partners and deploying them on customer engagements. As our professional services organization and the Workday-related consulting practices of our partner firms continue to develop, we expect these partners to increasingly contract directly with our subscription customers. As a result of this trend, and the increase of our subscription services revenue, we expect our professional services revenue as a percentage of total revenues to decline over time. Costs and Expenses Costs of subscription services revenue. Costs of subscription services revenue consists primarily of employee-related expenses related to hosting our applications and providing customer support, data center expenses, and depreciation of computer equipment and software. Costs of professional services revenue . Costs of professional services revenue consists primarily of employee-related expenses associated with these services, subcontractor expenses, and travel expenses. Product development . Product development expenses consist primarily of employee-related expenses. We continue to focus our product development efforts on adding new features and applications, increasing the functionality, and enhancing the ease of use of our cloud applications. Sales and marketing. Sales and marketing expenses consist primarily of employee-related expenses, sales commissions, marketing programs, and travel expenses. Marketing programs consist of advertising, events, corporate communications, brand awareness, and product marketing activities. Sales commissions are considered incremental costs of obtaining a contract with a customer and are deferred and amortized. Sales commissions for initial contracts are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be five years. Sales commissions for renewal contracts are deferred and then amortized on a straight-line basis over the related contractual renewal period. General and administrative . General and administrative expenses consist of employee-related expenses for finance and accounting, legal, human resources, information systems personnel, professional fees, and other corporate expenses. Results of Operations Revenues Our total revenues for the three and nine months ended October 31, 2020, and 2019, were as follows (in thousands, except percentages): Three Months Ended October 31, Nine Months Ended October 31, 2020 2019 % Change 2020 2019 % Change Subscription services $ 968,547 $ 798,516 21% $ 2,782,201 $ 2,256,695 23% Professional services 137,413 139,584 (2)% 404,111 394,212 3% Total revenues $ 1,105,960 $ 938,100 18% $ 3,186,312 $ 2,650,907 20% Total revenues were $1.1 billion for the three months ended October 31, 2020, compared to $938 million during the prior year period, an increase of $168 million, or 18%. Subscription services revenue was $969 million for the three months ended October 31, 2020, compared to $799 million for the prior year period, an increase of $170 million, or 21%. The increase in subscription services revenue was due primarily to an increased number of customer contracts as compared to the prior year period. Professional services revenue was $137 million for the three months ended October 31, 2020, compared to $140 million for the prior year period, a decrease of $3 million, or 2%, which was primarily due to a decrease in training revenue as a result of the COVID-19 pandemic. 30 Table of Contents Total revenues were $3.2 billion for the nine months ended October 31, 2020, compared to $2.7 billion during the prior year period, an increase of $0.5 billion, or 20%. Subscription services revenue was $2.8 billion for the nine months ended October 31, 2020, compared to $2.3 billion for the prior year period, an increase of $0.5 billion, or 23%. The increase in subscription services revenue was due primarily to an increased number of customer contracts as compared to the prior year period. Professional services revenue was $404 million for the nine months ended October 31, 2020, compared to $394 million for the prior year period, an increase of $10 million, or 3%. The increase in professional services revenue was due primarily to Workday performing deployment and integration services for a greater number of customers than in the prior year period. Operating Expenses GAAP operating expenses were $1.1 billion for the three months ended October 31, 2020, compared to $1.0 billion for the prior year period, an increase of $72 million, or 7%. The increase in GAAP operating expenses included an increase of $83 million in employee-related expense driven by higher headcount, partially offset by a decrease of $26 million in reduced travel expenses due to the COVID-19 pandemic. GAAP operating expenses were $3.4 billion for the nine months ended October 31, 2020, compared to $3.0 billion for the prior year period, an increase of $355 million, or 12%. The increase in GAAP operating expenses included increases of $288 million in employee-related expenses driven by higher headcount, $79 million related to a one-time cash bonus paid to non-executive employees in the first quarter of fiscal 2021 to help accommodate unforeseen costs brought on by the COVID-19 pandemic (“COVID-19 one-time employee bonus”), $38 million in facilities and IT related expenses, and $21 million in third-party expenses for hardware maintenance and data center capacity, partially offset by a decrease of $72 million in reduced travel expenses. We use the non-GAAP financial measure of non-GAAP operating expenses to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, and to evaluate our financial performance. See “Non-GAAP Financial Measures” below for further information. We believe that non-GAAP operating expenses reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business. We also believe that non-GAAP operating expenses provide useful information to investors and others in understanding and evaluating our operating results and prospects in the same manner as management and in comparing financial results across accounting periods and to those of peer companies. Non-GAAP operating expenses are calculated by excluding share-based compensation expenses, and certain other expenses, which consist of employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets. Non-GAAP operating expenses were $838 million for the three months ended October 31, 2020, compared to $795 million for the prior year period, an increase of $43 million, or 5%. The increase in Non-GAAP operating expenses included an increase of $52 million in employee-related expenses driven by higher headcount, partially offset by a decrease of $26 million in reduced travel expenses due to the COVID-19 pandemic. Non-GAAP operating expenses were $2.5 billion for the nine months ended October 31, 2020, compared to $2.3 billion for the prior year period, an increase of $247 million, or 11%. The increase in Non-GAAP operating expenses included increases of $171 million in employee-related expenses driven by higher headcount, $79 million related to the COVID-19 one-time employee bonus, $38 million in facilities and IT related expenses, and $21 million in third-party expenses for hardware maintenance and data center capacity, partially offset by a decrease of $72 million in reduced travel expenses. Reconciliations of our GAAP to non-GAAP operating expenses were as follows (in thousands): Three Months Ended October 31, 2020 GAAP Operating Expenses Share-Based Compensation Expenses (1) Other Operating Expenses (2) Non-GAAP Operating Expenses (3) Costs of subscription services $ 152,396 $ (16,767) $ (7,811) $ 127,818 Costs of professional services 142,785 (27,349) (824) 114,612 Product development 419,962 (128,423) (4,006) 287,533 Sales and marketing 302,870 (54,077) (8,352) 240,441 General and administrative 102,024 (33,216) (1,355) 67,453 Total costs and expenses $ 1,120,037 $ (259,832) $ (22,348) $ 837,857 31 Table of Contents Three Months Ended October 31, 2019 GAAP Operating Expenses Share-Based Compensation Expenses (1) Other Operating Expenses (2) Non-GAAP Operating Expenses (3) Costs of subscription services $ 122,305 $ (13,634) $ (7,593) $ 101,078 Costs of professional services 148,625 (22,249) (569) 125,807 Product development 401,742 (118,215) (4,420) 279,107 Sales and marketing 286,794 (47,142) (7,820) 231,832 General and administrative 88,884 (29,762) (1,453) 57,669 Total costs and expenses $ 1,048,350 $ (231,002) $ (21,855) $ 795,493 Nine Months Ended October 31, 2020 GAAP Operating Expenses Share-Based Compensation Expenses (1) Other Operating Expenses (2) Non-GAAP Operating Expenses (3) Costs of subscription services $ 442,666 $ (45,484) $ (26,298) $ 370,884 Costs of professional services 442,422 (74,467) (4,843) 363,112 Product development 1,282,127 (378,950) (20,710) 882,467 Sales and marketing 897,924 (150,881) (26,841) 720,202 General and administrative 296,461 (97,958) (5,111) 193,392 Total costs and expenses $ 3,361,600 $ (747,740) $ (83,803) $ 2,530,057 Nine Months Ended October 31, 2019 GAAP Operating Expenses Share-Based Compensation Expenses (1) Other Operating Expenses (2) Non-GAAP Operating Expenses (3) Costs of subscription services $ 355,935 $ (36,050) $ (31,992) $ 287,893 Costs of professional services 424,548 (57,390) (5,261) 361,897 Product development 1,127,695 (315,210) (23,431) 789,054 Sales and marketing 839,930 (128,686) (31,103) 680,141 General and administrative 258,932 (88,122) (6,772) 164,038 Total costs and expenses $ 3,007,040 $ (625,458) $ (98,559) $ 2,283,023 (1) Share-based compensation expenses were $260 million and $231 million for the three months ended October 31, 2020, and 2019, respectively, and $748 million and $625 million for the nine months ended October 31, 2020, and 2019, respectively. The increase in share-based compensation expenses includes the impact of restricted stock units (“RSUs”) granted to existing and new employees. (2) Other operating expenses include employer payroll tax-related items on employee stock transactions of $8 million and $6 million for the three months ended October 31, 2020, and 2019, respectively, and $38 million and $44 million for the nine months ended October 31, 2020, and 2019, respectively. In addition, other operating expenses include amortization of acquisition-related intangible assets of $14 million and $16 million for the three months ended October 31, 2020, and 2019, respectively and $46 million and $55 million for the nine months ended October 31, 2020, and 2019, respectively. (3) See “Non-GAAP Financial Measures” below for further information. Costs of Subscription Services See the table above for a reconciliation of GAAP to non-GAAP operating expenses. GAAP operating expenses in costs of subscription services were $152 million for the three months ended October 31, 2020, compared to $122 million for the prior year period, an increase of $30 million, or 25%. The increase in costs of subscription services included increases of $8 million in employee-related expenses driven by higher headcount, $6 million in depreciation expenses related to equipment in our data centers, and $6 million in third-party expenses for hardware maintenance and data center capacity. GAAP operating expenses in costs of subscription services were $443 million for the nine months ended October 31, 2020, compared to $356 million for the prior year period, an increase of $87 million, or 24%. The increase in costs of subscription services included increases of $23 million in employee-related expenses driven by higher headcount, $18 million in depreciation expense related to equipment in our data centers, $17 million in third-party expenses for hardware maintenance and data center capacity, and $5 million related to the COVID-19 one-time employee bonus. 32 Table of Contents Non-GAAP operating expenses in costs of subscription services were $128 million for the three months ended October 31, 2020, compared to $101 million for the prior year period, an increase of $27 million, or 26%. The increase in costs of subscription services included increases of $6 million in depreciation expenses related to equipment in our data centers, $6 million in third-party expenses for hardware maintenance and data center capacity, and $5 million in employee-related expenses driven by higher headcount. Non-GAAP operating expenses in costs of subscription services were $371 million for the nine months ended October 31, 2020, compared to $288 million for the prior year period, an increase of $83 million, or 29%. The increase in costs of subscription services included increases of $18 million in depreciation expense related to equipment in our data centers, $17 million in third-party expenses for hardware maintenance and data center capacity, $14 million in employee-related expenses driven by higher headcount, and $5 million related to the COVID-19 one-time employee bonus. We expect that GAAP and non-GAAP operating expenses in costs of subscription services will continue to increase in absolute dollars as we improve and expand our data center capacity and operations. Costs of Professional Services See the table above for a reconciliation of GAAP to non-GAAP operating expenses. GAAP operating expenses in costs of professional services were $143 million for the three months ended October 31, 2020, compared to $149 million for the prior year period, a decrease of $6 million, or 4%. The decrease in costs of professional services included $4 million in reduced travel expenses due to the COVID-19 pandemic and $4 million in reduced subcontractor expenses. GAAP operating expenses in costs of professional services were $442 million for the nine months ended October 31, 2020, compared to $425 million for the prior year period, an increase of $17 million, or 4%. The increase in costs of professional services included increases of $21 million in employee-related expenses driven by higher headcount and $12 million related to the COVID-19 one-time employee bonus, partially offset by a decrease of $13 million in reduced travel expenses. Non-GAAP operating expenses in costs of professional services were $115 million for the three months ended October 31, 2020, compared to $126 million for the prior year period, a decrease of $11 million, or 9%. The decrease in costs of professional services included decreases of $4 million in reduced travel expenses due to the COVID-19 pandemic and $4 million in reduced subcontractor expenses. Non-GAAP operating expenses in costs of professional services were $363 million for the nine months ended October 31, 2020, compared to $362 million for the prior year period, an increase of $1 million, or 0.3%. The increase in costs of professional services included increases of $12 million related to the COVID-19 one-time employee bonus, and $5 million in employee-related expenses driven by higher headcount, partially offset by a decrease of $13 million in reduced travel expenses. We expect GAAP and non-GAAP costs of professional services as a percentage of total revenues to continue to decline as we continue to rely on our service partners to deploy our applications and as the number of our customers continues to grow. Product Development See the table above for a reconciliation of GAAP to non-GAAP operating expenses. GAAP operating expenses in product development were $420 million for the three months ended October 31, 2020, compared to $402 million for the prior year period, an increase of $18 million, or 5%. The increase in product development expenses included an increase of $22 million in employee-related expenses driven by higher headcount, partially offset by a decrease of $5 million in reduced travel expenses due to the COVID-19 pandemic. GAAP operating expenses in product development were $1.3 billion for the nine months ended October 31, 2020, compared to $1.1 billion for the prior year period, an increase of $154 million, or 14%. The increase in product development included increases of $119 million in employee-related expenses driven by higher headcount and $31 million related to the COVID-19 one-time employee bonus. Non-GAAP operating expenses in product development were $288 million for the three months ended October 31, 2020, compared to $279 million for the prior year period, an increase of $9 million, or 3%. The increase in product development expenses included an increase of $12 million in employee-related expenses driven by higher headcount, partially offset by a decrease of $5 million in reduced travel expenses. 33 Table of Contents Non-GAAP operating expenses in product development were $882 million for the nine months ended October 31, 2020, compared to $789 million for the prior year period, an increase of $93 million, or 12%. The increase in product development expenses included increases of $57 million in employee-related expenses driven by higher headcount and $31 million related to the COVID-19 one-time employee bonus. We expect that GAAP and non-GAAP product development expenses will continue to increase in absolute dollars as we improve and extend our applications and develop new technologies. Sales and Marketing See the table above for a reconciliation of GAAP to non-GAAP operating expenses. GAAP operating expenses in sales and marketing were $303 million for the three months ended October 31, 2020, compared to $287 million for the prior year period, an increase of $16 million, or 6%. The increase in sales and marketing expenses included increases of $25 million in employee-related expenses driven by higher headcount and $4 million related to marketing and event spending, partially offset by a decrease of $15 million in reduced travel expenses due to the COVID-19 pandemic. GAAP operating expenses in sales and marketing were $898 million for the nine months ended October 31, 2020, compared to $840 million for the prior year period, an increase of $58 million, or 7%. The increase in sales and marketing expenses included increases of $66 million in employee-related expenses driven by higher headcount and $25 million related to the COVID-19 one-time employee bonus, partially offset by a decrease of $40 million in reduced travel expenses. Non-GAAP operating expenses in sales and marketing were $240 million for the three months ended October 31, 2020, compared to $232 million for the prior year period, an increase of $8 million, or 4%. The increase in sales and marketing expenses included increases of $16 million in employee-related expenses driven by higher headcount and $4 million related to marketing and event spending, partially offset by a decrease of $15 million in reduced travel expenses. Non-GAAP operating expenses in sales and marketing were $720 million for the nine months ended October 31, 2020, compared to $680 million for the prior year period, an increase of $40 million, or 6%. The increase in sales and marketing expenses included increases of $45 million in employee-related expenses driven by higher headcount and $25 million related to the COVID-19 one-time employee bonus, partially offset by a decrease of $40 million in reduced travel expenses. We expect that GAAP and non-GAAP sales and marketing expenses will increase in absolute dollars as we continue to invest in our domestic and international selling and marketing activities to expand brand awareness and attract new customers. General and Administrative See the table above for a reconciliation of GAAP to non-GAAP operating expenses. GAAP operating expenses in general and administrative were $102 million for the three months ended October 31, 2020, compared to $89 million for the prior year period, an increase of $13 million, or 15%. The increase in general and administrative expenses included increases of $10 million in employee-related expenses driven by higher headcount and $8 million in charitable donations, partially offset by moderation of operating expenses due to the COVID-19 pandemic. GAAP operating expenses in general and administrative were $296 million for the nine months ended October 31, 2020, compared to $259 million for the prior year period, an increase of $37 million, or 14%. The increase in general and administrative expenses included increases of $26 million in employee-related expenses driven by higher headcount, $12 million in charitable donations, and $6 million related to the COVID-19 one-time employee bonus, partially offset by a decrease of $5 million in reduced travel expenses. Non-GAAP operating expenses in general and administrative were $67 million for the three months ended October 31, 2020, compared to $58 million for the prior year period, an increase of $9 million, or 17%. The increase in general and administrative expenses included increases of $8 million in charitable donations, and $7 million in employee-related expenses driven by higher headcount, partially offset by moderation of operating expenses. Non-GAAP operating expenses in general and administrative were $193 million for the nine months ended October 31, 2020, compared to $164 million for the prior year period, an increase of $29 million, or 18%. The increase in general and administrative expenses included increases of $18 million in employee-related expenses driven by higher headcount, $12 million in charitable donations, and $6 million related to the COVID-19 one-time employee bonus, partially offset by a decrease of $5 million in reduced travel expenses. We expect GAAP and non-GAAP general and administrative expenses will continue to increase in absolute dollars as we further invest in our infrastructure and support our global expansion. 34 Table of Contents Operating Margins GAAP operating margins improved from (11.8)% for the three months ended October 31, 2019, to (1.3)% for the three months ended October 31, 2020. Our GAAP operating margins for the three months ended October 31, 2020, have been favorably impacted by our revenue growth outpacing headcount growth as well as moderation of operating expenses in response to the COVID-19 pandemic, including reduced travel. GAAP operating margins improved from (13.4)% for the nine months ended October 31, 2019, to (5.5)% for the nine months ended October 31, 2020. Our GAAP operating margins for the nine months ended October 31, 2020, have been favorably impacted by our revenue growth outpacing headcount growth as well as moderation of operating expenses in response to the COVID-19 pandemic, including reduced travel and marketing and event spending. We use the non-GAAP financial measure of non-GAAP operating margins to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, and to evaluate our financial performance. We believe that non-GAAP operating margins reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business. We also believe that non-GAAP operating margins provide useful information to investors and others in understanding and evaluating our operating results and prospects in the same manner as management and in comparing financial results across accounting periods and to those of peer companies. Non-GAAP operating margins are calculated using GAAP revenues and non-GAAP operating expenses. See “Non-GAAP Financial Measures” below for further information. Non-GAAP operating margins improved from 15.2% for the three months ended October 31, 2019, to 24.2% for the three months ended October 31, 2020. Our non-GAAP operating margins for the three months ended October 31, 2020, have been favorably impacted by our revenue growth outpacing headcount growth as well as moderation of operating expenses in response to the COVID-19 pandemic, including reduced travel. Non-GAAP operating margins improved from 13.9% for the nine months ended October 31, 2019, to 20.6% for the nine months ended October 31, 2020. Our non-GAAP operating margins for the nine months ended October 31, 2020, have been favorably impacted by our revenue growth outpacing headcount growth as well as moderation of operating expenses in response to the COVID-19 pandemic, including reduced travel and marketing and event spending. Reconciliations of our GAAP to non-GAAP operating margins were as follows: Three Months Ended October 31, 2020 GAAP Operating Expenses Share-Based Compensation Expenses Other Operating Expenses Non-GAAP Operating Expenses (1) Operating margin (1.3)% 23.5% 2.0% 24.2% Three Months Ended October 31, 2019 GAAP Operating Expenses Share-Based Compensation Expenses Other Operating Expenses Non-GAAP Operating Expenses (1) Operating margin (11.8)% 24.6% 2.4% 15.2% Nine Months Ended October 31, 2020 GAAP Operating Expenses Share-Based Compensation Expenses Other Operating Expenses Non-GAAP Operating Expenses (1) Operating margin (5.5)% 23.5% 2.6% 20.6% Nine Months Ended October 31, 2019 GAAP Operating Expenses Share-Based Compensation Expenses Other Operating Expenses Non-GAAP Operating Expenses (1) Operating margin (13.4)% 23.6% 3.7% 13.9% (1) See “Non-GAAP Financial Measures” below for further information. 35 Table of Contents Other Income (Expense), Net Other expense, net was $9 million for the three months ended October 31, 2020, as compared to other expense, net of $4 million for the prior year period. The increase in other expense, net included a $7 million reduction in interest income on marketable securities as a result of lower prevailing interest rates during the three months ended October 31, 2020, partially offset by a $4 million unrealized gain on an equity investment. Other expense, net was $31 million for the nine months ended October 31, 2020, as compared to other income, net of $3 million for the prior year period. During the nine months ended October 31, 2020, there was a $16 million decrease in interest income on marketable securities as a result of lower prevailing interest rates. Additionally, during the nine months ended October 31, 2019, there was a gain from the sale of a marketable equity investment of $7 million and capitalized interest costs of $6 million, which reduced interest expense. Liquidity and Capital Resources As of October 31, 2020, our principal sources of liquidity were cash, cash equivalents, and marketable securities totaling $2.9 billion, which were primarily held for working capital purposes. Our cash equivalents and marketable securities are composed primarily of U.S. treasury securities, U.S. agency obligations, corporate bonds, commercial paper, and money market funds. In April 2020, we entered into a credit agreement (“Credit Agreement”) pursuant to which the lenders would extend to Workday a senior unsecured term loan facility in an aggregate principal amount of $750 million (“Term Loan”) and an unsecured revolving credit facility in an aggregate principal amount of $750 million (“Revolving Credit Facility”). On April 2, 2020, $500 million of the Term Loan was funded, and the remaining $250 million of the Term Loan was funded on July 13, 2020. We can also borrow up to $750 million under the Revolving Credit Facility until April 2, 2025. For further information, see Note 10, Debt, of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The 2022 Notes are convertible at the option of the holders during the fourth quarter of fiscal 2021, since the trigger for early conversion was met. Specifically, the last reported sale price of our Class A common stock exceeded 130% of the conversion price of the 2022 Notes for more than 20 trading days during the 30 consecutive trading days ended October 31, 2020. The 2022 Notes were reclassified to current liabilities on the condensed consolidated balance sheet as of October 31, 2020. From November 1, 2020, through the date of this filing, the amount of the principal balance of the 2022 Notes that has been converted or for which conversion has been requested was not material. We have financed our operations primarily through customer payments, issuance of debt, and sales of equity securities. Our long-term future capital requirements depend on many factors, including customer growth rates, subscription renewal activity, timing and extent of development efforts, expansion of sales and marketing activities, introduction of new and enhanced services offerings, timing of construction or acquisition of additional facilities, investments, and acquisition activities. We may enter into arrangements to acquire or invest in complementary businesses, services, technologies, or intellectual property rights in the future. We also may choose to seek additional debt or equity financing. Our cash flows for the three and nine months ended October 31, 2020, and 2019, were as follows (in thousands): Three Months Ended October 31, Nine Months Ended October 31, 2020 2019 2020 2019 Net cash provided by (used in): Operating activities $ 293,802 $ 258,002 $ 714,695 $ 567,484 Investing activities (462,666) 32,559 (942,651) (355,541) Financing activities (5,906) 1,602 564,205 62,915 Effect of exchange rate changes 40 48 546 (204) Net increase (decrease) in cash, cash equivalents, and restricted cash $ (174,730) $ 292,211 $ 336,795 $ 274,654 Operating Activities Cash provided by operating activities was $294 million and $258 million for the three months ended October 31, 2020, and 2019, respectively. The improvement in cash flow provided by operating activities was primarily due to increases in sales and related cash collections, and moderation of operating expenses in response to the COVID-19 pandemic, partially offset by higher cash operating expenses driven by increased headcount. 36 Table of Contents Cash provided by operating activities was $715 million and $567 million for the nine months ended October 31, 2020, and 2019, respectively. The improvement in cash flow provided by operating activities was primarily due to increases in sales and related cash collections, and moderation of operating expenses in response to the COVID-19 pandemic, partially offset by higher cash operating expenses driven by increased headcount and the COVID-19 one-time employee bonus. We expect our business to continue to generate sufficient operating cash flows; however, if the COVID-19 pandemic worsens or is prolonged, our customers may continue to request payment timing concessions, which could materially impact the timing and predictability of our operating cash flows in any given period. Investing Activities Cash used in investing activities for the three months ended October 31, 2020, was $463 million, which was primarily due to a net cash outflow related to purchases and maturities of marketable securities of $379 million and capital expenditures for data center and office space projects of $78 million. Cash provided by investing activities for the three months ended October 31, 2019, was $33 million, which was primarily due to a net cash inflow related to purchases and maturities of marketable securities of $119 million, partially offset by capital expenditures for data center and office space projects of $55 million, capital expenditures related to owned real estate projects of $22 million, and purchases of non-marketable equity and other investments of $10 million. Cash used in investing activities for the nine months ended October 31, 2020, was $943 million, which was primarily due to a net cash outflow related to purchases and maturities of marketable securities of $681 million, capital expenditures for data center and office space projects of $205 million, and purchases of non-marketable equity and other investments of $63 million. Cash used in investing activities for the nine months ended October 31, 2019, was $356 million, which was primarily the result of capital expenditures for data center and office space projects of $196 million, capital expenditures related to owned real estate projects of $96 million, purchases of non-marketable equity and other investments of $17 million, net cash outflows related to purchases net of maturities of marketable securities of $89 million, and acquisition activity of $13 million. These payments were partially offset by proceeds of $55 million from sales of marketable securities. We expect capital expenditures, excluding owned real estate projects, will be approximately $280 million for fiscal 2021. These capital outlays will largely be used to expand the infrastructure of our data centers. We do not expect to make additional investments in owned real estate projects during fiscal 2021. Financing Activities Cash used in financing activities was $6 million for the three months ended October 31, 2020, which was primarily due to a payment on the Term Loan of $9 million, partially offset by proceeds of $4 million from the issuance of common stock from employee equity plans. Cash provided by financing activities was $2 million for the three months ended October 31, 2019, which was primarily due to proceeds from the issuance of common stock from employee equity plans. Cash provided by financing activities was $564 million for the nine months ended October 31, 2020, which was primarily due to proceeds of $748 million from borrowing on the Term Loan and $78 million from the issuance of common stock from employee equity plans, partially offset by the principal payment of $250 million in connection with the conversion of the 2020 Notes. Cash provided by financing activities was $63 million for the nine months ended October 31, 2019, which was primarily due to proceeds from the issuance of common stock from employee equity plans. 37 Table of Contents Non-GAAP Financial Measures Regulation S-K Item 10(e), “Use of non-GAAP financial measures in Commission filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of non-GAAP operating expenses and non-GAAP operating margins meet the definition of a non-GAAP financial measure. Non-GAAP Operating Expenses and Non-GAAP Operating Margins Our non-GAAP operating expenses and non-GAAP operating margins exclude the components listed below. For the reasons set forth below, management believes that excluding the component provides useful information to investors and others in understanding and evaluating our operating results and prospects in the same manner as management, in comparing financial results across accounting periods and to those of peer companies, and to better understand the long-term performance of our core business. • Share-Based Compensation Expenses. Although share-based compensation is an important aspect of the compensation of our employees and executives, management believes it is useful to exclude share-based compensation expenses to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies. Share-based compensation expenses are determined using a number of factors, including our stock price, volatility, and forfeiture rates that are beyond our control and generally unrelated to operational decisions and performance in any particular period. Further, share-based compensation expenses are not reflective of the value ultimately received by the grant recipients. • Other Operating Expenses. Other operating expenses includes employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets. The amount of employer payroll tax-related items on employee stock transactions is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of the business. For business combinations, we generally allocate a portion of the purchase price to intangible assets. The amount of the allocation is based on estimates and assumptions made by management and is subject to amortization. The amount of purchase price allocated to intangible assets and the term of its related amortization can vary significantly and are unique to each acquisition and thus we do not believe it is reflective of our ongoing operations. Limitations on the Use of Non-GAAP Financial Measures A limitation of our non-GAAP financial measures of non-GAAP operating expenses and non-GAAP operating margins is that they do not have uniform definitions. Our definitions will likely differ from the definitions used by other companies, including peer companies, and therefore comparability may be limited. Further, the non-GAAP financial measure of non-GAAP operating expenses has certain limitations because it does not reflect all items of expense that affect our operations and are reflected in the GAAP financial measure of total operating expenses. In the case of share-based compensation, if we did not pay out a portion of compensation in the form of share-based compensation and related employer payroll tax-related items, the cash salary expense included in costs of revenues and operating expenses would be higher, which would affect our cash position. We compensate for these limitations by reconciling the non-GAAP financial measures to the most comparable GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for or in isolation from, measures prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view our non-GAAP financial measures in conjunction with the most comparable GAAP financial measures. See “Results of Operations—Operating Expenses and Results of Operations—Operating Margins” for reconciliations from the most directly comparable GAAP financial measures, GAAP operating expenses and GAAP operating margins, to the non-GAAP financial measures, non-GAAP operating expenses and non-GAAP operating margins, for the three and nine months ended October 31, 2020, and 2019. Contractual Obligations Our contractual obligations primarily consist of our convertible senior notes, borrowings under our Credit Agreement, leases for office space and co-location facilities for data center capacity, third-party hosted infrastructure platforms for business operations, and agreements to purchase data center equipment. We do not consider outstanding purchase orders to be contractual obligations as they represent authorizations to purchase rather than binding agreements. 38 Table of Contents Convertible Senior Notes In June 2013, we completed an offering of $250 million of 1.50% convertible senior notes due July 15, 2020, which were subsequently converted during the second quarter of fiscal 2021. In September 2017, we completed an offering of $1.15 billion of 0.25% convertible senior notes due October 1, 2022 (“2022 Notes”). We are not required to make principal payments under the 2022 Notes prior to maturity. If the 2022 Notes are not converted to Class A common stock prior to their maturity dates, we are required to repay $1.15 billion in principal on October 1, 2022. The 2022 Notes are convertible at the option of the holders during the fourth quarter of fiscal 2021. From November 1, 2020, through the date of this filing, the amount of the principal balance of the 2022 Notes that has been converted or for which conversion has been requested was not material. We may receive additional conversion request that require settlement in the fourth quarter of fiscal 2021. We are also required to make interest payments on a semi-annual basis at the interest rates described in Note 10, Debt, of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Credit Agreement In April 2020, we entered into a credit agreement pursuant to which the lenders extended to Workday a senior unsecured term loan facility in an aggregate principal amount of $750 million and an unsecured revolving credit facility in an aggregate principal amount of $750 million. The Term Loan matures on April 2, 2025, and provides for quarterly repayment in installments of the principal amount, beginning October 2020, at a rate of 1.25% of the principal amount per quarter through January 2022, and 2.50% of the principal amount per quarter thereafter. The Revolving Credit Facility may be borrowed, repaid, and reborrowed until April 2, 2025, at which time all amounts borrowed must be repaid. The Term Loan and Revolving Credit Facility bear interest at the interest rates described in Note 10, Debt, of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The following table summarizes our contractual cash obligations under the Credit Agreement as of October 31, 2020, and assumes interest rates consistent with those in effect for our Term Loan as of October 31, 2020. There were no outstanding borrowings as of October 31, 2020, under the Revolving Credit Facility. Payments Due by Period (in thousands) Total Remainder of Fiscal 2021 Fiscal 2022 - Fiscal 2023 Fiscal 2024 - Fiscal 2025 Thereafter Term Loan $ 740,625 $ 9,375 $ 112,500 $ 150,000 $ 468,750 Interest obligation on Term Loan 40,047 3,486 19,410 15,546 1,605 Total $ 780,672 $ 12,861 $ 131,910 $ 165,546 $ 470,355 Leases We have entered into operating lease agreements for our office space, data centers, and other property and equipment with various expiration dates. These lease agreements often provide us with an option to renew. Third-Party Hosted Infrastructure Platforms for Business Operations We have entered into noncancelable agreements with third-party hosted infrastructure platform vendors with various expiration dates. As of October 31, 2020, future noncancelable minimum payments under these agreements were approximately $445 million. Data Center Equipment As of October 31, 2020, we have entered into noncancelable agreements to purchase $79 million of data center equipment during the remainder of fiscal 2021. Off-Balance Sheet Arrangements Through October 31, 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. 39 Table of Contents Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. Due to the COVID-19 pandemic, there has been uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require further updates to our estimates or judgments or require us to further revise the carrying value of our assets or liabilities as of October 31, 2020. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. During the nine months ended October 31, 2020, there were no significant changes to our critical accounting policies and estimates as described in the consolidated financial statements contained in the Annual Report on Form 10-K for the fiscal year ended January 31, 2020, filed with the Securities and Exchange Commission (“SEC”) on March 3, 2020. 40 Table of Contents