Workday Inc (WDAY) 2016 Q4 法說會逐字稿

Welcome to Workday's fourth-quarter earnings call.

At this time all participants are in a listen-only mode.

We will conduct a question-and-answer session towards the end of the conference.

With that, I will hand it over to Mike Haase.

Sir, you may begin.

Welcome to Workday's fourth-quarter FY16 earnings conference call.

On the call we have Aneel Bhusri, our CEO; Mark Peek, our Co-President and CFO; and Phil Wilmington our Co-President.

Following Aneel and Mark's' prepared remarks we will take questions.

Our press release was issued after close of market and is posted on our website where this call is being simultaneously webcast.

Statements made on this call include forward-looking statements such as those with the words will, believe, expect, anticipate, and similar phrases that denote future expectation or intent regarding our financial results, applications, customer demand, operations and other matters.

These statements are subject to risks, uncertainties, and assumptions.

Please refer to the press release and the risk factors in documents filed with the Securities and Exchange Commission, including our most recent quarterly report on Form 10-Q for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements.

In addition, during today's call we will discuss non-GAAP financial measures including non-GAAP operating losses, operating margins, EPS, and interest expense.

These non-GAAP measures exclude the effect on our GAAP results of share based compensation, employer payroll tax-related items on employee stock transactions, amortization of acquisition-related intangible assets and debt discount and issuance costs associated with our convertible notes.

We will also discuss free cash flows.

These non-GAAP financial measures which are used as measures of Workday's performance should be considered in addition to, not as a substitute for or in isolation from, GAAP results.

You can find additional disclosures regarding these non-GAAP measures including reconciliations with comparable GAAP results, in our earnings press release and on the investor relations page of our website.

Also, the customers page of our website includes a list of selected customers and is updated monthly.

The webcast replay of this call will be available for the next 45 days on our Company website under the Investor Relations link.

Our first quarter quiet period begins at the close of business April 15, 2016.

Unless otherwise stated, all financial comparisons in this call will be to our results for the comparable period of our fiscal 2015.

With that, let me hand it over to Aneel.

Thanks, Mike, and thanks again to everyone joining us for our Q4 call.

We appreciate your interest in Workday.

I'm pleased to announce that Workday ended fiscal year 2016 on a high note with a very strong Q4 across product lines and across the globe.

As you will hear from Mark, Q4 was also an excellent quarter from a financial metrics perspective and sets us up for a very exciting fiscal year 2017.

So let's start with some of the highlights for Q4.

Workday ended Q4 and fiscal year 2016 with 1,181 customers, representing an increase of over 100 customers from Q3, our biggest quarterly gain to date.

Our success with large enterprise accounts continued as we added Airbus, Marsh & McLennan, Kohl's, and F. Hoffmann-LaRoche and a 200,000-person global professional services organization as new HCM customers.

Even more exciting, Workday also ended fiscal year 2016 with 207 financial management customers, adding over 40 new customers in Q4 alone, far and away our strongest quarter of selling our financial management applications in the history of the Company.

During Q4 the pipeline for financials also grew significantly, up over 150% as compared to the fourth quarter of fiscal year 2015.

As we continue to drive sales of our financial management applications into larger and larger organizations, we are pleased to announce several large enterprise financials customers: The Ohio State University, Arizona State University, Brown & Brown Insurance, GoDaddy.com and one of the leading security exchanges in the world.

Q4 also you saw two very important customer go-lives at Workday.

First of all, transportation leader J.B. Hunt went live in our full financial management suite, making them our biggest financial customer in production.

As a Fortune 500 Company, J.B. Hunt is a strong proof point that supports the breadth and scalability of our financial management suite and our ability to meet the needs of Fortune 500 companies.

On the HCM side of our business, Bank of America went live, making them our largest HCM customer in production.

These two customer go-lives are major milestones for Workday and indicators of the strength of both our product and our business.

These two customers join our community of live customers who rank their customer satisfaction levels at 98%.

In total, over 70% of our customers are operating live with Workday applications.

Importantly, we also hit a major milestone with over 100 companies live on Workday financials.

As we wrap up Q4, I know many of you would like some color on the macro environment and the competitive dynamics in our industry.

Regarding the macro environment, we continue to monitor our pipeline closely but so far we have not witnessed any impact on demand.

We think demand for our products continues to be driven more by secular technology shifts, where we enjoy strong competitive advantage.

Our business also has minimal exposure to China at this time.

On the competitive front, I am pleased to report that our win rates in Q4 were the highest we have seen over the past eight quarters.

We fared very well against all of the major vendors in our market and enjoyed historically strong win rates against both of our legacy competitors, SAP and Oracle.

Our win rates were highest in the large enterprise market where we have a strong track record of customer success, in stark comparison to our legacy competitors who continue to struggle to provide live customer references at scale.

As we head into fiscal year 2017 we expect our momentum to continue and believe our net new ACV growth rate will accelerate as compared to fiscal year 2016, driven both by new customer acquisition and additional sales to existing customers.

We are incredibly thankful to our employees and our customers for helping us to become only the second peer enterprise SaaS company to reach $1 billion run rate in subscription revenues, following our friends at salesforce.com.

From a market perspective we have a $60 billion opportunity in front of us, believe the cloud HCM market to be lightly penetrated and see an opportunity in financials that is even more significant in size.

Our renewal rates are strong and sales to our customer base are also growing fast, as evidenced by the success of our recruiting product which now has been subscribed to by 545 customers in less than two years.

With the growing momentum we've experienced in the sales and deployment of our financial management applications, and the fact that approximately 30% of our new customers subscribe to the full platform, we have made the decision to have our entire group of sales representatives across the globe carry both HCM and financial management product lines, significantly increasing the coverage for our financial management applications.

This year also promises to be an exciting one from a products perspective.

We have two major updates scheduled for the next 12 months, Workday 26 and 27.

Key highlights of Workday 26 include French payroll, new machine learning and predictive analytic capabilities, branding and personalization, day-one score cards and new implementation tooling, all of which will be available in March of this year.

With Workday 27, scheduled for the fall of 2016, we will deliver exciting new Workday applications including planning, learning management and the full student product line.

Taken together, these three new offerings have a total addressable market of more than $5 billion.

As we head into fiscal year 2017, I would also like to highlight a shift in our go-to-market approach.

Specifically, given our success in simplifying the deployment process, combined with the growth in maturity of our partner ecosystem, we will not be ramping our own professional services organization at the same growth rates as we have in the past.

Importantly, our big implementation partners, including Accenture, Aon Hewitt, Deloitte, IBM, Mercer and PWC, have all aggressively scaled their Workday practices over the past 12 months to meet the demands of our joint customers, enabling Workday to rely more heavily on the partner ecosystem for the majority of our customers' implementations.

This shift allows Workday to deploy new headcount into other areas of the Company.

Lastly, I'm pleased to announce that our Co-President Phil Wilmington will be joining Mark and me for the Q&A session today.

Going forward, Phil will regularly attend our earnings calls to provide some color from the field.

Please feel free to direct sales and customer services-related questions to Phil, especially the hard ones.

I will now turn it over to Mark to cover our fourth-quarter results and our guidance for fiscal year 2017.

Take it away, Mark.

Thanks, Aneel, and good afternoon, everyone.

Our fourth quarter capped an excellent year for Workday.

Let me start with our strong financial results for the quarter and the year.

Subscription revenue is now at a $1 billion run rate and grew 44% to $262 million for the quarter and 52% to $929 million for the year.

Total revenue was $323 million, reflecting growth of 43% from Q4 of last year and $1.162 billion or 48% for the full year.

We continued to demonstrate strong momentum across our subscription revenue growth drivers, new customers, renewals, and sales of additional products to existing customers.

This momentum is also positively reflected in our backlog and unearned revenue.

At the close of fiscal 2016, the sum of backlog and unearned revenue represented $2.5 billion in future subscription revenue.

Our non-cancelable backlog which is not yet on the balance sheet was $1.56 billion, or annual growth of 62% or 63% in constant currency.

On our balance sheet unearned revenue at the end of fiscal year 2016 was $900 million which is 42% growth year over year, 44% in constant currency.

Current unearned revenue, which will be recognized over the next fiscal year as subscription revenue, was $769 million or annual growth of 40%.

The financial visibility provided by this future subscription revenue gives us high confidence in the sustained strength of our business.

While we continue to invest in the large opportunity we see ahead of us, our non-GAAP operating loss for the fourth quarter was about $800,000, close to breakeven.

For the year, our non-GAAP operating loss was $2.7 million or about 23 basis points of total revenue.

Throughout fiscal 2016, our non-GAAP operating margin was within 1% plus or minus of breakeven.

We are able to continue to invest in our business as our strong results translate into strong cash flow dynamics.

Operating cash flow for fiscal 2016 was $259 million.

That is over 150% growth in operating cash flow from last year.

Our free cash flow was also strong, increasing from breakeven last year to $125 million in fiscal 2016 or over 10% of total revenue.

Operationally, we continue to execute well against our vision and appreciate the continued support we have received from both our new and existing customers.

This quarter was the first in our history in which we signed over 100 new customers.

Again, this quarter the dollar value of contracts from renewing customers exceeded the original contract value, supporting our thesis that satisfied customers become long-term customers.

We successfully added and integrated 1,500 employees to Workday this year, bringing our total at year-end to over 5,200 people.

Let me now turn to guidance.

As we look at fiscal 2017 our pipeline looks strong.

For fiscal 2017 we currently expect derived billings, which is the sum of revenue and the sequential change in unearned revenue to be $1.855 billion to $1.875 billion or 30% to 31% growth, with just under 42% of total billings expected in the first half of the year.

We estimate that subscription revenue for fiscal 2017 will be $1.275 billion to $1.285 billion or growth of 37% to 38%.

As we pointed out last quarter, the timing of revenue recognition can be impacted by the amount of cash we bill and other contractual factors and we anticipate this will impact subscription revenue growth this year by up to 5 percentage points.

As Aneel mentioned, as a result of the great success of our partners, we are reallocating our investment in professional services and expect professional service revenue to be approximately $265 million in fiscal 2017, or growth of 14%.

We estimate that total revenue for fiscal 2017 will be $1.54 billion to $1.55 billion or growth of 33%.

We expect Q1 derived billings to be between $360 million and $365 million or growth of 33% to 34%, or 35% to 37% for subscription billings.

We expect Q1 total revenue to be $337 million to $339 million or growth of 34% to 35%.

Our subscription revenue forecast for the first quarter is $277 million to $278 million or 38% growth.

Subscription revenue is expected to grow sequentially in Q2 and each remaining quarter in FY17, but just under 10%.

We continue to prioritize growth versus margins while maintaining our longer-term goals of 20%-plus operating margins.

Although we do not think of HCM and finance as separate business units, the HCM and related products had non-GAAP operating margins in fiscal 2016 comfortably exceeding 10%, and on a path to exceed our longer term target of 20%-plus.

However, we believe the prize is much bigger than HCM.

And satisfied HCM customers are a great entry point for our financials product, as evidenced by customers such as, Aon, Netflix and J.B. Hunt.

As Aneel discussed earlier, given the strength of the business and the expansion of our addressable market, we plan to continue to invest in both product development and our sales and marketing activities.

Product investments first include new applications, learning, planning and student; and secondly, continued innovation of existing products as we expand both our technical and functional lead over our competitors.

Our sales investments will focus on expanding our sales force and presale support to accelerate our growth and focus on the opportunity in financials.

As a result of these initiatives we will add at least at as many people as we did in fiscal 2016.

We expect to have non-GAAP operating losses of up to 1% of revenue in the first quarter and approximately breakeven for the year with operating profit in the fourth quarter.

This transition to operating profit is another milestone in our long-term objective of 20%-plus operating margins.

For fiscal 2018 we expect operating leverage and profitability for the year.

The GAAP operating margin for the first quarter is expected to be approximately 23 to 25 percentage points lower than the non-GAAP margin.

For the full year, the GAAP operating margin is expected to be approximately 25 to 27 percentage points lower than the non-GAAP margin.

Our non-GAAP EPS for both the quarter and the year were about breakeven with a $0.01 loss per share.

Given our net loss from a GAAP perspective, all outstanding stock options, warrants and common stock equivalents are anti-dilutive and not included in the loss per share calculation in our GAAP financial statements.

We expect CapEx, excluding our development and customer center, to be approximately $185 million.

Cash flow is inherently difficult to forecast on a quarterly basis due to changes in working capital but we expect operating and free cash flow growth, excluding new buildings, to approximate growth in billings for fiscal 2017.

Finally, as mentioned previously, we have invested in land near our Pleasanton headquarters for potential future expansion.

I'm pleased to announce that we're ready to break ground and build a state of the art customer briefing facility and development center on this land.

In fiscal 2017 we expect capital expense for the project to be approximately $125 million.

The entire project is expected to be ready for occupancy in fiscal 2019 and we will fund construction from cash on our balance sheet.

To summarize, we're very pleased with our very strong fourth quarter.

Looking ahead, we're continuing to invest for the long term and see a very large opportunity in front of us.

You should expect us to continue making significant investments in our product development and global market expansion to maximize our long-term growth opportunities.

With that, let's begin the Q&A process.

(Operator Instructions)

Your first question comes from the line of Mark Murphy with JPMorgan.

Thank you very much and congratulations on a very strong finish to the year.

I had a question for either Aneel or Phil.

It appears that Oracle's cloud credits, in other words their free trials, are expiring or perhaps not being offered as aggressively anymore as they had been previously.

I'm curious if you sense that you have quote, unquote, weathered the storm, if you will, in terms of that type of competitive tactic that could perhaps be subsiding at this point?

And if so, could that enable your win rates to continue trending higher this fiscal year as it appears they have been in the last few quarters?

So thank you, Mark, for the question.

I'd say first and foremost, what's impacting our competitors, our legacy competitors in particular, is their inability to get customers live and into production, especially the large customers.

I think when both companies, when SAP and Oracle moved into the cloud, they were given a bit of a hall pass.

They marketed the right terms, they used the same buzz words.

At the end of the day we all get measured about getting customers successful and in production and they failed.

They have some proof points here and there but in the large part neither really embraced a true cloud model and I think they're paying the price for that.

Whether the sales activities or promotions that they've had has had an impact, I'll come back and ask Phil to respond to that.

I do think that referenceability is much more important today than it was 12 months ago because now they've had the time to get customers into production and haven't been able to and we continue to move forward.

Still 75% of our customers are in production and with J.B. Hunt and Bank of America, two proof points of very large companies in production with Workday and being happy.

I think that's actually the real driver behind win rates going forward.

I think the only thing that I would say in addition to that, Mark, is that it's a very educated consumer in the marketplace right now.

They realize that a discounted subscription offer is only one piece to the equation.

The amount of time that it takes to bring the application live, the cost of implementation, these are all factors that impact the total cost of ownership over time.

Again, to Aneel's point, referenceability drives home all of those factors.

So prospects are doing their homework.

They're talking to customers who have gone through similar experiences and they've looked at the balance of not only discounting but the cost to implement, et cetera, as it rounds out the financial picture.

And that's what they're basing their decisions on.

Thank you very much.

Your next question comes from the line of Keith Weiss with Morgan Stanley.

Thank you, guys, for taking the question and good quarter.

I was wondering about, as you enter FY17 and as you change the go-to-market strategy around the edges in terms of giving guys more to sell, selling across the entire portfolio and also getting partners more involved in terms of pushing more professional services, is there any chance of disruption or any reorientation that has to go on that we should be aware of as we head into Q1 and further in the year as those changes are put into place?

Or do you expect them to be pretty seamless?

I think we expect them to be seamless.

They've already happened.

In particular, in the sales change to carrying all products.

First of all, that's been the case in the mid-market for quite some time.

What we've seen is this success of selling the full platform.

And we highlight that 30% of our customers in Q4 bought everything that we have or bought HR and financials together.

That's beginning to move up market.

So it's a natural move to have the salesperson carry both products and it's something we've already had experience with in the mid-market.

We're now just moving it up market.

So the other part with the partners, again, that's just a natural progression.

Frankly, we built out a much bigger professional services organization several years ago because the ecosystem wasn't necessarily sure that Workday was going to be the vendor of choice in many cases.

Now that we've won so many large accounts, all of the big vendors over the last 12 months have made big investments and they're doing a great job.

They're getting our customers live, they're ramping up more, training consultants.

And it just takes the pressure off of us to be part of all the deployment.

It's a natural progression and it's the right time for us to shift that model.

That was always the intention going back to when we started the Company, to rely and work closely with our partner ecosystem.

It just took a little longer than we had expected.

Got it.

On the margin side of the equation, I'd imagine that there should be a pretty nice positive gross margin impact on the overall gross margins as you guys focus more on the subscription business versus doing the services work yourself.

Absolutely.

I don't know, Mark, if you want to add any detail.

Certainly we've guided professional services to be down to 14% and that will drive gross margin as we pick it up with subscription revenue.

Excellent.

Thank you very much, guys.

Your next question comes from the line of Brent Thill with UBS.

Thanks.

Mark, you accelerated the backlog to 63% constant currency which, I believe, is up over the low 50% number you put up last year.

Yet you're guiding the billings for somewhere around a low 30% growth rate.

Can you walk through the delta behind the backlog growth and then the billing delta for this year?

Brent, when you look at subscription revenue billing it's going to be in the mid 30%s.

So part of it is just part of the 30% to 31% is a result of where we see professional services going next year.

And we just had a terrific year with respect to large customers, just a slightly expanded length of contract by about two months relative to a year ago.

And so we focus very much on the economics on a contract-by-contract basis and all in all it was a great year.

Okay.

For Aneel and Phil, as relates to the highest win rate in eight quarters, can you talk a little about what you're seeing, what you think was the cause for that nice acceleration in the fourth quarter?

And just so I'm clear, when you now have all the reps on financials, when you look at the extra capacity now that's been brought behind financials, can you give us a sense of what percent was on quota to now everyone's on quota?

What's the tailwind, if you will, that you're adding now on a percentage basis?

Or if there's another relevant metric that would be helpful.

In terms of our success in Q4, I would attribute it to great sales execution, a great sales team led by Phil.

Coming back, we're going to sound like a broken record on this but it's really coming back to customer success.

We really do a great job getting customers into production and into success.

We're running at 98% customer satisfaction.

That's becoming a much more important factor as the market matures.

Again, I'll say it again.

In the early days when the slidewear looks the same and the buzzwords sound the same, it's hard for customers to tell.

After the legacy guys have had a couple years of trying and not succeeding getting customers into production, they begin to understand that there might not be so much meat behind the bone, or meat on the bone, in terms of actually not focusing on sales but actually customer success.

I guess the best thing to look at for how we believe the business is going to move forward next year, we say very clearly we expect the net new ACV growth rate to accelerate in 2017 versus 2016.

That comes largely due to our belief that financials is really beginning to hit its stride and HR continues to do quite well.

And Phil, do you want to talk about sales force productivity or anything else on that side?

I think part of sales force productivity is not only the efforts that the account executives or salespeople have in that process, but along with our referenceability, along with driving our message by encouraging prospects to talk to other customers, we will continue to lead with our product.

We show our product very early in sales cycles; we put it in the hands of prospects.

We help them get a feel for how that product could improve the day-to-day operating environments and efficiencies within their companies.

And then we challenge our competitors to do the same.

As Aneel said, there were a lot of claims that were made early on as to what products could do, what slides said and that's not what helps drive customers' decisions.

We've got great solution consultants in our organizations that play part of our sales teams and they help put that product in the hands of prospects during the demonstrations and evaluations.

And our product speaks for itself and our customers help then substantiate that with their referenceability.

Thank you.

Your next question comes from the line of Justin Furby with William Blair & Company.

Thanks, guys, and congrats.

I wanted to first ask either Aneel or Phil, the 45 financials wins in the quarter, that's a big number.

I was wondering, if you look out to fiscal 2017 and your billings guidance, are we at a point where financials could be something like 15% to 20% of billings or no, not yet?

I'm curious how long in your mind until we're at a spot where we're at parity in terms of new business between HR and financials.

And when we get there, you how fast do you think the HR business is growing at that point?

I know it's obviously a guess but appreciate any commentary.

There's like five questions in there.

Yes, I try to make as many as I can.

(laughter)

Definitely we see a future where financials will be at least half of the net new business.

I think Q4 -- I wouldn't say it caught us by surprise because we've been planning for financials to take off.

It did happen, it took off.

And we're seeing the platform deals, we're seeing the high attach rates and we're seeing the customer success.

An interesting data point which will help you model this out, it took us six years to get us to our first 100 financial customers and additional year to get to our 200-customer level.

Obviously the pace of financials sales has accelerated quite dramatically in the last 12 months.

We expect that to continue over the foreseeable future.

The hard part in answering your question is HR continues to grow well and grow at a nice clip.

It's hard for us to forecast that far out when financials may take over HR.

We don't want it to take over HR anytime soon because that would mean HR is slowing down but financials is growing at a much faster clip than HR.

I don't think -- Mark, 15% to 20%, that's probably a little early for that?

That's a bit early for that.

It's a bit early for that but it's not a crazy assumption in the not-so-distant future.

Okay, that's helpful.

And then, Mark, on the 10% sequential sub guide in -- I think you said Qs 2 through 4. That seems to be even bigger than what you've done the last few quarters.

I'm wondering, trying to better understand what drives the confidence around that number.

And then I've got one more if I can slip in as well.

Sure.

We initiated subscription revenue guidance for the year and wanted to make sure that we had a nice, clean calendar going out through fiscal 2017.

But the subscription revenue guidance is really a derivative of the billings and the bookings that we've done as reflected in the current unearned.

So it's just under 10% sequentially, is our starting point, driven off of the $277 million to $278 million we expect in Q1.

Okay.

And then on the commentary around HR and financials -- and I appreciate that in terms of two very different margin profiles.

Wondering how long you think it is before financials might hit something like a breakeven trajectory in terms of EBIT margin.

Thanks.

Well, I think it goes back to the question that you asked Aneel about where the bookings cross.

We're not putting a time frame on it but clearly what we've seen from HR is once we have a business with -- now has 1,200 customers, is progressing really nicely, we're beginning to go through a renewal cycle on it, is that there's a lot of leverage to this model.

We continue to invest also in additional products as we move forward and expanded our TAM in the last few years by almost 50%.

So I don't want to put a time frame on individual products but certainly we wanted to give you a look, at least, at HR and to show you the profitability of this model.

I might also add that the competitive landscape for financials looks quite appealing.

I think we continue to win our fair share in HR.

I'd say the financials landscape is probably even more attractive.

SAP doesn't really have a cloud strategy for financials.

Oracle's going to struggle with the same issues about getting customers into production with Fusion as they have with HR.

Got it, that's helpful.

Thanks, guys, and congrats.

Your next question comes from the line of Heather Bellini with Goldman Sachs.

Great, thank you.

I just had a couple questions.

I was wondering if you could walk us through some of the initial feedback from the sales changes where now the salespeople are carrying all the products.

I guess what I'm wondering is how do we think about the sales cycles for financials accelerating as a result of that?

And then the second question would be related to have you noticed any changes in conversations with the Fortune 500 where it seems like they've obviously embraced HCM and the cloud and financials has been slower to take off.

I'm just wondering how the conversations with those customers over the last few months might have started to differ in the largest customers.

Thank you.

So I'll take the second question first, Heather, and then I'll turn over the first one to Phil.

Okay, thanks.

On the second question, definitely a lot more Fortune 500 conversations around financials.

The Fortune 500 marketplace is generally a risk-neutral to risk-averse marketplace so they've been looking for proof points.

J.B. Hunt is a really, really important proof point for us to have them in production.

They have fairly high transaction volumes.

And then people are looking at Aon.

Netflix has been in production for a while.

So now we have the proof points that are not theoretical, that are actual, and it's causing us to have more of those conversations.

We're not finding any issues about financials in the cloud being any different than HR in the cloud.

So I suspect it's going to play out the same.

People were looking for proof points and they were looking for enough functionality to turn off their legacy systems and I think we now have both.

I do expect that financials is going to accelerate both in terms of the number of deals as well as the size of deals and Q4 was a proof point.

And again, it took us six years to get to 100 and only a year to get to 200.

That tells you what's happening in the business right now.

Heather, on the first part of your question, I think one of the things that we're learning is that in direct response to what our customers were asking for, they want to deal with a consistent approach as it relates to looking at our applications to fulfill all of the needs on the application side of their enterprise.

The way we first came to market, they dealt with an HR rep and then as we were rolling financials out, they would deal with another team that would come in on financials.

Now that's a consistent approach.

So the development of the understanding of the customers' needs that we get in the beginning parts of the sales cycles goes all the way through our sales cycle.

And the role of technology and the role of the CIO is also changing, as we're not viewed as just a particular one-application vendor.

It allows our people a better opportunity to engage and work with the CIOs of organizations as they look at Workday as a complete application platform partner for both HR and financials.

We're seeing that consistency come back in terms of feedback from prospects and customers as being very beneficial so that they get the understanding of the impact of our applications across their enterprise.

I think with the 30% of the wins we had being platform wins during the last quarter, during the fourth quarter, it evidences that as working.

Great, thank you.

Your next question comes from the line of Karl Keirstead with Deutsche Bank.

Thanks.

Question for Mark.

Mark, long-term DR upticked meaningfully for the second quarter in a row.

Do you mind taking a second to walk through that?

Assuming it's greater demand for multi-year deals, does it take any added discounting to pull that off?

A little color would be helpful.

Thank you.

Sure.

It's relatively simple.

First of all, our discounting discipline has stayed really strong and really consistent over the last eight quarters or so.

And so what the non-current unearned revenue really represents is the amount of revenue that we won't be recognizing in that next year.

And it goes back to the five points that we talked about last quarter and that impacts the subscription revenue growth this year.

Okay.

Thank you, Mark.

Your next question comes from the line of Brendan Barnicle with Pacific Crest.

Thanks so much.

Mark, I wanted to follow up on that 5%, actually.

That was what you guided to last quarter as well.

It had been a little bit lower earlier on.

Are we now at a stable point where you think 5% is what it will be?

Or will that change as you have more of a mix towards financials?

That's where we think it's going to be.

We've reflected it back in the commentary a quarter ago and it's reflected in the guidance this year.

Things have really remained unchanged.

Then we expect that to reverse beginning next year and into 2019.

Terrific.

And then just a follow-up for Aneel.

Aneel, over the years you've talked about verticals.

Now that you've built out more of the financials and more of the add-ons to HCM, do you think or look at focusing more on those verticals as you do product planning for this year?

If you were to look at our success with financials, it actually is very much tied to the verticals we've focused in on.

We have said from day one, we're focused on the 70% of the market that is non-manufacturing.

So the 70% of the market that's services-based.

The first three verticals we really focused in on were E&G, education and government, financial services and healthcare and we're seeing strong traction across all three of those verticals.

With professional services automation, we're moving more into the technology vertical.

We're going to continue to expand verticals as we get proof points on the ones that we're in until we've got pretty good coverage across all the services verticals.

I also do think that over time we will get some traction within the manufacturing vertical by way of integrating into an existing on-premise manufacturing system where they want a modern accounting system but might want to leave their manufacturing system on premise.

Great.

Thanks so much for taking my questions.

Your next question comes from the line of Scott Berg with Needham.

Hi, guys, I echo the sentiment on the great quarter.

I guess two questions for either Aneel or Phil on the financial side.

First of all, who do you consider to be your primary competition from what you saw in the quarter?

Trying to understand who you displaced more.

Because the mid-market competitors in that end segment are certainly different than the enterprise customers.

And then secondly, from a capacity standpoint, your implementation capacity was being shifted off to partners.

Trying to understand how that directly relates to financials versus the more mature HR market that I assume the partners are really probably working with.

Sure.

From a competitive perspective it's the same, it's SAP and Oracle.

We've really moved out of the low end of the mid-market where we might have seen NetSuite.

We see NetSuite in a very, very small handful of situations now.

So it really is primarily SAP and Oracle.

Every now and then we'll replace Great Plains or Dynamics.

Microsoft doesn't really have a cloud strategy for their financial products.

I'd say that's the competitive landscape.

And more and more as we move up market with some of the enterprise wins we highlighted it's SAP and Oracle.

It shouldn't be a surprise, those systems were bought together, HR and financials were bought together in the client server wave from SAP, Oracle and PeopleSoft.

We win HR, we go back and win financials, it's going to be those two vendors.

On the professional services front, we feel very comfortable with where the ecosystem is with HR.

We feel pretty good about where it is with financials but given some of the road map items we might have for an Aon, if there's road map items for a customer like that, we'll stay more involved on the services side.

But for a mainstream financials customer that buys Workday and goes live on Workday, we feel very comfortable with the ecosystem.

Phil, do you want to add anything?

Your next question comes from the line of John DiFucci with Jefferies.

Thank you.

Mark, I'd like to go back to Karl's question on the jump in long-term deferred.

Obviously customers are paying more upfront, a longer duration up front.

Why would they do that?

And then should we expect that to continue going forward?

Is that at least a primary driver of your increased billings guidance?

Yes, John, it's less about how much the customer pays up front as it is some of the other contractual terms.

We talked about it at some length last quarter.

So this just represents billings where we've actually billed and collected the cash but the revenue recognition isn't going to happen until next year.

So a lot of it is reflected in the five points of growth impact we've talked about in 2017.

Certainly we have some customers who make the decision to pay upfront.

As we've said repeatedly, we don't discount for upfront payments.

We have a model that funds itself with $260 million of operating cash flow and $125 million of free cash flow this year.

Is this at least part of what's driving your increased billings guidance?

Yes.

And if I could quickly, Aneel, you talked about an acceleration in new subscription ACV.

I'm curious, is that pipeline-based?

Is that looking out at financials?

It sounds like you're getting some good traction there, early but good.

What is that?

What's behind that?

It's all of the above.

And I wouldn't say it's early.

We had a great year for financials customers.

It might have been early in Q1 but after Q4 it's now become mainstream.

It's become a product line that we can predict what we're going to close in a given quarter, which we couldn't have done 12 or 15 months ago.

So we have a lot more confidence in what numbers we can drive off of financials.

HR and the full HR platform continues to be very strong.

Recruiting continues to attach well and we have all of these new products coming online like learning and planning.

We have a lot of market opportunity in front of us and more SKUs coming, so we feel -- I frankly feel better about the business going into this year than I have the last two.

Phil, you want to talk about how you see the market developing and why we have the confidence that business will accelerate this year?

I think a couple things.

One, we talked about a significant increase, over 150% increase, in financial pipeline as we enter the year versus when we entered last fiscal year.

The last point that Aneel just mentioned I think is very important, and that is we continue to see attach rates go up with some of the new SKUs that come out of product development.

So we're developing product in conjunction with requests that our customers are making for what they need to see to round out the product suites.

Aneel mentioned recruiting.

There's been expenses.

There's talent management.

We have learning on the horizon.

So all of these increase a very powerful product suite that we have in Human Capital Management.

The same is true for financials.

So it's an increase in pipeline and it's an increase in opportunity with each of the customers that make up that pipeline.

And both of those components are key to our growth strategy.

Great, guys, that's clear.

Thank you.

Your next question comes from the line of Kash Rangan with Merrill Lynch.

Hey, guys, thanks for taking my question.

Aneel, Phil and Mark, question for you is that since financials being sold by the broader sales force is a relatively new approach as far as the enterprise segment is concerned, I'm wondering if the weight of the billings performance is going to be shifted towards the second half of the year.

Or is this something that's going to be equally weighted throughout the year?

A second question, Aneel, really pleasantly surprised by the success, of course, you declared it at our conference last year, the financial service becoming mainstream.

Curious if you can give us a little bit more color.

Are these big M&Cs that are replacing financials?

Or are these smaller companies that are implementing financials for the first time?

And also the scope of this implementation.

Are these pedal to metal full breadth of the entire business or just some portions of larger businesses?

Any color would be useful.

Thank you very much.

Sure.

On that last question, in almost all cases it's the full breadth of our financial products and it's for the full company.

We generally, on the HCM or on the financial side, have not sold to departments; we've always been enterprise level.

In terms of size of companies, they've been across the board.

We will take the mid-market business when it's there.

Just like HR, it's a run-rate business.

But we're also landing larger organizations.

People might not lend as much credence to the higher ed world because they don't know the scale of those businesses.

The Ohio State University and Arizona State University are like Fortune 500 organizations, both in terms of the scale and complexity of their business, the transaction volumes and the use of the product.

So we're seeing traction across the board.

I suspect you'll see in this fiscal year 2017 some more Fortune 500 names.

We feel comfortable where we are with Fortune 500 names as proof points, so we'll take them on.

But right now we're trying to take as much business as we can across the marketplace.

I think as to the first part of your question, the transition and Aneel used the word transition and really stated that the transition is largely behind us.

This isn't something as it relates to everyone selling financials that we just began to launch as we launched into this fiscal year.

Training, preparation, sharing of accounts and the participation that's necessary in the field was really executed on in the fourth quarter of the previous year.

And we were still able to achieve great results.

Got a tremendous amount of appreciation and respect for the way that our field organization handled the transition in the fourth quarter to position us to be ready and to continue that performance as we entered the first quarter of this year, as we'll see, I think, consistently throughout the year.

Operator, we're going to take two more questions.

Absolutely.

Your next question comes from the line of Mark Moerdler with Sanford Bernstein.

Thank you.

Two questions.

First, Mark, understanding that financials is still subscale and growing fast.

But looking longer term, is there any reason that financials won't have the same margins as HCM?

And then a follow-up for Phil.

Yes, I can't see any reason why financials won't have at least the same margins as HCM.

Excellent.

And Phil, are you seeing any change in the time it takes to close financial deals from when you start til the process -- the deal closes?

No, I think the sales cycle itself is very similar.

We see, both in the platform sales as well as independent product suite sales, very consistent sales cycles.

Again, leading with product and then substantiating with reference helps collapse that selling time.

I think we'll see the same trends going forward.

Thank you, appreciate it.

Congrats on the quarter.

Thank you.

Your final question comes from the line of Steve Ashley with Robert W. Baird.

Hey, thanks very much.

With moving the implementation off to -- professional services off to your ecosystem partners, clearly customer satisfaction is the most important thing for you.

Have you done anything in terms of structuring the oversight of their deployment and allow you to be able to closely monitor it?

Is there anything within SLA and customer satisfaction related to monitoring their activity?

Just wondering if you're putting in some structure to that relationship.

That's a great question.

So first of all, I would say this is definitely a continuum decision rather than we just flipped a switch and handed it over to the partners.

This has been something that's been in process for the better part of five years and we are not going away as a professional services organization.

We just said we're not going to grow it as fast.

A couple things to your question.

We have had metrics in place, both on certifications and the quality of projects really since we started engaging with partners.

And we continue to work with them to make sure the certification process is a good one as well as the customer success is high.

That's always been a key part of what we do.

And we have an engagement manager on every implementation project, regardless of whether Workday is involved or not.

That's just the way that we can stay close to the project even if we're not the implementation arm doing the implementation itself.

In many cases our best partners are doing the implementation but I still might be an executive sponsor.

Phil might be an executive sponsor, staying close to these projects with support from our services team to make sure that the implementation is going well.

I want to make it clear, this is not a binary handoff.

This is just a continuum.

Professional service as an organization is going to continue to grow.

We don't feel we need to grow it at the same rate because the partners have filled the gap.

That is really helpful.

Thank you.

Thank you everybody for joining us today.

We thank you for your participation in today's earnings call.

You may you now disconnect and have a great day.