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EX-32.2 - EXHIBIT 32.2 - Workday, Inc.wday-10312016xex322.htm
EX-32.1 - EXHIBIT 32.1 - Workday, Inc.wday-10312016xex321.htm
EX-31.2 - EXHIBIT 31.2 - Workday, Inc.wday-10312016xex312.htm
EX-31.1 - EXHIBIT 31.1 - Workday, Inc.wday-10312016xex311.htm

 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
(Mark One)
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended October 31, 2016
OR
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-35680
 
 
 
Workday, Inc.
(Exact name of registrant as specified in its charter) 
 
 
 
Delaware
 
20-2480422
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
6230 Stoneridge Mall Road
Pleasanton, California 94588
(Address of principal executive offices)
Telephone Number (925) 951-9000
(Registrant’s telephone number, including area code) 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of November 30, 2016, there were approximately 201 million shares of the registrant’s common stock outstanding.
 
 
 



Workday, Inc.
 
 
Page No.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 

2


PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Workday, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
 
October 31,
2016
 
January 31,
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
386,557

 
$
300,087

Marketable securities
1,527,238

 
1,669,372

Accounts receivable, net
268,945

 
293,407

Deferred costs
23,067

 
21,817

Prepaid expenses and other current assets
88,788

 
77,625

Total current assets
2,294,595

 
2,362,308

Property and equipment, net
334,265

 
214,158

Deferred costs, noncurrent
33,551

 
30,074

Goodwill and acquisition-related intangible assets, net
212,087

 
65,816

Other assets
48,071

 
57,738

Total assets
$
2,922,569

 
$
2,730,094

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
28,374

 
$
19,605

Accrued expenses and other current liabilities
66,075

 
43,122

Accrued compensation
103,206

 
91,211

Unearned revenue
900,441

 
768,741

Total current liabilities
1,098,096

 
922,679

Convertible senior notes, net
527,547

 
507,476

Unearned revenue, noncurrent
123,179

 
130,988

Other liabilities
36,288

 
32,794

Total liabilities
1,785,110

 
1,593,937

Stockholders’ equity:
 
 
 
Common stock
200

 
193

Additional paid-in capital
2,549,639

 
2,247,454

Accumulated other comprehensive income
2,622

 
799

Accumulated deficit
(1,415,002
)
 
(1,112,289
)
Total stockholders’ equity
1,137,459

 
1,136,157

Total liabilities and stockholders’ equity
$
2,922,569

 
$
2,730,094

See Notes to Condensed Consolidated Financial Statements.


3


Workday, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Subscription services
$
335,722

 
$
242,700

 
$
921,953

 
$
667,435

Professional services
73,860

 
62,566

 
210,782

 
171,484

Total revenues
409,582

 
305,266

 
1,132,735

 
838,919

Costs and expenses(1):
 
 
 
 
 
 
 
Costs of subscription services
54,645

 
39,791

 
155,224

 
106,860

Costs of professional services
72,240

 
61,963

 
198,140

 
164,887

Product development
185,311

 
124,020

 
488,975

 
338,700

Sales and marketing
149,549

 
111,658

 
416,217

 
312,983

General and administrative
57,721

 
38,008

 
144,609

 
106,707

Total costs and expenses
519,466

 
375,440

 
1,403,165

 
1,030,137

Operating loss
(109,884
)
 
(70,174
)
 
(270,430
)
 
(191,218
)
Other expense, net
(3,105
)
 
(6,722
)
 
(30,136
)
 
(17,737
)
Loss before provision for (benefit from) income taxes
(112,989
)
 
(76,896
)
 
(300,566
)
 
(208,955
)
Provision for (benefit from) income taxes
1,077

 
915

 
2,147

 
(165
)
Net loss
$
(114,066
)
 
$
(77,811
)
 
$
(302,713
)
 
$
(208,790
)
Net loss per share, basic and diluted
$
(0.57
)
 
$
(0.41
)
 
$
(1.54
)
 
$
(1.10
)
Weighted-average shares used to compute net loss per share, basic and diluted
199,479

 
190,727

 
197,093

 
189,185


(1)      Costs and expenses include share-based compensation expenses as follows:
 
 
 
 
Costs of subscription services
$
5,472


$
3,203

 
$
14,837

 
$
8,424

Costs of professional services
7,436


5,424

 
18,698

 
14,022

Product development
45,968


29,547

 
117,250

 
78,990

Sales and marketing
22,597


15,321

 
62,443

 
36,908

General and administrative
24,982


15,164

 
59,684

 
42,353

See Notes to Condensed Consolidated Financial Statements.


4


Workday, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(114,066
)
 
$
(77,811
)
 
$
(302,713
)
 
$
(208,790
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Net change in foreign currency translation adjustment
(322
)
 
(318
)
 
111

 
(518
)
Net change in unrealized gains (losses) on available-for-sale investments
(392
)
 
(237
)
 
542

 
(574
)
Net change in market value of effective foreign currency forward exchange contracts
5,924

 
181

 
1,170

 
1,178

Other comprehensive income (loss), net of tax
5,210

 
(374
)
 
1,823

 
86

Comprehensive loss
$
(108,856
)
 
$
(78,185
)
 
$
(300,890
)
 
$
(208,704
)
See Notes to Condensed Consolidated Financial Statements.


5


Workday, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
2016
 
2015
 
2016
 
2015
Cash flows from operating activities
 
 
 
 
 
 
 
Net loss
$
(114,066
)
 
$
(77,811
)
 
$
(302,713
)
 
$
(208,790
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
30,453

 
22,260

 
83,239

 
60,717

Share-based compensation expenses
100,098

 
68,659

 
266,555

 
180,697

Amortization of deferred costs
6,507

 
5,389

 
18,520

 
17,749

Amortization of debt discount and issuance costs
6,782

 
6,422

 
20,071

 
19,008

Gain on sale of cost method investment

 

 
(65
)
 
(3,220
)
Impairment of cost method investment

 

 
15,000

 

Other
78

 
48

 
1,678

 
(1,334
)
Changes in operating assets and liabilities, net of business combinations:
 
 
 
 
 
 
 
Accounts receivable
(20,360
)
 
(14,727
)
 
24,695

 
17,420

Deferred costs
(7,973
)
 
(8,744
)
 
(23,247
)
 
(19,327
)
Prepaid expenses and other assets
(1,425
)
 
(9,522
)
 
(14,103
)
 
(24,998
)
Accounts payable
2,260

 
(3,719
)
 
2,080

 
461

Accrued expense and other liabilities
30,591

 
29,785

 
29,619

 
36,700

Unearned revenue
38,514

 
34,719

 
117,854

 
85,063

Net cash provided by (used in) operating activities
71,459

 
52,759

 
239,183

 
160,146

Cash flows from investing activities
 
 
 
 
 
 
 
Purchases of marketable securities
(380,620
)
 
(623,377
)
 
(1,571,756
)
 
(1,485,422
)
Maturities of marketable securities
449,592

 
551,270

 
1,614,495

 
1,261,863

Sales of available-for-sale securities
63,340

 
69,187

 
92,192

 
98,711

Business combinations, net of cash acquired
(144,209
)
 
(23,475
)
 
(147,879
)
 
(31,436
)
Owned real estate projects
(59,705
)
 

 
(85,479
)
 

Capital expenditures, excluding owned real estate projects
(27,518
)
 
(37,893
)
 
(88,535
)
 
(91,682
)
Purchases of cost method investments

 
(700
)
 
(300
)
 
(16,450
)
Sale of cost method investment

 

 
315

 
3,538

Change in restricted cash
3,900

 

 
(100
)
 

Other

 

 
(296
)
 

Net cash provided by (used in) investing activities
(95,220
)
 
(64,988
)
 
(187,343
)
 
(260,878
)
Cash flows from financing activities
 
 
 
 
 
 
 
Proceeds from issuance of common stock from employee equity plans
4,491

 
2,360

 
33,267

 
25,096

Principal payments on capital lease obligations

 
(663
)
 

 
(3,127
)
Other
435

 
246

 
1,006

 
1,025

Net cash provided by (used in) financing activities
4,926

 
1,943

 
34,273

 
22,994

Effect of exchange rate changes
(137
)
 
(399
)
 
357

 
(561
)
Net increase (decrease) in cash and cash equivalents
(18,972
)
 
(10,685
)
 
86,470

 
(78,299
)
Cash and cash equivalents at the beginning of period
405,529

 
230,578

 
300,087

 
298,192

Cash and cash equivalents at the end of period
$
386,557

 
$
219,893

 
$
386,557

 
$
219,893

Supplemental cash flow data
 
 
 
 
 
 
 
Cash paid for interest
$
48

 
$
8

 
$
3,293

 
$
3,252

Cash paid for income taxes
655

 
618

 
4,802

 
1,652

Non-cash investing and financing activities:
 
 
 
 
 
 
 
Vesting of early exercise stock options
$
445

 
$
472

 
$
1,365

 
$
1,416

Property and equipment, accrued but not paid
25,917

 
17,237

 
25,917

 
17,237

Non-cash additions to property and equipment
67

 
4,308

 
982

 
6,491

See Notes to Condensed Consolidated Financial Statements.

6


Workday, Inc.
Notes to Condensed Consolidated Financial Statements
Note 1. Overview and Basis of Presentation
Company and Background
Workday provides financial management, human capital management, and analytics applications designed for the world's largest companies, educational institutions, and government agencies. We offer innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. Our applications are designed for global enterprises to manage complex and dynamic operating environments. We provide our customers highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources. We were originally incorporated in March 2005 in Nevada and in June 2012, we reincorporated in Delaware. As used in this report the terms "Workday," "registrant," "we," "us," and "our" mean Workday, Inc. and its subsidiaries unless the context indicates otherwise.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (GAAP) and applicable rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. The condensed consolidated financial statements include the results of Workday, Inc. and its wholly-owned subsidiaries. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the information contained herein reflects all adjustments necessary for a fair presentation of Workday’s results of operations, financial position and cash flows. All such adjustments are of a normal, recurring nature. The results of operations for the quarter ended October 31, 2016 shown in this report are not necessarily indicative of results to be expected for the full year ending January 31, 2017. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended January 31, 2016, filed on March 22, 2016. There have been no changes to our significant accounting policies described in the annual report that have had a material impact on our condensed consolidated financial statements and related notes.
Certain prior period amounts reported in our condensed consolidated financial statements and notes thereto have been reclassified to conform to the current period presentation. The reclassifications were immaterial and had no effect on previously reported operating results or financial position.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. These estimates include, but are not limited to, the determination of the relative selling prices for our services, certain assumptions used in the valuation of equity awards and the fair value of assets acquired and liabilities assumed through business combinations. Actual results could differ from those estimates and such differences could be material to our condensed consolidated financial position and results of operations.
Segment Information
We operate in one operating segment, cloud applications. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, who is our chief executive officer, in deciding how to allocate resources and assessing performance. Our chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level. Since we operate in one operating segment, which is equivalent to our reportable segment, all required financial segment information can be found in the condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
On May 28, 2014, the FASB issued ASU 2014-09 regarding ASC Topic 606, Revenue from Contracts with Customers. The standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for our fiscal year beginning February 1, 2018. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and are in process of assessing the financial statement impact of adoption.

7


On January 5, 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10), which requires entities to carry all investments in equity securities at fair value through net income. The guidance is effective for our fiscal year beginning February 1, 2018. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
On February 25, 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases”. The guidance is effective for our fiscal year beginning February 1, 2019. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
On March 30, 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies the accounting for share-based payment transactions, including accounting for income taxes, forfeitures, and classification in the statement of cash flows. The guidance is effective for our fiscal year beginning February 1, 2017. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and are in the process of assessing the financial statement impact of adoption.
On October 24, 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Prior to the issuance of this ASU, existing guidance prohibited the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset had been sold to an outside party. The guidance is effective for our fiscal year beginning February 1, 2018. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.
Note 2. Marketable Securities
At October 31, 2016, marketable securities consisted of the following (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. agency obligations
$
972,605

 
$
507

 
$
(101
)
 
$
973,011

U.S. treasury securities
192,253

 
107

 
(15
)
 
192,345

U.S. corporate securities
187,606

 
26

 
(207
)
 
187,425

Commercial paper
261,177

 

 

 
261,177

Money market funds
162,001

 

 

 
162,001

 
$
1,775,642

 
$
640

 
$
(323
)
 
$
1,775,959

Included in cash and cash equivalents
$
248,721

 
$

 
$

 
$
248,721

Included in marketable securities
$
1,526,921

 
$
640

 
$
(323
)
 
$
1,527,238

At January 31, 2016, marketable securities consisted of the following (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. agency obligations
$
1,018,513

 
$
127

 
$
(405
)
 
$
1,018,235

U.S. treasury securities
338,736

 
70

 
(141
)
 
338,665

U.S. corporate securities
135,065

 
36

 
(18
)
 
135,083

Commercial paper
177,390

 

 
(1
)
 
177,389

Money market funds
148,961

 

 

 
148,961

 
$
1,818,665

 
$
233

 
$
(565
)
 
$
1,818,333

Included in cash and cash equivalents
$
148,961

 
$

 
$

 
$
148,961

Included in marketable securities
$
1,669,704

 
$
233

 
$
(565
)
 
$
1,669,372


8


We do not believe the unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence, which includes our intent to hold these investments to maturity as of October 31, 2016. No marketable securities held as of October 31, 2016 have been in a continuous unrealized loss position for more than 12 months. We classify our marketable securities as available-for-sale at the time of purchase and reevaluate such classification as of each balance sheet date. We may sell these securities at any time for use in current operations or for other purposes, such as consideration for acquisitions, even if they have not yet reached maturity. As a result, we classify our investments, including securities with maturities beyond 12 months as current assets in the accompanying condensed consolidated balance sheets. Marketable securities on the condensed consolidated balance sheets consist of securities with original maturities at the time of purchase greater than three months and the remainder of the securities are reflected in cash and cash equivalents. During the three and nine months ended October 31, 2016, we sold $63 million and $92 million, respectively, of our marketable securities and the realized gains from the sales are immaterial.
Note 3. Deferred Costs
Deferred costs consisted of the following (in thousands):
 
October 31,
2016
 
January 31,
2016
Current:
 
 
 
Deferred professional service costs
$
580

 
$
895

Deferred sales commissions
22,487

 
20,922

Total
$
23,067

 
$
21,817

Noncurrent:
 
 
 
Deferred professional service costs
$

 
$
360

Deferred sales commissions
33,551

 
29,714

Total
$
33,551

 
$
30,074

Note 4. Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
 
October 31,
2016
 
January 31,
2016
Land
$
6,592

 
$

Buildings
92,366

 
4,280

Computers, equipment and software
292,662

 
230,705

Computers, equipment and software acquired under capital leases
17,958

 
24,400

Furniture and fixtures
22,937

 
18,894

Leasehold improvements
107,959

 
86,282

 
540,474

 
364,561

Less accumulated depreciation and amortization
(206,209
)
 
(150,403
)
Property and equipment, net
$
334,265

 
$
214,158

During the third quarter of fiscal 2017, we purchased real property located in Pleasanton, California, which includes land together with an office building of approximately 209,000 square feet and parking structures, for $47 million.
During the first quarter of fiscal 2017, we purchased real property located in Pleasanton, California, which includes land together with an office building of approximately 58,000 square feet, for $15 million. Additionally, we started construction of our new customer briefing and development center (development center) in Pleasanton, California, consisting of approximately 410,000 square feet of office space.
Depreciation expense totaled $23 million and $18 million for the three months ended October 31, 2016 and 2015, respectively, and $67 million and $51 million for the nine months ended October 31, 2016 and 2015, respectively.
Note 5. Business Combinations
On August 5, 2016, we acquired a leading provider of operational analytics and data discovery tools for the purpose of enriching the analytics in our products. We have included the financial results of the acquired company in the consolidated financial statements from the date of acquisition. The purchase consideration of this acquisition was $144 million, net of cash acquired.

9


The following table summarizes the estimated fair values of assets acquired and liabilities assumed as of the date of acquisition (in thousands):
Cash and cash equivalents
$
3,213

Other tangible assets
3,523

Acquired developed technology
42,000

Customer relationship assets
1,000

Accounts payable and other liabilities
(1,737
)
Unearned revenue
(6,000
)
Net assets acquired
41,999

Goodwill
105,423

Total purchase consideration
$
147,422

The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. The fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. The preliminary estimated fair values of assets acquired and liabilities assumed, including current income taxes payable and deferred taxes, and identifiable intangible assets may be subject to change as additional information is received and certain tax returns are finalized. We expect to finalize the allocation of purchase consideration as soon as practicable and no later than one year from the acquisition date.
Developed technology represents the estimated fair value of the acquired existing technology. The goodwill balance is not deductible for U.S. income tax purposes.
Additionally, during the second quarter of fiscal 2017, we acquired a cloud-based educational video platform company for $5 million, resulting in increases of $3 million and $2 million in acquired developed technology and goodwill, respectively.
Note 6. Goodwill and Acquisition-related Intangible Assets, Net
Goodwill and acquisition-related intangible assets, net consisted of the following (in thousands):
 
October 31,
2016
 
January 31,
2016
Acquired developed technology
$
65,500

 
$
20,461

Customer relationship assets
1,338

 
338

 
66,838

 
20,799

Less accumulated amortization
(12,946
)
 
(5,308
)
Acquisition-related intangible assets, net
53,892

 
15,491

Goodwill
158,195

 
50,325

Goodwill and acquisition-related intangible assets, net
$
212,087

 
$
65,816

Developed technology and customer relationship assets from acquisitions are typically amortized over a useful life of three to four years. Goodwill amounts are not amortized, but rather tested for impairment at least annually during the last three months of the fiscal year. As of October 31, 2016, our future estimated amortization expense related to acquired developed technology and customer relationship assets is as follows (in thousands):
Fiscal Period:
 
2017
$
5,105

2018
19,286

2019
18,904

2020
10,281

2021
316

Total
$
53,892


10


Note 7. Other Assets
Other assets consisted of the following (in thousands):
 
October 31,
2016
 
January 31,
2016
Cost method investments
$
14,004

 
$
28,742

Acquired land leasehold interest, net
9,702

 
9,781

Technology patents, net
2,328

 
3,020

Other
22,037

 
16,195

Total
$
48,071

 
$
57,738

Amortization expense related to the acquired land leasehold interest and technology patents was less than $0.3 million for each of the three month periods ended October 31, 2016 and 2015, and $0.8 million for each of the nine month periods ended October 31, 2016 and 2015.
During the second quarter of fiscal 2017, we recorded a $15 million other-than-temporary impairment for one of our cost method investments. The impairment expense was recorded in Other expense, net in the condensed consolidated statements of operations. We test our cost method investments for impairment at least annually, and more frequently upon the occurrence of certain events.
Note 8.    Fair Value Measurements
We measure our financial assets and liabilities at fair value at each reporting period using a fair value hierarchy that requires that we maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:
Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 — Other inputs that are directly or indirectly observable in the marketplace.
Level 3 — Unobservable inputs that are supported by little or no market activity.
Financial Assets
We value our marketable securities using quoted prices for identical instruments in active markets when available. If we are unable to value our marketable securities using quoted prices for identical instruments in active markets, we value our investments using independent reports that utilize quoted market prices for comparable instruments. We validate, on a sample basis, the derived prices provided by the independent pricing vendors by comparing their assessment of the fair values of our investments against the fair values of the portfolio balances of another third-party professional’s pricing service. To date, all of our marketable securities can be valued using one of these two methodologies.
Based on our valuation of our marketable securities, we concluded that they are classified in either Level 1 or Level 2 and we have no financial assets or liabilities measured using Level 3 inputs. The following tables present information about our assets that are measured at fair value on a recurring basis using the above input categories (in thousands):
 
 
Fair Value Measurements as of
October 31, 2016
Description
 
Level 1
 
Level 2
 
Total
U.S. agency obligations
 
$

 
$
973,011

 
$
973,011

U.S. treasury securities
 
192,345

 

 
192,345

U.S. corporate securities
 

 
187,425

 
187,425

Commercial paper
 

 
261,177

 
261,177

Money market funds
 
162,001

 

 
162,001

 
 
$
354,346

 
$
1,421,613

 
$
1,775,959

Included in cash and cash equivalents
 
 
 
 
 
$
248,721

Included in marketable securities
 
 
 
 
 
$
1,527,238


11


 
 
Fair Value Measurements as of
January 31, 2016
Description
 
Level 1
 
Level 2
 
Total
U.S. agency obligations
 
$

 
$
1,018,235

 
$
1,018,235

U.S. treasury securities
 
338,665

 

 
338,665

U.S. corporate securities
 

 
135,083

 
135,083

Commercial paper
 

 
177,389

 
177,389

Money market funds
 
148,961

 

 
148,961

 
 
$
487,626

 
$
1,330,707

 
$
1,818,333

Included in cash and cash equivalents
 
 
 
 
 
$
148,961

Included in marketable securities
 
 
 
 
 
$
1,669,372

Financial Liabilities
The carrying amounts and estimated fair values of financial instruments not recorded at fair value are as follows (in thousands): 
 
 
October 31, 2016
 
January 31, 2016
 
 
Net Carrying Amount Before Unamortized Debt Issuance Costs
 
Estimated
Fair Value
 
Net Carrying Amount Before Unamortized Debt Issuance Costs
 
Estimated
Fair Value
0.75% Convertible senior notes
 
$
321,635

 
$
416,392

 
$
310,013

 
$
362,250

1.50% Convertible senior notes
 
210,812

 
310,170

 
203,923

 
264,063

The difference between the principal amount of the notes, $350 million for the 0.75% convertible senior notes and $250 million for the 1.50% convertible senior notes, and the net carrying amount before unamortized debt issuance costs represents the unamortized debt discount (see Note 9). The estimated fair value of the convertible senior notes, which we have classified as Level 2 financial instruments, was determined based on the quoted bid price of the convertible senior notes in an over-the-counter market on the last trading day of each reporting period.
Based on the closing price of our common stock of $86.68 on October 31, 2016, the if-converted value of the 0.75% convertible senior notes and the if-converted value of the 1.50% convertible senior notes were greater than their respective principal amounts.
Derivative Financial Instruments
We conduct business on a global basis in multiple foreign currencies, subjecting Workday to foreign currency risk. To mitigate this risk, we utilize hedging contracts as described below. We do not enter into any derivatives for trading or speculative purposes.
Our foreign currency contracts are classified within Level 2 because the valuation inputs are based on quoted prices and market observable data of similar instruments in active markets, such as currency spot and forward rates.
Cash Flow Hedges
We are exposed to foreign currency fluctuations resulting from customer contracts denominated in foreign currencies. We have a hedging program in which we enter into foreign currency forward contracts related to certain customer contracts. We designate these forward contracts as cash flow hedging instruments as the accounting criteria for such designation have been met. The effective portion of the gains or losses resulting from changes in the fair value of these hedges is recorded in Accumulated other comprehensive income (loss) (OCI) on the condensed consolidated balance sheets and will be subsequently reclassified to the related revenue line item in the condensed consolidated statements of operations in the same period that the underlying revenues are earned. The changes in value of these contracts resulting from changes in forward points on our forward contracts are excluded from the assessment of hedge effectiveness and are recorded as incurred in Other expense, net in the condensed consolidated statements of operations. Cash flows from such forward contracts are classified as operating activities.
As of October 31, 2016 and January 31, 2016, we had 159 and 65 outstanding foreign currency forward contracts designated as cash flow hedges with total notional values of $224 million and $133 million, respectively. All contracts have maturities not greater than 15 months. The notional value represents the amount that will be bought or sold upon maturity of the forward contract.
During the three and nine months ended October 31, 2016, all cash flow hedges were considered effective.

12


Foreign Currency Forward Contracts not Designated as Hedges
We also enter into foreign currency forward contracts to hedge a portion of our net outstanding monetary assets and liabilities. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are recorded in Other expense, net in our condensed consolidated statements of operations. These forward contracts are intended to offset the foreign currency gains or losses associated with the underlying monetary assets and liabilities. Cash flows from such forward contracts are classified as operating activities.
As of October 31, 2016 and January 31, 2016, we had 23 and 21 outstanding forward contracts with total notional values of $32 million and $22 million, respectively. All contracts have maturities not greater than 15 months.
The fair values of outstanding derivative instruments were as follows (in thousands):
 
 
Condensed Consolidated Balance Sheets Location
 
October 31,
2016
 
January 31,
2016
Derivative Assets:
 
 
 
 
 
 
Foreign currency forward contracts designated as cash flow hedges
 
Prepaid expenses and other current assets
 
$
6,940

 
$
4,695

Foreign currency forward contracts designated as cash flow hedges
 
Other assets
 
88

 

Foreign currency forward contracts not designated as hedges
 
Prepaid expenses and other current assets
 
350

 
605

Derivative Liabilities:
 
 
 
 
 
 
Foreign currency forward contracts designated as cash flow hedges
 
Accrued expenses and other current liabilities
 
$
1,445

 
$
98

Foreign currency forward contracts not designated as hedges
 
Accrued expenses and other current liabilities
 
190

 
56

Gains (losses) associated with foreign currency forward contracts designated as cash flow hedges were as follows (in thousands):
 
 
Condensed Consolidated Statement of Operations and Statement of Comprehensive Loss Locations
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
 
 
 
2016
 
2015
 
2016
 
2015
Gains (losses) recognized in OCI (effective portion)(1)
 
Net change in market value of effective foreign currency forward exchange contracts
 
$
6,107

 
$
182

 
$
1,606

 
$
1,180

Gains (losses) reclassified from OCI into income (effective portion)
 
Revenues
 
183

 
1

 
436

 
2

Gains (losses) recognized in income (amount excluded from effectiveness testing and ineffective portion)
 
Other expense, net
 
517

 
44

 
833

 
86

(1) 
Of the total effective portion of foreign currency forward contracts designated as cash flow hedges as of October 31, 2016, net gains of $1.8 million are expected to be reclassified out of Accumulated other comprehensive income (loss) within the next 12 months.
Gains (losses) associated with foreign currency forward contracts not designated as cash flow hedges were as follows (in thousands):
 
 
Condensed Consolidated Statement of Operations Location
 
Three Months Ended 
 October 31,
 
Nine Months Ended 
 October 31,
Derivative Type
 
 
2016
 
2015
 
2016
 
2015
Foreign currency forward contracts not designated as hedges
 
Other expense, net
 
$
1,195

 
$
270

 
$
654

 
$
348


13


We are subject to master netting agreements with certain counterparties of the foreign exchange contracts, under which we are permitted to net settle transactions of the same currency with a single net amount payable by one party to the other. It is our policy to present the derivatives gross in the condensed consolidated balance sheets. Our foreign currency forward contracts are not subject to any credit contingent features or collateral requirements and we do not believe we are subject to significant counterparty concentration risk given the short-term nature, volume, and size of the derivative contracts outstanding.
As of October 31, 2016, information related to these offsetting arrangements was as follows (in thousands):
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets Presented in the Condensed Consolidated Balance Sheets
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
Net Assets Exposed
 
 
 
 
 
Financial Instruments
 
Cash Collateral Received
 
Derivative Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Counterparty A
 
$
810

 
$

 
$
810

 
$
(810
)
 
$

 
$

Counterparty B
 
6,568

 

 
6,568

 
(783
)
 

 
5,785

Total
 
$
7,378

 
$

 
$
7,378

 
$
(1,593
)
 
$

 
$
5,785

 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Liabilities Presented in the Condensed Consolidated Balance Sheets
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
Net Liabilities Exposed
 
 
 
 
 
Financial Instruments
 
Cash Collateral Pledged
 
Derivative Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Counterparty A
 
$
852

 
$

 
$
852

 
$
(810
)
 
$

 
$
42

Counterparty B
 
783

 

 
783

 
(783
)
 

 

Total
 
$
1,635

 
$

 
$
1,635

 
$
(1,593
)
 
$

 
$
42

Note 9. Convertible Senior Notes, Net
Convertible Senior Notes
In June 2013, we issued 0.75% convertible senior notes due July 15, 2018 (2018 Notes) with a principal amount of $350 million. The 2018 Notes are unsecured, unsubordinated obligations, and interest is payable in cash in arrears at a fixed rate of 0.75% on January 15 and July 15 of each year. The 2018 Notes mature on July 15, 2018 unless repurchased or converted in accordance with their terms prior to such date. We cannot redeem the 2018 Notes prior to maturity.
Concurrently, we issued 1.50% convertible senior notes due July 15, 2020 (2020 Notes) with a principal amount of $250 million (together with the 2018 Notes, referred to as the Notes). The 2020 Notes are unsecured, unsubordinated obligations, and interest is payable in cash in arrears at a fixed rate of 1.50% on January 15 and July 15 of each year. The 2020 Notes mature on July 15, 2020 unless repurchased or converted in accordance with their terms prior to such date. We cannot redeem the 2020 Notes prior to maturity.
The terms of the Notes are governed by Indentures by and between us and Wells Fargo Bank, National Association, as Trustee (the Indentures). Upon conversion, holders of the Notes will receive cash, shares of Class A common stock or a combination of cash and shares of Class A common stock, at our election.
For the 2018 Notes, the initial conversion rate is 12.0075 shares of Class A common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $83.28 per share of Class A common stock, subject to adjustment. Prior to the close of business on March 14, 2018, the conversion is subject to the satisfaction of certain conditions as described below. For the 2020 Notes, the initial conversion rate is 12.2340 shares of Class A common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $81.74 per share of Class A common stock, subject to adjustment. Prior to the close of business on March 13, 2020, the conversion is subject to the satisfaction of certain conditions, as described below.
Holders of the Notes who convert their Notes in connection with certain corporate events that constitute a make-whole fundamental change (as defined in the Indentures) are, under certain circumstances, entitled to an increase in the conversion rate. Additionally, in the event of a corporate event that constitutes a fundamental change (as defined in the Indentures), holders of the Notes may require us to repurchase all or a portion of their Notes at a price equal to 100% of the principal amount of the Notes, plus any accrued and unpaid interest.

14


Holders of the Notes may convert all or a portion of their Notes prior to the close of business on March 14, 2018 for the 2018 Notes and March 13, 2020 for the 2020 Notes, in multiples of $1,000 principal amount, only under the following circumstances:
if the last reported sale price of Class A common stock for at least twenty trading days during a period of thirty consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price of the respective Notes on each applicable trading day;
during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the respective Notes for each day of that five day consecutive trading day period was less than 98% of the product of the last reported sale price of Class A common stock and the conversion rate of the respective Notes on such trading day; or
upon the occurrence of specified corporate events, as noted in the Indentures.
In accounting for the issuance of the Notes, we separated each of the Notes into liability and equity components. The carrying amounts of the liability components were calculated by measuring the fair value of similar liabilities that do not have associated convertible features. The carrying amount of the equity components representing the conversion option were determined by deducting the fair value of the liability components from the par value of the respective Notes. These differences represent debt discounts that are amortized to interest expense over the respective terms of the Notes. The equity components are not remeasured as long as they continue to meet the conditions for equity classification.
We allocated the total issuance costs incurred to the Notes on a prorated basis using the aggregate principal balances. In accounting for the issuance costs related to the Notes, we allocated the total amount of issuance costs incurred to liability and equity components. Issuance costs attributable to the liability components are being amortized to interest expense over the respective terms of the Notes, and the issuance costs attributable to the equity components were netted against the respective equity components in Additional paid-in capital. For the 2018 Notes, we recorded liability issuance costs of $7 million and equity issuance costs of $2 million. Amortization expense for the liability issuance costs was $0.4 million and $1 million for each of the three and nine month periods ended October 31, 2016 and 2015. For the 2020 Notes, we recorded liability issuance costs of $5 million and equity issuance costs of $2 million. Amortization expense for the liability issuance costs was $0.2 million and $0.5 million for each of the three and nine month periods ended October 31, 2016 and 2015.
The Notes, net consisted of the following (in thousands):
 
October 31, 2016
 
January 31, 2016
 
2018 Notes
 
2020 Notes
 
2018 Notes
 
2020 Notes
Principal amounts:
 
 
 
 
 
 
 
    Principal
$
350,000

 
$
250,000

 
$
350,000

 
$
250,000

    Unamortized debt discount(1)
(28,365
)
 
(39,188
)
 
(39,987
)
 
(46,077
)
Net carrying amount before unamortized debt issuance costs
321,635

 
210,812

 
310,013

 
203,923

    Unamortized debt issuance costs(1)
(2,402
)
 
(2,498
)
 
(3,458
)
 
(3,002
)
Net carrying amount
$
319,233

 
$
208,314

 
$
306,555

 
$
200,921

Carrying amount of the equity component(2)
$
74,892

 
$
66,007

 
$
74,892

 
$
66,007

(1) 
Included in the condensed consolidated balance sheets within Convertible senior notes, net and amortized over the remaining lives of the Notes on the straight-line basis as it approximates the effective interest rate method.
(2) 
Included in the condensed consolidated balance sheets within Additional paid-in capital, net of $2 million and $2 million for the 2018 Notes and 2020 Notes, respectively, in equity issuance costs.
As of October 31, 2016, the remaining life of the 2018 Notes and 2020 Notes is approximately 20 months and 44 months, respectively.

15


The effective interest rates of the liability components of the 2018 Notes and 2020 Notes are 5.75% and 6.25%, respectively. These interest rates were based on the interest rates of similar liabilities at the time of issuance that did not have associated convertible features. The following table sets forth total interest expense recognized related to the Notes (in thousands):
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2016
 
2015
 
2016
 
2015
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
Contractual interest expense
$
656

 
$
938

 
$
656

 
$
938

 
$
1,969

 
$
2,813

 
$
1,969

 
$
2,813

Interest cost related to amortization of debt issuance costs
352

 
167

 
353

 
168

 
1,056

 
504

 
1,057

 
505

Interest cost related to amortization of the debt discount
3,930

 
2,333

 
3,710

 
2,191

 
11,622

 
6,889

 
10,974

 
6,472

Notes Hedges
In connection with the issuance of the Notes, we entered into convertible note hedge transactions with respect to our Class A common stock (Purchased Options). The Purchased Options cover, subject to anti-dilution adjustments substantially identical to those in the Notes, approximately 7.3 million shares of our Class A common stock and are exercisable upon conversion of the Notes. The Purchased Options have initial exercise prices that correspond to the initial conversion prices of the 2018 Notes and 2020 Notes, respectively, subject to anti-dilution adjustments substantially similar to those in the Notes. The Purchased Options will expire in 2018 for the 2018 Notes and in 2020 for the 2020 Notes, if not earlier exercised. The Purchased Options are intended to offset potential economic dilution to our Class A common stock upon any conversion of the Notes. The Purchased Options are separate transactions and are not part of the terms of the Notes.
We paid an aggregate amount of $144 million for the Purchased Options, which is included in Additional paid-in capital in the condensed consolidated balance sheets.
Warrants
In connection with the issuance of the Notes, we also entered into warrant transactions to sell warrants (the Warrants) to acquire, subject to anti-dilution adjustments, up to approximately 4.2 million shares in July 2018 and 3.1 million shares in July 2020 of our Class A common stock at an exercise price of $107.96 per share. If the Warrants are not exercised on their exercise dates, they will expire. If the market value per share of our Class A common stock exceeds the applicable exercise price of the Warrants, the Warrants will have a dilutive effect on our earnings per share assuming that we are profitable. The Warrants are separate transactions, and are not part of the terms of the Notes or the Purchased Options.
We received aggregate proceeds of $93 million from the sale of the Warrants, which is recorded in Additional paid-in capital in the condensed consolidated balance sheets.
Note 10. Commitments and Contingencies
Facility and Computing Infrastructure-related Commitments
We have entered into non-cancelable agreements for certain of our offices, data centers and computing infrastructure platforms with various expiration dates. Certain of our office leases are with an affiliate of our Chairman, David Duffield, who is also a significant stockholder (see Note 15). Our operating lease agreements generally provide for rental payments on a graduated basis and for options to renew, which could increase future minimum lease payments if exercised. This includes payments for office and data center square footage, as well as data center power capacity for certain data centers. We generally recognize these expenses on a straight-line basis over the period in which we benefit from the lease and we have accrued for rent expense incurred but not paid. Total rent expense was $19 million and $13 million for the three months ended October 31, 2016 and 2015, respectively, and $53 million and $32 million for the nine months ended October 31, 2016 and 2015, respectively.
In January 2014, we entered into a 95-year lease for a 6.9-acre parcel of vacant land in Pleasanton, California, under which we paid $2 million for base rent from commencement through December 31, 2020. Annual rent payments of $0.2 million plus increases based on increases in the consumer price index begin on January 1, 2021 and continue through the end of the lease.

16


Legal Matters
We are a party to various legal proceedings and claims which arise in the ordinary course of business. In our opinion, as of October 31, 2016, there was not at least a reasonable possibility that we had incurred a material loss, or a material loss in excess of a recorded accrual, with respect to such loss contingencies.
Note 11. Common Stock and Stockholders’ Equity
Common Stock
As of October 31, 2016, there were 125 million shares of Class A common stock and 76 million shares of Class B common stock outstanding. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock can be converted into a share of Class A common stock at any time at the option of the holder.
Employee Equity Plans
Our 2012 Equity Incentive Plan (EIP) serves as the successor to our 2005 Stock Plan (together with the EIP, the Stock Plans). Pursuant to the terms of the EIP, the share reserve increased by 10 million shares on March 31, 2016, and as of October 31, 2016, we had approximately 58 million shares of Class A common stock available for future grants.
We also have a 2012 Employee Stock Purchase Plan (ESPP). Under the ESPP, eligible employees are granted options to purchase shares at the lower of 85% of the fair market value of the stock at the time of grant or 85% of the fair market value at the time of exercise. Options to purchase shares are granted twice yearly on or about June 16 and December 16 and exercisable on or about the succeeding December 15 and June 15, respectively, of each year. Pursuant to the terms of the ESPP, the share reserve increased by 2 million shares on March 31, 2016. As of October 31, 2016, 6 million shares of Class A common stock were available for issuance under the ESPP.
Stock Options
The Stock Plans provide for the issuance of incentive and nonstatutory options to employees and non-employees. Prior to our initial public offering, we also issued nonstatutory options outside of the Stock Plans. Options issued under the Stock Plans generally are exercisable for periods not to exceed 10 years and generally vest over five years. A summary of information related to stock option activity during the nine months ended October 31, 2016 is as follows:
 
Outstanding
Stock
Options
 
Weighted-
Average
Exercise
Price
 
Aggregate
Intrinsic
Value (in millions)
Balance as of January 31, 2016
12,862,976

 
$
4.21

 
$
756

Stock option grants

 

 
 
Stock options exercised
(3,090,247
)
 
3.88

 
 
Stock options canceled
(79,094
)
 
9.37

 
 
Balance as of October 31, 2016
9,693,635

 
$
4.27

 
$
799

Vested and expected to vest as of October 31, 2016
9,679,684

 
$
4.26

 
$
798

Exercisable as of October 31, 2016
9,281,018

 
$
4.02

 
$
767

As of October 31, 2016, there was a total of $6 million in unrecognized compensation cost related to unvested stock options which is expected to be recognized over a weighted-average period of approximately 10 months.

17


Common Stock Subject to Repurchase
The Stock Plans allow for the early exercise of stock options for certain individuals as determined by the board of directors. We have the right to purchase at the original exercise price any unvested (but issued) common shares during the repurchase period following termination of services of an employee. The consideration received for an exercise of an option is considered to be a deposit of the exercise price and the related dollar amount is recorded as a liability. The shares and liabilities are reclassified into equity as the awards vest. We had $1 million and $3 million recorded in liabilities related to early exercises of stock options as of October 31, 2016 and January 31, 2016, respectively.
Restricted Stock Units
The Stock Plans provide for the issuance of restricted stock units ("RSUs") to employees. RSUs generally vest over four years. A summary of information related to RSU activity during the nine months ended October 31, 2016 is as follows: 
 
Number of  Shares
 
Weighted-Average
Grant Date Fair Value
Balance as of January 31, 2016
9,211,082

 
$
81.48

RSUs granted
6,493,662

 
75.89

RSUs vested
(3,065,468
)
 
81.15

RSUs forfeited
(589,088
)
 
78.17

Balance as of October 31, 2016
12,050,188

 
$
78.71

As of October 31, 2016, there was a total of $825 million in unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over a weighted-average period of approximately 2.8 years.
Restricted Stock Awards
The Stock Plans provide for the issuance of restricted stock awards to employees. Restricted stock awards generally vest over five years. Under the EIP, $0.3 million restricted awards of Class B common stock are outstanding with weighted average grant date fair value of $13.05, all of which are subject to forfeiture as of October 31, 2016. During the nine months ended October 31, 2016, $0.2 million shares of restricted stock awards vested with weighted average grant date fair value of $12.65.
As of October 31, 2016, there was a total of $3 million in unrecognized compensation cost related to unvested restricted stock awards, which is expected to be recognized over a weighted-average period of approximately 1.1 years.
Performance-based Restricted Stock Units
During the first quarter of fiscal 2017, 0.1 million shares of performance-based restricted stock units (PRSUs) were granted to the Chairman of the Board, Chief Executive Officer and certain of Workday’s executive management. These PRSU awards include performance conditions and service conditions, and will generally vest over four years if the performance conditions are achieved for the fiscal year ended January 31, 2017. As of October 31, 2016, vesting of the PRSUs was not considered probable. As a result, no compensation expense was recognized.
Additionally, during fiscal 2017, 0.3 million shares of PRSUs were granted to all employees other than executive management and include performance conditions related to company-wide goals and service conditions. We expect to grant additional shares related to this program for employees hired in fiscal 2017. These PRSU awards will vest if the performance conditions are achieved for the fiscal year ended January 31, 2017 and if the individual employee continues to provide service through the vesting date of March 15, 2017. As of October 31, 2016, vesting of these PRSUs was considered probable, and there was a total of $18 million in unrecognized compensation cost related to these performance-based restricted stock units which will be recognized over a weighted-average period of less than 5 months.

18


Note 12. Other Expense, Net
Other expense, net consisted of the following (in thousands):
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2016
 
2015
 
2016
 
2015
Interest income
$
2,805

 
$
1,126

 
$
7,916

 
$
3,079

Interest expense (1)
(7,206
)
 
(8,001
)
 
(23,151
)
 
(23,838
)
Gain from sale of cost method investment

 

 
65

 
3,220

Impairment of cost method investment

 

 
(15,000
)
 

Other income (expense)
1,296

 
153

 
34

 
(198
)
Other expense, net
$
(3,105
)
 
$
(6,722
)
 
$
(30,136
)
 
$
(17,737
)
(1) 
Interest expense includes the contractual interest expense related to the 2018 Notes and 2020 Notes and non-cash interest related to amortization of the debt discount and debt issuance costs (see Note 9).
Note 13. Income Taxes
We compute the year-to-date income tax provision by applying the estimated annual effective tax rate to the year-to-date pre-tax income or loss and adjust for discrete tax items in the period. We reported a tax provision of $2 million for the nine months ended October 31, 2016 and a tax benefit of $0.2 million for the nine months ended October 31, 2015. The income tax provision of $2 million for the nine months ended October 31, 2016 was primarily attributable to $3 million in state taxes and income tax expense in profitable foreign jurisdictions offset by a $1 million benefit from the release of a valuation allowance resulting from certain acquired intangible assets from a business acquisition from the prior quarter.
The tax benefit of $0.2 million for the nine months ended October 31, 2015 consisted of a $2.8 million provision primarily resulting from income tax expense in profitable foreign jurisdictions and U.S. income tax expense on estimated taxable income before considering the realization of excess benefits from stock based compensation offset by a $3 million tax benefit from the release of an acquired uncertain tax position including interest and penalties due to the lapse of the statute of limitations.
We are subject to income tax audits in the U.S. and foreign jurisdictions. We record liabilities related to uncertain tax positions and believe that we have provided adequate reserves for income tax uncertainties in all open tax years. Due to our history of tax losses, all years remain open to tax audit.
We periodically evaluate the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is dependent on our ability to generate sufficient future taxable income during periods prior to the expiration of tax attributes to fully utilize these assets. As of October 31, 2016, we intend to continue maintaining a full valuation allowance on our deferred tax assets except for certain foreign jurisdictions.
Note 14. Net Loss Per Share
Basic net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potential shares of common stock, including our outstanding stock options, outstanding warrants, common stock related to unvested early exercised stock options, common stock related to unvested restricted stock units and awards and convertible senior notes to the extent dilutive, and common stock issuable pursuant to the ESPP. Basic and diluted net loss per share was the same for each period presented, as the inclusion of all potential common shares outstanding would have been anti-dilutive.
The net loss per share attributable to common stockholders is allocated based on the contractual participation rights of the Class A common shares and Class B common shares as if the loss for the year had been distributed. As the liquidation and dividend rights are identical, the net loss attributable to common stockholders is allocated on a proportionate basis.
We consider shares issued upon the early exercise of options subject to repurchase and unvested restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. In future periods, to the extent we are profitable, we will subtract earnings allocated to these participating securities from net income to determine net income attributable to common stockholders.

19


The following table presents the calculation of basic and diluted net loss attributable to common stockholders per share (in thousands, except per share data):
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2016
 
2015
 
2016
 
2015
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
Net loss per share, basic and diluted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocation of distributed net loss
$
(70,639
)
 
$
(43,427
)
 
$
(45,622
)
 
$
(32,189
)
 
$
(185,317
)
 
$
(117,396
)
 
$
(120,938
)
 
$
(87,852
)
Denominator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
123,534

 
75,945

 
111,826

 
78,901

 
120,657

 
76,436

 
109,582

 
79,603

Basic and diluted net loss per share
$
(0.57
)
 
$
(0.57
)
 
$
(0.41
)
 
$
(0.41
)
 
$
(1.54
)
 
$
(1.54
)
 
$
(1.10
)
 
$
(1.10
)
The anti-dilutive securities excluded from the weighted-average shares used to calculate the diluted net loss per common share were as follows (in thousands):
 
As of October 31,
 
2016
 
2015
Outstanding common stock options
9,694

 
13,877

Shares subject to repurchase
236

 
757

Unvested restricted stock awards, units, and PRSUs
12,761

 
10,136

Shares related to the convertible senior notes
7,261

 
7,261

Shares subject to warrants related to the issuance of convertible senior notes
7,261

 
7,261

Shares issuable pursuant to the ESPP
359

 
262

 
37,572

 
39,554

Note 15. Related-Party Transactions
We currently lease certain office space from an affiliate of our Chairman, Mr. Duffield, adjacent to our corporate headquarters in Pleasanton, California under various lease agreements. The average term of the agreements is 10 years and the total rent due under the agreements is $8 million for the fiscal year ended January 31, 2017, and $90 million in total. Rent expense under these agreements was $2 million and $1 million for the three months ended October 31, 2016 and 2015, respectively, and $6 million and $4 million for the nine months ended October 31, 2016 and 2015, respectively.
Note 16. Geographic Information
Revenues
Revenue by geography is generally based on the address of the customer as defined in our master subscription agreement. The following tables set forth revenue by geographic area (in thousands):
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2016
 
2015
 
2016
 
2015
United States
$
333,128

 
$
256,507

 
$
930,295

 
$
703,846

International
76,454

 
48,759

 
202,440

 
135,073

Total
$
409,582

 
$
305,266

 
$
1,132,735

 
$
838,919

No single country other than the United States had revenues greater than 10% of total revenues for the three and nine months ended October 31, 2016 and 2015. No customer individually accounted for more than 10% of our accounts receivable, net as of October 31, 2016 or January 31, 2016.

20


Long-Lived Assets
We attribute our long-lived assets, which primarily consist of property and equipment, to a country based on the physical location of the assets. The following table sets forth property and equipment by geographic area (in thousands):
 
October 31,
2016
 
January 31,
2016
United States
$
289,943

 
$
176,398

Ireland
37,266

 
29,451

Other
7,056

 
8,309

Total
$
334,265

 
$
214,158

Note 17. 401(k) Plan
We have a qualified defined contribution plan under Section 401(k) of the Internal Revenue Code covering eligible employees. During the second quarter of fiscal 2017, we began to match a certain portion of employee contributions up to a fixed maximum per employee. Our contributions to the plan were $3 million for the three and nine months ended October 31, 2016.

21


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. All statements contained in this report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “seek,” “plan,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the “Risk Factors” section. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied by the forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activities, performance, or achievements. We are under no duty to update any of these forward-looking statements after the date of this report or to conform these statements to actual results or revised expectations.
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 elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, as well as in the section entitled “Risk Factors.”
Overview
Workday provides financial management, human capital management, and analytics applications designed for the world's largest companies, educational institutions, and government agencies. We offer innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. Our applications are designed for global enterprises to manage complex and dynamic operating environments. We provide our customers highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources.
We were founded in 2005 to deliver cloud applications to global enterprises. Our applications are designed around the way people work today – in an environment that is global, collaborative, fast-paced and mobile. Our cycle of frequent updates has facilitated rapid innovation and the introduction of new applications throughout our history. We began offering our Human Capital Management (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 offer Workday applications to our customers on an enterprise-wide subscription basis, typically with three-year terms and with subscription fees largely based on the size of the customer’s workforce. We generally recognize revenues from subscription fees ratably over the term of the contract. We currently derive a substantial majority of our subscription services revenues from subscriptions to our HCM application. We market our applications through our direct sales force.
We have achieved significant growth in a relatively short period of time. Our diverse customer base includes large, global companies and our direct sales force generally targets organizations with more than 1,000 workers. A substantial amount of our growth comes from new customers. Our current financial focus is on growing our revenues and expanding our customer base. While we are incurring 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. Our operating expenses have increased significantly in absolute dollars in recent periods, primarily due to the significant growth of our employee population. We had approximately 6,400 and approximately 4,900 employees as of October 31, 2016 and 2015, respectively.

22


We intend to continue investing for long-term growth. We have invested, and expect to continue to invest, heavily in our application 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 services partners to support local deployments. We expect to make further significant investments in our data center infrastructure as we plan for future growth. We are also investing in personnel to service our growing customer base. These 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 will make it difficult to determine if we are allocating our resources efficiently. We expect our product development, sales and marketing, and general and administrative expenses as a percentage of total revenues to decrease over time 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 and by utilizing more of the capacity of our data centers.
Since inception, we have 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 services 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 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.
Components of Results of Operations
Revenues
We primarily derive our revenues from subscription services fees and professional services fees. Subscription services revenues primarily consist of fees that give our customers access to our cloud applications, which include related customer support. Professional services fees include deployment services, optimization services, and training.
Subscription services revenues accounted for 81% of our total revenues during the nine months ended October 31, 2016 and represented 97% of our total unearned revenue as of October 31, 2016. Subscription services revenues are driven primarily by the number of customers, the number of workers at each customer, the number of applications subscribed to by each customer, and the price of our applications.
The mix of the applications to which a customer subscribes can affect our financial performance due to price differentials in our applications. Compared to our other offerings, our HCM application has been available for a longer period of time, is more established in the marketplace and has benefited from continued enhancements of the functionality over a longer period of time, all of which help us to improve our pricing for that application. However, new products or services offerings by competitors in the future could impact the mix and pricing of our offerings.
Subscription services fees are generally recognized ratably as revenues over the contract term beginning on the date the application is made available to the customer, which is generally within one to two weeks of contract signature. Our subscription contracts typically have a term of three years and are non-cancelable. We generally invoice our customers in advance, in annual installments. Amounts that have been invoiced are initially recorded as unearned revenue. Amounts that have not yet been invoiced represent backlog and are not reflected in our condensed consolidated financial statements.
The majority of our consulting engagements are billed on a time and materials basis, and revenues are typically recognized as the services are performed. We offer a number of training options intended to support our customers in configuring, using and administering our services. In some cases, we supplement our consulting teams by subcontracting resources from our service partners and deploying them on customer engagements. As Workday’s professional services organization and the Workday-related consulting practices of our partner firms continue to develop, we expect the partners to increasingly contract directly with our subscription customers. As a result of this trend, and the increase of our subscription services revenues, we expect professional services revenues as a percentage of total revenues to decline over time.
Costs and Expenses
Costs of subscription services revenues. Costs of subscription services revenues consist primarily of employee-related expenses related to hosting our applications and providing customer support, the costs of data center capacity, and depreciation of computer equipment and software.
Costs of professional services revenues. Costs of professional services revenues consist primarily of employee-related expenses associated with these services, the cost of subcontractors and travel.

23


Product development. Product development expenses consist primarily of employee-related costs. 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 costs, sales commissions, marketing programs and travel. Marketing programs consist of advertising, events, corporate communications, brand building and product marketing activities. Commissions earned by our sales force that can be associated specifically with a non-cancelable subscription contract are generally deferred and amortized over the same period that revenues are recognized for the related non-cancelable contract.
General and administrative. General and administrative expenses consist of employee-related costs for finance and accounting, legal, human resources and management information systems personnel, legal costs, professional fees and other corporate expenses.
Results of Operations
Revenues
Our total revenues for the three and nine months ended October 31, 2016 and 2015 were as follows (in thousands, except percentages): 
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Subscription services
$
335,722

 
$
242,700

 
38%
 
$
921,953

 
$
667,435

 
38%
Professional services
73,860

 
62,566

 
18%
 
210,782

 
171,484

 
23%
Total revenues
$
409,582

 
$
305,266

 
34%
 
$
1,132,735

 
$
838,919

 
35%
Total revenues were $410 million for the three months ended October 31, 2016, compared to $305 million during the prior year period, an increase of $105 million, or 34%. Subscription services revenues were $336 million for the three months ended October 31, 2016, compared to $243 million for the prior year period, an increase of $93 million, or 38%. The increase in subscription services revenues was due primarily to an increased number of customer contracts as compared to the prior year period. Professional services revenues were $74 million for the three months ended October 31, 2016, compared to $63 million for the prior year period, an increase of $11 million, or 18%. The increase in professional services revenues was due primarily to the addition of new customers and a greater number of customers requesting deployment and integration services.
Total revenues were $1.1 billion for the nine months ended October 31, 2016, compared to $839 million during the prior year period, an increase of $294 million, or 35%. Subscription services revenues were $922 million for the nine months ended October 31, 2016, compared to $667 million for the prior year period, an increase of $255 million, or 38%. The increase in subscription services revenues was due primarily to an increased number of customer contracts as compared to the prior year period. Professional services revenues were $211 million for the nine months ended October 31, 2016, compared to $171 million for the prior year period, an increase of $40 million, or 23%. The increase in professional services revenues was due primarily to the addition of new customers and a greater number of customers requesting deployment and integration services.
Operating Expenses
GAAP operating expenses were $519 million for the three months ended October 31, 2016, compared to $375 million for the prior year period, an increase of $144 million, or 38%. The increases were primarily due to an increase of $108 million in employee-related costs driven by higher headcount, $9 million in depreciation and amortization expense and $4 million in service contracts expense to expand data center capacity.
GAAP operating expenses were $1.4 billion for the nine months ended October 31, 2016, compared to $1.0 billion for the prior year period, an increase of $373 million, or 36%. The increases were primarily due to an increase of $275 million in employee-related costs driven by higher headcount, $22 million in depreciation and amortization expense and $13 million in service contracts expense to expand data center capacity.

24


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 and the ability of operations to generate cash. 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, as they exclude expenses that are not reflective of ongoing operating results. We also believe that non-GAAP operating expenses provide useful information to investors and others in understanding and evaluating our operating results and future 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 $406 million for the three months ended October 31, 2016, compared to $304 million for the prior year period, an increase of $102 million, or 34%. The increases were primarily due to an increase of $69 million in employee-related costs driven by higher headcount, $10 million in facility and IT-related expenses, $5 million in depreciation and amortization expense and $4 million in service contracts expense to expand data center capacity.
Non-GAAP operating expenses were $1.1 billion for the nine months ended October 31, 2016, compared to $841 million for the prior year period, an increase of $271 million, or 32%. The increases were primarily due to an increase of $179 million in employee-related costs driven by higher headcount, $24 million in facility and IT-related expenses, $16 million in depreciation and amortization expense and $13 million in service contracts expense to expand data center capacity.
Reconciliations of our GAAP to non-GAAP operating expenses were as follows (in thousands):
 
Three Months Ended October 31, 2016
 
GAAP
Operating
Expenses
 
Share-Based
Compensation
Expenses(1)
 
Other
Operating
Expenses(2)
 
Non-GAAP
Operating
Expenses(3)
Costs of subscription services
$
54,645

 
$
(5,472
)
 
$
(118
)
 
$
49,055

Costs of professional services
72,240

 
(7,436
)
 
(171
)
 
64,633

Product development
185,311

 
(45,968
)
 
(5,792
)
 
133,551

Sales and marketing
149,549

 
(22,597
)
 
(661
)
 
126,291

General and administrative
57,721

 
(24,982
)
 
(713
)
 
32,026

Total costs and expenses
$
519,466

 
$
(106,455
)
 
$
(7,455
)
 
$
405,556

 
 
Three Months Ended October 31, 2015
 
GAAP
Operating
Expenses
 
Share-Based
Compensation
Expenses (1)
 
Other
Operating
Expenses (2)
 
Non-GAAP
Operating
Expenses(3)
Costs of subscription services
$
39,791

 
$
(3,203
)
 
$
(64
)
 
$
36,524

Costs of professional services
61,963

 
(5,424
)
 
(107
)
 
56,432

Product development
124,020

 
(29,547
)
 
(1,594
)
 
92,879

Sales and marketing
111,658

 
(15,321
)
 
(196
)
 
96,141

General and administrative
38,008

 
(15,164
)
 
(396
)
 
22,448

Total costs and expenses
$
375,440

 
$
(68,659
)
 
$
(2,357
)
 
$
304,424


25


 
Nine Months Ended October 31, 2016
 
GAAP
Operating
Expenses
 
Share-Based
Compensation
Expenses(1)
 
Other
Operating
Expenses(2)
 
Non-GAAP
Operating
Expenses(3)
Costs of subscription services
$
155,224

 
$
(14,837
)
 
$
(570
)
 
$
139,817

Costs of professional services
198,140

 
(18,698
)
 
(887
)
 
178,555

Product development
488,975

 
(117,250
)
 
(12,152
)
 
359,573

Sales and marketing
416,217

 
(62,443
)
 
(2,458
)
 
351,316

General and administrative
144,609

 
(59,684
)
 
(2,449
)
 
82,476

Total costs and expenses
$
1,403,165

 
$
(272,912
)
 
$
(18,516
)
 
$
1,111,737

 
 
Nine Months Ended October 31, 2015
 
GAAP
Operating
Expenses
 
Share-Based
Compensation
Expenses(1)
 
Other
Operating
Expenses(2)
 
Non-GAAP
Operating
Expenses(3)
Costs of subscription services
$
106,860

 
$
(8,424
)
 
$
(326
)
 
$
98,110

Costs of professional services
164,887

 
(14,022
)
 
(631
)
 
150,234

Product development
338,700

 
(78,990
)
 
(4,975
)
 
254,735

Sales and marketing
312,983

 
(36,908
)
 
(1,154
)
 
274,921

General and administrative
106,707

 
(42,353
)
 
(1,499
)
 
62,855

Total costs and expenses
$
1,030,137

 
$
(180,697
)
 
$
(8,585