Dayforce, Inc. (DAY) Earnings Call Transcript & Summary

we're thrilled. I'm Kevin McVeigh, part of the UBS Research Department here. We're thrilled to host Dayforce CFO, Jeremy Johnson. I think this might be your first conference, right?

No, maybe second or third. Yes.

Second or third. But in a while. So we're actually thrilled to have Dayforce here. What I typically do with most of these is start with the initial introduction on the company. I think a lot of you folks know the company, but I think it's always so helpful to do that, Jeremy, not only for folks in the audience, but also for the folks online. And just as a reminder, I try to keep these as collaborative as possible. So if there's any questions in the room, we've got folks that can pass around a microphone. And I also have an iPad for anybody online. So if you have any questions, they'll come in through the iPad, and we can ask them on your behalf.

But maybe start a little bit. I think you've got a unique view on Dayforce in particular since you were the CFO at one point and have come back more recently. But just talk to the Dayforce story today a little bit because I think 1 of the things that have been really unique and underappreciated is some of the real meaningful transformation the company has gone through, which I think really under kind of appreciates the predictability of the model. But just maybe talk to that a little bit competitive positioning because the question we get a lot is where you folks sit relative to the mid- to down market players. Maybe start there a little bit, and you've got a ton more questions, but I think that's a good place to start, particularly given -- I know you had a really effective Investor Day a couple of weeks ago, which we'll get into as well.

That's great. Well, first of all, thanks for having me. It's great to be here, and it's good to see everybody. Look, I think Dayforce has been through quite a transformation. And that transformation really started when we brought together Dayforce and Ceridian back in 2012 time, and that's actually when I started at Dayforce. From 2012 to really 2018, the idea was to bring the compliance of and payroll of Dayforce -- of Ceridian with the workforce management expertise of Dayforce and put it on to a single application, and that single application allows you to do what we call the continuous calculation of net pay. And that allows for things like the Dayforce Wallet and some of the adjacencies that we do and essentially allows anyone to see their earned wages during the active pay period. It's a pretty unique innovation in payroll and probably the only innovation in the payroll workforce management space in the last 20 or 25 years. From 2012 to 2018, we focused on building the product. That is the combined platform of Dayforce with the Ceridian payroll engine and tax engine and the Dayforce Workforce Management. We also knew that beyond that, it allowed us to do some pretty interesting things like build out the entire HCM suite onto the single application of Dayforce and also build out native global payroll applications to allow you to do the continuous calculation in native jurisdictions as well. So we built it out with U.S. and Canada in mind. We then extended into U.K. and Ireland, and now we're going into Germany and Europe. We've got Australia, New Zealand, Singapore and a few other territories where we can go native and then build a full platform play across the globe. In 2018, we had our IPO, a very successful IPO. And from 2018 to now, it's basically have been about building out that full HCM suite. We brought in Joe Korngiebel from Workday, who basically did the same thing at Workday, building out their HCM suite and came in and filled out all the edges. So we now go beyond just the compliance. We have the entire talent modules as well. The way we think about it and the way we compete is really in 2 segments. We call it major markets. It's about 500 to 3,500 employees. And in that segment, it's the full HCM suite that we're selling. We typically go in with an ROI or a consolidation play. And we're delivering quantifiable value by replacing, on average, 12 different solutions with 1 Dayforce solution. And that seems to be resonating really nicely and we're having good success in the major markets this year. In the large enterprise segments, enterprise and large enterprise, so 3,500 and above, we go all the way up into the hundreds of thousands of employees, we still start with compliance modules. And that's the pay workforce management benefits is really where we start, and then we can land and expand as we move on with that relationship and mature that relationship with customers. Competitive set for us is largely the same as it's always been. It's UKG. It's Workday. It's ADP. As you move up, you still see the SAPs and the Oracles of the world, and that really hasn't changed.

You got a lot there. Very helpful. I want to unpack a little bit because I feel like it gets lost on the market sometimes is how unique the technology is, right? Like your ability to kind of pay almost realtime is unique to your tech stack. So maybe talk to that a little bit. And I think 1 of the more effective ways I've tried to articulate it is, you can almost you do pay literally realtime because the technology allows you to do that as opposed to a lot of your competitors to essentially pay their, right, because of that. So maybe talk to that technology a little bit. And with that, you've obviously gone through a meaningful client transformation, where a lot of the legacy Ceridian clients were on-prem. You fit them into the cloud. So your cloud business is about 85% of revenue today, up from about 25%, I think, back in 2018. So a real meaningful shift. And we're going to go somewhere with that after you answer this question just because there's a real margin opportunity in free cash flow. But maybe we talk to that because I think the technology is probably 1 of the more underappreciated parts of the story, particularly given the complexities in the enterprise space.

Yes. And we realize the benefits of kind of our technology innovation through the Dayforce Wallet, but we also use it to win new business. And there's kind of -- we built this -- the products that you could do the continuous calculation. And the reason we ultimately built it was because we knew payroll and HR people were feeling pain in their existing products. And we built it because in a historical world, you had time and pay in separate systems. And you can't start pay until you run time. And your time system needs to be import into your pay and then you can start. And guess what, you have about 2 days, a really tight crunch to finalize your payroll. And ultimately, you kind of commit pay when you run out of time as opposed to when you're ready. And so you lead with errors. You have risk from a compliance standpoint. You might have the Department of Labor knocking on your door, which is something that nobody wants. So we built it for that purpose, really to solve a pain point that our prospective customers and our existing customers. And we actually realize that, I think it's shown nicely through the Dayforce Wallet, as you mentioned. Because when you have this ability to now do a continuous calculation, you can do those -- not only do those audits throughout the active pay period, but you can also allow people to access their wages during the active pay period. And we built out a product called the Dayforce Wallet. Essentially, it's -- you can download the application, see a card, request the card and see your earned wages during the active pay period, access those wages for free, move them on to your card for free. And when you go spend, that's when Dayforce makes our money on the interchange when you go spend. We also have, if you want to move it off to a different bank account or a different wallet, you can have -- you can do so with some fees. And it's really a unique differentiator for Dayforce in that it started with nothing. Last year, we had about $12 million in revenue on that product. It's going to be above $30 million in this year. And it's a really nice way to kind of highlight our competitive differentiation.

No doubt. I want to talk about the '24 guidance, '25 guidance a little bit and then the longer term, the 2031 that you introduced at Investor Day. But One thing I wanted because we get the question a lot is to kind of what the addressable market is. And 1 of the things that was really, I think, brought to light at the Investor Day was how much the TAM has grown, right? And I think you expressed that through kind of the per employee per month, the common metric that we kind of focus on is PAPM. Now that's kind of shifted from about $12 up to $48. So maybe talk to that a little bit. And within that, talk to the incrementals because obviously, the sell back to the base is a much higher margin than kind of new logos. So maybe we can talk about the targets a little bit, but I want to start there because I think the growth is 1 of the things that helps solve some of the competitive questions we get.

Yes. And the HCM TAM itself is growing. Depending on what you look at, it's growing around 10% a year. The -- our ability to access that TAM is also expanding and it has expanded. So when we started with payroll and time, we could only access a certain portion of that HCM market. As you -- as we build out the HCM suite, we can now access more and more of that and more TAMs available. What that looks like for us is not only our global expansion, but also our product expansion and our expansion into managed services allows us to go back and sell into the base of customers that we have gotten over the last few years, where we didn't have that ability. So we have a bunch of white space inside our customer base that we can go and cross-sell, and it's an area of focus for us. If you -- the way I kind of think about it is 2 ways. One, at about kind of 1,500, 2,000 employees, which is our average customer size, we sell them the compliance modules, which is pay benefits and time, and that's about $10 to $12 per employee per month. As you add on the talent and analytics functionality, you can get that same customer double. So now another $10 to $12 or $20 to $24 per employee per month. We can also now sell them managed services, which is essentially us being the payroll team for you. Payroll, it's not a fully outsourced product, but it's outsourcing your payroll functionality to us. And we can get another $10 to $12 per employee per month at that kind of 1,500, 2,000 employee range. We now have the ability, we think, to go back and sell additional, call it, intelligence, so Copilot and automated agents, which can get another 5% to 7% on top of that. So that's the first way we kind of see this TAM expanding. I think the second way is, in the past, we probably sold about 30%. In 2023, it was actually 30% of our total sales were add-on sales to the base, so customer base sales. This year, we're around 40%. We chose to invest this year because the product is ready and we think our managed margins at a spot where we can lean in. We know the product has some -- the ability to go and realize some of that white space there. And so we built out a customer base sales team and are having a lot of success this year on that. So I kind of look at it in both ways there.

Just to wrap up this point. I think you also talked about some potential margin expansion in managed services and where that is today and what you can -- I think the hope as we get it closer to corporate average. Maybe help frame what drives that?

Yes, that's right. Look, managed services is something that we've had a demand for a number of years, but we haven't leaned into proactively until now. And the reason we hadn't leaned into proactively is because we hadn't had the margin profile yet. The margin profile was pretty ugly when you first started selling it, and we really did it as almost a favor to some customers that said, "Hey, we really want this." But we saw an opportunity to expand margins through both automation, lower-cost jurisdictions of some resources there, and then using technology to solve the problem and scaling 1 person over multiple clients. And we've gotten the margin profile of that close to that of the software margin profile. So if we're at about 80% on the cloud recurring gross margin this year, the margin profile is kind of in the low 70s percent range of the managed. And so now we feel comfortable leaning into it, and it's certainly a nice boost to revenue and it's a nice cross-sell opportunity, and there's not really much downside anymore.

Makes a lot of sense. I may stop there, see if there's any questions in the audience. Keep going then. Maybe we talk about the 2024 guidance a little bit, the initial '25 and then 2031. And I think a big area of focus in the market has obviously been on the margin expansion as well as the free cash flow conversion. And I think 1 of the things we took comfort in was the buyback that you announced earlier in the year. So maybe remind us because obviously, there's only 1 quarter left in the year 2024. It was really encouraging to see the initial were implied. I don't want to be too specific, whatever the term was on '25. But maybe talk to some of the thought process on that? And particularly, I think you're talking about a 12% plus free cash flow margin in '25, scaling up to 20% plus. And maybe just talk about some of the puts and takes within the context of the revenue build and then the margin and cash flow because it's obviously been an area. And then to the extent, I don't know if you can comment, obviously, there's 1 quarter left in '24. One thing I wanted maybe just on '24 is I don't think sometimes the market appreciates how predictive some of the revenues, right? And I think part of that is just the average client size is a lot larger, the implementation is a little bit more involved. So I'm not trying to put words in your mouth, but there's a fair amount of visibility, particularly as we've got 1 quarter left. Maybe talk to that a little bit, and then some of the building blocks on '25 and then into 2031 as well.

That's good. Yes. So in -- we do have a lot of visibility in our business. And it comes from the fact that we invoice our customers on a per employee per month basis at go-live. And it -- that allows us, and we try to pass that visibility down to the investors and the investment community through our guidance. It allows us to set very tight ranges, it allows us to feel confident, and then it allows us to plan the business from a cost perspective really nicely. We have put an outsized or an emphasized focus on profitability this past year. And it's -- I think it's an area of focus for me. It's something that I hear from investors. It's something that I know that we can improve profitability. And included in that is also a transition to free cash flow and a focus on free cash flow as opposed to just non-adjusted EBITDA or other profitability metrics. So the guidance that we gave for next year on a prelim base or kind of a quarter earlier than we normally would is revenue growth of 14% to 15%, excluding float on a constant currency basis, adjusted EBITDA margins above 31% and free cash flow margins above 12%. And both of those profitability metrics are pretty significant expansions over 2024. And, it's also expansions when we are -- can see a headwind coming from float, which for us is a nice tailwind in our business. But when rates come the other way, it kind of hurt us from a profitability perspective. So if you think about how we're driving profitability in the business, we're actually driving through that, the float headwind that we expect for next year. I think when I think about profitability, it really comes in the form of kind of 2 or 3 things. The first 1 is the recurring gross margins. We're nearing 80% on a cloud recurring gross margin. We don't look at that as a ceiling. We think there's still room to go there. We think there's room for obviously expanding through the cross-sell motion that we have and the upsell motion. So as you add products, you don't necessarily have to add people at the same rate. We certainly think there's room to get more efficient from a scale perspective, from a cost geography perspective and from an automation perspective as well, and that can all help our cloud recurring gross margins. As you think about G&A, it should be an area of consistent scale for us. And that's what you've seen in the past, and you should expect it in the future. And then specifically, as you think about next year, this year was an area of investment in sales and marketing for us. And we invested in customer base sales. We invested in some major market sales teams. And next year, I think you'll see us reap the productivity of those investments. We also invested in brand this year as well, and we'll continue that investment. But we're going to start to reap the productivity from some of that investment, and you should see that in our free cash flow and adjusted EBITDA.

And 1 of the things, too, I think you talked to a little bit, but maybe just any thoughts on how our view on Gen AIs, we think there's -- it's more an operational opportunity in terms of expense leverage as opposed to -- and this is across HCM. I don't think there's a step function change in revenue from it. But maybe talk about how that factors into just implementation. And then, again, I think 1 of the things that we appreciate is how much the revenue is remixed, right? I mean the on-prem business has been a little bit of a headwind, right, because that's revenue running off as kind of the cloud scale, if that becomes smaller and smaller and naturally should help the revenue. And then the professional service dynamic because obviously, there's been, I think, a little bit of an initiative to shift some of that capacity to GSIs, which should help the margin as well. So maybe just -- I know there's a lot there, but it all factors into, I think, the margin progression, particularly to your point against. And maybe just remind us because I can't remember like what some of the float assumptions were for '24 as opposed to '25, maybe the headwind you're working through there?

Yes. Maybe I'll start with Gen AI and then move into some of the professional services dynamics, and then we can talk about float. On some of the AI products we have, we've got a really nice, I think, head start there because of the way our product is platformed. We have a single application with a kind of a single code base across our entire platform. And what that means is that it sets us up really nicely to build things like a Copilot, which is out in market now. Obviously, you've heard us talk about some of the agent and the agent approach that we're taking as we move forward here, and we expect that to be in market in 2025. But I think we have a nice head start because of the way we're architectured there. Any time that we can -- our customers can realize quantifiable value, we think we have a sales opportunity. And what we've seen so far with the Copilot in its early days is that our customers are realizing quantifiable value there. They're able to save time from maybe it's their HR team's time. They're able to save -- employees are able to save time from doing some of the same tasks that they normally would have done very manually and taking a lot of manual time. So there is quantifiable value there, and we're confident that we can realize that and then take that to the next level with some of this agent approach there. As I mentioned, we think there's about a 5% to 7% uplift opportunity from some of the -- on the revenue per customer from an AI side of things. I think the second 1 was we wanted to talk about professional services.

Yes.

Professional services, if you think about longer term, we kind of plan on growing professional services slightly slower than our Dayforce recurring services. And that's -- it might be a -- it's probably a little bit lumpier than normal recurring services. But I do think that on average, you should see it kind of just slightly lag the Dayforce recurring side of things. And that's because we are continuing to use global SIs to do a good chunk of our implementations, and that we've had a lot of success there. I think this year, year-to-date, about 40% of our sales have been SI partner influenced sales. And you'll likely see that continue. It won't get to 100%. I think you'll see us do a lot of the implementations in the major market space ourselves. Budget envelopes in that space really, I think, worked nicely there because of that, and bringing an SI in becomes a little bit cost prohibitive for our customers. And so we have a nice leg up that we've already built out a lot of those implementations internally and that implementation team. But in the larger enterprise side of things, we're leveraging the SIs to not only do the implementations, but also bring us pipeline. And that's where you'll see us kind of lean in on the implementation side of things there. I think over time, you should expect the professional services and other gross margin to get towards breakeven. Right now, we're just under breakeven in kind of the low negative teens. And we can get more productive in our own implementation efforts, and we'll also use the global SIs a little bit more in the large enterprise side of things.

I'm glad you mentioned a follow-up on it because it's important, too. It becomes its own distribution channel for you. So maybe talk about, right, because as they scale, right, their partners become more entrenched in the product and they're able to sell it and you have a pretty meaningful multiplier effect. So maybe talk to the pacing of -- I think the number you quoted, 40%, maybe where that's been historically. And again, that becomes its own -- the distribution becomes pretty powerful as 1 CFO leaves and then go to another organization, it's a terrific platform, we need to implement it here. Maybe talk to that dynamic a little bit, too.

Yes. I'll tell you what, it's been built from the ground up. We had almost 0 SI-influenced deals at IPO time. We had a few partners here and there that you can kind of talk to as partner influence. But from an SI perspective, we built that up since our IPO. And if 1 of our growth levers is to move it dramatically into the enterprise space, we knew it was an area where we could be successful and we hadn't really been. Historically, it had all mostly been major market, and we had opportunistically competed in the enterprise space. And when we made the decision to move up into the enterprise, we had to build out the global SI partnerships. And so we've taken kind of the largest SIs that you can think of, the Accentures, Deloittes, PwCs, as well as some of those second tiers. So BDO is a big partner of ours and a few of the more renal players. And we built out -- help them build out practices, train their staff. And now we're moving with some of them even more into a partner sell, where they're actually selling on our behalf. And that's kind of early phases. But ultimately, with some of them, that's where we can go. So we think it's a good opportunity for us, and it's something we've been successful in, and you need to be successful when you're competing in the enterprise there.

And 1 thing, and I think maybe just for the audience, I think it's underappreciated some time, too, is the professional services are a function of the client size, right? So if you've got a big enterprise client and you can see it in kind of the revenue mix across the folks that are more enterprise-centric yourself kind of the Workdays, the ADPs of the world alight before they sold their business, right? There's a reason that professional services is the size they are, and it's a complexity implementations ongoing support. So as you're able to kind of lean into that distribution channel and meaningfully lower margin, again, just can be a real another additive aspect of the story that we don't think it's fully appreciated, particularly as you kind of work through and scaled it.

I think it's a really good point. Yes. I think it is probably underappreciated, the work that we've had to do to go into the large enterprise and build out these SI relationships. And it's been a heavy lift, but we're actually starting to reap the benefits of that. Obviously, you can hear from some of the metrics on 40% of our deals were partner-led this year.

And we didn't talk about them. Maybe just any assumptions -- not assumptions, but anything you'd call out. And it's hard, but just with the new administration, I know any type of change in benefits can be good for the business. But anything you'd highlight, potential changes and just how are you thinking about the macro as you thought about the '25 -- '31 is obviously pretty hard, as is '25. But maybe just any thoughts on just what type of macro assumptions are embedded in the '25? And then anything from a regulatory perspective potentially? I mean, obviously, nothing's changed, but that we should monitor?

I think it's a wait and see for us. It's pretty early to tell. And certainly, there are some areas that you could see changes happening that we could be the benefactor from. But ultimately, you don't know at this point. We haven't built any kind of tailwinds from any of this into a model. And I think we just got to take a wait-and-see approach right now. I don't think we saw much negative from past administration. And seriously, we really haven't seen much positive or negative changes in administrations over time. But we'll see. This 1 could be different.

And from like any way to think about like what type of unemployment assumptions just as is? And typically, I think when you got on the float, maybe what type of assumptions do you have from a 10-year perspective or just in the '24 and '25?

Yes. So unemployment levels, obviously, as customers add more employees, we benefit from that. This year haven't gotten much of a benefit from it at all as employment levels at our customers have remained flat. I think there's probably some pockets of strength and pockets of weakness. But at the highest level, it's kind of remained flat, which was what our expectation was. But it's a nice one-for-one benefit. And if the employment or the economy improves and the macro improves, certainly, we can be a benefactor of that. I think from a float perspective, the way we kind of think about it is we take our kind of float portfolio, which grows the average funds, which is $4.5 billion or so on an average basis, grow 5% to 6% on an annual basis, and that's been historical. We expect that to continue in the future. And then rates yield this year, we're yielding about 4.1% on that balance. We'd expect those to come down next year to probably where they were in 2023, which was about 3.7%. And that should get you, as I talked about at the Investor Day, probably about a $10 million to $20 million headwind next year. Now we invest our float funds pretty, I think, I guess, we invest them in a core portfolio and a liquidity portfolio. It's about 50% in core, which is kind of longer duration investments, 2.5 years on average, and we hold the maturity there. So we're actually still working our way up the yield curve there even as rates are coming down. And then, obviously, on the liquidity portfolio, it's overnight. So we think longer term, probably I would model around the 3% yield.

That's helpful.

Appreciate the time. I know we've talked about just profit being a big focus this year, especially with the free cash flow guidance, and that's been pretty strong. I mean as you think about that in terms of revenue, I know things can always change. Like how are you all thinking, like if you need to make a change, how much would you focus on preserving some of the profit stuff as it goes through the year?

Yes. It's a great question. And I -- it always is a balance between growth and profitability. I do believe that if we wanted to grow faster and invest, we could invest more and grow faster. We've kind of taken the approach that profitability is a pretty big focus area for us and somewhere that I think we can improve on. And because of that, I think you've seen us kind of limit some investment. Obviously, this year was an investment in sales and marketing. But in the future, we should expect that to remain relatively flat. And we should reap some nice profitability out of both the growth of the business, but then also our kind of constrained investment. It's probably the right move to make right now just given where the market is. But if things change, you may see us pivot a little bit, and that could be changed more towards profitability. If we find some more opportunities, then we can get more productive. And you could also see us say, "Hey, we see a ton of opportunity here," and maybe it's not going to be. But I think right now, our guidance is 100 to 200 basis points on average a year in free cash flow margin expansion. And I think it's a good way to think about it, that we should be able to deliver that with just the things that I mentioned on cloud recurring gross margin, on G&A scale and then kind of scaling the rest of the business.

Got it. And on that free cash flow margin guide, that delta between the free cash flow expansion that we have and the EBITDA expansion, what's causing that difference?

Ultimately, it's -- I think we've talked about 100 to 150 basis points of adjusted EBITDA expansion and 100 to 200 basis points of free cash flow expansion. It's really just the free cash flow is a little bit lumpier than adjusted EBITDA. And our -- I think our adjusted EBITDA is quite high already. So we've got a little bit of room in some of the balance sheet that we can continue to reap.

I think we're running up on time. But Jeremy, anything we didn't ask or obviously, just terrific event. But just anything to kind of highlight as we close it out here?

I think we ran the gamut in questions. I appreciate it, and I appreciate you all taking the time and obviously, for hosting us here. It's a great event, and we really like it.

Thrilled to have you for sure. Thank you, all.

Thanks, everybody.