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

Perfect. Thank you for joining us today. Right now, we have Dayforce. So with us today from Dayforce, we have David Ossip, CEO; Jeremy Johnson, CFO. And then also on the line is David Niederman, Head of Investor Relations. First, thank you for joining us today.

Pleasure to be here, Jared.

Perfect. So to get it started, in terms of your sources of new clients, a common thing investors ask us is the penetration of cloud payroll software. When you look across your majors, enterprise and large enterprise, new client pipeline, what is the composition of organizations still using an on-prem payroll solution? And what should the takeaway for us to be about cloud payroll adoption in both North America and internationally and that growth opportunity cloud modernization of payroll presents for you?

Thanks for the question, Jared. First point I'd make is I don't think I've seen a change in the composition as to where we're getting our business from. So in the time that we've been selling Dayforce, which dates back to about 2013, the sources for the Dayforce business on the payroll side, generally, it came from other providers such obviously as ADP, and we're seeing more from the UKG side today. As we go more upmarket, and as you know, we compete in 3 different segments: majors, which goes up to 3,000 employees; enterprise, to 12,000; and beyond that we call it large enterprise. In the large enterprise space, it's more likely that you'll see on-prem PeopleSoft, very old PeopleSoft. You'll see on-prem SAP. You'll see on-prem Oracle. We're still coming across quite a bit of AS/400 custom software that was written a long time ago. When you go into the enterprise space, we still see a lot of that, specifically in certain industries. So as you get into industries like utility, mining, you're more likely to come across the AS/400 or possibly on-prem SAP systems. When we go into the majors space, usually, it's organizations that have an existing piece of software. So it would be the ADP and the UKG that I mentioned. But also, you would see the various types of pays in that world where they grow beyond the complexity of that type of software.

Perfect. And then Flex Work, which I believe is your most notable offering release since Wallet, expands the company into the digital staffing market. What do you estimate the TAM to be for this offering?

It's still very early. And just for the people online, what Flex is it -- we effectively built the Dayforce engine so we could calculate continuously. In other words, when people clock in and clock out, we calculate immediately the net earnings. And then we delivered the Dayforce Wallet, which allowed people to get paid instantly. The Dayforce Flex is the next step of that evolution, which is allowing an organization to find workers instantly. In other words, if I have a vacant shift, I can post it to effectively the Talent cloud, and then people that have the skill set and are in the Talent cloud are able to pick up the shift. And when they do that, they clock in, clock out, we calculate instantly. We pay them instantly as well. So it has that instant nature for both the worker and from the employer. It's still in what I'd call lab stage. We launched it probably about 4, 4.5 months ago. We have probably about 50 to 60 customers that have signed up for it. It looks very promising. If it does go, it's probably -- the TAM would be at least as large as we find on the HCM side. But it's still very early day. A lot of our R&D focus is on bringing other great products to market as well. And if you look at the numbers this year, about 35% to 40% of our sales have been back to the base of add-on HCM modules. And I would say that's probably the most noticeable features or, if you like, product and technology innovation that we've done over the last years. You see that in the average, PEPM going up quite nicely. We still believe there's tremendous white space in the 6,700 customers that we have live on the platform. So a lot of our innovation goes to the HCM side as well.

Got it. And it's also worth calling out Flex Work can be offered to organizations not using the Dayforce platform as well. Do you see the focus being there on the existing HCM clients? Or do you see an even greater opportunity outside of your client base?

It's probably one of the areas that we could have done better on Dayforce Wallet. When we launched Dayforce Wallet, we limited the Wallet to the Dayforce customers, which meant that we limited the market to about 3% of the overall TAM. With Flex, it's available to everyone. And in fact, I'll probably say that at least half of the initial Flex customers are not Dayforce customers. So it obviously expands the TAM quite considerably.

Got it. And then I want to circle back here on Wallet. So it has been experiencing rapid growth, actually say it as your fastest-growing offering. It is expected to be above $30 million for FY '24. First, can you clarify, is that on an actual revenue earned basis? Or is that more so an ARR basis? Just to clarify.

So it's on revenue earned basis. So we ended off the year last year at about $12 million, $12.5 million. This year, it will be over $30 million. From an ARR perspective, we'll probably end the year over $40 million.

Oh wow. And what is the PEPM you are deriving on Wallet currently? And do you see an opportunity to expand this over the medium term?

Yes, I think you will see it. This year, we effectively launched 2 new offerings effectively, AFT and IFT. One allows the employees to transfer money instantly over the OCT rails as opposed to over ACH. And the second allows employees or workers to pull money from the Dayforce Wallet into apps like Cash App and the like. And we derive revenue from that. We just recently launched direct to bank. In fact, we did a press release on it this morning, which would allow employees to transfer money directly to their debit cards attached to their existing bank accounts instead of going through the KYC process, downloading the app and registering for the Dayforce plastic, which, as you know, is a Mastercard that we offer. The relevance of that is that when we look at the usage of the Dayforce Wallet today, it's mostly the unbanked workers in the U.S., which is probably less than 20% of the overall TAM. And given the ability for people to do on-demand pay directly to their existing bank accounts should boost the usage of the Wallet.

Got it. And is Wallet currently accretive to both your cloud recurring gross margin as well as your adjusted EBITDA margin? Or is that something in the future we could potentially see that being accretive to margins?

I think in the long term, it will be accretive. At the moment, it's probably a little bit decretive because it is still growing when we look at it, especially on the EBITDA side given the amount of P&T and there's a bit of marketing we put in around the actual Dayforce Wallet program. What I'd also point out, it's been a very strong differentiator for us in selling Dayforce. And today, the capabilities of the Dayforce Wallet have become just base features for a modern payroll system. And the fact that with us is completely native as opposed to an add-on like the other players in the market has allowed us to win more Dayforce Payroll and Dayforce HCM business as well.

Got it. And I did want to talk on your recent Investor Day and some of the targets provided there. So you did detail long-term expectation of growing Dayforce recurring ex float growth in the mid- to upper teens. What's really underlying that on a simplified basis of P x Q, with P being revenue per client employee growth and Q being client employee served growth? And how does that compare to recent trends?

Look, we've always taken this durable approach to growing the actual size of the business. And I would say it's largely balanced between bringing on new customers and increasing the wallet share across the actual clients.

Got it. And then at the Investor Day, you also pointed an expectation of that Bureau recurring ex float revenue trending towards 0 due to Dayforce migrations and then the end-of-lifing of certain business lines. How much of that Bureau that is left is still potentially migratable to Dayforce? And how should we think about the cadence of those migrations here?

Of the $70 million Bureau -- $70 million of Bureau revenue, about half of it will end up in Dayforce and the other half would be end-of-life.

Got it. And then as part of those long-term targets for nonrecurring growth is anticipated to grow in line to slightly lower than Dayforce recurring, which would represent an acceleration from recent growth rates, you're also intending to shift more implementations to the SI channel over this time period. Can you talk about the growth rate -- growth outlook for implementations factored here, just given it does account for over 50% of this revenue mix in that nonrecurring revenue?

So when I'm looking at the actual growth profile, I would say that you'll see similar growth rates on the professional services and other. For Dayforce next year, as you probably saw this year, it might accelerate slightly. Inside that particular line item, you do have the value-added services work that we do to already live customers. And as the base of Dayforce live customers continues to grow and with the add-on modules that we're doing, there is a growth path to really more kind of balanced, more profitable growth of professional services and other. Jeremy, anything you would add to that?

Yes. I think the only other thing I'd add there is just over the last few years, keep in mind that we've built out this kind of SI program pretty much from scratch from 2018 to 2023 or so. And that means going from zero implementations essentially on SI paper to where we're at right now, which is kind of partners driving 30% to 40% to the implementations. And while we certainly can get beyond that, you're not going from 0 to where we are today anymore. So the -- we do expect, I think, the shift from the revenue side of things more towards partners is that's kind of built into the base right now. And now we can continue to grow. We're also, as David mentioned, selling those value-added services, which are actually more profitable. And those 2 things combined, I think it should get us to that non-Dayforce kind of professional services and other growing somewhat in line or slightly behind our overall Dayforce recurring revenue.

Got it. And what are those key value-added services here? And then why should those growth rates accelerate? Is that more so just investment in the sales motion there? Just curious in terms of what would be driving that. Or is it just a larger client base overall in terms of expanding that service -- those services there?

It's mostly the latter. So you've got many more customers that are live on the actual platform. Our value-added services would be where customers come to us and they buy other specific blocks of ours. Might be specific interoperability capability that they're looking for. It might be configuration of various types of collective bargaining agreements. It might be workflow configuration on the HR self-service perspective. It might be help around the design of their compensation plans and how they'd like to roll them out. It might have to do as well with learning and the like.

Got it. And upsells back to the existing base are a key growth driver for the business. In situations where you are just the payroll and/or WFM vendor, which has been discussed to be primarily in that large enterprise segment, is what you're focused on upselling different than when also the HRIS vendor? I guess, basically, is your right to win additional software modules in that HCM suite impacted by not having ownership of the HRIS module?

So let me break it down by segment because I think the approach is somewhat different. Overall, most of our customers today still are largely payroll on time, even in the major market segment. So we're finding there's a tremendous upsell capability even across that, say, 500 to 3,000 employee major market segment and definitely in the 3,000 to 12,000 enterprise segment. And as you know, we brought on a gentleman named Barnes probably about 18 months ago, and he stood up a fantastic back-to-the-base sales motion. As we go upmarket, you're correct, it is mostly payroll on time. Although in very large enterprise, when there are organizations that have a high degree of frontline workers, so you can think about retail, hospitality, possibly manufacturing, in that area, we seem to be doing quite nicely in selling the core HR and the talent acquisition and the other talent modules. For, let's call it, professional services organization or mostly desktop worker organizations, we are finding that in a very large enterprise space, the core HR is not necessarily the talent modules. So it is possible that a large customer could use one of the ERPs for the system of record, the HR component. But they probably are still using best-of-breed vendors like Cornerstone and iCIMS and possibly smaller LMS and ATS and performance management vendors. And over there, we do have the ability to win those modules because of the natural interactive connectivity that we have with the frontline worker when they clock in, clock out, view their schedules, view their pay slips. They're always in our system. So we're finding the ability to sell those modules. And then lastly, when we talk about add-ons, we also talk about managed services. This is where we take over either the payroll processing or the benefit processing for the clients. And we're finding that is very popular in the enterprise and large enterprise parts of the market. In fact, that's where we entered the market with those particular services. If I think about our overall PEPM today, which I think is important for people to understand, when we do payroll and time, there's probably about $12 of PEPM across those particular modules. When we add the core HR and the talent modules, that adds about another $10 to $12. When we add managed services, that adds another $10 to $12. And then when we add the analytic components, which would be products like the Copilot, which is a GenAI capabilities for dashboards, analytics, measures, the Dayforce Studio -- Integration Studio, there's probably another $10 to $12 over there as well. And so just by having a balanced approach to market, whether it be segment or whether it be the actual type of product we're selling, it gives us quite a lot of optimism and confidence over the long-term growth of the business, which gets back to your earlier question.

Got it. The company has been discussing the consolidation of vendors is just one of the demand drivers. When you specifically look at multi-country payroll, what kind of opportunity do you see from the consolidation of payroll vendors on that multi-country payroll front here?

It's not uncommon to see somewhere around a 50 to 90 vendor consolidation when you deal with these very large global companies. So if you deal with a company that might be operating in, let's say, 50 different countries, most likely on the core HR side, they've got a range of different vendors. They might have different ERPs. They might have legacy systems. They may have in-country providers. You'll see the same on the payroll side. You'll see the same on the workforce management side, and you'll see the same on the talent side. So whereas in North America, we typically do a 12:1 consolidation. When you go into these large global countries, it grows quite dramatically. It could be as many as 90 today.

Got it. I guess double-tapping on this multi-country payroll opportunity. What do you believe is going to determine the winners and losers in the multi-country payroll market over the medium to long term? Is it as simple as which vendors have the most number of countries with native payroll engines?

No, I don't think so. So when you're going to multi-country, the first part is, I think that the actual architecture of the platform begins to count. And you have to have it designed natively into the product from the very beginning. It's almost impossible to retrofit global on top of an existing platform. There are specifics about culture, about data localization, about language localization that have currency -- constant currency. They just have to be native in everything that you actually do. You also have to think about how you do from a deployment perspective because as you get into certain countries, DPA and data residents become very, very important. You have to understand how to actually do it from a contracting perspective as well as there are different constraints and liabilities. For example, if you get into the EU, you go into things like GDPR, which has to do with data privacy that you have to take into account. So the first part is, I think, you have to design the product correctly from a native perspective. The second component is that you have to do -- you have the ability to do the actual processing and handle the compliance in the different geos that you're actually competing with. And that's more than just having the technology. That's actually having the understanding of how it comes together. The third component is when you're in North America, the complexity probably is on the payroll side, especially in the U.S. given the number of jurisdictions that you're dealing with. As you probably know, before Pennsylvania Act 32, which came out in 2012, there were about 15,000 payroll jurisdictions, and then Pennsylvania Act 32 added the local jurisdictions. So in states like Pennsylvania, that added 7,000 new jurisdictions just in that. And so that complexity tied together with things like how you do your remittances, your money movement and the taxes and the multi-J became very hard. When you get outside of the U.S., payroll becomes simpler relative to workforce management. And so when you go into countries like the U.K. or you go into the EU, you start to have to deal with different types of workforce management complexities. The same applies when you go into things like New Zealand with the Holiday Act. If you go to Australia with the multi-awards, workforce management becomes very complex. So you have to have the ability to do very complicated workforce management. And on that, I would probably argue there are probably 2, 3, at max, global vendors that can actually handle the workforce management side. The same applies to leave administration. And when you go into the HR side, the concept of a person differs quite considerably on a global basis. To do a true global system, you have to have a viewpoint of a global employee, and then you have to have work contracts below that particular employee in order to do it properly. And so there's a lot of base work that has to go in. It probably has taken us, well, since 2013 to build this out. I think we're well ahead of others inside the marketplace. I think we've got a very strong advantage when it comes to the global payroll side.

Got it. And then on the margin side here. So you are guiding to around 5 points of improvement on your free cash flow conversion relative to adjusted EBITDA in FY '25 and about 25 basis points annually over the long term. Can you detail and ideally rank the primary drivers to this improvement in free cash flow conversion relative to adjusted EBITDA?

Yes. I'll start, and then I'll hand it over to Jeremy for a bit more kind of finer detail. At a high level, the profitability of the company, the free cash flow of the company is driven by the percentage of overall revenue that is Dayforce recurring. Every year, we increase the percentage probably by about 1% also. In other words, 1% of the total revenue of the company shifts over from professional services and other to the Dayforce recurring side. The Dayforce recurring side currently contributes at about 80%, and we believe we can keep taking it up by about a percentage or so each year, maybe a little bit more than that. If we look at it since the time of the IPO, I think we've taken a Dayforce recurring, Jeremy, from what about -- up by about 13.2%, something like that in that particular area, so about an average of, what is that, about 200 per year, I guess?

That's right.

So every year, we increase the profitability of the recurring side. That increase in profitability comes from a number of areas. One, as we sell more to the actual base, the add-on revenue contributes probably well above 90%, probably very high 90%. If we sell some like performance management, we don't have to add any hosting capacity and we don't have to add any support people into it, so it flows all the way to the bottom line. And so as we go back to the base sales, you will see the profitability increase from that perspective. The second is we just get more efficient. And that comes from as customers are on the product longer, they become more self-sufficient. As we've built out the Dayforce community, we're finding that customers are helping customers. We've added GenAI capability to the help flow, if you like, that the GenAI product is able to answer about 70 -- sorry, 86% of the knowledge base inquiries, which is about 70% of the inquiries. So we just become more profitable through the use of either more -- customers have been in the product longer or the use of automation and tools like GenAI. And also from a workforce perspective, we've become mindful as to where we have people. And so we've obviously moved people to lower-cost jurisdictions, whether it be in the Philippines, India and Mauritius, which also has allowed us to improve profitability from that perspective. And that basically drives it. When we go down to the actual EBITDA side or the operating cash flow side, we also -- as we grow, you're seeing efficiencies in areas like G&A, in terms of our sales and marketing, in terms of P&T. You'll see us continually focus on that. And the last point would be that there's obviously a focus on free cash flow. And so we've become very careful about how we actually spend. And we're obviously now managing, if you think -- all aspects of kind of cash flow across the business. Jeremy, what did I miss? Or what would you add?

You hit, I think, all of it. Maybe I'll just add a couple of things. One is to reiterate the fact that profitability is the key long-term driver of our kind of free cash flow margin expansion. I think as we head from where we expect to be kind of this year in that 9.5% to 10% free cash flow margin range to that 20% long-term target, the profitability is the key. I think the things that will help us get that conversion from adjusted EBITDA to free cash flow improved, and you've seen it this year, is mostly kind of scaling working capital and scaling some capital expenditures as a percent of revenue. And those are the 2 things where when you really focus on your working capital, I mean, we did a couple of interesting and innovative things this year on the wallet securitization line where we're no longer just using our balance sheet to fund kind of wallet advances. We're actually securitizing some of those, and it makes a lot of sense to do that. We'll continue to look at different ways to do that. But also just focusing on the balance sheet of driving DSO improvement, driving DPO improvement and just kind of putting a lens towards a focus on that one really helps that conversion improvement.

That makes sense. Managed services is an area the company is leaning into, with only 2% to 4% attachment currently relative to market adoption rates ranging from 12% to 26%. What is driving demand for it? Is it really just the cost savings for clients?

No. It's not a cost play for the client. So what managed services are is where the client purchases a SaaS offering and they still use it from a self-service and from an analytics and even a configuration perspective. But instead of being on a learning curve of 1 to do the regular payroll processing and the benefits open enrollment, they leverage our services. And because we do it at scale, we're able to apply a lot of technology to it, which means that we can improve the compliance, we can increase the accuracy. And we probably can do it better than the client can actually do it. So it's largely driven from a compliance perspective of getting off that single learning curve on to a platform where we do it on a regular basis. Currently, the gross margin on the managed side is about 77%. So it's a couple of percentage points less than what we see in the cloud. But we're pretty confident that it is going to actually reach very similar margins as we actually see on the cloud side of the actual business. The third reason is that a lot of our clients experience high turnover rates of their payroll staff. The average turnover rate of payroll professionals is typically over 20% in the industry. And so this also allows them to handle that because we obviously have a deep bench of very talented staff who know the industry very, very well. And then lastly, as customers go global, it's very, very difficult for North American organizations or possibly even European organizations to be able to do payroll on a global basis because of the differences across all the different geos that you actually see. And we obviously help with that, too.

Got it. And in the last few minutes here, I do want to touch on GenAI. The company has introduced multiple GenAI offerings and is monetizing by charging a PEPM fee. How do you believe Dayforce's GenAI offerings are differentiated from some of the competitor solutions out there?

So first, we were the first to actually enter the marketplace with GenAI. We have a few natural advantages. The first is we have that single data model and we have very well-formed data across the entire domain of people. Second is that the home page for our application is a product that we call the Hub. The Hub is a content management system. And any documents that are loaded up into the Hub, whether it be PDF or Word or HTML or the like, we now index from an AI perspective. For each client, we use, as you know, an open-source Mistral model for the large language model. And then on top of that, we actually train the model on our specific domain and on the Dayforce system. So think about it, payroll information, the Dayforce implementation guide, knowledge bases and the like. And then for each customer, we have a local language model that is trained with the documents that they've uploaded to the Hub. When a user goes into the Copilot and they ask a question, we answer it using all of the documents for which that person is in the audience too, which means that I can go in there, I can say, "Tell me about the employee handbook, tell me about the benefits policy, what is my eye care coverage." I can also ask operational questions. For example, if I'm a retail seller and a person comes in to ask about tennis shoes, I could say, "Hey, what's the best tennis shoe between $150 and $200 for someone who has wide feet?" And the product will answer that as well. We've also now moved into more of the agent side as well. So if I'm an employee, I could say, "Hey, can I take Friday off?" It will come back and say, "Yes, you can or you can't if you can." It will ask you particulars about what type of occasion or what type of time-off you would like and initiates the actual workflow for you, too. What we shared at our annual conference, Discover, was moving into areas now, which you'll see next year, around analytics. Show me, I can go to the Copilot. Show me by location, in the form of a bar chart, turnover rates and generates the actual chart for me. We're going into areas of things like autonomous anomaly detection for payroll and more and more around the actual workflow side. With us, we actually have it in production. It's available today. And so we're quite optimistic about what we can actually do on the data side. And if you remember when I spoke about the growth of the overall PEPM, about 25% of that comes from what we call our data products, including the Copilot and other.

Perfect. Well, I see we are at time here. We really appreciate you guys joining us today. And with that, we'll move on to our next segment here. Thank you.

Great. Thanks, Jared. And congrats on the new title as well.

Thank you.