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Nov. 7, 2019, 4:27 p.m. EST

10-Q: CERIDIAN HCM HOLDING INC.

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(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial condition and results of operations as of, and for, the periods presented. You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and notes thereto included elsewhere in report and in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2018, in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission ("SEC") on February 28, 2019 (our "2018 Form 10-K"). This discussion and analysis contains forward-looking statements, including statement regarding industry outlook, our expectations for the future of our business, and our liquidity and capital resources as well as other non-historical statements. These statements are based on current expectations and are subject to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in Part II, Item 1A, "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements." Our actual results may differ materially from those contained in or implied by these forward-looking statements. Any reference to a "Note" in this discussion relates to the accompanying notes to the unaudited condensed consolidated financial statements included elsewhere in this report unless otherwise indicated.

Overview

Ceridian is a global human capital management ("HCM") software company. We categorize our solutions into two categories: Cloud and Bureau solutions. Cloud revenue is generated from HCM solutions that are delivered via two cloud offerings: Dayforce, our flagship cloud HCM platform, and Powerpay, a cloud HR and payroll solution for the Canadian small business market. We also continue to support customers using our Bureau solutions, which we generally stopped actively selling to new customers following the acquisition of Dayforce in 2012. We invest in maintenance and necessary updates to support our Bureau customers and continue to migrate them to Dayforce.

Dayforce provides HR, payroll, benefits, workforce management, and talent management functionality. Our platform is used by organizations, regardless of industry or size, to optimize management of the entire employee lifecycle, including attracting, engaging, paying, deploying, and developing their people. Dayforce was built as a single application from the ground up that combines a modern, consumer-grade user experience with proprietary application architecture, including a single employee record and a rules engine spanning all areas of HCM. Dayforce provides continuous real-time calculations across all modules to enable, for example, payroll administrators access to data through the entire pay period, and managers access to real-time data to optimize work schedules. Our platform is designed to make work life better for our customers and their employees by improving HCM decision-making processes, streamlining workflows, exposing strategic organizational insights, and simplifying legislative compliance. The platform is designed to ease administrative work for both employees and managers, creating opportunities for companies to increase employee engagement. We are a founder-led organization, and our culture combines the agility and innovation of a start-up with a history of deep domain and operational expertise.

We sell Dayforce through our direct sales force on a subscription per-employee, per-month ("PEPM") basis. Our subscriptions are typically structured with an initial fixed term of between three and five years, with evergreen renewal thereafter. Dayforce can serve customers of all sizes, ranging from 100 to over 100,000 employees. We have rapidly grown the Dayforce platform to more than 4,150 live Dayforce customers as of September 30, 2019. For the three and nine months ended September 30, 2019, we added over 160 and 450 net new live Dayforce customers, respectively.

On April 30, 2018, we completed our initial public offering ("IPO"), in which we issued and sold 21,000,000 shares of common stock at a public offering price of $22.00 per share. We granted the underwriters a 30-day option to purchase an additional 3,150,000 shares of common stock at the offering price, which was exercised in full. A total of 24,150,000 shares of common stock were issued in our IPO. Concurrently with our IPO, we issued an additional 4,545,455 shares of our common stock in a private placement at $22.00 per share. We received gross proceeds of $631.3 million from the IPO and concurrent private placement before deducting underwriting discounts, commissions, and other offering related expenses.

We applied a portion of the net proceeds from the IPO to satisfy and to discharge the indenture governing our outstanding $475.0 million principal amount senior notes due 2021, and they were redeemed on May 30, 2018 ("Senior Notes"). Concurrently, we also refinanced our remaining debt under our (i) $702.0 million (original principal amount) senior term debt and (ii) $130.0 million revolving credit facility, including accrued interest and related costs and expenses, with new senior credit facilities consisting of a $680.0 million term loan debt facility and a $300.0 million revolving credit facility. Please refer to Note 8, "Debt," for further discussion of the debt transactions.

The IPO, private placement, and debt refinancing had the following impacts to our results of operations and cash during the three months ended June 30, 2018:







                                                                  Impact to
                                                                Statement of
                                                                 Operations       Impact to Cash
                                                                      (Dollars in millions)
        Gross proceeds from the IPO and private placement                         $         631.3
        Costs capitalized within stockholders' equity                                       (36.3 )
        Redemption of Senior Notes                                                         (475.0 )
        Debt refinancing fees, reflected as a reduction to
        long-term
          debt                                                                               (3.6 )
        IPO and debt refinancing related expenses reflected
          within results of operations:
        Cost of revenue                                         $        (2.1 )
        Selling, general, and administrative                            (23.2 )
        Impact on operating profit                              $       (25.3 )
        Interest expense                                                (25.7 )
        Impact on net loss                                      $       (51.0 )             (51.0 )
        Non-cash IPO-related share-based compensation expense                                 8.1
        Non-cash interest expense adjustments                                                (4.9 )
        Cash to balance sheet from the IPO and private
        placement                                                                 $          68.6
        Proceeds from issuance of the new $680.0 million
        Senior
          Term Debt                                                                         680.0
        Repayment of the $702.0 million Senior Term Debt                                   (657.0 )
        Cash to balance sheet from the IPO, private placement
          and debt refinancing                                                    $          91.6
        


Contemporaneously with the IPO and concurrent private placement, we distributed our interest in LifeWorks to our existing stockholders of record prior to the IPO on a pro rata basis in accordance with their pro rata interests in us ("LifeWorks Disposition"). As a result of the LifeWorks Disposition, we no longer have any material obligation under the LifeWorks joint venture agreement. Please refer to Note 3, "Discontinued Operations," for further discussion of the LifeWorks Disposition.

Our Business Model

Our business model focuses on supporting the rapid growth of Dayforce and maximizing the lifetime value of our Dayforce customer relationships. Due to our subscription model, where we recognize subscription revenues ratably over the term of the subscription period, and high customer retention rates, we have a high level of visibility into our future revenues. The profitability of a customer depends, in large part, on how long they have been a customer. Because in our business model, PEPM subscription fees are not charged until the customer goes live, and because we incur costs in advance of receiving PEPM revenue that are not fully offset by our implementation fees, we estimate that it takes an average of 2.5 years before we are able to recover our implementation, customer acquisition, and other direct costs on a new Dayforce customer contract. As the proportion of Dayforce customers who have been live for two or more years increases, our related profitability increases. The following sets forth the number of live Dayforce customers at the end of each quarter presented:







                           September       June 30,       March 31,       December       September       June 30,       March 31,       December
                           30, 2019          2019           2019          31, 2018       30, 2018          2018           2018          31, 2017
        Live Dayforce
          customers             4,169          4,006           3,851          3,718           3,465          3,308           3,154          3,001
        Dayforce
        customers
          live for two
        or more
          years                 2,855          2,690           2,480          2,339           2,148          2,014           1,872          1,770
        Proportion of
          Dayforce
        customers
          live for two
        or more
          years                    68 %           67 %            64 %           63 %            62 %           61 %            59 %           59 %
        


Over the lifetime of the customer relationship, we have the opportunity to realize additional PEPM revenue, both as the customer grows or rolls out the Dayforce solution to additional employees, and also by selling additional functionality. We incur on-going costs to manage the account, to support customers, and to sell additional functionality. These costs, however, are significantly less than the costs initially incurred to acquire and to implement the customer.

How We Assess Our Performance

In assessing our performance, we consider a variety of performance indicators in addition to revenue and net income. Set forth below is a description of our key performance measures.

Live Dayforce Customers

We use the number of customers live on Dayforce as an indicator of future revenue and the overall performance of the business and to assess the performance of our implementation services. We had 4,169 customers live on Dayforce as of September 30, 2019, compared to 3,465 customers live on Dayforce as of September 30, 2018. Please refer to the "Our Business Model" section above for the number of live Dayforce customers at the end of the quarters presented.

Adjusted EBITDA

We believe that Adjusted EBITDA and Adjusted EBITDA margin, non-GAAP financial measures, are useful to management and investors as supplemental measures to evaluate our overall operating performance. Adjusted EBITDA and Adjusted EBITDA margin are components of our management incentive plan and are used by management to assess performance and to compare our operating performance to our competitors. We define Adjusted EBITDA as net income or loss before interest, taxes, depreciation, and amortization, as adjusted to exclude net income or loss from discontinued operations, sponsor management fees, non-cash charges for asset impairments, gains or losses on assets and liabilities held in a foreign currency other than the functional currency of a company subsidiary, share-based compensation expense and related employer taxes, severance charges, restructuring consulting fees, transaction costs, and certain other non-recurring charges. Adjusted EBITDA margin is determined by calculating the percentage Adjusted EBITDA is of Total Revenue. Management believes that Adjusted EBITDA and Adjusted EBITDA margin are helpful in highlighting management performance trends because Adjusted EBITDA and Adjusted EBITDA margin exclude the results of decisions that are outside the normal course of our business operations. Please refer to the "Results of Operations" section below for a discussion of Adjusted EBITDA and Adjusted EBITDA margin.







        Results of Operations
        Three Months Ended September 30, 2019 Compared With Three Months Ended
        September 30, 2018
                                             Three Months Ended
                                                September 30,                 Increase/ (Decrease)              % of Revenue
                                         2019               2018              Amount            %            2019          2018
                                                       As Adjusted (b)
                                            (Dollars in millions)
        Revenue:
        Recurring services
        Cloud                         $    131.0      $           103.5     $     27.5           26.6 %        64.8 %        58.1 %
        Bureau                              36.4                   46.0           (9.6 )        (20.9 )%       18.0 %        25.8 %
        Total recurring services           167.4                  149.5           17.9           12.0 %        82.7 %        83.9 %
        Professional services and
        other                               34.9                   28.6            6.3           22.0 %        17.3 %        16.1 %
        Total revenue                      202.3                  178.1           24.2           13.6 %       100.0 %       100.0 %
        Cost of revenue:
        Recurring services
        Cloud                               39.0                   35.4            3.6           10.2 %        19.3 %        19.9 %
        Bureau                              10.4                   13.7           (3.3 )        (24.1 )%        5.1 %         7.7 %
        Total recurring services            49.4                   49.1            0.3            0.6 %        24.4 %        27.6 %
        Professional services and
        other                               37.6                   32.5            5.1           15.7 %        18.6 %        18.2 %
        Product development and
        management                          17.5                   14.5            3.0           20.7 %         8.7 %         8.1 %
        Depreciation and
        amortization                         9.0                    8.5            0.5            5.9 %         4.4 %         4.8 %
        Total cost of revenue              113.5                  104.6            8.9            8.5 %        56.1 %        58.7 %
        Gross profit                        88.8                   73.5           15.3           20.8 %        43.9 %        41.3 %
        Selling, general, and
        administrative expense              82.3                   57.3           25.0           43.6 %        40.7 %        32.2 %
        Operating profit                     6.5                   16.2           (9.7 )        (59.9 )%        3.2 %         9.1 %
        Interest expense, net                7.8                    8.8           (1.0 )        (11.4 )%        3.9 %         4.9 %
        Other expense, net                   1.6                    0.9            0.7           77.8 %         0.8 %         0.5 %
        (Loss) income from
        continuing operations
          before income taxes               (2.9 )                  6.5           (9.4 )       (144.6 )%       (1.4 )%        3.6 %
        Income tax benefit                 (65.6 )                 (0.7 )        (64.9 )      (9271.4 )%      (32.4 )%       (0.4 )%
        Income from continuing
        operations                          62.7                    7.2           55.5          770.8 %        31.0 %         4.0 %
        Loss from discontinued
        operations                             -                   (3.0 )          3.0          100.0 %           -          (1.7 )%
        Net income                    $     62.7      $             4.2           58.5         1392.9 %        31.0 %         2.4 %
        Adjusted EBITDA (a)           $     46.4      $            36.4     $     10.0           27.5 %        22.9 %        20.4 %
        Adjusted EBITDA margin (a)          22.9 %                 20.4 %          2.5 %         12.4 %
        


(a) Please refer to the "Non-GAAP Measures" section for a discussion and reconciliation of Adjusted EBITDA and Adjusted EBITDA margin, a non-GAAP financial measure.

(b) Please refer to Note 2 of the notes to the condensed consolidated financial statements for a summary of adjustments.

Revenue. The following table sets forth certain information regarding our revenues for the three months ended September 30, 2019, compared with the three months ended September 30, 2018.







                                                                                                                              Percentage
                                                                                                                              change in
                                                                                     Percentage           Impact of           revenue on
                                                                                      change in          changes in            constant
                                                                                     revenue as            foreign          currency basis
                                         Three Months Ended September 30,             reported          currency (a)             (a)
                                          2019                     2018             2019 vs. 2018                           2019 vs. 2018
                                                              As Adjusted (b)
                                              (Dollars in millions)
        Revenue:
        Cloud
        Dayforce
        Recurring services          $          109.4         $            82.5                32.6 %             (0.4 )%               33.0 %
        Professional services and
        other                                   34.3                      27.9                22.9 %             (0.3 )%               23.2 %
        Total Dayforce revenue                 143.7                     110.4                30.2 %             (0.3 )%               30.5 %
        Powerpay
        Recurring services                      21.6                      21.0                 2.9 %             (0.9 )%                3.8 %
        Professional services and
        other                                    0.2                       0.3               (33.3 )%           (33.3 )%                  -
        Total Powerpay revenue                  21.8                      21.3                 2.3 %             (1.4 )%                3.7 %
        Total Cloud revenue                    165.5                     131.7                25.7 %             (0.5 )%               26.2 %
        Bureau
        Recurring services                      36.4                      46.0               (20.9 )%            (0.3 )%              (20.6 )%
        Professional services and
        other                                    0.4                       0.4                   -                  -                     -
        Total Bureau revenue                    36.8                      46.4               (20.7 )%            (0.3 )%              (20.4 )%
        Total revenue               $          202.3         $           178.1                13.6 %             (0.4 )%               14.0 %
        


(a) Please refer to the "Non-GAAP Measures" section for additional information on our constant currency revenue, a non-GAAP financial measure.

(b) Please refer to Note 2 of the notes to the condensed consolidated financial statements for a summary of adjustments.

Total revenue increased $24.2 million, or 13.6%, to $202.3 million for the three months ended September 30, 2019, compared to $178.1 million for the three months ended September 30, 2018. This increase was primarily attributable to an increase in Cloud revenue of $33.8 million, or 25.7%, from $131.7 million for the three months ended September 30, 2018, to $165.5 million for the three months ended September 30, 2019. The Cloud revenue increase was driven by an increase of $27.5 million, or 26.6%, in Cloud recurring services revenue, and $6.3 million, or 22.3%, in Cloud professional services and other revenue. The increase in Cloud recurring services revenue of $27.5 million was due to $19.8 million from new customers, add-ons, and revenue uplift from migrations of Bureau customers, net of customer losses; $5.0 million from the migration of Bureau customers; and $2.7 million from increased float revenue related to Cloud recurring services revenue.

The increase in Cloud revenue of $33.8 million was partially offset by a decline in Bureau revenue of $9.6 million, or 20.7%. Of the $9.6 million decline in Bureau revenue for the three months ended September 30, 2019, approximately 52% was attributable to customer migrations to Dayforce. Excluding the impact of migrations to Dayforce, Bureau revenue declined by $4.6 million, or 9.9%.

On a constant currency basis, total revenue grew 14.0%, reflecting a 26.2% increase in Cloud revenue, partially offset by a 20.4% decline in Bureau revenue. Cloud revenue growth reflected a 27.0% increase in Cloud recurring services revenue and a 23.0% increase in Cloud professional services and other revenue. Please refer to the "Non-GAAP Measures" section for additional information on our constant currency revenue.

Cloud revenue by solution. Cloud revenue was $165.5 million for the three months ended September 30, 2019, an increase of $33.8 million, or 25.7%, compared to Cloud revenue for the three months ended September 30, 2018. Dayforce revenue increased 30.2%, and Powerpay revenue increased 2.3% for the three months ended September 30, 2019, as compared to revenues for the three months ended September 30, 2018. On a constant currency basis, Dayforce revenue increased 30.5%, and Powerpay revenue increased 3.7% for the three months ended September 30, 2019. Our new business sales to Dayforce and Powerpay customers comprised approximately 85% of our increase in Cloud revenue for the three months ended September 30, 2019, and approximately 15% consisted primarily of customer migrations to Dayforce from our Bureau solutions. As we migrate our Bureau customers to Dayforce, we typically experience a revenue increase from such customers driven by increased product density on the Dayforce platform.

Float revenue. Investment income from invested customer trust funds included in recurring services revenue was $18.3 million and $15.8 million for the three months ended September 30, 2019, and 2018, respectively. The average float balance for our customer trust funds for the three months ended September 30, 2019, was $3,117.5 million, compared to $2,965.9 million for the three months ended September 30, 2018. On a constant currency basis, the average float balance for our customer trust funds increased 5.5% for the three months ended September 30, 2019, compared to three months ended September 30, 2018. The average yield was 2.33% during the three months ended September 30, 2019, an increase of 22 basis points compared to the average yield in the three months ended September 30, 2018. For the three months ended September 30, 2019, approximately 39% of our average float balance consisted of Canadian customer trust funds, compared to approximately 40% for the three months ended September 30, 2018. Based on current market conditions, portfolio composition and investment practices, a 100 basis point change in market investment rates would result in approximately $18 million of change in float revenue over the ensuing twelve month period. There are no incremental costs of revenue associated with changes in float revenue.

Cost of revenue. Total cost of revenue for the three months ended September 30, 2019, was $113.5 million, an increase of $8.9 million, or 8.5%, compared to the three months ended September 30, 2018. Recurring services cost of revenue for the three months ended September 30, 2019, was consistent with the three months ended September 30, 2018. Professional services and other cost of revenue increased $5.1 million, or 15.7%, for the three months ended September 30, 2019, compared to the three months ended September 30, 2018, primarily due to additional costs incurred to implement new customers.

In accordance with ASC 350, we are required to capitalize certain software development costs. Please refer to Note 2, "Summary of Significant Accounting Policies," for further discussion of our accounting policy for internally developed software costs. Costs related to software development activities that do not qualify for capitalization, such as development, quality assurance, testing of new technologies, enhancements to our existing solutions that do not result in additional functionality, and costs related to the management of our solutions are presented as product development and management expense. The increase in product development and management expense of $3.0 million for the three months ended September 30, 2019, compared to the three months ended September 30, 2018, reflected increases in Dayforce product development efforts, including the build out of our international offerings; and increases in product management labor costs. For the three months ended September 30, 2019, and 2018, our investment in software development was $17.4 million and $14.4 million, respectively, consisting of $8.7 million and $7.5 million, of research and development expense, which is included within product development and management expense, and $8.7 million and $6.9 million in capitalized software development, respectively.

Depreciation and amortization expense associated with cost of revenue increased by $0.5 million for the three months ended September 30, 2019, compared to the three months ended September 30, 2018, as we continue to capitalize Dayforce related and other development costs and subsequently amortize these costs.

The table below presents total gross margin and solution gross margins for the periods presented:







                                                   Three Months Ended September 30,
                                                    2019                      2018
                                                                        As Adjusted (a)
             Total gross margin                          43.9 %                     41.3 %
             Gross margin by solution:
             Cloud recurring services                    70.2 %                     65.8 %
             Bureau recurring services                   71.4 %                     70.2 %
             Professional services and other             (7.7 )%                   (13.6 )%
        


(a) Please refer to Note 2 of the notes to the condensed consolidated financial statements for a summary of adjustments.

Total gross margin is defined as total gross profit as a percentage of total revenue, inclusive of product development and management costs, as well as depreciation and amortization associated with cost of revenue. Gross margin for each solution in the table above is defined as total revenue less cost of revenue for the applicable solution as a percentage of total revenue for that related solution, exclusive of any product development and management or depreciation and amortization cost allocations.

The overall 13.6% increase in revenue outpaced the 8.5% increase in cost of revenue, and gross profit increased by $15.3 million, or 20.8%, as we continued to leverage our investment in people and processes to realize economies of scale, while also expanding our service offerings internationally.

. . .

Nov 07, 2019

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