Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2021 Earnings Call. I would like to inform you that this conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. Thank you. I'll now turn the conference over to Mr. Danyal Hussain, Vice President Investor Relations. Please go ahead.

Thank you, Michelle. Good morning, everyone, and thank you for joining ADP's second quarter fiscal 2021 earnings call and webcast. Participating today are Carlos Rodriguez, our President and Chief Executive Officer, and Kathleen Winters, our Chief Financial Officer.

Thank you, Danny, and thank you everyone for joining our call. This morning we reported results reflecting our continued strong business performance and momentum, with our second quarter revenue and margins both outperforming our expectations, as our business continued to demonstrate resilience in the face of ongoing economic headwinds. We reported revenue of $3.7 billion, up 1% on a reported basis and flat on an organic constant currency basis, with adjusted EBIT margin down 30 basis points. Coupled with a slight increase in the effective tax rate versus last year, the reduction in our share count led to our adjusted diluted EPS being flat versus last year, much better than the decrease we were expecting. During the second quarter, we continued to see signs of improvement in the overall operating environment, which had positive implications for pays per control, new business bookings, and retention. Our pays per control metric performed slightly better than expected, as it improved sequentially to a decline of 6% versus the larger declines we experienced in Q1 and the latter part of fiscal 2020. Underlying employment trends in Q2 were consistent with what we experienced in Q1, with larger enterprises somewhat slower to show improvement but with small and midsize businesses demonstrating a healthy level of hiring. We performed well on employer services new business bookings. Even though bookings declined 7% this quarter, this was well ahead of our initial expectations earlier this year and in line with the revised expectations we communicated last quarter. It's important to point out that our new business bookings for the first half nearly matched last year's half, despite the very difficult environment.

Thank you, Carlos, and good morning, everyone. Q2 was another strong quarter across every major business metric. While we will still see some pandemic-related headwinds for the balance of the year, we are more confident in our outlook given that we believe the toughest part is behind us. Our performance thus far into the year reaffirms the resilience of our business model, the strength of our product, and the ability of our sales and service teams to perform even in the toughest of environments. We remain confident in our ability to execute as we move forward. In the second quarter, our revenues grew 1% on a reported basis, flat on an organic constant currency basis, which is significantly better than our expectations coming into the year and better than even the revised expectations we had as of last quarter. Once again, ES retention rates represented favorability, as did very strong performance from our PEO. We managed expenses prudently while making important incremental growth and productivity investments and delivered margins that were better than our expectations. Our adjusted EBIT was down just 1% despite pressure from a decline in client funds interest. Our adjusted effective tax rate increased 20 basis points compared to the second quarter of fiscal 2020. Our share count was lower year-over-year, driven by share repurchases. As a result, our adjusted diluted earnings per share of $1.52 was flat versus last year's second quarter. Moving on to the segments. For ES, our revenues declined 1% on a reported basis, and 2% on an organic constant currency basis, representing continued sequential improvements driven by record level retention and the more modest 6% decline in pays per control versus 9% last quarter. Client funds interest declined 23% as average yield declined 50 basis points versus last year.

We'll take our first question from the line of Bryan Bergin with Cowen. Your line is open.

Hi, good morning. Thank you. I'll ask two upfront here. So first on bookings, can you talk about the composition of bookings in 2Q versus 1Q? And give us a sense if you can dissect the strongest and weakest demand across client size? And then, just looking at the SG&A level this quarter, can you comment on the drivers of the sequential dollar growth there? I heard the comments on accelerated investment. Is that primarily sales force headcount addition or other areas of spend?

Sure, let me take the bookings part, and I'll let Kathleen talk about the SG&A. On the bookings, and I think some of this is just the lumpiness of the results. There's a couple of things that happened, but it's hard to call it a trend right, because we only really have two quarters of post-pandemic results. But in essence, our mid-market business performed a lot better. Workforce now and the mid-market business did much better in this quarter than in the last quarter. If you remember, last quarter, we mentioned that we got some help from our international business, particularly in multinational deals, and even though that was strong double digits last quarter, it was kind of slightly negative this quarter. In the context of what's happening in Europe, which started to shut down and encounter challenges before the U.S., we're pretty happy with that. Our sales teams over there accomplished a lot in the second quarter, despite sequentially not being as strong as the help we got in the first quarter. We also had really strong bookings in the first quarter in our down-market business, with modest help from client conversions. Additionally, when we have a strong finish to a year, we typically get off to a slower start, and the opposite is also true. When we have a hard year, we tend to have a stronger start. Our bookings are counted at the time of sale, and there's some flexibility in the sales force about when to book a sale. Overall, our momentum in the second quarter in terms of bookings was stronger than in the first quarter, despite what the reported numbers might show. I will let Kathleen talk about SG&A.

Sure. So on the SG&A side, there are a lot of things within that SG&A. But I would think about it this way. From an overall standpoint, we continue to invest in sales, as we've mentioned, and that is both headcount investment, as well as continuing to look at marketing investment. So you have that investment in sales, but you've also got the work we're doing around transformation, which would offset that investment, as well as discretionary cost control which we are very focused on doing. Overall, you've got investments in headcount and marketing, transformation work that we continue to pursue, and discretionary cost control. That does change if you look at or not change, but the SKU first half the second half is a little bit different. We have significant bookings growth in Q4, our expectation, and so of course, that's going to result in higher Q4 selling expense for us.

Thank you.

Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.

Hi, guys. Good morning. Just want to make sure I understood, the employee service bookings for the quarter came in line with expectations, but you guys did decide to raise the full year. So just want to make sure I understand the pipeline and visibility that's causing that raise. And then on retention to record levels. Are you seeing anything in particular on the competition front that is having less of an impact in years past that's driving the higher retention? Thanks so much.

Sure. On the pipeline question, we do have some visibility. But some of this is really about extrapolating momentum, because in the down market, it's really more about headcount and productivity than it is about pipeline in the up market. So we have fair visibility in parts of our business, but in other parts, we base our confidence on experience, productivity metrics, and headcount. Last quarter, we anticipated much better results than expected, and now we have a vaccine rollout that is also helping. The balance of stimulus and economic activity plays a role in our projections as well. GDP numbers are looking strong, and there's tremendous potential for growth as the economy continues to recover. Regarding retention, I would say there are two data points to consider. First, retention has reached record levels this year, as we've focused on improving our product and service. We've seen positive momentum in our down-market and mid-market businesses that aligns with better execution. Second, we're observing improvements in our balance of trade with several competitors over time due to stronger products and customer service. This combination has led to higher retention levels, and we are feeling optimistic about bookings in the future.

Bryan, if I could just interject, the only other detail I'd add is that when we look at leading indicators, including appointments, referrals, demos, and opportunities created, our sales team is inputting leads into the system. All of those are trending better going into the second half than they were before going into the year. So we're feeling very optimistic, as you can tell from the raised bookings guidance. In particular, the digital leads are up significantly. Just wanted to provide that transparency for you.

And then on the retention side, it's clear we have higher-than-ever retention levels. Our products are stronger, and our commitment to moving clients onto our newer platforms has significantly contributed to that. We have made considerable progress migrating clients, resulting in improved retention rates. Moreover, higher retention rates are a result of improved service and execution on our commitments to clients. The competition impact has been favorable for us as we are observing improvements in our balance of trade metrics concerning major competitors. Higher retention rates and growing bookings are clear indicators of our improving market position.

Helpful. Thanks for taking the questions.

Our next question comes from Jeff Silber of BMO. Your line is open.

Thanks so much for taking my question. Two-part question, first is on pricing. I believe it was last quarter maybe the quarter before you talked a little bit about some of your competitors offering pricing concessions. I'm just wondering if that's been continuing. And as a follow-up, I'm just wondering if you're seeing any diverging trends by geography, especially in certain areas where we're seeing higher COVID cases? Thanks.

So, let me take the second one first regarding divergence. Yes, we would expect to see what we have seen because we are large and somewhat insulated from overall GDP and specific geographic challenges. For example, we did see some challenges in Southern California in terms of bookings in the down market and mid-market there. Even so, we're impressed that our bookings are flat for the first half of the year versus last year. There are some locations that faced real headwinds like the Midwest, but other areas are better due to increased economic activity. On the price side, last quarter, we did mention competitors' pricing actions, but we did not see any pricing help at that time. However, recently we have noticed a slight improvement in our pricing, which we generally expect, seeing around 30 basis points of help this quarter. Our normal price increases were paused a few months ago due to circumstances, but we have resumed modest price increases due to the value of additional services we provide at no extra cost to clients.

All right. That's great to hear. Thanks so much for the color.

Our next question comes from Pete Christensen of Citi. Your line is open.

Good morning. Thanks for the question. Nice trends here. Carlos, given the lifted view on ES bookings and retention, how would you characterize some of the trends you're seeing in the tax rate for additional modules and how should we think about the runway for the next two or three quarters? How do you see that evolving, particularly with some of your new R&D developments?

It's a great question because there's still a lot of room for us there. We're very focused on market share and new unit growth. But we don't mind additional share of wallet and additional tax rate because that's helpful too. Our bookings have generally been balanced for many years, about half of it coming from new logos, and half of it coming from incremental attach. As an example, in the mid-market, we're kind of in the 60% to 70% range in terms of a tax rate for things like workforce management. We are doing well not just in our new strategic platforms, but also in products that are less commonly discussed, like retirement services, which show low tax rates. There is significant opportunity for us across all business units, and we remain optimistic about our incremental tax rate.

Great. Thank you.

Our next question comes from Samad Samana with Jefferies. Your line is open.

Hi. Good morning. Thanks for taking my questions. Maybe stepping back for a big picture question a little bit in a time machine. If I think back to the Analyst Day in 2018 and some of the company's key initiatives around the service alignment and taking costs out of the business, and getting to call it mid-20s EBIT margin. I guess aside from the world being very different with what happened with COVID. But I'm curious Carlos if you could just think as far as those initiatives went and getting the margin structure of the business toward that. Would you say that were ex what happened with rates and what COVID? Would we be in that shape today? And I guess, maybe thinking forward, how should we think about the structural margins of this business post recovery? And can it be at those long-term levels that we talked about before? And then I have one follow-up.

Yes. Let me give you a little bit of color on that because, again, I was doing my homework last night. I think our margin in '18, which you would have seen in that Analyst Day, was 20.7%. We’re now forecasting for fiscal year '21, around 22.3% to 22.5%, which is well ahead of what we talked about at Analyst Day, excluding significant headwinds from COVID and client funds interest. Therefore, the overall picture for margin is positive, and while revenue has faced difficulties, it’s transitory, not an existential threat. We expect to return to growth and margin enhancement on track with our expectations.

Just to clarify, Samad, our formal margin expectation is 22.0% to 22.5%.

Great. Thanks, I appreciate. And as a follow-up on that on the booking in this quarter and just as you think about bookings for maybe the next couple of quarters. When you think about the performance, is there a way to think about it, in terms of driven by field reps versus digital inbound through marketing? Are there channels that are doing better or worse in terms of bringing more customers into the top of the funnel and driving new bookings?

Yes, I think I'll tell you what…

Maybe I'll just interject before Carlos responds to that one. One important thing to note is we've seen record leads coming through digital marketing now. We've increased our investment in digital marketing cautiously, ensuring we're getting appropriate ROI. Our strategy is to meet the clients where they want to be met and pursue every possible channel, including increasing our digital marketing investments.

Your comment earlier summarized well, the business is definitely performing much better than it looks, due to the client funds interest headwind impacting both margin and revenue growth. However, we have record leads that will contribute positively to future bookings. Our sales force has modern tools to compete effectively, and will adapt to any necessary changes in client interactions, whether digital or face-to-face. We will be ready to meet the needs of clients across various channels optimally. Digital marketing has provided us impressive leads that we'll continue focusing on.

Great. Thanks again for taking my questions. I really appreciate the thoughtful answers.

Our next question comes from Kartik Mehta with Northcoast Research. Your line is open.

Good morning. Carlos, you talked about net gains. I'm wondering if that's related strictly to ADP having a better set of products, or is that related to the competition doing something else? And just my second question, you've talked a lot about the sales process. And I'm wondering if you believe afterward, through this pandemic, with vaccinations done, that fundamentally if the sales process will change, and that you'll use more digital versus face-to-face? Thank you.

I'm aligned with other CEOs that, though our company operates across many market segments from down to up market, I think we will see a return to face-to-face meetings in some respects, especially for sales meetings. However, there have undoubtedly been new techniques learned that could remain relevant. Statistically, prior to the pandemic, only 10% of the workforce worked from home, and this rose to 33% at the peak. The expectation is that this will not revert back entirely to where we were, but there will be a hybrid presence in how we operate. Returning to your first question, net gains are due to a combination of ADP providing a better set of products and certain incremental client preferences impacted by the pandemic, which we can't wholly quantify. I can say that strategic platforms are growing very well against competitors, which is encouraging.

Got it. I appreciate it. Sounds very optimistic. Thank you.

Our next question comes from Mark Marcon with Baird. Your line is open.

Hey, good morning, and thanks for taking my questions. Questions regarding Next Gen payroll and Next Gen HCM. Can you provide more color on Next Gen Payroll regarding the number of clients that have been sold? What percentage of the existing Workforce Now base has been converted? What are you seeing in terms of satisfaction once it's in place? And then my follow-up is on Next Gen HCM, what does the outlook look like for new sales and bookings?

Thank you for the question. The outlook on both Next Gen Payroll and HCM is quite positive. On Next Gen Payroll, we have approximately over 200 live clients and over 500 sold. It's possible that up to 25% of the sales acquired thus far for Next Gen Payroll may not have been attained without it. Satisfaction rates are high, indicating positive momentum. For Next Gen HCM, we have begun implementation in Mexico using a federated development process, onboarding clients in an impressive timeframe. This approach shows our capability to scale effectively. We anticipate a robust future for both platforms as our teams work to drive further adoption and success.

Got it. I appreciate it. Sounds very optimistic. Thank you.

Our next question comes from Kevin McVeigh with Credit Suisse. Your line is open.

Great. Thank you. Hey, Kathleen, you talked about the digital transformation a couple of times. We're in argue kind of in that process. I think the last number you'd referenced was about a $150 million benefit. Is that still the way to think about it in the $150 range? Or does that get accelerated based on some of the investments in your portfolio as a result of the Q2 outperformance?

Yes, Kevin thanks for that question. That $150 million estimate follows. It's our expected benefit for the current fiscal year from digital and transformation efforts. We are in early innings for this journey, with initiatives intended to remove work from the system. Some efforts are accelerating, while others could take longer to implement effectively. We continue to build a pipeline of projects to enhance our operational efficiency across all facets of the business.

And just one quick follow-up. How does that impact your addressable market, because I'd imagine it probably expands it in terms of average client size, things like that? Is there any way to frame what the transformation is going to mean in terms of addressable market longer-term?

That's a good question, and it’s something we consider carefully. While we think we can address more clients effectively with our innovative digital products, the overall impact in the down market could expand our reach, providing a more end-to-end solution. In the up market, our acquisition of Celergo strengthens our position. With new platforms, we aim to satisfy complex client needs we previously could not accommodate. All of this signifies a growth in our addressable market and paves the way for future gains.

Yes. The digital work we’re doing aims to improve from a top-line as well as from an efficiency standpoint. Whether it's through expanding our addressable market or reducing sales cycle time, we expect substantial benefits across various business units, enhancing overall service quality, driving retention, and boosting our operating margins.

We have time for one more question. And our last question comes from Tien-Tsin Huang of JP Morgan. Your line is open.

Thanks so much. Good results and I appreciate the very clear guidance as well. Just a question and a follow-up or clarification. Just on the KPIs, Carlos, that you're most focused on the second half. Just hearing everything you talked about, positive revisions to retention and bookings. I'm curious, if there are any underappreciated KPIs at this point of the cycle that we should be tracking to gauge the sustainability of the improvement that you're talking about, as we get through the second half of the year? And just a clarification, I think you touched upon it in the last comment here. Just the 25% of sales of Next Gen payroll that would not have been attained without it. Are you - are those clients on a cloud platform that are looking for a cloud like the controls and whatnot that you're talking about that was the condition for considering? I'm just trying to understand why they didn't consider it before it if that makes sense?

Yes, listen, I think unfortunately, I don't have that level of detail I'm afraid to say. Our sales force is closely monitoring the rollout of Next Gen platforms. They believe that 25% additional logos were secured as a result of Next Gen Payroll. There are likely multiple factors for that increase, including product enhancements, compliance support, and service improvements that we've introduced to make ADP more attractive to potential clients compared to competitors. Regarding KPIs, the traditional metrics such as client retention, new bookings, and overall productivity are crucially important. Still, I would point out that when we analyze productivity per sales rep and service productivity, we observe a direct correlation between productivity and our sales and service associates' effectiveness. Tracking these can offer insights about future revenue growth and operational efficiency.

Very clear. Thanks so much.

This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Carlos Rodriguez for closing remarks.

Well, I think I mentioned already that it's hard to imagine where we were just a quarter ago. Because I think on the same call a quarter ago, there was no vaccine, there was no stimulus approved, and there was no new administration in Washington. We were still waiting for or looking forward to an election. So, besides all of the great things that our associates are doing in terms of execution, our sales force and all of our associates, in terms of helping our clients through this and helping each other, I just thank God for where we are today versus where we were last quarter, because we know now, I think we knew some of us knew that we would be okay eventually. But now, we know for sure that we're going to be okay in terms of our friends, our families, but also our economy and I think our companies and the things that we also value on the professional side. So, very excited about the prospects of getting through the next month or two, which I know are going to be challenging for all of us, but also looking forward to much better times ahead; to plenty of pent-up demand, to growth and productivity, to strong GDP, and all the great things that are going to happen once we finally defeat the virus and move on. So I would just close by saying thank you to the scientists, the pharmaceutical companies, and everyone else who got us to where we are today and that continue to move us forward as a country and as a globe. And I appreciate you all joining the call and listening to us today. Thank you.

Ladies and gentlemen, this does conclude the program, you may now disconnect. Everyone have a great day.