Earnings Call Transcript
AUTOMATIC DATA PROCESSING INC (ADP)
Earnings Call Transcript - ADP Q2 2022
Operator, Operator
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 2022 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 will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. To withdraw your question, press the pound key. Thank you. I will now turn the conference over to Mr. Danyal Hussain, Vice President, Investor Relations. Please go ahead.
Danyal Hussain, Vice President, Investor Relations
Thank you, Michelle and welcome everyone to ADP’s second quarter fiscal 2022 earnings call. Participating today are Carlos Rodriguez, our CEO, and Don McGuire, our CFO. Also joining us for Q&A is Maria Black, President of ADP. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC’s website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today’s call. During our call, we will reference non-GAAP financial measures which we believe to be useful to investors and that excludes the impacts of certain items. A description of these items, along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today’s call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. With that, let me turn it over to Carlos.
Carlos Rodriguez, CEO
Thank you, Dany, and thank you everyone for joining our call. We’re pleased to have delivered strong second quarter results, including 9% revenue growth, 20 basis points of adjusted EBIT margin expansion, and a 9% increase in adjusted diluted EPS, all ahead of our expectations. It remains a very dynamic and challenging business environment for our clients and prospects, but we believe the value of working with a trusted ACM partner with more than seven years of expertise is more compelling than ever, and we see evidence of this reflected in our continued sales momentum as well as our very high levels of client satisfaction and retention, which continue to drive upside to our results. As usual, let me start with some highlights from the quarter. Our employers services new business booking results were strong despite the onset of the omicron variant at the end of the quarter. We experienced a record Q2 booking level and like Q1, we were pleased to be ahead of pre-pandemic sales productivity levels. We experienced robust double-digit growth in nearly every one of our ES businesses, and as we saw earlier in the year, we experienced even stronger performance in our PEO segment, where demand is especially robust. As we outlined at our November investor day, the pandemic and the dynamic macroeconomic environment have made running HR more challenging for our clients. Today our clients navigate a tight labor market across their organizations, higher than usual worker turnover, new legislative requirements, and in many cases staffing challenges specifically within their payroll and HR departments. The strong broad-based demand across our ES and PEO segments reflect the fact that clients of all sizes are increasingly looking for greater levels of assistance and expertise to help address their needs, in some cases seeking our intuitive yet comprehensive software offerings while in other cases seeking a more fully outsourced solution. We believe we provide extraordinary value through all business environments, and today’s environment supports a continuation of a positive decades-long secular trend in global HCM. Moving onto employer services retention, we are pleased to have experienced continued strength. Although our retention in the quarter did decline very slightly versus last year’s elevated level, it declined by less than we had anticipated and would have represented a record Q2 if you were to exclude last year’s pandemic impacted retention levels. With overall client satisfaction once again reaching a record level this quarter, this strong retention is not surprising to us. Moreover, early January results look strong, giving us greater confidence for the rest of the year, and we are pleased to be raising our retention guidance once again. Our ES pays per control metric came in slightly better than expected at 6% growth in the quarter. We are very pleased to see the U.S. unemployment rate back below 4%, which reflects the U.S. economy’s ongoing improvement and resulting strong demand for workers. Meanwhile, labor force participation is gradually recovering and as it does, we should continue to benefit from higher than usual pays per control growth. Over the first half of the fiscal year, we’ve tracked ahead of our expectations and are now raising our pays per control outlook for the full year. In the second quarter, our PEO had stellar performance once again and was well ahead of our expectations with 15% revenue growth and 16% average worksite employee growth, representing acceleration from last quarter despite a slightly harder growth comparison. Across the board strength in our PEO continues to be driven by several factors, including better than expected retention and bookings contributing to client growth, better than expected hiring within the PEO client base, further adding to worksite employee growth, and better than expected wage levels further adding to revenue growth. While some of these tailwinds will normalize over time, we remain very confident in the outlook of our PEO business over the coming years. During our November investor day, we also outlined key aspects of our growth strategy by product and by business unit, and we are confident about sustaining healthy growth in our fast-growing businesses and optimistic about accelerating our growth in our businesses that continue to transition to our most modern offerings. One aspect of our growth strategy that we discussed is an overall greater focus on marketing, which we believe will allow us to better activate our existing scale distribution. We believe at ADP, we can deliver a lot of incremental value from tactical investments, and we look forward to sharing more in the very near future. One key product initiative we talked about during investor day that cuts across our businesses is the development of a new unified user experience, and in the second quarter we were pleased to have made further progress on this effort. As a reminder, we shared last quarter that we moved our Run client base over to the new ADP UX, and now only a quarter in, early indicators suggest that clients are in fact finding it more intuitive, resulting in fewer client service contacts. In Europe, we have been gradually transitioning our client base over to our award-winning IHCM platform, and in Q2 we seamlessly moved those clients over to the new ADP UX. We’re now very excited that just this month, we began our pilot of the new ADP user experience for Workforce Now, which when coupled with our next-gen payroll engine makes for an even more differentiated offering for what is already a market-leading HCM solution in this target market. In terms of a few other highlights, I’m pleased to share that we reached a new milestone by running 1 million pay slips for a single client on a single day for the first time. At the other end of the spectrum, our Roll mobile app, which serves the micro-segment, continues to outperform our initial expectations. In another milestone in calendar 2021, the ADP mobile app had over 1 billion log-ins, highlighting the growing amount of direct engagement we have with employees and managers around the world. To that point, this month our return to workplace mobile solution, part of the ADP mobile app, was awarded the Business Intelligence Group’s 2022 Big Innovation Award. As a final highlight, just this week we launched our bill pay feature in the Wisely app. Bill pay is free to Wisely users and fully integrated into the app, and has been a top requested feature from our user base. We believe this addition will further drive engagement and retention, and we look forward to continuing to expand the Wisely ecosystem. Overall, Q2 represented a solid outcome on both the financial front as well as with respect to key strategic initiatives. I’d like to thank our associates who continue to deliver these exceptional products and outstanding service to our clients, and I’ll now turn the call over to Don.
Don McGuire, CFO
Thank you, Carlos, and good morning everyone. In the second quarter, we delivered 9% revenue growth on both a reported and organic constant currency basis. Our adjusted EBIT margin was up 20 basis points, better than planned, and supported by our better than expected revenue growth, offset partially by increased PEO pass-throughs and headcount growth in our implementation and service organizations. I’ll share more on this last point when I discuss our outlook. Our tax rate was up slightly in the quarter versus last year, driven by the lapping of a one-time international tax benefit we experienced last year. When including the benefit from share repurchases, we had a 9% increase in our adjusted diluted earnings per share. Moving onto the segments, our employer services revenue increased 6% on a reported basis and 7% on an organic constant currency basis. In addition to the strong bookings, retention trends, and pays per control performance Carlos outlined, our client funds interest grew for the first time since the pandemic started as lower average yield was offset by a tremendous 28% balance growth. This growth included some benefit from the lapping of last year’s deferred employer social security taxes and incremental benefit from the repayment of a portion of those employers’ social security taxes, which together contributed several points of growth in addition to the already robust growth from higher client count, employment growth, and higher wages. Our ES margin increased 40 basis points, ahead of our expectations for the quarter and supported by better than expected revenue performance. Moving on, our PEO continued to deliver exceptional performance with 15% revenue growth in the quarter. Average worksite employees accelerated to 16% year-over-year growth and reached 660,000 for the quarter. Key contributors were strong bookings and retention, as well as very healthy pays per control growth within the PEO client base. Revenues excluding zero-margin pass-throughs grew 18%, which was driven by worksite employee growth as well as higher average wages and higher SUI revenues per worksite employee. PEO margin was down 10 basis points in the quarter. Included in that figure was pressure from workers’ comp and SUI expenses due primarily to worker mix and wages. Moving on to our updated outlook for the year, for ES revenues we are narrowing our guidance and now expect growth of about 6%, the upper end of our previous guidance range of 5% to 6%. The primary drivers for our higher outlook are the stronger Q2 performance, our higher client funds interest outlook for the year, and higher pays per control growth, partially offset by an expectation from incremental FX headwind in the back half of this year on the recent strengthening of the U.S. dollar. For our client funds interest revenue, we’re raising our outlook by $20 million to a range of $440 million to $450 million. Like last quarter, we’re raising our balance growth assumption meaningfully to now expect growth of 18% to 20%, whereas our client funds yield expectation is unchanged despite the improvement in interest rates. This is primarily because our stronger than previously expected balance performance creates a temporary lag with greater short term investments before we purchase higher yielding fixed rate securities. For U.S. pays per control, we’re raising our outlook by 1% to now expect 5% to 6% growth. We continue to expect that a gradual ongoing recovery in labor force participation will support job growth, and the first half of the year was a bit ahead of expectations. In addition to client funds and pays per control, we are raising our retention guidance slightly and now expect it to be down 40 basis points for the year. Although we still anticipate some normalization in client switching activity, trends so far this year have been very positive, and January is looking like a continuation of that same strength. One thing we’re not changing at this time is our ES booking guidance. As Carlos outlined, our Q2 performance was strong, but bookings is one place where the evolving pandemic conditions and the omicron variant has potential to create noise, as we saw at the outset of the pandemic. Although we haven’t seen a material impact at this time, we still think it’s prudent to maintain a wide range of outcomes in our guidance. For our ES margin, we are making no change to our outlook of up 75 to 100 basis points. Although we are raising our revenue guidance and although some of that is coming from high margin revenues, like client funds interest and pays per control, at the same time we are now more fully caught up on implementation and service headcount after running a bit behind earlier this year and late last year. This investment in implementation and service teams is critical both because the current year-end period is important to our clients and their employees, and also as we look to get ahead of the needs of our growing client base. With the continued outperformance in retention, we’re now planning to grow our implementation and service teams slightly more than we had previously planned as we exit this fiscal year. In addition to this growth in personnel, we also took one-time compensation actions across our organization in recognition of broader inflation trends in the market. The incremental expenses associated with those actions are now included in our outlook. Although this tight labor market has created its own set of challenges for most companies, we are very pleased to have been able to grow our organization as much as we did these past few months, and the wage increases we layered in give us confidence regarding our staffing levels at a busy time of year. We are also pleased to have been able to support those changes without detriment to our existing guidance ranges. Moving onto the PEO, following the strong first half trends in both client growth and worksite employee growth, we are now expecting average worksite employees to grow 13% to 15%, and we are likewise raising our guidance for PEO revenues and revenues excluding zero-margin pass-throughs by two percentage points each. Our outlook will continue to be sensitive to employment trends within our PEO client base, as well as bookings and retention performance, so although we are currently contemplating growth to be a bit lower in the back half of the year, we could continue to see upside if the current robust trends persist. For PEO margin, we are making no change to our guidance of flat to down 50 basis points for the year. Although we are raising our revenue guidance, we are at the same time expecting higher SUI and workers’ comp expenses to create offsetting margin pressure. Putting it all together for our consolidated outlook, we now expect revenue to grow 8% to 9%. For adjusted EBIT margin, we continue to expect an increase of 50 to 75 basis points. As we shared earlier this year, we expect our margin improvement to be concentrated in the fourth quarter and expect our margin to be down in Q3, particularly following the recent personnel growth and wage increases. We’re making no change to our tax rate assumption. With these changes, we now expect growth in adjusted diluted earnings per share of 12% to 14%. Thank you, and I’ll now turn it back to Michelle for Q&A.
Bryan Keane, Analyst
Hi guys, congrats on the results. Just wanted to ask on the impact of omicron, especially in December and January. Is there any noticeable impact in sales or retention, or anything that you’d call out particularly from the rise that we’ve seen from the virus and omicron?
Carlos Rodriguez, CEO
I believe you heard in our prepared statements that the answer is no. Reflecting on the quarter, omicron began to surge in mid to late December, and it’s remarkable how swiftly things have changed. Currently, it seems like we are on the downswing in the northeast U.S., which indicates a quick shift. However, we didn’t observe any significant impact in the quarter we just reported. Now that we are in the next quarter, it’s challenging to discuss it since we are only three weeks in. You may have seen various reports, including one in the Journal regarding the IMF potentially lowering global growth projections, partially due to omicron, among other factors. We recognize that we are not immune to these economic ripples, including those from omicron, but so far, we haven't witnessed a substantial impact. Most forecasts for annual GDP growth remain consistent, suggesting slight decreases in first-quarter GDP growth predictions, likely pushing activities forward. It appears that in the coming weeks, things will start to normalize in some areas, leading to a rebound in economic activity as anticipated by several economists. To summarize, we haven’t experienced any major declines in demand or economic activity, although we remain cautious about potential economic influences. For instance, when our associate population travels less, it affects economic activity overall—fewer people driving or dining out can have a ripple effect. However, we have not observed any significant drops in demand or activity based on our numbers yet.
Bryan Keane, Analyst
Got it, that’s helpful. Just as a follow-up, I wanted to ask about the strength in the balance growth - it was up 22% last quarter and up 28% this quarter. I'm curious if you consider how much inflation could be influencing that figure, along with any other notes. I'm aware you raised the guidance, but I'm just surprised by the strength there.
Don McGuire, CFO
Yes, we have had some growth. Certainly wages were a little bit of that, but also as we said in the prepared remarks, the big driver was the lapping from last year with the deferral, so certainly the deferrals represented a few points in the growth of those balances in the quarter, although even the deferrals were only for a few number of days towards the end of the month of December. Certainly we look at those, but as we said, we do expect the balance growth to continue and we expect it to be firm based on the pays per control and the increase in number of people working for our clients. I think that’s the biggest driver.
Carlos Rodriguez, CEO
In terms of a refresher, there’s a social security tax deferral. Not everyone lives day to day like us, but it was a significant part of the stimulus package, and those social security deferrals need to be repaid in two installments. We just completed the first repayment, which positively impacted our balance, and the second half is due by December 31 of next year. That's something to consider, as it could support our balances moving forward.
David Togut, Analyst
Thank you, good morning. Could you unpack demand trends, looking at Run, Workforce Now, and Vantage HCM in the quarter and what’s embedded in your 12% to 16% ES bookings growth outlook? As a follow-up, if you could comment on your recent announcement that you’re expanding Workforce Now with international functionality, what sort of traction do you expect to see there? Thanks.
Maria Black, President
Yes, good morning, this is Maria. Thanks for the question, David, happy to comment on both. With respect to the overall performance in the quarter, as was stated in the prepared remarks, we had strong double-digit growth that did really go across our scaled offerings, specifically in the down market. We saw the strength in our Run platform, we saw the strength in our retirement solutions, definitely experienced strength in the Workforce Now platform. I’ll cover off on your second question as well as we get to the press release that we just issued. Additionally in the second quarter, we also saw strength in GlobalView, so very happy with our international contribution to the quarter, so that was really the strength across the double-digit growth that we saw in employer services. As it relates to the Workforce Now press release that I think we issued in the last couple days regarding the offer that now is on a global basis, the ability for our U.S.-based and Canadian-based companies to process payroll on the Workforce Now platform across multiple countries, in partnership with our Celergo offering. Very excited to have this offering, as you could imagine. Over the course of the last decade but certainly in the last couple years, the ability for mid-market customers to really be able to support international employees on their end is a growing demand, and we’re pretty excited to be able to satisfy that demand with this new offer.
Kevin McVeigh, Analyst
Great, thanks so much. Carlos, I think you talked about improvement in retention against a still challenging environment overall. Can you maybe reconcile those comments a little bit because, all things equal, I would think tougher environment, maybe you have a little bit more pressure from a client perspective. Can you unpack that a little bit?
Carlos Rodriguez, CEO
Yes, we've been discussing for several quarters that it's not necessarily a tougher environment in general, but rather tougher comparisons. Our understanding was that we benefited from some advantages during the pandemic, particularly in terms of client retention. There was a decrease in clients switching services, and bankruptcy rates also dropped significantly, which contributed to retention levels. Government stimulus and reduced switching helped enhance our retention metrics. Additionally, our Net Promoter Scores and overall client satisfaction have remained very high. It's challenging to differentiate these factors, so we anticipated a slight decrease in our retention rates since those favorable conditions won't last. We've observed some of this in the current market. Although our down market SBS has decreased slightly compared to last year, other areas are performing well, and overall results are better than we had expected. The real question is whether we can maintain this performance. Our goal is to keep everything intact, and that’s why we're focused on ensuring that we provide the right level of service and implementation. If we meet our retention forecasts for the year, which looks promising compared to our original plans, it will significantly affect our long-term growth and value creation for the company.
Kevin McVeigh, Analyst
That’s very helpful. Could you remind us what the rate sensitivity of 25 basis points means? I was also surprised to see the increase in the extended investment strategy, as I thought there would be more of a lag effect. Given how long we’ve been in a rate cycle, I’m curious about the dynamics of client funds in relation to the extended investment.
Don McGuire, CFO
I will begin by addressing the second question regarding the rate environment and its implications for us. Generally, when fund balances rise quickly, we need to invest in short-term items or instruments until we can invest in longer-term options. This means we often do not see as much improvement as we would prefer. However, if there were a 25 basis point increase in the rates of our short-term investments, it would result in approximately $9 million of EBIT over a year, which isn't a significant amount. Conversely, if that increase also applied to intermediate-term investments, it would have a greater impact—about $23 million before taxes over the same period, which is certainly meaningful. As we consider investing those funds for the long term and with rates moving in a more favorable direction, we see some potential for the future. Nonetheless, we do not anticipate a substantial increase in client fund interest for the remainder of the second half, which we have already discussed in today's forecast.
Carlos Rodriguez, CEO
Kevin, could you clarify the question on the extended portion, where specifically you’re focused there?
Kevin McVeigh, Analyst
I guess just the dynamics of the client funds interest revenue versus the extended investment strategy, what the timing difference is on those two in terms of when you’d see it, because obviously you saw a little bit of benefit from extended investment in term of the outlook, not as much on the client fund side, but is there a timing element to the extended versus the client funds.
Carlos Rodriguez, CEO
If we're discussing balance growth, the extended strategy's growth is more closely linked to the fluctuations in cash flows from one year to the next. It relates to our forecast of what the minimum balance will be for the year compared to our average balance, which differs from the forecast for client funds. Over the long term, yes, the extended balance should grow in accordance with the client funds balance growth, but in the short term, year-to-year variations introduce quite a bit of noise. This is primarily what accounts for the difference rather than the lag effect. The lag effect mentioned relates more to the growth in client fund balances. When there is significant growth, we sometimes struggle to reinvest quickly due to the number of available opportunities in the market that meet our desired credit quality. However, within a few quarters, we can catch up; it's just a matter of how swiftly we can deploy additional funds. The straightforward takeaway regarding our strategy is to consider what's occurring with yields, overall balance growth, and the net impact of our client fund strategy. Looking at that aspect, the outlook appears positive. For instance, our reinvestments in Q1 yielded about 1%, and in Q2, 1.5%. We see similar trends in the market. The shifts in the two-year and five-year rates are even more notable than in the ten-year rates. For us, when we refer to long-term investing, we're talking about three, five, or seven years, not beyond that, due to our portfolio investment approach. In this context, the environment regarding wage inflation, balance growth, and rising interest rates is very favorable. While we aren't ready to make predictions for 2023 and 2024 yet, there is considerable discussion around short-term mechanics, as many are focused on the immediate future. However, our focus is more on the long term, and we might experience several years of tailwind from increased client funds interest.
Kevin McVeigh, Analyst
You’re going to have a high-class margin problem, Carlos.
Carlos Rodriguez, CEO
Yes, listen - I’ve been waiting 10 years. I had hair when I started as CEO, and I remember telling the treasurer at the time, rates have to go up next year, and then next year I said rates have to go up next year, and here we are. But this time, dammit, I’m right!
Tien-tsin Huang, Analyst
Thanks so much guys, good morning. Really good results, better base control, looking at better retention, in-line bookings, raising balance growth, and all that good stuff. I think of all of these as positive forces for margin expansion, right, so you’re keeping the margin the same, so is that just a function of the costs you discussed, or is that some conservatism as well? Just trying to better understand that.
Carlos Rodriguez, CEO
Well if the question is about conservatism, I’ll let Don handle it.
Don McGuire, CFO
I believe we have a solid forecast ahead of us, and I'm not overly conservative in our approach. It's important to note that we increased our revenue projection by $150 million compared to the previous forecast, while also raising our expenses by $115 million. If we analyze those expenses, the $115 million increase includes $48 million related to PEO pass-throughs, which is contributing to a drag on our margins. Without that factor, our margins would likely be better, but that's the reason we haven't improved more in that area. Overall, I think we've done a commendable job of incorporating these elements into our guidance and solidifying our expectations.
Tien-tsin Huang, Analyst
No, for sure. It’s very good.
Carlos Rodriguez, CEO
Just one other thing, I think we should also add to your point in terms of tone, we want to make sure we’re clear here that we’re not insulated from the world. There is no question that there is pressure on costs, particularly around wages, and we are a technology services company so we have costs around R&D and so forth. We also have costs around the service side of our business, and you’ve heard in the prepared comments that Don mentioned that we’ve taken some actions that are what I’d call mid-cycle, so not the typical annual wage increases, because we felt we needed to do something to make sure that we held onto our people and that we were attracting the right kinds of people, so we are doing some things. Now, the good news on the other side of that coin, which I’m assuming will come up later as a question but may as well address it now, like some other industries but not every other industry, we do have a fair amount of, and the industry has shown, demonstrated historically and, I think, there are some recent signs from competitors that pricing is more elastic than in many industries. This is not a commodity business, and there’s a fair amount of room. The problem is you have to exercise that room very carefully because you want to remain competitive, and on and on and on. You’ve heard that story from us for many years too, that we really want to win in the market, we want higher retention rates, so we can’t just go around willy-nilly passing through price increases, but the fact is we can and we will if it’s driven by market forces and cost increases that are experienced across the board. We’re confident that our competitors will do the same thing, and some of them already are.
Tien-tsin Huang, Analyst
You answered my follow-up on pricing. Thank you Carlos. Thank you Don.
Samad Samana, Analyst
Hi, good morning. Thanks for taking my questions. I wanted to maybe circle back to the PEO business and the strength there, it continues to perform really well. I was curious, can you remind us, when we think about the source of new bookings for PEO, how much of it is new to ADP for the first time versus conversions of potential existing customers in the SMB side of the base that you’re upselling over to PEO? How should we think about the source of new bookings?
Carlos Rodriguez, CEO
I think it’s been pretty consistent for a long time at around 50%, right?
Maria Black, President
That’s right.
Carlos Rodriguez, CEO
It’s about half, that we kind of mine our own. It’s a combination of mining our own clients, but we also mine our own sales force. Our sales force is able to bring in obviously new clients straight onto the PEO, but we also have a very large installed base that, as you alluded to, we mine. I think it’s 50/50, if I’m not mistaken. It hasn’t really changed that much over the years.
Samad Samana, Analyst
Great, that’s helpful. As I consider the consolidation of the user base onto a single interface, there are clear advantages for users. How should we evaluate the potential positive impact on gross margins as more users transition to this unified interface, especially in terms of service and maintenance costs going forward? How might this develop in relation to gross margins?
Carlos Rodriguez, CEO
I believe that's a valid point. We are implementing several strategies aimed at standardizing our processes to achieve greater efficiency, and this is certainly an area where we've seen potential improvement. Historically, ADP's research and development were somewhat fragmented, but since my predecessor, we've focused on becoming more cohesive. Enhancing user experience offers a clear opportunity for us to improve our competitiveness and allocate our resources more effectively, which should also yield some benefits on the back end in terms of margins. However, I wouldn’t say that margin improvement is the main focus. There will be some positive effects on margins and efficiency, but the primary goal is to excel and provide the best products with a strong market presence. This is crucial because, today, it's not just our clients who interact with our products; their employees are also engaging with them, particularly through our mobile app. Therefore, the user experience significantly impacts engagement.
Samad Samana, Analyst
Great, helpful. Congratulations on the solid results.
Carlos Rodriguez, CEO
Thank you.
Bryan Bergin, Analyst
Hi, good morning, thank you. First, I want to follow up on retention. Can you dig in a little bit more about the underlying drivers, so out of business closures versus competitive switching behaviors? When you think about the 40 basis point year-over-year decline you forecasted, how much is due to a pick-up in that closure rate versus competitive losses?
Carlos Rodriguez, CEO
Most of the issues stem from the down market and the normalization of economic factors, such as closure rates. While "closure rate" may not be the perfect term, it falls into the category we monitor, which includes both uncontrollable and controllable losses. Controllable losses pertain to service and product issues, while uncontrollable losses include obvious factors like bankruptcies and businesses shutting down. During the pandemic, not only did bankruptcies decrease, but all categories of uncontrollable losses also fell. Although there has been some normalization since then, it hasn’t fully returned to pre-pandemic levels. We can confidently highlight our excellent service and solid NPS scores, despite some normalization trends in the down market. In other areas, our retention rates are strong and improving, often better than in previous years. We are less tolerant of excuses regarding normalization in these segments because they are not as sensitive to economic fluctuations, and we now understand the potential for retention in mid-market and international segments, with international consistently performing well and our goal to sustain high retention levels. However, it would be naive to disregard economic factors and normalization in the down market, and this is reflected in our forecast.
Bryan Bergin, Analyst
Okay, makes sense. Then just on the PEO strength, so the sequential increase in worksite employees was really notable here. Can you just dig in a little bit more? I heard better units, so better retention, better bookings, but does seem like there’s been a release or a tipping point here around clients converting to this model. Can you just talk about that?
Carlos Rodriguez, CEO
Yes, we’re really excited about the progress. To clarify on the pandemic comparisons, we did experience some challenges in PEO sales. While we are optimistic and performing well, it's not at the same level as last year in ES. We noted that the average client size has decreased somewhat, and wage growth has been modest, which affects PEO sales more than ES. However, the trend is now reversing; client sizes are increasing with new bookings, which is significant, and wage growth is positively impacting PEO. This doesn't affect ES as much since billing isn't based on wages like it is in PEO. There are several tailwinds assisting us, but the key point is the strong growth in average worksite employees, which remains solid despite inflation and wage growth. This success is also supported by an increase in average client size for new business bookings. While the growth is encouraging, it's important to note that we are returning to levels seen before the pandemic, and we aim for a growth rate of 1% to 2% going forward, though currently, it's exceeding that.
Ramsey El-Assal, Analyst
Hi there, thanks for taking my question today. I wanted to ask you about your HCM products and the cross-sell opportunity into your base of payroll customers, sort of an update in terms of where you are there and whether you could potentially accelerate that process.
Maria Black, President
Yes, so happy to comment on our HCM products and how our sellers go to market to drive the combination of new business bookings between new logos as well as add-on business, our HCM products from an attached perspective. As you can imagine, a lot of the investments that we’ve spoken about for several years in existing products, a lot of the investments that we’re making into our existing platforms - we just talked about the new UF and the impact that’s making in our down market and will continue to make, coupled with the investments that we’re making into our next-gen products, are all investments that are anchored in a belief that we can continue to expand the offerings to our existing clients as well as new clients. Excited about the execution on each one of these initiatives and the impact that it will make to our bookings and the mix of bookings between new logos and HCM products attached.
Carlos Rodriguez, CEO
Our attach rates are generally strong, especially in categories like workforce management, which we previously referred to as time and labor. These products typically have high attach rates, while others vary. Looking ahead, our opportunity lies not only in acquiring new clients, which is a major focus for us to increase market share, but also in expanding our share of wallet. Currently, our penetration in many product categories is still relatively low.
Don McGuire, CFO
Yes, there are always various opportunities being evaluated. Although recent weeks have posed challenges for some companies, we have not altered our objectives. Our goal remains to ensure that any potential pursuit fits within our portfolio, whether through geographical expansion or by filling a product niche. We will continue to adhere to these guidelines. If certain opportunities become more affordable and fall within these categories, we will definitely consider them more seriously than we might have a few months ago. Carlos, would you like to add to that?
Carlos Rodriguez, CEO
No, all I was thinking was that in some cases, if people pay us, we’ll buy their companies.
Ramsey El-Assal, Analyst
All right, fantastic. I appreciate it. Thanks so much.
Mark Marcon, Analyst
Good morning everybody, and congratulations on the quarter. I was wondering, could you give us a couple of updates with regards to some of the products? In terms of next generation pay, to what extent has that been further rolled out? What’s the update there?
Carlos Rodriguez, CEO
I would say we had a really good first year end. When you look at the midmarket, which is the next generation pay, it's currently being sold in part of what we refer to as the core midmarket, specifically in the range of 50 to 150 clients. I believe we are selling between 20% and 25% of our new businesses on the new platform, and we anticipate being generally available by the end of the calendar year.
Maria Black, President
This calendar year, that’s right.
Carlos Rodriguez, CEO
End of calendar year, so that’s kind of what we talked about at investor day. I would say that, call it December-January sales season, because a lot of those clients, they want to start clean on January 1, so it’s a fairly important point of the year in terms of judging where you are in terms of sales results and so forth, and we had a fairly good, I think, number of starts. We were happy, I would say, with the early January, late December, what I would starts results - in other words, those are clients that we sold previously, that we got started and we have up and running. We try and avoid getting into specifics of how many clients, because then every quarter you guys are going to ask us, but I’d say that that’s going really well and we’re on track for this GA by the end of the calendar quarter, and then we had a good start season for end of December, beginning of January.
Mark Marcon, Analyst
That's great. It seems like one of your initial comments, Carlos, emphasized the breadth of Roll, mentioning that it's performing well on the lower end while also noting that one client experienced a million transactions in a single day, which is certainly impressive. Could you provide us with an update on Roll? Now that you have some experience with it, how much more optimistic are you about its potential and your ability to penetrate that micro segment of the market? Additionally, how does your capacity to serve companies globally and at a large scale enhance the upper end of the market?
Carlos Rodriguez, CEO
We are quite different from most companies because we are completely focused on HCM and serve various segments and regions, which gives us a unique position. It's important to stay enthusiastic about each segment. For example, Roll is a thrilling opportunity in its specific market. On the other hand, we have clients with massive operations; one client has a million employees, and we processed their payroll and a million paychecks in a single day. To match that volume, we need many smaller Roll clients, and while they are excited about their growth, Roll also plays a significant role in ADP's expansion and competitiveness in the marketplace. It’s hard to make direct comparisons because, like having multiple children, you have to appreciate each one. I believe all our segments, including Roll in the down market, GlobalView in the up market, are performing well, and we’re optimistic about our opportunities in each. I'm trying to provide a clear answer. It’s genuinely exciting because the growth rate for Roll is impressive, and if we were a startup, we would be sharing impressive rates. However, Dany has advised against it because, at this moment, it's not significant for a $15 billion company, yet it holds promise for the future in five to ten years.
Mark Marcon, Analyst
I was trying to point out that when you first introduced Roll, you presented it modestly, but it seems to be gaining significant traction now. I'm curious if you could share your perspective on how large that could potentially become.
Carlos Rodriguez, CEO
It’s definitely gaining good traction, and we’re excited about it. However, I don't want to exaggerate its significance because we have a large organization, and it's important to consider how everything fits together in our forecast. In terms of dollar impact, I want to emphasize that this product and segment are competing with certain competitors. We feel optimistic about our potential in gaining market share and growth, but it’s crucial not to view this as something that will significantly boost ADP’s growth rate by one to two percentage points on the top line in the next year or two. Unfortunately, that’s not how it works mathematically. All of these elements need to come together—next-gen payroll, next-gen HCM, Roll, GlobalView, Celergo, and PEO—to reach our target numbers. We believe we manage our portfolio effectively, and the combination of all these businesses achieving varying degrees of success contributes to the results we are reporting and forecasting.
Eugene Simuni, Analyst
Thank you, good morning. Congrats on another strong quarter, guys. Wanted to ask about Wisely and your general personal finance product strategy. You highlighted the bill pay offering in your prepared remarks. Can you just remind us what are the next big milestones for this overall strategy, and I know it’s a small part of your portfolio, but will you at some point maybe start providing some metrics that can help us track the growth of this area like some businesses like that provide, such as number of cardholders, frequency of transactions, the amount spent, and so on?
Maria Black, President
Yes, so happy to comment on the overall Wisely product strategy and where we’re heading with the opportunity - it’s incredibly exciting for us, and then we can talk through what those metrics could be to give some solid basis of growth over time. As it relates to the overall MyWisely app and the strategy we have within the Wisely portfolio, it is really a strategy that is anchored in financial management. That financial management in the app happens through education, budgeting, savings tools, rewards. What you heard today, which you just mentioned as well, which is the launch of our bill pay feature, we believe is significant. It’s exactly what we all probably use with respect to any type of an online bill pay, where you can scan the check and actually facilitate end-to-end bill processing through a mobile device, so that is all part of the MyWisely app and the overall financial management strategy - think financial wellness, etc. that we’ve employed. In addition to that, the other thing that’s forthcoming is the launch of our early wage access, our EWA as we refer to it, which is really that ability for our clients’ employees or employees to gain access to wages that they’ve earned as they earn them, so this is also a big piece to the overall equation with respect to the overall Wisely. Things that we’re monitoring actively right now, back to the question around how many cardholders, etc., certainly we’re looking at that. We’re looking at other types of what type of cardholders are using what feature functionality. There is some data that you could look at as it relates to how many reviews we have on the app, the quality of the app certainly supersedes some of the competition in the space. We’re pretty proud of the impact that our financial wellness tool, MyWisely app is creating in the market. I’ll let Dany or Carlos comment on cardholder tracking and when and if we’ll disclose that.
Carlos Rodriguez, CEO
Yes, we see that as a key takeaway for us. We'll consider other suggestions and aim to be open-minded about our disclosures. However, this conversation about Wisely is different from the one about Roll. While we're excited about both, Wisely represents a much larger opportunity than Roll. That said, given the size of ADP, Wisely doesn't rank as our top priority for driving overall results. With a diverse portfolio, there are numerous factors that need to align for us to achieve growth on $15 billion. I estimate that this business contributes around 2% or 3% of our total revenue, or even less. We appreciate the growth and know it's happening at a faster pace than our overall average. Although the topics you're inquiring about are relevant and could positively impact ADP's growth rate, it would be misleading to overemphasize their importance, as some might have done relative to their own companies. For us, there are many other critical factors that must align. We shouldn't create hypothetical numbers based on an unrealistic scenario of having 100% of our clients using the card. That approach would be distracting and unproductive, as it's unlikely to happen overnight and may take time. Nonetheless, we will consider how we can provide you with more information about Wisely's progress, which we find exciting, but it's important to recognize that other aspects of our disclosures, such as pays per control and new business bookings, are more significant drivers of our results.
James Faucette, Analyst
Thank you very much, and good morning. Most of my questions have been answered, but I wanted to talk just a little bit about, or ask about strategy. In the past, you’ve mentioned customer service capabilities being a differentiator related to SaaS players. How should we think about the persistence of differentiated service levels as your own AI capability grows in importance and we look at the future of self-service initiatives may cause your own services and service levels to look more like traditional SaaS players? I guess I’m just wondering how we should be thinking about that strategically and what the implications are in the business. I recognize it probably fits well within a few of your most recent comments, like it takes a while to move the needle, but would love to get a sense of where you think you’re going in those areas.
Carlos Rodriguez, CEO
It's a great question because it's a topic that not only the management team discusses but also the board, as we clearly see the opportunity there. We have several advantages starting out, such as having a wealth of data, which can be utilized for more automation, whether through AI, machine learning, or other technologies. Having this information is crucial for monetizing our services and adding value for our clients. We have dedicated significant time to this effort and recently appointed a chief data officer to oversee all our data initiatives, ensuring we effectively utilize our resources to create advantages for our clients, allowing us to retain them longer and offer them more products. From simple tools like chatbots to advanced AI, we've already implemented various solutions, many of which we have shared through press releases and at our investor day. Nonetheless, there remains much more potential for growth in this area. This is a significant opportunity for us, and, as previously mentioned regarding disclosure, we need to improve how we communicate our progress and the ways we are leveraging this potential, as it will be meaningful for ADP over the next five to ten years.
Jason Kupferberg, Analyst
Thanks guys. I just wanted to start with the EPS guidance for fiscal ’22 - I guess we’re going up 1% at the midpoint, so call it $0.06. Just breaking that down, it looks like the raise in the float income expectations is about $0.04 of that, and presumably the rest revenue outlook. I just wanted to see if that math is correct.
Carlos Rodriguez, CEO
That sounds pretty good. The key takeaway is that we are investing, and this is not the first time you’ve heard this from ADP. The opportunity in front of us is significant; our bookings are growing and the economy is performing well despite the turmoil in the stock market. This environment is favorable for us, and we are preparing accordingly. You can expect this to lead to long-term improvements in our growth rates and margins. Please don’t be distracted by short-term fluctuations; if it seems like we haven’t significantly raised profits, you’re probably right. However, we’ve been discussing how we are keeping pace with wage growth, and we have pricing strategies that we have yet to implement. We’re not a company that panics, so we won’t suddenly raise prices on our base. We will wait for appropriate times to adjust prices naturally, and we won’t delay actions on wages and hiring until that happens because that wouldn’t make sense. We’re a well-run company and if there’s a timing issue by a quarter or two, that’s acceptable. We believe our situation is still quite strong. Considering the inflationary pressures we face, we’re proud of the results and growth we’re achieving. However, we are indeed feeling more pressure on expenses now compared to about 18 months ago. This is typical during comparisons, especially after the pandemic when we cut expenses by being very careful with hiring. Our revenues didn’t drop as much as anticipated, but now we need to ensure we are adequately staffed, factoring in rising wages as well. Overall, we feel confident in our execution and performance, and that’s how the numbers align with your observations.
Jason Kupferberg, Analyst
Okay, those are all good points. Just last one from me, I wanted to see if you could elaborate a little bit on the competitive landscape, just what you’re seeing down market, midmarket, enterprise-wide. Interested in just any changes in the mix or the aggressiveness of any competitors across the spectrum. Thank you.
Carlos Rodriguez, CEO
Given our competition across various segments, it's difficult to make a broad statement. Some of our competitors only operate within a single segment, making it challenging to generalize. Overall, I think things are business as usual. While it may not sound exciting, we’ve recently focused on a few partnerships that are proving beneficial for us. However, there are also others gaining ground. Generally, the market environment remains stable, and it seems like the industry has numerous growth opportunities, with everyone trying to capture their own share while also competing for each other's share. Overall, it's a positive landscape.
Maria Black, President
I concur. I would echo the sentiment on the overall HCM space and the environment, and I don’t think anything has materially changed. But we certainly intend to continue to win our fair share and more.
Jason Kupferberg, Analyst
Okay, I appreciate that. Thanks guys.
Carlos Rodriguez, CEO
Thank you. Regarding the current economic conditions and market dynamics, which we don't monitor closely on a daily basis, we've had some discussions and inquiries regarding capital allocation and structure. Personally, I'm very focused on the dividend, and it's interesting that no one has asked about it. It seems like the dividend is not a priority for anyone at the moment, but we might be moving into a time when it becomes relevant again. Perhaps one day I will receive a question about the dividend. We are currently in our 47th year of consecutive increases in dividends. If we look back over the past 10, 15, or even 20 years, considering the stock's cost basis and today's dividend yield, this company has been remarkably profitable. While capital gains are certainly significant, the focus shifts as market conditions evolve. I'm not hoping for a market downturn, as it impacts us just like everyone else, but I appreciate ADP's competitive positioning, our solid balance sheet, our dividends, and our capital allocation strategies. However, what I’m most proud of is our associates. As we move further from the pandemic, and despite challenges like omicron, we're in a much better position now than before. We wouldn't be where we are without our associates. Early in the pandemic, we were definitely understaffed since we had to manage expenses while workloads increased due to all the government regulations aimed at providing support. This surge in regulations created significant work for fewer employees, and I am incredibly grateful for those who stepped up during that challenging time to support our clients and help us get through. I’m proud that we have fulfilled our commitments, playing an important role in keeping parts of the economy functioning, alongside other essential services. Our associates deserve all the recognition for their contributions. Thank you for listening, and we look forward to our next discussion in the upcoming quarter.
Operator, Operator
This concludes today’s conference. You may now disconnect. Everyone have a great day.