Earnings Call Transcript - ADP Q1 2023

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 First Quarter 2023 Earnings Call. I would like to inform you that this conference is being recorded. 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 first quarter fiscal 2023 earnings call. Participating today are Carlos Rodriguez, our CEO; Maria Black, our President; and Don McGuire, our CFO. 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 exclude the impact 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. And with that, let me turn it over to Carlos.

Carlos Rodriguez, CEO

Thank you, Danny, and thanks, everybody, for joining the call. As you saw this morning in the news, we have a little bit more excitement than normal, but I promise you that in one and a half hours, we'll go back to our boring selves because we do have a business to run. But before I talk about the quarter, I thought it was appropriate to just share a few thoughts given the transition from me to Maria as our new CEO. As you know, I'm going to continue as Executive Chair, but obviously, that's going to be a role primarily supporting Maria and also helping the Board and not really being involved in day-to-day operations. So it's definitely going to be my last earnings call, which is hard to say because it’s been 44 earnings calls for me. But it's really been an incredible ride. Obviously, I could thank a lot of people. One person in particular that I do want to call out is John Jones, who is going to remain our Lead Independent Director. The combination of John and Les Brun before him were incredible mentors to me, incredibly helpful in providing advice and guidance on behalf of the Board. I'm also proud to call them friends. I also want to thank Gary Butler and Art Weinbach, my predecessors who gave me the opportunity to be here today and also helped me a lot in terms of making me the person I am and the leader that I am today. I'm proud of a couple of things. I'll just mention a few. One of them is I'm proud of our growth. We doubled our revenues over the last 10 or 11 years. Today, we reached an important milestone of 1 million clients. It's a great thing to have happening here on my last earnings call. We made it through a lot of challenges, economic challenges, including financial repression in terms of interest rates, which fortunately now we have a little bit of the opposite situation, which we'll talk about today. We made it through a pandemic that hopefully only happens every 100 years, and we had some dissident shareholders that also had some opinions about how to run ADP that we had to deal with. I'm proud of our associates. I'm proud they've always shown their commitment to our clients and to ADP. It’s remarkable, and our associates always step up to the plate and deliver. We do keep the economy going, and we do make sure that commerce worldwide operates smoothly. Our associates are the ones who get that done, and I'm proud of them. The person I'm most proud of is Maria. She has been tested, she is prepared, she has been through a very thoughtful and long succession process, and she will be only the seventh CEO of ADP. I know she is the right person starting from the ground up. Most importantly, she knows our industry, and she knows our clients' needs deeply, and that will serve us well for growth orientation, which I think will be important for ADP's future. The last thing I'll say is that I recently told our team that I strive to be a servant leader. And I want all of you to know that I tried to be that way for our shareholders, clients, and associates. It's been truly an honor of a lifetime to serve as ADP’s CEO. We like to fly under the radar, and I know that nobody is going to write books about us, but this is one of the most successful commercial enterprises in history. I encourage you to look at our history and compare it to some of the greatest investors and investments of all time. I feel like I joined a championship team and won the Super Bowl being here at ADP. But right now, it's time to pass the torch. It's always great to have change, especially in a company like ADP because I know you can rely on our consistent, predictable results. But we also have to continue to grow for decades, and that's exactly what we're doing with Maria. So before I talk about the quarter and the results, I'm going to turn it over to Maria and let her say a few things.

Maria Black, President

Thank you, Carlos. You mentioned servant leadership, and I have to say that you are truly the embodiment of servant leadership. You have always kept our North Star true, which is putting our clients and our associates first. I know I speak on behalf of all our stakeholders, our associates, shareholders, the communities we serve, and the 1 million clients we now have the honor of serving. Thank you for everything that you've done over the decade that you served as our CEO. I'm truly humbled and grateful for this opportunity and certainly for the confidence that you and the Board have given me in this role. I am genuinely thrilled to lead ADP. You mentioned it, and it's true. I started with this company 26 years ago, selling ADP's products door-to-door. This experience gave me a true understanding of the client centricity that we embody as a company. Since selling door-to-door, I've served in roles across ADP in sales, service, implementation, operations, including our PEO and SBS. I'm really proud of our role in our clients' lives and how they trust us to help them succeed in their HCM journey. For the last 73 years, we've had an amazing legacy and a culture anchored in innovation and in developing technology and solutions that help address our clients' needs. I'm committed to empowering our dedicated 60,000 associates who make everything happen. I also want to thank the stakeholders and the Board for your confidence as we continue to build on ADP's strong results-oriented foundation, drive product innovation, and deliver consistent value creation that we're known for as the leader in the HCM industry. So with that, I think it's appropriate to turn it over to the results this quarter.

Carlos Rodriguez, CEO

Thanks, Maria. Speaking of consistent value creation, let me start talking a little bit about the results here so we can get to the questions. We got off to a really strong start in fiscal 2023, with strong results that reflected the momentum we've been building for several quarters now. In Q1, we delivered 10% revenue growth, 11% on an organic constant currency basis, driven by strength in several of our businesses. We delivered 30 basis points of adjusted EBIT margin expansion as our revenue outperformance helped us overcome elevated expense growth from last year's first quarter as well as continued investments in the business, which we anticipated and communicated to you last quarter. We delivered 13% adjusted EPS growth in the quarter, and we remain well-positioned as we move ahead for the rest of the year. I'll cover a few highlights for the quarter before I turn it back over to Maria. Our new business bookings showed continued momentum through Q1 with demand strongest in our downmarket offerings like RUN and our retirement services businesses. We also continue to see strong traction in our PEO solution. At the same time, bookings growth in our international business started a bit softer than we had hoped. We're continuing to watch the demand environment in international markets as clients and prospects deal with a number of uncertainties. Overall demand remains strong, and our pipeline looks solid. Our ES retention was at a record level led by great performance in our mid-market. We accomplished this year-over-year improvement despite normalization in small business rates. We assume normalization in out-of-business rates towards pre-pandemic levels as the year progresses, and we are very pleased with the Q1 results that were better than expected. Our pays per control metric was 6% for the quarter, in line with our expectations as strong hiring by our clients was reflected in strong pays per control growth this quarter. I believe we will see deceleration in pays per control growth later this year, and we've noted slowing employment growth. But job postings and leading indicators suggest strong short-term demand for labor will persist. Moving on to our PEO, we saw a modest deceleration in average worksite employee growth, which was expected, but 12% growth was slightly ahead of our expectations for the quarter. Our HRO businesses combine to serve over 3 million worksite employees. As I mentioned earlier, we crossed the 1 million client mark during the quarter. What an incredible accomplishment. We accomplished this by driving improvement and growth through different employment cycles and technology shifts. It's a proud moment made possible by our relentless focus on meeting our clients' needs. Looking ahead, we recognize the need to remain agile in this unique economic environment. We hope for inflation normalization without significant harm to the economy. If macroeconomic conditions prove more challenging, we believe our stable business model will allow us to maintain our focus on innovation and long-term sustainable growth.

Maria Black, President

Thank you, Carlos. As I mentioned earlier, I'm proud of the collective efforts of our associates who made this achievement possible. One of the beauties of having 1 million clients and directly serving 3 million worksite employees is that we have unparalleled insight into HR department needs, and we are putting that insight to work. I'm proud to share that, in September, we won the top HR product at the annual HR Tech Conference for the eighth year in a row, this time for a new offering we're calling Intelligent Self-Service. HR departments today devote a significant amount of time to addressing questions from their workers. Intelligent Self-Service uses predictive analytics to proactively address common issues. This solution ultimately improves the experience for workers and allows HR practitioners to focus on more strategic items. There are a few different components to Intelligent Self-Service. The first is action cards, which alert workers of necessary actions in the ADP mobile app. A second component is our virtual assistant chatbot, expanded to workers to address their requests. The third piece is case management, which helps with more complex problems requiring HR systems. Intelligent Self-Service aims to create a better HR experience and we believe it can reduce our clients' case volume by 30% or more. We've rolled out some components and are getting positive feedback. I also want to provide a Q1 update on our new user experience. Last year, we moved clients on RUN, iHCM and Next Gen HCM as well as the ADP Mobile app over to the new user experience. I’m pleased to share we've taken the client base from 20,000 to over 80,000 through the end of Q1 with essentially all Workforce Now clients on this new experience. These outcomes we hoped to achieve with the user experience work excite us, and we are continuing to roll out enhancements to more solutions within our key platforms. From our voice of employee offering to our new Intelligent Self-Service capability, our product teams are busy and clients are excited about the continued innovation at ADP.

Don McGuire, CFO

Thank you, Maria, and good morning, everyone. Our first quarter represented a strong start to the year with 10% revenue growth on a reported basis and 11% growth on an organic constant currency basis. Our EBIT margin was up 30 basis points, coming in above expectations as strong overall revenue growth overcame inflation-related cost pressures. Our robust revenue and margin performance drove 13% adjusted EPS growth for the quarter supported by our ongoing return of cash to our investors via share repurchases. In our Employer Services segment, we grew 9% on a reported and 11% on an organic constant currency basis. This growth was driven by strong bookings and retention performance delivered in recent quarters and solid contributions from price and pays per control. The client funds interest, which primarily benefits the ES segment, grew nicely with 39% driven by balance growth and improved yield. We now expect ES segment revenues to grow 7% to 8%, with key assumptions including ES new business bookings expected between 6% and 9%. While we are seeing stable demand, we remain cautious in light of potential slowing global economic conditions. Meanwhile, we aim to maintain strong retention levels in our other business units. In terms of our PEO segment, revenue grew 13% in the quarter. Average worksite employees increased 12% year-over-year. Let me now turn to our updated outlook for fiscal '23. We expect consolidated revenue growth of 8% to 9% this fiscal year and adjusted EBIT margin expansion of 125 basis points to 150 basis points. We still expect our effective tax rate for fiscal '23 to be about 23%, and we now expect adjusted EPS growth of 15% to 17%, supported by our steady share repurchases.

Peter Christiansen, Analyst

First, congrats to Maria. Looking forward to seeing your touch on strategic vision here and certainly to Carlos for such a successful tenure as CEO, particularly through some volatile events in the last couple of years. I just had a question about bookings trends. If there's any color on any differentiating trends you're seeing at this point of the year, could you attach rates or ancillary changes in behavior?

Maria Black, President

Thank you, Pete, and thank you for the well wishes. I certainly appreciate them. We feel confident in our overall bookings outlook at 6% to 9%. In the first quarter, we were technically pleased with the results, which were a record from a year-on-year perspective. The strength we saw in our downmarket offerings, including our RUN portfolio, small business segment, and our insurance and retirement offerings has been consistent. However, we are keeping an eye on our international business, where we feel demand remains stable. When we look at that the international space, there’s more pull-forward impact from our record Q4 that we need to rebuild our pipeline. Thus far, we don’t see macro trends impacting demand, so we remain optimistic about the strength continuing in downmarket and across HRO and PEO offerings.

Don McGuire, CFO

With respect to pricing, we've been happy with our pricing execution. We're mindful of the incremental costs for our clients. We're pushing towards the upper end of our expectation for price increases, around 100 basis points to 150 basis points. If we look at our client base, particularly with larger clients, there are contractual obligations that limit our ability to raise prices significantly, but we've executed well across the business.

Tien-Tsin Huang, Analyst

Congrats, Carlos. I want to ask if the focus might be more so on the employee now in addition to the employer, in addition to modernization, maybe data? Just some thoughts there would be great.

Carlos Rodriguez, CEO

That was for you, Maria, given that I'll be sitting on the beach.

Maria Black, President

Thank you for the chance to comment. It's early days in our long-term strategy. I have spent eight years as part of the management team Carlos alluded to earlier, and that has been on an incredible modernization journey. The focus is on client centricity, ensuring that our clients are satisfied and their employees thrive. My goal is to make sure that our products and experiences have our clients singing about ADP, and I believe we're well set up for that journey ahead.

Kevin McVeigh, Analyst

Why is now the right time for this transition? You've done an amazing job and you're still young. Thoughts on timing?

Carlos Rodriguez, CEO

It’s a good question. The transition planning started long ago, as I identified the timing opportunity aligning leadership with long-term goals. There is an optimal point where new ideas continue to flow, and it's better for the organization. This was a collective decision made with the current Board and recognizes the importance of strong leadership.

Kartik Mehta, Analyst

I'd like your thoughts on the economy. Looking at your results, is it correct to think everything is doing well?

Carlos Rodriguez, CEO

We obviously don't have the market cornered on economic forecasts. It's essential to be cautious as economic forecasts can mislead. Over these years, our business model has proven to be resilient; we perform better in some conditions than others. However, labor remains strong, and our clients are looking for tools to manage their workforce.

Jason Kupferberg, Analyst

Can you provide more details on your Intelligent Self-Service offering and timelines for reducing customer service costs?

Maria Black, President

I’m glad you asked. The 30% improvement is about capturing time for our clients by leveraging predictive analytics to optimize capacity for HR. We're just starting to see some early results and we'll track progress as we roll out this product.

Don McGuire, CFO

The first quarter's pays per control growth of 6% was higher than expected. We anticipate moderation later on, reflecting typical seasonal fluctuations, but we are cautious about gauging full-year trends.

Carlos Rodriguez, CEO

The beauty of our business model is that bookings drive revenue. We anticipate strong revenue based on established bookings from prior quarters. It's important to recognize that not selling widgets, we will not see cliffs in revenue. If we have a strong pattern and strong revenue growth where prior bookings contribute significantly, we may not have immediate issues with slowdowns.

Bryan Bergin, Analyst

Can you expand on bookings trends in your pipeline? Notable changes you've noticed recently?

Maria Black, President

Healthy pipelines are evident, with deal cycles reflecting a return to pre-pandemic norms. There's stability as the demand for HCM remains strong and pipelines are robust.

Carlos Rodriguez, CEO

It's really satisfying to see strong execution in our mid-market management retention rates. The mid-market's performance underlines our ability to adapt and succeed regardless of returning economic conditions.

Danyal Hussain, Vice President, Investor Relations

Ultimately, it seems the down market did not contribute significantly to our retention success in Q1. The mid-market performance appears to be the larger impact.

Samad Samana, Analyst

Regarding Workforce Now's new UX transition, can you explain its economic benefits? Are they reflected as cost reductions or improvements in retention?

Maria Black, President

Yes, it impacts satisfaction, retention, and sales efficiency. It influences multiple economic outcomes. The overarching expectation is improved performance based on the new UX enhancements.

Don McGuire, CFO

The laddering strategy we've employed has served us well in varying interest rates. We're cautious about making changes but expect strong returns on our current portfolio.

Carlos Rodriguez, CEO

I appreciate the consideration of stability over making significant moves based on potentially volatile short-term conditions. It’s essential to maintain our long-term strategy while navigating through these conditions.

Mark Marcon, Analyst

Can you talk about how you're prepared for current fall selling season? What improvements could increase PEPM?

Maria Black, President

We do feel confident, especially with increased headcount and productivity. Our new user experience, product enhancements, and strengthening of our value proposition are pivotal as we move forward in the selling season.

Carlos Rodriguez, CEO

Thank you all. This will be my last earnings call after 44 of them. I've enjoyed being a part of this historic commercial journey with ADP. I appreciate all contributions from our team, and I look forward to supporting ADP in future endeavors.

Operator, Operator

Thank you for participating in today's program. You may now disconnect. Everyone, have a great day.