Automatic Data Processing, Inc. (ADP) Earnings Call Transcript & Summary

Good morning, [indiscernible] business analyst at Deutsche Bank. And we're really excited to have the CFO of ADP, Kathleen Winters, with us to do a virtual fireside chat. Format for the call will be I will ask Kathleen some of the questions. And then from there, you can also enter questions in the portal or you can e-mail me any extra questions to my e-mail at bryan.keane@db.com.

So with that, I'll turn it over to you, Kathleen. And maybe we could just start out and start a little bit kind of high -- big picture here. How would you characterize the recovery? And on the earnings call, I know you mentioned that the pace of recovery slowed a little bit. So maybe we can walk through some of the cadence of kind of where we were from the trough to where we are now?

Sure. Good morning, Bryan, and thanks for having me in this virtual format, and good morning to everyone on the call. It's a great question to start with, kind of starting big picture here. I mean, look, this situation, this economic scenario is really one that no one's ever kind of been through an economic set of events exactly like this before. I mean, obviously, closing down the entire U.S. economy to combat the health crisis is certainly unchartered territory. As you said, look, we saw some really steep declines from an economic standpoint going through the chain of events here back in March and April. And we saw a deterioration in unemployment right up to the point where we had reported our Q3 earnings at the end of April, so significant declines at that point in time. And it seems, it appears that, that was the bottom. We certainly hope that's the case. And since then, we have seen some good economic rebound and employment rebound. You've seen partial reopenings that have been driving some improvement. Obviously, the fiscal support, the PPP program. And so clearly, there was some pretty rapid recovery for a few weeks, starting in early May, coming off that deep trough in April. And we've seen that rebound, and we've seen unemployment -- latest unemployment numbers now at about 8%, obviously not back to pre-pandemic levels but still some good recovery since the trough. But there are still clearly areas of the economy and businesses that have not fully recovered and continue to need help, in particular obviously travel and entertainment and hotels and restaurants and other small businesses. So we do see that it seems the recovery has slowed to kind of a more of a modest pace here and flattened out. I mean you all see the same data that we're seeing. We've used that data to inform our outlook and our guidance for the year. For fiscal year '21, we've planned for a very gradual recovery. The unemployment levels, being at about that 8% level, is probably a little better than what we would have expected, say, 60 or 90 days ago. But certainly, there's still some improvement that's needed to get to what we are assuming the point will be at when we get to the end of our fiscal year, which is Q2 calendar year of next year.

Right. And when I think about pays per control, if I just run through the metrics here, I know it was down about 11% in the fourth quarter, reaching a low, I think, it was mid-teens before exiting the quarter at about down 10%. And then guidance for pays per control is for it to decline about 3% to 4% in fiscal year. And I think the cadence is something like down high single digits in the first half, then maybe negative mid-single-digits decline in third quarter, fall by maybe a positive mid- to single-digits growth in the fourth quarter '21. So -- and I think you just mentioned that translates -- I think you guys were talking about 7% unemployment by June 2021. Just thinking about that cadence and the fact that we're already at 8% for unemployment, are we a little bit ahead of maybe where we might have guided to for pays per control?

Yes. So look, we think this is a really important area for us to be as transparent as we can around the assumptions underlying our guidance and how we're thinking about it. And you're right, we've kind of said anchor on that 7% unemployment by June of 2021, the end of our fiscal year, is kind of what we're tracking to and the assumption that's underlying our guidance. So we want to be as transparent as we can on that. Yes. As I said earlier, we're kind of -- we're at 8% already. So it seems like perhaps there's some -- if you think about our guidance in terms of being -- having that significant pressure in the first half of the year but getting better and better sequentially each quarter until you get to that 7% unemployment. Being at roughly an 8% now, you'd say, "Well, okay, there's favorability there." But remember, there's still continued improvement that has to happen. And while that momentum and improvement has seemed good, it has kind of flattened out. So we've still got a ways to go to get to that point. And while the unemployment numbers are a good indicator, it's not exactly a 1:1 with regard to our pays per control. So we'll be as transparent as we possibly can be as we go through each quarter to share with you what we're seeing in pays per control on a quarterly basis, how that's impacting our revenue actuals and outlook for the balance of the year and then any revisions as we go.

Just on the side note, didn't pays per control have a bigger factor on margin than revenue? Because I know incrementally, it probably doesn't cost you, at least the expense side doesn't cost much to add additional people on the payroll.

Yes, that's right. I mean the pays per control impact in both directions, right? It's going to have that margin flow-through. Because as we're seeing clients' level of employees go down, right, that's obviously impacting our top line. But there's not a lot of cost that comes out with it. And so we'd lose that really high-margin revenue, which has impacted our margin and our margin guidance for fiscal '21. On the flip side, as that comes back, that should benefit as well. But we'll see how that recovery happens.

Got it. Wanted to ask about retention. I know it was down about 20 basis points to 90.5% or 90.5% guidance is for retention and Employer Services to drop about 50 to 100 basis points in fiscal year '21 from elevated out-of-business losses. What type of client losses are you seeing versus previous recessions? And how does that alone impact the retention?

Sure. It's a great question and a critical question. Because when you think about our performance and the way we think about it and as we think about the criticality and the importance of kind of bookings, retention and our profitability levels, so -- and I'm sure we'll get to all of those things here. But from a retention perspective, maybe I'll start with kind of what we've seen during a typical recession, and in particular during the great financial crisis. At that point, during the great financial crisis, we saw retention decline about 120 basis points and then started to recover, but that did take multiple quarters to play out. And also, we saw small business was hardest hit during that. But we're expecting some of the same dynamics this time around, in particular, we're seeing the impact in our small business segment in terms of the pressures there. In Q4, we saw elevated losses with some clients going out of business. We saw some clients maybe perhaps not fully going out of business but suspended processing, stopped processing for a period of time. And the way we -- we do count that as part of our retention metric that as clients stopped processing for a period of time, they're counted as losses. So we certainly saw those elevated losses in Q4. And we're expecting to see continued pressure as we go through fiscal '21, similar to and aligned with kind of what we saw during the financial crisis. We're not expecting it to be as bad as what we saw in Q4. But we still expect there to be some pressure. We do hope that and believe that the worst is behind us. But that pressure will continue for a couple of quarters. And -- but importantly, I call that and we call that kind of the noncontrollable aspect of retention. It's important to think about the controllable aspect and to understand that from a controllable aspect of retention. We're actually doing quite well. In fact, if you look at our pre-pandemic levels of client satisfaction and retention, we have some really, really good momentum. And look, while it's a competitive marketplace, we don't think the competitive dynamics have really shifted as a result of this that much. And we believe we were really well positioned and saw in our numbers in our client satisfaction scores and our retention metrics before the pandemic. And from a controllable aspect, we think that's going to continue. And we think we'll see really good momentum coming out of it.

Helpful. Wanted to move to bookings. I know fiscal year '21 bookings guidance is for negative growth in the first half '21, then flat to positive in third quarter with more substantial growth in the fourth quarter of '21. And I think for the full year, you're talking about flat to up 10% bookings growth. What are the key factors to hit those bookings targets? And how much visibility do you have, given the pipeline?

Yes, critical question. It's something we're obviously hugely focused on and talking about every day and looking at the data every day. Look, it's challenging to forecast bookings in this environment. As you know, bookings can be volatile quarter-to-quarter during normal times, let alone during these times. But we're looking closely at the data and we're looking at the leading indicators. And again, we're forecasting this in the context of what's happened here in terms of the buying behaviors of our clients and prospects having been significantly changed as a result of the environment. We've made this full shift to virtual as our clients have. But quite frankly, we did that pretty quickly and pretty well, honestly. Half -- 1/3 of our sales force was already operating in a virtual environment. So while it wasn't without a lot of effort from a lot of parts of the organization, we've really shifted well to that virtual selling environment. As you know, we saw a substantial decline in the sales activity in Q4. And given the broad reach that we have across industries and across all company sizes, we're really seeing that companies across the board were really stressed with the environment. And across the board, really, we saw that there's really just that focus on operating every day as opposed to prioritizing purchases and switches of HCM solutions, if you will. But since that point in time, we have seen activity levels pick up. And we do expect the environment to normalize. We firmly believe it's not a matter of if, it's a matter of when things normalize and return to pre-pandemic levels. If the overall economic picture improves, we expect to see productivity of our sales force is going to improve. We do, however, think that bookings will still be pressured and challenged in the first half of the year and turn positive in the second half. But will it be better than that? We'll see, I don't know. What I can tell you is that I firmly believe we're well positioned to capture the opportunity as the economy improves and as clients and prospects are more engaged and more willing to engage on these discussions. We're seeing activity levels trend up. So if you look at kind of the data that we have in terms of number of meetings, number of demos being scheduled, we're seeing that continue to improve. So we've seen some positive leading indicators. And we'll keep you updated as we go. We look forward to updating you each quarter as we go through the year.

I know ADP highlighted expected investments, including the sales force. How much is sales force expected to grow in fiscal year '21 versus kind of a normal year?

Yes. It's a great question and a really important strategic topic for us. We think investing through the cycle, in the sales process and investing in product as well, and we'll probably get to that, too, but we think investing through the cycle is critical. It's strategic, it's critical and we're well positioned to do it. We've got the financial strength to do it. And that gives us a great advantage. We've indicated that we are continuing to invest in sales and broadly distribution. That does include growing our sales headcount modestly in a very measured way and particularly as we kind of track and assess what segments of the market are recovering earlier or faster. We're also investing beyond sales headcount, there's other types of sales investment, too, that we continue to do. We're investing in tools and technology to support our sales organization. So we talked about the -- and I mentioned the virtual selling environment, making sure our sales force can operate effectively in this environment. We're making sure that they've got the right technology and the right tools to do online training, to do online coaching so that we can continue to make our salespeople more and more effective and take those salespeople that are newer to the organization and continue to coach and train them and increase their productivity as they go along from a tenure perspective. We've made sure we're investing in things like making sure we can do demos the right way and in a really effective way in the virtual world. So beyond the sales headcount, we continue to invest in tools and in technology, in pricing analytics. And then I would also add ongoing investments from a marketing perspective. We've continued to support our marketing investments. We've kind of done a little bit of a pivot away from kind of broad-based marketing to focus on what we think really resonates well with clients and prospects in this environment, and so to focus on that great expertise and history that we have of compliance and payroll expertise and dependability and ability to provide service to clients. And we continue to invest in our channel partners as well, providing the right technology and ability to participate in virtual demos there. So it's really -- we think, look, the smart thing and the right thing to do from a strategic standpoint is to make sure that we are well positioned for the recovery. We've been through lots of cycles before. We know how to do this. We think it's the right strategy and the smart strategy. And that's what we're doing.

How does the market look between the upmarket, mid-market and then of course, a downmarket and even international? Is there different growth rates happening in each market? And I'm sure the pandemic is probably impacting the most the downmarket, but love to get your thoughts on that.