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

Really great to see everybody in person. It's amazing. So thanks for coming in. My name is Tien-Tsin Huang. I cover the payments, the processors and IT services sector. And I was just telling Carlos Rodriguez, President and CEO of ADP, really appreciate him always supporting the conference and I do value the time and it's really so nice to see him. So Carlos, welcome. Thanks for being a part of the event.

Thanks for having us. It's great to see people -- human beings.

No, it really is. It's a different feeling so...

And particularly good to see you.

Likewise, likewise. And like I said, I mean it, like Carlos coming to all these events. It's good to have him back. We're going to do a fireside chat. I took a lot of questions from investors. So hopefully, we can get through all of those. We'll have a little bit of time at the end to take your questions live. So well, just raise your hands if you're ready for that. We have Maria and Danny and the audience as well. If they'd like to chime in, feel free. So let's get right into it, Carlos. If that's all right.

I think I'd start, if you don't mind, with the obligatory macro question. ADP sees a ton from a macro perspective. So love to hear what you're seeing on the ground from an employment standpoint, from a demand standpoint, where are you optimistic and where do you think a little bit caution is warranted?

Sure. So as you mentioned employment, obviously, the lens that we have is through what's happening on the employment side, but it's a pretty important part of what drives the macro. And I think there's good news, there's bad news and there's good news. On the good news front, when we just reported last quarter 7% pays per control growth, which is kind of our measure of same-store growth of our clients in terms of employment, that's really a sign that the economy is on solid footing for now. So obviously, we're all reading the same headlines, but the growth is -- and demand is still there for people. Obviously, the demand for people is related to demand for goods and services. So it feels to me like the economy is strong. But that brings us to the second part, not so good, which is inflation obviously is prompting the Fed to take action here that I think most of us who have been around for a long time would hazard to guess it's going to slow down the economy. So we're preparing ourselves for that. Some of that is good for us. Obviously, interest rates going up helps us with our float income. I'm sure you'll have a question or 2 about that. But the inflationary pressures on wages are also real. It's real for us, for ADP, as well. We have 60,000 people to deliver our services and build our products and so that's putting pressure on our costs. So there's obviously the negative from inflation, but that pressure on wages, the shortage of people, low unemployment rates, all those things are, kind of full circle back to the positives, are really good for us in terms of creating demand for our products and services. And as you know, bookings really is the key to our success in terms of being able to grow long term. So net-net, I think it's a good backdrop for us and a good environment. But for sure, there are some caution signs on the road here with inflation that have to be dealt with.

Good. So let's -- before we dig into how that might play out for the rest of the year, the quarter, Carlos, was very, very strong. I know stock reacted well. What were some of the 2 or 3 things that stood out? You mentioned bookings. Do you want to talk through some of that?

Sure. Well, we'll start with, I'd say bookings, retention and I think I already mentioned pays per control. So that tells you something about the underlying strength of the business and I think of the macro, that's a really nice tailwind for us. So that is an obvious strength. But the other surprising strength was retention. We'll get to bookings in a minute. But client retention has held up a lot better than we really expected. And when I say we really expected, we didn't know what to expect because this is -- it's not like we've had other pandemics that we've been through. So this improvement in retention that we had, we suspected that some of that we'd have to give back. And the good news is we haven't given back very much of it. We've given back some of it in our downmarket business, where we have the most economic sensitivity in terms of out of business, bankruptcies, et cetera. But as you know, that's also been a source of strength for the economy: low bankruptcies, not a lot of out of business, a lot of capital out there. Again, that could shift and it could change. But for now, it's been a positive. But the strength in the other parts of our business in the mid-market, the upmarket, international in retention have been really good news for us. I think some of it is probably we underestimated the positives of some of the transformations we've done around client migrations to newer platforms. We still have some work in some areas, but in some places we finished that work several years ago and the pandemic probably created some noise where it was difficult to see what the end state was going to be. But the end state is feeling like it's better than it was pre-pandemic from a retention standpoint. So you've got to knock on wood because it's definitely a volatile environment, but that was really encouraging, the near record retention even now 2 years after the pandemic started, which clearly raised retention because of lower switching rates. But I think now people, if they want to switch, they can switch, but they're not. They're staying with ADP. So I think that's a good news story for us. And then bookings is the last category. Having double-digit bookings growth is huge for us. As you know, the difference between our bookings and our losses is really what goes into the top of the funnel to create revenue growth. Revenue growth creates operating leverage and margin opportunity. So it's as you said, I think the quarter was all good. It's hard to pick in anything.

So just to dig in on retention, I've got a lot of questions from investors they asked me to ask you about that. You mentioned upgrading the platform so that should drive up more stickiness. Maybe there's a shift towards outsourcing that's also contributing to retention. Is there a way to rank some of the factors? You talked about it briefly, but in your mind, what's here for good? What's structural?

The good news is it's hard to rank because I find my experience is that if there's one thing, that thing might not last. And if it's a lot of things, that's better news. And I think it's a lot of things. Another thing that I think is happening that maybe some of the folks that are asking you may or may not be recognizing is -- and this is probably happening in other industries. But if you're in an industry where you're, in our case, we're outsourcing, we're helping people with HR, payroll, all those back office challenges and they're having trouble hiring people and retaining people, they come to us. Now of course, we have the same challenge of hiring and recruiting and retaining, but we have a little bit of an advantage because we do this for a living and we have some leverage in terms of having people work, which we have, a little harder over time, et cetera. So we have a relative advantage, I think, in terms of being able to find the resources to actually get the work done. And with 3.5% unemployment, I think that many companies find themselves in a tough spot where they're not only trying to find people to wait tables, to do work in their factories and -- or even white collar jobs, but they also have all these back-office tasks that they have to worry about, too. So it's just one less thing to worry about. And I think this is an environment where I think more people will look to outsourcing, and I think that's happening. I think you also have other factors that are more structural like the fact that we completed the migrations of our clients in our mid-market. Now mid-market is a big business for us. It's very profitable. And we went through several years of instability as a result of what we were doing, which was the right thing strategically long term but very painful in the short term, which was to move to our or newer platforms in the mid-market. But we finished that in 2018 and we were beginning to see -- I think we were saying it on some of the earnings calls, we were beginning to see traction in terms of retention and bookings also picking up. Our balance of trade against competitors was getting better and the pandemic hit. And then you really can't compare anything. You lose all comparability. But now as we kind of go back to more normal times, I think some of those structural improvements seem to be manifesting themselves in the form of better retention in the mid-market. And then also, our downmarket business, the retention rates there, even pre-pandemic, were 300 to 400 basis points higher than when, unfortunately, when I ran the business because it makes me look bad that it's gotten so much better. And I think some of that was structural because of that platform migration that I think we completed in 2015, which is the platform we call RUN. And then our international retention has been strong all along, so it's up a little bit versus kind of pre-pandemic, but it was always very strong, kind of mid-90s. Just an incredibly strong retention rate in the international business. And then the PEO has also just been a solid performer. We don't -- when we report retention, as you know, it's really employer services retention, but for color, I would just tell you that the PEO has got great retention as well compared to also 10, 15 years ago, when a certain person used to run that business as well.

We can guess who that is. We -- before I forget, so right -- so thinking about retention and pricing, right? So pricing can influence retention clearly. In the 20 years I followed ADP, it's one of the few companies that has pricing power. So with inflation happening and the ability to potentially alter price or reprice, how do you weigh that versus where you are with retention?

It's a great question because price is something that you can't think about in a vacuum, right? You have to think about it in the context of the competitive environment, also the macro environment. And I would say that, you probably know this and the conversations we had for years, [ Jan ] and I, about our thinking there was that we were more interested in being more competitive and winning market share than in being, dare I'd say, piggish on the pricing side. Because there is no question that there's pricing power. It's not unlimited pricing power, but there is more pricing power in our business than probably most. We exercised that power very, very carefully for about a decade. And that decade happened to be a decade where inflation was 2% at best. I think that was appropriate. I think that strengthened us, made us more competitive, helped us in terms of new business bookings, but also on the retention side. But the reality is we do have inflation now that is changing the backdrop. And then the competitive landscape is also -- not that I have deep insight into competitive pricing, but some of our competitors who used to compete against us purely on price, call it, 10, 15 years ago, as a result of our careful management of our pricing, have become closer to us in terms of price. So there's no longer that challenge or that issue there. So I would say that we have an opportunity, and it's safe to say that what we derive from price in terms of revenue growth, which we think we've always quoted as kind of a 0.5 percentage point of revenue growth would come from price, suffice it to say it's going to be higher than that. Now what it's actually going to translate into, I think you know this, we haven't finalized our operating plan yet or given our guidance for the next fiscal year, which starts on July 1, but it's going to be higher than 0.5 point. And you can probably -- if inflation was 2% to 3% and now at 6%, you can probably guess where we would be aiming at because we don't want to go overboard and create a competitive problem. But we need to cover our costs as well, right? Our costs are going up like everyone else's are.

Yes. Makes sense, Carlos. I'm sure you'll be thoughtful about it. I think also in thinking about inflation and ADP rates, you do benefit from rising rates with a very large float balance. And we haven't seen rising rates in a while. And so the question is, with rates rising, are you going to let that flow through? Or could you use that as a form of pricing to perhaps be more competitive? I don't know if you want to walk through, for those that are newer to the name, how the flow piece works, but I'm curious what you're thinking about rates rising and letting that flow through.

Yes. So the way -- in a nutshell, the float is really the difference between when we collect the money that needs to be paid to the employees of our clients and the taxes that the clients need to remit to the federal government and also the state agencies, we collect it literally a day or 2 before it's due, on average. In some cases, to some of the, for example, state unemployment taxes, we can hold that money. We take it from the clients as the payrolls are processed. We might not have to remit it for a couple of weeks, a month. In some cases, we literally have to remit the money the next day, but the average is a couple of days. But a couple of days and $35 billion, it adds up, but obviously impacted by interest rates. So the float is straightforward. It's really a timing difference of a lot of money because we're handling the wages and the taxes of our clients. And to put it in perspective, at the peak, and I think it was in 2009 when we last peaked in terms of client funds interest, we had $15 billion in balances and our average yield was 4.5%. And you can do that math in terms of what -- you move forward from there. I am so lucky to become CEO in 2011 and then proceed to have 10 years of purgatory in terms of interest rates. And the way we manage our portfolio is we ladder our portfolio. So we have about 20% that is maturing each year. So as rates went down, it was a slow, painful death for me in terms of each year lower and lower returns. Even though balances were growing a little bit, the net-net of it was a huge headwind for us. And I think we bottomed out somewhere probably around $400 million in client funds interest versus I think we were around $700 million back in the numbers. The math that I just gave you hopefully adds up to something close to that. So now you fast-forward, now rates are starting to go up again. They're obviously nowhere near 4.5%. It's anybody's guess whether they're going to go up to 4.5% now, but it doesn't really matter whether they get all the way to 4.5% because I finally, finally after 11 years, I finally catch a break. So last year, we had a $120 million headwind from client funds interest. And this year, it's a slight positive in '22. We haven't given guidance for '23, but we give a lot of disclosure where people can do their own math. And this is what leads to your question, which is if you do the math, you realize we're going to get a windfall. And it's nice to have. You've seen from our performance in the past that we're able to deliver margin improvement and growth despite $100 million headwinds from client funds interest -- or from interest rates going down, so I think it's a pretty durable business model. What we do on the way up in terms of rates rising? It's safe to say that some of that will flow to the bottom line. How much of it? I think it's probably fair for -- to give us a little bit of time and wait. We're probably a month or 2 from finalizing our operating plan because if we have investment opportunities, whether it's -- if the macro cools, I would -- ironically, I would anticipate more of it falling to the bottom line. But if we see opportunities like in this kind of environment where bookings are growing double digits, retention is strong, demand is strong, we're going to invest as much as possible to accelerate growth. But we're going to do things based on ROI like we always have. And we're going to invest whether interest rates are up or interest rates are down. So to some extent, I think you would expect some of that to flow to the bottom line, but I think it's a little early to be predicting. Let's just say it's going to be easier for us to achieve our margin objectives in the next year or 2 is probably the best way to put it without making any commitment before we're actually ready to do that.

No. Fair enough. And yes, margin expansion you could almost take it to the bank for ADP. So it will be a different flow of momentum, let's say, we want to see on rising rates. So I'm really curious to see what happens, Carlos. We're excited about hearing what the plan is, but I know you guys are always very disciplined. So you mentioned bookings, so let's get back to that. And the demand environment will probably influence some of your thinking on what you're going to let flow through. Demand environment, you mentioned, was strong. So talk to us about competition. I know there's always these questions around SaaS versus traditional competitors. There's a lot of new software-oriented upstarts as well. But ADP is invested heavily in software and tech, but also is still a services business. So where are we in that pendulum between SaaS and traditional service providers?

Listen, we appreciate the understanding of that nuance because I think it is a nuance that we -- obviously what we do is driven by tech and we've been making huge investments in tech. And our clients and the employees of our clients all interact with our platforms and our technology and they have to be consumer-grade, has to be a great user experience. But the business model has, for sure, a service component, whether you want to call it compliance, service, we talked about taxes. All that money movement of moving all that money has a service component behind it because you have issues sometimes with reconciliation of the taxes, not from us, but in terms of from the client side. So we are a little different from a pure software model where, in a software model, you build the software and then you'll have somebody else who provides those services that typically software doesn't just -- I know that's the image that somehow it just does everything. But even for some of our competitors, I don't want to mention any names, but some of our competitors are more software-oriented. They would just use -- the clients would use Accenture, Deloitte to provide the services, including the implementation of the software and then the ongoing support and the ongoing services. By the way, in some cases, some of our competitors and their clients use some of our services on a private-label basis to deliver some of those solutions because we have big leverage in the back office on some of these services. So it's an important nuance. I personally think that it's a differentiator for us. Like now in this market, we just talked about people don't have their own ability to hire people and retain people to do these things, right, in terms of payroll, HR and HCM, we do that. We don't just provide the software. So whether it's the PEO or the BPO businesses in our Employer Services business, they are on fire because of this component that we have that we call services in addition to the software. So I think it's a strong differentiator. It makes it stickier. It's not that somebody can't come along with a better software solution and then, poof, your businesses is gone because I know it's hard to [ do ] their magic because when you have great software, you think it's always great, but there are very few companies out there that have -- we know a few of them, that are durable. But most software is easily replaced, if I could be so bold as to say that. So I think our -- the durability of our business model is, in fact, the service component and I think the complexity of what we do in the back office.

So we were -- you were talking about declining rates and that being a headwind, but you've still delivered a lot of growth in margin through that, including tech investments. So what's left to do? You mentioned a lot of platforms that you've converted, including your old PEO business and whatnot. I think you still have the tax engine and some of the payroll in the cloud. So just catch us up on what's left to shift to the cloud and modernize. And is there a step-function benefit that we might see, either from growth or margins.

It's a great question. The most obvious place where there's a lot of attention paid by the third parties, if you will, is the upmarket business for us. And it's because of the visibility it has and some of the competitors that we compete against in that space. But to put it in the context of our $15-plus billion in revenue, it's about $1 billion in revenue. Now the upside for us is we'd like it to be $2 billion or $3 billion in revenue. And that's why we've been making the investments there to have the same outcomes we've had in the downmarket and in the mid-market in the U.S., which is build newer next-generation platforms, move all our clients on to them and then have them on these versionless software solutions that we can then easily enhance, improve with a great user experience and just -- and win more business, right, and grow bookings. So the upmarket is the place where we still have a lot of work to do. So we are, I think, built in terms of the platform, but we're in the early stages of rolling out that platform called Lifion. So what that means is that we're, call it, in the, I don't know, eighth inning in terms of the platform and the technology, but we're in the early innings in terms of the client migrations and the transition. And we've seen how hard that is in the mid-market and in the down market, but we've also seen how great it is once you've completed it. So that's the biggest upside, I think, in terms of if you want to call that step change. We're big enough that very few things do step change for us because there's going to be the other $15 billion in revenue that has to find its own ways to grow in addition to this upmarket business getting better and stronger. And then the second category that doesn't really come up a lot is really our international business, where we have been working on platforms there as well. We have a platform called iHCM, where we have thousands of clients on it now. But the international business is much more complicated because it's so many countries. And on top of all the individual countries, we have what we call a multi-country payroll solutions, which are for companies who have employees in 5, 10, 20, sometimes 40 different countries. That's a place where there is also work to be done. Incredibly high retention rates, great growth, great business. So it's not like the business is underperforming. But if you think long term, 5, 10 years down the road for ADP to kind of sustain its growth and its success, we have -- that's a place where we have, I think, some work to do.

Good. And I know on the last call, you talked about stepped-up costs of running the business. You mentioned inflation impacting your own labor costs. So is there still a lot of money flowing to the P&L in terms of investments in platforms? Or are we really just seeing this as a -- so maybe a catch-up in some -- on spend on the people side?

Well, I think our references to inflationary costs were really more around the earlier question you mentioned. We have a lot of people in service and implementation and helping deliver on the value proposition to our clients. Our investments in platforms, technology, et cetera, I would describe them as consistent. Like we've been consistent investors in upgrading, renewing, modernizing. As an example, we've made a huge investment in our user experience, which cuts across multiple platforms, regardless of what platform the client is on, which makes a huge difference. We've made investments in data and analytics. We've invested in the Wisely Pay card that I think you're familiar with. So I would say that we're a steady investor and a growing investor in our R&D. Now we're going to have inflationary costs there as well. But to put it in perspective, we have a lot more people in service and implementation than we have in R&D, although we have a lot of people in R&D as well. And all of those are going up. And some -- there are pockets like in data analytics, for example, it's very competitive in terms of wages. So we're going to have to spend more there. I just mentioned user experience. That's another place where you can name your price if you're someone that is in the user experience side of R&D. But there's other places where there's not as much pressure where we are able to use some offshore outsourcing and some third parties and kind of keep those costs still rising, but not quite as much as the places that are really hot. But anyway, net-net, unfortunately, I wish I could tell you that there are some pockets where there isn't inflationary pressure, but it's across the board. Like we're seeing it every -- even in some of our corporate functions, we're seeing the pressure. There's just so much change and people reevaluating their jobs. And people like us, like the corporations like we're all doing it to each other because we told our recruiting groups we need people, go get them wherever you need to get them. So they go steal people from someone else then we go steal their people. And it's capitalism, right? And unfortunately, these things have a way of -- they've got to kind of work themselves out, which is what the Fed is helping with because I think the Fed is going t slow some of this down.

Yes. No, that's well said. So really, the platform investments have been consistent. It's really more, like you said, the cost side. So that's good to...

Yes. And listen, besides the platforms themselves, again, we don't get too much into like we -- it's boring, but I'd say we spent as much money on migrations and movement of clients as we have on the platform. I mean it's -- this is -- again, in modern -- now that we've modernized in the downmarket and in the mid-market, you actually don't have that going forward. So that's probably something that's helping us from a margin standpoint because these are not step-change migrations anymore. Like the modern tech stocks, very easy to make enhancements improvements. There's no downtime to do them and very little friction for the client. It's really a change management issue because if any of us have experienced -- if you do online banking or you have an online broker, like if they change your user interface, that's like a change management issue. But for them, they just literally push a button and the next day -- that's a mistake to push a button and do it the next because then you get a lot of pushback. But the key is to release a lot of incremental improvements and every now and then do major revamps just to -- but that's so much easier than what we were doing for years before that. So -- but there was a lot of cost and a lot of investment, and there still is some cost and investment in the upmarket and in international for this lift in terms of moving these clients on to these modern platforms.

Okay. Now we'll be asking you for updates, I'm sure, Carlos. So we've got 6 minutes left. I did want to hit you up on Wisely and data and take audience questions, but I have to ask you about PEO given you are the PEO guru here. I always want to pick your brain and we so obviously cover some PEO stocks, you know that. You guys are the biggest player from a scale perspective, no doubt, yet you're growing above market and above a lot of the smaller players. What -- how sustainable is that? Is it a tech difference? Is it a service difference? Is it a scale issue? And do you see any new players coming up that are -- been on your mind from that kind of standpoint?

Everybody is on our mind because you never underestimate -- again, back to capitalism. We've got a lot of competition, whether it's in the PEO or in other places, and trust me, we don't underestimate anyone. But we have some really -- some big advantages. The installed ADP base provides about 50% of the clients to the PEO. So we still go through a sales process and a change process for the client, but starting off with warm leads like that is a huge advantage compared to some of our competitors. Our friends at Paychex have a similar advantage. But we find that to be quite useful. We obviously have scale, as you mentioned, because we already are big. So that gives you some real economies of scale in terms of negotiating benefit plans, 401(k), workers' comp, et cetera. So a lot of advantages from scale. But I think the macro is helping as well. And I think it's a good question in terms of how sustainable. As you know, our PEO has been pretty successful for almost 25 years now through multiple economic climates. PEO has never declined, has always grown in terms of unit growth, worksite employees. This is quite unusual, what we're getting here right now. And so I would expect some moderation may not be what everybody wants to hear, but the macro is a big help. The clients themselves are growing. So that pays per control growth that you see in the Employer Services side, that translates really into worksite employee growth in the PEO. So that kind of magnifies the success of the business model. And that's a direct flow-through because in Employer Services, the way we price the pays per control has an impact, which we've quantified for you. In the PEO, it's direct. Every employee that a client hires, it's 100% incremental revenue to ADP into total source. So I think that tailwind from strong pays per control growth is something that we've been cautioning and guiding people that it will abate both in employer services and in the PEO, and that will create a headline growth number for worksite employees that will be lower than it was in the last quarter, but I still feel pretty good that we'll be able to have, I'm hoping, double-digit growth for some time. I'm not talking about short-term guidance for '23. I'm just -- our goal in the PEO is to keep growing double digits.

Yes. No allergic reactions from Danny. There has been a double-digit figure out there on the long term. So no doubt about that on revenues.

I'm sorry, on revenue.

On revenue. On revenue.

I did say revenue, didn't I? Kind of go back to the tape.

Questions from the audience, let's take some. We have a little under 3 minutes, if there are any. Otherwise, I'll keep going. Questions. Let's do Wisely. I've used this term probably in other interviews with you, Carlos, call it a sleeping giant from a fintech perspective because you touch so many employees, many of which probably could have better mobile services from a banking perspective. So tell us about what the plan is for Wisely, because there are a lot of pure-plays that are trying to do the same thing. But again, I feel like you have such a huge distribution advantage.

We do. Again, back to the distribution, we've talked about the PEO having a distribution advantage. This is a little bit of a similar situation because we obviously pay so many people, we have their attention. We have this mobile app where people go to check to see if they got paid. They go to change their benefits, to add dependents. I mean those are all opportunities to get somebody's attention. So it is a pretty big advantage in our opinion. We've got a lot more focus on this than we had a year or 2. We've done some org structure stuff to add, I think, on the talent side to Wisely but also to break it out as what we call now an emerging business, if you want. We can use whatever term you want to use, but we're pretty excited about it. We always were. I'd say we're super excited about it now just because of the focus and attention it's getting and the opportunity that you described, which is pretty large. Any employee who gets moved over to Wisely, the profitability compared to the float business, for example, is multiples of what we get on the float side. So because people always have wondered about this float business in terms of, oh, interest rates might go down or payments might get sped up, but we have this other thing called Wisely, right, which I think could actually make that into a net positive. Even though we don't technically call it float, you'd call it interchange fees or other fees, but there's a lot of upside there. So pretty excited about that business given the large installed base that we have and the connection we have that we're establishing with the employees of our clients. It's a learning process for us because historically, ADP's relationship really was with the clients themselves, but technology has allowed us to build a relationship through mobile apps with the employees of our clients, and hence, the Wisely opportunity.

Should I ask you about data or should we let you go?

Let's wait 3 more seconds. No, you have to let me go because you're out of time.

We are out of time. We'll get you on the next time. More excuse -- more reason for you to come back. Carlos. Like I said, always a pleasure to talk to you. You're always very thoughtful and very balanced, and I do value that. So thank you for the time. Thank you, Carlos.

Thank you.