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

Thanks, everyone, for joining. This is Tien-Tsin Huang. I'm the payments, IT services analyst here at JPMC. So kicking it off with a lot of fireside chats here at the services conference. And super happy to have Danny Hussain, VP, Investor Relations at ADP join us to come back. I always enjoy chatting with Danny. We'll do a fireside chat. We'll take questions here from the audience as well. So I'll make sure I'll leave some time for that. But Danny, thanks for being here.

Thank you, Tien-Tsin. Happy to be here.

That's great. Great to see you. So I hope you have a good day here with a lot of meetings. So I figured we'd kick it up as always, Danny, with the obligatory state of the union on the economy and what you're seeing. You have such a good view, of course, on employment, wages, some access to SMBs, et cetera. So what are you seeing on the ground?

Yes. So I guess just to start, since we serve companies across the spectrum, clearly, we do care about all major economic indicators, we track, whether it's PMI, consumer spend. We're in some ways exposed to all of it given our client base, but clearly, the elements that matter most to us are things that affect employment, either directly or indirectly. And we, of course, have our own data as well that supplements what we see outside. So there's the employment picture itself in terms of what's happening today, and we all track BLS numbers and the ADP National Employment Report as well. Data there suggests clearly, we're still adding heads to the overall labor force, which is good in many ways, and it's challenging, I think, in many ways as well. Good, of course, in the sense that for us, we derive some of our revenues from that. So we're happy to see that our clients continue to add that they're optimistic about their ability to grow and therefore, they're investing in their own labor forces. And the most recent few months, you're still looking at adds of over 200,000 employees. These are really good numbers looking back historically. So it's just fascinating that you still have that strength and then you extend beyond what we're seeing today and look at overall demand for labor force in terms of either the JOLTS report or our own internal data in our recruitment businesses where we see job postings on behalf of our clients. All of that is still strong. The numbers have come down a little bit. But overall, we're still looking at a net demand for labor that's not being met. Question, of course, for everybody is how long does that net demand last? And that's something, unfortunately, we don't have a crystal ball insight into at this point. But for sure, the near-term outlook looks positive for labor. The other things that we track, just given our exposure to companies of all sizes, small businesses demonstrate a lot of cyclicality, as we all know. And so formations and bankruptcies matter a lot to us. And we track public data formations and that has an impact on our ability to drive new business bookings growth among our small business target market. That's pulled back since the early days of the pandemic, but that's still at healthy levels. And we're likewise seeing a lot of clients coming to ADP, de novo clients, ones with no history. It's great source for us, and we expect that to continue over the near term separately or bankruptcies. We've seen, of course, some normalization since the early days of the pandemic, whereby companies where really benefiting from stimulus and they were, on average, staying in business longer than the typical small business maybe should. That's starting to normalize. We've now seen 2 years, a 2-year stack of normalization. So we feel like we're most of the way there. But what we're not seeing is that bankruptcy level or out of business level extend beyond into what we would consider to be a recessionary levels. So still healthy, and that still feels good. So those are the ones that matter most to us at this point.

So we get a lot of questions on retention, bankruptcies. And I always like to think that ADP has some positive selection bias in the sense that your clients are going to be a little healthier than average, and that they're looking to outsource and protect their people, their employees, et cetera. So do you have exposure from a vertical perspective here that might be different than the broader market as people start thinking about bankruptcies and changes in employment, things like that? So just a question on just your vertical exposure and how you index.

Our mix from a vertical standpoint, probably mirrors the overall market for our Employer Services business, which is our major segment. The PEO business, which is faster growing and now constitutes over 35% of our revenue, that business does have clear selection bias. And it's for a couple of reasons. Number one, there's a size bias. We generally serve companies with an average of, call it, 45 employees, but it's more limited in the range of size. So we don't generally serve very, very small companies in our PEO. I think 1 to 5 employees, they don't have the complex needs that lend themselves well to the PEO business. Likewise, the PEO tends to phase itself out when you get to a couple of hundred employees. So the sweet spot really is companies with 10 to a couple hundred. That part of the market actually tends to fare pretty well in downturn environments because they're just less exposed to bankruptcies than a company with, call it, 1 to 5 employees. So you -- by taking out that tail, you have some positive mix selection industry. Likewise, the PEO tends to resonate more with companies in white collar, high wage businesses that are really trying to differentiate, and then you're mixing yourself away from manufacturing and other cyclical businesses. So again, from a vertical standpoint, the PEO is probably positively mix compared to the typical U.S. company in our ES segment. So those 2 things matter. And generally, what you see then is the average PEO client tends to fare pretty well in a downturn. Now that it's such a big part of our business, it does matter. So we're happy about that, and we would expect the PEO to continue to do well. Globally, hard to paint a single picture across all markets outside the U.S., but the average ADP client outside the U.S. tends to be larger than the average ADP client in the U.S. So there to -- we tend not to be exposed to out-of-business losses to the same degree that we are in the U.S.

Okay. Perfect. Thanks for going through that. So I'd like to always ask you, right, this question of similar to the survivorship bias. The shift towards outsourcing, as things get tougher, we hear about OpEx cuts across different companies this earnings season. Does that push things more towards outsourcing, Danny, in your mind or not? And so going into a recession, could you see a pickup in demand for ADP services?

Possibly. When we go into a recessionary environment, for sure, one thing that changes is the specific value prop that our sales force is going to be pitching to clients. And one of them is exactly that, can ADP in some way, save the client money, whether it's by helping them reduce part of their own workforce or perhaps getting benefits at a lower cost? And so the sales force is highly attuned to what the end client is looking for, and I've actually already started to hear rumblings of that transition. So it's weird because we're still in a very tight labor market where part of the pitch is the market is so hot that you need help attracting talent and securing talent. And then we're already thinking about what would clients look for in a recession. And so it's just a very strange dichotomy where we're almost making both of those pitch points at the same time. In general, the sales force would rotate to that type of pitch, and we certainly can help our clients. I would say, overall, the demand environment does tend to decline in a recessionary environment for obvious reasons. Clients are -- they do have to spend the money, working with somebody like ADP, and it's hard to get those decisions and approvals over the finish line in that environment, but we tend to do relatively well, I would say, even in a recessionary environment.

Okay. Good. So thinking about going into a recession here, I know we've talked about this before, how is ADP different than in past cycles to absorb or weather a recession, whether it's mild or harsh? And there's a lot of history for ADP as a public company, but the company is quite different, right, than, say, '07, '08. So how do you look at it?

The company is different, and the recession will likely be different. So 2 things to consider. How is ADP changed? We've become a little more downmarket levered since the financial crisis, and that's mainly due to the strength of our downmarket offering over these past 11 years. And so we've gained market share. That part of the business is growing faster than our overall business. And so we've mixed now to smaller businesses on the margin. At the same time, in the financial crisis, we started with a very healthy interest rate backdrop, and that became a huge headwind for us for a number of years. So we were dealing with unemployment levels being higher for many quarters in a row. So it was a persistent headwind. And on top of that, you had a headwind from rates falling to, will the Fed cut to 0? But medium-term rates are also falling precipitously. And so that hurt us for many years owing to our laddering strategy. Now unemployment is great. And so clearly, there's room for downside as we look into a potential recessionary environment. So we fully expect that would be a headwind, and that affects all of our businesses, whether you're a small business or a large business, but the rate environment is favorable. This is interesting new type of recession that we're facing. And for us, at least, depends exactly what expectations are for what the Fed will do, but that potentially gives us a multiyear tailwind while we're dealing with headwinds in other parts of our business. And so financially, you can end up with a very solid outlook for ADP, whereas in reality, we're potentially looking at ways to invest, put some of that float to drive underlying growth, which ultimately is the more important driver for ADP's long-term success. We feel good about where we stand, and we tend to take a very pragmatic and patient approach. So even, for example, when we entered a recession earlier in the pandemic, we did not shoot from the hip. We didn't do massive layoffs because we wanted to see how things played out before we made any such decisions. You can expect us to likewise take a similar approach as we move into the next part of the cycle.

So you've given us the tools to stay with [ food ] income. You've given us a tool at $25 billion, $20 billion in flow rates are going to rise. The question, of course, is what you suggested the balance between reinvesting and letting it flow through to the bottom line? But we look at it as pricing, right? I mean it's basically a form of pricing as well in terms of benefit to you, ADP. So is there an opportunity to use that and maybe be more aggressive competitively to win business versus sharing that with the shareholders by letting it flow through?

We would probably look at it differently than pricing. Certainly, we want a substantial portion to drop to the bottom line. I think the question really is about magnitude and how much it drops. But there are always places in ADP to invest, whether that's in making the products even better, adding to our distribution and the marginal return on those investments and sometimes they're very clear cut and sometimes, they're multiyear investments with fuzzier paybacks. So we're dealing with that at all times. When you've got a multiyear tailwind of float, it can be tempting to lower your hurdle rate and in theory, invest more in incremental projects. We try to maintain the discipline to not do that. With that said, we do see a lot of opportunity to invest and grow. We think we're only 10% of the overall addressable market. And with that being the case, we would like to continue driving long-term sustainable growth. We just want to be smart about the investments and also be thoughtful about shareholder returns.

Hey, look, that's the ADP way, we know, which is why I want to ask if there's a potential for change in picking there. Because to we haven't seen a rising rate environment, obviously, in a while. How about the competition will weigh here in terms of some of the thinking, I suppose, on pricing? Have you -- while the days of growth at any cost is over, have you seen any change in the competitive landscape, especially from some of the private name, some of the digital first names that I know we're getting a lot of attention going into the pandemic?

We haven't seen significant changes in the competitive environment. What we've seen clearly are some competitors get larger, and we've also gotten larger. So a lot of their growth appears to have come from consolidation of smaller, what we would consider to be regional vendors. And that's almost an intuitive inevitability that long term in our industry, you would expect market share to consolidate to the larger vendors that have national scale and have differentiated products. What we've observed in our industry is that pricing is, in general, very rational. When we do compete in a head-to-head RFP, it's generally differentiating your product and service as opposed to trying to lead with price. Now often, the client expects some form of incentive upfront, just like a consumer would signing on to either a card program or a new phone line, they would expect to get a couple of months free and so forth. So in general, the norm in our industry is you do have these upfront incentives, but the long-term pricing is predicated on having that client for 10-plus years. And nothing has really changed in that regard. If anything, I think pricing has come up in the industry over time, which, again, is a good outcome. And it's a reflection of, I think, is what makes our industry so attractive that we are all differentiated in different ways, and price is not the way that you stand out.

Yes. And when we think of ADP, we think of it as a name that has pricing power. And I think maybe could you remind us, this is going to be an above-average pricing year for ADP? What's the thinking there?

This year, we did share we would expect 100 to 150 basis points of contribution to our revenue from price, which is more than we would typically get the actual price increases are higher for the businesses that are eligible for price increases just for context. With that said, it's hard to anticipate whether this is a new normal. We are clearly making these higher-than-normal price increases in reaction to an inflationary environment. That's very different from the one we've experienced in the last 10 years. And so in trying to anticipate what happens next year, I think we would want the latest data possible. So we fortunately don't have to make this decision every day. We generally raise our prices for our clients once a year. And that decision is just been put behind us for the summer. And so for fiscal 2023, we're set, we don't have to make any further decision, it's really, as we look ahead to the next fiscal year. We'll be making that decision as we approach the spring and summer, and we're hoping for inflation to settle down by then. So hopefully, we're not talking about another year of elevated price.

Yes. Hey, look, retention has been high, inflation has been high for your own OpEx base as well. So not too surprising to hear, and that's consistent with the peer group. But let's have a couple of more then we'll open up just on the OpEx side since we're on inflation. Any levers to consider here that could be pulled if things get a little bit tougher for ADP after a period of investment after the pandemic? I know you took on a lot of people to deal with PPP tax credits, those kinds of things. Anything unusual in the OpEx base?

The biggest individual cost for ADP is labor. So it's our own 60,000-plus workforce, and they're doing real work. Today, a question always going into recession is whether the work you have is the work that you expected to have a few months in advance when we make specific hiring decisions or staffing decisions. In the pandemic, we did not make any major headcount reductions. We also paused hiring. So we stayed flat for a period of time. And then we were surprised to the upside at our growth and how strong retention was and ended up having to catch up on headcount just to meet those elevated needs and that elevated volume of work. We finally have caught up. It's been a tight labor market. So it's taken a little while, but we are caught up now and we're staffed appropriately for the level of work that we have today. If we go into a recession, and we have significant reductions in client counts because of bankruptcies, there's probably some change in staffing that may be appropriate in that environment. But there's no particular reason to think that, that's a situation that we're in and that we may be faced with. And like I mentioned before, we tend to take a very patient approach. So unlike a company that has to anticipate 6, 12 months out because they need to order raw materials, we don't have to do that. And so we don't have to commit to what our headcount is going to be 6, 12 months from now. We can wait and see how the market develops, how the actual client demands develop, and then we can make our decisions as we go. Again, 1 of the strengths and joys of being in this business.

Yes. I agree. So let me ask one more, then we'll open it up. Just with Maria coming in as new CEO, how is she going to lead differently than Carlos? What can you tell us about changes that we might see?

Well, they're both incredible people, and they're both very different. You know Carlos, you've known him for many years, and he's highly analytical, generally, the smartest person in the room, and he's really empathetic. So he's always thinking about both sides of any decision. Not to say that Maria will be any different. I think the perspective she's trying to bring is one that served her well over the course of her career, which is how can we meet the needs of the client and builds everything, our product and our service with that client mindset -- the client-oriented mindset. So the approach is subtly different. I think what it will mean is we do a lot more of trying to listen and understand the client, not that we weren't doing it before, but we just emphasize that more than we ever have and then build to those specifications. And that, long term, we believe, will serve us well. We already have record level client satisfaction, near record-level retention. We know there's room to take that even higher, and I think the organization is really excited that Maria is going to be the one that takes us there because she's the perfect one for the role.

Yes, definitely seems like a client or a customer champion type, for sure. Questions, happy to take them, if any? Andrew here. Say in the mic as this is being recorded.

I figured I'd ask for an update on Wisely, anything new there? I know you talked about it on, I think, 2 earnings calls ago. So I just wanted to learn a little bit more on how you're distributing it, how you're marketing it? Anything on that?

Sure. Question on Wisely. We actually put out a press release just this morning, early wage access is becoming more broadly available among our Wisely client base, the latest stats we shared that we had over 1.5 million cardholders and growing. And we haven't shared the revenue recently, but it's a sizable business, and it's continuing to grow nicely. We believe we're differentiated in how we go to market and acquire Wisely cardholders in a cost-effective manner. And we all know the card industry is extremely competitive and winning over that marginal cardholder becoming top of wallet is challenging. So we don't believe that we need to be the very best in all manners. We already have one advantage, and we need to be good enough in all other manners, have bill pay, have the financial wellness tools that we offer today. We're making further improvements to the overall wallet, too. We recently enhanced our branding, and there's opportunity to invest more in marketing. But I don't think you should expect a substantial change in our strategy. I think it's one of the many tools that we can go to market with and offer to our clients to help them be a better employer to their workers. And in doing so, we get this nice high-margin card business as a side benefit.

Anyone else? I mean just staying with Wisely in this -- the bigger theme, and I guess for everyone else to benefit, right, Wisely is your wallet that helps under-banked individuals get a bank account and spend with a debit card. But the broader theme, I think Carlos and Maria and you and your peers have talked about is serving the employee more. I think ADP historically has been very employer-centric. And so is this an important consideration to -- for us, whether that be through data or customer acquisition or retention, Danny? Is there more cost to service the employee versus the employer?

Yes. It's a really good question. That is a theme internally. We're focused on -- again, Maria is focused on it. And if you think back historically, what employees would have used somebody like ADP for in their day to day, you would check your pay stub, you would get your W-2. And then the next logical place was you could do your clock in and clock out, so timekeeping was something the employees touched. We started to introduce benchmarking and insights for frontline managers. So let's say you worked in a manufacturing plant, and you had 15 people report in to you, you could see how your overall engagement was trending and you had metrics at your fingertips, just to help you be more informed. So we've continued to add more and more to that employee experience. And now one of the things that companies care a lot about is being in touch with their employees throughout the entire employee life cycle. And so we recently introduced a tool called Voice of the Employee, whereby we actually allow employers to very easily issue very quick surveys to their workforce to understand, not just at a big broad level of how engaged are you and how happy are you at work, but instead ask very specific questions about how your onboarding experience was, how your payroll experience has been so that the employer feels they have an understanding of what their employees are thinking about or concerned about. And in doing so, that clearly should make the employer feel more capable and more informed in their decisions. And that, we believe, is another differentiator in using ADP. So it all comes down to making the employer happy, making that practitioner happy, but reaching the employee directly, we think is one key way that we can continue to do that.

Yes. And Danny, I do get this question a lot in terms of the data that you see a lot of data on the employee side. You mentioned benchmarking. But is there a data monetization opportunity in front of ADP? How high on the priority list is that for Maria on the board?

It is definitely a priority. We think there's a lot more we can do with our data. There are always opportunities that we are thinking about and many that we say no to because we, at the same time, are thoughtful about our reputation and what we're using client data for. So we balance our -- the financial ambitions against some of these other considerations. For sure, though, we think there's a lot of opportunity. You're familiar with some of our partners in the credit bureau space that bring a lot of business our way. And we certainly like the income and employee verification businesses. We also introduced a couple of years ago, some opportunities to, for example, help people make informed decisions about muni bond investments. We work with realtors as they think about what markets have improving wages. So there are places that we already participate in, that probably could stand more investment and would go from here. There are also de novo opportunities as well that we are starting to explore. Not much more I can share on it at this point. But I can tell you, it is a focus of ours. It's not as critically important to our long-term success as the rollout of our new UX for Workforce now or our Next Gen Payroll engine, some of these huge investments. But it is something that in the long term can drive nice accretion on both the revenue and margin front.

Okay. Any final question? Let me look at this. The performances of the company has been great, navigated the pandemic extremely well. The company is viewed to be very defensive. I mean, so do you share that view here going into a recession, Danny, sitting in your seat and fielding questions? I'm sure you're getting a lot of questions about how the company is going to fare into a recession. How would you summarize the answer to that?

Yes, it's a great point and a great way to end. We often get pushed back in from new investors about our valuation and why it feels so expensive, and totally sympathize with that perspective. But the reason is we tend to do well in almost any environment. And our shareholders know that they're not going to be significantly surprised almost regardless of the environment. So it's no secret that if employment slows down, there will be a headwind, but employment will come back at some point. So that's not a long-term concern for most of our shareholders. Likewise, flow that comes and goes, and we're very transparent about the impact. So I guess the question is, are we doing the right things to enhance our competitiveness for the long term so we can keep benefiting from the secular growth in our industry? We see a long runway of growth. We serve 40 million employees today. There are over 3 billion people in the world that get paid. So a big addressable market, and we have a lot of upsell opportunity even within our existing base. So there's no shortage of opportunity. We take a very consistent approach to investing and we build our business truly for the long term. So when I think about our opportunities to grow, we don't see any end to the runway, and we think we can continue to compound for the foreseeable future.

All right. Let's end it there. Good stuff, Danny. Thanks for the update.

Thanks, Tien-Tsin.

Appreciate it.