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

Okay. Welcome back, everybody. Very pleased to welcome Danyal Hussain, Head of Investor Relations at ADP. Danny, thank you so much for being here.

Thank you, Ramsey, of course.

I'll start with the macro backdrop. That's where everybody seems to start, and I'm going to do the same thing. What are you guys seeing from a macro/employment perspective?

Yes. I think starting backwards from the labor market data that we've got. BLS jobs still very healthy. I think 175,000 jobs added in April. NER reports something very similar, 190,000 jobs and if you just contextualize where we're at today, it's looking generally speaking, very healthy. So the last several months have been anywhere from 200,000-ish jobs, 300,000 jobs. If you were to go back to prepandemic, we had this very long bull run in the labor market, and you were looking at something similar. So 200,000-ish jobs added per month. And obviously, every quarter, every month is driven by different industries. I think right now, what we're seeing is some contribution out of things like health care. I think construction has been doing well, and leisure and hospitality has been doing extremely well since troughing in the pandemic. A little bit softer contribution from some other industries, perhaps the more interest rate sensitive ones like professional services and like tech, but all in, when you add it up, it's still adding up to good growth in absolute terms. And then when we look at, for planning purposes and other purposes, is the -- whatever forward-looking indicators there are for labor as well. So the JOLTS report put out by the BLS is looking reasonably healthy. I think it was 8.5 million job postings out there, which is still more than one for every unemployed person. So generally speaking, it's still in a good spot. It has come down quite a bit from where it peaked, which I think was over 11 million jobs. So it's gradually making its way lower, but it's still a good indicator for demand for labor, which obviously portends hopefully good growth in labor in the coming months. We have similar data internally at ADP. We have recruiting solutions, job postings, et cetera, that we look at. We don't publish these metrics. But when we look at it internally, it does correspond to what we're seeing in things like the JOLTS report. So again, all in, labor is in a reasonably healthy shape. And we did see, fortunately, it looks like inflation came down in line with expectations. And hopefully, what that means is the Fed does not have to tighten too much and labor can keep going relatively strong in this coming quarter.

I hope so too. I've always had the view that with your company, payroll processing is kind of a historical core of the model. It's obviously still a very critical, large critical business for you. But there's the sort of human capital management solutions as an increasingly important growth driver, let's put it that way. Do you guys segregate out sort of HCM from the core? I mean, I know you don't report it out that way, but is it a fair way to look at it, like that's where the -- there's a real nice secular opportunity that you're executing on HCM versus core payroll?

The short answer is yes. So for us, we see growth opportunity in a lot of different vectors. One is still in that traditional payroll opportunity. If you look globally, we pay over 41 million people around the world, over 25 million here in the U.S.. And there's, I think, over 3 billion people that work around the world. So a huge amount of opportunity is in driving core payroll growth. And over time, since its founding, ADP has expanded. Of course, from payroll, we started offering other solutions like time and attendance. We branched out into a whole lot of other industries, as you well know, things like brokerage services that we helped pioneer. We had a dealer services business. We were really attracted to anything that was recurring and high quality in nature. Over time, we divested a lot of those and really focused on this emerging industry, which is HCM. And so HCM for us means generally speaking, it's software that enables an HR department to do its job well. And payroll is foundational. If you think about any company, you can get away with not providing top-tier time and attendance or not having a benefit solution from many companies, you cannot get away from having payroll. So payroll has always been the core to the HCM suite in our perspective, which is good because it's one thing that we do really well. But over time, as we've tried to generate higher revenue per employee and revenue per client, it's pretty clear that we still look to this opportunity to drive HCM attach rates higher. And so lately, we've been seeing a lot of tailwind in things like 401(k) retirement, which have a lot of legislative tailwinds. Still a lot of runway there, but it's an example of something that's really a hot hand for us as we speak. We've offered workers' compensation, other insurance services to small businesses. It's something that integrates really well into our small business platform. And then when you go into the mid-market and enterprise space, that's really where you have real HR departments that care about things like talent acquisition, benefits administration, compensation planning. And so we have a lot of these bits of the HCM suite that we have sold into the base over time and remain an opportunity for us. We haven't really disclosed attach rates on the whole for all of these different HCM solutions, but we have given a few numbers here and there. So just for context, most recently, I think we disclosed that 401(k), we had 150,000 clients in that business. So we're providing the 401(k) recordkeeping for 150,000 different small businesses out of the 850,000 plus that we serve today. So less than a 20% attach rate, clearly, a lot of room to run. If you were to look at something like workers' comp insurance, we have over 200,000 clients there, still 20-ish percent attach rate, so a lot of room to run. And elsewhere, in the HCM suite and the mid-market enterprise space, you have a really wide range of attach rates. Some things we have very high attach rates and others are newer and emerging, things like benchmarking where we think we have a lot more room to run. So we feel optimistic we can keep driving that revenue per employee and revenue per client higher. And the end all be all end of the spectrum would be offering outsourcing. So that's really where you take over the HR department for some of these clients. And the revenue you earn per employee is substantially higher. So now you're at multiples of just offering core payroll. And it's something that we've been doing really well for many years, not only in the PEO business, which we've now been in for over 20 years but also for this, what we call, HRO business, where we're providing more of an a la carte service and outsourcing bits and pieces of the HR function for our clients. So a lot of runway there as well.

Retention has been -- it's an important metric for you guys, and you just outperformed over the last couple of cycles. What's driving the success there? What do you think has been the bigger sort of differentiating factors there? And what do you expect moving forward? I mean, it's always tough to keep it going in perpetuity, but what do you think?

Yes. So again, for context, we had a record level of retention rate last year of 92.2%. And our aspiration as of our last Investor Day back in 2021 was to have a retention rate anywhere in the range of 91% to 92%. We felt like that was a reasonable range. Of course, there's going to be some variability year-to-year and there are macro considerations like bankruptcies that have an effect. But broadly speaking, our portfolio has gotten stronger. Our clients are happier than they've ever been, and that's the biggest driver of retention rate. We think we have more opportunity to drive those client satisfaction levels higher. And over time, if you pick any one of the ADP businesses that we operate in, so small business, mid-market, enterprise, international, our goal will be to try to drive that core retention rate higher, driven by a stronger platform, improvements to the product and then a better service offering as well to do everything we can to keep those clients happy. And we've actually done a really good job of that. The other thing to consider, which we also outlined back in 2021 is there's a mix impact. So structurally, you're going to have lower retention in something like small business where you have more bankruptcies. And that's just a natural part of the business. We're okay with that. We can generate high margins despite those higher bankruptcy levels. The question is, what does the ADP portfolio look like 5 years from now or 10 years from now? Does our small business continue to grow as a share of the overall pie? Or does the overall portfolio maintain more of a steady state from where we're at today. So those are the type of things that would affect the retention rate above and beyond us just driving up client satisfaction. But clearly, we're focused on that client satisfaction component, and we feel pretty good about where we're at today.

Let's talk a little bit about PEO. It seems to have its own cycle in a sense that might not be fully aligned with your larger segment cycle. Walk us through with PEO. I guess, A, is that a fair way to look at it? And B, just walk us through with PEO sort of some of the dynamics that have shaped performance in that business and maybe where we are now in terms of looking forward a couple of quarters?

It is definitely a fair way to frame the PEO. So there are certainly elements of what I would consider the traditional labor cycle that affect the PEO. So everything from the health of small businesses, which is generally where we sell this to the amount of employment growth that we're getting, all of those will have direct effects on the PEO business' growth rate. Above and beyond that, to your point, there are other things that are unique to the PEO model. Specifically, you have to consider the overall health care inflation environment because we provide medical benefits to our clients. And then you have to consider things like workers' compensation and state unemployment insurance, which we likewise provide. These may not be strategic things to a small business, but they, of course, want to have a good rate. And what we charge is going to be a function of those market rates. And in some of them, as an example, workers' comp, you have had a very long cycle of softening pricing because claims have generally been very healthy in workers' compensation. And so that has an effect on our revenue. It doesn't really affect the overall value prop or the growth of the business, but it's just something to consider on a short-term basis when it comes to revenue growth. So the most important thing for the PEO is that we're able to offer our clients something better than what they would be able to go and obtain on their own. We're generally saving them a ton of time and effort for managing effectively the HR department for them. We're giving them great benefits, Fortune 500 quality benefits. We're giving them competitive workers' compensation. We're providing an unemployment insurance for them. So we're making life easy, and all of that comes at a premium price. For the most part, we think this is providing tremendous value for small businesses, and there's still a ton of opportunity to drive growth structurally in the whole industry. And so we're focused on doing that. And in the meantime, yes, in the individual year may be subject to the ebbs and flows of labor growth in certain industries or in workers' compensation price trends, all of that may have a short-term impact, but doesn't detract from the long-term growth opportunity of the PEO.

And is there any comments that you can make on the current enrollment season? How are things going?

Not much I can share. You're right that right now, we are going through our annual enrollment. And our job is to meet our clients, share with them our perspective on what plans make the most sense, provide any insight that we can to help them keep their employees happy, but also manages very expensive benefit that they offer to their clients. And if we do it right, we can help our clients manage through years and years of medical inflation but still provide a very good value offering to their employees, keep their own employee attrition levels at reasonable levels and keep these clients happy. So what tends to happen is we go through this process with our clients. Inevitably, we will lose some of those clients who either opt to no longer offer benefits, insurance to their employees or alternatively, they may go price shop for a cheaper plan elsewhere. But generally speaking, we have a dedicated team of people that do this really well year in and year out. And so that's our job this year as well.

Fair enough. When I look at your ADP's growth versus public peers, it seems like you're holding your own, if not taking a little share. What does the competitive environment look like for you? And that might -- there might be some layers to that question. I mean we're just talking about PEO and there might be some other dynamics in PEO versus the rest of the business. But how does the competitive landscape -- has it changed at all? Or you just -- you guys just have tightened up the screws and are executing beautifully.

The competitive environment for the whole HCM industry has not changed a whole lot, except that it became a lot more consolidated over time. So if you were to rewind even 20 years ago and you spoke to an ADP seller, they were going head-to-head against tough competitors at that time. Now the big difference between ADP today and ADP 20 years ago is that the product has become so much important, more important over those years, and we've done a lot to consolidate onto fewer platforms and ultimately have better products, HCM products in the market. And we did that when it became a much more important part of the overall value prop. So I would say that we've improved just in time. Had we not, then obviously, we may have had a more difficult balance of trade to some of these competitors. But the point is we have improved substantially. We consolidated all of our down market clients onto one single platform, and then we did the same in the mid-market as well. And those clients are happier than they've ever been. Retention levels, we mentioned last year we're at record levels in our mid-market in our international space. And we're losing fewer clients to those key competitors, even though those competitors have grown their sales forces aggressively and have been coming after us. So absolutely, we've done a lot to drive that client experience and our objective is to keep the momentum going, lose fewer clients to those competitors and ultimately, win market share.