Automatic Data Processing, Inc. (NASDAQ:ADP) Q3 2023 Earnings Call Transcript

Automatic Data Processing, Inc. (NASDAQ:ADP) Q3 2023 Earnings Call Transcript April 26, 2023

Automatic Data Processing, Inc. beats earnings expectations. Reported EPS is $2.52, expectations were $2.45.

Operator: Good morning. My name is Michelle and I will be your conference operator. At this time, I would like to welcome everyone to ADP’s Third Quarter Fiscal 2023 Earnings Call. I would like to inform you that this conference is being recorded. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead.

Danny Hussain: Thank you, Michelle and welcome everyone to ADP’s third quarter fiscal 2023 earnings call. Participating today are Maria Black, our President and CEO; 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 the 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 risks. 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. I will now turn it over to Maria.

Maria Black: Thank you, Danny and thank you everyone for joining us. For our third quarter, we delivered strong results, including 10% organic constant currency revenue growth, 110 basis points of adjusted EBIT margin expansion and 14% adjusted EPS growth. Our continued solid financial performance underscores the power of our innovative and mission-critical HCM solutions that serve over 1 million diverse clients around the world as well as our highly recurring revenue business model. As usual, I will start with some highlights from the quarter. The demand environment was healthy overall. And in Q3, we drove another quarter of solid Employer Services, new business bookings growth, representing a record Q3 bookings amount. Bookings performance continues to be particularly strong in our downmarket portfolio.

In Q3, we sold and started over 60,000 new run clients, where a new user experience has helped us reach record level new client satisfaction rates these past few quarters. We also had strong bookings results in our insurance and retirement services offerings supported not only by legislative tailwinds, but also by the competitive positioning of our downmarket HCM ecosystem. Demand for our employer services HR outsourcing solutions remained high and we have recently reached the 10,000 client mark. We also saw continued booking strength in our compliance-oriented solutions, including tax remittance and wage payments, which have always been key differentiators for us. On a year-to-date basis, we are within our bookings guidance range and are trending in line with our expectations from the outset of the year and we look forward to finishing the year with a strong close.

Our employer services retention rate came in better than expected once again. While we continue to experience normalization in our downmarket out of business rates, this was offset by the strong retention rates in our U.S. mid-market and international businesses, both of which continue to benefit from years of improving client satisfaction. As such, we are pleased to be raising our full year retention guidance. Our employer services paid for control grew 4% for the quarter and continues to decelerate at a very gradual pace. As we have seen for several quarters now, layoffs at many larger companies have been offset by the labor demand elsewhere, which in total has resulted in year-over-year employment growth. With this continued resilience, we are pleased to expect the higher end of our previous pays per control guidance range.

Last, on our PEO, while growth in revenue and average works on employees continued to decelerate this quarter, we were pleased to see PEO bookings growth reaccelerate nicely in Q3, especially in March. This represented a much better performance than we experienced in Q2 and resulted in our largest quarter for PEO bookings ever. Despite the current inflationary environment and broad-based macroeconomic uncertainty, we are focused on our PEO sales execution and on delivering continued strong client satisfaction and we remain confident in the long-term secular growth opportunity. Stepping back, while we are pleased to be on track to deliver very strong full year financial results, we are even more excited about how we are leveraging our unmatched scale and decades of innovation experience to drive continued progress on our important modernization journey.

We are making our solutions more powerful and easier to use and we are making our unparalleled insight and expertise more accessible than ever. In doing all this, we are delivering an experience that’s better for our clients, better for their employees and better for ADP. I mentioned the tens of thousands of new clients we onboarded in our downmarket, over a third of those clients utilized our digital onboarding experience, yielding a faster time to start, happier clients and greater productivity for our implementation team. We just completed our busy year-end period during which we helped our clients with over 75 million U.S. tax forms and to further enhance the client experience, we proactively service critical year-end data to our clients before they had to search for it.

This not only reduced friction for them, but also reduced the number of calls and interactions with our service teams. For years, we have directly engaged and served our clients’ employees through channels like Wisely. As we focus on the overall employee experience we can offer, we continue to add valuable functionality like a savings envelope that employees have used to move more than $1 billion into savings over the last 12 months and a new financial wellness hub with tips, tools and education to drive better financial outcomes. With our new intelligent self-service solution, we are already interacting with over 3 million client employees per month through our action card feature. And our voice of employee solution is helping thousands of clients obtain better insights from their employee population, which can drive higher engagement and satisfaction for those employees.

The opportunity to continue creating value and efficiency in the world of work is meaningful and we believe these modern approaches that reduce friction and exceed client expectations will help us deliver on that in the coming years. With that in mind, I want to provide some perspective on how we are strategically positioning ourselves to invest over the near-term given the economic backdrop. As we shared earlier this year, in fiscal 2023, we were impacted by higher wage inflation. We also added to our service and implementation capacity to meet the expectations of our growing client base and we invested throughout the year in sales and product. As we position for potential economic slowdown beyond this fiscal year, we are being thoughtful about how we prioritize our investments.

At the same time, we are very much committed to our ongoing modernization journey, which is critical to our sustainable growth and that will require continued steady reinvestment into the business. In the coming quarters, I look forward to updating you on near-term growth priorities for ADP. Before turning it over to Don, I want to take a moment to recognize our associates for their continued focus on helping our clients through the many challenges they face each day, especially amid these uncertain times. Resiliency and partnerships represent core components of the ADP brand promise and are among the many reasons businesses around the world choose to partner with a leader in the industry. Our unrelenting support through years of growth, years of challenge and the years in between is something they have grown to count on and we are honored to support them.

With that, I’ll turn it over to Don.

Don McGuire: Thank you, Maria and good morning everyone. I will provide some more details on our Q3 results and update you on our fiscal ‘23 outlook before briefly touching on fiscal ‘24. Let me jump straight into the segments, starting with Employer Services. ES segment revenue increased 11% on a reported basis and 12% on an organic constant currency basis, which is the strongest ES revenue growth we have experienced in quite some time. As Maria shared, ES new business bookings were solid and kept us on track with our full year outlook. We believe the full range of bookings outcomes is still on the table given the relative importance of Q4 bookings to our full year results. So we are not making any change to our guidance, but we do believe the middle of our guidance range feels most likely at this point.

On ES retention, following another quarter of better-than-expected results, we are again revising our outlook and we now expect retention to be down only 10 to 20 basis points for the full year compared to our prior outlook of down 20 to 30 basis points. This again will be driven by retention decline in our down market from normalized out-of-business losses and is mostly offset by improved overall retention elsewhere. Pays per control remained strong in Q3 and we are raising our outlook to now assume about 4% pays per control growth for the year compared to our prior outlook for 3% to 4% growth. Client funds interest revenue increased in Q3 in line with our expectations and we are updating our full year outlook utilizing the latest forward yield curve, which in this case resulted in no major change.

And on FX, we had about 1 percentage point of ES revenue headwinds in Q3 and there is no change to our outlook for a full year headwind of between 1% and 2%. Following our strong Q3 ES revenue growth, we are pleased to be raising our outlook once again to now expect about 9% growth, up from 8% to 9% before. Our ES margin increased 80 basis points in Q3, which was in line with our expectations. We are narrowing our full year outlook to now expect about 200 basis points of margin expansion and we still see significant opportunity to invest in sales, product and elsewhere throughout the organization to capitalize on the growth opportunity in front of us, which we are choosing to do at this juncture. Moving on to the PEO, we had 5% revenue growth driven by 3% growth in average works on employees.

As a reminder, this deceleration is driven by a few factors, including slow pays per control growth, difficult comparisons versus record retention levels and softer recent bookings growth that we experienced the last 2 years. For this fiscal year, we now expect PEO revenue growth of about 8% with growth in average works on employees of about 6%, both at the lower end of our prior ranges. Maria mentioned the bookings reacceleration in Q3 and we are feeling upbeat about reaccelerating the revenue growth in the coming several quarters. This guidance update is mainly due to a tweak to our pays per control assumption within the PEO as it decelerated a bit more than we previously assumed, somewhat different from what we experienced in the ES segment.

We are separately lowering our outlook for revenue, excluding zero margin pass-throughs to a range of 7% to 8% due mainly to lower SUI rates in Q3 than we previously anticipated. PEO margin increased 140 basis points in Q3, which was better than expected due primarily to continued favorable workers’ compensation reserve adjustments, which we had not assumed as well as the lower SUI costs I just mentioned and we are raising our outlook for PEO margin to now expect it to be up 50 to 75 basis points for fiscal ‘23. Putting it altogether, we still expect consolidated revenue growth of 8% to 9% in fiscal ‘23, but now believe it will be towards the higher end of that range. We are maintaining our outlook for adjusted EBIT margin expansion of 125 to 150 basis points and for a fiscal ‘23 effective tax rate of about 23%.

And we now expect adjusted EPS growth of 16% to 17% and compared to our prior outlook of 15% to 17%. I also want to provide some early high level color on what to expect for next year. We are still going through our annual planning process, but there are a few things to consider at this point. First, assuming a slowing economic backdrop, pays per control could be at a below normal growth rate next year, among other potential macro considerations. I would also point out that while client funds interest appears positioned to give us some contribution to growth, based on the latest forward yield curve, it will likely be very modest. At the same time, we have good momentum in our ES bookings performance and ES retention and we are feeling upbeat about the continued opportunity to build on our decades of success.

Thank you. And I’ll now turn it back to Michelle for Q&A.

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Q&A Session

Operator: Thank you. We will take our first question from Bryan Bergin with Cowen. Your line is open.

Bryan Bergin: Hi, all. Good morning. Thank you. So Don, maybe just building on those last comments you had there, I am curious just any indications or call-outs worth mentioning as it relates to fiscal ‘24? Really in the context of the medium-term outlook that you have given in the past, just how should the Street consider the magnitude of potential impacts across some of these KPIs from a potentially slower macro environment?

Don McGuire: Yes, Brian, good morning. Thank you for the question. It’s still early. We are still in the middle of our planning process. I think we have a lot of things going in our favor sales. We are – we still have relatively high client fund interest. Pays per control have been good and strong. Bookings continue to be strong as we said earlier. So as we get into ‘24, I think we are going to be in a pretty healthy spot with what we know today. I guess the challenge we all have is trying to guess what’s coming in terms of the broader macro situation. We continue to see strong demand. Retention continues to be pretty good, although it’s normalizing a little bit in the down market as we did expect. But I think things feel pretty good at this juncture.

So I am going to have to ask you to bear with us a little bit as we make our way through our plan and we stay tuned to what’s going on in the macro environment even closer as we get forward or closer to our July 1 beginning of the year.

Bryan Bergin: Okay. That’s fair. And just on the PEO, so works on employee view downtick and I think you were down sequentially in average works on employees. Can you just talk about what you are seeing in kind of the pays per control versus the retention aspect in the PEO? And with bookings reaccelerating, how long does the reconnection to improve growth take?

Don McGuire: So the – we did have, as you mentioned, we had a particularly strong PEO bookings month in March, which we are optimistic is going to continue and help us as we go forward. Certainly, we are going to have to see how those bookings continue through the balance of the year, trying to anticipate how those are going to actually result in revenue. Things do start relatively quickly in the PEO business, but it’s going to take some time once again to see how that stuff rolls from bookings into revenue. But we are pretty optimistic about how things went in the third quarter, especially with the finish and we do expect to see that reacceleration as quickly as we want to. And by the way, back to your earlier question a little bit, we talked about high single-digit growth in our mid-term view and we won’t be happy if we don’t get something like that.

Maria Black: Yes. I think, Brian, if I can just comment on the quarter-over-quarter real quick as I think you mentioned the sequential growth Q2 to Q3 and works on employees. That is something that obviously we noticed as well and as Don mentioned, from a medium-term perspective, we are definitely still committed from the medium-term to the works on employee growth that we have guided to for that. However, as it relates to kind of the quarter-over-quarter, we noticed the same thing that you noticed. And obviously, that’s not the ideal situation and we are hopeful that won’t be the case as you look sequentially on the quarter-to-quarter, Q3 to Q4, but also year-on-year. And I think that’s really a byproduct of timing and that timing is really about retention, right.

So it’s really about, call it, third quarter retention results, which we have cited before were a bit softer than we expected. And as a result of that, you see the sequential piece to the quarter-on-quarter.

Bryan Bergin: Okay. Is that just a function of the type of client within PEO?

Maria Black: In terms of the type being.

Bryan Bergin: More white collar?

Maria Black: I don’t know that it’s a function of more white collar, I think it’s really a function of some of the feelings that we have post-pandemic as the renewals have really been kind of, call it, rippling through the business of the PEO. So it’s really a byproduct of some of the post-pandemic impact that we saw in the PEO. So it’s really a byproduct of the retention softness that we saw in the first quarter, in the second quarter and then quarter-on-quarter this past quarter. So I don’t think it’s necessarily a byproduct of – because retention continues, albeit it’s normalizing a bit in the down market. We do have very strong retention in the mid-market. We also have strong retention, albeit tiny bit less than last year in the down market. So I don’t really think it’s a byproduct of the client base or white collar, I think it’s really a byproduct of kind of a post-pandemic environment in the PEO.

Bryan Bergin: Okay, thank you.

Operator: Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.

Bryan Keane: Hi, good morning. Thanks for taking my questions. I guess just trying to look at Employer Services, really strong growth in the quarter, 12% organic. If you back into the guidance for fourth quarter, it looks like a little bit of a deceleration. I think you get to something around 8% growth. So just trying to understand the puts and takes there for the fourth quarter guide versus the strong results in the third quarter?

Don McGuire: Yes, thanks for the question. The biggest impact, I guess, in terms of growth would be we are going to continue to see strong growth from client fund interest in the fourth quarter. But certainly, Q3 is by far the strongest quarter just given the seasonality of tax receipts, etcetera, for us. So I think that would be one of the key drivers. And of course, we did mention as well that we expect to see pays per control growth coming down and softening a little bit, even though a bit higher than we expected to see. Last quarter, it is coming down. It’s certainly starting to moderate.

Bryan Keane: Got it. Got it. And then on the bookings side, although bookings were strong, I think you commented maybe towards the lower end of the range of 6% to 9% and just can you help us maybe think about how bookings will translate into future revenue growth for the employer services? If you can just remind us, just as we get our models set or start thinking about fiscal year ‘24.