Q3 2021 Automatic Data Processing Inc Earnings Call

Yeah.

Sure good morning.

And Steven Wald on of the payments analyst here at Morgan Stanley. This morning, I'm joined by Kathleen Winters CFO of ADP, thanks for being with Us Kathleen.

And debate here.

So before I start a couple of housekeeping notes, leaving and disclosure here for important disclosures. Please see the Morgan Stanley Research disclosure website at Www Dot Morgan Stanley Dot Com Slash research disclosures. If you have any questions. Please reach out to you and Morgan Stanley sales representative and separately. There is a ask question feature and the left side of everyones screen.

And you should feel free to use it and because of our work those in towards the end to accumulate portion here.

Just a quick way to start off here Kathleen is to get sort of a two minute overview for those who aren't as familiar with the ADP story of how the business model generally works and sort of how you've been navigating through the pandemic. So far this year.

Sure. Thanks, Steve.

And just a couple of seconds here on <unk>.

P and business model and some of you may know.

We are a global HCM software and services provider.

We serve clients of all sizes actually from small businesses with a handful of employees to large global enterprises, we're global we operate and a 140 countries.

And we very much jumped and focusing on a multiyear journey that we've been going through too.

To simplify and transform and update our product suite and our portfolio.

So that's been a big focus for us over the last several years and will continue to be a focus and I'm sure, we'll talk a little bit about that.

On.

In terms of how we've been navigating through Cal.

Calendar, 2020 and the COVID-19 crisis, and look it's been a child and very challenging year for everybody companies and individuals and challenging across the board.

And it's amazing.

Amazing to think we're and month 12, the last months of calendar 2020, and and I think we're all probably grateful that that's finally here. So we can turn on a quarter corner, if you well on.

What we've seen and how we've been navigating.

Look we've obviously had a.

Global economic slowdown, which has resulted in a steep decline and employment metrics and employment numbers, which of course impacts us heavily.

You know, we saw that steep decline with and I'll use from U S. Unemployment numbers, but we saw that go from pre COVID-19 U S unemployment at three 8% and <unk>.

And we saw it deteriorate to about 13% in our Q4 of fiscal year, 'twenty and we and you know it's fairly substantial amount of recovery, but not quite to pre COVID-19 levels for sure with the October unemployment metrics being at this point.

9%, so still quite a ways to go and so how have we been navigating through all that because we do see you know we've had that as I said very steep deterioration and women metrics on.

And it's still quite some uncertainty ahead and in our view right as you look at various parts of the economy still and partial shutdowns dealing with the pandemic you see small businesses continuing to have challenges and and struggles and uncertainty, particularly with regard to how much stimulus there will be going forward if any at all.

And you know large enterprises, you see various other large companies and with and employment reductions.

So there's you know there's a fair amount of uncertainty and recovery that we're still I'm looking at.

Various sectors of the the global economy in terms of travel.

Travel and restaurants still you know a lot of struggle and challenges out there on particular sectors on.

And how we've been navigating through that and what those challenges mean for us.

Look just like all companies and this has been a significant disruption for us impacting our fiscal year 'twenty and our fiscal year 'twenty one.

We are reacted I think you know pretty well actually quite nimbly, we were able to move our entire workforce our 58000.

Employee workforce around the globe to a walk to a work from home environment like many companies have to do them and we did that really without skipping a beat now I don't say that to imply that there wasn't a lot of effort and work and you know.

Hard work by people around you know around the company to make that happen, but we made it happen and we moved those 50000 people without skipping a beat on client service and in fact, one of the things and kids and I'm sure. We'll talk about the importance of client service and our business model, but one other things. We did is we saw the need and the demand like and clients.

Service requests.

And we reallocated a number of our employees our resources to the client service area. So that we could meet those needs, which we believe and the long term is critically important to continuously need services those client services needs.

And so you know and I would say.

The other thing that we made.

You know a particular point of focusing on during this time period is really looking hard at our approach to investment and while some companies you know have been in a position where they needed to pull back on investment. During this recession. We were fortunate enough that we've got a very strong business.

Model high degree of recurring revenue very high retention rates highly cash generative model and so we're fortunate that we're able to continue to support that investment and we have not pulled back in terms of investment and the critical areas of our sales and distribution and our product portfolio. So we're really happy to be able to.

And do that.

On the other thing I would say is you know in terms of how we've been navigating and managing through this time as I mentioned at the beginning on my comments, we've been doing a lot of transformation and that transformation is around our hum product portfolio as well as our and our cost infrastructure.

Sure.

All of that transformation work continues and we have not slowed down on that at all on.

The projects that we have in flight continue in fact, we're pushing even harder to make them go as fast as we can and we're working very hard at continuing to develop a pipeline of additional transformation projects. So I'll pause there and that's a little bit about kind of how we've been navigating through.

True and thinking about managing through the current environment quite.

Great, where you've given us a lot to get through and sort of go through there. So thanks for that comprehensive overview, maybe a good place to start and you talked about a lot of things you did sort of since March and adjusting to me, but to the endemic but also on.

Investments that were already underway and things you've already changing on your business model and if we sort of look back for the last few quarters results. It seemed like there was a bit of a bottleneck or a freeze in terms of selling activity or bookings, obviously declined quite a bit you pointed to the obvious disruption I'm curious if you could sort of walk us through because it was sort of hard to see from the outside how much of that was driven by.

The adjustments you had to make as a business to you our selling motion versus sort of like just the clients on people worried about staying in business managing cost versus dealing with HCM vendors could you sort of talk through what that looked like how much of it was each and how that's really changed since March obviously, the bookings have come back quite robustly and the latest quarter.

Sure.

Yeah, you know for critical question I mean, when you think about our business model and you know some critical metrics like we are constantly focused on you know new.

New business bookings sales and new business bookings client retention and level of profitability. So I'm you know thank you for that kind of question on on the new business bookings you know look what happened with this and the disruption of the COVID-19 disruption, obviously huge disruption right I mean, we've never seen anything like.

And this before with the global economy, you know being so massively disrupted.

You know it was a very rapid and steep decline. So you know you look at these recessions and downturns and you try to look at previous recessions to learn from it and to apply and say how did we perform last time and what's it going to look like this time and I think most people feel like and believe this is just different from anything we've seen before in terms of.

On the speed of the decline and that's what we saw in our you know our Q4 as of June 30 year, and you know and our Q4, we saw that very steep decline and new business bookings with companies just kind of you know what I'll say kind of hunkering down and there was so much uncertainty during that period.

Time for sure we had a.

Big effort as I said earlier, we're kind of moving everyone to a virtual environment and a work from home environment. So for sure that has some impact in terms of you know a.

A kind of temper.

Temporary a short kind of distraction to get everybody working in that environment, but that was pretty short and pretty you know.

And minor in comparison to what I would say it was the real impact of company hunkering down and they don't know what you know at that point and time. They didn't know what was coming and it was just a real impact to clients and prospects willingness and ability I would say to engage and think about you know making decision.

And whether it's.

A new venture kind of.

Kicking off and you know needing to get software in place or a company, making a change from one provider to another and there was just no real you know clients ability and willingness to engage was probably the biggest impact here quite frankly with our the way our sales force is.

And is designed and constructed pretty even pre COVID-19, we had a large portion of our sales force about one third of our sales force operating what we call. Our in house sales. So they were operating in a virtual environment already so there really wasn't much of a shift for them. They were used to that virtual engagement.

And the virtual sales cycle. It was really the other the two thirds Porsche and getting them fully up to speed, which I think we did quite well.

And you can see that right. When you look at the Q1 bookings number I'm seeing the positive sales growth the positive bookings growth in Q1, which quite frankly, we were pleasantly surprised that it was that good you know as I said earlier, we've looked at prior recessions and how.

We performed and you know my takeaway from studying those prior periods as you know, it's typically choppy during the recovery and you know to have the steep decline in Q4, and then a recovery for US right away and Q1 is great and you know I caution.

Everyone that I do believe it is going to continue to be choppy. So we'll see how it plays out the balance of the year, but on the work the sales.

For us it's fully enabled with all the technology they need to engage virtually to the extent clients and prospects are willing to do it.

That's really helpful context in terms of what you already sort of outgoing versus what you had to adjust to it and certainly and it comes out tomorrow side and a lot of questions about comparatively how ADP works so and.

And offers its products versus other players on the market and you know obviously you have the broadest range on the service model on the HCM side of things in terms of product offering and go to market approach, but a lot of attention over the last several years was paid for use on a lower touch and maybe.

And we'll call them SaaS platforms, and the space and certainly as we went into the pandemic people felt that those were going to be better position I'm curious to hear your thoughts on how adp's approach is differentiated and resonates today or remainder early on and clients during the pandemic and how do you see that dynamic evolving over time.

Just in general, but also how it changed as a result of a virus conditions.

Yeah, Yeah locally or a you know a software provider and a service provider and and short I would say you know that's not going to change as a result of the pandemic and quite frankly, I think our ability to meet clients.

Where they want to be match and.

And being able to meet the range of broad range of different client needs is a great advantage for us.

And there are some clients that want to have.

Have a full and you're kind of automated kind of no human interaction service model and then they want to do whatever you know payroll or HCM changes they need to take them on and do it from there on you know.

And to use our mobile App, which we were first and mobile and Dom you know quite adept at being able to provide that for clients. Some clients want to do that other clients that maybe arent and I'm willing to engage that way or may have more complex needs or changes or questions.

Or you know clients that may not have the internal resources or internal expertise and want to have that ability to have a different sort of service model and we provide that and I expect it will continue to provide that for the foreseeable future.

Very helpful.

Maybe switching a little bit gears and and it makes for the competitive landscape.

If we were and are sort of go through each of the segments, we serve being the price service model out there between down market for us and the mom and pop shops upwards of Fortune 500 companies like Morgan Stanley.

And of all of them and that's kind of rare and the space. So I'm kind of curious if you just could walk us through the spectrum of each segment and how you view that from a competitive intensity today as well as a greenfield opportunity. Obviously these are not all the same in terms of addressable market and sort of open space for everybody to go into.

Yeah.

And you're right. It is does it really set us aside in terms of the breadth of what we offer and that we.

Really serve all segments of the market small business mid market large.

Large enterprise space.

Look the HCM industry is and attractive space, it's a growing and space and because of that because of that attractiveness you <expletive>.

Expect that it would be incredibly competitive.

It's been incredibly incredibly competitive and it remains incredibly competitive I don't think that's going to change so but that's fine. That's fine I mean, you know I I think it's great for us to have that level of competition.

And you know when I think about what do we need to be good at to win and that competitive space and we need to be great from a sales from a go to market standpoint, and we talked a bit about that already we need to be great with product in terms of long term product strategy and execution from an R&D for <unk>.

Factor on and we need to be great at what I'll call operations service and implementation because if we while other clients with our product, but if we're not wowing them from a service perspective, that's not good from a long term perspective, so we need to be great at all of those things and we're focused on being great at all of those things and that applies to each of them.

Market segments, small business mid market and upmarket and <unk>.

Small business, we've been doing you know and the down market, we have been doing incredibly well and continuing to grow our client count you may have heard on our most recent earnings call. You know we've got over 700000 clients now on our and our small business segment on our one product.

So a new a new record for us from a client count perspective, and Midmarket and I'm also very very competitive space with our work force now product that's performing quite well, we went through a process to streamline and <unk>.

Rationalize the product portfolio and that space and having done that we were seeing really really good momentum pre COVID-19.

And we're seeing great retention right now in fact, we had record retention in that space, both actually both on the down market and small business segment and mid market and Q1, and we had record retention so doing quite well there.

And the upmarket space you know and you know there is some established players there and we're focused right now on our investment in our next Gen HCM product, which will help solidify our position in the upmarket space and that'll be a kind of a multi year.

Journey for us as we scale that up but we're really excited about that.

And then just lastly internationally I would say, it's a fairly fragmented market we compete with.

And some local and regional providers, but have been seeing very very nice growth, there and as well.

That's super helpful Rundown, and and I think one other thing that's really helped over time as you guys sort of defining the market and sort of the opportunities and how youre going after each of those opportunities.

If I ever wanted to pay back to before the virus. If we can remember that for you talked about on your innovation day, and and addressable market and about 150 billion and obviously, that's not relevant to all your peers. Some of those are.

I'm not going to be and all of the spaces you are in and you've talked about that growing sort of 5% to six per cent per year.

And then Furthermore, recently isn't incrementals for the optimism I'm getting from for your and Carlos tone on the earnings call in terms of the opportunity coming out of the downturn for you and all players and the market seems everyone sees an opportunity here to really expand growth I'm curious if you could sort of talk through that perspective against your comments today, but also more recently.

And it's gonna be sort of uneven from here to there and walk us through how we sort of get from here and there and the reality that sometimes coming out of a downturn, even if there's incremental opportunity. The first few years and they're not always the fastest growth years.

Sure Yeah, I mean, if you think about the HCM space and what was driving growth pre COVID-19 and and you said if anyone can remember back that far you know we think about it in terms of you know a couple of different you know.

And maybe categories I'll call. It in terms of what's driving for growth, but we think about it.

You know the way work gets done and you know the way you know pay occurs the way that happens the.

And the way HR functions the way business gets done and just how technology supports all of that you know all of those the HCM space with evolving right for even pre COVID-19 and driving that growth I mean, you know, we see growth and the mid single digit and.

Area.

For the industry right. So you know pre COVID-19, we were seeing that growth you know and then you look at what's happening during COVID-19 and you say well you know what's changed for the for the long term has anything changed you know if any of that going to stop no does it you know does it accelerate even further.

Possibly I don't know, but you know you think about it in terms of you know maybe I'll just call out one or two other things in those categories and I mentioned.

And you think about HR.

And the way HR functions and the need to obviously manage a work force and engage talent.

You know I think HR functions now having gone through this disruption huge huge disruption that nobody anticipated you know a global pandemic happening in 2020 right.

HR and see Wow, we've gotta be prepared we gotta have missed and service capability, we're gonna be prepare to manage our workforce to ensure we've got and gauge mental will get productivity to make the changes we need to make in a very seamless way even and then.

And a huge disruption because it happened.

So if anything I think you know the value proposition is even stronger coming out of COVID-19 post COVID-19 than it was before it's hard to measure exactly by how much but I think its strength in and then you look at technology and you say well you know gosh. The technology just has to be it has to be there.

And it has to be state of the yard it has to be modern.

People, both you know.

For users.

On the buyer the and if our software the employees of each of our clients.

Back to a you know world class consumer grade type.

Technology experience.

And so you know again, I think coming out of COVID-19, and if anything there's stronger demand greater growth opportunity and a stronger value proposition and what we offer.

That's very helpful and certainly something we'll have to watch for is it and to see how it translates into the results over time, you know and near term risks and overtime, but.

Maybe shifting gears towards the margin and I know that was an area of strength this quarter.

Other one and that sort of surprised and the number of those to the outside and particularly as you had guided that there could be incremental pressure on a number of sources, particularly on the topline pressures as a result of ongoing investment and the business.

You sort of obviously it was an upside surprise you sort of feel sort of sounded generally positive longer term about the margin, but you also cautioned that from here for the next nine to 12 months is going to be some bumps on the road and that's typically not even margin across the board for your business. So maybe you could just walk us through a particularly for those of US who are not as close to the story.

And you sort of see the next six 912 months and margin as well as you know if we come back to the pre virus you were sort of trending into the mid twenties on an adjusted basis is that still the natural margin for this business or do you see that evolving higher or lower over time, depending on mix shift or like you said the need to invest to give all of these offerings declines going forward.

Yeah, and so a lot of questions to address there in terms of margin and profitability and.

On.

You know maybe I'll start with the long term view and then comes back to the shorter term deals because quite frankly I think for long term view is very important here and you know short term, it's always tough looking at certain metrics and particular margin or bookings on a short term thing.

And as you know quarterly basis, and trying to draw conclusions from that I caution people from doing that.

And so from a long term perspective look pre COVID-19, we had long term margin targets of 23, and a quarter or 225, and a quarter and we were well on our way and that basically adds if you will be lower and that range.

So we were seeing great momentum there you know COVID-19 happened, obviously that had an impact on our top line and that impact is very.

Very high margin.

Impact that it had so you know think about it as you know the number of employees and for which we're processing pay cash.

And on down the revenue has come down, but we're not able to take all of that and.

Associated amount and cross out right, because we're still providing supporting the product we're still providing the services that we talked about so well for sure. There was some cost actions be we're able to and did take you know it.

And a very high margin revenue loss right.

<unk> had an impact on.

And set us back from a margin perspective, but when you think about it from a long term perspective, and you think about.

Well just like it hurt us on the you know coming down on the downside, it's gonna help us coming up right. During the recovery. So we're gonna you know, it's going to depend on what the shape of the recovery looks like how the employment numbers come back that will certainly have an impact on.

But the other thing and that's going to have an impact is remember I said, we did not pause on any of our transformation work right all of the projects that where and why continue to be and flight. So everything we're doing and you know we've got a you know a nice track record here of several years of doing really.

Meaningful substantial transformation work that has given us profitability improvement and margin expansion.

And that work continues and so you know look you know I'm I'm I'm optimistic about the future and going forward and you know when we have the economic recovery that coupled with the continuing transformation work we're doing.

I'm optimistic about where we can go and no in terms of kind of the shorter term view and this year, you know and how that might look again quarter by quarter. You know, there's lots of puts and takes and when you look at a quarter in isolation.

And I think it's more important to look at the longer term you know at least looking at a one year period, we feel good about the year in terms of being able to continue the transformation work. We've talked about we've talked about the work, we're doing and digital we talked about procurement and real estate transformation that we're doing them all.

That will continue and will help US you know what you know just a lot depends on what the top line impact is going to be and how that plays out and if there's a particular quarter, where you know we've got a softer revenue quarter.

Because of the various pressures on the top line, that's obviously going to impact us and for the quarter on a margin perspective.

And I appreciate that that's super helpful to sort of guide us through and when the last few minutes I want to make sure I get for questions on the weather a couple here I'm going to try and blend and as best they can because they are somewhat similar thinking about where ADP differentiates itself and the client retention aspect, how do you sort of see.

And I think of the up market is probably the safest area of client retention and and most where do you think your motives strongest and how do you sort of see retention, particularly in some of the areas where people tend to view ADP is more solidified going forward.

Yeah, so and it's.

It's a good question and I'm glad you asked it because as I said earlier look sales retention and profitability, it's not a complicated and model right. We've got to do everything we can to focus on no constantly you know maintaining and driving improvement in each of those areas. So from a retention perspective.

Hum look our retention is actually.

Very high very good retention and to your point is strongest in the up market and <unk>.

And down market, we do see some churn if you will from out of business, but that's.

You always see that and a smaller business segment.

And a bit more of that in Q4 than in normal times because of the pandemic, but actually in Q1, we didn't see a lot of out of business impact.

And we are a little cautious about that of how that's going to play out during the balance of the year. So we're watching that and we've reflected that and our guidance with regard to seeing potential out of business pressure and therefore impact on retention.

But you know we're feeling we're feeling I'm quite pleased and and confident that we've made the decision as the right assistance for the long term that will drive retention, we've had record retention and small business and.

Mid market and you know what we've got strong retention and up market as well. So you know we're pretty we're pretty optimistic about what we can do there right.

Got to get cut off on time here, but maybe if I can get and the last 30 seconds and a one liner and what the area of greatest upside that you think investors should be paying attention to for ADP.

[laughter] one line is hard and you know I guess, what I would say there is look theres a reason why ADP has been around for 70 years.

And we know how to win.

And we know how to win and good times and and that.

We've got a great business model and as I've said, we're confident and our market position and.

And we've got great Optionality. So I think that's critical for people to understand we've got you know that strong business model strong balance sheet optionality ability to invest through the cycle and that's gonna be critical because that positions us extremely well coming out of it.

Well, that's going to take it for time and thank you for joining us.

Thank you very much.