Automatic Data Processing, Inc. (NASDAQ:ADP) Q3 2024 Earnings Call Transcript May 1, 2024
Automatic Data Processing, Inc. beats earnings expectations. Reported EPS is $2.88, expectations were $2.79. ADP isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, my name is Michelle, and I’ll be your conference operator. At this time, I would like to welcome everyone to ADP’s Third Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the call 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 2024 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 their 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’ll now turn it over to Maria.
Maria Black: Thank you, Danny, and thank you everyone for joining us. This morning, we reported strong 7% revenue growth and 14% adjusted diluted EPS growth for the third quarter as we continued to make progress delivering against our strategic priorities and as the labor market and the overall HCM business environment remained stable. I’ll begin with a review of the quarter’s results and provide a brief update on our strategy before turning it to Don to update you on our outlook and share some early considerations for next year. In Q3, we delivered solid Employer Services new business bookings growth reaching record bookings for our Q3 period and keeping us on track for our full-year outlook. We maintained momentum in our small business portfolio with particularly strong growth in our retirement services offering, and in Q3, we also delivered strong bookings results in our midmarket, enterprise and international businesses.
With a steady demand backdrop and a healthy new business pipeline, we are focused on continuing to execute for the remainder of the year. Employer Services retention was very strong in the third quarter and once again exceeded our expectations also reaching a new record level for our Q3 period led by our midmarket business. Our overall retention continues to benefit from ongoing investments in our key platforms and from our commitment to delivering an exceptional client experience, which together helped our client satisfaction scores reach a new all-time high for our Q3. Our Employer Services pays per control growth was steady at 2% reflecting the resilient overall U.S. labor market and the fact that our clients continue to add to their workforces at a moderate pace, and our PEO revenue growth of 5% for the third quarter was in line with our expectations despite continued short-term pressure from below normal hiring activity we’ve been experiencing among those clients.
Moving on to a broader update, we continue to push forward on our three strategic priorities, leading with the best HCM technology, unmatched service and expertise in a broader scale to ultimately deliver the best possible experience not just to the buyers of our products but everyone that engages with ADP. We are investing with purpose to deeply understand and deliver value to a vast set of personas from small business owners that count on us to HR professionals and executives of the largest global enterprises to millions of employees and gig workers around the world who engage with our solutions through CPAs, banks, brokers and other key partners to our thousands of dedicated service and implementation associates and to our sellers who represent ADP in the market every day.
It’s with these personas in mind that we continue pushing forward on our strategic priorities, and in Q3, we made steady progress. Our first priority is to lead with best-in-class HCM technology. We’ve been rolling out ADP Assist these past couple of quarters, which as a reminder will be embedded in our key platforms and utilizes GenAI to surface insights, aid decision-making and streamline day-to-day tasks for our clients and their employees. In Q3, we were very excited to begin piloting a new feature that enables our small business clients to not only leverage GenAI to answer questions and better understand how to initiate an HR action which we outlined in recent quarters but to actually allow them to issue commands to complete that HR action.
For example, users can now type I need to rehire Alex or I would like to give Alex a leave of absence and are expedited through that workflow. Our second priority is to provide unmatched expertise in outsourcing. We continue to extend GenAI capabilities to a broader portion of our service associates, and in Q3, we started rolling out a new tool for some of our implementation teams. Now they can use GenAI to take in unstructured client employee data reducing manual data entry and minimizing errors during the implementation process. While it’s still early, we are excited about its potential benefits. Our third priority is to benefit our clients with our global scale. The ADP marketplace remains a differentiator for us and is a perfect example of a benefit our clients receive from partnering with the leader in HCM.
As a growing number of our hundreds of partners offer AI-enabled solutions, in Q3, we established ADP marketplace AI principles that require our partners to commit for the same type of responsible AI principles that govern our own products including human oversight, monitoring, explainability and mitigating bias. Our clients put a huge amount of trust in us and this is another example of how ADP strives to ensure the responsible use of AI throughout the ADP ecosystem. We also continued to extend our market-leading global scale, and in Q3, we reached 1 million paid employees on our I-HCM platform, which continues to scale in several countries in Europe and we made further progress in growing our presence in the APAC region, where we have recently been expanding our in-country payroll and workforce management presence in a number of markets.
In 2024, we are celebrating our 75th anniversary and we pride ourselves on having built ourselves into a brand that truly matters to employers, their employees and the broader world of work. Our focus on our strategic priorities positions us to deliver more value than ever for our over 1 million current clients and to the tens of thousands of new clients we welcome to the ADP family every quarter. I’d like to highlight just a few of these new client wins from Q3 to give you an appreciation for the variety of ways in which we deliver value for them. In U.S. small business, we had a new Boutique Donut Shop referred to us from one of our CPA partners. The client chose ADP for the strength of our run platform, our reputation for great service, our strong relationship with our CPA and our ability to provide retirement services.
Since this was a first time small business owner, our sales team even took the time to help the business owner set up their business the right way from guiding the client on obtaining a state tax ID to making sure the client obtained the appropriate workers compensation insurance. In U.S. midmarket, we won a multistate operator of rehabilitation centers, this client wasn’t happy with our prior HCM provider and Workforce Now proved a much better fit. What makes me the most proud in this example is how one of our ADP marketplace partners played a key role in the decision to switch to ADP by independently highlighting the advantages we offered in terms of ease of integrations, a capability we have invested in over the years. In U.S. enterprise, we welcomed a large luxury resort that operates multiple hotels, restaurants and retail stores on site and was dissatisfied with the prior provider’s level of client service.
The client was so happy following their seamless ADP implementation, which included onsite training for their HR team that they accelerated their plans to add-on features like benefits, recruiting, onboarding, wage garnishment and tax credits. In our International business, one recent win was a leading airline that utilized ADP in certain countries and asked us to help better define their global payroll strategy. Ultimately, they expanded the scope of our services to include in additional 18 countries and started that rollout in the third quarter with plans to add other countries over the next year to enable true consolidated global reporting and analytics. And as a final example, our HRO team started a New York-based design firm after its leadership team recognized the company lacked the HR infrastructure required to adequately attract and retain the right talent.
They turned to our PEO offering for truly comprehensive support, attracted by the breadth of our offering including features like the MyLife Advisors program, which supports employees as they make benefit in other important life decisions. We also advise this client in the development of a comprehensive benefits strategy to support their multigenerational workforce and help them attract the talent that they need to grow. As you can tell from these examples, it’s often a combination of our technology, expertise and overall breadth that resonated with these businesses, and the result is incredible diversity in our client base and a resilient overall business model. We look forward to leaning in and delivering even greater differentiation in the market going forward.
Overall, we were pleased with the strong financial and strategic outcomes in the third quarter. I’d like to thank our associates who continued to deliver exceptional products and service to our clients, in whose efforts drive these client wins and retention. Thank you again for all you do for ADP and for our clients. And now, I’ll turn it over to Don.
Don McGuire: Thank you, Maria, and good morning, everyone. I’ll provide more color on our results for the quarter and our updated fiscal 2024 outlook. Overall, we reported a strong third quarter with our consolidated revenue growth and our adjusted EBIT margin coming in a bit above our expectations. The interest rate backdrop has improved since we last provided our full year outlook, so we are updating our outlook for that as well as making a few other changes, which I’ll detail. I’ll start with Employer Services. ES segment revenue grew 8% on a reported basis and 7% on an organic constant currency basis. As Maria shared, we had a good quarter in ES new business bookings with broad-based growth across our client segments. We have a tough compare in Q4 following last year’s strong finish but with a steady HCM demand environment and healthy pipelines, we feel on track to deliver our 4% to 7% new business bookings growth outlook for the year.
Also, as Maria mentioned earlier, our ES retention exceeded our expectations and increased slightly from last year. Given our continued strong retention performance, we are increasing our full-year retention outlook slightly, we now anticipate a 20 to 30 basis point decline in full year retention which is better than our prior forecast. ES pays per control growth held steady at 2% in Q3 and we now expect growth to round to 2% for the year, the high end of our prior 1% to 2% growth outlook, and client funds interest revenue exceed our expectations in Q3 due to higher average client funds balances and a slightly better average yield. We are revising our full-year client funds interest outlook to reflect our Q3 results and the increase in prevailing interest rates since our last update.
We now expect fiscal ’24 average client funds balance growth of about 3% and we are raising our expectations for client fund’s interest revenue and net impact from our client fund’s extended investment strategy. In total, there is no change to our fiscal ’24 ES revenue growth forecast of 7% to 8%, although we are now likely to come in towards the higher end of that range. Our ES margin increased 230 basis points in Q3, driven both by operating leverage and the contribution from client funds interest revenue growth. With our strong Q3 results and the slightly more favorable client funds interest rate backdrop, we are raising our fiscal ’24 ES margin outlook and now anticipate growth of 180 to 190 basis points. Moving onto the PEO. We had 5% revenue growth driven by 3% growth in average work site employees in the third quarter, representing slight acceleration from the first half of the year.
These results were largely in line with our expectations and we were encouraged by the gradual stabilization in our PEO’s pays per control growth which decelerated but only slightly from the prior quarter. We continued to anticipate soft pays per control growth through the end of the year and expect work-site employee growth to hold steady at about 3% keeping us on track for our full-year outlook for work-site employee growth of 2% to 3% and revenue growth of 3% to 4%. PEO margin decreased 220 basis points in Q3. As we shared last quarter, we expect this year’s workers’ compensation reserve release benefit to be significantly lower than what we experienced these last few years, and in particular, last year’s $73 million benefit. We are updating our fiscal ’24 outlook to now assume a minimal release benefit, and as a result, we are further revising our overall PEO margin expectation to be down 120 to 140 basis points in fiscal ’24 versus our prior expectation for a decline of 80 to 100 basis points.
Putting it all together, there is no change to our fiscal ’24 consolidated revenue growth of 6% to 7%. With the two changes to segment margins, largely offsetting one another, we continue to expect our adjusted EBIT margin to increase by 60 to 70 basis points. We still anticipate an effective tax rate of around 23% and we continue to expect fiscal ’24 adjusted EPS growth of 10% to 12% with the middle of that range still the most likely outcome. As we look ahead to fiscal ’25, I wanted to share a couple of early thoughts at this point. First, give them the fullness of the labor market, we are planning for pays per control growth to once again be below normal levels next year and to decelerate modestly from this year’s growth level in both ES and our PEO segments with the resulting revenue pressure more apparent in the PEO segment given its more direct revenue sensitivity to work-site employees.
We will of course share those exact assumptions with you when we give our formal guidance in a few months. On the expense side, we are also planning to continue growing our GenAI related spend next year. As you’ve heard from us all year long, there are many ways we can put GenAI in the hands of all of the different stakeholders that work with or on behalf of ADP, including our client practitioners, their employees, our service and implementation teams, our sellers and our developers. These are critical investments and they are the right investments for ADP, but we expect the associated benefits and productivity of growth to phasing gradually over time likely representing overall margin pressure for the year. At the same time, we appear positioned for continued tailwind from interest rates, though the extent of this benefit will of course depend on how the yield curve continues to develop.
As usual, we’re focused primarily on maintaining good momentum in our new business bookings and maintaining our strong client satisfaction and retention and we remain upbeat about our strategy for the years ahead. And now over to Q&A.
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