Automatic Data Processing Inc (ADP) — Q2 2015 Earnings Call Transcript

Thank you. Good morning. This is Sara Grilliot, ADP's Vice President, Investor Relations, and I am here today with Carlos Rodriguez, ADP's President and Chief Executive Officer; and Jan Siegmund, ADP's Chief Financial Officer. Thank you for joining us for our second quarter fiscal 2015 earnings call and webcast. Before we get started with Carlos's commentary on the quarter, I want to give you an update on our Investor Day. The event will be held on March 3rd in New York City and we have an exciting agenda planned that will showcase our new products and include an update on our business and strategic initiatives. We look forward to seeing you there. I'd like to remind everyone that today's call will contain forward-looking statements that refer to future events, and as such, involve some risks. We encourage you to review our filings with the SEC for additional information on risk factors that could cause actual results to differ materially from our current expectations. With that, I'll now turn the call over to Carlos.

Thank you, Sara. And good morning, everyone. This morning we reported solid results for our second quarter of fiscal 2015 including revenue growth of 7% and worldwide new business growth of 15%. During the quarter, we increased the number of businesses in the cloud to 480,000 and migrated 22 million users to our new user experience, providing them with a new way to access their pay information. Since last year we have more than doubled the number of mobile users to 3.6 million. We are on track with our client migrations and are pleased that we have migrated almost all of our small business clients to ADP RUN. We now have fewer than 2,000 clients left on the legacy EasyPay platform. We are excited as we prepared to sunset this platform in the coming week. This continued progress was made possible by our investments and innovations and our laser focus on leading in the Human Capital Management or HCM market. We remain optimistic as our strengthening portfolio of strategic platforms continues to experience success in recent months. The success is evident by our year-to-date record client revenue retention in both the US and internationally, as well as our strong new bookings growth as clients of all sizes are seeing the value in ADP's integrated offerings and the value we provide in helping them manage their workforce. In the US, we continue to be focused on growing our suite of integrated cloud-based HCM solutions and we are pleased with the number of new clients choosing our flagship platforms ADP RUN, Workforce Now, and Vantage, as well as the adoption rates of additional modules by our existing client base. Our HR business processing outsourcing solutions, especially our PEO, continue to perform quite well as businesses look to fully outsource increasingly complex HR processes to ADP. To further enhance our capabilities, during the quarter we launched ADP Health Compliance targeted primarily at larger enterprises. This new solution, which ADP is uniquely positioned to deliver, helps businesses navigate the challenging and complex landscape associated with ACA healthcare compliance. We are optimistic about the interest we've seen from clients and the opportunity this represents. We are also keenly aware of our opportunity in the HCM space outside of the US. Although the European economic situation remains a challenge, ADP's strength in global compliance and our presence in 100 countries has contributed to our success internationally. Not only have we seen solid execution in sales for multinational corporations, but we continue to enjoy a leading position abroad for our in-country solution. Overall, we are pleased by the balanced success we are seeing across our portfolio. We are constantly looking for ways to provide better, value-added services for all of our clients whether they are small businesses or multinational corporations. We continue to sharpen our focus and evolve the end-to-end client journey, leveraging our unique insights and expertise to create a more integrated and seamless client experience. We also understand that no two companies have the same needs or the same way of doing business. So providing flexibility and adaptability of our market-leading solutions is essential. For this reason, we introduced the ADP marketplace earlier this fiscal year, which is designed to help employers make the most of their workforce data by empowering partner companies and developers to deliver new and innovative applications that leverage and integrate with ADP's data. The openness of the ADP marketplace, which is enabling access to our Application Programming Interfaces or APIs, enables workforce data integration across multiple workforce management platforms, provides clients with a more seamless and efficient HR process, and lets clients extend the value of their relationship with ADP. In the three months since launch, our development team has begun working with potential partners. We are excited about the opportunity it provides for ADP to collaborate with third-party developers and provide solutions that help our clients better manage their workforce. As we leverage ADP's unique big data capability, we are delighted with the launch of our ADP Workforce Vitality Report this October. The new report from the ADP Research Institute is unique in its ability to provide insight into the health of the US labor market—not just job numbers but the quality of jobs and the trends driving its momentum. When considered together with our well-regarded National Employment Report, we are sending a clear message to the market that ADP is at the forefront of identifying, analyzing, and driving actionable insights in the HCM space. In that regard, we are also encouraged by the demand we are seeing for ADP's analytic solutions, which are particularly strong among our up-market clients. We introduced these solutions just one year ago, and while the product is still in its early stages, we are enthusiastic about future opportunities for ADP to leverage our big data capability. In summary, we have entered the back half of our fiscal year on solid footing. While we certainly understand and are aware of the changing dynamics in the HCM space, we are confident that our robust offerings and insightful expertise will enable us to maintain and extend our leadership position. Again, thank you very much for your continued interest in ADP, and I look forward to speaking with many of you at our Investor Day on March 3rd. With that, I'll turn the call over to Jan to walk you through our second quarter results.

Thank you very much, Carlos. And good morning, everyone. I am pleased with ADP's results for the quarter. Revenue grew 7%, nearly all organic. Pretax earnings grew 8%. The effects of foreign currency translation negatively impacted the quarter's revenue and pretax earnings growth by approximately one percentage point. As Carlos described, ADP's sales force executed well in the quarter, delivering combined worldwide new business bookings growth of 15% over last year's second quarter. As expected, investments in our products and sales force moderated earnings growth in the second quarter. Earnings per share grew 8%, which included a negative impact of about 1% due to foreign currency translations. Our tax rate in the quarter was higher than last year's second quarter. However, it was better than we anticipated due to an expected one-time tax benefit. ADP continued its shareholder-friendly actions, repurchasing over 5 million shares in the quarter at a cost of $436 million. As a reminder, ADP received $825 million in dividend proceeds from CDK as a result of the spin-off that occurred on September 30th, which were intended to fund share repurchases in accordance with the tax-free nature of the spin. We intend to complete these share repurchases by June 30, 2015, subject to market conditions. Employee Services revenue grew 4% from the addition of new recurring revenues tools from our HCM solution. This growth rate was impacted by almost two percentage points from foreign currency translation, as well as higher revenues received in last year's second quarter from administering employment tax credit for our clients here in the US. Certain one-time benefits we experienced in last year's quarter also resulted in a more difficult compare. Despite the more difficult compare and the growth headwinds we experienced from foreign currency translation, we continue to be pleased with the fundamentals of our business model. Our client revenue retention, which is at a year-to-date all-time high, improved slightly over last year's second quarter. Same-store pays per control in the US remain strong, with an increase of 3%, and client fund balances grew 7%, driven by net new business growth as well as growth in pays per control. As a reminder, approximately 15% of our client fund balances are held outside the US, most notably in Canada, the UK, and in the Netherlands. Although our year-to-date balance growth is at the high end of our forecasted range of 5% to 7% for the full year, we anticipate coming in closer to the midpoint of the range due to expected pressure from foreign currency translation in the next two quarters. We continued to be pleased with the overall revenue growth in our international business, with positive results in Asia Pacific and Latin America, as well as the success of our multinational offerings. Although the economic situation in Europe continues to be sluggish, same-store pays per control was flat over last year's second quarter following several periods of decline. Our pretax margin expansion in Employee Services was 30 basis points in the quarter. Our business continues to perform well; however, anticipated higher selling expenses and planned investments in products caused margin pressure over last year's second quarter. The PEO continues to outperform, posting another quarter of strong revenue growth of 18% compared to last year's second quarter. Average worksite employees grew 15% to 354,000. The solid execution of our sales force and the strength of our distribution model continued to be a key driver of our growth. We are also pleased that efficiencies in sales and operations continue to drive margin expansion in the PEO, which delivered about 140 basis points of improvement in the quarter. ADP's consolidated pretax margin improved by 30 basis points in the second quarter, which included a drag of about 20 points from slower growth of our high-margin client fund revenues, as these highly profitable revenues grew at a slower rate than overall revenue. Now, I'll take you through our fiscal year 2015 outlook, which has been updated to reflect the results we have seen in the first half of the year as well as the expected impact of foreign currency translation on our full-year results. We've experienced a solid first half in worldwide bookings growth, and although we have a tough compare in the third quarter compared with last year's third quarter growth of 14%, we now expect to achieve about 10% full-year growth in new business bookings over the $1.4 billion sold in fiscal year 2014. The fundamentals of our business are solid, and for total ADP we still expect revenue growth of 7% to 8% despite the current environment surrounding foreign exchange rates. Although the overall forecast remains the same, we do expect changes on a segment level in Employee Services and the PEO. We are adjusting our forecast for Employee Services to reflect expected headwinds of about two percentage points from the impact of foreign currencies and translation and now expect about 5% growth compared to our prior forecast of 6% to 7%. And while the employment tax program was extended through the end of calendar year 2014, it has not yet been renewed for calendar year 2015, and we therefore expect lower revenue than previously anticipated from these tax credits filed on behalf of our clients. For the PEO, we are increasing our revenue forecast to reflect solid performance during the first half of our fiscal year, and we now expect the PEO to deliver 15% to 17% growth compared with our prior forecast of 13% to 15% growth. So the mix is changed, but overall, we expect to be on track for our full-year revenue guidance even with the expected headwinds from foreign currency translation. Our pretax margin forecast for total ADP remains the same; we still expect 75 to 100 basis points of margin improvement from the 18.4% in fiscal year 2014. On a segment level, we are modifying our margin expansion forecast for the PEO and now expect margin expansion of up to 100 basis points compared with our prior forecast of up to 50 basis points. Our forecast of margin expansion in Employee Services remains unchanged; we still anticipate about 100 basis points of margin expansion. We're updating our forecast with effective tax rate to reflect the one-time benefit we've received in the second quarter and we now anticipate a tax rate of 34.2% compared with our prior forecast of 34.6%. Although we have changed our forecast of tax rate, we expect to have earnings pressure from the impact of foreign currency translation in the second half of the fiscal year, so there is no change to our diluted earnings per share forecast. We still expect growth of 12% to 14% compared with $2.58 in fiscal year 2014. As a reminder, this forecast of 12% to 14% includes an anticipated $0.02 benefit resulting from share repurchases funded by the $825 million in dividend proceeds ADP received as a result of the spin-off of CDK. However, the forecast does not contemplate further share buyback beyond the anticipated dilution related to equity comp plans and the dividend proceeds from CDK. There is no change to our previous forecast related to the client funds investment strategy. We could experience some pressure in client funds interest revenue in the second half of the year due to the changing interest rate environment and the impact of foreign currency translation on interest earned outside the US, however, we are maintaining our forecast and still anticipate an increase of $5 million to $15 million over last year from the client funds extended investments strategy. The detail of this forecast is available both in the press release and in the supplemental slides on our website. In closing, last week I had the opportunity to participate in ADP's annual ReThink Conference in London. This was our largest ever gathering of clients and prospects representing multinational corporations. HR finance and IT executives from some of the largest companies in the world joined us for two days of discussions about the future of HR and ADP's HCM capabilities. In the many personal conversations I had with these leaders at ReThink, it is clear that our vision for HCM is resonating, giving me confidence that we continue to be on the right path. With that, I'll turn it over to the operator to take your questions.

Thank you, good morning. Great performance in the new business sales this quarter. Could you give us some details on where you saw most of the strength?

It was actually across the board.

Okay, great. With the RUN migration now over can you talk about where you are shifting those resources? And also could you give us some client count for Workforce Now versus those still on the legacy platform and when you would expect to be able to shut legacy platforms down?

Jan has the numbers regarding Workforce Now. I want to emphasize how proud we are of our organization and small business for successfully managing the significant challenge of migrating several hundred thousand clients, which now appears to have been the right decision. Our retention rates, margins, and cost structure have all improved in that sector over the last two to three years. However, at the time, it wasn't clear that this would be the result. There were concerns about losing clients and facing competitive challenges, but the migration was executed exceptionally well, enhancing our competitiveness, market position, and market share. The organization did an excellent job, and we are now nearing the completion of the task with only a couple of thousand clients remaining. I want to commend the team for their efforts, as this experience serves as a valuable example for the rest of the organization in demonstrating the positive outcomes of a well-managed migration. The simplification and efficiency brought about by operating on a single platform, training one group of implementation associates truly represents a significant achievement. Our focus now shifts to the mid-market and up-market. We have gained substantial momentum with Workforce Now in the mid-market and are looking to focus on larger clients shortly. Our priority is to utilize both internal and external resources to accelerate migrations in the up-market. In response to your question, we are reallocating resources that were previously dedicated to the RUN migration and small business sector to assist with national accounts. In the mid-market, we are steadily continuing our efforts to transition as many clients as possible to our strategic platforms. I believe Jan has the relevant data.

Yes, Sara. So as Carlos mentioned, of course RUN is a huge success story. We now have almost 425,000 clients on that platform; it is really a wonderful outcome. We are making similar steady progress on the PEO migration in major accounts, and I think we have formally alluded that we would finish this by the end of the fiscal year; we are still on track for that. We migrated approximately 3,000 in the first half and we have about the same left, so we are really here in the final stages of also finishing that major migration project.

I think the other thing just to reiterate why we are doing this. I think there are a variety of reasons but clearly two of the most important reasons are as we reduce the number of legacy platforms, we can reinvest those funds into our strategic go-forward platforms. So that's exciting to be able to put even more resources into the new stuff. And second of all, it is to improve our competitiveness in the market because this older legacy platform sometimes creates an exposure from the client retention standpoint. So I think we've so far, knock on wood, I think proven that we are achieving both of those things and it is part of our migration strategy.

Thank you. And good morning. Carlos, you highlighted increased competitiveness as you move clients off legacy platforms and onto some of the new platforms, could you perhaps share some insights in terms of direct competitive experience let’s say down market versus Paychex and perhaps in the mid-market versus Ultimate where you have almost completed the transition to Workforce Now?

We try not to get into specifics on competitors. I think overall in the categories that you described we have obviously a lot of data around win-loss ratios and we have some data around market share and that’s why we make the comments that we believe our competitiveness is improving because I think our metrics show that. Again, these are incremental improvements but we are still happy with them and they are going in the right direction. I don't know if Jan has any additional color, but we measure competitiveness really in terms of winning or losing in the marketplace. We believe that our win rate curve improved as a result of not just our investments in new products but also these moves are putting our clients on the newest platform.

This is a follow-up to that. You mentioned 15% global booking growth in Employee Services and strength across the board. Can you flush that out a little bit? Is some of the strength driven by particularly new products? Is this tending to be more kind of down market with RUN? Is it up market with Vantage HCM?

As we have indicated in previous calls, we strive to provide consistent answers regardless of whether the news is positive or negative. Sales can fluctuate significantly compared to our revenue and other business metrics due to the nature of our new business bookings. Various factors influence this variability, including incentives, which we have discussed before; they can sometimes have a negative impact and create challenging comparisons. Additionally, the economy plays a role, along with competition, the strength of our products, and the timing of product releases. All these factors contribute to the overall situation, making it difficult to pinpoint specific reasons for our sales performance. However, this is our second quarter of achieving double-digit sales growth. When I review the trends from our extensive historical data on quarterly sales, I feel optimistic about our current position. Last year, we finished with 7% sales growth after several years of double-digit growth. This year, our revised guidance suggests we are on track for double-digit gains, which is highly encouraging. It seems we have broken away from the pattern of experiencing negative sales during economic downturns, as we have seen in the past. Our performance this quarter and over the past six months shows that we can sustain double-digit growth even amid economic challenges and international issues. While I wish I could provide a more objective answer, the reality is that a variety of factors contribute to our success. Our products are continuously improving, our sales team is performing exceptionally well, and we've adjusted our incentives to yield better results. We've also modified our sales workforce to enhance efficiency. I commend our small business division for their efforts with migrations and our sales team for their execution this quarter and over the last six months, considering the challenges of the previous year. Importantly, we’re seeing double-digit sales growth across all segments—from up market to mid-market to low end—so unfortunately, I can’t offer more specific details on that.

Great, thanks, good morning, guys. And congrats on another strong quarter and good momentum. Wanted to start off can you remind us how new sales break down throughout the fourth quarter? I don't think there is that much variability, but if you could address that and maybe related to that, January is a big month on the small business side. Maybe just your thoughts as we exit that month how the sales activity was there?

Funny you should mention that, because I asked Sara for that data a couple of days ago just to—we are obviously not going to talk about January because that's the—it's next quarter's discussion but we do have the January results, and I was curious to see how much of the year's quota has been expanded because we do have very strong sales in November. And very strong sales in January due to seasonality. But we also have, as you have probably seen in the past, very strong June mainly driven because of year-end incentives which we've talked about quite a bit. Both the positives and the negatives. So the long and short of it is that it actually works out to the right balance. So in seven out of 12 months we have expanded about 7/12ths of our quote and I think in the six months there is probably a little bit less but it is really not meaningful in terms of difference in terms of you being able to think through or me being able to think about the odds of us being able to meet our forecast given where we are in the year. We feel pretty good about hitting our forecast.

It definitely sounds that way. And then just follow up to that, the pays per control outlook 2% to 3%; you have been at 3% now over the first half of the year. Is that just conservatism keeping the low end of the range here? What do you think is realistic that you are going to be able to do better than that?

Yes. Maybe I’ll answer that. Really we’re for the first half of the year, and the number itself is not that impactful for our total results. It really depended on—if the economy is going to change significantly of course we have great employment growth in the country for now a number of years so we didn't feel we needed to update it but it should be right around somewhere.

And as a reminder, 1% change in pays per control is $8 million in annual revenue. So if that were to change by half of a percent for the rest of the year, it would be a $2 million impact for revenue. So I think, as Jan said, it’s really not that impactful but more importantly we have seen this movie before where we are incredibly pleased that it is holding up at that level and it has been that way for a few years. But it will at some point come down to 2.5 or 2 or somewhere in that range but we hope it continues indefinitely but we are not planning on that.

Now that the January 1st deadline is passed can you just talk a little bit more about the new ACA product, how did it perform in the quarter and how it has done since the beginning of the year?

We don't have any specific numbers that we can share but we are very, very pleased. Jan may want to add his own color. We had a business review with the folks running that business quite recently, and the number of units that we've sold and the new business bookings we have generated from this product, we have actually started with a handful of clients, and we have a very large backlog, and we're very excited about it.

I think maybe a few key points. The ACA product has a new direction, serves, of course, as an example of ADP's strength of combining technology with compliance. It remedies one of the largest problems we solve for clients. This ACA product is targeted for large clients of our market product, so the number of units that we will be selling and trying to achieve in the realm of a national account type product. What yields our positive outlook on the product is really started in earnest in the last quarter and second quarter to sell this product, and the pace of how the pipeline has built and our ability to close a number of machines in that space caused optimism. I don't think it will augment clearly and will support the growth rate of new business bookings, but it would be wrong to anticipate that this would have a tonnage point difference in our sales growth rate going forward. But it is going to be an important product that rounds out our value proposition and combined with our core offerings is very powerful.

Thanks, Jan. Maybe my enthusiasm got ahead of me because our blessing and our curses that we have nearly $1.6 billion in new bookings, and $11 billion in revenue. I think Jan is very correct that my enthusiasm wasn't intended to imply that this is going to add two to three points of either sales growth or a point of revenue growth. You can just do the math in terms of what that would imply. We hope that over the next two to three years it could be meaningful and significant, but clearly, for this year, it is not going to—it's helping and rounding things out, but I should have probably been more careful in the choice of my words.

Thanks for the clarification. And maybe just a follow-up on the same topic. As the PEO business continues to do very well, can you talk about what you are seeing in terms of customer demand for your ASO type products?

Sure. First of all, let me just say that I was actually in Atlanta, had a great visit to Atlanta in December and visited with a couple of the business units that operate mainly out of our Atlanta office, including the PEO, and folks who run the ASO. That business just in general is executing incredibly well, both PEO and the ASO. So really all of our BPO offerings—mid-market, up-market, and the ones that you're referring to, PEO and ASO—are all I think really resonating in the marketplace, probably driven in part by this increasing complexity around compliance. Some of it is ACA-driven in terms of people just looking for alternatives which is creating more meetings and more discussions which leads to more opportunities and closing more business. Some of it may be what appears to be a growing need for focusing on talent as the unemployment rate begins to dip here and people start to focus more on attracting, retaining, and managing their workforce well. I think there are probably a number of reasons creating some tailwind. But the very great discussions, and our business is really executing very, very well, both ASO and PEO, across the board. Great execution on the sales results but also in terms of the implementation of our business and the underlying metrics of the business in terms of pays per control, they’re all in very good shape. So great discussion.

Hi, guys, good morning. Let me just first follow up on that last point. The PEO continues to be incredibly strong. Is there any way to know how long the momentum continues at this level? And I guess what I'm particularly interested in, are you seeing any—now that a lot of businesses are in compliance with ACA, are you seeing any decline or is there any sense that maybe there was some pulled-forward demand to get into compliance, or are those drivers of more people being interested and considering their options remaining strong in calendar 2015?

I think our plan is to have the momentum continue forever. That would be the way we are planning things because in part the market share of the PEO industry in general in relation to the total employment for small and midsized businesses is relatively low. This theme has been true for a couple of decades. The backdrop in terms of the economy and the regulatory environment has some impact on whether clients are open to discussion or not. But the fact of the matter is you want to be in businesses preferably with lower penetration versus the higher penetration. I think the PEO is that kind of business where only a couple percentage points at most of employees in the available market are actually using a PEO. We believe that theoretically the opportunity is very large and then it becomes a question of execution. I mentioned earlier that we haven't seen any signs yet that everyone is all of a sudden in compliance and that there is no more interest in the PEO because you saw the quarter results, and I think our forecast for sales results for the rest of the year for that business does not indicate any feeling or belief that interest is drying up. So I think that there is a need to be in compliance, but if you remember, ACA is mostly affecting clients with over 50 employees. What is causing some of the interest in PEO is the entire backdrop around ACA and the regulatory environment, which is people scrambling to have competitive benefit plans that they can compete with some of these exchanges. So it's not specifically clients that need it on a particular date to be in compliance. I think this is something that will continue for many years to come where small companies and midsize companies are going to be looking for alternatives to healthcare plans that they may have in the past, add on an individual plan basis, whether they look at our solutions through the PEO or they look at exchanges. People are just looking for alternatives to control healthcare costs to be competitive in their own business.

Great. And then the follow-up, it seems like you're starting to get more, whether it's products or other from the innovation lab you set up a year or two ago, and I guess, can you give us a high-level sense, do you think those investments are going to lead to noticeable incremental revenue in the next few years, or is it more on the margin? And as part of that maybe could you just give us an example of what kind of thing the ADP marketplace offering might be able to lead to? What would be like a tangible example of a potential product there?

Just in terms of—I’ll let Jan talk about the examples in the ADP marketplace because he is equally excited about that. But in terms of your question about innovation-driven products and growth coming from that, again, back to unfortunately, you have to go back to the comment in terms of just keeping us all on the same page because of our size and our new business bookings, our new business bookings per year are larger than most of our competitors combined. So we have a large path. The innovation lab and some of our focus on product is intended to, as Jan’s words, round out and ensure and hopefully improve a little bit on our growth rate in sales and revenue. We would be less than ambitious if we told you that we're just trying to stay in place. But we're clearly trying to accelerate our growth. Again the expectations that we create are very important for us to be transparent, and I think for us to move our revenue growth up a couple percentage points is very difficult and requires a big increase in new business bookings and very, very good client retention. So having said all that, that's our plan, to try to continue to drive and improve revenue growth through better net new business which is the difference between start or new business bookings and our losses. Our innovation investments are a large part of that. As we said multiple times, all of the products that we've discussed that have come out thus far, that are new out of either the innovation lab or some of our other processes that we have internally in terms of new product launches are relatively small in comparison to the size of our new business bookings in total and to ADP overall. So it is very, very hard to say today that it is going to add x amount of incremental sales for revenue growth, but that's our plan over multiple years, to really have a pipeline of organically built and organically developed products that are easier to use, provide better value to our clients, and are better integrated to drive more unit sales but also more sales of our additional modules around benefits, talent management, and other areas around HCM in addition to our traditional payroll. So I don't know, Jan, if you want to talk about the marketplace.

Absolutely. So of course the marketplace is basically an offering that allows third-party software developers, as well as clients, to easily integrate with our core product offering. With ADP focusing on human capital management, we realize that we're living in an integrated world. I think we have the utmost flexibility for our clients to integrate our solutions into their overall businesses, which is very important. We expect, for example, vertical-specific applications to be available in industries like the restaurant or retail that would leverage employment data for additional value adds or components to it. But it could be also products like advanced management that we don't offer and have a close relationship to our core payroll offering that will benefit from tight integration into our core product set. The message we want to send primarily with this call is our push for innovation and to be at the leading front of having flexible and easy-to-integrate technology that makes the value to our clients the highest is our intent. And that may be a different notion compared to the ADP that you would have known three, four, five years ago, where we were a little bit more proprietary and harder to integrate, and today we really believe that through that integrated network of applications. So that's what the marketplace is really about.

I think, in a nutshell, it's really ask for, and we already have an app there, and we intend to drive more partnerships. We hope that it will not only make things better for our clients because of their ability to integrate, but we do have revenue share agreements like anyone else would have in their types of app stores. The key question is what's going to be the degree of success? Because this is literally brand new so we will obviously keep you informed because this could end up being a large opportunity, or it may not, from a revenue and sales standpoint.

Hi. Thanks for taking my questions. First, on the PEO segment, can you provide any color on the mix of your customer base and what traction are you seeing more at the mid to low end? And what positive impact does it have on operating margin in the midterm?

In the PEO, the mix of business, our PEO tends to be more white and gray collar than I think the average of the US economy and some other PEOs. Our average client size I believe is around 40, if I'm not mistaken. Yes, I'm getting the confirmation it is around 40. That tends to be probably slightly larger than maybe some other PEOs. But we still have a lot of small business clients. It's obviously their averages. We have large clients that improve the average but it's still largely an under 50 sweet spot business if you will. In terms of industries, we tend to stay away from high-risk things like roofing and construction. In terms of the impact on the margins on the overall business, we segment report so it's mathematically a drag on our earnings when the PEO is growing as robustly as it is. Having said that, the fact of the matter is that on an earnings standpoint, it is an incredibly accretive and profitable attractive business on any measure, whether it's on an MPV basis, the business requires no investment per se. Whatever investment we make, most of them run through the P&L so there's no kind of outside capital investments driving return other than what you are seeing, which is a very, very high return business despite the fact that because of its profile it happens to have a lower margin because of all the pass. We will grow the PEO as fast as we can because it will add to EPS growth and shareholder value, and we will explain and manage through the margin compression if necessary.

I also meant that just from a customer profile point of view as it changes over the next few years based on your investments and based on your sales and marketing push, what kind of a positive or negative impact does it have as your customer profile in the PEO segment changes? And probably just one other question is, more from a product portfolio perspective. Are there any obvious areas in your product portfolio where you want extra investment both organically and through M&A?

Let me just clarify, you're expecting what kind of change in our client profile on the PEO?

I was saying that if your customer profile size probably decreases from base say 40 numbers to probably 20 or whatever that is, do you have more profitability as the size of your customer profile decreases?

It’s been very consistent for a long, long time, and I don't anticipate that it is going to change dramatically. When we had our business review in Atlanta, the profitability of our large clients versus our small clients, there's some differences, but it wasn't meaningful. We have 350,000 worksite employees now. To move that number from 40 to 20 is almost impossible in any kind of reasonable period of time. On your question about what things do we want to invest more in, I think we are going to continue to make the same kinds of investments that you have seen us do over the last two or three years, which are really focused on creating a better integrated, easier-to-use experience for our clients. The work we’re doing in the up-market and the work you’ve seen us do in Workforce Now are all around all of that. We believe we have already a very broad set of solutions in HCM all the way from recruitment to retirement. So what we're really trying to do is enhance the usability of our products and the integration of our products, and we mentioned in our talking points that we believe that data analytics is a huge source of potential competitive advantage and insight that we could provide for our clients. Now that we're all in on HCM, we want to be known for helping our clients better manage their workforce, and that means going beyond just data processing. We want to provide expertise and insight with the data we have, and I think allows us to do that, but it requires some investment as well.

Hi. I wonder on the new bookings growth, can you give us some idea what of that is attributable to either changed incentives versus the macro versus the new products you have in place? I'm just trying to get a sense of how you can break that down. And I have one follow-up.

I may have confused the issue by bringing even the topic of incentives. There have been no changes in incentives. I just always mention that because it seems to rear its head sometimes in our fourth quarter, either positive or negative. And then it rears its head again in the first quarter because we have a lot of incentives that drive year-end results. This is true in almost every company that has a sales force where you have accelerators or incentives towards the end of the year. I think it happens a lot in software companies, and so we're no different. So this specific quarter, no changes in incentives, so there's really nothing to report there. I should have probably not brought it up. In terms of how much of it was new product versus sales force execution, I think the people from R&D would say that it was 100% product, and sales would say that it's 100% execution. So the truth is probably somewhere in between.

Let me add; it would be, as you know, the sales model drives from adding heads to our sales force and overall drives productivity of our sales force with enhanced productivity of our product and better execution, and it would be balanced growth profile.

That productivity has really been phenomenal for multiple years now. I’m sure that products are helping but clearly it’s also really great execution and great leadership in that organization. They have proven once again this quarter that we have the best direct sales force in the world.

Got it. And then just on any color on win rate changes, if you want to be, either at the company level or within the individual mid-cap, large-cap spaces that you are going after?

We watch those numbers very carefully, and we're also very, very careful about how we talk about it. I would just tell you the best way to describe it is a generalization. I think Jan can add; I would say that we are very, very pleased with the focus that our business leaders have in improving our win rate. Our win-loss rate, not just at the retention level in terms of losing clients but upfront in the sales process. I think we have leaders who understand the importance of winning in the marketplace and of increasing market share; and the metrics we have are very encouraging.

As we've discussed over time, at the highest level, improving sales, improving retention generally just has to be an indicator about this business relative to prior periods, and that's really virtually the only number that you can draw from at the high level. At the detailed level, I think we shared with you that our losses are comprised not of a single poor lost competitor but from a whole range of 20, 30, 40 competitors that we all need to monitor. So I think it would be probably misleading to point out single ones, and it’s not a single competitor that is immaterial, but the aggregate of the 30, 40 competitors that we monitor is very important to us. So that’s why I think it’s probably most fair to go with the directional comments that Carlos gave and round it out with the overall competitiveness of accelerating sales together to form an overall picture.

Hi, this is Ashish Chhabra calling in on behalf of Bryan Keane. Thanks for taking our question. Quickly on the PEO, pretty solid growth there. If you look at the average worksite employee paid growth over the last four quarters, those have been trending in the mid-teens or even higher. Those have been significantly higher than what the normal growth has been over the last few years. So just looking forward, does this accelerated growth create tougher comps going forward? And also what would be the normalized growth in the worksite employees as we look forward on a more normalized basis? Thanks.

I think it’s a very good question, and again, we would hope that the momentum continues indefinitely, but I would tell you that when you look at our operating plans and our forecasts, the compares do get more difficult. That business happens to have a great deal of lumpiness on January 1st because of the way taxes operate in the PEO environment. Ironically, it was a change in the law as part of the year-end Congressional law that were passed that are going to make that a little bit easier going forward, and PEOs are not going to have to restart taxes. So that should smooth out the lumpiness of that business somewhat and not have such a huge peak in January. The reason I bring that up is because of that peak in January, the growth rate of that business, even though it tends to have another peak in June because of our fiscal year-end and the incentives that we always talk about in sales there, January has been a particularly important number for us in the PEO business because the difference between the new business bookings and the losses that take place in that December to January timeframe tend to drive the year-over-year growth rate on worksite employees for the next 12 months on a calendar year basis. Because of just the size of the business, which is 350,000 worksite employees, anyone can do the math and figure out how many new worksite employees we need to sell. We know what our retention rate is, and you could probably guess close to what our retention rate is, and you can figure out that the need to sell that many clients is larger than probably all but two or three other competitors in the space. So the compares are getting difficult to say the least. We are entering the law of large numbers. So if it were me, I would probably be expecting moderation in the growth rate. It doesn’t mean that it is going to happen next quarter or this fiscal year, but I think it is a good idea to moderate the expected growth rate of that business. We've been incredibly pleased with it for the last two or three years, but I think we're just trying to be realistic here in terms of expectations.

Carlos, thanks for that color. And a quick follow-up again on the PEO side. When I look at revenue for average worksite employees, that has been trending more in the $3 range in the first half of the year. Can you just talk about what are the drivers there? Is it more higher fees, more pass-through? And as you look forward, how should we think about that particular metric? Thanks.

Actually all of the above. So it's additional fees as in fees that drive our kind of bottom line we call processing revenue, and hence our profitability plus also the pass. Whenever you have inflation in either workers' compensation or in benefits costs, that will also drive growth obviously in revenue and also growth in revenue per worksite employee in that business. We give you the worksite employee number, and we provide in the Q and in the 10-K pass-through, and you can actually do the math and figure out how much of the growth is coming from pass-through. We’re trying to be transparent on how much of the growth is coming from our fees; and again, back to my visit to Atlanta, I think they're both growing at reasonable rates. So there isn’t—and again, we would tell if you our fees were dropping and it were all because of pass-through. The reason we haven’t told you that is because it’s not true and there’s nothing to report. It’s been consistent for many years now that the PEO has been growing its own internal fee income per worksite employee at a growth rate of 2% to 3% and then the pass has been growing at varying rates, depending on what's happening with healthcare inflation.

Hi, guys, this is Ryan Cary calling in for Jason. I just wanted to dig deeper into FX. I was hoping you could give us a little more color on your assumption for the remainder of the year. So when we are looking at the 1% full-year headwinds, does that assume the dollar trading at the current levels?

Yes. That is the assumption.

Okay, great, thanks so much. And then now that the dealer service business spun out, and really a pure play HCM company, is it plausible you might look to M&A a bit to extend your reach further into the market? And kind of looking beyond that, when looking at the market, where do you see the most M&A opportunities? Is it more in the legacy core payroll processing side of the business or is it more along the PEO/BPO side?

We actually—we do still do acquisitions in our core payroll business as you have just described. They tend to be kind of tuck-in, and they’re just migrations. As you can tell from our theme, we're trying not to maintain and add additional platforms in our business for the time being. But we do those. Again, because of our size, we don't talk about those a lot, but we are actively using our capital to grow market share when we can since there is a good MVP associated with the acquisition. We tend to call those client-based acquisitions where we are buying the clients and moving them onto our platform rather than buying the entire entity or the company. Outside of that space in terms of just the broad HCM market, again, we think we have a broad solution from recruitment to retirement, but we absolutely understand and acknowledge that there are people that are stronger than we are in some parts of HCM, and it may be appropriate at some point and in some cases to enhance our capabilities through M&A activity or through acquisitions. So we are— it may not feel like it or look like it to many people, but we do want to use our capital, but we want to use it wisely. It has to make sense in terms of the technology that we're getting, and it can't just be revenue and a new platform. That's not our strategy; so it has to be on our terms and it has to fit into our strategic direction. But we believe that there are opportunities out there that would enhance our competitiveness and our ability to grow and add new business bookings, but we're being incredibly disciplined. As you know, the valuation backdrop is not favorable in the HCM market right now. The other big opportunity for us is geographic. You saw that we made an acquisition in Latin America last year. This is a place where, again, back to the issues of market share, we talk about the PEO having very low penetration in general. In many cases, we have only scratched the surface of opportunities in many of the geographic areas we serve. Not just multinationals but also many countries. This is another area where it would be a safe assumption to plan on us using our capital to expand our reach globally. It can be counterintuitive because today, it feels like because of what's happened with FX, everyone is running from international. Generally speaking, that's exactly the time to look at something, when everyone else is running away. So we're continuing to look for opportunities outside the US and trying to find ways to enhance our competitive strength and growth internationally.

Thanks so much. I think we've seen an earnings season with a number of other companies and the impact of declining oil prices on their business. I was wondering if you have seen any of that either in a positive or negative way. On the negative side, I would think would be if you have a lot of energy exposure, if you've seen some reduction in payroll from some of those customers. Thanks.

I think it's a good question. Just because of our size and our geographic spread and our industry spread, the answer would be no. Certainly not something that we've been able to identify. We will look at it again to make sure that my answer is correct, but we really don't have that kind of concentration in our business. We're so big and so broad, both in the US and also globally, that the real impact is the FX impact, which may or may not be connected to what's going on with oil, but it's certainly connected to what's happening in Europe and Japan and other parts of the world. Luckily for us, only 18% in this case luckily for us because it is something we've been trying to address, which I just mentioned in my previous comments. We are trying to become bigger internationally. The fact is that today our revenues outside the US are only 18%. And as you know, some companies that are peers in the S&P 500 have close to 50% of their operating earnings and their revenues outside the US. We have relatively less exposure, and that happens to work out well right now. Our operating income, I believe, is only 15% exposed outside the US. Both the 18% and the 15% include Latin America, Brazil, and include some business in Asia. So our European exposure is even less than 18%. Again, it's a drag on our revenues and our operating income, but our relative basis, it's a smaller impact for us than it is for some of our other large cap brethren.

Great. And just a follow-up to that. Can you just remind us where your international exposure is the largest?

It is in Europe.

In Europe. And how about Canada?

Canada would be number two.

Canada would be number two. Canada is actually a relatively large business, let's call it between $300 million and $400 million, and it's quite profitable. It’s like a small version of the US, a very good business. I have been in Canada for decades and decades. The reason I mention that is clearly because of the profitability of that business, and we have a very good float income business in Canada as well. The impact of the Canadian dollar move has a decent impact on our overall revenue growth in Canada and also our operating income growth in Canada when it gets translated to US dollars.

Yes, good morning. Thanks for taking my questions. Just on the PEO, one more little thing. Anything of note during the critical year-end selling season?

The only thing of note is it did a spectacular job.

Okay. And you talked a lot about integrated solutions, and I suspect we will hear a lot about that at the Analyst Day, but how would you sort of view—grade yourself in integrated solutions, and what areas are you looking to improve there?

I don't think I'm going to take that bait. So I think it varies. I think our strategic platforms are actually quite well integrated and quite broad and have rich feature functionality. We still have pockets. We haven't been able to migrate clients where competitors would point out lack of integration. I think that's just lack of ability or termination to move those clients to our strategic platform. Once we have those clients on our strategic platform, I think these issues of integration tend to fade into the background. It’s a legitimate criticism of us, but it's old news, and it won't be true in the near future.

Thank you. Hey, guys. This may seem like an odd question, but over the last few years, as you guys have progressively simplified the overall business, the talk that sort of comes up is what are the synergies, and are there synergies that you can point to why the Employer Services and PEO business should be under one roof? Or can you take advantage of the excellent performance in PEO and the valuations in pure-play PEO and share that business and become really a pure-play ES?

Frankly, the two businesses, because of co-employment, pass-through and a number of other issues, it’s a separate segment. But the businesses share a lot in common, including the sales forces work very, very close together. Our small business and midsize business sales forces, of which you know we have thousands of people on the street, provide leads to our PEO sales force, which has its own sales force, but without their brothers and sisters in the rest of ADP, I don't believe that our PEO would have the kind of success that it has today. The biggest synergy we believe that we have is in distribution and in sales, and we believe it is large, and very big move for our business has been historically, and I think it will be going forward. I think there are other advantages. We have capital, so when we run into issues around historically in the marketplace around workers' compensation, we've been able to do things that others eventually were able to do but we had more flexibility in terms of being able to use our capital and our strong credit rating. I think there are other advantages to having the PEO be part of ADP, but the most important one is the sales synergy. So I would say that I can't envision that business being a separate business.

Thank you. I'll try to be quick. Just following up on that, on all these PEO questions, just to clarify was the raise in the outlook driven by what we are seeing in January or something else? Just trying to get some understanding around the change there.

No. It was really based on the prior six months.

Okay. And then have you —

Is that answer you were looking for on the PEO?

I guess I'll ask one more just on the sales headcount growth on PEO. Have you disclosed what that is? Have you elevated that number in the last 12 months?

No. We don't really disclose sales headcount by business unit. But you can assume that it is growing somewhat in line with the overall sales headcount growth of plus or minus a little bit, but not as — as Jan said, we are trying to grow our sales headcount between 2% and 4% and then try to achieve the rest of our sales results through productivity improvements.

And then just quickly on the international pays per control. Did you — can you give that by three regions, big regions and that's all I have. Thanks a lot, guys.

We disclosed the European thing and as I mentioned, it was flat for the quarter, and we have, I guess, 10 or 20 basis points decline in each of the quarters before. So it really has flattened out in Europe, so a very casual utilization.

I think when we talked about the European performance and almost that backdrop is still sluggish as we would describe it but overall the performance actually of our national was quite good.

Thank you all for joining the call today. You probably could tell that we are very pleased with the fundamental performance of the business here in the first six months. Very, very happy with the record client retention and the very, very strong new business bookings growth. I think both of those things reflect that we are winning our fair share in the market. Despite the economic headwinds from foreign currency translation and some still ongoing pressure from interest rates, we are still on track to deliver our full-year revenue and earnings guidance which is very satisfying for us. I hope to see you at our Investor Day on March the 3rd in New York City. Thank you again for joining us and have a nice day.