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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings and welcome to the Bright Horizons Family Solutions Second Quarter 2018 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Elizabeth Boland, Chief Financial Officer of Bright Horizons Family Solutions. Thank you, Ms. Boland. You may begin.
Thanks, Devin, and hello to everyone on the call today. With me are Stephen Kramer, our Chief Executive Officer; and Dave Lissy, our Executive Chair. Before I turn it over to Stephen, let me just cover off a few administrative matters.
Today's call is being webcast and a recording will be available under the Investor Relations section of our website at brighthorizons.com. As a reminder to participants, any forward-looking statements that are made on this call including those regarding future financial performance are subject to the Safe Harbor statement included in our earnings release.
Forward-looking statements inherently involve risks and uncertainties described in detail in our 2017 Form 10-K that may cause actual operating and financial results to differ materially. Any forward-looking statement speaks only as of the date on which it's made and we undertake no obligation to update any forward-looking statements.
We also refer today to non-GAAP financial measures which are detailed and reconciled to their GAAP counterparts in our earnings release, which is available under the IR section of our website.
Now, I'll turn it over to Stephen for the review and update on the business.
Thanks, Elizabeth. And again thanks for joining us this evening. Let me start things off today with a recap of our financial and operating results for the second quarter and an update of our growth outlook for 2018. Elizabeth will then follow with a more detailed review with the numbers before we open it up for your questions.
As we reach the midpoint of the year, we continue to be really pleased with our performance against our targets and with the progress we are making in our various initiatives to drive both near and long-term growth across all of our business segments.
For the quarter, revenue grew 10% to $490 million and adjusted earnings per share of $0.87 increased 18% from last year. In our full service center segment, revenue grew 10% in Q2, continuing the strong start we had in the first quarter. We added 21 centers including new client centers for Mercedes-Benz in Georgia, JPMorgan in Texas and HCA in Tennessee along with two multi-center tuck-in acquisitions in the UK.
Our back-up division also grew 10% in the quarter, while educational advisory expanded by 21% on launches of new clients, expanded utilization and rate increases. Recent new client launches for these segments include Charles Schwab, Con Edison, Zappos, Viacom as well as Barclays. With the performance year-to-date and projected additional new client adds in the second half of the year, we remain on track to achieve our 2018 top line growth target of 10% to 12% for back-up and 20% for ed advisory services.
Following on from this solid top line growth, we also continue to deliver strong and consistent operating results across the business. In the second quarter, adjusted operating income expanded 30 basis points, as we begin to realize certain operating efficiencies from the investments we've been making over the last year or so along with the continued solid performance in our core business.
Let me expand on a couple of the key investment areas. First, with respect to our marketing and technology investments, I continue to be really excited about our progress, piloting personalized outreach to select back-up clients as well as the receptivity of both our clients and parent users, as we roll out greater web and mobile functionality across all of our services. As a reminder, our overriding goals for these investments are to enhance our customers' user experience, to build utilization levels of our services within our client workforces, and over time to deliver more efficient and automated support services.
Turning to our lease/consortia center strategy, we have now opened 75 of these centers in select urban settings where we see a concentrated population of our target demographic, a limited supply of high-quality childcare, and strong opportunities to meet the needs of our client partners. While we are opening another cohort this year, the earliest classes of these centers are now fully ramped and contributing at mature operating levels. As a result, the margin these centers collectively contribute has begun to shift from a slight headwind in the first part of the year to a modest contributor in 2018, and we expect the headwind to continue to naturally diminish as more classes ramp to maturity.
In summary, we are pleased with the positive results of our operations and marketing teams in that they are delivering specifically for these centers and we continue to see significant value creation opportunity in these centers over time. As we move into the second half of 2018, we do so with good momentum across all aspects of our business. As we have previously discussed, our growth strategy is focused on organic as well as acquisition growth. Our sales pipeline in each of our services remain strong with interest across industries with both new and existing clients. All of this puts us in a solid position to achieve our organic growth plan in 2018.
On the acquisition front, we are pleased to have completed two additional tuck-in acquisitions in the second quarter, both in the UK. As we have talked about, we continue to pursue opportunities that range in scale both here in the U.S. and abroad, and the four deals we have completed to-date in 2018 reflect that strategy in action. Our pipeline remains strong with a good mix of smaller networks and single center opportunities both here in the U.S. and in Europe, and we continue to expect acquisitions to be a key contributor to our forward growth plan.
As has been the case for our entire 30-year history, our continued success is based on our unwavering commitment to our people. No single group of employees is more critical to Bright Horizons than the teachers in our childcare centers. Given the diminishing pool of qualified early educators and tightening labor pool in general, we recently announced the Bright Horizons Early Education Degree Achievement Plan. Leveraging the expertise of our EdAssist division, we developed a breakthrough program to enable our teachers to earn an associate's and bachelor's degree in early childhood education. This program is truly a win-win-win. Our teachers will become more highly educated and grow their careers with us, the families we serve will continue to benefit from the highest quality care and education, and Bright Horizons will enjoy an even more qualified and engaged workforce in the years ahead.
Finally, let me update you on our outlook for the remainder of the year. We are reiterating our 2018 revenue growth guidance in the range of 8% to 10% and leverage operating performance to drive adjusted EPS growth in the range of 16% to 18% over 2017 or $3.13 to $3.16 per share.
With that, Elizabeth can review the numbers in more detail and I'll be back to you during Q&A.
Great. Thank you, Stephen. Once again, recapping the headlines for the quarter, overall revenue was up 10% or $44 million in total for the quarter. On a segment basis, the back-up division expanded $5 million on the top line which was also 10% and ed advisory services was up $3 million or 21% and this is primarily from new client launches and the expanded utilization by our existing client base. The $36 million increase in the full service center revenue was driven by rate increases, enrollment gains, contributions from new centers and positive foreign exchange.
In Q2, the gross profit increased $12 million to $126 million and was 25.7% of revenue. Adjusted operating income increased $7.5 million to $66 million and was 13.5% of revenue, up 30 basis points. In our full service segment, adjusted operating income expanded 20 bps to 11.2% on gains from enrollment growth in our mature and ramping centers, contributions from our new and acquired centers and from price increases, ahead of our cost structure. The operating margins in back-up and ed advisory can vary from quarter to quarter based on the timing of when new clients launch and the service utilization levels, but both of these segments also expanded operating income margins in the quarter to approximately 27.5% and 21% respectively.
While we continue to absorb the near-term effects of our investments as Stephen discussed previously, we are beginning to realize some operating efficiencies, which are reflected in the improving operating margins this quarter.
Interest expense of $12.2 million in Q2 of 2018 was down just over $1 million from 2017 as incremental revolver borrowings to finance acquisitions and share repurchases were offset by lower interest rates. Our current borrowing cost approximates 4% and $500 million of our term loans are fixed with an interest rate swap.
We ended the quarter at 3.4 turns of net debt to EBITDA. Our structural tax rate in the quarter approximates 23% and it's consistent with what we estimate for the full year 2018, that's down 1 percentage point from what we reported in 2017 of 24%. Through June of this year, operating cash flow of almost $190 million was up more than $20 million over 2017 levels. Improving operating performance and positive working capital movements contributed to that trend.
As part of our capital allocation strategy, our first priority is continue the investments in growth through new center investments and acquisitions, illustrated by the $65 million we have spent year-to-date on new centers and acquisitions. We've also continued to execute on our share repurchase program acquiring a total of 840,000 shares in the first half of 2018.
At June 30, 2018, we operated 1,065 centers with capacity to serve over 118,000 children and we now continue to serve more than 1,100 clients across our service lines. Adding a bit to the guidance headlines that Stephen touched on earlier, we continue to project top line growth for the full year in the range of 8% to 10% over 2017, including low double-digit revenue gains in our back-up division of 10% to 12% for the full year and roughly 20% growth in our ed advisory services.
We expect to add approximately 55 to 60 new centers in 2018, inclusive of both new organic and acquired centers. And our outlook also contemplates closing approximately 25 centers, as we maintain the discipline we've established over the last several years.
On the operating side for the full year, we expect to continue to gain approximately 1% to 2% from enrollment in our mature and ramping centers and we estimate price increases to average 3.5% to 4% across our P&L center network. All these elements contribute to improved operating performance and margins in 2018 compared to 2017, consistent with our plan in the range of 50 to 100 basis points in 2018 as the factors mitigating margin expansion from 2017 diminish over the course of the year.
On a couple of other key metrics for the year, we estimate amortization to be around $32 million, depreciation of around $70 million and stock compensation in the range of $14 million to $14.5 million. Based on our outstanding borrowings and estimates of additional interest rate increases in 2018, we're projecting interest expense of approximately $49 million to $50 million.
As previously reviewed, the structural tax rate is expected to approximate 23% in 2018. Weighted average shares outstanding are also projected to be 59 million for the full year. We're estimating that we will generate approximately $260 million to $270 million of cash flow from operations and have a total of about $45 million of maintenance CapEx, yielding $215 million to $225 million of free cash flow to invest in the ongoing growth of the business.
Overall, we expect to invest $45 million to $50 million in new center capital for centers that are opening in 2018 as well as those that will open in early 2019. The combination of all these factors lead to our projection that we'll generate adjusted net income of $184 million to $186 million and adjusted EPS growth of approximately 16% to 18% in 2018, which translates to $3.13 to $3.16 a share or adjusted EPS.
Looking specifically to Q3 of 2018, we're projecting again 8% to 10% top line growth and our outlook for adjusted net income is in the range of $42 million to $43 million and for adjusted EPS in the range of $0.72 to $0.73 per share.
So, with that, Devon, we are ready to go to Q&A.
Thank you. Our first question comes from the line of Andrew Steinerman with JPMorgan. Please proceed with your question.
Hi. Good evening. This is Michael Cho in and for Andrew. Just had a question on the...
Hello.
Hi. On the new lease/consortium center openings projected for 2018. What is the year-to-date number and what is the projected number for 2018 as we stand today?
Right. So we have added a total of 4 year-to-date and we are projecting the back half to have a heavier weighting, so we are projecting between 8 and 10 for the remainder of the year, depending on the completion of the construction cycle and licensing, et cetera.
Got it. Thank you. And just to follow up on that in terms of the margin outlook, you referenced the 50 to 100 basis points. I guess, one, has that outlook for the new lease/consortium centers changed since you gave the original guide? And if so, how did that impact margin in terms of 2018 guide expansion?
Yeah. Just sort of touching on a little bit of context there, we have, as Stephen mentioned, we have opened now 75 of these sort of more urban-centric lease/consortium centers in the last five to six years so far and have another, as I say, 8 to 10 to open this year and into early 2019. So there's, obviously, a wide array in the portfolio and, as we said, the earliest classes are now performing as we had planned. And the timing of the other ramps is dependent on, as I say, the construction cycle and getting licensing done, broadly speaking, continue to be on track for the ramp trajectory. Compared to where we guided the beginning of the year, we're probably a couple of units behind where we may have planned to be open at this time of the year. But it's sort of a natural timing challenge to land that precisely on when they will get opened.
So I think the broad answer is we continue to be on track to see what we had planned at the beginning of the year in the group as a whole and that the margin headwind that we've been talking about for the last couple of years with the density of the losses in the ramp-up timeframe is beginning to abate and we've positive outlook there that we will have some contribution – net contribution to that by the time we get to the end of this year and so on track to achieve that goal.
Okay. Great. Thank you.
Thank you.
Thank you. Our next question comes from the line of Manav Patnaik with Barclays. Please proceed with your question.
Thank you. Good evening. Firstly, congratulations on that Barclays contract. Good job.
Thanks, Manav.
Thanks, Manav.
Just to stick on that ed advisory piece, though. So, first, the growth obviously has been pretty impressive, all these new contracts that you talked about. Does that mean – like, is there any reason to think the second half of the year then for whatever reason slows down? Like, maybe you can try and just help us understand like these new businesses like Barclays Schwab (00:18:50) whatever, how does that start then flowing through in terms of revenue and EBITDA or is it solely dependent on new business here?
Yeah. So just to give a little bit of background in terms of how our contractual relationships work on the ed advisory side. So what will typically happen is we will sign a contract with a new client and then there'll be an implementation phase. During that implementation phase, we are not actually accruing the economics associated with the contract because ultimately that gets amortized over the life of the contract. But once the particular service goes live, that is when we start to see the true economics of the contract. So once the client is live, the employees are utilizing the service, that is when we start to see the economics. So, what's nice about the ed advisory business and it's true in the other – in the back-up business as well, is once the services are live, we start to see a nice build in terms of the revenue. So I think what you'll see for the remainder of the year and obviously this will hold true into the future, is a scenario where we'll continue to garner new clients, we'll continue to implement them and then ultimately over time have good visibility into the kinds of economics that we're used to seeing on a per contract basis.
And that's also where the...
Go ahead, Elizabeth.
I was just going to say and that's also where the utilization comes along, as Stephen was saying, with the revenue build it's as (00:20:26) the awareness and the utilization and the rollout of the program becomes more pervasive within each client and so that can lend to some of this. I mentioned a variability quarter-to-quarter is when does the utilization happen, but it's also in the early stages of a client absorbing the new business that the awareness is building and that's part of our marketing efforts to the eligible employees.
And, I guess, there's no seasonality per se in the business, right? I mean, when I just look back in the last few years, I mean, it seems like sequentially at least from a dollar basis, it keeps growing with utilization. Is that fair?
Well, there can be some – there certainly is some utilization seasonality in back-up care as the back-up care will be consistently more used in summer vacation timeframe and during school vacation weeks. So there will be some element to that to – to that utilization, so there'll be some – it's actually the opposite cost structure because there's more cost in the summer and less cost with some of the other capitated clients throughout the year. But on the ed advisory, there can be a little bit of school year cycling, but I think because of the size of the business and the fact that it's in such a ramping phase, it's less visible individually.
And just one more on the, I guess, the tuition program you just launched for your employees, I mean, I guess, I can see how that's a great retention tool. Just any implications in terms of expenses and so forth or if you adjust the pay structure to accommodate that. Just any thought, that would be helpful.
Yeah, absolutely. I mean, we're obviously very excited about that program, the reception from our employees has been terrific. And what we would say about it is that it will be a slow build in terms of exactly how the investment comes in, right? Because going back to school is a big decision for people. So I think we have gotten great receptivity both in the recruiting market as well as from our existing employee base. As we sort of exit out this year, we anticipate we'll start to have our first learners enter into the program, so we don't expect there to be a significant expense impact. And then, over time, as it builds, we also anticipate that there will be offsets, right? So we imagine that, over time, it's steady state. This should be a relatively cost-neutral type program, understanding that there is a real ROI built into both recruiting and retention benefits, not to mention the fact that we see this as a real stamp as it relates to our culture and reinforcing that culture and being an employer of choice and being on the cutting edge in our field.
So, again, I think it really puts us and sets us apart in the thought leadership position that we like to be in. But ultimately, Manav, we see this is something that is going to be a great benefit to the teacher as we see it, as a great benefit to the quality in our centers and then ultimately we see it as a great benefit to Bright Horizons from an attraction and retention standpoint.
Got it. Thanks a lot, guys.
Thanks, Manav.
Thanks.
Thank you. Our next question comes from the line of David Chu with Bank of America. Please proceed with your question.
Hi. Thanks. So we saw a nice lift in back-up care this quarter despite a tougher comparison. Is there anything to note here?
I think it's what we've talked about, David, in terms of the slight variability that we can see. The business is close to $60 million a quarter in revenue, so it can move around on $1 million or so of what's added. But I think we are pleased with the growth in both the utilization that we are seeing in back-up care suite and across the clients that have been with us for many years. I think that that's the most encouraging thing that we're seeing along with the nice array. We cited some of them in the prepared remarks, but the nice additions of new clients who are adopting this. So I really think it's what we had said at the beginning of the year, we see a 10% to 12% revenue growth capability in back-up and despite seeing maybe a little bit of movement between quarters that we're on track to continue to deliver on that. And you see this quarter, as you say, a nice step from last quarter.
Okay. Great. That's helpful. And so in terms of the lease consortium centers, which years are now at maturity, like is the 2015 centers, for example, have they reached maturity as well? Just trying to gauge – my sense is this started in 2013. Correct me if I'm wrong. I'm just trying to gauge.
Yeah. No, you're right. We kind of used 2013 as the baseline year. And so the 2013 and 2014 classes, you're right to sort of clarify that, they are at maturity. The 2015 class, certainly some of the centers in that class are mature, some that opened either in the last part of the year would still be ramping and so there's a little bit of mix in the 2015 class, but you're in the right ballpark about which ones are mature.
Okay. And just lastly, one housekeeping question, the FX impact for the quarter?
So, FX, it was just a little bit under 1.5% in the quarter on last year, so a bump to revenue, as I say, just under 1.5% and the sort of a similar effect slightly under 1.5% on the operating income.
Okay. Perfect. Thank you.
Thank you. Our next question comes from the line of George Tong with Goldman Sachs. Please proceed with your question.
Hi, everyone. This is Allison Chou on for George. Thanks for taking my question. Could you please elaborate on how your sales pipeline is building with your new and existing clients and provide an update on your cross-selling initiatives?
Absolutely. So, certainly, as you rightly point out, we have opportunities with new prospects that currently don't enjoy any services from Bright Horizons. And then in addition to that, we have a real effort focused on those clients who only undertake one or few of our services. Ultimately, the way we think about it is that 20% of our current client base buy more than one service and so while that percentage has been pretty static over the last year or two, we continue to increase the number of clients who are buying more than one service. But, of course, at the same time, we're bringing in new clients that again introduce a Bright Horizons service individually.
And so we are pleased with the efforts. We certainly are seeing nice opportunities across our client base. We're seeing opportunities between all of the different service configurations. So we're seeing center clients buy back-up, we're seeing EdAssist clients buy centers. So all of the configurations are working nicely. And at the same time, given the current war for talent that is out there in the marketplace, we're seeing really nice interest from individual organizations that have not worked with Bright Horizons in the past. So we're feeling really good about the sales pipeline at this point in the year.
That's great. And just one follow-up. Could you guys please discuss the current selling environment in both the U.S. and international, first in terms of client purchasing trends as well as in terms of competitive dynamics?
Sure. So first what I would say is that most of the employer work that we do is here in the United States. So we have a small back-up business in the UK. The Netherlands is a third-party support that comes from government. So when we think about the employer opportunity, it is primarily focused here in the U.S. The selling environment given, as I said, the war for talent, is one that we think is very positive. So, organizations are very interested in figuring out ways that they can differentiate themselves from other employers and at the same time, make their current workforces more productive. And so our services play very nicely into those types of people strategies.
In terms of the competitive environment, I would say that it is pretty consistent to what we've seen over the years. In each of our three service lines we enjoy a very significant competitive distance from our next largest competitor, whether that be in onsite or near-site childcare centers, whether that be in back-up care or whether that be in ed advisory. So I think that we continue to have really good market position and continue to leverage the great relationships that we have to sell additional services and at the same time that strong referenceable base with blue chip companies gives us a pretty strong advantage in addition to the quality of the services that we deliver.
Great. Very helpful. Thanks.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Jeff Meuler with Robert W. Baird. Please proceed with your question.
Hey, good afternoon, guys. This is Nick Nikitas on for Jeff. Full service organic growth looked pretty good despite a slightly more difficult comp. You gave the FX. Thanks for that. But can you break out the acquisition contribution as well and then just with the underlying strength, is that still benefiting from the lease/consortium ramp or is that more of a margin driver at this point?
Yeah. So, acquisitions contributed – Stephen mentioned, we had done a couple of tuck-ins in the UK. So we have a little bit of a bump up in acquisition contribution this quarter. It's a little under 2.5% of the overall revenue growth. Still the organic full service continues to be strong and there is certainly some contribution coming there from the cohort of lease/consortium centers that are ramping. So the 2015, 2016, 2017 classes are still contributing modestly to that as well as those centers that we've added this year. I think the other element, maybe that's slightly positive on the overall average, our tuition rate increases are at the higher end of our 3% to 4% range on average, so more like 3.5% to 4% than the 3% to 4%. So there's sort of a contributor tailwind on that front as well. But I think the stability of the enrollment gain across the portfolio along with the stable rate increases and the contributions from new centers happen over time, but that's one of the benefits of the three-year ramp. It takes a while, but we get to enjoy it for a couple of years too as it comes into the revenue stream.
Yeah. That's helpful. Thanks. And then just as you continue to grow the lease/consortium footprint over the next couple of years, are you looking to expand within existing markets where you guys have a presence and you see continued strong demand that maybe your capacity isn't fully meeting or at this point is it kind of more still about expanding the footprint to new cities?
Yeah, so at this point, we've circled up over 100 sites in existing markets that we currently focus on. So you think about the major metros in the U.S., whether that be Boston or New York or the Bay Area, Seattle, you look at a place like London or Amsterdam or Rotterdam, we continue to see really good opportunity to continue to infill in those urban markets. So, that really is our focus in the near term is to continue to build out our presence in those urban markets across the three geographies in which we operate.
Great. Thanks.
Thank you.
Thank you.
Thank you. Our next question comes from line of Hamzah Mazari from Macquarie. Please proceed with your question.
Hi. This is Kayvan Rahbar filling in for Hamzah. I just wanted to go back to this price increase that you're talking to being on the high end. Are you seeing the tightness in the labor market and inflation around that as a contributing factor? I mean, should we change how we think about price increases at all in this environment?
I think the reason that we're seeing slightly at the higher end of the range, so it's a distinction that I'll just make that – we certainly do make decisions locally and individually center by center and on average it's trending at 3.5% to 4%. That is reflective of our philosophy and strategy to price ahead of what we see or expect to see on the wage front. Wages are trending up a bit from a year ago, so we've trended the price increases slightly higher and wages along with the rest of benefits and from a total rewards standpoint are going up a little faster than wages. So the 1% differential that we target to maintain between price and wages allows for some of that variability in both timing of when the tuition increase is going which is once a year and when we absorb or need to incur any personnel costs.
So we are seeing the same way that our client partners are seeing a tightness in the market. We are also seeing some wage firmness and we're reflecting it. We continue – as Stephen outlined before, we want to be the employer of choice, we want to be the leader in both the quality of the offer that we have for our employees, but also the compensation package. So we continue to be on the forefront of that as well, so we are seeing that, yes.
Okay. Thank you for that. And then just a quick follow-up question, government support in the international centers, can you foresee any changes there, are there any recent trends?
Yeah, it's been interesting. So we obviously continue to track lots of global markets, but are most focused of course on the two that we operate in which is the UK and the Netherlands. And in both markets, government generosity is on the increase as opposed to the decrease. So you look at a market like the UK and a good example of that is they've moved from 15 hours of free care to 30 hours of free care for 3- and 4-year-olds. So again, I think they are looking to invest more as they recognize the need for additional support and their interest in getting more people into the workforce, given low unemployment rates.
And then when we look at the Netherlands, again their plans are to increase their support of what they call KDV, which is traditional childcare. And so again in that market, we continue to see the generosity of the government continue to increase and that also comes in that market in the form of rate. So they are also increasing their rate starting in 2019. So again, we see governments at least in those two markets thinking about the importance of childcare and the importance of supporting it in greater ways as opposed to in less.
All right. Thanks for that. I appreciate. It's very helpful.
Thanks, Kayvan.
Great. Thank you. Excellent. Well, thank you all very much for joining us this evening. And hope you enjoy the rest of your summer. Take care.
Thanks, everyone. See you on the road.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.