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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 Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Elizabeth Boland, Chief Financial Officer for Bright Horizons Family Solutions. Thank you. Ms. Boland, you may begin.
Thanks, Steve, and hello to everybody on the call today. With me today are Stephen Kramer, our Chief Executive Officer; and Dave Lissy, our Executive Chair. Before I turn it over to Stephen, let me cover off a few administrative matters. As just stated, 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 that may cause actual operating and financial results to differ materially. And these are described in detail in our 2017 Form 10-K. Any forward-looking statements 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 also available under the IR section of our website.
Now let me 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 third quarter and an update on our growth outlook for 2018. Elizabeth will then follow with more detailed review of the numbers, before we open it up for your questions. As we come to the end of 2018, we continue to be really pleased with the performance against our targets and with the progress we're making in our various initiatives to drive both near- and long-term growth across all of our business segments.
For the quarter, revenue grew 9% to $472 million and adjusted earnings per share of $0.73, increased 18% from last year. In our full service segment, revenue grew 8% in Q3, continuing the strong start we had in the first half of the year. We added 15 centers, including new client centers for Electronic Arts in Southern Methodist University, and we opened additional centers for ExxonMobil, [ Tennessee ] and Centene. Our backup division grew 11% in the quarter, while educational advisory expanded by 19% on launches of new clients, expanded utilization and rate increases. Recent new client launches for these segments include Anheuser-Busch and Fred Hutchinson Cancer Research as well as cross-sells to Sprint and Zürich. We now have more than 250 clients, who purchased more than 1 of our services and we continue to be very excited about these cross-selling opportunities. Tracking our solid top line growth, we also continue to deliver strong and consistent operating results across the business. In the third quarter, adjusted operating income expanded 60 basis points, as we leverage enrollment gains in our newer and ramping full service centers, maintain strong contributions from our backup and Educational Advising segments and see operating efficiencies from the investments that we've been making.
Let me update you on a couple of the key investment areas. First, with respect to our marketing and technology investments, we are pursuing a number of programs to target our outreach and to utilize technology to speed and improve the customer experience. I talked last quarter about 1 of the programs, piloting personalized marketing journeys to select backup clients. One such journey targeted a small sample of registered users, who had not used backup care at all in the past year. We've been really encouraged by the strength of the e-mail open rates and the subsequent conversion to backup use. While this is just one example, it's illustrative of our success to date and the opportunities ahead for this type of targeted marketing. From the user experience perspective, we are also pleased to have really positive client and parent response as we continue to enhance our 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 and over time, to deliver more efficient and automated support. We really like the impact that these investments have been making and the technology and utilization in overall revenue growth that are ensuing.
The success that we have had to date reinforces our conviction in the long-term value and growth opportunity associated with making continued investments in these areas.
Turning to our strategy to invest in lease/consortium centers. We have now opened more than 80 in select urban settings, where we see a concentrated population of our target demographic, limited supply of high-quality child care and strong opportunities to meet the needs of our client partners. The earliest classes of these centers are now fully ramped and contributing at mature operating levels. While the newer cohorts, including the centers we are opening this year, are still ramping their enrollment. 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 the second half of 2018. And we expect the headwind to continue to naturally diminish as more classes ramp to maturity.
In summary, we continue to see significant value creation opportunity in these centers over time. Our growth strategy is focused on organic as well as acquisition growth. And as we approach the end of this year and look ahead to 2019 and beyond, I'm really optimistic about the sales and growth momentum across all aspects of our business.
Our growth comes from cultivating new clients and from expanding our existing client relationship to cross-sells of new services and additional take-up of current services. Our sales pipeline in each of our services remains strong with interest across industries with both new and existing clients. The intense competition for talent presents significant opportunities, given the nature of services we offer to our employers to attract and retain the people they most need. Our unique positioning and reputation as a quality leader puts us in a solid position to achieve our organic growth plan in '18 and continue the momentum in 2019. We also continue to execute on our acquisition strategy and expect acquisitions to continue to be a key contributor to our growth plan. So far in 2018, we have completed transactions that added total of 28 centers. We continue to cultivate a solid pipeline of prospects, pursuing opportunities that range in scale, both here in the U.S. and abroad and our pipeline has a great mix of networks and single center opportunities. Before I wrap up, I wanted to update you on the initial success of our early education degree achievement plan that we announced this past summer, as one of our initiatives to address the diminishing pool of qualified early educators and a tight labor market in general. This breakthrough program, which has generated significant buzz with both prospective and current employees is designed to enable the teachers in our childcare centers to earn associates and bachelor's degree in early childhood education at absolutely no cost to the teacher. Given the interest in enrollment levels in the program, we are optimistic that this will have a strong ROI, both in terms of quality and stability of our workforce.
Now let me update you on our outlook. We remain on track to achieve 8% to 10% revenue growth in 2018, and adjusted EPS growth in the range of 16% to 18% over 2017 or $3.14 to $3.16 per share. Finally, I also want to provide some initial perspective on 2019. We believe we're well positioned to continue the positive momentum we've demonstrated over the years. While we're not yet providing detailed guidance for next year, we anticipate a continuation of this year's performance with revenue growth in the range of 8% to 10% and sustained operating margin leverage. We will need to factor in higher interest rates and a slightly higher effective tax rate for next year and we expect this all to translate into adjusted earnings per share growth for 2019 in the low- to mid-teens. 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 9% or $38 million in the quarter. On a segment basis, the backup division expanded $6 million on the top line or 11%, and advisory services was up $3 million or 19%, primarily from new client launches and the expanded utilization by our existing client base. The $29 million increase in full service center revenue was driven by rate increases, enrollment gains, and contributions from new centers. The foreign exchange impact was modest, but was a slight headwind to the growth for the quarter. In Q3, gross profit increased $10 million to $113 million or 24% of revenue and adjusted operating income increased $7 million to $55.5 million and was 11.8% of revenue. In our full service segment, adjusted operating income expanded 90 basis points to 8.8% on gains from enrollment growth in our mature and ramping centers from contributions from our new and acquired centers and from price increases ahead of our cost inflation. The operating margins in backup and Ed advisory can vary from quarter-to-quarter based on the timing of new client launches, the service utilization levels and the timing of certain spending to support our growth. Both of these segments reported solid operating income margins in the quarter of approximately 25%, respectively, broadly consistent with our expectations. Interest expense of $11.8 million in Q3 of '18 was up just about $1 million over 2017 levels, and incremental revolver borrowings, which have financed acquisitions and share repurchases, and for modestly higher interest rates. Our current borrowing cost approximates 4% with $500 million or about half of our term loans fixed with an interest rate swap. We ended the quarter at 3.3x net debt-to-EBITDA. Our estimate for the 2018 structural tax rate on adjusted net income continues to approximate 23%, down from 24% in 2017. And with our improved operating performance and the positive working capital movements, we continue to generate strong cash flow. Through September of this year, our operating cash flow of $240 million was up $27 million over 2017 levels. As part of our capital allocation strategy, just as a reminder, our first priority continues to be investments in growth through new center investments and acquisitions. And this is illustrated by the around $100 million, we spent this year so far on new centers and acquisitions. Through September, we've also acquired 840,000 shares under our share repurchase program. At September 30, we were operating 1,071 centers with capacity to serve more than 118,000 children. And we continue to serve more than 1,100 clients across our service lines.
Just adding briefly 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. We expect to add approximately 60 new centers in '18, including new organic and acquired centers. And our outlook contemplates closing approximately 20 to 25 centers, as we maintain the discipline that we've established over the last several years. On the operating side for 2018, we expect to continue to add approximately 1% to 2% to the top line from enrollment in our ramping and mature centers and to realize price increases in the range of 3.5% to 4% across our P&L center network. All of these elements contribute to improved operating performance and margins in 2018 in the range of 50 to 60 basis point improvement compared to 2017, as the factors that mitigated margin expansion in 2017 have diminished over the course of this year.
On some other key metrics for the full year 2018, we're estimating the amortization of $32 million to $33 million, depreciation of around $70 million, stock compensation of around $14 million. Based on our outstanding borrowings and estimates of interest rates for the rest of the year, we're projecting interest expense in the range of $48 million to $49 million. As previously mentioned, the structural tax rate is expected to approximate 23% in 2018, the same rate that is applied year-to-date. Lastly, weighted average shares outstanding are projected to be $59 million for the year.
From a cash flow perspective, we estimate that we'll generate approximately $270 million of operating cash flow and have $45 million to $50 million of maintenance capital, which will yield $220 million to $225 million of free cash flow to invest in the ongoing growth of our business.
We also expect to invest $40 million to $50 million of that in new center capital for centers that are opening this year and/or will be opening in early 2019.
The combination of all these factors lead to our projection of adjusted net income of $185 million to $186 million for 2018 and adjusted EPS growth of 16% to 18% or a range of $3.14 to $3.16 a share for the year. So with that, Steve, our prepared remarks are over and we are ready to go to Q&A.
[Operator Instructions] Our first question is from Manav Patnaik with Barclays.
My first question, Steve, is around obviously, you gave us the preliminary 2019 guidance, and I appreciate that. Obviously, it doesn't sound like that you're seeing any signs of either slowdown or demand or whatever. But just curious, like compared to prior periods like what kind of behavior would you see from clients, if we were to get some sort of indication that maybe things are going to slow down a bit?
Yes, so thanks, Manav. So what I would say is that we aren't seeing that in our client or prospect base. At this point, the conversations and discussions that we're having are really focused on the work for talent that exists sort of pervasively across industries. And so the discussion that certainly we're having are focused around that, and how our services can either help employers to attract, retain employees and in many cases, they're talking about how they can make those employees they have even more productive, given the number of openings that they have. So at this point, we're not hearing conversations about slowdown. We're really hearing conversations about how we can support them as employers to not only be employers of choice, but also how we can help them to differentiate themselves from competitors in the market.
Got it. And to your comment on all the cross-sells, well, firstly, you talked about the 250 clients using more than 1. Can you just frame like you have before compared to, I guess, how many total clients? And I was just curious like, are these cross-sells more backup and full center that makes sense? Or have you been able to sell the Ed advisory piece as well? I know we've signed up, but just curious broadly.
Yes, no. That's a great question, Manav. So the universe of clients that we have approaches 1,100 and is on our way towards 1,200 in terms of the total client base. At this point, we've seen an uptick, so we're now at about 22% of our clients offer more than 1 of our services. And in terms of how the cross-sells are happening, I'm really pleased to report that we're seeing them go in all directions. So as I mentioned, we have center clients which are adding additional centers. We have center clients that are introducing backup care. We have backup care clients that are introducing a center for the first time. And then certainly, we're seeing our dependent care clients in those areas introduce our Ed advisory. So what I would say is, we have, I believe gotten the incentives and the structures right around our sales team and our account management teams so that, that these kinds of cross-sells are happening across the client base and across the services.
Got it. And just last question. Elizabeth, just in terms of the higher tax rate for next year and maybe in the interest rate versus '18, can you just maybe help -- tell us what the moving pieces would be?
Well, from a tax rate standpoint, it's really a matter of the mix. The U.S. blended rate with federal and state is still in the 27% to 28% range and the U.S. is obviously the biggest portion of our business. So while we have slightly lower rates abroad, that mix pushes the rate up as we grow. And then there is also -- the other factor in the tax rate is the effect of the equity transactions, when individuals exercise their options or they invest, there is a windfall tax benefit that goes into the tax expense. And so that just becomes a smaller portion of the mix. So that's the reason that the tax rate. We estimate it will pick up between 50 and 100 basis points a year for the next couple of years just from a general direction standpoint. Obviously, there's a variety of things that can affect that in the future, but that's the general modeling. On the interest rate front, we try to follow the LIBOR curve. Our debt is -- half of it is just fixed and the other half is floating against LIBOR. So we have considered that there would be another 2 interest rate increases next year. And we will continue to generate cash and pay down our revolver, but the moving pieces then just push a little bit more interest expense into the overall total.
Our next question is from Andrew Steinerman with JP Morgan.
I just want to let you know that I use College Coach this semester, as my daughter applies to college, and it was awesome. Anyhow, my question has to do with the 2019 growth rate, 8% to 10%, I assume is $1 growth rate, should we think about an FX number in addition to that? And if you could give us a sense of what you've baked into there in terms of center closings and acquisitions, just the range?
Sure. So it would be similar algorithm to what we have in our investor deck, which doesn't contemplate a dramatically different foreign exchange from where we're now, Andrew. It's been in the range that the pound is the larger element for us. The pound has been between high $1.20, so call it $1.30 to $1.35, so in that range we wouldn't expect there to be a dramatic difference there. And of course, that can change, but that's what we're -- we're not considering much FX effect in that 8% to 10%. Overall, center growth would be considering closings again in the range of probably average of 25 centers closing and between 50 and 55 being added, of which an average of 15-or-so would be coming from acquisition. So 1/3 of the growth coming from acquisition and the rest organic.
Elizabeth, I actually meant it in a percentage basis, like in your slide deck, your typical closings is 1% to 2% on revenues and the acquisitions is assumed to be 1% to 2%, so is that -- what that works out to?
Let me -- I haven't looked at it that way. Maybe I take another look. That's okay. I'll take another look and see if those metrics still apply.
Great. Thanks, Andrew, and thanks to JPMorgan Chase for being a multiservice client.
Our next question is from Gary Bisbee with Bank of America Merrill Lynch.
This is David Chu for Gary. So just along the 2019 preliminary framework, I assume the kind of segment expectations haven't really changed either.
Probably that's right. We would expect that 8% to 10% that we would be getting probably 1.5% to 2% coming from our backup and Ed advising services businesses so that they would again be growing in the range of the low double-digit, so backup in the 10% to 12% range and the Ed advisory business in the mid- to high-teens.
Okay, great. And then, can you just discuss like the expected costs for these early education future program? I'm not sure if you've addressed it in past quarters.
Yes, so we didn't address it directly in terms of what the dollar cost would be. Again, what we would say is, we expect that this will have a strong ROI in terms of our ability to attract and retain employees. And in addition to that, the actual dollar amounts that we'll be investing won't be material in the context of our overall financial structure.
Okay, great. And then just lastly, Elizabeth, could you provide a bridge along the lines of margins for the quarter? So just could you quantify the lease/consortium benefit in the quarter as well as the drag for tech investments, if there are some?
Yes, I mean, the quarter we developed, obviously, some positive operating margin leverage. I would characterize the lease models as continuing to come along. So maybe adding 5 basis points, 10 basis points or so to that overall contribution. From a tech investment standpoint, I think, we're -- we continue to invest in these technology efforts in sort of tech marketing efforts. So I say that just to make sure that everyone on the phone understands these were not one-and-done kinds of investments, they are ongoing. But at this point, we are -- there may be a little bit of drag in there still in terms of lapping last year, but it's modest. So I think what you're seeing is a positive basic operating performance and that we've largely lapped that initial step up of spending. But maybe there's a modest headwind in there. But what we're pleased about is that having sort of bedded in that level of spend and seeing some of the value in the early days outcomes that the investments are proving to be fruitful. And as we continue to refine what we're doing it through ongoing investment that we will continue to see that benefit down the road. Okay. Let me just answer before we go to the next question. Let me just answer Andrew's question about acquisitions impact. It would indeed, Andrew be in that range of revenue contribution from acquisitions will be in the 1% to 2% range is our estimate.
Our next question is from George Tong with Goldman Sachs.
You've indicated that approximately 22% of your clients are purchasing more than 1 service. Can elaborate on what this percentage was last year? And where you see this mix trending over the next year, particularly in light of your framework for 2019 guidance?
Yes. So as we've commented on previous calls, there's actually a pretty good resistance in terms of what the percentage is, right?
And it's in 20%, 21%.
So it's in the 20%, 21%. Now it's in 22%. So it moves relatively slowly just because the denominator is large and also is growing with clients who are introducing their first service. So what I would say is that while we're making really good progress in terms of the number of our existing clients that are buying an additional service, we also are making great progress at bringing in new prospects, who are ultimately purchasing 1 service as their introductory service. So we certainly, in the plan, we'll continue to see nice progress. But in terms of that percentage, we don't expect to move that percentage at a heightened rate in any great way.
It makes sense. Very helpful. And then, you indicated, your newer lease/consortium centers are starting to reach maturity. As you look forward to 2019, can you comment on what the pace of new lease/consortium centers will look like? And what that -- what the impact might be to margin performance?
Yes. So we now have in this sort of more recent cohort that we've talked about, as Stephen mentioned, more than 80 of these centers, of which the earliest classes are maturing, contributing. So we would expect to open a similar -- this year's openings will be in the 12 to 14 centers range depending on a couple that are teed up to open in fourth quarter if we get them open this year versus next. Next year, we would expect to open similarly something in the -- between 10 and 15 of the centers. So the headwind of the individual class would be consistent to what we saw this year, but because we have another class in the early stage that's maturing, our expectation is that, that they will -- it will be contributing in maybe 10 to 20 basis points of margin tailwind as we continue to get more mature enrollment there. Individually, though the classes themselves will continue to be -- they have a ramp up stage that takes between 15 and 18 months to get to breakeven and so it is a long ramp-up period.
[Operator Instructions] Our next question is from Jeff Meuler with Baird.
So the short question is going to be, what needs to happen or at what point do you get back to sustain margin expansion in the backup care business? But the longer form is going to be, is there anything else going on other than the tech investments? And what I guess, I'm wondering about is, anything changing from a competition standpoint? Obviously, the care.com and Starbucks partnership caught a lot of headlines, but don't know what's going on under the covers, anything changing in terms of the different channels for delivery like more of your care being delivered for more expensive channels, anything like that?
Yes. So let me start with competition. So look, we've had competition in our services forever, right? And when you have the size of addressable white space that exists in the markets in which we compete, there are always going to be new entrants that come and those that depart. What I would say is, we continue to feel really confident about our competitive position within the marketplace. And so using as the example, our center business, we still continue to maintain a 6x the number of the amount of market share compared to our next largest competitor. It's even more in our other 2 lines of service. So we feel really good about our competitive position. I'd also say that we feel really good about our win rate. So we don't win every time, but our win rate is incredibly high. Obviously, if you know we're disappointed that Starbucks chose Care, on the other hand, I think, it was for very specific reasons. And I just observed that while we win almost all the time, we don't win every time. So we don't see competition as a key ingredient in terms of being a headwind going into the future. What I would say in addition to that is that we look at Ed advisory and backup as growth businesses. And so in any given quarter, we may have slightly changing margin profile, but at the end of the day, what we're really focused on in those 2 lines of service are continuing the growth algorithms that we enjoy. And so I think what you're starting to see also is some really good and sustained growth and that's how we focus that business.
Okay. And then, I don't know that this will have a big impact on the market, maybe it will, maybe it won't. But just the Amazon announcement of $15 cash comp. I guess, I kind of perceive that, one, there is gradual acceleration in wage inflation, that's a benefit for you, because you're able to push through bigger price increases. But can you just talk to any historical examples where maybe there's been a need for a step-function increase in pricing, if there ever has been? So I'm thinking, like if there was any state minimum wages that went up meaningfully and just your ability to pass that through to clients, should it occur?
So Jeff, I think you're pointing out an individual example of what we've been battling for many years. It's been a challenging labor market for a while now. And for us, it's been challenging for many years affected by certainly some states that have promulgated it different minimum wage levels that have been announced and we've been able to address that. They've given -- there's been an on-ramp for that, that we've been able to address over time, but those kinds of legislative changes affect wages as well as other employee costs. And it's been -- as I say, it's a complex environment for us to be working in and we're doing -- we have a lot of programs that address this, that have been able to successfully price against that, but it does continue to be challenging and it becomes more challenging the longer that it goes on. I think that for us, it's the value proposition of having the quality offer and making sure that we are -- as much as we know about that information, that we're not hesitant about addressing it as it's happening and that is what we are doing. To your question about step changes, we have -- so for the example of Amazon, they're in Washington, in Seattle, they've had this minimum wage effect happening in that state anyway. And so there's been an opportunity to make more significant price steps in that geography. And occasionally, we have done that in other locations too, but it's one that we like to be as paced as we can and sustained over time, rather than doing major step ups, because it's more absorbable for families over time. But, Stephen, I don't know...
And I think the other point, if we think about our labor force, right, so the teachers in our centers. Certainly, wage is an important element in terms of their overall package. But we really pride ourselves, as you know, Jeff on the benefits package that we offer, and equally on their ability to continue to grow in their career and be with an organization that really professionalizes the work that they do. And so, yes, we are very focused on wages and yes, we're very focused on ensuring that we continue to have our families absorb price increases, because of the quality of the services that we offer related to those wages. On the other hand, we think the value proposition that we have with our employees is broader than just simply wage.
Got it. And then, just one final one from me -- sorry, if I missed it. But what was the acquisition contribution to revenue in the quarter?
One second. Acquisitions, so the overall revenue growth in the quarter was just -- it was about 2%.
2% to consolidated or 2% to full service?
2% to consolidated.
Our next question is from Hamzah Mazari with Macquarie Group.
This is Mario Cortellacci filling in for Hamza. Just wondering, if there are any other international markets besides the U.K. and the Netherlands that have similar characteristics, where maybe it would make sense to -- for you guys to be in?
Yes, it's a great question. So the way we look at international expansion is, we are most interested in markets where there is some form of third-party support for the services that we offer. So for example, here in the U.S., we've really pioneered the concept of having employers invest alongside of families to offset the cost, the full cost of a quality early childhood education. And in a place like the Netherlands, our partner really is government. And so the government has significant subsidy to offset and invest alongside of families. And so if we think about that as a rubric and we look around the world, obviously, the U.K. is in between. There is some employer support. There is some government support. And then beyond that, as we look at other markets, we look at places that look like that. And again, these are not necessarily places that are on the immediate horizon, but they meet the criteria that we're describing are places like France that has strong employer and government support. You look at places like Australia, which again have employer and government support. There are places in Asia again that either have government and/or have employer support. So those are the kinds of places that we continue to keep a watchful eye on. And typically, as you'll see from our history, we are focused on continuing to remain focused on those employer -- sorry, those providers in the market that are the true quality leaders and we maintain relationships with quality providers around the world, and ultimately, would likely enter in new country by partnering with one of those like-minded providers.
Great. And just a quick follow-up, and this is more from a macro perspective. Could you maybe speak to some key demographic trends that you're looking at in the U.S. and maybe even watching for a while, or maybe you've seen a shift lately, I'm not too sure it's something that you guys keep an eye on?
Yes, so we certainly look at the macro trends, and when we think about our services overall, unemployment rate is a key trend for us to continue to watch. So obviously, in the current low unemployment rate market, it's a very vibrant market for us as we've been discussing on this call. When we think about our childcare segment, of course, we are very focused on the more highly-educated, more affluent and later parents, who are having their first child later. And so we watch that trend because that tends to be the demographic that we're looking at. So those are the kinds of statistics that we look at. We often get asked whether or not we focus on actual birth rate sort of generically? And that tends not to be a good indicator for us, given the fact that, that is to macro a statistic and doesn't necessarily speak to the demographic that we serve. Excellent. Well, thank you very much for participating this evening. Thank you for the questions, and we look forward to seeing many of you out on the road.
Thanks, everybody. Have a good night.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.