Bright Horizons Family Solutions Inc.

Greetings and welcome to the Bright Horizons Family Solutions second quarter 2019 earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Elizabeth Boland, Chief Financial Officer. Thank you, Elizabeth. You may begin.

Thanks, Ashley, and hello to everybody on the call today. With me on the call is Stephen Kramer, our Chief Executive Officer, and Dave Lissy, our Executive Chair. And after my few administrative matters, I'll turn the call over to Stephen. Today's call is being webcast, and a recording will be available into the Investor Relations section of our website, brighthorizons.com. As a reminder to participants, any forward-looking statements 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 they are described in detail in our 2018 Form 10-K. 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. So Stephen will now take us through a review and update on the business. Stephen.

Thanks, Elizabeth, and thanks to all of you who have joined us this evening. As always on today's call, I'll review our financial and operating results for this past quarter and update you on our growth plans and outlook for 2019. Elizabeth will then follow with a more detailed review of the numbers before we open it up to your questions. As we move to the second half of 2019, we continue to be very pleased with our strong and consistent performance. For the second quarter of this year, we are reporting top line growth of 8% to $528 million and adjusted EPS growth of 14% to $0.99 a share. In our full service business, we added 12 locations, including client-sponsored centers for MindBody, our sixth center for Penn State University, and three lease consortium centers in the greater Seattle area. In addition, we expanded our backup care and ed advisory client portfolios with recent launches for Nestle, BJC Healthcare, Peloton, and WeWork. Our cross-selling and cross-promotion efforts also continued to yield good results this past quarter. A few examples of existing Bright Horizons clients who added a second or third service this past quarter include Allstate, Freddie Mac, the University of Southern California, and Vertex. As we've shared on prior calls, only about a quarter of our existing clients currently purchase more than one of our services, so the addressable opportunity in this area is still significant. Tracking our solid top-line growth, We also continue to deliver strong and consistent operating results across the business. In the second quarter, adjusted operating income grew 13% and expanded 70 basis points to 14.2% of revenue. In our full service segment, we continue to leverage solid enrollment gains from both our mature centers and from our newer client and lease consortium centers that are ramping to mature operating levels. Turning to our backup segment, The strong top line growth and operating performance reflect three key components. First, My Family Care, which we acquired in the first quarter of 2019. We're really pleased with the integration thus far and feel good about the opportunity to extend our leadership position in the emerging backup care market in the UK. Second, solid new client launches coupled with strong use by existing clients. While the feedback on our backup service has always been strong, the entire team takes a lot of pride in the progress and satisfaction related to our enhancements to the end user experience, including speed of care confirmation. Third, the targeted and personalized marketing campaigns. These initiatives drive new registrations, reservations, and ultimately more use by the employees of our client partners. The increasing shift to reservations being made on our mobile and web platforms also drive growth and operating leverage. Given the results to date, we'll continue to invest in the technological tools and innovative strategies to meet our clients' needs and expectations going into the future. Now I'll touch briefly on the three strategic growth areas we're focused on. First, our organic growth strategy continues to be focused on cultivating new clients and expanding our existing client relationships through cross-sells and additional use of current services. The sales pipeline in each of our services remains strong with interest across industries and with both new and existing clients. Next, our lease consortium centers. We have now opened 95 of these centers over the last six years with a focus on select urban settings where we see one, a concentrated population of our target demographic, two, a limited supply of high-quality childcare, and three, strong opportunities to meet the needs of our client partners in these locations. We are encouraged by the progress and positive contribution from this group of centers as they ramp to mature operating levels and are optimistic about the significant value creation opportunity of this strategy. Finally, with regard to M&A, we continue to cultivate a solid pipeline of acquisition prospects in each of our three primary geographies, including a good mix of networks and single centers that meet our high quality and performance thresholds. In the second quarter, we acquired three centers in the Netherlands that fit this profile. Over time, we also have opportunities to acquire businesses like My Family Care that enables us to further solidify our leadership position in our backup and educational advising segments. Beyond acquisitions, we actively seek relationships with like-minded providers that can deepen our service offerings and geographic scope for our clients. Today, I'm pleased to share that we've entered into a partnership with PME Familian Service, an innovative and highly regarded provider of full service and backup care for leading employers and families in Germany. This arrangement reflects our commitment to expanding the impact we have with our multinational clients in key markets around the globe. I also want to take this opportunity to reflect on employee recognition events that have been occurring across Bright Horizons over the last few months. This year we had a record number of award nominations by clients, families, and colleagues. I have personally attended many magical evenings where we celebrated the great success of our teams and individual employees across the U.S. and abroad. My heartfelt appreciation goes out to all of our 34,000 employees who work tirelessly each day to make a difference in the lives of children, families, learners, and workplaces. So in closing, we believe that we are well positioned to continue the positive momentum and operating agility we have demonstrated over the years. We anticipate continued strong performance with revenue growth in the range of 8% to 10% for the full year. We project that continued operating leverage will drive adjusted earnings per share in the range of $3.59 to $3.64. With that, Elizabeth can review the numbers in more detail, and I'll be back to you during Q&A.

Thank you, Stephen. So once again, recapping the headlines for the quarter, overall revenue was up 7.8% or $38 million in the quarter. The 6% growth in full service center revenue which was $24.5 million, was driven by rate increases, enrollment gains, and contributions from new centers, including about 1% from acquisitions. Also, foreign exchange rates created approximately 150 basis points of headwind to the full service growth for the quarter. So on a common currency basis, this segment expanded 7.5%. Our backup operations also continue to perform well, generating 19% top-line growth in the quarter. In addition to new clients who launched service, revenue expanded on contributions from My Family Care in the UK and on strong utilization from existing clients. Ed advisory services grew 16% on new client launches and on expanded use by the existing base. In Q2 of 19, gross profit increased $13.6 million to $140 million, or 26.4% of revenue, and adjusted operating income increased to $75 million, or 14.2% of revenue, which, as Stephen mentioned, is up 70 basis points from the second quarter of 2018. On a segment basis, our full-service adjusted operating income expanded 60 basis points to 11.8%, on gains from enrollment growth in our mature and ramping centers, on the contributions from new and acquired centers, and on tuition increases leveraging on our strong cost management. Our backup operations generated operating income margins of 26.3% in the quarter on solid utilization levels and improving efficiency of service delivery. The addition of My Family Care to the backup segment generates some headwind as we complete the integration and execute on the growth opportunity embedded therein, and as we build scale in the UK backup business. Interest expense of $12 million in Q2 of 2019 was down slightly over last year on lower average revolver borrowings. Our current borrowing cost approximates 4%, with $500 million of our term loans fixed with an interest rate swap. We ended the quarter at 2.75 turns of net debt to EBITDA. As we've commented in the past, we continue to generate strong operating cash as well, 190 million in the first half of 2019. In terms of deploying that cash flow in our capital allocation strategy, our first priority continues to be investments in the growth of the business, followed by share repurchases under our existing authorization. Through June of this year, we've invested $50 million in new centers and acquisitions and have reinvested $20 million into our existing operations and support functions. Lastly, at June 30th, we operated 1,083 centers with the capacity to serve 120,000 children, and across all of our service lines, we partner with more than 1,100 clients. Now, adding to the guidance headlines that Stephen touched on earlier, As he said, we continue to project top-line growth for 2019 in the range of 8% to 10%. We are projecting that our backup division will grow between 17% and 19% for the full year, including approximately 4% coming from the addition of MyFamilyCare. We continue to project top-line growth in our ed advisory services in the range of 15% to 20%, and in our full service segment, we're projecting top-line growth in the range of 6.5% to 7.5%. Again, this includes a foreign exchange headwind of about 1.5 percentage points on projected lower pound and euro rates for the remainder of 2019. On the operating side for 2019, we expect to continue to add approximately 1% to 2% to the top line from enrollment in our ramping and mature full-service centers and to realize average price increases in the range of 3.5% to 4% across the P&L center network. We expect to add between 45 and 50 new centers, including organic openings and acquisitions. And consistent with our discipline strategy over time to prune underperforming centers, we also anticipate that we will close approximately 25 locations. Top line growth, discipline cost management, and service delivery efficiency contribute to improved operating performance across all of our segments. And it drives margin improvement for 2019 in the range of 50 to 100 basis points. On some other key metrics for the full year 2019, we estimate amortization of 33 million, depreciation of 75 to 78 million, and stock compensation in the range of 17 to 18 million. Based on our outstanding borrowings and estimates of interest rates for the rest of the year, we project that interest expense will approximate 46 to 47 million. And on the tax front, we're now projecting the structural tax rate to approximate 23% for the year. Lastly, weighted average shares are projected to approximate 59 million for the year. We estimate we'll generate approximately 310 to 325 million of cash flow from operations and have 45 million of total maintenance capital, yielding 260 to 280 million of free cash flow available for investment in the ongoing growth of the business. We have circled up 50 to 55 million in new center capital for centers that are opening this year and in early 2020, fairly consistent with the last couple years. The combination of all these factors lead to our projection of adjusted net income of 211 to 213 million in adjusted EPS in the low double digits to a range of $3.59 a share to $3.64 a share. Looking specifically to Q3, 2019, we're projecting top-line growth in the range of 9 to 10 percent as we expect to sustain the growth drivers we reported this past quarter. On the bottom line, we're projecting adjusted net income in the range of 50 to 51 million and adjusted EPS in the range of 85 to 87 cents a share. So with that, Ashley, we're ready to go to Q&A.

Thank you. We will now be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the keys. One moment, please, while we poll for questions. Thank you. Your first question today comes from Andrew Steinemann from JP Morgan. Please go ahead.

Hi, it's Andrew. You mentioned a partnership with a German partner in child care. Tell us a little bit more about this partner and what you see in the German market that's similar or dissimilar to your current markets in terms of how child care is paid for and is this a backup market as well?

Sure. Thank you, Andrew. As we mentioned, PME is going to be a partner, and we have long admired the team at PME as well as the extensive set of clients and services that they offer within the child care market. So they operate a series of on-site centers for employers, and at the same time, they also have a robust business directed at backup care. And so from our perspective, we look at it as a really great way to serve our U.S. and U.K. multinational clients in the German market and at the same time extend the capabilities in that way. In addition to that, it is a wonderful way for us to get to understand and explore what is one of the largest economies in the world that does have a strong strategic focus, both from a governmental perspective as well as from an employer perspective in the area of childcare. And as you know and others know, we are always looking at markets where there is some form of third-party support, and Germany certainly qualifies both from the governmental support as well as from employer support within that market. So we really see it both from a full-service childcare perspective to serve our clients here in the U.S., and the UK in Germany, as well as an extension of the backup services that we do in each of those two markets into Germany.

Right. And, Stephen, right now, while it's a partnership, is there any direct monetary benefit from PMA to Bright Horizons as you refer them work?

So we do have a minority interest in the company, but it's a small stake. I think that the value that we see is in the relationships and building both knowledge of the market and capitalizing on these client arrangements in the near term. But it is early days, and we will see how it unfolds.

Okay. Thank you very much. Thank you.

Your next question comes from George Chong with Goldman. Please go ahead.

Hi. Thanks. Good afternoon. You mentioned that 1% to 2% of your revenue growth in the quarter is coming from enrollment growth. Within this range, can you elaborate on how enrollment growth is trending, specifically how enrollment growth is responding to your recent technology investments and the broader macro cycle?

Yeah, so I think that our view of both the current situation with enrollment and our mature, speaking about our Our mature class principally in that range is that it's a very good market right now. We have really consistent enrollment growth across the portfolio and feel like the – I think the service delivery is certainly an element of that. And in our full service centers, the primary technology investment that parents and sort of the end user – experiences on the tools in the classroom, My Bright Day in particular, and the ability to continue to serve backup care in our own full-service center. So we certainly are seeing some good traction there, but the 1 to 2 percent enrollment gain is, we think, a very strong indicator of good performance across the group.

Got it. That's helpful. You've recently made the decision to pair account managers with product specialists to drive a higher velocity of cross-selling. Can you expand on your progress there in the quarter and how we may expect to see benefits from this in your growth rates?

Yeah, so certainly, as you indicate, we continue to be very focused on cross-selling, and we gave a few examples of some nice client wins who were investing and are investing in a second and a third service. Certainly what we're seeing in the marketplace is that the trust and the quality of the services that we deliver really enable us to have our client partners feel the ease of moving into a second or third service. In terms of velocity, you know, we really bake it in in the overall view that we have for growth in general. And so the way I would think about it is that we continue to see strong demand for our services from, new prospects to the Bright Horizons family, as well as those who currently invest in a service. And we'll continue to chip away at the client base and believe that will continue to be an important source of growth going forward.

Got it. That's helpful. Thank you.

Your next question comes from Manav Patnik from Barclays. Please go ahead.

Hey, this is Ryan on Fermatov. Just curious if you could walk through your thoughts on, I guess, A, why enter Germany, and I guess more specifically, why now? And then just the thoughts on the partnership versus acquisition and just kind of how you think about that with new markets.

Yeah, so we – look, we continue to scan the globe for countries that we think we can have an impact on and have some form of third-party support. And the other important ingredient and element in all of that strategy is finding like-minded partners. And so the answer to your question very directly around Germany is we think that market represents a long-term possibility for us and believe that it has all of the trappings of a market that we think we can add value in and found a like-minded partner who was not interested at the current to become acquired but rather interested in creating a partnership will through this partnership get to know each other better but also it gives us an opportunity to learn the market even more closely. Germany represents a market that while on the surface has many of the right attributes and elements it also has a relatively complex set of local approaches so within each of the states within Germany they have different regulation and different funding. And so I think this gives us a really unique window into how Germany operates and how the individual states operate. So we think this is a great opportunity to do that with a high quality, well understood player in that market.

Got it, thanks. And then some of your comments, you talk about investing and especially in the tech side. Is that incremental, do you think, to what you're already doing, or do you think that's just kind of an ongoing investment that's already really in the run rate?

I think largely, Ryan, it's in the run rate, but we continue to grow and innovate, and I think that technology solutions, when we have success with them, we want to be sure that we're not just capitalizing on the results of those investments themselves, but that we're continuing to innovate. So, you know, largely in the run rate, but we'll see it track the rest of our growth and continue to modestly expand because it certainly is a wave of the future. And, you know, we don't see it. We talked a couple years ago about a stepped-up level of spending being an incremental headwind. We're not seeing that at this stage, but we want to be mindful to continue to invest and to invest appropriately to to drive and support the results that we're projecting.

Got it. Thank you.

Yep. Thank you.

Your next question comes from Gary Bisbee with Bank of America Merrill Lynch. Please go ahead.

Hey, good afternoon. A question that I probably asked you two years ago, but it feels like it's worth coming back to. How are you thinking about Brexit and any risks around the U.K.? There's been a lot more press lately about businesses shifting employees outside of the U.K. I know Bank of America sent them to Dublin and Paris, and I'm sure that's going on in a lot of places. Do you have a sense if that's impacting the business? Have you heard any feedback from corporate customers and how they're thinking about demand for the service? And just any updated thoughts. Thank you.

Yeah, no, it's a great question. So by and large, we continue to see a strong opportunity in the UK and we continue to see nice enrollment as well as nice client interest in our backup and other services. I think the reality is that we do have some small pockets, individual centers that we believe have some headwind as it relates to individuals that may have gotten transferred out or something that could be attributed to Brexit. But by and large, we still feel really good about what the opportunity looks like. I just highlight again that the majority of our portfolio is really concentrated in the southeast, so the greater London area. And in that area, there is still a supply-demand imbalance as it relates to childcare. And so we continue to see good take for our services. And then on the client side in particular, we continue to see demand as it relates to our backup services in particular.

Okay. And can you give us an update on where you are? I know there's the acquisition and whatnot, but where is the business? Is it right to think that the vast majority of backup revenue is in the U.S.? I guess what's it going to take to drive the mix of your U.K. business, you know, towards what it is here?

Yeah, so it is definitely still the vast majority of our backup revenue is here in the U.S. We have a nicely growing business in the U.K., obviously through the acquisition of MyFamilyCare. That was a nice step function up from where we were. And likewise, we see that leadership position and likewise the ability to continue to cross-sell our U.S. multinational clients as well as see increased interest in the category with us again being the market leader as a real positive step forward. So overall, we think that there is good opportunity in the UK. It's in the really early innings as it relates to where we are in the development of the backup client base in the UK, but all indications are that it should continue to grow nicely in that market.

Thanks. And then just one quick clean-up one. I didn't hear anything about share repurchases. Did you do any in the quarter or not?

Minor.

Okay. All right. Thanks, guys.

Thank you.

Once again, if you wish to ask a question, please press star 1 on your telephone and wait for your name to be announced. Your next question comes from Jeff Miller, Baird. Please go ahead.

Yeah, thank you. In terms of the better organic backup care growth that you're experiencing, is it all being driven by the, I guess, targeted and personalized marketing campaigns driving more usage or the component where you're signing up new clients or some other factor? Are those also accelerating for you?

Yeah, so I think that certainly we are seeing a nice adoption of our service in the marketplace. So New sales and cross-sells within the backup line of service is certainly an important ingredient to that velocity. But as you rightly point out, the personalized marketing is working, and we are certainly focused on making sure that we are driving additional registrations as well as reservations through a more personalized approach. And then the third thing I would highlight is that we really have been making some nice improvements to create a much more seamless experience. And so we're seeing nice adoption of both our web and mobile platforms that are also driving Instant Book, which allows the end user to secure care instantly. And so within that context, we're seeing people, individual users, have the ability to know that they have confirmed care, and therefore, one, feel more confident in our service, and then two, have fewer cancellations of care because they've gotten it instantaneously. So I think it's a combination of those three elements that are really driving the nice success that we're seeing in our backup line of service.

Okay. And then just so we can maybe think of long-term capital allocation options, roughly how big is PME in terms of number of centers? And is this family-owned? Is it private equity-owned? Anything you could help us with there?

Yeah, so it's a family-owned business. They are order magnitude $50 million of revenue. So it's a modest business but long established. So it's been in operation for 25-plus years at this point. So we characterize it as a modest investment, and it is that. And so I think from a capital allocation, it's not something that's absorbing much of our free cash flow.

Got it. And then just last, on the new center capital, roughly what is the split between employer-sponsored and lease consortium?

So that is basically all lease consortium centers. We don't really put capital in our client-sponsored centers. So The average range of investment for new centers that we would be opening is between $2.5 million to $3.5 million of capital. And we also, to the extent that we have any pre-opening spend, that would be captured there for the following year to open.

Thank you. Thank you.

Your next question comes from Jeff Silver with BMO Capital Markets. Please go ahead.

Thanks so much. I wanted to ask about some of the labor issues going on. We see many states and municipalities raise minimum wage effective July 1st. I know you pay more than minimum wage, but are you seeing that floor being lifted, kind of pressuring wages, and is it getting more difficult to pass those through to your clients? Thanks.

Yeah, so I think the reality for us is that, as you say, we're not a minimum wage payer per se, but certainly as that floor increases, we are certainly responsive to the marketplace and making sure that we continue to lead the market as it relates to wages. That said, we have always been and continue to be very thoughtful and planful about the tuitions and still see a strong ability, as we always have, to continue to pass along those wage increases, even in places where they may be larger than typical, onto those tuitions. And so we feel really good about our ability to continue to outpace the wage increases that we are paying by the tuition fee increases that we are passing along to families.

Okay, great. And Elizabeth, I've got one for you. Is it possible to give us a little bit more color how you got to the 85, 87 cents adjusted EPS estimate for next quarter, or the current quarter. Thanks.

I'm not sure I understand what you mean by how we got there. There's a table.

Can you give us some guidance on margins and some of the below line items, if possible?

We don't typically allocate it out by line item like that. We do have a reconciliation to the GAAP guidance that's in the earnings release. I think broad framing around the operating margin performance would be consistent with what we've seen in the first part of the year, and I gave you guidance on interest and tax rates, so I think they're pretty much in there.

Okay, appreciate it. Thanks.

Thank you.

There are no further questions at this time. I'd now like to turn the floor back over to Elizabeth for closing comments. All right.

Thank you very much. We appreciate everyone joining us on the call. Thank you for the thoughtful questions and wishing everyone a good evening. Take care.

We'll see you on the road.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.