Bright Horizons Family Solutions Inc (BFAM) 2022 Q3 法說會逐字稿

Greetings, and welcome to the Bright Horizons Family Solutions Third Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Michael Flanagan, Senior Director of Investor Relations. Thank you, Michael. You may begin.

Thank you, Paul, and hello to everyone on the call. With me here are Stephen Kramer, our Chief Executive Officer; and Elizabeth Boland, our Chief Financial Officer. I'll turn the call over to Stephen after covering a few administrative matters. Today's call is being webcast, and a recording will be available under the Investor Relations section of our website, brighthorizons.com.

As a reminder to our participants, any forward-looking statements made on this call, including those regarding future business and financial performance, including the impact of acquisitions and COVID-19 on our operations, 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 are described in detail in our 2021 Form 10-K and other SEC filings. Any forward-looking statement speaks only as of the date on which it is 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 under -- which is available under the IR section of our website.

Stephen will now take us through the review and update of the business.

Thanks, Mike. Hello to everyone on the call, and thank you for joining us this evening. I hope that you and your families are doing well. I'll start tonight with a review of our third quarter results and provide an update on the business and outlook for the year. Elizabeth will follow with a more detailed review of the numbers before we open it up for your questions.

First, to recap the head line numbers for the third quarter. Revenue in the quarter increased 17% to $540 million, with adjusted net income of $38 million and adjusted EPS of $0.66. In our full-service childcare segment, revenue increased 14% in the third quarter to $381 million. We added 4 organic centers, including 1 for our new client, Kwik Trip, and we completed the acquisition of 75 centers in Australia. We also reopened 4 of our temporarily closed centers in Q3, ending the quarter with 99% of 1,081 centers opened.

Across our portfolio of like-for-like centers, we saw mid-single-digit year-over-year enrollment growth in Q3. In the U.S., our centers located in the largest metro areas continue to progress their enrollment recovery, with New York City, San Francisco and the Bay Area, Los Angeles and Atlanta showing notably strong year-over-year enrollment gains. Our higher ed, health care and industrial clients that represent approximately 60% of our client center portfolio continue to show the highest occupancy levels, while our tech and consumer client centers experienced the fastest enrollment growth over the prior year.

In terms of age mix, infant and toddler enrollment grew 8% over the prior year, more than double the rate of our preschool, despite the more acute staffing challenges in these younger age classrooms due to tighter title -- teacher-to-child ratios. While staffing continues to constrain enrollment in most geographies, we saw incremental progress on the retention and recruiting from this past quarter. Our recent investments in teacher compensation have had an impact on retention, and we continue to see greater interest in job seekers.

Taken together, this has resulted in continued improvement in net hiring. Importantly, the gains made in overall staffing levels is enabling center directors to spend less time covering classroom hours and more time on traditional leadership activities, including engaging with prospective families through tourism visits. These marketing activities, which had been severely curtailed during the pandemic, are helping us rebuild the enrollment pipeline to drive all classrooms back toward pre-pandemic occupancy levels.

Outside the U.S., enrollment trends were missed. In the U.K. and the Netherlands, growth was muted as the labor market challenges continue to restrict our ability to serve all of the enrollment demand that we have. We have several initiatives underway to drive recruitment in the face of a market that remains very challenging in the availability of qualified classroom staff. In addition to stalling of our enrollment growth, the other short-term impact of this is higher labor costs, given a greater reliance on agency staff to augment directly employed teachers, which comes at a cost premium.

In Australia, where we closed on the Only About Children acquisition on July 1, we are pleased with this initial quarter's performance. Specifically, enrollment was in line with our expectations, even while Australian operations continue to experience similar labor dynamics that we see across our global center operations.

Let me now turn to back-up care, which delivered exceptional results this quarter. Revenue increased 30% over the prior year to $129 million, outpacing expectations on strong yields in the third quarter. We also continued to see good new client success, with Q3 launches for Hard Rock International, Leader Corporation, Lucid Group and Premier Health Partners, to name a few.

As we spoke about last quarter, we were encouraged to see the record use in June, with that momentum continuing throughout the third quarter. We saw use across all of our care types resulting in our highest revenue quarter in our back-up segment history. Of particular note was the contribution of Steve & Kate’s Camp, an acquisition that we made in 2021. Under our ownership, we expanded their footprint, enabling us to increase our available back-up capacity and serve a growing number of families with school-age children.

Additionally, as part of our broader strategy to expand the utility of back-up care to a broader set of eligible client employees, we recently rolled out pet care as an additional use case. This follows the successful pilot with a third-party service provider over the last several months. Along with virtual tutoring and expanded school-age camp program, this is the latest example of our product innovation designed to drive greater adoption and frequency of use.

Moving on to our education advisory business, which delivered revenue growth of 14% to $31 million. We added several new clients in the quarter, including launches with AmerisourceBergen, Johns Hopkins and VMware. We continue to see solid use levels, with particularly notable participant growth at EdAssist in the quarter. I continue to be excited about our opportunity in workforce education as this remains an area of focus for employers looking to differentiate their employee value proposition and upskill employees into hard-to-fit roles.

Let me now briefly touch on our consolidated outlook for the rest of 2022. We remain on track to achieve $2 billion in revenue, and we are narrowing our adjusted EPS to a range of $2.60 to $2.65 per share or growth of 30% to 33% for the full year.

Before wrapping up, I want to take this opportunity to reflect on the signature employee recognition events that have been occurring across Bright Horizons over the last couple of months. This year, we had nearly 25,000 award nominations from clients, families and colleagues. And after 2 years of only virtual celebrations, it was great to celebrate with colleagues here in Newton 2 weeks ago. My heartfelt appreciation goes out to all of our employees who work tirelessly each day to make a difference in the lives of children, families, learners and workplaces.

So in closing, we are encouraged by the continued progress we are seeing across our business. We have met the challenges of the last 2-plus years head on by making investments in teachers' compensation and benefits, expanding recruiting work streams, further investing in technology to enable seamless client and end-user experiences and developing and launching new care types to reach a broader range of clients and employees whose need for childcare and family supports have never been greater.

I continue to believe that the strength of our client relationships and the unique employer sponsor business model, coupled with the acute need for our quality services, position us well to execute against our short- and long-term objectives, all while remaining steadfast in our focus on delivering the highest-quality care for education for children, family and clients.

With that, I'll turn the call over to Elizabeth, who will review the numbers in more detail, and I'll be back to you during Q&A.

Thanks, Stephen. Hello, everybody, and thanks for joining us tonight. I'll recap the quarter results and then provide some updated thoughts on the remainder of the year as well. For the third quarter, overall revenue increased 17% to $540 million. Adjusted operating income held steady at $46 million or 8% of revenue, while adjusted EBITDA of $81 million or 15% of revenue increased 2% over the prior year. In the third quarter, we added 79 new centers, reopened 4 centers that had been temporarily closed and permanently closed 12 centers, thereby ending the quarter with 1,081 centers.

Our full-service revenue increased $47 million to $381 million in Q3 or 14% over the prior year. Revenue gains were driven by increased enrollment in pricing, which contributed approximately 10% to revenue expansion as well as by the addition of Only About Children, which we acquired effective July 1 and which contributed $37 million in the quarter. Enrollment in our centers opened for more than 1 year increased mid-single digits, with 5% enrollment growth in the U.S. And our European operations were narrowly positive, less than 1%, reflecting the effects of having to limit enrollment due to constrained availability of staff.

Our occupancy levels averaged 55% to 60% in Q3 as the typical preschool enrollment seasonality over the summer months results in lower occupancy sequentially from Q2 to Q3. 2 notable factors were 7% headwinds to this growth. First, the strengthening dollar resulted in a $19 million year-over-year headwind in Q3. And second, ARPA support for childcare services, support we received on clients' behalf, reduced client subsidy revenue by $10 million, which was an incremental $6 million compared to the prior year.

Adjusted operating income for the full-service segment contracted $13 million to a loss of $3 million in Q3. The third quarter is historically our weakest quarter from an operating income standpoint, mainly driven by the preschool enrollment seasonality over the summer months. As we've seen throughout the year, ARPA government funding directed in the childcare sector continues to provide support to the inefficient cost structure during this ramping period. We received $14 million of this support in Q3, up slightly from the $12 million we received last year.

Looking at the components of operating income. In this most recent quarter, it was impacted by higher labor costs, including investments in teacher compensation, which were effective mid-quarter and an outside spend on agency staffing internationally. In addition, as center directors are covering fewer staff vacancies, as has been the case over the last 2 years, they have been able to pivot back to leading center operations and enrollment initiatives. This is a key driver to rebuilding the enrollment pipeline and converting new enrollments for the future.

Back-up care revenue growth increased 30% in the third quarter with total revenue of $129 million. As Stephen mentioned, we're particularly pleased with the strength of use growth through the quarter and the resulting operating performance, which delivered $40 million of operating income or 31% of revenue in the quarter. Our educational advising segment delivered growth of 14% on contributions from new client launches, the expanded use in EdAssist, College Coach admissions and financing advising and in our Sittercity marketplace.

As we've spoken about in the past, education advisory is in an earlier growth stage, and the associated innovation carry out the required investments to execute against a growing and evolving market opportunity. This can result in variability in the operating performance quarter-to-quarter as the businesses invest and grow and scale. Illustrating this, while additional investments in technology and customer acquisition within these businesses dampened operating profit earlier this year, this most recent quarter reflects solid operating profit growth and margins of 27%.

Turning now to a few other earnings factors. Reported interest expense was $12 million in Q3, including $1.5 million related to the accreting interest on the $106 million deferred payment for Only About Children, which is payable at the end of 2023. Excluding this amount, which is added back in the non-GAAP adjustments, we expect interest to tick up to around $12 million -- $12 million plus in Q4 given the current rate environment. The structural tax rate on adjusted net income has also increased to 27% for 2022 compared to 22% in Q3 of 2021 on increasing taxable income and lower tax benefits from equity activity under ASU 2016-09.

Turning to the balance sheet and cash flow. Through September, we generated $131 million in cash from operations, made capital investments of $251 million, including a $206 million for the acquisition of OAC and executed share repurchases totaling $183 million. We ended the quarter at 3.5x net debt-to-EBITDA with $33 million -- $32 million of cash and debt of $1.1 billion.

Moving on to our outlook for the rest of 2022. Our updated guidance reflects the current operating trends and performance and includes a more significant foreign exchange headwinds, higher interest expense and higher tax rate expectations than previously estimated as well as the continued inflationary pressures that we've been seeing with labor, energy and food costs. In terms of top line, we expect 2022 revenue of $2 billion, which includes approximately $60 million year-over-year headwind from foreign exchange. This is approximately $15 million higher than we had previously estimated.

At the segment level, we are expecting full-service to grow roughly 15%, back-up care to grow in the range of 15% to 18% and ed advisory to increase between 8% and 12%. In terms of earnings, this will translate into adjusted EPS in the range of $2.60 to $2.65 for the full year 2022. This narrower range includes our updated estimates of the higher tax rate that I mentioned, 27%.

So with that, Paul, we are ready to go to Q&A.

(Operator Instructions) Our first question comes from George Tong with Goldman Sachs.

Based on your year-to-date revenue performance and your outlook for $2 billion in revenues in 2022, it would appear that you're guiding to 4Q revenue being slightly down from 3Q, down around 5% to 6%. And usually, 4Q revenue is up from 3Q. So can you confirm if that's the case? And if so, besides FX headwinds, are there any other factors that may cause 4Q revenues to be lower than 3Q?

So the foreign exchange is the main change. I think that you're seeing, George, in Q4. Sequentially, we do have back-up in its high watermark in Q3, so there's a little bit of a pullback that we would see in back-up given the 15% to 18% range that we've provided there, but those are really the only factors, I don't know if it's a downgrade. In our view, it's really the same range that we had provided with the adjacent FX.

Okay. Got it. That's helpful. And then secondly, could you tell us how much in government subsidies you recognized both on the revenue side and on the cost side and what the outlook is from here on out?

Yes. So I think I commented on that. In the P&L centers, we had $14 million coming through that was a cost offset in our cost-plus-type client center where we have an offset to the revenue that was around $10 million. And so that -- again, because it reduces the cost in a client center that reduces the amount of subsidy that the client needs to pay us. So it has that -- effect of it not really accruing to us. It accrues to the benefit of a client. So we think of the P&L impact is $14 million, and so that's the P&L effect.

For the rest of the year, we would be expecting that to correlate, that $14 million that we saw this quarter, to perhaps another $5 million to $10 million for the rest of the year. And from a client standpoint, it would be -- it's probably $4 million, $5 million or so that they offset client revenue, but similar proportion to what we saw in Q3.

Our next question is from Andrew Steinerman with JPMorgan.

Could you go over in the third quarter, what the organic constant currency revenue growth post closings were? And also, on a year-over-year basis, could you let us know what's implied in the fourth quarter, again, on organic constant currency post-closing basis?

So organic -- well, let me go back. I mentioned how much revenue contribution there was from Only About Children, Andrew, that was around $37 million, and we had another $3 million or so from other smaller tuck-in acquisitions. So a total of $40 million of the growth was inorganic. So the remainder constant currency, I think, would have to slightly be able to do the calculation here quickly, but I don't know...

Yes. No, FX was $19 million, both in full-service, around 6%. The ARPA -- the client ARPA that we received, the ARPA we should -- clients was another kind of 300 basis points or so. So organic constant currency within full-service was around 10% growth year-on-year.

Did you say 10%? I didn't hear you.

10%. Yes, full-service for about 10% constant currency organic.

Okay. And what's implied in the fourth quarter in terms of organic constant currency again on a post-closing basis?

Well, we have about another $20-or-so-plus million of FX headwind year-on-year. Only About Children, similar performance in the fourth quarter. And then another, Elizabeth said, $4 million to $5 million of ARPA that we would...

We can simple that out, Andrew, but it's probably close to that 8% to 10%.

Our next question comes from Manav Patnaik with Barclays.

You mentioned -- you gave a lot of, I think, statistics around infant and toddler growing 8%, twice preschool, et cetera. I was hoping you could just maybe, on a high level, just maybe help appreciate what the kind of quarterly improvements you're seeing in and how that ties in with what you're hearing from your clients in terms of what the return-to-office cadence looks like that should help you guys or not?

So Manav, do you mind just repeating the question? You were a little bit muffled.

Was it about (inaudible)?

Yes, just was the client -- you gave a bunch of different carve-outs on infant growth and preschool growth. And without having a base for it, I was just hoping you could filter it out for us in terms of what you hear -- really hearing from your clients in terms of the quarterly cadence of occupancy.

Well, maybe just I'll start here, Manav. Just on the -- when you talk about infant, preschool, we saw a different performance within that -- those 2 segments within the third quarter. The infant and toddlers grew in the high single-digit range year-on-year. And moment there were preschool was in the low single-digit range. So we saw better growth in that cohort, which has been more staff constrained more recently in the last year or so given the tighter teacher-to-child ratios within those classrooms. So I think we were encouraged by that. It should bode well as we think about building that pipeline of enrollment, particularly that will feed into these older classrooms over the next 6, 12, 18, 24 months. So that's what some of the different performance we saw within those 2 age groups.

And then the question was about clients and client sentiment, Manav, which I believe was the second part of your question. We continue to have really positive sentiment from our existing client base around the sectors and the importance of those centers to their employees and specifically to some of their return-to-office plans.

In addition to that, certainly, we have seen a very strong pipeline as it relates to prospective clients being interested in investing in childcare, very specifically looking at new centers as well as client -- or prospective clients who may self-operate their own centers in the form of health care or higher ed, who have historically many of them have self-operated, being interested in the potential of transitioning those centers of management. And so I think, in all of those cases, we are very well positioned to continue to partner with clients on this really important topic to them and to their employees.

Got it. And Elizabeth, could you just help us with how we should think about the margins in the fourth quarter, especially for full-service and the other ones seem perhaps easier?

Yes. The performance which were full-service this quarter was, as I talked about, constrained by a number of the labor impacts. And so we would expect those to be continuing in the fourth quarter to some degree, so that full-service -- that the full-service segment performance should be close to breakeven around that range and perhaps plus/minus, but close to that similar, hopefully, a bit improved, but that's around where we are in this quarter. So we would expect that to be similar and a little bit of uptick in enrollment through the rest of the year but modest.

And back-up performance, as you might know from the history of the way that back-up performs, sequentially or just overall for the year, we have a high watermark in terms of revenue and had solid margins this quarter. Our long-term view on back-up would be 25% to 30% operating margins. But in Q4, it often is a bit higher. And so given the way that utilization gets consumed, people have banks of use that they can use it or lose it. And so there tends to be some opportunity there with our clients. And so we would look to margins to be closer to 35%, maybe as high as 40% in Q4. And then the advising business is fairly steady. As we've said, 25% to 30% is where we delivered this quarter so could be to the higher end of that in Q4 as well.

Our next question is from Jeff Silber with BMO Capital Markets.

I just want to confirm something. Did you say that third quarter full-service center utilization was 55% to 60%? And then also, what would be implied for that specific metric in the guidance for the fourth?

So yes, I did. The overall average is 55% to 60% as we sort of came through the seasonality. We would expect it to be lifting up a couple of percentage points on average for the rest of the year. And so that's, as I said, a little bit of uptick now that we're through the fall cycling and re-enrollment. But the bigger list would be early in 2023 as we get into that but more of a high water mark is Q1, Q2.

Okay. That's helpful. And I know you go through your center footprint and you continuously call the number of centers. I think you said it was 12 this past quarter. But are there certain geographies where maybe some centers the utilization is so low that it might pay to be a little bit more aggressive in either closing or consolidating? Is that something you might be considering?

Well, I mean, it's an important question, Jeff, because we have, obviously, over the last couple of years, as COVID took hold, and we had to take a very hard look at the portfolio and where we were seeing demand coming back as the centers reopened. We do have -- in terms of trying to stratify, if you will, how the portfolio is operating, we have some very, very high performers. In fact, 25% of the portfolio is operating. I think we talked about last time, just maybe to clarify that, we talked last time about -- our range was -- our average range was 55% to 65% enrolled. And we noted that about half of the portfolio was above that 65% threshold.

Just setting that previous commentary to one side for a second, we have a target enrollment level that we consider mature centers to be aiming for 70% to 80% has been where we operate, and that's where we are targeting to get back to, if you will, from a post-COVID recovery. And so if we look at that 70% to 80% range, we actually have 25% of our portfolio is operating, in the third quarter, they're operating at around 80%. So we have good -- really strong performance sidelines, 1/4 of the portfolio is very, very well performing. Not all the way back in terms of margin delivery, but the margin as a percentage of revenue, even though the usage is back, the enrollment is strong, and we have -- we have 1 more cycle probably of price-to-cost ratio to get back to our pre-COVID margin there, but very close on that piece.

But the underperformers, which is your question, about 20% -- so 25% is above, but 20% are actually very underperforming. So operating at less than 40% occupancy. And those are the ones that would be certainly on a strong watch list to be sure that the efforts that we have -- we are persisting with because we see some positive signs of enrollment or some staffing success driving enrollment. But those would be some that may be candidates for consolidation, closure potentially in the future. But we are still working to enroll in those centers because we believe in the locations broadly for that group of it's roughly 150 centers that are in that more significantly underperforming group. And with those, we see great opportunity. But as you say, we need to be disciplined as we always have been to potentially consolidate or close if necessary in the future.

Sorry. The only other fine point I'd put on that is we have centers in that third grouping, right, that are underperforming that are in the same geographies as ones that are in the middle group and in the top group. And so that gives us the confidence that, again, over time, as we continue to grow our staffing levels and continue to enroll that there is sightlines. So to answer your question very directly, we don't have a specific geography that we believe, ultimately, we are going to sort of [unmap], close out. Instead, we look, as we always do, center by center. But the nice thing is that we have good sightline in each of our major geographies to see performance, as Elizabeth said, that is in that top-performing category.

Our next question is from Toni Kaplan with Morgan Stanley.

I wanted to ask another question about the government subsidies. I believe a number of the large programs liquidate in '23. So just wanted to help understand the expectations of what this means for '23 year-over-year and maybe what a normal year for government subsidies are like maybe pre-COVID.

Sure. Thanks, Toni. So just to recap where we are this year, we are expecting essentially a positive income statement effect, if you will, of around $50 million to $60 million for government. I mean it's primarily ARPA funding that we are now in the midst of receiving that ARPA funding, as you suggest, is sunsetting in September of 2023 based on the current status of the regulation. So states still have money to distribute, quite considerable funds to distribute, but based on our sightlines on what we and where our footprint is and where we have applied for support there, we expect that 2023 could be half that. And to be -- TBD on whether that is better, but it's up to the states to decide. So certainly, we are looking ahead to a reduction in the amount of support that we've been able to receive this year looking ahead to '23.

Prior to COVID, we have a very small footprint of families who are receiving support through various government programs. And so while maybe 0.5% or 1% of our revenue in pre-COVID environment that we had such support in the U.S. Of course, in our international operations, it is a -- their national programs and so families access the support for the 3- to 5-year-olds in the U.K. and for all families in the Netherlands and Australia. So those support systems are just eligible for working adults and working parents. And so those -- in terms of their support factor, it's really built into the tuition structure.

Terrific. And just as a follow-up, I know you mentioned the utilization, 55% to 60%. I think previously it was 55% to 65%. And so -- is it the backfill issue that is really driving this down? Is it the staffing issues that have been consistently like leading to an inability to open more classrooms? Like I guess what's sort of the main drivers of the sort of decrease?

Yes, it's actually a seasonal change. The sequential decline is quite consistent with where we've seen there's growth over last year, so a year-over-year increase. A sequential change from Q2 to Q3 is based on the preschool cycling out into elementary school. And so that's why we cited the gain in enrollment is higher in our infants and toddler groups and a little bit lower in the preschool group as that net gain in preschoolers is about half, 3%, 4%, whereas infants and toddler growth is more like 7%, 8%, averaging out to around that mid-single digits.

So the change from 55% to 65%, on average, is simply that sequential seasonality and not weakness, per se, from staffing. I think our staffing challenges are constraining the growth from being more than that. And so that's where we have been talking about the -- our investments in the wage construct, benefits construct in order to attract the staff and really take advantage of the demand that we have to move that group of centers that wasn't in the strongest-performing group that I mentioned that is an 80% enrolled or the weaker performing group that's under 40% enrolled. So to get that 40% to -- 70% group, if you will, up to its target, that's where we have the real opportunity.

Our next question comes from Faiza Alwy with Deutsche Bank.

So I was wondering if you could maybe indulge us a little bit in terms of how we should be thinking about 2023. Obviously, it's early, and I'm sure you haven't -- you're probably in the middle of your planning process. But how are you approaching 2023? What are some of the things that we should keep in mind as it relates to enrollment, pricing, wages, staffing? Sort of anything you'd like to address would be very helpful.

Sure. I'm happy to start, and Stephen can weigh in as well. So as we look ahead to 2023, right, we are in the throes of our planning process for that, and we will, of course, have more specific information to provide when we talk to you all next. But as we look at the events closing out 2022, we have been making progress, as we said, on the enrollment front. We've invested in our recruiting efforts, our teacher attraction, retention, marketing. We're investing in wages, et cetera. So we would expect pricing increases in our full-service business, certainly to see pricing increases above our historical average. So certainly, we haven't finalized this, but certainly would be looking to ranges in the -- at least the mid- to higher single digits, so 5% to 7%, knowing that we need to remain competitive and we're in a marketplace, and we are certainly aiming to get enrollment back as well as maintain the pricing that we believe are appropriate for the service we're delivering.

So pricing is around that. We would expect wage inflation to be ameliorating some, maybe reverting to a more typical range of around 3% to 4%, although our wage costs will be higher than that because we did make a substantial investment in compensation this summer and fall. And so the knock-on effect of that would be that the labor costs will likely be in more of the high single digits to 8% to 10% likely overall because of the -- that knock-on effect coupled with a more modest wage inflation. Other inflationary costs are coming through things like energy and some other consumer goods that we have, although those are smaller portions of our overall cost structure.

From our backup business standpoint, this year, we are looking at growth in the mid- to higher double digits, 15% to 18%. That has been a very strong year. We're coming off of the COVID lapping year effect. We have good strong client accounts that we can continue to build on. And so we would expect that to grow in the double digits, but probably more like low to mid-single digits. Again, we will refine as the year goes on, but that's what we're looking at probably from the back of business standpoint. And that's probably the array of broad-brush metrics of how we're looking at next year, but any thoughts on sort of client picture, Stephen?

Yes. Absolutely. Thank you. So I think that as we are heading into the final parts of this year moving into next, we continue to feel really good about our pipeline from a client perspective. That's both for new centers as well as for backup and ed advisory. I think that the core services that we are offering are very much in the interest of employers as they continue to see stressors as it relates to their own workforce and their own return-to-office plans.

I would say that, from a reception on our existing client base, what I would say is that, especially on the backup side of our business, use cases, new use cases are being adopted really well. And so when we think about the virtual tutoring getting implemented at, call it, 2/3 of our clients, pet care already being adopted by a good minority of the clients, I think that what we're showing is our ability to, through both centers, back-up care and through ed advisory to continue to extend across a broader set of life stages and career stages for our employees.

And then finally, we continue to do research among our parents that are users of our centers and continue to hear about the importance of health and safety as well as the importance to continuing to focus on socialization and education, given what disruption had occurred through the pandemic. So overall, feel really good going into 2023 as it relates to those who we serve.

That's very helpful. I guess just a follow-up question as it relates to full-service. Is it fair to say that from here the incremental enrollment is more -- is going to more come from filling the staffing gap as opposed to a different sort of more return-to-work and less of a hybrid arrangement and things like that? Is that a fair way to think about it?

Yes. I think that it is safe to say that, at this point in the cycle, staffing is a real constraint in our ability to serve increasing numbers of families. So it's fair to say that in more than half of our centers we have demand that outstrips our ability to actually service those interested families. I would say, in addition to that, we continue to, as Elizabeth alluded to earlier, we continue to work really hard to improve our retention rates, do things -- our staff retention rate, do things like our wage increases and other benefits enhancements and, at the same time, get really specific about improving our top of funnel for new recruits and then ultimately, streamline the process to hire.

So I would say that, yes, staffing is the larger part of the impediment in terms of our ability to grow enrollment. And at the same time, it is a -- and continues to be a major area of focus for us, where we believe we continue to make strides.

Great. If I may just ask one more quickly on just the margins on educational advisory. I know you've made some tech investments earlier in the year. Are those -- are you past those investments? Because I see a pretty big increase in margins this quarter? Like is this -- I know that your long term is 25% to 30% margins. Is that -- are we sort of past the investments? And is this sort of the new run rate?

Well, it is our -- that's in the range of what our long-term expectation of that segment would be, and we've cited 20% to 30%. I know that's a wide range when we cited 20% to 30% as a range for a technology backbone, less labor-intensive technology delivered service. But I think it's fair to say that, in a more emergent type of segment like the ed advising businesses all are, there are periodic and episodic investments that need to be made.

So I wouldn't say that the investments are in the rear view mirror, the early part of the year between some technologies, some enhanced -- the buildup of the -- some of the elements of the Sittercity marketplace, the ongoing investment in our EdAssist business, which is both doing advising for adult learners and administrative processing of the college work. It is an ongoing investment, and I think keeping up with the development and innovation in that sector will require ongoing investment. So I think we were just trying to point out why it might be lumpy. A couple of quarters may have some investment and then you may see the -- either the short-term payoff or a longer-term payoff strategy.

Our next question is from Jeff Meuler with Baird.

Question on full-service margin. So I hear you on seasonality and temp staffing cost. On the other side, you have the ARPA benefit. Is there anything else that's worth calling out and the one that would potentially come to mind for me, anything on the Australia acquisition? I understand you're excluding the transaction costs, but are there any like upfront cost, severance, it onboards at lower margins? There was acquired deferred revenue write-off from month push. Just anything else that would be unusual that's going into the back half margins?

Yes. It's a good question and not to -- I don't think we want to have to -- I don't want to sound like we're just giving a litany of things that could be a headwind, but there are. We did have some -- we have some integration costs with the [Only About Children] acquisition, which are not the transaction costs themselves, but just as you say, some costs of onboarding the team and whether it's onetime system conversions and things like that. But there's about $1 million, just under $1 million in the second half that would be affecting the margins, a little bit of that continuing next year, but would begin to abate as we complete the integration early in 2023.

The other thing I'd call out, Jeff, is that in the U.S., I think we've been experiencing, of course, some inflation, but the energy costs in the U.K. and then the ones have been particularly high. And they're smaller portions of our business, but they certainly are adding several million dollars to the second half of the year in terms of overall cost inflation that, that has -- had the opportunity to be both persisting and/or abating if things settle down a bit more in Europe. So that's another headwind, I guess, that I'd call out.

And then on back-up care, I get that the care-type expansion is broader than summer camps and the other areas are growth full. And I hear that the momentum in record usage for traditional folks services continuing. But just given the seasonality, can you quantify Steve & Kate's for us in the quarter and the year ago from a revenue perspective? And is that -- is there any tail of that into Q4? And is there any like outsized margin benefit from that business during Q3?

So we don't really tend to pull out to quantify the smaller groups. But I'd say that once you hit on an important element, which is Steve & Kate's Camp have a very high utilization over the summer. And the revenue actually falls away and they have intermittent camps, 4 different events for (inaudible) over the holidays and school vacation times, there are opportunities there, but it's not the same intensity as we experience over the summer. So they certainly contributed several million to the revenue growth in the quarter, but that would be much more dependent in Q4.

Okay. And then just last for me, can you just talk through balance sheet management plans, just how you're thinking about steady-state leverage currently, kind of managing fixed (inaudible) floating exposure, et cetera, given rising rates?

Sure. So we had obviously done significant investments in the third quarter with the acquisition of OAC and also had some substantial share repurchases. We're about 3.5x of debt right now. And that's certainly a comfortable level for us given our EBITDA profile, et cetera, but we would be looking to sort of continue to grow into that at this point.

We are looking at -- we've always said that we'd go to the 2.5 to 3.5x with our general leverage target and including a significant acquisition of like OACs (inaudible) that is certainly something that is right in our strategy. And our debt is -- we are seeing some escalation to the interest cost, but we do have caps on our debt, 80% of it that is protecting us from the variability of interest rates. A portion of those caps roll off next fall, and then we had a sequential forward starting cap it tailed on after that. So we have -- our debt is essentially 80% to 90% covered and converted fixed with those caps in place and a little bit of variable rate...

Our next question is from Stephanie Moore with Jefferies.

This is Hans Hoffman in for Stephanie Moore. I was just wondering, outside of financial services and health care, are you guys seeing any verticals where employer-sponsored daycare is beginning to ramp, I guess, a bit more than you thought? And then just sort of what is the sales like looking there?

Yes. So when we think about industry verticals, I think we've shown really good success over the years across verticals. Certainly, in the current day, there's particular strength that we've announced over the last 18 months in health care and higher ed. But in addition to that, we certainly are seeing it in manufacturing and distribution as well, which are 2 industry verticals that historically were not as much a focus of our efforts. But again, I think, given the challenges that they see and the workforces that they are looking to attract and retain, on-site chapter centers have become a more attractive element.

So overall, in terms of the pipeline, we feel good about it. And as I mentioned earlier, we feel good about some new ground-up opportunity as well as the transition of management from some self-operated programs. So again, overall, we feel good about the pipeline. We feel good about the interest both inbound and us approaching. And so overall, going out of the year into next year, feeling good about the interest.

Got it. That's helpful. And then if you could just provide us with an update, I guess, how you're kind of thinking about capital allocation priorities?

Yes. So as I just said, we did some pretty significant capital investment in Q3 with our acquisition of Only About Children and about $180 million or so of share repurchases. So we are in an absorption digestion mode, certainly are continuing to look at smaller tuck-in acquisitions opportunities, and we'll continue to be judicious about those. But at this point, we are in a focus on growing enrollment and recovering in the primary base business.

We have a number of lease models that are in development. And so those are new center growth that's in the $35 million to $50 million of spend in the next 12 months period. And that's the primary focus of capital allocation at the moment, and we'll be paying down the revolver that we have outstanding. It's about $100 million or so, and that would be the near-term view.

Okay. Well, thank you all very much for joining us on the call this evening and wishing you a good evening.

Thanks, everyone. Take care.

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