Bright Horizons Family Solutions Inc (BFAM) 2018 Q1 法說會逐字稿

Greetings, and welcome to Bright Horizons Family Solutions First Quarter 2018 Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Stephen Kramer, Chief Executive Officer. Thank you. You may begin.

Thanks, Sherry, and hello to everyone on the call today. With me on the call are Dave Lissy, Executive Chair; and Elizabeth Boland, our Chief Financial Officer, who'll go through a few administrative items before I kick off the call. Elizabeth?

Hi, everybody, and thanks from me too for joining us today. For reference, this call is being webcast and the earnings release that we issued after the market closed today as well as a recording of this call are or will be available under the Investor Relations section of our website at brighthorizons.com.

Some of the information we're providing today incorporates forward-looking statements, including those addressing our operating strategy and financial outlook for Q2 and the full year 2018, our expectations for revenue growth, operating margins, business segment contributions, growth plans, center additions and closures, capital investments, interest expense, FX rates, tax rates, adjusted net income and EPS and cash flow.

Forward-looking statements inherently involve risks and uncertainties that may cause actual operating and financial results to differ materially. These risks and uncertainties include those that are described in the Risk Factors of our 10-K and in other SEC filings. 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.

Lastly, the non-GAAP financial measures that we discuss are detailed and reconciled to their GAAP counterparts in our press release and will also be included in our Form 10-Q, which will be available under the Investor Relations section of our website, once we have filed that with the SEC.

So now I'll turn it back over to Stephen for the review and update on the business.

Thanks, Elizabeth. On today's call, I'll review our financial and operating results for the first quarter and provide an update on our growth outlook for 2018. Elizabeth will then follow with a more detailed review with the numbers before we open it up for all of your questions.

We're really pleased with our strong start to the year with solid contributions from each of our 3 lines of business. Revenue grew more than $41 million or 10% to $464 million and adjusted earnings per share of $0.72 increased 18% from last year.

In our Full Service center segment, revenue grew more than 9% in the quarter and we added 15 centers, including new client centers for Houston Methodist Hospital and Premier law firm Cravath, Swaine & Moore, along with 2 multi-center tuck-in acquisitions. New client launches, expanded utilization and rate increases, drove revenue increases of 9% in our backup division and 26% in our Educational Advisory segment for the quarter.

Recent new client launches for these segments include Sprint, Volkswagen Group, Emory Healthcare and Santander. As we have discussed on prior calls, the timing of when new clients launch their service as well as utilization levels, can each contribute to some variability in the quarter-to-quarter growth rates. That said, we are pleased to be tracking well against our 2018 top line growth targets of 10% to 12% for backup and approximately 20% for our Ed advisory services.

Following on from the solid top line growth, we also continue to deliver strong and consistent operating results across the business while making important investments to support further growth and operating efficiency. We are therefore on track to regain operating margin leverage in the range of 50 to 100 basis points for the full year 2018. On that topic, let me take a minute to give you an update on technology and marketing investments that we've been making. The goal of these investments in people and systems are to enhance our customers' user experience, to build utilization of our services within our clients workforces, and over time, to deliver more efficient and automated support services.

User feedback has been especially strong about the service delivery enhancements to our backup care operating system and mobile app. On the Ed advisory side of our business, we launched the first mobile app in our industry to rave reviews. We've also had good success piloting marketing journeys for backup users focused on engaging registered users to book additional sessions of backup care.

While we are making IT investments in all 3 of our operating segments, there is more of an impact in backup and Ed advisory due to the technology backbone of their respective service delivery systems.

Turning to our newer lease/consortium centers strategy, we have now opened 74 of these centers in select urban settings where we see a concentrated population of our targeted demographic, limited supply of high-quality child care and strong opportunities to meet the needs of our client partners in these locations. While we are set to open another cohort of [Audio Gap] fully ramped centers that are contributing at mature operating levels. As a result, the margin these centers collectively contributing is beginning to shift from a slight headwind in the first part of the year to a modest contributor in 2018 as a whole. And we expect the headwind to continue to naturally diminish as more classes ramp to maturity.

We continue to be very excited about the significant value creation opportunity in this group of centers and have dedicated operating and marketing resources to deliver these results. As we approach the midpoint of 2018, we do so with good momentum across all aspects of our business. Our growth strategy continues to be focused on organic as well as acquisition growth and leveraging the breadth of our existing client base to cross-sell our additional value-added services.

Our sales pipeline in each of our services remains strong with interest across industries and with both new and existing clients. All of this puts us in a solid position to achieve our organic growth plan in 2018.

On the acquisition front, we are pleased to have completed 2 tuck-in acquisitions in the first quarter, 1 in the U.S. and 1 in the Netherlands. As we have talked about, we continue to pursue opportunities that range in scale, both here in the U.S. and abroad and the recently completed deals reflect that strategy in action. Our pipeline remains strong with a good mix of smaller networks and single center opportunities both here in the U.S. and in Europe. And with the visibility we have now, we continue to expect acquisitions to be a key contributor to our forward growth plan.

Before I wrap up, I want to extend my congratulations to each and every member of the Bright Horizons Family. We have recently been recognized in our 3 major geographies as a great place to work, specifically in the 2 locations of our U.S. support offices, Massachusetts and Colorado as well as a Great Place to Work in the U.K. and in the Netherlands.

So now to update you on our outlook for the remainder of the year. We are reiterating full year 2018 guidance targeting revenue growth in the range of 8% to 10% and leveraged operating performance to drive adjusted EPS growth in the range of 18% over 2017 or $3.12 to $3.16 per share.

With that, Elizabeth can review the numbers in more detail, and I'll be back with you during Q&A.

Thank you, Stephen. So just recapping the headlines for the quarter, overall revenue was up 10%, $41.5 million in the quarter. On a segment basis, the backup division expanded $4 million on the top line or 9% and Ed advisory services was up more than $3 million or 26%, primarily from new client launches and expanded utilization by our existing client base.

The $34 million increase in full service center revenue was driven by rate increases, enrollment gains, contributions from newer centers and positive FX.

In Q1, gross profit increased $9 million to $114 million or 24.5% of revenue and adjusted operating income was up $4 million to $56 million, which translated to 12% of revenue. We generated approximately 10% operating margin in our full service segment and 26% in both backup and Ed advisory in this past quarter.

In full service, the gains from enrollment growth in our mature and ramping centers, contributions from new and acquired centers and price increases are partially offset by the mix of centers in the overall portfolio. Also, as previously discussed, operating margins in backup and Ed advisory can vary from quarter-to-quarter based on the timing of new client launches and service utilization levels. Also, we continue to absorb the near term effects of the investments in technology and people, to enhance the user experience and to expand consumption of our services as well as increase the efficiency of our ultimate service delivery. And that is also reflected in slightly lower operating margins this quarter.

As we move through 2018, we expect to gradually regain operating margin leverage and to be able to generate 50 to 100 bps of improvement for the year. In the first quarter of 2018, overhead was approximately 10.8% of revenue, down 10 basis points from 2017. In this arena, particularly, we've been able to regain modest overhead leverage now that the integration of the Asquith acquisition is complete and we're starting to lap the incremental spending on the technology and marketing that we've been discussing.

Interest expense of $11.5 million in Q1 of '18 was up $700,000 over 2017 as incremental borrowings that financed the Asquith acquisition and share repurchases were partially offset by lower interest rates. Our current borrowing cost approximates 4% with $500 million of our term loans, which is about half fixed within an interest rate swap.

We ended the quarter at 3.5x net debt-to-EBITDA. Our estimate for the 2018 structural tax rate on adjusted net income approximates 23%. This includes the favorable effects of the lower federal rate offset by a less benefit from stock option exercises than we realized in 2017.

In Q1 of '18, we also generated operating cash flow of $106 million, similar to what we reported for Q1 of '17. Our improved operating performance was offset by certain working capital payments, including prepaids and income taxes, which generated some timing variability in the working capital in the quarter in relation to historical trends. As part of our capital allocation strategy, we also continued to invest in growth through new center investments and acquisitions, as Stephen discussed, and have also continued our share repurchase program. We've acquired a total of 840,000 shares in the first quarter of 2018.

At March 31, we operated 1,051 centers with capacity to serve over 117,000 children and we serve more than 1,100 clients across all of our service lines, full service, backup and Ed advisory.

Adding to the guidance headlines that Stephen touched on earlier, our outlook for 2018 now anticipates top line growth in the range of 8% to 10% over 2017, including low-double digit revenue gains in our backup division, 10% to 12% for the full year, and roughly 20% growth in our Ed advisory services.

In our full service segment, we're planning to add approximately 55 to 60 new centers in 2017, including organic, new and acquired centers. Our outlook also contemplates closing approximately 25 to 30 centers, maintaining the discipline we have established over the last several years.

On the operating side, for 2018, we expect to continue to gain approximately 1% to 2% from enrollment in our ramping and mature centers and we estimate price increases averaging 3.5% to 4% across the P&L center network, while maintaining a 1% spread between price and our center cost increases. All these elements contribute to improved operating performance. And as we've mentioned, we project operating leverage of 50 to 100 bps in 2018 as the factors mitigating margin expansion in 2017 diminish over the course of the year.

Some other key metrics for the full year of 2018, we estimate amortization in the range of $32 million to $33 million, depreciation of around $70 million and stock compensation of $14 million to $14.5 million. Based on our outstanding borrowings and estimates of additional interest rate increases in 2018, we're projecting interest expense of approximately $50 million for the year.

As previously reviewed, the structural tax rate is expected to approximate 23% in 2018, the same rate that we applied in Q1. Weighted average shares outstanding are projected to be 59 million shares for the year.

On the cash flow side, we expect to generate approximately $220 million to $230 million of free cash flow with $260 million to $270 million of cash flow from operations offset by a $45 million or so of estimated maintenance capital spending. We're also projecting that we'll invest $45 million to $50 million in new center capital for centers that are opening this year and in early 2019.

The combination of all these factors lead to our projection that we will generate adjusted net income of $183 million to $186 million and adjusted EPS growth of approximately 16% to 18% in 2018 or $3.12 to $3.16 a share.

Looking specifically to Q2 of '18, we're projecting 8% to 10% top line growth and our outlook for adjusted net income is in the range of $49 million to $51 million with adjusted EPS in the range of $0.84 to $0.86 a share.

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

(Operator Instructions) Our first question is from Andrew Steinerman with JP Morgan.

Andrew, are ready to ask your question? Mr. Steinerman? We will move on to the next question, that would be Jeff Meuler with Robert W. Baird & Co.

Nick Nikitas on for Jeff. Stephen, in your remarks, you mentioned the solid new business pipeline you guys are seeing. Is there any change or improvement post corporate tax reform? Or would you kind of characterize that as largely kind of similar situation with what are still pretty favorable selling conditions?

Yes, I mean, what I would say is it's more of the latter. So obviously, on the margin, organizations have contemplated what to do with their tax reform dollars. And so, if there were any segment that we see that has shown the best benefit from that, it would be in our educational advisory area, where employers -- certain employers have come out and stated that they want to invest more in their tuition assistance programs. That said, overall, we just see favorable selling environments based on the economic conditions that we currently find ourselves. So that's really where I would focus. The attention is much more around the current economic conditions as opposed to very specifically around the tax reform.

Okay. That make sense. Nice to see the positive feedback on the IT investments you guys are making. To date, has that largely just been on a customer experience perspective? Or have you guys started to see any increase in the usage rates or other areas where it's flow through?

So we survey individual users after each use and so that's when we've been really able to most pick up the feedback. And I think we've seen a small improvement as it relates to some reuse rates. But again, what I would say is, the majority of the feedback we're receiving both on the backup side and at Ed advisory, is really in terms of user experience. We expect longer term that user experience should translate into more use. But today, it's really focusing on just a very positive experience, and clearly, that positive experience is being projected not only to us but also to our client partners, which again in longer term can only be positive.

Yes, make sense. Just one last one, Elizabeth, on the full service Q1 growth, could you break out the FX and M&A components?

Sure. So just bear with me 1 second. So the contributions from acquisitions was a little over 1.5%, FX was about 2.5%.

Our next question is from George Tong with Goldman Sachs.

Can you discuss the margin progress of your newer lease/consortium centers? And when you expect the overall group of centers to be margin accretive as the successive classes mature?

Sure. So just to sort of reset the table a bit on this, we have -- as Stephen mentioned, we have now 74 centers in this newer grouping of lease/consortium centers that we've opened since the beginning of 2013. That cohort of centers along with the others that we expect to open this year are generating in the neighborhood of $150 million, $160 million of revenue we expect in 2018, it was about $120 million last year. And so we've got good growth in each of the cohorts. These centers were positive in 2017. So they're margin positive in the whole as a class, but they are, as you mentioned, a headwind to margin improvement because of the relative scale of that revenue to the amount of margin dollars. So what we would expect to see is that, that margin continued to improve from the mid- to high single digits to continue to gain a bit on that and to be -- it's a slight headwind in the first part of this year, similar to what we had talked about before 10, 15 basis points or so, but becoming somewhat positive to overall margin contribution by the end of the year in the range of that same number, positive 10, 15 basis points or so but that's a sort of midyear inflection point.

Got it. Very helpful. Secondly, you touched a little bit on your pipeline performance. Can you elaborate on how your sales pipeline is building from both your new and existing clients and provide an update on your cross-selling initiatives?

Absolutely, happy to. So if we take a step back, as I mentioned, we have a good pipeline both from new and existing clients. And what's exciting about the pipeline is that it's really agnostic as it relates to industries and geography. So we see a strong pipeline across the country as well as in all of the major industries. When we think about the cross-selling efforts, I think, we've been particularly pleased to see the good percentage of the overall pipeline is growing into our existing accounts. So when you think about at this point, 20% of our clients offering more than 1 service, we are definitely seeing the number of those clients go up despite the fact that, again, we aren't seeing great movement on the 20% because we continue to bring in new clients, who on average are purchasing 1 service to start. So again, I think, we've seen good momentum of the number of clients growing that have more than 1 service, and then, ultimately, the overall client base continuing to grow as well.

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

It's Henry Chien calling for Jeff. Stephen, I was wondering if you could comment a bit on how the acquisition landscape is shaping up? Whether it's just -- are you seeing a good deal flow in terms of tuck-in acquisitions or any markets that look attractive to you?

Yes. So obviously, we started the year well, right? So we had an acquisition here in the U.S. and we had an acquisition in the Netherlands. They were very much prototypical for us as it relates to good, small groups, high-quality in geographic areas that make sense with nice financial profiles. And we continue to see good pipeline as we look into the future of those kinds of deals. And as you know, acquisitions are lumpy, and so, they will come in as they come in, but certainly, our team here in the U.S. as well as in the U.K. and in the Netherlands continues to see good proactive efforts of reaching out to owners, having good conversations, and ultimately, we have good visibility into some nice small groups into the future that we believe at some point we'll be able to close in the same way that we did here in the first quarter.

Got it. Okay. That's good to hear. And just on the -- just from the number side, it looks like gross margins came down a little bit. I was just curious if there is anything going on in the quarter, what sort of drove that?

Sorry, Henry, which margin were you talking about? Full service?

That's a -- yes, overall gross margin.

Overall gross margin. So what you're seeing I think is the sort of the continuation of the -- a couple of factors that we had talked about last year. We had the -- some incremental spending in some areas last year that wasn't all happening in Q1. So we're still lapping some of that initial investment cycle and a bit of headwind there from the lease/consortium centers that I was talking about a minute ago. Those are probably the primary factors. Otherwise, it's just a matter of mix. It can be slight mix on where we have a concentration of revenue in the U.K. and just a way that, that comes in the full service segment versus contributing from backup or Ed advisory. So those are the primary drivers.

Our next question is from Manav Patnaik with Barclays.

Elizabeth, my first question is -- so first question is just around some of the moving pieces to guidance maybe. So you brought back some shares, lowered your share counts. I think in the press release, your tax rate in one of the footnotes said you used 22% for the full year. I think you said 23% on the call. So I want to clarify that. But I guess what I was getting at is that 50 to 100 basis point of margin that's a big range for the year. So did some of that just get pushed out into '19 maybe to offset? Are you just taking a wait and see approach here?

Yes, I mean, I think, just touching on both of those, the tax rate just -- so the clarification there is that, the tax rate you've seen in the footnote is referring to the GAAP tax rate. The 23% is applied on our adjusted net income and adjusted EPS. So it's just a slightly higher rate than the GAAP rate. So sorry for that proximity that's confusing. With respect to the range on the operating margin improvement, I think, we've sort of alluded to the moving parts. And I think as we come into the year and Stephen said this, we feel -- continue to feel really good about the performance in this fairly large cohort of lease/consortium centers about the spending that we've done to support the continued growth in backup and Ed advisory and we just need to have that continue to come to fruition as the year goes along. So I think, the range is appropriate for where we are and what we're seeing on the possibility for the year and just needing to again, get everything put into place. But it's a matter I think of having the time to absorb what we've talked about for the last year or so.

And I guess, is there a progression that we should think about for the rest of the year? Or like was there anything in the quarter that either got delayed or surprised you relative to your guidance on the full service side maybe?

No, I mean, I think, we -- as we had come into the year and indicated that we'd be -- we're on this sort of on-ramp, if you will, with both lease/consortium centers and even any -- the groups that we've acquired over the last couple of years. And so, having -- coming into the year, we knew that we would be marching on the same path that we sort of ended in 2017 at. So I think that we're really well in the range of what we expect, how we expected to start the year off and that this would be a little bit back-end weighted just given the pieces that are contributing to the return and what we were lapping from '17.

Okay. And then just last one for me, for you Stephen, is the acquisition in Netherlands, I think, correct me if I'm wrong, at least I don't recall you doing one for some time there. With the U.S. kind of saturated, U.K. done, will that be an area we'll see more coming in? Can you just help us understand the pipeline there?

Yes, sure. So first, what I would say is we have a strong pipeline in each of the 3 geographies. And what I really like about our acquisition pipeline as well as how we've been executing is that we have a really good track record and a good pipeline in each of the geographies. So it is certainly not a good assertion that the U.S. is drying up in terms of pipeline. I think we continue to see really good deals as was demonstrated in the first quarter this year. And in the Netherlands we acquired last year, we've acquired again this year. And so I think you will see us really moving between geographies and taking the best opportunities out of the market as we see them. And so, our teams are really active in each of the 3. And I think your expectation should be that you'll continue to see us execute across all 3.

(Operator Instructions) Our next question is from Hamzah Mazari from Macquarie Group.

This is Kayvon Rahbar. I'm filling in for Hamzah. Can you talk how much of your business is directly levered to the current U.S. tuition reimbursement spend? How much your forecast are going forward?

So in the Ed -- so the Ed advisory business, last year, we ended just under $60 million and as we mentioned, have about 20% growth factor on that segment. The lion’s share of that is our EdAssist business, which is in the, both advising and advising to adult learners and the tuition reimbursement side of the business. So I think if I'm understanding the question right, we'd be expecting to grow that by 20%. It is a -- the tuition spend itself in the sort of global marketplace is substantially higher. This is just a fee that we take for doing the administration that we would be growing at that level, but tuition reimbursement spending continues to be strong in the general industry. We estimate that market in the range of $15 billion to $18 billion or so of annual spend and we take -- as I say, we take an administrative fee on that level of spending.

And the only thing I would add just to be clear is that -- those dollars that Elizabeth is alluding to get invested are employer dollars, right? This is not a market that is driven by the government other than the fact that there is obviously a tax incentive up to $5250 for -- per employee from employers to support tuition assistance. I'd say, the other dimension that's probably important to point out that you may or may not know is the vast majority of that market today, employers are actually administering their tuition assistance programs themselves. So we're really convincing employers who currently "self-operate" these programs to outsource them to us so that we can ultimately more strategically manage them and support their employees to upskill the workforce, and ultimately, get to a place where their dollars are better spent than they are when they self-manage.

All right. That's very helpful. And then another question unrelated and I was taking notes, so forgive me if this is already asked. But how should we think about free cash flow conversion, free cash flow EBITDA or net income, however you define it going forward? How should we be thinking about that?

So we were estimating free cash flow. So we define it as cash flow from ops after maintenance capital. So we're estimating $220 million to $230 million this year. And our expectation in terms of a growth rate that, that would continue to grow similarly to our EBITDA. So it would be in the -- if our top line growth is 8% to 10% and we're leveraging that, so a mid-teens growth rate on our cash flow as well.

Great. Well, thank you very much for participating in our call this afternoon and we'll look forward to seeing you all out on the road.

Thanks everybody. Have a good night.

Good night.

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